-1-

Entrance of Cable TV Service Provider into Broadband Internet Service Market : Service Bundling and Role of Acces

s Charge

ByJae-Hyeon Ahn, Jungsuk Oh, Sunghee Shim

September, 2004

-2-

Contents

Ⅰ. Introduction research background and objectives

Ⅱ. The Model basic setting and variables definition

Ⅲ. Analysis

Ⅳ. Conclusions results, limitation & further study

-3-

I. Introduction

1. Research Background

2. Research Objectives

-4-

Convergence of Network and Service

Bundling and Tying of Telecommunications Service

Conflict with Incumbent Player with Essential Bottleneck Facilities

Access Charge Issue

Research Background

Broadband Internet Service Market

Incumbent(Bottleneck Facilities)

Cable TV Service Market

Entrant BundlingBundling

Ex. – Cable Service Provider (SO) & Telecommunications Service Provider (KT)

-5-

Modeling Competition in Broadband Internet Service Market

Incentives for Bundled Service Impact on Incumbent Player

Access Charge Level that Maximizes Social Welfare

Research Objectives

Broadband Internet Service Market

KT(possessing bottleneck facilities)

Cable TV Market

SO BundlingBundling

ModelingModeling

Analysis of Broadband Internet Market

Analysis of Social Welfare

Analysis of Broadband Internet Market

Analysis of Social Welfare

-6-

Ⅱ. The Model

1. Basic Setting

2. Variables Definition

-7-

The Model – basic setting

Difference from previous research models

BundlingBundling

One-Way-AccessOne-Way-Access

Previous Model

BundlingBundling

One-Way-AccessOne-Way-Access

The Model

+

Cable TV Broadband Internet

Cable TV Broadband Internet

Essential facilities of the Incumbent

Essential facilities of the Incumbent

-8-

The Model – basic setting

Firm 1, 2, Market 1, 2

Market 1 – Cable TV Service Market

- Monopolized by Firm 1

Market 2 – Broadband Internet Service Market

- Classical Hotelling Location Model (competition of firm 1, 2)

- Incumbent (firm 2) versus Entrant (firm 1)

- Incumbent owning bottleneck facilities for broadband Internet service provision

- Entrant paying access charge for using incumbent’s facilities

-9-

The Model – variables definition

Cable TV Market

Normalization of consumer population to 1

Two groups of consumers- Consumers with willingness to pay of VH - Consumers with willingness to pay of VL

CM1 : unit cost of Cable TV service

Assumption: -> firm 1 will set its price at VH

Broadband Internet Service Market

Heterogeneous preference for service- [0,1] ~ uniformly distributed in [0,1]

Firm 1 is located at 0 and firm2 at 1 Firm 2 is regulated on its access price level

Firm 2 is an incumbent and possesses first-mover advantage

1 1

1( ) ( )

2 H M L Mv c v c

-10-

The Model – variables definition

Variables definition

: Standal alone value (fixed value) of broadband Internet service

: General costs for broadband Internet service provision

: transportation cost : Incumbent advantage parameter : Prices of firm 1 and 2 : Access charge per unit demand : firm 2’s cost of managing and repairing its bottleneck facilities

Consumer’ net utility located at

- is a parameter representing for the incumbent’s advantage

1 2 1MU v tx p

2Mv

t

1 , 2p pa

2Mc

c

2 2 2(1 )MU v t x t p

[0,1]x

0,1

-11-

Ⅳ. Analysis

-12-

Analysis

1 2 22 (1 )Mp p v t

1 2 1 21 2

( ) ( )(1 ) (1 ),

2 2 2 2

p p p pd d

t t

2 1Mv p

2 2Mv t p

2 1Mv p

t

2 2{ (1 ) }Mv t p

t

2 1Mv tx p 2 2(1 )Mv t x t p

* 1 2( )(1 )

2 2

p px

t

0 1

Full Market Coverage

2Mv is sufficiently high that the market is fully covered

No Bundling Case

Bundling Case

Analytic Framework

Incentives for Service Bundling

The Effect on the Incumbent

Profit

Social Welfare Level

Role of Access Charge

-13-

Analysis

When firm 1 does not take bundling strategy

Profit maximization problem of firm 1 and 2

Equilibrium prices and profits

1 1

1 21 1 1 2

( )1 (1 )( ) ( )( )

2 2 2WOB

H M Mp p

p pMax Max v c p c a

t

2 2

1 2 1 22 2 2

( ) ( )(1 ) (1 )( )( ) ( )( )

2 2 2 2WOB

Mp p

p p p pMax Max p c c a c

t t

* *1 2 2 2,

3 3M M

t tp c t a p c t a

*1 1

1 1( )( ) ( )

3 2 6 2WOB

H M

tt v c

*2

1 1( )( ) ( )( )

3 2 6 2 6WOB t

a c t a c

-14-

Analysis

Profit functions

- Firm 1

- Optimal profit function independent of the level of access charge

- Firm 2

- Optimal profit as a increasing linear function of access charge

2*

1 1

{ (3 )} 1( )

18 2WOB

H M

tv c

t

2*

2

(3 )( )

18WOB t

a a c

a

-15-

Analysis

Firm 1’s broadband Internet demand having high reservation value in cable TV

market

L

VL Type Consumers

2 1( )WBM Lv p v

2 2WB

Mv t p

2 1( )WBM Lv tx p v

2 2(1 ) WBMv t x t p

0 1

1 2(( ) )1 (1 ){ }

2 2 2

WB WBH

H

p v p

t

1 2(( ) )1 1 (1 ){ }

2 2 2 2

WB WBH

H

p v p

t

1 2(( ) )1 (1 ){ }

2 2 2

WB WBL

L

p v p

t

1 2(( ) )1 1 (1 ){ }

2 2 2 2

WB WBL

L

p v p

t

2 1( )WBM Hv p v 2 2

WBMv t p

2 1( )WBM Hv tx p v

2 2(1 ) WBMv t x t p

VH Type Consumers

H0 1

Firm 2’s broadband Internet demand having high reservation value in cable TV

market

Firm 1’s broadband Internet demand having low reservation value in cable TV

market

Firm 2’s broadband Internet demand having low reservation value in cable TV

market

-16-

Analysis

When firm1 takes bundling strategy

Profit maximization problem of firm 1 and 2

- Firm 1

- Firm 2

1 1

1 2

1 1 1 2

1 1 2

(( ( )) )(1 ) 2( ){ }2 2

( ) (( ) )(1 ){ }

2 2 2

WB WB

WB WBH L

WB WBM M

p p

WB WBH M H

v vp p

Max Max p c c at

v c p v p

t

2 2

1 2

2 2 2

1 2

( )(( ) )(1 ) 2( ){ }

2 2( )

(( ) )(1 ) 2( ){ }2 2

WB WB

WB WBH L

WB WBM

p p

WB WBH L

v vp p

Max Max p c ct

v vp p

a ct

-17-

Analysis

Equilibrium prices and profits

* 1 11 1 2

( ) ( )

3 2 6WB H M L M

M M

v c v ctp c c t a

* 1 1 11

1 1 1

3( ) ( ) ( )1{ }{ }

3 6 2 6 12( ) ( ) ( )1

{ }2 2 6 6 4

WB H M L M L M

H M L M H M

v c v c v ctt

tv c v c v c

t t

* 1 12

1

( ) ( )1{ }{ }

3 6 2 6 12( )1

( ){ }2 6 12

WB L M L M

L M

v c v cta c t

tv c

a ct

* 12 2

( )

3 6WB L M

M

v ctp c t a

-18-

Analysis

Profit functions

- Firm 1

- Optimal profit function independent of the level of access charge

- Firm 2

- Optimal profit as a increasing linear function of access charge

* 1 1 11

1 1 1

3( ) ( ) ( )1{ }{ }

3 6 2 6 12( ) ( ) ( )1

{ }2 2 6 6 4

WB H M L M L M

H M L M H M

v c v c v ctt

tv c v c v c

t t

2* 1

2 1

( )(3 )( ) {4 (3 ) ( )}

18 72WB L M

L M

v cta a c t v c

t

-19-

Analysis

Incentive for service bundling and its effect on the incumbent

Incentive for service bundling

- A higher service differentiation leads to a higher incentive for service bundling by firm 1- Incentives for service bundling is not affected by the level of access charge

Its effect on the incumbent

- Incumbent’s profit and market share is reduced by the entrant’s bundling strategy

* *1 1 0WB WOB

2 21 1 1 1

11

[9( ) 9( )( ) ( ) ](3 ) ( )

4( )H M H M L M L M

L M

v c v c v c v ct

v c

* * 12 2 1

( )( ) ( ) [4 (3 ) ( )] 0

72WB WOB L M

L M

v ca a t v c

t

-20-

Analysis

t

Region C: With Bundling

Region B: Without Bundling

The region D where fu ll coverage is not satisfied

The region A where non-negative condition is not satisfied

Region A

Region D

0

1

Figure 1

The entrant’s incentives for service bundling

1(3 )t

12 2 1

( )(3 ) 2( ) ( )

2H M

M M L Mv c

t v c v c

11

3( )(3 ) 2( )

2H M

L M

v ct v c

t

Region C: With Bundling

Region B: Without Bundling

The region D where fu ll coverage is not satisfied

The region A where non-negative condition is not satisfied

Region A

Region D

0

1

Figure 1

The entrant’s incentives for service bundling

1(3 )t

12 2 1

( )(3 ) 2( ) ( )

2H M

M M L Mv c

t v c v c

11

3( )(3 ) 2( )

2H M

L M

v ct v c

*2 ( )WB a

*2 ( )WOB a

1la

Figure 2

Given a fixed access charge, the change of incumbent’s

profit by the strategic choice of the entrant

*2 ( )WB a

*2 ( )WOB a

1la

Figure 2

Given a fixed access charge, the change of incumbent’s

profit by the strategic choice of the entrant

-21-

Analysis

Social Welfare Analysis

When firm 1 doesn’t take bundling strategy

- Total Consumer Surplus:

- Social Welfare

When firm 1 takes bundling strategy

- Total Consumer Surplus:

- Social Welfare

1 2 1 2( ) ( ) ( )WOB WOB WOB WOB WOB constant with respect tW CS a CS a a o a

1 2 ,WOB WOB WOB WOBCS CS a constant with respect to a

1 2 ,WB WB WB WBCS CS a constant with respect to a

1 2 1 2( ) ( ) ( )WB WB WB WB WB constant with respect toW CS a CS a aa

-22-

Analysis

The amount of decreasing in total consumer surplus as the increase of access charge

= the amount of increasing in incumbent profit as the increase of access charge

Total social welfare is constant with respect to the level of access charge

The role of access charge

- The redistribution of the total surplus between consumers and incumbent

-23-

Ⅴ. Conclusion

1. Results

2. Limitations and further study

-24-

Conclusion - results

Results

Incentive for Service Bundling and its effect on the incumbent

Incentive for Service Bundling

Incentives for service bundling independent of the level of access charge

The higher differentiation, the higher incentives for service bundling

Its effect on the incumbent

The decrease of incumbent’s profit

Social Welfare Analysis

Total Surplus and Access Charge

Total consumer surplus as a linear decreasing function of the level of access charge

Incumbent profit as a linear increasing function of the level of access charge

Total surplus being independent of access charge

Role of access charge

The redistribution of the total surplus between consumers and incumbent

-25-

Conclusion – limitation and further study

Investment on infrastructure and equipment by players with essential facilities Cross-entrance and interconnection issues

Access price determination and socially optimal access charge- Number of existing customer, network externality, degree of service differentiation, incumbent’s first-mov

er advantages

Integration of wireless and wireline markets, convergence between telecommunications and broadcasting industries

Price and access charge regulations

-26-

Ⅵ.

Appendix

-27-

Appendix

2 2 0 2 2

(3 )0 ( ) ( ) , (3 ) 2( )

2M M M M

ta v c l t v c

Full Market Coverage Case

Without Bundling

Full Market Coverage Constraint

Non-negative market share constraint

WithBundling

12 2 1 1

12 2 1

( )(3 ) 10 ( ) { ( )} ( ),

2 2 2( )

(3 ) 2( ) ( ( ))2

H MM M L M

H MM M L M

v cta v c v c l

v ct v c v c

11

3( )(3 ) 2( )

2H M

L M

v ct v c

Always satisfied

Full Market Coverage Constraint

Non-negative market share constraint