Business of Platforms Bottlenecks and Interconnection Pricing version
Business of Platforms: Bottlenecks and Interconnection Pricing (version 11102020) n n Nicholas Economides, Giuseppe Lopomo and Glenn Woroch, Strategic Commitments and the Principle of Reciprocity in Interconnection Pricing, chapter 5 (pp. 62 -99), in Gary Madden (ed. ) The Economics of Digital Markets, Edward Elgar (2009). Nicholas Economides, Giuseppe Lopomo and Glenn Woroch, Regulatory Pricing Policies to Neutralize Network Dominance, Industrial and Corporate Change, vol. 5, no. 4, pp. 1013 -1028, (1996). 1
One-sided bottlenecks 2 A 1 C B 3 n n n The early (1900) AT&T owned link 1 (long distance) and link 2 (local) “Independent” phone companies possessed link 3 (local) AT&T refused to interconnect the independents at point B to provide part of the long-distance service ABC 2
One-sided bottlenecks 2 A 1 C B 3 n n n Only alternative for independents to be acquired by AT&T Very effective strategy: market share (in terms of phone lines) of AT&T by 1935 was 89% from about 50% in 1914 When AT&T was broken by DOJ in 1981 its share was the same, 89%! 3
One-sided bottlenecks 2 A 1 C B 3 n n n Reverse problem in the 1970 s Now AT&T controls all local lines (link 1) and most long distance (link 2) MCI entered in LD (link 3), has no local lines MCI desperately needed interconnection to reach users AT&T provided low quality interconnection to local lines to MCI 4
What do you do when you have a bottleneck? Bottleneck is a monopoly you exploit by n Charging high prices, e. g. Apple store collecting 30% of price for each thirdparty app bought n Excluding competitors, e. g. AT&T before 1935 and AT&T in the 1970 s n Expanding in adjacent markets, e. g. Microsoft adding browser to Windows n You can run afoul of antitrust laws! 5
6
Interconnection Pricing. “Vertical Price Squeeze” 2 A 1 C B 3 n 7
Two-sided bottlenecks (1) n n n Each of two firms is monopolist, each with a different bottleneck, and each firm requires the other’s bottleneck to produce its output Two local telephone companies, each customer subscribes only to one local telephone company, and each company requires the other’s network to complete calls Calls originate at A 1, A 2 and terminate at B 1, B 2 8
Two-sided bottlenecks (2) Example: New Zealand n n n Each call has “origination” (p 1, p 2) and “termination” charges (q 1, q 2) “Termination charges” at B 1, B 2 for calls from the rival network can be used to disadvantage and foreclose the rival network Problem in U. S. telecommunications solved by setting equal termination fees (reciprocity); unresolved in ATM, credit card, and other unregulated networks 9
Leveraging of market power across markets n n Various types of exclusionary arrangements Instruments: n n n Technical standards Bundling and other pricing strategies Non-price discrimination strategies (raising rivals’ costs) 10
Limited effects of antitrust policy n In markets with strong network effects, n once few firms are in operation, the addition of new competitors, even under free entry or with eliminating barriers to entry to encourage competition, does not change the market structure, and hence competition landscape, in any significant way n antitrust authorities may not be able to significantly affect market structure by eliminating barriers to entry 11
Leveraging Example n n n In the middle 1980 s, Nintendo refused to allow third party games (software) to play/work on its game console unless the game manufacturer agreed not to write a similar game for two years for competing game systems Nintendo used its dominance in the game market at the time to coerce developers to make games just for its platform, and thereby to increase the value of the Nintendo platform while hurting rival platforms Practice stopped under threat from DOJ 12
n n Issues in “after-markets” where consumers are “locked-in” to a durable good or service arises out of commitments of durable nature Examples n n n refusal of Kodak to supply to repair companies replacement parts for Kodak photocopiers lack of email address portability for ISPs lack of number portability for wireless phones long after it was feasible 13
Example from computing industry: subsidizing complementary goods n n Firm A chooses to make its product incompatible with others Firm A subsidizes firms that produce complementary goods Alternatively, firm A subsidizes its division that sells complementary goods As a result n n n The value of firm A’s product increase The entry hurdle of firm A’s rivals increases Possible creation of market power, but action also has procompetitive justification 14
Impose compatibility? n n n In platforms, incompatibility is a necessary condition for possible creation of market power Key to increasing total surplus: public standards, compatibility But it is very difficult for US antitrust authorities to intervene and/or define standards Different in the EU which tried to impose compatibility between Microsoft and Sun servers (MS and Linux servers are compatible) Imposing compatibility may reduce incentives to innovate The “dynamically incorrect” standard may be chosen n n If forced to choose a single standard, the FCC would have chosen TDMA or GSM at the first PCS auctions CDMA proved more efficient later on 15
Dynamic efficiency issues n n n Static efficiency may lack in dynamic efficiency Possibility of a lock-in to a technology which, when decisions taken in every period, looks optimal given past decisions, but is sub-optimal if decisions are delayed and all the decisions are taken at once Lock-in may occur as a consequence of the race to be a dominant firm in a network industry 16
Innovation issues n Efficiency and intensity of innovation in monopoly compared to competition and oligopoly is an open question in economics 17
Traditional Regulation? 18
When should regulation be used? n n n Regulation it is best suited for industries with well defined and not changing products and services Regulation is not well suited in industries with rapid technological change and frequently changing product definitions Regulation can be used by the regulated companies to keep prices relatively high, as exemplified by telecommunications regulation Often regulators are very close to the interests of the regulated parties rather than to the interests of the public Often regulators are not well informed about key variables as well as changes in the industry 19
When should regulation be used? n n Regulators at both the state and federal levels are under pressure and influence by both the executive and the legislative parts of government, and cannot be as impartial as a judge There is a tendency for regulators to expand their reach into related and new markets These drawbacks can create significant surplus loss due to regulation However, regulatory rules can and should be used effectively and appropriately in cases of dominance or monopolization of essential network bottlenecks to assure n that firms do not leverage their monopoly to adjacent markets n that prices are not too high 20
Review questions n n n What are one-sided and two-sided bottlenecks? Describe their differences? In one-sided bottleneck, what instruments (pricing strategies) can an advantaged player deploy to squeeze out smaller players? Give a concrete example. How can the monopoly pricing issues arising from two-sided bottlenecks be resolved? True or False: In markets such as ride-hailing or e-commerce where there exist strong network effects, removing barriers to entry will significantly alter their market structures. What are the benefits and issues if we impose compatibility on a company and its rivals? In your opinion, when are market regulations appropriate? 21
- Slides: 21