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Network Competition Business Strategy, Industry Structure

Network Competition Business Strategy, Industry Structure. IS250 Spring 2010 chuang@ischool.berkeley.edu. Summary. Market segmentation, service differentiation, and bundling strategies can improve producer revenue, but raise questions on “neutrality” of the network

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Network Competition Business Strategy, Industry Structure

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  1. Network CompetitionBusiness Strategy, Industry Structure IS250 Spring 2010 chuang@ischool.berkeley.edu

  2. Summary • Market segmentation, service differentiation, and bundling strategies can improve producer revenue, but raise questions on “neutrality” of the network • Vertical integration and horizontal mergers are driven by scale and/or scope economies, but may increase market concentration to the detriment of competition and consumer welfare John Chuang

  3. p Recap: Monopoly,Duopoly, andPerfect Competition Consumer Surplus 1 p(q) = 1 - q p* q q* 1 Producer Revenue Dead Weight Loss (DWL) John Chuang

  4. Telco Business Strategy • Imagine being the CEO of a telco, cable company, or ISP: • Convergence means more competitors • Service increasingly commoditized (which leads to more intense price competition) • Fixed costs as high as ever • Life as a regulated monopoly was so much easier! John Chuang

  5. How to Increase Revenue? p • Price discrimination • Market segmentation • E.g., business vs. residential • Personalized pricing • Service differentiation • E.g., video vs. email data • The debate on “Network Neutrality” • Implications to consumer, producer and social welfare 1 p(q) = 1 - q q 1 John Chuang

  6. p Comparisons Consumer Surplus 1 p(q) = 1 - q p* q q* 1 Producer Revenue Dead Weight Loss (DWL) John Chuang †: specific example from previous slide, with two market segments of 50% each

  7. p p + = q q Source: Bakos and Brynjolfsson, 2000 Bundling • Multi-product pricing • Rationale: reduce dispersion in WTP for bundle • Example: voice, video, data (triple-play) • Consumer 1 WTP: $40, $40, $40 • Consumer 2 WTP: $10, $10, $100 • Sell voice, video at $40 each, data at $100 --> Revenue = $180 • Sell bundle at $120 --> Revenue = $240 John Chuang

  8. Management Control • Vertical integration • Horizontal merger • Determinants: • Technological efficiencies (+) • Transactional efficiencies (+) • Market imperfections (-) John Chuang

  9. Vertically Related Markets • Upstream/downstream relationship • Examples: • Steel: ore & coal mines; steel mills • Software: OS; applications • Telephony: local access; long distance • Internet: physical transport; internet access; content/services John Chuang

  10. Vertical Integration • Good: • economies of scope savings • internalize transaction costs • reduce prices & increase total welfare • Bad: • if one component is monopolistic; possibility of foreclosing competition in other component John Chuang

  11. Vertical Integration Example • Telephony was vertically-integrated industry • AT&T (Ma Bell) offered end-to-end solution • Divestiture in 1984 • Local service (the seven baby bells) • Long distance service (AT&T) • (Re-)Integration in 2005: • SBC acquired AT&T ($16B) • Verizon acquired MCI ($7B; Qwest had rival offer) John Chuang

  12. Horizontal Merger • Proposition: Economies of scale • Objection: concentration leads to market power and reduction in competition • No network externality benefits (all networks are interconnected anyway) • Larger network has less incentive to interconnect, or to maintain a high quality interconnection, with smaller networks • Larger network has negotiation power over smaller networks John Chuang

  13. Horizontal Merger • Example 1: Local Telephony • Seven Baby Bells Merging • AT&T: SBC + Pacific Bell + Ameritech + Bell South • Verizon: Nynex + Bell Atlantic (+ GTE) • Qwest: US West • Facilities-based competition • e.g., wireless, cable, satellite, fiber, PLC, … John Chuang

  14. Horizontal Merger • Example 2: Internet Backbone • MCI-WorldCom (Sept 1998; $37B; MCI backbone divested to Cable & Wireless) • WorldCom-Sprint (Oct 1999; $129B; rejected by DoJ and EU 2000) Fiber system route miles (UUNET) John Chuang Source: Kende 2000

  15. Summary • Market segmentation, service differentiation, and bundling strategies can improve producer revenue, but raise questions on “neutrality” of the network • Vertical integration and horizontal mergers are driven by scale and/or scope economies, but may increase market concentration to the detriment of competition and consumer welfare John Chuang

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