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Introduction The Model Equilibrium access charges Commitment contracts Discussion

Investment with commitment contracts:The role of uncertainty

EuroCPR 2010

Claudia Saavedra V.claudia.saavedra@polytechnique.edu

Ecole Polytechnique

30 March 2010

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Motivation

Telecom infrastructure an heritage of the formerly State-ownedmonopolyUpgrade and renovation of infrastructureRegulatory authorities will likely apply ex ante regulation forwhoever builds a networkFostering retail market competition without hindering investmentcan be a challenging objective

Introduction The Model Equilibrium access charges Commitment contracts Discussion

The aport of this paper

What is the paper’s main question?

Private incentives to invest on a new network when it cannot befinanced by direct subsidies and revenues from the market are theonly source of fundingApplication to game theory to investment incentivesIndustry players are uncertain about future industry profitability

Introduction The Model Equilibrium access charges Commitment contracts Discussion

The aport of this paper

Overview of the results

Access regulation gives firms a second-mover advantageFor adverse market configurations, more sophisticated accesscontracts including commitment clauses between firms can bemore efficient than simple linear wholesale access tariffs.

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Framework

The Model

Two ex ante identical firms in an infrastructure-based industrySunken cost for building the facility I > 0

FBC Facilities-based competitionTwo firms with infrastructure

SBC Service-based competitionOne firm with infrastructure

NC No service is providedFuture industry profit flows are uncertain

Good state (high profits) θH with probability µ ∈ [0, 1]Bad state (low profits) θL with probability 1− µ0 < θL < θH

θ is revealed only if investments are made

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Framework

The Model

Two ex ante identical firms in an infrastructure-based industrySunken cost for building the facility I > 0

FBC Facilities-based competitionTwo firms with infrastructure

SBC Service-based competitionOne firm with infrastructure

NC No service is providedFuture industry profit flows are uncertain

Good state (high profits) θH with probability µ ∈ [0, 1]Bad state (low profits) θL with probability 1− µ0 < θL < θH

θ is revealed only if investments are made

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Framework

Cournot competition p = 1− (q1 + q2)Facilities-based competition profits

ΠC = θ {qi(p− c)}︸ ︷︷ ︸profit flow

−I

c ∈ [0, 1] marginal infrastructure usage cost,Service-based competition profits for the access Provider and the

access Seeker

ΠP (w, θ) = θ {q1(p− c) + q2(w − c)} − IΠS(w, θ) = θ {q2(p− w)}

c < w < 1 usage-based access chargeNo infrastructure Π = 0

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Framework

Cournot competition p = 1− (q1 + q2)Facilities-based competition profits

ΠC = θ {qi(p− c)}︸ ︷︷ ︸profit flow

−I

c ∈ [0, 1] marginal infrastructure usage cost,Service-based competition profits for the access Provider and the

access Seeker

ΠP (w, θ) = θ {q1(p− c) + q2(w − c)} − IΠS(w, θ) = θ {q2(p− w)}

c < w < 1 usage-based access chargeNo infrastructure Π = 0

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Framework

Cournot competition p = 1− (q1 + q2)Facilities-based competition profits

ΠC = θ {qi(p− c)}︸ ︷︷ ︸profit flow

−I

c ∈ [0, 1] marginal infrastructure usage cost,Service-based competition profits for the access Provider and the

access Seeker

ΠP (w, θ) = θ {q1(p− c) + q2(w − c)} − IΠS(w, θ) = θ {q2(p− w)}

c < w < 1 usage-based access chargeNo infrastructure Π = 0

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Framework

Timing of the game1 Nature chooses θH or θL

2 Regulatory authority sets the access charge w3 Firms simultaneously decide invest or to delay investment→ If at least one firm invests θ is revealed. Then the other firm chooses to

seek access or stay out of the market or to bypass and build own

infrastructure

4 If investment, retail competition

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Retail market equilibrium

Retail equilibrium

There exists a retail market equilibrium such that profit flows:

πs(w)︸ ︷︷ ︸access seeker

< πc︸︷︷︸facilities competition

< πp(w)︸ ︷︷ ︸access provider

< πm︸︷︷︸monopolist

whenever c < w < wm.wm: access charge foreclosing the access seeker

Industry profits:

ΠC(θ) = θπc − IΠP (w, θ) = θπp(w)− IΠS(w, θ) = θπs(w)

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Retail market equilibrium

Retail equilibrium

There exists a retail market equilibrium such that profit flows:

πs(w)︸ ︷︷ ︸access seeker

< πc︸︷︷︸facilities competition

< πp(w)︸ ︷︷ ︸access provider

< πm︸︷︷︸monopolist

whenever c < w < wm.wm: access charge foreclosing the access seeker

Industry profits:

ΠC(θ) = θπc − IΠP (w, θ) = θπp(w)− IΠS(w, θ) = θπs(w)

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Retail market equilibrium

Additional assumption

Facilities based competition is viable only in a good state

ΠC(θH) ≥ 0 ≥ ΠC(θL)

0

ΠC(θH)

w access charges

Profits

ΠC(θL)

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Retail market equilibrium

Additional assumption

Facilities based competition is viable only in a good state

ΠC(θH) ≥ 0 ≥ ΠC(θL)

0

ΠC(θH)

w access charges

Profits

ΠC(θL)

ΠS(w, θL)

ΠS(w, θH)

ΠC(θL)

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Retail market equilibrium

Additional assumption

Facilities based competition is viable only in a good state

ΠC(θH) ≥ 0 ≥ ΠC(θL)

0

ΠC(θH)

w access charges

Profits

ΠS(w, θH)

w̃

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Perfect Information

Benchmark: Perfect Information

Invest Seek accessInvest ΠC(θ) , ΠC(θ) ΠP (w, θ) , ΠS(w, θ)

Seek access ΠS(w, θ) , ΠP (w, θ) 0 , 0

Investment equilibrium

θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium

θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Perfect Information

Invest Seek accessInvest ΠC(θL) , ΠC(θL) ΠP (w, θL) , ΠS(w, θL)

Seek access ΠS(w, θL) , ΠP (w, θL) 0 , 0

Investment equilibrium

θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium

θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Perfect Information

Invest Seek accessInvest ΠC(θL) , ΠC(θL) ΠP (w, θL) , ΠS(w, θL)

Seek access ΠS(w, θL) , ΠP (w, θL) 0 , 0

Investment equilibrium

θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium

θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Perfect Information

Invest Seek accessInvest ΠC(θL) , ΠC(θL) ΠP (w, θL) , ΠS(w, θL)

Seek access ΠS(w, θL) , ΠP (w, θL) 0 , 0

Investment equilibrium

θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium

θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Perfect Information

Invest Seek accessInvest ΠC(θL) , ΠC(θL) ΠP (w, θL) , ΠS(w, θL)

Seek access ΠS(w, θL) , ΠP (w, θL) 0 , 0

Investment equilibrium

θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium

θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Perfect Information

Invest Seek accessInvest ΠC(θH) , ΠC(θH) ΠP (w, θH) , ΠS(w, θH)

Seek access ΠS(w, θH) , ΠP (w, θH) 0 , 0

Investment equilibrium

θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium

θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Perfect Information

Invest Seek accessInvest ΠC(θH) , ΠC(θH) ΠP (w, θH) , ΠS(w, θH)

Seek access ΠS(w, θH) , ΠP (w, θH) 0 , 0

Investment equilibrium

θ = θL There exists wL such thatw < wL then there is no investmentw ≥ wL then (Invest, Seek access) is the equilibrium

θ = θH There exists w̃ such thatw < w̃ then (Invest, Seek access) is the equilibriumw ≥ w̃ then (Invest, Invest) is the equilibrium

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Uncertainty

Uncertain θ

With analogous (but slightly more complicated) analysis:

First important result

If the firms have the option to wait for the other firm to invest andreveal θ then (Invest today, Invest today) is not equilibrium for anyaccess charge.

Then the regulatory authority needs encourage(Invest today, Seek access) or (Invest today, Invest tomorrow)equilibrium

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Uncertainty

Uncertain θ

With analogous (but slightly more complicated) analysis:

First important result

If the firms have the option to wait for the other firm to invest andreveal θ then (Invest today, Invest today) is not equilibrium for anyaccess charge.

Then the regulatory authority needs encourage(Invest today, Seek access) or (Invest today, Invest tomorrow)equilibrium

Introduction The Model Equilibrium access charges Commitment contracts Discussion

SBC

Equilibrium access charges

Service-based competition equilibrium

There exists a “low” access charge wSBC < w̃ that inducesservice-based competition in any state of the world.

c

wm

w̃

I Investment cost

access charges

Introduction The Model Equilibrium access charges Commitment contracts Discussion

SBC

Equilibrium access charges

Service-based competition equilibrium

There exists a “low” access charge wSBC < w̃ that inducesservice-based competition in any state of the world.

c

wm

w̃

I Investment cost

access charges

Service-based competition

Introduction The Model Equilibrium access charges Commitment contracts Discussion

SBC

Equilibrium access charges

Service-based competition equilibrium

There exists a “low” access charge wSBC < w̃ that inducesservice-based competition in any state of the world.

c

wm

w̃

I Investment cost

access charges

Facilities-based competition

Introduction The Model Equilibrium access charges Commitment contracts Discussion

SBC

Equilibrium access charges

Service-based competition equilibrium

There exists a “low” access charge wSBC < w̃ that inducesservice-based competition in any state of the world.

c

wm

w̃

I Investment cost

access charges

wSBC

Introduction The Model Equilibrium access charges Commitment contracts Discussion

SBC or FBC

x-based competition equilibrium

There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL

induces facilities-based competition if θH

c

wm

w̃

I Investment cost

access charges

Introduction The Model Equilibrium access charges Commitment contracts Discussion

SBC or FBC

x-based competition equilibrium

There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL

induces facilities-based competition if θH

c

wm

w̃

I Investment cost

access charges

wxBC

Introduction The Model Equilibrium access charges Commitment contracts Discussion

SBC or FBC

x-based competition equilibrium

There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL

induces facilities-based competition if θH

c

wm

w̃

I Investment cost

access charges

wSBC

wxBC

Introduction The Model Equilibrium access charges Commitment contracts Discussion

SBC or FBC

x-based competition equilibrium

There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL

induces facilities-based competition if θH

c

wm

w̃

I Investment cost

access charges

wSBC

wxBC

Risk premium

@@R

Introduction The Model Equilibrium access charges Commitment contracts Discussion

SBC or FBC

x-based competition equilibrium

There exists a “high” access charge wxBC > w̃ that:induces service-based competition if θL

induces facilities-based competition if θH

c

wm

w̃

I Investment cost

access charges

no investment

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Alternative contracts

Negotiated access contracts

To induce investmentAccess contracts with commitment clauses between firms are oneanswer to the dilemma of preserving market competition andencouraging investment in adverse market configurations.

c

wm

w̃

I Investment cost

access charges

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Alternative contracts

To improve static efficiency

If the only possible investment equilibrium is xBC, and if it requires ahigh wholesale price, then commitment clauses allow to lower accesscharges improving static efficiency.In particular, there exists a range of wholesale prices that areincentive compatible for both firms.

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Final comments

Discussion

Simple game examines investment incentives when firms aresubject to access regulationAccess regulation gives firms a second-mover advantageIn order to induce investments, the regulatory authority has twooptions:

Set low access charge that discourages opportunistic bypassingSet high access charge that compensates the leading investingfirm for loss revenues in good states

In adverse market configurations, access contracts withcommitment clauses encourage investments with lower accesscharges improving static efficiency

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Final comments

Discussion

Simple game examines investment incentives when firms aresubject to access regulationAccess regulation gives firms a second-mover advantageIn order to induce investments, the regulatory authority has twooptions:

Set low access charge that discourages opportunistic bypassingSet high access charge that compensates the leading investingfirm for loss revenues in good states

In adverse market configurations, access contracts withcommitment clauses encourage investments with lower accesscharges improving static efficiency

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Final comments

Discussion

Simple game examines investment incentives when firms aresubject to access regulationAccess regulation gives firms a second-mover advantageIn order to induce investments, the regulatory authority has twooptions:

Set low access charge that discourages opportunistic bypassingSet high access charge that compensates the leading investingfirm for loss revenues in good states

In adverse market configurations, access contracts withcommitment clauses encourage investments with lower accesscharges improving static efficiency

Introduction The Model Equilibrium access charges Commitment contracts Discussion

Final comments

Thank your for your attention