Network subscription and services usage in European telecommunications industries

INFORMATION ECONOMICS AND POLICY

ELSEVIER

Information Economics and Policy 8 (1996) 25-50

Network subscription and services usage in European telecommunications industries Paola Garrone* Dipartimento di Economia e Produzione and CIRET, Politecnico di Milano, Piazza Leonardo da Vinci 32, 20133 Milano, Italy

Received 10 November 1994; accepted 29 March 1995

Abstract Efficiency changes for telecommunications carriers are studied both in a network expanding under constant services intensity and in industries experiencing an increasing demand for extra service, relying upon data from nine European telecommunications industries over the period 1980-1992. Estimation outcomes show that only the smallest European network infrastructures are characterized by increasing returns of scale, whereas those of the service-specific economies turn out to be very low over the relevant range of sizes. Therefore, competition in extra services should not be prevented, even if some regulation difficulties are arisen by the smallest carriers. Moreover, no allocative efficiency is estimated to characterize the joint management of network and services. Key words: Telecommunications; Multiproduct economies; Vertical organization J E L Classification: L96; L22

1. Introduction O v e r the last fifteen years m a n y empirical works have widely e x a m i n e d e c o n o m i e s of scale in t e l e c o m m u n i c a t i o n s (hereafter T L C ) industry. S o m e *Tel. +39-2-23992742, fax +39-2-23992710, e-mail: [email protected]. An earlier version of this paper has been awarded the ITS 1995 Prize for a young researcher. The author would like to thank M.G. Colombo and the participants in the ITS Conference (Sidney, 3-6 July 1994) for helpful comments. The financial support by a CNR grant (94.04.04185.ST74) and by a BT fellowship are gratefully acknowledged. 0167-6245/96/$15.00 © 1996 Elsevier Science B.V. All rights reserved S S D I 0167-6245(95)0001 1-9

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of them have also attempted to estimate economies of scope affecting pairs of services provided by public networks. In addition, other analyses have tested the status of natural monopoly of the industry through the estimation of cost subadditivity. More recent analyses have used panel samples either to carry out new estimates of the cost subadditivity degree or to study the impact of some operating characteristics on the production structure ~. For our purposes it is worth noting that these panel models regard the access lines to the T L C network as a determinant of the carriers' cost structure. A refinement of the mainstream model is aimed both at controlling for the heterogeneity of panel individuals and at distinguishing between economies of scale and economies of density. This p a p e r claims that the network access has to be modeled as an output of the carriers. It is widely understood that the access to the network and the usage of the services are diverging both on the demand and on the supply side of the industry. Policy makers are increasingly focusing on differences between the operations of the various layers of the industry (access network, transport network, basic services, enhanced services) to learn about their different regulation needs. Different production structures would determine different competitive regimes in different layers and, as a consequence, would also affect the optimal vertical organization of the industry. As a matter of fact, if scale economies were exhausted in the service provision and were not exhausted in the network access, the risk of extension of monopoly power should be monitored. Furthermore, if the joint provision of services and network access were p e r se a source of allocative efficiency, special caution should be exercised in proposing vertical restructuring of the sector. This p a p e r is aimed to quantify scale and scope economies that are at work in firms providing both access to the T L C network and a vector of communication services 2. The application will use data from nine E u r o p e a n T L C industries (Denmark, Finland, G e r m a n y , Greece, Italy, The Netherlands, Spain, Sweden, Switzerland) over the period 1980-1992. The production structures of the firms of these countries are modeled through the specification of a cost function in a flexible form, the definition of an admissible output region and the definition of appropriate indexes for the output economies. Firstly, scale economies are estimated in a network expanding under constant services intensity. Secondly, product-specific scale economies for local calls and long-distance calls are estimated, in order to evaluate efficiency changes in industries that are experiencing an increasing d e m a n d for extra service. Lastly, I propose a synthetic index for scope E.g. see Hansen (1993) or Shin and Ying (1992). z I will focus on these two broad types of output, thus neglecting to some extent differences among productive characteristics inside the set of communication services. See Kiss and Lefebvre (1987) on multi-output cost models.

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economies, based upon the comparison between the subadditivity degrees of hypothetical duopolies that are characterized by a different degree of specialization. Section 2 of the paper presents the motivations and the scope of the empirical analysis. In Section 3 the methodology of the work is illustrated. Section 4 surveys the empirical outcomes of the study and suggests some policy implications.

2. Preliminary analysis 2.1. Motivations

By now, let us assume that the network access itself is a product (Section 2.3 will return on this point). Under this hypothesis the following application is mainly aimed at providing some empirical support to important policy decisions. Increasing divergences between the markets of services and network access suggest to test whether the cost structure underlying the provision of these two outputs is similar and whether the joint provision of the two outputs is a source of efficiency for the industry. The current TLC policy debate explores and supports the development of competitive markets for service providers, long-distance carriers, radiomobile carriers, because sector experts seem to share the view that economies of scale affect uniquely the fixed network access infrastructure. The hypothesis "differences between the network operation and the service provision in optimal sizes" is thus critical and should be tested. If not rejected, attention should be paid to the risk of extension of monopoly power from the operation of network infrastructure towards the provision of services. As a matter of fact, to be successfully performed, competition at the high stages of the sector requires that interconnection and equal access to the end-users facilities are granted. In this respect, the industry practitioners solicit the discussion whether the carriers should focus on network operation and on basic delivery activities or whether and how they could also participate in the services provision and in other TLC markets (Neu and Neumann, 1993; Brennan, 1987). With regard to the latter question, it should be noted that if scope economies are at work in the production of network access and services provision, they could (partially) outweigh benefits descending from a vertical restructuring of the industry. 2.2. Scope o f the analysis

Given the relevance of the questions so far mentioned, empirical and conceptual limitations of our analysis are now to be pointed out, so as to precise the application field of our results.

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• Allocative efficiency criteria are not enough to depict the optimal organization of the industry. Firstly, the oligopolistic interdependence is a relevant determinant of TLC national market organizations because of the increasing globalization. Secondly, extraordinary transactional complexity is likely to affect vertical interfaces between the layers of the industry. At least these two conceptual references should contribute to select the ex ante feasible alternatives to monopoly 3. • All the firms of our sample are vertically integrated towards the network operation. Services charged to the users are almost fully produced with a network that is internally operated 4. Therefore, when we will study the efficiency of duopolies emerging from the breakup of the monopoly, we will maintain a vertical integration. In this respect, scope economies will spring from the provision of more or less services to network subscribers. Therefore, the analyzed hypothetical duopolists will be monopolists in their region. Nonetheless, as far as efficiency is concerned, scope (or specialization) benefits will be the same as the ones characterizing a market with 'pure' network operators and 'pure' services providers as well. The definition of the model will add some empirical limitations. 2.3. The access to the T L C network is an output

Empirical studies devoted to TLC carriers do not use to distinguish sharply between the efficiency changes associated with the increase of the network size and the ones associated with the increase of the service usage intensity 5. This is partly caused by the use of time series and by the consequent scarcity of degrees of freedom. Panel sets of data are potentially more informative, as they are characterized by a larger number of observations and by a good spread of data. By taking advantage of this information richness, Shin and Ying (1992) test the cost subadditivity in US Local 3 D u e to empirical difficulties (see Section 3.5), the rejection of the naturality of monopoly in T L C industry turns out to be perhaps too an ambitious project. More importantly, given the relevance of theoretical frames other than allocative efficiency in shaping optimal industry configuration, such a test turns out to be not so critical. 4 Even if most carriers are present in D e n m a r k , Finland, and Italy, they are divided geographically and they can be regarded as semi-separated units of the same organization, because of severe institutional constraints linking them. ~ A survey of the classical econometric analyses of the North-American industries can be found in Kiss and Lefehvre (1987). Comparisons between the efficiency of fictitious two-firm sectors and the efficiency of monopoly are carried out in Evans and H e c k m a n (1984), R611er (1990), and in Shin and Ying (1992).

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Exchange Carriers and Hansen (1993) studies the impact of regional features on district units of Norwegian Telecom. T o our purposes, the relevant feature of these analyses is that both of them have included the network access lines among outputs in the models. Shin and Ying contrast a whole set of fictitious partitions of the industry to the modeled monopoly. However, they do not emphasize the role played by different output mixes in the relative efficiency of different monopoly breakups. Conversely, Hansen estimates both scale economies and density economies 6. The author finds that economies of density would imply increasing returns to scale, while global scale economies would prove that constant returns to scale are at work. Empirical outcomes of Hansen are our starting point in refining the mainstream model of T L C carriers, as far as they distinguish between size of the network and size of the firm. A re-definition of T L C outputs is worthwhile because of many reasons; in the following sections we will briefly examine some of them. Firstly, referring to the distinction between density economies and scale economies, an issue which may appear obvious has to be reminded. Let two carriers be characterized by the same technology and the same inputs markets. Let also them provide equal traffic (local, long distance, international). They can incur very different costs, depending on the number of access lines of the network and, in more general terms, on the topological and geographical structure of the network. Therefore it is appropriate to stress differences between firm size and level of output. However, the network size is more than an operating characteristic affecting the production problem of the carrier. Furthermore, the network access itself is more than an intermediate input, even if decisions on the physical connection to the network are to some extent endogenous to the carrier, dependent on the network technology. The network subscription is indeed a product provided by T L C carriers. The proposition can be substantiated from different standpoints. Firstly, let us focus on the demand side of the market. Becoming a subscriber implies being identified by the information system of the carrier both as a source and as a destination of traffic. This operation is perceived by consumers as a sort of option to enjoy TLC services (Taylor, 1980), and the subscriber can benefit even from receiving communications (Hayashi, 1992: "call externalities"). The T L C demand analyses clearly distinguish the demand for network subscription from the demand for services usage (Taylor, 1980), even if the former is recognized as a sort of necessary

~' Density economies are defined by Caves et al. (1984) in a paper devoted to airlines. They intend to distinguish between firm size and level of output. "Returns to density are the proportional increase in output made possible by a proportional increase in all inputs, with points s e r v e d . . , held fixed".

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condition for the latter. Individual choice models point out the role of subscribers characteristics in services usage demand (Atherton et al., 1990). Secondly, let us focus on the supply side of the TLC industry. The linkage between services and network is getting increasingly loose owing to technical 7 reasons . In integrated networks the transport network and the information network are distinguished and are going to be separated to increase the flexibility of the production process. The transport network is in charge of the basic functions as transmission, switching, and delivery of the calls. By contrast, the information network is services-oriented. It comprises a network operating system and a set of gateways towards the information providers. Due to this, a great deal of applications are becoming available to the network subscribers. Two different functions thus coexist in the TLC carriers: the network operation and the service provision. In conclusion, it should be noted that access to the network facilities is increasingly demanded from TLC carriers not only by the traditional endusers (business and residential) and by the internal information network, but also by foreign carriers, radio-mobile network carriers, service providers, large user groups. These 'external' information providers demand a delivery service for their calls. To these users the TLC carriers are suppliers of the network access, lnterconnection transactions are usually excluded by the pricing system and are carried out via complex agreements (Neu and Neumann, 1993). However, my model will especially address the role of end-users, thus identifying the access with the subscription.

3. The model

3.1. Specification of the outputs In Table 1 the average growth rates for access lines, calls (both local and long-distance), and long-distance calls are reported for the sample and for the nine European countries, over the years 1980-1992. It is to be underlined that access lines show a weaker growth pattern. Evidence for this would be even clearer if yearly data were used, rather than average figures s. In general terms, there is no country expanding its network access more rapidly than its service provision. All the countries show a

7 E.g. digitization allows the physical path of the call to be no longer the same for control and signalling information (with the introduction of the C o m m o n Channel Signaling System). C h a n g e s in the transport network structure are simply reflected in the information network by a change in databases content. As a matter of fact, in the early eighties some countries had to overcome some weaknesses in infrastructure inherited from preceding years.

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P. Garrone / Information Economics and Policy 8 (1996) 25-50 Table 1 Growth rates of the TLC outputs Average of

Access lines

Calls (local and long-distance)

Long-distance calls

Sample Denmark ('80-'91) Finland ('80-'92) Germany ('80-'88) Greece ('80-'90) Italy ('80-'92) The Netherlands ('80-'91) Spain ('80-'87) Sweden ('88-'91) Switzerland ('80-'91)

0.04 (I.03 0.04 0.04 0.05 0.05 0.03 0.05 0.(12 0.03

0.(16 0.(14 0.08 0.04 0.10 0.07 0.05 0.03 0.(14 0.(15

0.06 (I.05 0.07 0.05 (I.07 0.09 0.07 0.06 0.03 0.06

traffic increase more than proportionate or comparable to the subscribers increase, especially as far as long-distance calls are concerned. In particular, today countries like Denmark, the Netherlands, Sweden or Switzerland are characterized by low growth rates in access lines, while the services demand by itself is expanding (differently from the early eighties in Greece, Italy and Spain). According to the figures of Table 1, the demand of TLC in European industries can be sketched through two extreme modes. On the one hand, there are 'traditional' new network subscribers who demand network access, given a constant intensity of service usage per line. I will refer to this kind of output as 'basic access' and to the related growth pattern as 'geographic' expansion. On the other hand, an extra amount of calls (especially longdistance ones) is demanded, given the amount of network subscribers. I will refer to this kind of output as 'extra service' and to the related growth pattern as 'near-horizontal' expansion. In some countries (e.g. Sweden) the demand for extra service prevails. However, at present the two demand streams coexist in most of the aforementioned countries. The preceding notes help to explain the output specification I have adopted. According to the mainstream applied literature, I took the dual method to analyze the production structure of TLC carriers; I also addressed my attention to the alternative single-output versus multi-output cost function (see a survey in Kiss and Lefebvre, 1987). In principle the cost function should contain both subscribers and local calls and long-distance calls, for a multi-output specification would nicely fit with the variety of outputs so far examined. Unfortunately, lines and local calls are often demanded in near-fixed proportions (see Table 3 and section devoted to data). On the other hand, a single aggregate output could be incorrect. But if a vector of output qualities is specified along with an index of the 'main'

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output, the choice among the two possibilities is mainly an empirical question. As a matter of fact, Gagn6 (1990) proposes a method to estimate the effect of changes in output qualities that allows for an effective singleoutput-with-qualities specification. The T L C demand within the countries of the sample and over the period 1980-1992 can be described, firstly, as a demand for 'basic access' (an access line along with a base of communications services) and, secondly, as an additive demand for 'extra service'. The former is the main output and the latter takes into account the level and nature of extra traffic. It can be further detailed in demand for extra local calls and demand for extra long-distance calls. A large number of local calls per line usually hints a relevant diffusion of communication services. However, it can also document some peculiarities in local network design or a lack of infrastructure. Therefore a second quality was included in the model: the share of longdistance calls. The long-run cost function can thus be written as follows: c = c ( y , qLOC, qLD, PK, PL, f )

(1)

where c is total costs, y is the number of network subscribers, qLOC is the number of local calls per line, qLD is the fraction of long-distance and international calls out of the total number of calls, PK is the price of capital, PL is the price of labor, f is a vector of operating characteristics affecting the production process (I will include the technology level (T) and a measure of the geographical coverage of the country ( G ) 9 ) . 3.2. D a t a a n d variables

Our sample consists of a panel of data of nine European countries over 1980-1992: Denmark, Finland, Germany (the former Western Germany), Greece, Italy, The Netherlands, Spain, Sweden, and Switzerland. Other European countries have been excluded because of lack of data. In particular, physical proxies for output variables were often missing. The primary data source is the Yearbook of Common Carrier Telecommunication Statistics of International Telecommunications Union, edition 1993 (STARS database) and the preceding ones 1°. After excluding years which In many European countries, the pace and the direction of technical change in TLC industry is mainly dictated by the government's decisions on public investments and by Community resolutions. So I assumed T to be exogenous. ~'~I also used the Yearbook of the Conf&ence Europ6enne des Administrations des Postes et des T61&ommunications, 1990 edition; the United Nations Demographic Yearbook, 1989 edition; the Yearbook of International Labor Office, 1993 edition and the preceding ones; the World Road Statistics of International Road Federation, 1991 edition; The Financial Statistics of the International Monetary Fund, 1993 edition and the preceding ones.

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are not completely available and years with 'obvious' errors, the data set comprises 206 points. To calculate total costs (c) and input cost shares, I added up operating expenses for material and services and depreciation. Values are in 1985 dollars. As far as the input prices are concerned, the price of labor (PL) is the compensation per employee per year 1~. As to the price of capital (pn) I attempted to divide the depreciation expenses by the number of installed lines (Shin and Ying, 1992; Garrone, 1995). However, the resulting prices turn out to vary among carriers by a factor greatly exceeding 10, because of regional differences in national networks. I assumed the existence of a world market for TLC equipment and I followed the technique for the estimation of factor prices adopted by Spady and Friedlaender (1978). I projected the depreciation expenses per line on a space of network- and country-specific variables, on the one hand, and of year dummies, on the other 12. Since the equipment market is global, the coefficients of the latter are the serie of the capital price. In conclusion, the ratio of the maximum and the minimum is now 1.22. According to the last section, the main output variable is the basic access to the network (y), proxied by the number of subscribers (fixed and mobile). Extra service is proxied both by the number of local calls (LOC) per line (qLoc = LOC/y) and by the share of long-distance and international (LD) calls (qLD = LD/(LD + LOC)). For some countries the minutes of conversation have been transformed in calls, with a conversion rate equal to the average of the observed ratios of the two panels. The technological level is proxied by the percentage of digitized lines

u I divided the labor expenses by the total staff taken from the CEPT yearbook for all countries in 1985. These values are the 1985 country bases of indexes whose time trend is the wage index of IMF statistics. The resulting panel of wages shows quite a high ratio between maximum and minimum (see Table 2: this ratio is 5.46). However, a better model (as the one specified for the equipment - see footnote 12) would have needed to identify main features of the organization of the labor market, and up to now the panel so far mentioned has been maintained. ~2Country specific differences are captured by a vector of technological and regional variables. I chose to proxy the geographical easiness of the country (and of the efficiency in the design of the network as a consequence) through the square kilometers of country area per line and the number of kilometers of (paved and unpaved) roads per square kilometer of country area. The fraction of distribution network (and of local loops) out of the total extension of the network depends on the absence of rural areas and on the presence of high-density towns: I included the percentage of rural population and the percentage of inhabitants living in the largest country city. Lastly, especially for Nordic countries, mobile networks are operated along with fixed ones: the percentage of mobile subscribers is included as well. A Translog form yielded good coefficients estimates, with an adjusted R-squared index of 0.98, and a DurbinWatson statistics of 1.84 (in a panel with data ordered for individuals, the DW statistics captures the relevance of residual individual effects). Contact the author for further details.

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(T) 13. The country-specific regional aspects are summarized by the geographical coverage of the country (G). I intended to control for the demographic density and for the 'coverage' itself, namely the easiness to install, maintain and operate the network. I assumed that a larger network of roads per country area (without distinguishing between highways, paved and unpaved roads) would reflect a higher population density, a milder orography and weather, a relative scarcity of rural areas. G is thus proxied by linear kilometers of roads per square kilometer of country area. As Table 2 reports, G ranges between 0.22 (Finland) and 3.32 (The Netherlands). Finally, I normalized the data set to the expansion point, dividing every variable by the observed mean. The resulting data set is quite spread around the sample mean. In Table 2 the summary statistics of the panel are reported. According to the proxies of Table 2, the cost function Eq. (l) can be written as follows: c = c ( y , qLoc(LOC, y), qLD(LD, LOC), PK, PL, f ) = c ( y , LOC, LD, PK, PL, T, G ) .

(2)

According to the definitions of Section 3.1, two different sources of the economies of scale currently affecting the TLC carriers can be studied: • a geographic expansion of the network; • a near-horizontal expansion in the services. We can measure the effects of basic access assuming that both qLoc and

Table 2 Summary statistics of the panel (average European carrier) Variable

Mean

Min/ mean

Max/ mean

Costs Lines Local calls Long-distance calls Local calls per line Long-distance share Capital price Labor price Geographic coverage Technology level

2057.4 (10b $) 8906500 8070 × l0 b 3857 × I0~ 906.2 0.32 0.10 20464.9 (S/year x employee) 1.2 (km/km 2) 13.3

0.65 0.21 0.15 0.08 0.44 0.09 0.09 0.39 0.22 0.00

6.83 4.06 2.44 3.99 2.59 0.55 0.11 2.13 3.32 6.47

L3Zero values have been changed in 0.0001 to allow for logarithmic transformations required by the Translog form. Pulley and Braunstein (1992) say that the typical estimates of the Box-Cox parameters of Generalized Translog are usually close to zero, that is, to the implicit values of simple Translog.

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qLD are fixed: ~. is the elasticity of costs to basic access. The formulation of ey reflects the view that an access line is always d e m a n d e d with a base of calls, which is assumed to be the average E u r o p e a n one (see Table 2), and it captures the effects of geographic expansion. In respect of the discussion in Section 3.1, studying the effects of the increase of lines by itself would m a k e no sense, since this is to be regarded as an endogenous rationalization, rather than as a response to customers. Therefore, in % I assumed qLOC and qLD to be held constant with respect to y, that is to say L O C and L D are proportional to y. The effects of both local and long-distance extra traffic can also be analyzed: eLOC and eCD are the corresponding elasticities. It should be evident that an increase in local calls (LOC) cannot take place without a decrease in the share of long-distance calls (qCD)" We can measure the output elasticities, even if the specification is single-output, and the local and long-distance calls are included in the function via the two p a r a m e t e r s qLOC and qLD (Gagn6, 1990): Olnc ey = 81ny '

Olnc ¢?lnc OlnqL D ELOC -OlnqLoc + OlnqL D OInLOC '

Olnc OlnqL D eLD = OlnqLD OlnLD "

(31

3.3. Specification o f the cost function

A cost function will be estimated. For this purpose I adopted the Translog functional form. It is well known that we can interpret the Translog function as a local approximation to the 'true' underlying cost function• Our approximation point is the average E u r o p e a n carrier depicted by the statistics of Table 2. Recent works show that the flexible functional forms can violate classical regularity conditions in the output space outside the neighborhood of the approximation point (R6Uer, 1990). At extreme sample points, marginal costs can degenerate, and extrapolations are no longer reliable 14. Therefore I decided to use the Translog approximation inside its definition frame• Following R611er's claims, I assume that points with positive marginal costs are acceptably approximated• I will not extrapolate the behavior of individuals lying outside the 'admissible' output region (R611er, 1990; Shin and Ying, 1992)• It is noteworthy that such limitation is imposed also to hypothetical firms that are derived from the breakup of monopoly to study the scope (specialization) economies• The 'admissible' region in the outputs space is defined as follows. H However, the alternative quadratic specification does not provide a fair approximation to the choice of inputs. The composite form, recently proposed by Pulley and Braunstein (1992), seems to solve the trade-off between regularity and flexibilityin the outputs. The application of such a methodology is on the agenda.

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• Every output (access, local calls and long-distance calls) ranges between the observed maximum and minimum (see Table 2). • The ratio of every pair of outputs ranges between the observed output ratios (see Table 3). • Marginal costs are positive. The definitions in Eq. (3) will allow us to check the marginal costs. As far as the specific form of Eq. (2) is concerned, the Translog approximation can be written as follows: lnc = a 0 + avlny + CrLOCInqLoc + aLDlnqLD + CrKlnpK + OtLlnpL + arlnT

+ a¢;lnG + ~ flyy(lny)-") + ~l flLOCLoC(lnqLoc)2 + ½ ~LDLD(IBqLD)2

+ 4/3~K(lnp~): + ½ ~3~L(inp0 2 + ½ /3T~(lnT): + ½/3~(lnG)~ + fl~,LoclnylnqLoc + ~,,LDlnylnqLD + flyKInylnpK + flvLlnylnpL

+ ~vrlnylnT + ~yGlnylnG +/3LOCLDInqLOClnqLo + /3LOCKInqLOclnpK + flLoCLlnqLOclnpL + flLoCTlnqLOclnT + ~LOCGInqLOclnG

+ flLDKIHqLDInpK + flLDLInqLDInpL + flLDTlnqLolnT + flLD~;lnqLolnG + flKLlnpKlnPL + ~KrlnpKlnT + flKJnpKlnG + flLylnpLlnT + flLGlnPLlnG + flTGInTlnG.

(4)

Symmetry in second-order terms and linear homogeneity in input prices are imposed. According to Shephard's Lemma the cost shares are derived. The two equations cannot be linearly independent. Once errors have been added, only the capital cost share equation is estimated simultaneously with Eq. (4). I run estimates by using the Zellner technique, program R A T S 3.11.

3.4. Economies of scale The usefulness of the estimates of the effects on costs of the two typical modes of growth (geographic and near-horizontal) will be two-fold. First of Table 3 Observed output ratios Ratios between outputs

Mean

Minimum

Maximum

Long-distance calls/lines Local calls/lines Long-distance/localcalls

392.5 906.15 0.54

172.94 389.93 0.09

861.03 2344.8 1.23

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all, they can give insights in the real (in)efficiency gains that carriers can experience. On the other hand, they can contribute to test whether scale economies characterize both the provision of basic access and the provision of the service by themselves. In other words, scale economies estimates will provide some evidence to the policy debate. The widespread support for a competitive regime in services documents that no returns to scale are expected in the service provision. Conversely, it is quite widely expected that larger network infrastructures are more efficient than smaller ones or, at any rate, the effects of scale are expected not to be exhausted for the operation of network infrastructure in some small countries 15. As a matter of fact, under the empirical approximation provided by the model, scale economies estimates can give some clue to the production structure underlying service provision and network operations; either these activities are e m b e d d e d in an unique firm or they are separated. It should be emphasized that since neither a stand-alone infrastructure expansion nor a stand-alone traffic expansion are observed, my estimates will only indirectly provide some evidence on these two expectations. Table 1 shows that some countries are characterized by a steady network access demand and by a relevant growth rate in extra service. How do the carrier's costs change as the number of lines/subscribers is held fixed and the traffic grows? Effects of a near-horizontal increase are proxied by product-specific scale economies. According to the above reported mainstream view, the local-calls-specific scale economies, SC-LOC, and the long-distance-calls-specific scale economies, SC-LD, are likely to be smaller than 1. I reformulated the standard definition of product-specific scale economies (Baumol et al., 1982: average incremental costs divided by the marginal cost) in order not to extrapolate the carriers' behavior outside the admissible region. In other words, I give a local formula. Let (y, LOC, LD) be a point of the admissible region. Let LOCMA x be the maximum value lying in the admissible region given L D and y. The average incremental cost are defined as the ratio between the extra costs the firm incurs moving from L O C to LOCMA x (given y and LD) and the quantity of extra local calls (LOCMA x - - L O C ) . As to the marginal costs I will rely on the arithmetic average of the values that eLOc (see Eq. (3)) assumes at L O C and LOCMA X. SC-LOC = ( c ( y , LD, LOCMAx) -- c ( y , LOC, LD))/(LOCMA x - LOC) ELoc(Y, LOC, LD)*c(y, LOC, L D ) / L O C

(5) The derivation of SC-LD is straightforward. ~5See Ergas (1987), among others, on the traditional motivations for access economies of scale.

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As far as the test of scale effects in a network is concerned, the simultaneous occurrence of scale diseconomies in extra service and scale economies in basic access should be regarded as a serious clue that network infrastructure has not exhausted the range of increasing returns to scale. Economies of scale in basic access SC-ACC can be measured as follows: S C - A C C = (G) '

(6)

3.5. E c o n o m i e s o f scope

A second quantitative evaluation tackles the scope (specialization) economies: I intend to test whether the joint provision of basic access and extra service is a source of efficiency for TLC firms. Expectations are mixed because at present the services provision is mainly internal to the 'national' carriers that still use to feed the service (and information) provision with technical skills typically spilled from the transport network operation. Therefore the identification of a carrier as a unique agent implicitly promotes a joint activity (umbrella-brand effect). The existence of these common resources would induce to hypothesize scope economies. On the other side, information process activities, typical of service provision, are likely to become more and more distant from the transport network activities. The former are associated with applications, the latter with the network hardware and the network operating system. Specialization economies could thus apply. The estimation of scope effects is not an easy work. Firstly, we are not allowed to extrapolate costs outside the admissible region to measure, say, stand-alone costs. Secondly, in order to capture the mere scope effects we would need to hold the global output levels of the industry constant. In this regard, an analytical inquiry, e.g. the study of transray convexity would need a definition of some weighted output (Baumol et al., 1982). We propose an empirical measure, the specialization economies index, SPEC, that relies on the well-known definition of 'degree of cost subadditivity' (SUB) used by Evans and Heckman (1984). SUB measures the subadditivity degree of hypothetical duopolies (firm A and firm B) with respect to the monopoly from whose breakup they derive. It is to be noted that our measure, SPEC, does not describe the transray behavior. In this regard, heterogeneity of pricing systems of different countries suggests not to use value weights to aggregate subscriptions and calls, nor an appropriate aggregate physical index seems to exist. Therefore I will measure multiproduct economies rather than pure scope economies, as other empirically appealing measures based upon SUB do (see the 'quasi' economies of scope by Pulley and Braunstein, 1992). Given the output vector of the industry, SPEC will compare two different duopolies characterized by the s a m e scale

P. Garrone / Information Economics and Policy 8 (1996) 25-50

39

at least for a subset of outputs. By contrast, SUB or the Pulley-Braunstein index use to compare efficiency of a monopoly with the efficiency of a duopoly. In other terms, I will reduce the role played by scale effects in multiproduct economies (even if I will not completely remove it). Let y = [Yl . . . . . yn] "r be the n-dimensional vector of the global output of the industry. Let A = [A~. . . . . An]T be a parallel vector of shares ranging between 0 and 1, and let A c = [ 1 - A ~ , . . . , 1-An] T be the vector of complementary shares. The firm A will provide yTA, while the firm B will provide yVAC. Given y, SUB will be defined over the space of possible monopoly partitions whom A belongs to: SUB(A) = c - c(A) - c(AC).

(7)

Specialization economies affecting the industry are defined with regard to two disjoint groups of products. Given a n-dimensional product set, let us focus upon two subsets: the first is composed by the first m outputs and the second is composed by the remaining n - m outputs. The duopolist A provides a share A of the m outputs originally supplied by the industry. He also provides a share of the remaining n - m outputs L6. The firm A turns out to provide a share A = [A1 =/x, . . . , A m = j[~, / ~ m + l = /2 . . . . , A, = u]T; the firm B will provide the complementary vector. The partitions belonging to the set that can be described by A and by the complementary vector differ only because of different degrees of specialization in the n - m outputs. The special partition characterized by ~ =/x can be regarded as the baseline of all the duopolies characterized by Al . . . . . Am -=/x. Under the base partition the vectors of outputs of firm A and firm B are fully equiproportional. Let us call the subadditivity degree of the base partition SUBBAsE(IZ ). It gives us an insight in the gain of efficiency that is achievable via a breakup on pure scale effects. A measure of the relevance of scope economies between the two groups of outputs is thus SPEC, the ratio between the subadditivity gain achieved by a specialized partition (with P C / z ) and the one achieved by the base partition (with u = # ) . If specialization is a source of efficiency SPEC(v ~ / x ) will be larger than 1: SUB(~) SPEC(~, n) = SUBBAsE(~) .

(8)

Now let me point out some features of the index in Eq.(8). Doubtless, it is an empirical measure and the information it gives is quite circumscribed. Firstly, the study of the effects of different output compositions is carried out via simulations rather than analytically, because of the algebraic complexity of SUB (Eq. (7)) and the narrowness of admissible region.

~6 1 will a s s u m e an e q u i p r o p o r t i o n a l a m o u n t of the n products for the sake of simplicity.

40

P. Garrone / Information Economics and Policy 8 (1996) 25-50

Secondly, SPEC depends on the output proportions in the early monopoly, since the base partition lies on the ray of the monopoly in the output space. Thirdly, it is not completely cleaned out by scale effects. Lastly, SPEC is also dependent on the choice of base partition, that is, on/x. With regard to the last question, some typical values can be chosen. For the sake of simplicity we can mainly focus on some typical policies of monopoly breakup. Let us analyze the symmetric partition, that is the partition with /x = 0.5. Otherwise, if the breakup of monopoly is thought as occurring via the entry of a new firm, the smallest admissible/x can be used. On the other hand, firstly, SPEC gives a synthetic insight in the efficiency degree that could be gained through specialization. Secondly, it does not need any extrapolation outside the admissible output set. Thirdly, it does not require forced aggregation between different outputs. Lastly, with respect to other subadditivity measures, the scale impact is reduced to the product-specific scale economies that firms experience by moving from a balanced output vector into a specialized one. In this application, the two groups under investigation are the network access lines and, on the other hand, the local and long-distance calls. It should be noted that in TLC industry the base partition is the duopoly accomplished by a division of the current monopolies on a geographical base. To test the (in)efficiency of joint provision of basic access and extra service in the TLC sector, we define the vector A of outputs shares of the industry provided by the fictitious duopolist A. If the outputs are [y, LOC, LD], A can be written as follows: A(/x, v) = [/x, v, v] T .

(9)

According to the foregoing notes, expectations about the value of SPEC in European TLC industries are not clear (whether it is smaller or larger than 1).

4. Empirical results 4.1. Estimation o f the cost f u n c t i o n

The estimation results for the Translog equation (Eq. (4)) are presented in Table 4. Only 8 parameters out of 44 are characterized by a confidence level below 0.99. The adjusted R-squared statistics is 0.94 for the cost function and 0.60 for the capital share 17. t7 Further insights in how the estimates perform can be derived from the cost DW statistics, since it depicts the presence of not observed individual effects in a panel ordered by individuals. The value of 1.53 is encouraging.

41

P. Garrone / Information Economics and Policy 8 (1996) 2 5 - 5 0

Table 4 Estimates of the cost function coefficients (t-statistics for zero value) Variable

Coefficient (t-statistics)

Constant y qLOC qLD PL PK G T

yxy qLOC X qLOC qt.D X qLD PL XPL PK X PK G XG TxT y x qLoc

y x qLD y X PL

-0.18 ( - 1.79) 0.96 (25.57) 4.35 (28.63) 2.07 (12.76) 0.35 (35.93) 0.65 (67.69) 1.73 (50.90)

Variable y x p• yxG y XT qLOC X qkD qtx,C X p~ q, oc × PK

qtoc X G

--

qLOC X T

0.42 (2.76) -- 10.46 (--12.60)

qLD X PL qLD X PK

-

qLD X G

--0.03 (--1.87) --0.03 (-- 1.87) -1.62 (-13.08) -0.01 ( - 1.09) 4.21 (32.87) --3.92 (--11.94) --0.09 (-- 10.92)

qtt~ × T PL X PK PL X G PL X T PK x G. PK X T G XT

Coefficient (t-statistics) 0.09 (10.92) 4.40 (70.84) --3.15 (--6.77) 0.20 (6.19) --0.20 (6.19) -3.92 (-22.39) 0.03 (1.90) 0.19 (6.89) --0.19 (6.89) 0.13 (5.15) 0.06 ( 1.87) -0.01 ( - 1.06) 0.01 (1.06) -0.08 ( - 10.83)

T h e e x c l u s i o n o f s o m e t e r m s has b e e n t e s t e d a n d i m p l e m e n t e d . F o r t h e f i r s t - o r d e r t e r m s , t h e t e c h n o l o g y level has no e x p l i c a t i v e p o w e r 18. T h e r e m a i n i n g f i r s t - o r d e r t e r m s a r e the v a l u e s o f the cost elasticities for t h e a v e r a g e E u r o p e a n c a r r i e r ( T a b l e 2). T h e y a r e significantly d i f f e r e n t f r o m z e r o a n d t h e y h a v e the e x p e c t e d sign. T h e g e o g r a p h i c c o v e r a g e of t h e c o u n t r y ( G ) t u r n s o u t to b e cost-using. This c o u l d b e c o u n t e r - i n t u i t i v e . H o w e v e r , t h e d i s t r i b u t i o n n e t w o r k is m o r e e x p e n s i v e t h a n t h e t r u n k n e t w o r k to b e o p e r a t e d , a n d t h e elasticity to G is also likely to c a p t u r e t h e i n s t a l l a t i o n a n d m a i n t e n a n c e difficulties which c h a r a c t e r i z e h i g h - d e n s i t y a r e a s . T h e e s t i m a t e o f 0.96 for the coefficient of y c o u l d i m p l y c o n s t a n t r e t u r n s to scale in basic access for a c a r r i e r with a r o u n d 8 m i l l i o n lines a n d an a v e r a g e (see T a b l e 2) i n t e n s i t y o f usage (see Eq. (3)). I n p u t s h a r e s (coefficients o f prices) s h o w t h a t e x p e n s e s for o p e r a t i o n , m a i n t e n a n c e a n d i n s t a l l a t i o n a r e still m o r e r e l e v a n t t h a n the c a p i t a l d e p r e c i a t i o n e x p e n s e s . A s far as t h e cross- a n d s e c o n d - o r d e r t e r m s a r e c o n c e r n e d , t h e n e x t s e c t i o n s will illustrate o u t p u t s i n t e r a c t i o n s a n d s e c o n d - o r d e r effects. By n o w , it is n o t e w o r t h y t h a t , firstly, t h e basic access is c a p i t a l - u s i n g , while e x t r a service p r o v i s i o n is l a b o r using. S e c o n d l y , l o w e r scale e c o n o m i e s for LSThis outcome can be explained by a possible 'steady-state efficient' nature of radical technical changes (as digitization is). The negative second term suggests that cumulative effects are at work (Garrone, 1995).

42

P. Garrone / Information Economics and Policy 8 (1996) 25-50

the basic access (given the local calls per line and the long-distance share) could emerge in regions with a higher 'coverage' (see the positive cross-term between G and y). Thirdly, the more digitized the network (a higher technology level T), the lower the scale effects of extra service are. Lastly, the cost-using effects of the geographic coverage are likely to saturate (see the negative second-order term of G); in addition, the digitization of the network seems to further lower a threshold value (see the negative crossterm between T and G).

4.2. Economies of scale As Sections 2.1 and 3.4 have underlined, sector practitioners challenge that the scale effects of the calls are different from the scale effects of the access. In the very next section I will present the empirical outcomes on the proposed measures of returns to scale. Later I will try to link the provided evidence with the experts hypotheses. First of all, let us examine scale economies related to a geographic expansion of the carrier through the index SC-ACC (Eq. (6)). Given an average intensity of service (see Table 2 for qLoc and qLD), we are allowed to extrapolate the behavior of carriers whose size ranges between 5878000 and 15051000 subscribers (well inside the observed minimum and maximum). Table 5 reports scale economies for the smallest, the average and the largest carriers of the permitted range. Fig. 1 illustrates the dependence of SC-ACC on the number of subscribers over the whole permitted range. What is the evidence on the effects of a geographic growth on the costs? For the average European carrier (Table 2), a 1.04 value has been estimated for SC-ACC, with a 0.95 confidence range equal to [0.97-1.11]. Such an outcome suggests that a network of about 8 million lines (under average operating conditions and service intensity) opens the range of carriers characterized by decreasing returns to scale in basic access. The geographic breakup of largest carriers is likely to free some efficiency for the industry, at least at given average qLOC and qLD" The column 'Geographic duopoly' of Table 6 reports the subadditivity degree (normalized to the costs of an

Table 5 Basic access scale economies (geographic expansion) Size of the netwo rk

SC-ACC

5878.29 × 10 ~ lines 8906.15 x lO S lines 15051.99 x 103 lines

1.27 1.04 0.85

P. Garrone

Information Economics and Policy 8 (1996) 25-50

43

1,2 ~

~

0,8

~

0,6 ~

0,4 0,2

0~1!~1~1111111i11]11

Idl~llqpPIIIIIIIbill]lq~ll~ll~lllllbllillllllillll~ll~ii~lllll~::~l:ll~!llllil

Fig. 1. Scale economies of network basic access. average carrier of Table 2) for two special hypothetical duopolies of the largest 'admitted' carrier (one with about 15 million access lines and proportional local calls and long-distance calls). What are the effects of a b r e a k u p of this carrier in two carriers who are equiproportional in the outputs? A symmetric partition turns out to reduce costs of the industry and an asymmetric one does the same (41% of the lines operated by one duopolist and 59% by the other duopolist). The second goal of our analysis of scale economies was the study of the efficiency characterizing carriers who mostly face a demand of extra service (e.g. D e n m a r k , The Netherlands, Sweden, or Switzerland), that is, who expand 'near-horizontally'. In Section 3.1, I sketched this case by assuming that they have fully saturated the demand for the basic access. In other words, the advanced customers of the network demand m o r e local calls or m o r e long-distance calls per line. To this aim, we estimated S C - L O C and SC-LD indexes (Eq. (5)). In Fig. 2, I present the curves of the two indexes as function of the amount of subscribers. Having checked for marginal costs and output ratios, implies a range of 6590000-14962000 lines. W h a t can we learn about scale benefits in the service provision from our results? To this purpose, an attentive exam of Fig. 2 is needed. The trend of Table 6 Subadditivity degree for typical duopolies

Symmetric partition of the network /x = 0.5 Asymmetric partition of the network/x = 0.415

Geographic duopoly ~,=/~

Near-horizontal duopoly

0.04 (v = 0.5) 0.02 (~, = 0.5)

0.06 (v = 0.59) -0.07 (v = 0.44)

44

P. Garrone / Information Economics and Policy 8 (1996) 25-50

1,2

0,8

o,~ I ' ' " " ~,

--~

~-~-W.-~-.

c

o," I

LINES [~O'B]

Fig. 2. Product-specific scale economies (near-horizontal e×pansion): Long-distance calls and local calls.

S C - L O C and SC-LD is not monotonic as the trend of SC-ACC is. As a matter of fact, the former are based on average incremental costs of local calls (or long-distance calls) and marginal costs, the latter only on marginal costs. A first evidence is that over a relevant range of operation returns to scale for long-distance calls are larger than returns to scale for local calls. This fact could be implied by the sophisticated switching software of 'toll' calls routing and billing, that could imply a special benefit for larger firms. Extra local calls (above the average value of some 900 calls per line) are never characterized by product scale economies larger than 0.8 (0.74 for the average carrier). If we focus on the neighborhood of the average carrier and on a large fraction of the admissible region, we can doubtless reject the hypothesis of increasing scale returns also for extra long-distance calls (above the average value of some 450 calls per line): a value 0.68 is estimated for the average carrier. On the other hand, between 11578000 and 12380000 lines we cannot exclude constant returns to scale for extra long-distance calls. By now, whether this feature is caused by the curvature characteristics of the Translog or by some structural event is not clear. H o w e v e r , in the following we will adopt as a synthetic measure of the two product-specific scale economies their means over the admitted range. These means are 0.75 for SC-LD and 0.69 for SC-LOC. Let us now turn to the experts view of the scale effects in the industry layers. What is the evidence on scale benefits in the provision of basic access and in the provision of the service? To some extent, expectations on different structural features in the two layers of the industry are supported by our results. As far as the Fig. 2 evidence is concerned, by now it is enough to notice that both calls-specific economies of scale are smaller than 1 over the whole

P. Garrone / Information Economics and Policy 8 (1996) 25-.5¢)

45

permitted range, even though some caveats have been raised. If we rely on the average values above presented, we can argue that economies of scale in the higher stage of the sector (service provision) are very low. If we temporarily assume that extra efficiency does not spring from the joint production of the outputs, the claim for a competitive organization for services providers seems to be supported by the empirical evidence. Policy makers are thus right when they wish market mechanisms governing the production of T L C outputs other than the access and a basic amount of calls. Given such evidence, let us now focus on Fig. 1 and on Table 5 to gain some insights in network infrastructure economies of scale. As it has been told, the effects of scale in the operation of network infrastructure are expected not to be exhausted in some small countries. Let us consider the carriers operating a network smaller than some 8 million lines. Diseconomies of scale have been shown to affect the provision of services in this range. Simultaneously, economies of scale turned out to characterize the basic access, that is to say, a balanced mix of lines and calls. T h e r e f o r e we could hardly believe that the p u r e network operation stage has exhausted the increasing returns to scale range. No clear evidence can be raised by the comparison of SC-ACC, on the one hand, and SC-LOC and SC-LD, on the other, for larger carriers. However, it seems reasonable to assume that diseconomies of scale in services coexist with diseconomies of scale in network for the largest ones (SC-ACC is equal to 0.85 for a carrier operating some 15 million lines under average operating conditions). In conclusion, as far as the network operation stage is concerned, we could claim that a widespread opinion is likely not to be fully correct, at least for some carriers. Such a view is often summarized in the expression 'the network infrastructures are still a natural monopoly'. As a matter of fact, under average operating conditions, increasing returns to scale in the network operation are likely to be at work only for small carriers, because SC-ACC is larger than 1. 4.3. E c o n o m i e s o f scope

The preceding section reported the estimates of scale economies. SCA C C estimates imply that a breakup of the current monopolies on a purely geographic base could raise the efficiency of the industry (see Fig. 1 and 'Geographic duopoly' column in Table 6). What happens if the industry moves from a geographic duopoly (two firms with a proportionate mix of outputs) into a specialized one (a near network operator and a near service provider, being 'near' implied by the need not to extrapolate stand-alone costs)? Does the sector as a whole gain some efficiency? Breaking up the average industry (Table 2) would not be fair, because of the narrow admissible area. Therefore I simulated the breakup of the largest

P. Garrone / lnJbrmation Economics and Policy 8 (1996) 25-50

46

admitted carrier. This firm is characterized by 1.69 times the outputs of the average firm: 15051000 lines, 13639 local calls, 6518 million long-distance calls. By now, let us address the monopoly partitions that have as baseline the symmetric partition (A = [0.5, 0.5, 0.5]). In the first step we separate the industry in two equal halves on a purely geographic base (symmetric partition, first row of Table 6). The corresponding subadditivity degree (normalized to costs of average carrier) is positive (0.04), as Table 6 reports. Such a breakup turns out to be efficient, under a purely allocative view. The sum of the costs of the duopolists is smaller than the cost of the former monopoly. This is a consequence of the mere scale effects and here the index SPEC is 1, by definition. Now let the duopolists specialize. In Fig. 3 we illustrate the relative gain in industry efficiency obtained by moving into the near-horizontal duopoly. It is to be compared with the 0.04 efficiency gain caused by the geographic partition (and a SPEC value equal to 1). The SPEC index increases as one of the two duopolists increases (and the other one symmetrically decreases) the provision of local and longdistance calls, with the access lines of the two firms held fixed. The admissible region allows us to extrapolate inside a range of v (ratio between baseline output and specializing output) between 0.41 and (I.59. Economies of specialization are doubtless at work. The subadditivity degree related to specialization can be 1.44 times greater than the subadditivity degree related to the 'geographic' baseline partition (see Table 6: 0.06 versus 0.(14). This happens at the most 'near-horizontal' partition (p = (I.591 that is empirically permitted. Despite of the common resources (technical skills and identity in customers mind) that still exist between the network operation and the provision of extra service, the joint production is relatively inefficient. A firm which provides more extra service increases its 1,60

~

1 O0

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080

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0,20

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d d d d d d c ; d d d 6 d d d d d 6 ~ S d 6 6 6 ¢ ~ d 6 6 d N 6 d 6 6 NI { M U

=

.51

Fig. 3. S P E C for duopolies with symmetric partition 0 ' = # = I).5) as baseline.

P. Garrone / Information Economics and Policy 8 (1996) 25-50

47

costs to a smaller degree with respect to the cost saving of the firm that increasingly focuses on network operation. Whether the 'service provider' or the 'network operator' reaps the benefits of this organizational change is not clear. Nor it is clear if specialization economies are due to pure scope effects or to product-specific scale economies. Further analyses are thus needed. In order to have a second example, we focus on an asymmetric breakup of the network (second row in Table 6). Such a case simulates the consequences of the entry of a smaller carrier in the industry, even if quite a poor approximation is allowed in our empirical framework. Always on a geographic base, we obtain again the appropriate baseline duopoly, characterized by A = [0.41, 0.41, 0.41]. The other duopolist (under the base partition) provides 59% of the three outputs. Table 6 reports that the normalized subadditivity degree for this geographic partition is positive (0.02). Once again the breakup of monopoly is cost saving for the industry, due to scale economies SC-ACC, even if to a smaller extent than with respect to the symmetric partition. Here the SPEC index is 1, by definition. As the duopolists specialize, the change in the industry efficiency is illustrated in Fig. 4, over the admitted range (u E [0.34, 0.44]). The SPEC index turns out to be asymmetrical around the geographic partition. The industry as a whole reduces costs with respect to the geographic partition only if it is the smaller network that specializes in extra traffic (the subadditivity degree is 0.05-see Table 6). Conversely, the sector efficiency is reduced if the smaller firm focuses on the network access (the subadditivity degree i s - 0.07). Such an asymmetry could be caused either by some features of the model we adopted (say, the slope of marginal costs) or by some 'true' threshold in pure scope effects. Further analyses are needed. However, it could be pointed out that monopoly naturality would be rejected by this outcome. As a matter of fact, a global subadditivity of 3,00

1,00 i

c~ -1,00

(~

6

6

6

6

6 i

-2,00

-3,00 I -4,00 NI (MU = .41)

Fig. 4. SPEC for duopolies with asymmetric partition (u = / x = (t.41) as baseline.

(5

48

P. Garrone / Information Economics and Policy 8 (1996) 25-50

cost is not confirmed, and efficient breakup paths have been identified. To summarize, if the total output of the industry is divided into two firms, it is more convenient that the smaller of the two carriers increases the production of services. Under such a pattern of growth, the empirical outcomes confirm that the joint provision of basic access and network operation seems not to be promoted by reasons of allocative efficiency. By now, let us emphasize that the efficiency increase so far guaranteed by the geographic breakups can further i n c r e a s e - g i v e n the global output vector - if the two firms specialize. More specifically, an efficient specialization pattern is available even in asymmetric duopolies.

5. Conclusion

This paper focuses on the differences between the network access and the service usage in the production structure of TLC carriers. The estimation of a cost model has shown that a sharp distinction between these two classes of T L C products provides a richer evidence. Since neither pure network operators nor pure service providers are observed, empirical outcomes are carried out by emphasizing two extreme modes of growth in European T L C industries: the geographic and the near-horizontal expansion. In the former new subscribers add to the network, and calls increase proportionately. In the latter a steady base of subscribers demands more and more services. First of all, scale benefits have been addressed. Estimates of economies of scale are aimed at empirically supporting a widespread debate on sector policies. As a matter of fact, under the assumption that allocative efficiency contributes to define optimal organization of the sector, the opinion that 'optimal' sizes are different in infrastructure operation and in service provision is widespread. Activities related to services would be characterized by decreasing returns to scale (even internally to the carrier). Two indexes for scale economies have been related to the two demand dynamics: the basic access scale economies capture the effects of a radial expansion of the T L C carrier, while the product-specific scale economies capture the effects of a growth in the higher stage of the industry (in local and in long-distance calls). The latter has been re-defined in order not to violate the approximation region of the flexible cost function. The service-specific economies turn out to be very low and the competition for extra traffic should not be prevented. At the same time, the provision of basic access would seem to be affected by scale economies in the smallest part of the operating range of European firms. Such outcomes hint that the smallest network infrastructures are characterized by increasing returns of scale. Therefore, some regulation difficulties arise by the risk of monopoly power extension into extra services in the smallest carriers.

P. Garrone / Information Economics and Policy 8 (1996) 25-50

49

If the traditional joint provision of network access and services was characterized by lower costs, a vertical restructuring of the industry (aimed at separating the service provider from the network operator) would lower the welfare. An index for multiproduct (or, conversely, specialization) economies between network subscription and services has been specified. It relies upon the cost subadditivity degree of hypothetical breakups of the monopoly. If compared with traditional measures for multiproduct economies, our index reduces the scale effects, and it does not require any severe aggregation among highly heterogeneous outputs. Given an output vector of the sector, I estimated the efficiency of a specialized duopoly (a near network operator and a near service provider) belonging to the admissible output region. There is always one specialized partition of the monopoly more efficient than the corresponding geographic partition. It is empirically confirmed that one of the necessary conditions for vertical disintegration in European TLC industries is the absence of any benefits derived from joining in an unique firm both the network and the services. There are many possible developments of this analysis. Firstly, more regularity of the functional form in the output space would allow information to be obtained for not-average industries as well. Secondly, firm goals other than allocative efficiency should be embodied in the model.

References Atherton, T., M. Ben-Akiva, D. McFadden and K. Train, 1990, Microsimulation of local residential telephone demand under alternative service options and rate structures, in: A. De Fontenay et al., eds., Telecommunications demand modelling (North-Holland, Amsterdam). Baumol, W.J., J.C. Panzar and R.D. Willig, 1982, Contestable markets and the theory of industry structure (Harcourt Brace Jovanovich, San Diego, CA). Brennan, T.J., 1987, Why regulated firms should be kept out of unregulated markets: Understanding the divestiture in United States v. AT&T, The Antitrust Bulletin (Fall), 741-793. Caves, D.W, L.R. Christensen and M.W. Tretheway, 1984, Economies of density versus economies of scale: Why trunk and local service airline costs differ, Rand Journal of Economics 15, 471-489. Evans, D.S. and J.J. Heckman, 1984, A test for subadditivity of the cost function with application to the Bell System, American Economic Review 74, 615-623. Ergas, H., 1987, Regulation, monopoly and competition in the telecommunications infrastructure, in: ICCP, trends of change in telecommunications policy (OECD, Paris). Gagn6, R., 1990, On the relevant elasticity estimates for cost structure analyses of the trucking industry, The Review of Economics and Statistics 72, 160-164. Garrone, P., 1995, The adoption of technological innovations: Dynamic and cumulative effects in telecommunications networks, Economics of Innovation and New Technology 4, forthcoming. Hansen, B., 1993, The impact of technology generations and regional aspects on the production structure in a network. A study of Norwegian Telecom, in: EARLE Conference Proceedings (EARLE, Tel Aviv).

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