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The economics of local loop architecture for multimedia services
Information Economics and Policy 10 (1998) 107–126
The economics of local loop architecture for multimedia services a, b Lorenzo Pupillo *, Andrea Conte a
Telecom Italia, Via della Vignaccia 167, 00163 Rome, Italy b Elsacom, Rome, Italy
Abstract This paper illustrates the transformation going on in the new local loop architectures for multimedia services due to new technologies, both wireline and wireless. New local loop architectures such as the hybrid fiber / coax (HFC), fiber to the curb (FTTC) and, in the future, fiber to the home / building (FTTH / B) tend to have production and economic cost characteristics that are fundamentally different from the traditional twisted pair copper distribution networks. Their scale economies tend to be lower and there are also strong indications of significant economies of scope that were not available to either telephone or cable television networks of the past. Policy implications are: (1) that it is very unlikely that a single uniform architecture will prevail in the way that twisted copper pair dominated the telephone network and coax cable dominated cable television in the past. Rather, the local loop of the future is more likely to be characterized by heterogeneous technologies. (2) We will see increased competition in the local loop due to a low probability of effective entry preemption and entry encouraged by reduced economies of scale and new economies of scope. Key words: Local loop; Economy of scale; Economies of scope; Entry preemption; Technology mix; HFC; FTTC; FTTB JEL Classification: L13; L51; L96; M21
1. Introduction The local loop is going through its most fundamental transformation in this century. New technologies, wireline as well as wireless, are at the source of this * Corresponding author. 0167-6245 / 98 / $19.00 1998 Elsevier Science B.V. All rights reserved. PII S0167-6245( 98 )00007-9
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change. The impact on industry, however, represents much more than a technological transformation. It affects not only the core of the telephony market structure but also the whole world of telecommunications where wireline telephony is converging with wireless services and cable television. As a result, it is not surprising that the local loop is increasingly becoming the focus of the government policy debate. For over half a century, the local loop was conceived as the heart of the bottleneck monopoly. This was the main argument to defend the PTTs monopoly. However, it was also the very premise upon which the divestiture of the Bell System was argued. Other segments that were considered to be competitive had to be separated from the bottleneck local loop. Only recently, new models were formulated which look at the local loop not as a bottleneck but as competitive. In this paper, we suggest that the absence of scale economies in the local loop may extend beyond wireless technologies to new local loop wireline architecture such as the hybrid fiber / coax (HFC), fiber to the curb (FTTC) and, eventually, to future fiber to the home / building (FTTH / B). These technologies tend to have production and economic cost characteristics that are fundamentally different from the traditional twisted pair copper distribution networks. Their scale economies tend to be lower. There are also strong indications that these new architectures can achieve significant economies of scope that were not available to either telephone or cable television networks in the past (cf. Johnson, 1994). The growing ability of wireless technologies to be cost competitive with the existing twisted copper pair telephony in the provision of narrowband service (up to ISDN) enables wireless providers to expand the range of service they offer to tetherless and even fixed local access in direct competition with the existing telephone networks. Moreover, the narrowband constraint of today’s wireless distribution network is expected to give way soon to competitive wide and broadband access capabilities. In the meantime, wireline technologies like FTTC or HFC can be used to offer PCS services. Wireless networks are not the only source of economies of scope in telecommunications. The convergence of telephony, wireless, and CATV enables multimedia services to be developed using combined elements of these various access technologies. Economies of scope mean that customers will be increasingly able to satisfy multimedia needs through any of a number of suppliers from formerly distinct industries.
1.1. Outline of the paper In Section 2 we will present the different local loop network architectures in some detail. In Section 3, we will assess the economics of these transformations in the local loop with the help of economic models developed to evaluate different network architectures and plan investment for broadband networks. In Section 4, economic cost characteristics will be discussed focusing on the
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new role played by variable costs (electronics / optronics) in the most promising network architectures proposed for local access today. Section 5 will discuss the policy implications of the preceding analysis.
2. Description of the network architectures This section describes different network architectures that are able to support a set of similar broadband and narrowband multimedia services. Descriptions of the different architectures are based on proposals by Telecom Italia suppliers and focus on macro-architectural structures. These proposals take into account the actual network situation in terms of preexisting infrastructure and installed base in areas served by Telecom Italia. Due to the continuous updating in access technologies, the following description cannot exhaust all the possible local loop architectures. It focuses only on the ones most relevant when the analysis was carried out, at the end of 1996, and tries to emphasize their economics. However, the trends in technology seem to reinforce the results of our analysis.1 All the architectures described here can support multimedia services with inherently different levels of quality. Therefore, we assume that such differences (i.e the difference in term of quality of service between a PPV service offered on a HFC network and a PPV service on an FTTE network) in performances are known. A technical comparison in terms of quality and cost-effectiveness is outside the scope of this work. To ensure comparability of service offerings for purposes of comparison, the following architectural descriptions will also include the hardware and software elements necessary to support interactive services and integrate the existing POTS services. This choice does not exclude the possibility that some technical problems could occur in the progressive network up-grading to support IMM and POTS services. It is beyond the scope of this work to validate the technical feasibility of such upgrading on live networks.
2.1. Hybrid fiber-coaxial ( HFC) architecture A number of optic fiber cable-based architectures have been deployed by different Telecom and cable operators around the world. However, the network architectures originating from different starting points have resulted in a large variety of similar HFC structures, but with quite different costs and topology. The 1
In the FTTE (fiber to the exchange) architecture the variable costs assumes values .70% of the total cost per connected user.
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following HFC architecture reflects the possible implementation in three stages of a full service network in Italy, on the base of the existing installed network: 1. the first step is distributive video services; 2. the second step is IMM and on-line services introduction; 3. the last step is the integration of the POTS service over the HFC network. There is a common consensus (cf. Reed, 1992) that these HFC networks provide the potential for upgrading to interactive digital networked services. Fig. 1 shows the likely architecture of a HFC system and its key components. A HFC network is potentially able to support the following services: 1. analogue distributive (Pay TV) services; 2. digital distributive services (including hundreds of MPEG compressed video channels); 3. digital interactive services; 4. PSTN services. A HFC network employs fiber and coaxial cable to reach the customer’s premises. The key technical feature of a HFC network is that all the information delivered over the network reaches all the network users. This resource sharing has some security implications (e.g. potential limitation for the security of the high quality communication services).
Fig. 1. HFC system (hybrid fiber coax).
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Analog (PAL 8 MHz) and digital (MPEG2 6 Mbit / s) video channels will be deployed in the downstream bandwidth (54–862 MHz). The allocation of frequencies to provide broadcast, interactive and PSTN services is: 1. 54–470 MHz broadcast (analog and digital); 2. 470–862 MHz (downstream for interactive services). The bandwidth 5–30 MHz is available for signalling in the starting phase of the project and will be used for up-stream channels and POTS services in the following years.
2.1.1. HFC for distributive services With the initial configuration the main service to be provided will be analogue and digital video channels. These will be sent from the head-end throughout the network via a distribution node (DN). A DN is the first topological element of the network for broadcast services. DNs will receive all the broadcast signals from the head ends (HE) of the service providers. All these channels will be distributed over local nodes (LN). The LN will receive the signals from DN and retransmit these signals to the fiber node (FN) located in the coverage area. With an analogue PAL TV channel requiring 8 MHz, this means that, in practice, up to 50 channels could be provided in the bandwidth 54–470. A key feature of the architecture is the provision of a backchannel of about 50 MHz. This is likely to be used for responses from the set-top-box. Furthermore, it might allow a menu driven system for ordering ‘pay per view’ movies or other distributive services. The back channel can also be used to enable the headend to ‘poll’ the stored set-top units for data that relate, for instance, to ordering ‘pay-per-view’ movies. The system employs a ‘bus’ architecture. That is to say that each household does not have a dedicated cable but shares the bandwidth — a very large one (862 MHz) — on the cable with other households. This type of network is similar to that employed in cable TV systems and is used widely by cable operators with considerable operational experience. The video signals then pass to the home where they are received and processed by a set-top-box. Initially, up to about 400 homes could be serviced on each fiber node, but as the network is upgraded to provide interactive services, more cable FNs could be introduced to provide more bandwidth per household. For broadcast TV, where every household receives the same signals, there are enough available channels. However, where customers need a dedicated channel, there will be a limit to the number of dedicated channels in the 470–862 bandwidth. Thus, the number of FNs will increase from 1 per 400 houses to 1 to 300–350 homes.
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2.1.2. HFC for interactive services Upgrading the system to provide interactive services involves the use of the 50 MHz backchannel at the local node. The sizing of the network presents some problems, since the capacity and reliability requirements of future services are still not well understood. At present, there is no standard model for such networks. However, an assumption of 25% simultaneous access for IMM services at the peak hour was made.
2.1.3. HFC integration of telephony and broadband services One possible scenario for the final upgrade of the HFC network is its full integration into a broadband PSTN. However, although some examples (e.g. Scientific Atlanta) are available at the moment, the technical and economic effectiveness of such integration are still to be demonstrated (at least in the long term).
2.2. HFTTB architecture While the HFC solution is generally considered the best solution to provide analog and, perhaps, digital, broadcasting services, its suitability for IMM and POTS services is still under discussion among telecom operators. Also, if we consider that most of the common costs (for broadcasting, IMM and PSTN services) are civil engineering costs (including ducts), one possibility for building up an architecture to be upgraded in order to support more advanced services in the near future for business and consumer market purposes is the HFTTB. This architecture consists in the overlapping of a PON (passive optical network) with a HFC network. The major impact in terms of services is that the 622 bit / s downstream link (via ATM PON) and the 155 bit / s upstream link ensure enough bandwidth to provide full bi-directional interactive services. The economic evaluation of this solution was assessed by considering a parallel passive optical network co-located with the HFC network. Specifically, the additional costs considered are highlighted in Fig. 2. A HFTTB network is able to support the following services: 1. 2. 3. 4.
analog and digital video channels; on-line data services; interactive video services; full bi-directional communication services (including POTS).
All the broadcasting services will be provided via the HFC network, all the others using the PON.
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Fig. 2. HFTTB system (hybrid fiber to the building).
2.3. FTTC architecture One of the main considerations made about HFTTB is that when the time to provide analog broadcasting services is not a critical issue — there is a temporal lag that distances the current proposal from a mature FTTC technology — for the market, there is a viable solution: the FTTC network (fiber to the curb). The main difference between the parallel HFTTB and the FTTC network is that all the channels, distributive or interactive, will be handled as interactive channels. From the architectural point of view, the last 200 m, from the curb to the building, will be covered using copper pairs and VDSL modems (51 Mbit / s), downstream. As highlighted in Fig. 3, the basic philosophy of this architecture is that all the signals (broadcasting or interactive) will be collected at an LN level that corresponds ideally to a local switch of the PSTN. To evaluate the viability of this kind of architecture for both broadcasting and IMM services, the impact that the signalling traffic generated by broadcasting services (e.g. zapping) may have, still remains to be analyzed in further detail. However, to finalize the economic evaluation, some assumptions on the network size and its costs were made. The FTTC architecture is able to support the following services:
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Fig. 3. FTTC system (fiber to the curb).
1. 2. 3. 4.
digital video channels (with selection at network level); on-line services; interactive video services; bi-directional symmetrical services (including POTS).
2.4. MMDS /LMDS architecture MMDS offers the cheapest platform for broadcast services that can be rolled out very quickly. In the following section, a bundled offering of broadcasting as well as IMM services will be considered. The approach of an MMDS / LMDS network is resource sharing very similar to the HFC. In this case, also, all the information delivered by the antenna reaches all the customers. Referring to Fig. 4, the LMDS system consists of a DN with similar characteristics to the DN mentioned in HFC architecture. The signals transmitted by the antenna will be received at the premises level with a cost. The coverage of the radio cell could be made with omnidirectional antennas or directive antennas, depending on the radio, just as in the IMM implementation on HFC networks; some of the distributive channels could be directly addressed to the end users. The selection of such IMM channels is implemented via the signalling
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Fig. 4. LMDS system.
generated by the user’s set-top-box, routed to the video server (not included in the evaluation). Among all the architectures mentioned above, the LMDS for IMM services is the least mature, since the reliability of this architecture is strictly related to the use of the existing copper network for the return path. In addition to that, the implementation plan for an IMM network that uses radio access is not feasible in urban areas because of the antennas’ environmental impact (high frequencies, number of antennas, etc.). Another important issue to be addressed is the availability of frequencies. For the Italian scenario the possibilities considered were 28 or 40 GHz, in compliance with the Italian Regulatory framework. The MMDS / LMDS architecture is able to support the following services: 1. digital broadcasting channels; 2. IMM services (return path via PSTN); 3. on-line services (using MPEG for downstream and PSTN for return path). Both digital broadcasting channels and interactive channels are distributed in the same manner. However, in the case of IMM and on-line services, the channel selection will be made at the set-top-box level using addressable set-top-boxes. The signalling was implemented with a PSTN return path.
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3. Economic models This section presents the methodology and the specific assumptions made to evaluate the cost comparisons and the economics of the previously presented network architectures when they are deployed to carry broadcasting, interactive and on-line services and telephony. The aim of this description is to highlight all the key elements at the basis of economic evaluation. The approach of this paper involves the costs estimation of each architecture’s various components. The cost per connected home is considered as a standardized unit of analysis for cost comparison. This cost was calculated as follows: I O ]]] (1 1 w) Investment per home connected: ]]]] C O ]]] (1 1 w) t
i
i
i 51 t
(1)
i
i
i 51
where I is the specific and common investments per year, Ci is the connected homes per year, w is the W.A.C.C. (weighted average cost of capital), and t is the business plan period. Estimates were made of the likely changes in cost components over time and between different geographic areas. Assuming that the cabling will start in high density areas before low density and rural areas, cost estimates for all the households in different geographic areas were assessed on the basis of a spreadsheet model. The expression (1) is a more effective way of evaluating the economics and making comparisons than the use of the standard cost per ‘home passed’, since this concept is not objective and depends on several factors: technology, time to ‘upgrade’ a passed home to a connected home, etc. Moreover, the expression (1) considers the actual network revenue streams independently from the technology. Finally, the mentioned expression takes into account not a single year, but all the business plan period and emphasizes the financial effect in the calculation of the cost per ‘home connected’. The cost estimates were calculated as an average of confidential sources (Vendors) and official sources such as media reports and catalog studies (cf. Egan, 1991). Caution should be exercised in using the estimates presented. Furthermore, it should be noted that all the cost comparisons were developed considering a fixed HOME PASSED profile and varying the percentage of connected homes. As for the services’ availability over the different platforms, it should be noted that since the performance of the system is expected to be largely different, all the dimensioning (number of transmitters, number of customers per fiber node, etc.) was made to minimize such differences. In other terms, the actual differences due to different technologies in the services offered were compensated in part by an appropriate dimensioning of the networks (in order to have a certain block
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probability for concurrent access to the same content in a HFC network, the number of customers per FN has been reduced from 800 to 300–400). The cost comparison for both IMM and broadcasting services is assessed on the basis of different penetration scenarios. The economic evaluation for broadcasting and IMM services is made on the basis of the architecture to deploy broadcasting services only and the additional costs to extend such networks for IMM services. The allocation of the common costs between IMM and broadcasting services is based on homes connected per service. For IMM services subscribers, the dimensioning of the devices is calculated under the assumption that 25% of subscribers seek simultaneous and concurrent access to the video or IP server in the peak hour (as already specified).
3.1. Specific assumptions for each architecture Firstly, it must be stressed that 100% of wireline and cable plant is underground.
3.1.1. HFC For this architecture the following cost elements are considered for broadcasting services. 3.1.1.1. Distribution node ( DN) DN is the first topological element of the network for broadcast services: 1. 2. 3. 4. 5. 6.
analog matrix; combiner; monitoring and control; AM modulators; 64QAM modulators; splitters. All the installation charges and other civil costs are considered.
3.1.1.2. Links DN–LN Each DN will be linked with up to 32 LN. Each link length varies from 15 to 40 km, depending on the level of density of the area to be covered. For each fiber link between DN and LN the following costs are taken into account: 1. 2. 3. 4. 5. 6.
civil engineering costs; percentage of reuse of the infrastructure (only ducts); installation of the fiber inside the ducts; percentage of reuse of fibers; percentage of the total length used for multiple fibers; the average number of fibers for each duct.
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3.1.1.3. Connectors, etc. The values of all these parameters depend on the density of the area and the level of reuse of existing infrastructures. 3.1.1.4. Local node As shown in Fig. 1, the LN will receive the signals from DN and re-transmit these signals to the FN (fiber node) located in the coverage area. In terms of costs the following items are considered at LN level: 1. 2. 3. 4. 5. 6.
receivers from DN; optical receiver from FN (for up-stream channels); transmitters; passive splitters; passive optical devices; others.
Additional common costs and installation charges are included in the cost evaluation.
3.1.2. IMM The interactive and POTS services will be inserted at the local node level. Other specific costs were included for the network upgrading for IMM services: a simultaneous 64QAM modulator for each 16 VOD channels, connection management controller (to handle all the signals from QPSK modulators), ATM matrix interfaces, splitters, receivers, QPSK modulators, combiner system, etc. 3.1.3. POTS To provide POTS services, other specific costs are included in the calculation (optical transmitters, one for each FN, QPSK modulators, etc.). 3.1.3.1. Link LN–FN Up to four FN will be connected on each optical loop. The specified parameters are the same as the above mentioned ones for the link DN–LN. 3.1.3.2. Fiber node The FN receives the optical signal from the LN and performs the opticalelectronic conversion. Up to 300–350 users will be connected at each FN, depending on the density of the area. The FN will be installed in the center of the serving area. To estimate the FN costs, a total bundled cost provided by the suppliers was considered. It includes electronic devices (e.g. launch amplifier) and passive devices. Also, civil engineering and installation costs were added.
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3.1.3.3. Link FN–TAP Each FN will be connected with up to 16 TAP (average), one amplifier and related container were considered for each coaxial link. The length of this link varies from 200 to 250 m. 3.1.3.4. TAP This is the last topological element and is located at the building basement. The TAPs are completely passive for broadcasting provisioning services, while active electronics (NIU, containing QPSK modem, etc.) were considered for IMM and POTS services. 3.1.3.5. Vertical links A star topology was assumed to link the TAP to the customer premises with coaxial links. Common costs: 1. for HFC architecture, the vertical link (MDU) was split with 50% for broadcasting services and the remaining 50% for IMM services, including also the specific costs.
3.1.4. HFTTB The most significant elements of the cost model are: 1. additional OLT-ONU in the local node, 1 for FN; 2. additional splitters and combiners in the FN (to reuse the existing fibers in the link LN–FN); 3. installation of additional fibers between FN and TAP; 4. installation of ATM-ONU (including specific cards for IMM and POTS users) at the TAP level. Specific interfaces must be considered for the interconnection with the existing PSTN. As will be examined further on, in the cost comparison section, it is evident that the electronics costs (cards, ONU, etc) per user are now substantially increased in comparison to HFC: this increase confirms the increasing role the variable costs are playing in the new local loop architectures, thus, reducing the scale economies of the traditional local loop. For HFTTB, no cost allocation for vertical link was made, since two separate supports were used for IMM and broadcasting services.
3.1.5. FTTC To finalize the economic evaluation of the FTTC solution, only digital video channels were considered with the exclusion of all the analog chains in the
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HFTTC network and the inclusion of the switched digital video electronics. In particular, on the basis of the topology described for the HFTTB (LN–FN), the link costs are the same as for the parallel PON of HFTTB, with the exclusion of the last 200 m from FN to the home. The use of the VDSL cards at the FN level (here FN is only a topological reference, since the FN functionalities were implemented using FN cards at the ONU level) results in a larger investment in distributed electronics (‘at the premises level’). The increments in the maintenance cost related to this kind of architecture were also considered. The specific electronics are the following: 1. 2. 3. 4. 5.
video switch at LN level; ATM-ONU at FN level; PSTN, ISDN, VOD, FN (for broadcasting channels) cards; VDSL cards; others (rack, box, etc.).
In this case, a typical fixed cost (the coaxial cable) was eliminated and more variable costs (cards, video switch, etc.) were introduced. For FTTC, the copper re-use of the existing plant was considered at no cost.2
3.1.6. LMDS and MMDS The model assumption is that, only 75% of the passed homes are in maximum visibility.3 The cost evaluations were considered for the two assumptions of 40.5 GHz and 28.5 GHz. The total digital channels available are 144, of which 44 are allocated to broadcasting and the other 100 to simultaneous access to IMM services. Assuming, finally, that the antennas will be connected to the LN, via a 4-km fiber optic link, the more relevant (additional) specific costs are: 1. 2. 3. 4.
transmitters; antennas; antenna at building level (for 20 customers); vertical link (building).
2
In this case, from a methodological point of view, the evaluation is not strictly correct. A rigorous evaluation should require at least a cost allocation for the copper network usage. However, this proxy is balanced by the omission of the savings due to the network PSTN integration that were considered in the other cases. 3 The percentage of homes in maximum visibility is the result of statistics on urban coverage for an average Italian city. The other buildings are assumed to receive a reduced level of signal yet still acceptable for at least 85–90% of the homes. Better performances in terms of visibility would imply significant cost increments.
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Antenna installation costs are relevant because of the environmental impact of such installations.
4. Economics of local loop architectures This section will assess the current economics of local loop transformations. It is based on the results of the economic models evaluating different network architectures and broadband network plan investments and on the comparison of the different average cost functions calculated using expression (1). As mentioned above, the following curves highlight the cost trend in the case of a fixed similar ‘home passed profile’ with variation of the connected homes percentage. Due to the confidentiality of the sources employed for the estimation, only relative cost could be presented in the paper. The investment axis indicates an index not usable as an absolute value. Fig. 5, Fig. 6, Fig. 7 and Fig. 8 show different average cost functions for different network architectures and services. Starting from Fig. 5 showing the investments per home connected for broadcasting services, it is clear that while the average cost function for copper plant is strictly decreasing, thus, showing economies of scale over all of the possible output range, all the other cost functions exhibit different slopes and different degrees of scale economies. More precisely, the more we move towards architectures with a higher percentage of electronics (FTTC, Radio LMDS) the lower are the economies of scale.
Fig. 5. Investments per home connected (broadcasting services). Comparison with copper plant for POTS only.
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Fig. 6. Investments per home connected (IMM services). Comparison with copper plant for POTS only.
This pattern is clearer, if we look at Fig. 6, which shows investments per home connected for IMM services, and Fig. 7, which presents the investments in civil engineering per home connected. While the first one demonstrates the major role played — as demand varies in this type of services offering — by variable costs (electronics and optronics) and
Fig. 7. Investment in civil engineering per home connected.
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Fig. 8. Scope economies: investments per home connected (HFTTB).
points out the increase in the spread of the average functions, the reduction of scale economies for the FTTC type of architecture and the elimination of this effect for the LMDS solution, the second one shows that scale economies in the local loop remain in the civil engineering costs, especially for some network architectures like HFC. The most significant impact of the new economics of the local loop is outlined in Fig. 8 that shows how, for a HFTTB network, the cost of a joint offer of broadcasting and interactive services on the same network is lower than the costs of offering each service on a separate network (economies of scope). In addition, in our modeling, it appears that there may be also economies in the maintenance costs of one network instead of two.
5. Policy implications This section discusses the numerous policy implications of this analysis. Firstly, it is very unlikely that, in today’s competitive environment, a single uniform architecture will prevail in the way, over the century, twisted copper pair dominated the telephone network and the coax cable dominated cable television. The single technology solution was based on the old paradigm that maximizing network efficiency will automatically maximize customer value. Today, this approach is challenged by different factors:
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1. different carriers (CATV vs. TELCOs, etc.) seem to have different strategies; 2. there is a much higher level of technological uncertainty associated with the new architectures than in the past; 3. there is a different evaluation among carriers of the technology evolution; 4. competition is expected to take different forms; 5. the market appears to be fairly segmented by a range of services and willingness to pay for them. It follows that successful operators in the future will be able to manage a portfolio of technologies which best respond to the particular needs of various customer segments. Furthermore, the increasing role of variable costs in the new local loop architectures with the subsequent reduction in scale economies makes the technology mix solution more suitable to the multimedia market structure. Fig. 9 summarizes all the possible alternatives for multimedia services available to the different operators. Secondly, the biggest policy implication of the new local loop architectures will be the increased competition in the local loop, because of the low probability of effective entry preemption. In fact, while the decrease in economies of scale facilitates entry, the increase in economies of scope creates incentives to offer a new range of services through which entrants can differentiate themselves from dominant operators, since, very often, the newcomers plan to offer video, telephony, internet access and data transmission on the same network.
Fig. 9. A technology mix by operators.
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The issue of the entry deterrence through preemptive investment needs some additional comments. Shankerman (1996) refers to preemptive investment as a strategy where ‘entry by one firm makes subsequent entry by others unprofitable and thereby forecloses the market’. Moreover, he states that the entry deterrence requires a number of preconditions. Firstly, there must be an indivisible sunk entry cost (threshold scale).4 Secondly, the market should be too small to support more than one incumbent profitably at the threshold scale. Thirdly, for multiproduct incumbents there must be a sunk cost to exit.5 Given these considerations, it seems to us that the economics of the new local loop architectures make this strategy much less effective. In fact, because of the new role played by electronics and optronics, the new flexibility of these architectures definitely lowers the threshold scale, for penetrations greater than 20% and especially for interactive services offerings. Moreover, because of the different sources of revenue related to the mix of product offerings, the economies of scope that characterize these architectures make it easier to support more than one firm and make more viable a multiproduct offering.
6. Summary and conclusions The results of this analysis clearly illustrate the transformations going on in the new local loop architectures for multimedia services. New technologies, wireline as well as wireless, are the source of this change. While for over half a century, the local loop was conceived as the heart of the bottleneck monopoly the new local loop architectures such as the hybrid fiber / coax (HFC), fiber to the curb (FTTC) and, eventually, future fiber to the home / building (FTTH / B) tend to have production and economic cost characteristics that are fundamentally different from the traditional twisted pair copper distribution networks. Their scale economies tend to be lower because of the new role played by variable costs (electronics and optronics). There are also strong indications that these new architectures can achieve significant economies of scope that were not available to either telephone or cable television networks of the past. These results have interesting policy implications that are easily summed up in two main issues. Firstly, it is very unlikely that, in today’s competitive environment, a single uniform architecture will prevail in the way twisted copper pair 4
It is important to notice that Shankerman emphasizes that the initial entry commitment to be credible requires a level of sunk costs that cannot be easily replicated by a new entrant (threshold level). If this is not the case, subsequent entry can occur at a smaller scale and preemption will be ineffective. 5 If there was no exit cost for a multiproduct incumbent, for example for product one, entry by a second firm in this market will create price competition that reduces incumbent profits. Therefore, it can be more profitable for the incumbent to exit rather than to compete. It is clear that in this case the preemption investment strategy will not have credible entry-deterrence effects.
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dominated the telephone network and coax cable dominated cable television over the past century. The local loop of the future is more likely to be characterized by heterogeneous technologies. As a result, the inevitable competition will lead the successful operators to adopt most, if not all, of the forthcoming access technologies. Secondly, increased competition in the local loop will be the biggest policy implication because of low probability of effective entry preemption. On the one hand, the decrease in economies of scale facilitates entry; on the other hand, the increase in economies of scope creates incentives to offer a new range of services through which entrants can differentiate themselves from dominant operators. 8. Notation ADSL, asymmetric digital subscriber line; ATM, asynchronous transfer mode; DBS, direct broadcast satellite; FTTC, FTTK, fiber to the kerb; FTTCab, fiber to the cabinet; FTTE, fiber to the exchange; FTTH, fiber to the home; FTTP, fiber to the pole; HFC, hybrid optic fiber — coaxial cable; HFTTB, hybrid optic fiber — coaxial cable to the building; IMM, interactive multimedia services; IN, intelligent network; ISDN, integrated services digital network; LAN, local area network; MMDS, multichannel multipoint distribution system (microwave technology); MPEG, motion pictures expert group; ONU, optical network unit; PDH, plesiosynchronous digital hierarchy; POTS, plain old telephone services; PSTN, public switched telephone network; QAM, quadrature amplitude modulation; SDH, synchronous digital hierarchy; SONET, synchronous optical network; VOD, video-on-demand
Acknowledgements The views expressed here do not necessarily represent Telecom Italia and Elsacom standpoints on these issues. This work was done when Andrea Conte was a Telecom Italia employee. We thank Alain de Fontenay for bringing our attention to these issues and Stefano Parisse and Vincenzo Scarlato for helpful comments. All the remaining errors are ours. References Egan, B.L., 1991. Information Superhighways: The Economics of Advanced Public Communication Networks. Artech House, Boston. Johnson, L.L., 1994. Toward Competition in Cable Television. MIT Press, Cambridge MA. Reed, D.P., 1992. Residential Fiber Optic Networks, An Engineering and Economic Analysis. Artech House, Boston. Shankerman, M., 1996. Symmetric regulation for competitive telecommunications. Information Economics and Policy, 8, 1996.
The economics of local loop architecture for multimedia services a, b Lorenzo Pupillo *, Andrea Conte a
Telecom Italia, Via della Vignaccia 167, 00163 Rome, Italy b Elsacom, Rome, Italy
Abstract This paper illustrates the transformation going on in the new local loop architectures for multimedia services due to new technologies, both wireline and wireless. New local loop architectures such as the hybrid fiber / coax (HFC), fiber to the curb (FTTC) and, in the future, fiber to the home / building (FTTH / B) tend to have production and economic cost characteristics that are fundamentally different from the traditional twisted pair copper distribution networks. Their scale economies tend to be lower and there are also strong indications of significant economies of scope that were not available to either telephone or cable television networks of the past. Policy implications are: (1) that it is very unlikely that a single uniform architecture will prevail in the way that twisted copper pair dominated the telephone network and coax cable dominated cable television in the past. Rather, the local loop of the future is more likely to be characterized by heterogeneous technologies. (2) We will see increased competition in the local loop due to a low probability of effective entry preemption and entry encouraged by reduced economies of scale and new economies of scope. Key words: Local loop; Economy of scale; Economies of scope; Entry preemption; Technology mix; HFC; FTTC; FTTB JEL Classification: L13; L51; L96; M21
1. Introduction The local loop is going through its most fundamental transformation in this century. New technologies, wireline as well as wireless, are at the source of this * Corresponding author. 0167-6245 / 98 / $19.00 1998 Elsevier Science B.V. All rights reserved. PII S0167-6245( 98 )00007-9
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change. The impact on industry, however, represents much more than a technological transformation. It affects not only the core of the telephony market structure but also the whole world of telecommunications where wireline telephony is converging with wireless services and cable television. As a result, it is not surprising that the local loop is increasingly becoming the focus of the government policy debate. For over half a century, the local loop was conceived as the heart of the bottleneck monopoly. This was the main argument to defend the PTTs monopoly. However, it was also the very premise upon which the divestiture of the Bell System was argued. Other segments that were considered to be competitive had to be separated from the bottleneck local loop. Only recently, new models were formulated which look at the local loop not as a bottleneck but as competitive. In this paper, we suggest that the absence of scale economies in the local loop may extend beyond wireless technologies to new local loop wireline architecture such as the hybrid fiber / coax (HFC), fiber to the curb (FTTC) and, eventually, to future fiber to the home / building (FTTH / B). These technologies tend to have production and economic cost characteristics that are fundamentally different from the traditional twisted pair copper distribution networks. Their scale economies tend to be lower. There are also strong indications that these new architectures can achieve significant economies of scope that were not available to either telephone or cable television networks in the past (cf. Johnson, 1994). The growing ability of wireless technologies to be cost competitive with the existing twisted copper pair telephony in the provision of narrowband service (up to ISDN) enables wireless providers to expand the range of service they offer to tetherless and even fixed local access in direct competition with the existing telephone networks. Moreover, the narrowband constraint of today’s wireless distribution network is expected to give way soon to competitive wide and broadband access capabilities. In the meantime, wireline technologies like FTTC or HFC can be used to offer PCS services. Wireless networks are not the only source of economies of scope in telecommunications. The convergence of telephony, wireless, and CATV enables multimedia services to be developed using combined elements of these various access technologies. Economies of scope mean that customers will be increasingly able to satisfy multimedia needs through any of a number of suppliers from formerly distinct industries.
1.1. Outline of the paper In Section 2 we will present the different local loop network architectures in some detail. In Section 3, we will assess the economics of these transformations in the local loop with the help of economic models developed to evaluate different network architectures and plan investment for broadband networks. In Section 4, economic cost characteristics will be discussed focusing on the
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new role played by variable costs (electronics / optronics) in the most promising network architectures proposed for local access today. Section 5 will discuss the policy implications of the preceding analysis.
2. Description of the network architectures This section describes different network architectures that are able to support a set of similar broadband and narrowband multimedia services. Descriptions of the different architectures are based on proposals by Telecom Italia suppliers and focus on macro-architectural structures. These proposals take into account the actual network situation in terms of preexisting infrastructure and installed base in areas served by Telecom Italia. Due to the continuous updating in access technologies, the following description cannot exhaust all the possible local loop architectures. It focuses only on the ones most relevant when the analysis was carried out, at the end of 1996, and tries to emphasize their economics. However, the trends in technology seem to reinforce the results of our analysis.1 All the architectures described here can support multimedia services with inherently different levels of quality. Therefore, we assume that such differences (i.e the difference in term of quality of service between a PPV service offered on a HFC network and a PPV service on an FTTE network) in performances are known. A technical comparison in terms of quality and cost-effectiveness is outside the scope of this work. To ensure comparability of service offerings for purposes of comparison, the following architectural descriptions will also include the hardware and software elements necessary to support interactive services and integrate the existing POTS services. This choice does not exclude the possibility that some technical problems could occur in the progressive network up-grading to support IMM and POTS services. It is beyond the scope of this work to validate the technical feasibility of such upgrading on live networks.
2.1. Hybrid fiber-coaxial ( HFC) architecture A number of optic fiber cable-based architectures have been deployed by different Telecom and cable operators around the world. However, the network architectures originating from different starting points have resulted in a large variety of similar HFC structures, but with quite different costs and topology. The 1
In the FTTE (fiber to the exchange) architecture the variable costs assumes values .70% of the total cost per connected user.
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following HFC architecture reflects the possible implementation in three stages of a full service network in Italy, on the base of the existing installed network: 1. the first step is distributive video services; 2. the second step is IMM and on-line services introduction; 3. the last step is the integration of the POTS service over the HFC network. There is a common consensus (cf. Reed, 1992) that these HFC networks provide the potential for upgrading to interactive digital networked services. Fig. 1 shows the likely architecture of a HFC system and its key components. A HFC network is potentially able to support the following services: 1. analogue distributive (Pay TV) services; 2. digital distributive services (including hundreds of MPEG compressed video channels); 3. digital interactive services; 4. PSTN services. A HFC network employs fiber and coaxial cable to reach the customer’s premises. The key technical feature of a HFC network is that all the information delivered over the network reaches all the network users. This resource sharing has some security implications (e.g. potential limitation for the security of the high quality communication services).
Fig. 1. HFC system (hybrid fiber coax).
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Analog (PAL 8 MHz) and digital (MPEG2 6 Mbit / s) video channels will be deployed in the downstream bandwidth (54–862 MHz). The allocation of frequencies to provide broadcast, interactive and PSTN services is: 1. 54–470 MHz broadcast (analog and digital); 2. 470–862 MHz (downstream for interactive services). The bandwidth 5–30 MHz is available for signalling in the starting phase of the project and will be used for up-stream channels and POTS services in the following years.
2.1.1. HFC for distributive services With the initial configuration the main service to be provided will be analogue and digital video channels. These will be sent from the head-end throughout the network via a distribution node (DN). A DN is the first topological element of the network for broadcast services. DNs will receive all the broadcast signals from the head ends (HE) of the service providers. All these channels will be distributed over local nodes (LN). The LN will receive the signals from DN and retransmit these signals to the fiber node (FN) located in the coverage area. With an analogue PAL TV channel requiring 8 MHz, this means that, in practice, up to 50 channels could be provided in the bandwidth 54–470. A key feature of the architecture is the provision of a backchannel of about 50 MHz. This is likely to be used for responses from the set-top-box. Furthermore, it might allow a menu driven system for ordering ‘pay per view’ movies or other distributive services. The back channel can also be used to enable the headend to ‘poll’ the stored set-top units for data that relate, for instance, to ordering ‘pay-per-view’ movies. The system employs a ‘bus’ architecture. That is to say that each household does not have a dedicated cable but shares the bandwidth — a very large one (862 MHz) — on the cable with other households. This type of network is similar to that employed in cable TV systems and is used widely by cable operators with considerable operational experience. The video signals then pass to the home where they are received and processed by a set-top-box. Initially, up to about 400 homes could be serviced on each fiber node, but as the network is upgraded to provide interactive services, more cable FNs could be introduced to provide more bandwidth per household. For broadcast TV, where every household receives the same signals, there are enough available channels. However, where customers need a dedicated channel, there will be a limit to the number of dedicated channels in the 470–862 bandwidth. Thus, the number of FNs will increase from 1 per 400 houses to 1 to 300–350 homes.
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2.1.2. HFC for interactive services Upgrading the system to provide interactive services involves the use of the 50 MHz backchannel at the local node. The sizing of the network presents some problems, since the capacity and reliability requirements of future services are still not well understood. At present, there is no standard model for such networks. However, an assumption of 25% simultaneous access for IMM services at the peak hour was made.
2.1.3. HFC integration of telephony and broadband services One possible scenario for the final upgrade of the HFC network is its full integration into a broadband PSTN. However, although some examples (e.g. Scientific Atlanta) are available at the moment, the technical and economic effectiveness of such integration are still to be demonstrated (at least in the long term).
2.2. HFTTB architecture While the HFC solution is generally considered the best solution to provide analog and, perhaps, digital, broadcasting services, its suitability for IMM and POTS services is still under discussion among telecom operators. Also, if we consider that most of the common costs (for broadcasting, IMM and PSTN services) are civil engineering costs (including ducts), one possibility for building up an architecture to be upgraded in order to support more advanced services in the near future for business and consumer market purposes is the HFTTB. This architecture consists in the overlapping of a PON (passive optical network) with a HFC network. The major impact in terms of services is that the 622 bit / s downstream link (via ATM PON) and the 155 bit / s upstream link ensure enough bandwidth to provide full bi-directional interactive services. The economic evaluation of this solution was assessed by considering a parallel passive optical network co-located with the HFC network. Specifically, the additional costs considered are highlighted in Fig. 2. A HFTTB network is able to support the following services: 1. 2. 3. 4.
analog and digital video channels; on-line data services; interactive video services; full bi-directional communication services (including POTS).
All the broadcasting services will be provided via the HFC network, all the others using the PON.
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Fig. 2. HFTTB system (hybrid fiber to the building).
2.3. FTTC architecture One of the main considerations made about HFTTB is that when the time to provide analog broadcasting services is not a critical issue — there is a temporal lag that distances the current proposal from a mature FTTC technology — for the market, there is a viable solution: the FTTC network (fiber to the curb). The main difference between the parallel HFTTB and the FTTC network is that all the channels, distributive or interactive, will be handled as interactive channels. From the architectural point of view, the last 200 m, from the curb to the building, will be covered using copper pairs and VDSL modems (51 Mbit / s), downstream. As highlighted in Fig. 3, the basic philosophy of this architecture is that all the signals (broadcasting or interactive) will be collected at an LN level that corresponds ideally to a local switch of the PSTN. To evaluate the viability of this kind of architecture for both broadcasting and IMM services, the impact that the signalling traffic generated by broadcasting services (e.g. zapping) may have, still remains to be analyzed in further detail. However, to finalize the economic evaluation, some assumptions on the network size and its costs were made. The FTTC architecture is able to support the following services:
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Fig. 3. FTTC system (fiber to the curb).
1. 2. 3. 4.
digital video channels (with selection at network level); on-line services; interactive video services; bi-directional symmetrical services (including POTS).
2.4. MMDS /LMDS architecture MMDS offers the cheapest platform for broadcast services that can be rolled out very quickly. In the following section, a bundled offering of broadcasting as well as IMM services will be considered. The approach of an MMDS / LMDS network is resource sharing very similar to the HFC. In this case, also, all the information delivered by the antenna reaches all the customers. Referring to Fig. 4, the LMDS system consists of a DN with similar characteristics to the DN mentioned in HFC architecture. The signals transmitted by the antenna will be received at the premises level with a cost. The coverage of the radio cell could be made with omnidirectional antennas or directive antennas, depending on the radio, just as in the IMM implementation on HFC networks; some of the distributive channels could be directly addressed to the end users. The selection of such IMM channels is implemented via the signalling
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Fig. 4. LMDS system.
generated by the user’s set-top-box, routed to the video server (not included in the evaluation). Among all the architectures mentioned above, the LMDS for IMM services is the least mature, since the reliability of this architecture is strictly related to the use of the existing copper network for the return path. In addition to that, the implementation plan for an IMM network that uses radio access is not feasible in urban areas because of the antennas’ environmental impact (high frequencies, number of antennas, etc.). Another important issue to be addressed is the availability of frequencies. For the Italian scenario the possibilities considered were 28 or 40 GHz, in compliance with the Italian Regulatory framework. The MMDS / LMDS architecture is able to support the following services: 1. digital broadcasting channels; 2. IMM services (return path via PSTN); 3. on-line services (using MPEG for downstream and PSTN for return path). Both digital broadcasting channels and interactive channels are distributed in the same manner. However, in the case of IMM and on-line services, the channel selection will be made at the set-top-box level using addressable set-top-boxes. The signalling was implemented with a PSTN return path.
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3. Economic models This section presents the methodology and the specific assumptions made to evaluate the cost comparisons and the economics of the previously presented network architectures when they are deployed to carry broadcasting, interactive and on-line services and telephony. The aim of this description is to highlight all the key elements at the basis of economic evaluation. The approach of this paper involves the costs estimation of each architecture’s various components. The cost per connected home is considered as a standardized unit of analysis for cost comparison. This cost was calculated as follows: I O ]]] (1 1 w) Investment per home connected: ]]]] C O ]]] (1 1 w) t
i
i
i 51 t
(1)
i
i
i 51
where I is the specific and common investments per year, Ci is the connected homes per year, w is the W.A.C.C. (weighted average cost of capital), and t is the business plan period. Estimates were made of the likely changes in cost components over time and between different geographic areas. Assuming that the cabling will start in high density areas before low density and rural areas, cost estimates for all the households in different geographic areas were assessed on the basis of a spreadsheet model. The expression (1) is a more effective way of evaluating the economics and making comparisons than the use of the standard cost per ‘home passed’, since this concept is not objective and depends on several factors: technology, time to ‘upgrade’ a passed home to a connected home, etc. Moreover, the expression (1) considers the actual network revenue streams independently from the technology. Finally, the mentioned expression takes into account not a single year, but all the business plan period and emphasizes the financial effect in the calculation of the cost per ‘home connected’. The cost estimates were calculated as an average of confidential sources (Vendors) and official sources such as media reports and catalog studies (cf. Egan, 1991). Caution should be exercised in using the estimates presented. Furthermore, it should be noted that all the cost comparisons were developed considering a fixed HOME PASSED profile and varying the percentage of connected homes. As for the services’ availability over the different platforms, it should be noted that since the performance of the system is expected to be largely different, all the dimensioning (number of transmitters, number of customers per fiber node, etc.) was made to minimize such differences. In other terms, the actual differences due to different technologies in the services offered were compensated in part by an appropriate dimensioning of the networks (in order to have a certain block
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probability for concurrent access to the same content in a HFC network, the number of customers per FN has been reduced from 800 to 300–400). The cost comparison for both IMM and broadcasting services is assessed on the basis of different penetration scenarios. The economic evaluation for broadcasting and IMM services is made on the basis of the architecture to deploy broadcasting services only and the additional costs to extend such networks for IMM services. The allocation of the common costs between IMM and broadcasting services is based on homes connected per service. For IMM services subscribers, the dimensioning of the devices is calculated under the assumption that 25% of subscribers seek simultaneous and concurrent access to the video or IP server in the peak hour (as already specified).
3.1. Specific assumptions for each architecture Firstly, it must be stressed that 100% of wireline and cable plant is underground.
3.1.1. HFC For this architecture the following cost elements are considered for broadcasting services. 3.1.1.1. Distribution node ( DN) DN is the first topological element of the network for broadcast services: 1. 2. 3. 4. 5. 6.
analog matrix; combiner; monitoring and control; AM modulators; 64QAM modulators; splitters. All the installation charges and other civil costs are considered.
3.1.1.2. Links DN–LN Each DN will be linked with up to 32 LN. Each link length varies from 15 to 40 km, depending on the level of density of the area to be covered. For each fiber link between DN and LN the following costs are taken into account: 1. 2. 3. 4. 5. 6.
civil engineering costs; percentage of reuse of the infrastructure (only ducts); installation of the fiber inside the ducts; percentage of reuse of fibers; percentage of the total length used for multiple fibers; the average number of fibers for each duct.
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3.1.1.3. Connectors, etc. The values of all these parameters depend on the density of the area and the level of reuse of existing infrastructures. 3.1.1.4. Local node As shown in Fig. 1, the LN will receive the signals from DN and re-transmit these signals to the FN (fiber node) located in the coverage area. In terms of costs the following items are considered at LN level: 1. 2. 3. 4. 5. 6.
receivers from DN; optical receiver from FN (for up-stream channels); transmitters; passive splitters; passive optical devices; others.
Additional common costs and installation charges are included in the cost evaluation.
3.1.2. IMM The interactive and POTS services will be inserted at the local node level. Other specific costs were included for the network upgrading for IMM services: a simultaneous 64QAM modulator for each 16 VOD channels, connection management controller (to handle all the signals from QPSK modulators), ATM matrix interfaces, splitters, receivers, QPSK modulators, combiner system, etc. 3.1.3. POTS To provide POTS services, other specific costs are included in the calculation (optical transmitters, one for each FN, QPSK modulators, etc.). 3.1.3.1. Link LN–FN Up to four FN will be connected on each optical loop. The specified parameters are the same as the above mentioned ones for the link DN–LN. 3.1.3.2. Fiber node The FN receives the optical signal from the LN and performs the opticalelectronic conversion. Up to 300–350 users will be connected at each FN, depending on the density of the area. The FN will be installed in the center of the serving area. To estimate the FN costs, a total bundled cost provided by the suppliers was considered. It includes electronic devices (e.g. launch amplifier) and passive devices. Also, civil engineering and installation costs were added.
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3.1.3.3. Link FN–TAP Each FN will be connected with up to 16 TAP (average), one amplifier and related container were considered for each coaxial link. The length of this link varies from 200 to 250 m. 3.1.3.4. TAP This is the last topological element and is located at the building basement. The TAPs are completely passive for broadcasting provisioning services, while active electronics (NIU, containing QPSK modem, etc.) were considered for IMM and POTS services. 3.1.3.5. Vertical links A star topology was assumed to link the TAP to the customer premises with coaxial links. Common costs: 1. for HFC architecture, the vertical link (MDU) was split with 50% for broadcasting services and the remaining 50% for IMM services, including also the specific costs.
3.1.4. HFTTB The most significant elements of the cost model are: 1. additional OLT-ONU in the local node, 1 for FN; 2. additional splitters and combiners in the FN (to reuse the existing fibers in the link LN–FN); 3. installation of additional fibers between FN and TAP; 4. installation of ATM-ONU (including specific cards for IMM and POTS users) at the TAP level. Specific interfaces must be considered for the interconnection with the existing PSTN. As will be examined further on, in the cost comparison section, it is evident that the electronics costs (cards, ONU, etc) per user are now substantially increased in comparison to HFC: this increase confirms the increasing role the variable costs are playing in the new local loop architectures, thus, reducing the scale economies of the traditional local loop. For HFTTB, no cost allocation for vertical link was made, since two separate supports were used for IMM and broadcasting services.
3.1.5. FTTC To finalize the economic evaluation of the FTTC solution, only digital video channels were considered with the exclusion of all the analog chains in the
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HFTTC network and the inclusion of the switched digital video electronics. In particular, on the basis of the topology described for the HFTTB (LN–FN), the link costs are the same as for the parallel PON of HFTTB, with the exclusion of the last 200 m from FN to the home. The use of the VDSL cards at the FN level (here FN is only a topological reference, since the FN functionalities were implemented using FN cards at the ONU level) results in a larger investment in distributed electronics (‘at the premises level’). The increments in the maintenance cost related to this kind of architecture were also considered. The specific electronics are the following: 1. 2. 3. 4. 5.
video switch at LN level; ATM-ONU at FN level; PSTN, ISDN, VOD, FN (for broadcasting channels) cards; VDSL cards; others (rack, box, etc.).
In this case, a typical fixed cost (the coaxial cable) was eliminated and more variable costs (cards, video switch, etc.) were introduced. For FTTC, the copper re-use of the existing plant was considered at no cost.2
3.1.6. LMDS and MMDS The model assumption is that, only 75% of the passed homes are in maximum visibility.3 The cost evaluations were considered for the two assumptions of 40.5 GHz and 28.5 GHz. The total digital channels available are 144, of which 44 are allocated to broadcasting and the other 100 to simultaneous access to IMM services. Assuming, finally, that the antennas will be connected to the LN, via a 4-km fiber optic link, the more relevant (additional) specific costs are: 1. 2. 3. 4.
transmitters; antennas; antenna at building level (for 20 customers); vertical link (building).
2
In this case, from a methodological point of view, the evaluation is not strictly correct. A rigorous evaluation should require at least a cost allocation for the copper network usage. However, this proxy is balanced by the omission of the savings due to the network PSTN integration that were considered in the other cases. 3 The percentage of homes in maximum visibility is the result of statistics on urban coverage for an average Italian city. The other buildings are assumed to receive a reduced level of signal yet still acceptable for at least 85–90% of the homes. Better performances in terms of visibility would imply significant cost increments.
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Antenna installation costs are relevant because of the environmental impact of such installations.
4. Economics of local loop architectures This section will assess the current economics of local loop transformations. It is based on the results of the economic models evaluating different network architectures and broadband network plan investments and on the comparison of the different average cost functions calculated using expression (1). As mentioned above, the following curves highlight the cost trend in the case of a fixed similar ‘home passed profile’ with variation of the connected homes percentage. Due to the confidentiality of the sources employed for the estimation, only relative cost could be presented in the paper. The investment axis indicates an index not usable as an absolute value. Fig. 5, Fig. 6, Fig. 7 and Fig. 8 show different average cost functions for different network architectures and services. Starting from Fig. 5 showing the investments per home connected for broadcasting services, it is clear that while the average cost function for copper plant is strictly decreasing, thus, showing economies of scale over all of the possible output range, all the other cost functions exhibit different slopes and different degrees of scale economies. More precisely, the more we move towards architectures with a higher percentage of electronics (FTTC, Radio LMDS) the lower are the economies of scale.
Fig. 5. Investments per home connected (broadcasting services). Comparison with copper plant for POTS only.
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Fig. 6. Investments per home connected (IMM services). Comparison with copper plant for POTS only.
This pattern is clearer, if we look at Fig. 6, which shows investments per home connected for IMM services, and Fig. 7, which presents the investments in civil engineering per home connected. While the first one demonstrates the major role played — as demand varies in this type of services offering — by variable costs (electronics and optronics) and
Fig. 7. Investment in civil engineering per home connected.
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Fig. 8. Scope economies: investments per home connected (HFTTB).
points out the increase in the spread of the average functions, the reduction of scale economies for the FTTC type of architecture and the elimination of this effect for the LMDS solution, the second one shows that scale economies in the local loop remain in the civil engineering costs, especially for some network architectures like HFC. The most significant impact of the new economics of the local loop is outlined in Fig. 8 that shows how, for a HFTTB network, the cost of a joint offer of broadcasting and interactive services on the same network is lower than the costs of offering each service on a separate network (economies of scope). In addition, in our modeling, it appears that there may be also economies in the maintenance costs of one network instead of two.
5. Policy implications This section discusses the numerous policy implications of this analysis. Firstly, it is very unlikely that, in today’s competitive environment, a single uniform architecture will prevail in the way, over the century, twisted copper pair dominated the telephone network and the coax cable dominated cable television. The single technology solution was based on the old paradigm that maximizing network efficiency will automatically maximize customer value. Today, this approach is challenged by different factors:
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1. different carriers (CATV vs. TELCOs, etc.) seem to have different strategies; 2. there is a much higher level of technological uncertainty associated with the new architectures than in the past; 3. there is a different evaluation among carriers of the technology evolution; 4. competition is expected to take different forms; 5. the market appears to be fairly segmented by a range of services and willingness to pay for them. It follows that successful operators in the future will be able to manage a portfolio of technologies which best respond to the particular needs of various customer segments. Furthermore, the increasing role of variable costs in the new local loop architectures with the subsequent reduction in scale economies makes the technology mix solution more suitable to the multimedia market structure. Fig. 9 summarizes all the possible alternatives for multimedia services available to the different operators. Secondly, the biggest policy implication of the new local loop architectures will be the increased competition in the local loop, because of the low probability of effective entry preemption. In fact, while the decrease in economies of scale facilitates entry, the increase in economies of scope creates incentives to offer a new range of services through which entrants can differentiate themselves from dominant operators, since, very often, the newcomers plan to offer video, telephony, internet access and data transmission on the same network.
Fig. 9. A technology mix by operators.
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The issue of the entry deterrence through preemptive investment needs some additional comments. Shankerman (1996) refers to preemptive investment as a strategy where ‘entry by one firm makes subsequent entry by others unprofitable and thereby forecloses the market’. Moreover, he states that the entry deterrence requires a number of preconditions. Firstly, there must be an indivisible sunk entry cost (threshold scale).4 Secondly, the market should be too small to support more than one incumbent profitably at the threshold scale. Thirdly, for multiproduct incumbents there must be a sunk cost to exit.5 Given these considerations, it seems to us that the economics of the new local loop architectures make this strategy much less effective. In fact, because of the new role played by electronics and optronics, the new flexibility of these architectures definitely lowers the threshold scale, for penetrations greater than 20% and especially for interactive services offerings. Moreover, because of the different sources of revenue related to the mix of product offerings, the economies of scope that characterize these architectures make it easier to support more than one firm and make more viable a multiproduct offering.
6. Summary and conclusions The results of this analysis clearly illustrate the transformations going on in the new local loop architectures for multimedia services. New technologies, wireline as well as wireless, are the source of this change. While for over half a century, the local loop was conceived as the heart of the bottleneck monopoly the new local loop architectures such as the hybrid fiber / coax (HFC), fiber to the curb (FTTC) and, eventually, future fiber to the home / building (FTTH / B) tend to have production and economic cost characteristics that are fundamentally different from the traditional twisted pair copper distribution networks. Their scale economies tend to be lower because of the new role played by variable costs (electronics and optronics). There are also strong indications that these new architectures can achieve significant economies of scope that were not available to either telephone or cable television networks of the past. These results have interesting policy implications that are easily summed up in two main issues. Firstly, it is very unlikely that, in today’s competitive environment, a single uniform architecture will prevail in the way twisted copper pair 4
It is important to notice that Shankerman emphasizes that the initial entry commitment to be credible requires a level of sunk costs that cannot be easily replicated by a new entrant (threshold level). If this is not the case, subsequent entry can occur at a smaller scale and preemption will be ineffective. 5 If there was no exit cost for a multiproduct incumbent, for example for product one, entry by a second firm in this market will create price competition that reduces incumbent profits. Therefore, it can be more profitable for the incumbent to exit rather than to compete. It is clear that in this case the preemption investment strategy will not have credible entry-deterrence effects.
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dominated the telephone network and coax cable dominated cable television over the past century. The local loop of the future is more likely to be characterized by heterogeneous technologies. As a result, the inevitable competition will lead the successful operators to adopt most, if not all, of the forthcoming access technologies. Secondly, increased competition in the local loop will be the biggest policy implication because of low probability of effective entry preemption. On the one hand, the decrease in economies of scale facilitates entry; on the other hand, the increase in economies of scope creates incentives to offer a new range of services through which entrants can differentiate themselves from dominant operators. 8. Notation ADSL, asymmetric digital subscriber line; ATM, asynchronous transfer mode; DBS, direct broadcast satellite; FTTC, FTTK, fiber to the kerb; FTTCab, fiber to the cabinet; FTTE, fiber to the exchange; FTTH, fiber to the home; FTTP, fiber to the pole; HFC, hybrid optic fiber — coaxial cable; HFTTB, hybrid optic fiber — coaxial cable to the building; IMM, interactive multimedia services; IN, intelligent network; ISDN, integrated services digital network; LAN, local area network; MMDS, multichannel multipoint distribution system (microwave technology); MPEG, motion pictures expert group; ONU, optical network unit; PDH, plesiosynchronous digital hierarchy; POTS, plain old telephone services; PSTN, public switched telephone network; QAM, quadrature amplitude modulation; SDH, synchronous digital hierarchy; SONET, synchronous optical network; VOD, video-on-demand
Acknowledgements The views expressed here do not necessarily represent Telecom Italia and Elsacom standpoints on these issues. This work was done when Andrea Conte was a Telecom Italia employee. We thank Alain de Fontenay for bringing our attention to these issues and Stefano Parisse and Vincenzo Scarlato for helpful comments. All the remaining errors are ours. References Egan, B.L., 1991. Information Superhighways: The Economics of Advanced Public Communication Networks. Artech House, Boston. Johnson, L.L., 1994. Toward Competition in Cable Television. MIT Press, Cambridge MA. Reed, D.P., 1992. Residential Fiber Optic Networks, An Engineering and Economic Analysis. Artech House, Boston. Shankerman, M., 1996. Symmetric regulation for competitive telecommunications. Information Economics and Policy, 8, 1996.