Are Input Prices Irrelevant for Make-or-Buy Decisions? *

Transcription

1 Are nt Pries rreevant for ake-or-y Deisions? * Pii G Gaye Deartment of onomis Kansas State University anattan, KS , USA e-mai: gaye@kse Dennis L Weisman Deartment of onomis Kansas State University anattan, KS , USA Corresoning Ator eisman@kse V F ASTRACT Te 1996 Teeommniations At reqires inmbent roviers to ease netork ints to rivas at ost-base ries in orer to jm-start ometition Saington 005 ses te Hoteing moe to so tat int ries are irreevant for an entrant s eision to make or by an int reqire for onstream rotion We so tat tis rest eens on te artiar moe of ometition emoye Seifiay, int ries are not neessariy irreevant in te ertran vertia ifferentiation moe an are not irreevant in te Cornot moe t foos tat eartres from ost-base int ries may istort entrants make-or-by eisions in settings of ratia interest Key ors: aess arges, bi-or-by eisions JL Cassifiation: L43, L51, L * Te ators are gratef to Dae Leman an Davi Saington for ef isssions, an to te eitor, iae Cre, an tree anonymos referees for onstrtive sggestions for revision Te ators are soey resonsibe for any remaining errors 1

2 1 ntrotion Te 1996 Teeommniations At reqires inmbent roviers to nbne teir netorks an ease te inivia netork eements to rivas at ost-base ries 1 Te rose of tis nbning oiy is to jm-start ometition in markets tat ave traitionay been araterize as natra monooies n aition, te reise meaning of te term ost-base ries as been te sbjet of rotrate ebate in te eonomis iteratre as e as in ega an regatory roeeings 3 Fooing te assage of te 1996 At, te Feera Commniations Commission FCC, in onert it te inivia state bi servie ommissions, engage in a massive, mti-year effort to t in ae a osting metooogy esigne to give entrants te rigt rie signas it reset to te eision to make or by te int reqire for onstream rotion 4 Te FCC reenty revisite tis osting isse ot of onern 1 See Hasman an Siak 1999 for a omreensive anaysis of nbning oiies an teir onsmer efare effets See orrea an Pinar 006 for a strategi anaysis of nbning in i te inentives of te inmbent rovier to nbne vary over time as te treat of faiities-base entry beomes more reibe Te exress rose of te 1996 Teeommniations At as To romote ometition an ree regation in orer to sere oer ries an iger qaity servies for Amerian teeommniations onsmers an enorage te rai eoyment of ne teeommniations tenoogies Preambe, Teeommniations At of 1996, P L No , 110 Stat See, for exame, FCC 1996, Kan, Tariff an Weisman 1999, ayo an Kaserman 1999 an Weisman 000 for a isssion of tese isses See te Setember 00 seia isse of Te Revie of Netork onomis for a series of arties tat examine te Sreme Cort s revie of te FCC s osting metooogy for te riing of netork eements For a omreensive revie of te aess riing iteratre, see Armstrong 00 an Vogesang Te FCC emoye a neessary an imair stanar rater tan an essentia faiities stanar for etermining te soe of te nbning obigations imose on inmbent roviers See FCC 003A, s An essentia faiity exibits tree basi arateristis: it is neessary for rotion of te retai servie eg, basi teeone servie, it is monooy rovie an it annot be eonomiay iate or sef-sie by a ometitor For a omreensive anaysis of te essentia faiities otrine, see Lisky an Siak 1999 Teniay seaking, en te netork eement is an essentia faiity, tere is no make-or-by eision er se, sine by efinition te int annot be eonomiay iate

3 tat its TLRC tota eement ong-rn inrementa ost metooogy may serve to istort te entrants make-or-by eisions 5 Te fooing assages nersore te natre of te FCC s onerns Or onerns in evaating te TLRC riing res are someat ifferent tan tose resent at te time te Commission aote its Loa Cometition Orer At tat time, oa ometition as argey a teoretia exerise an e ae a remim on te nee to stimate entry into te oa exange market 6 To te extent tat te aiation of or TLRC riing res istorts or intene riing signas by nerstating forarooking osts, it an tart one of te entra roses of te At: te romotion of faiities-base ometition 7 To tis en, a key qestion onerns eter te efforts of regators evote to getting te ries rigt are misae For exame, if ne entrants make teir bior-by eisions on te basis of te reative osts of biing verss bying regaress of te ata ries for tese to otions tere o be no ase for regators to be onerne abot o aratey te reative ries signa information abot te reative osts Tis isse is igigte in a reent artie by Saington 005, o ses a Hoteing moe of ometition to emonstrate tat market entrants i make or by an int reqire for onstream rotion on te basis of a omarison beteen teir ost an te inmbent s ost of making te int instea of a omarison beteen teir ost 5 Te FCC 005, 0 ontine tis ine of tinking en it remove mass market siting as an nbne netork eement, in art, bease TLRC-base ries for siting isorage investment in faiities-base netorks 6 FCC 003 at 7 FCC 003 at 3 3

4 an te rie at i te int an be rase from te inmbent n oter ors, te ata eve of int ries is irreevant Tis rest as otentiay far-reaing eonomi an bi oiy imiations bease it o serve to rener tis ebate over te roer eve of int ries argey moot n oter ors, regators so eras evote teir time an effort to oter rsits We examine eter tis imortant fining onerning te irreevane of int ries is a genera rest, or is sensitive to te artiar moe of ometition emoye We fin tat eter int ries are inee irreevant eens on te artiar moe of onstream ometition 8 Seifiay, taking te Hoteing moe as a starting oint, e emonstrate a ontinm of finings in i int ries are irreevant, may not be irreevant an are not irreevant in te ase of Hoteing, vertia ifferentiation ertran an Cornot ometition, resetivey Tese teoretia rests o aear to be onsistent it a groing boy of emiria resear tat sggests tat int ries o infene te entrant s make-or-by eision 9, 10 n oter ors, eartres from ost-base int ries may istort entrants make-or-by eisions in settings of ratia interest 11 oreover, ness oiymakers 8 Notaby, Saington 005, 1636 observes tat ftre resear so onsier aternative moes of onstream ometition 9 See, for exame, Crana, ngraam an Singer 004 an isner an Leman 001 n aition, Hazett 005 ontens tat manatory netork saring as a te effet of reing rater tan stimating faiities-base investment 10 n aition, Hazett an Havener 003, 47 reort tat te sare ries of te narroban eqiment manfatrers, ining Lent an Norte, eine on annonement tat te FCC as iberaizing nbning res, essentiay oering te rie of te by otion Tis attern of retrns may iniate tat te market ereive tat a retion in te rie of te by otion o inrease eman for bying te int an onomitanty ree te eman for making te int, eteris aribs 11 t so be note tat Saington briefy onsiers moe extensions in i int ries may not be irreevant, bt tis is not te fos of is anaysis nor oes it aear to be te basis for is main oiy onsion tat regators may ave sbstantia fexibiity to strtre int ries to aieve oter 4

5 an be ertain tat te Hoteing moe araterizes ometitive beavior in oa teeommniations markets, setting int ries to refet osts aratey is neessary to ensre tat tere is no effiieny istortion in te bi-or-by eision Te format for te remainer of tis aer is as foos After otining te basi assmtions an efinitions in Setion, e revie te key fining from te Hoteing moe onerning te irreevane of int ries in Setion 3 Setions 4 an 5 examine eter te key rest on int rie irreevane os, more generay, in te ertran vertia ifferentiation moe an a sime Cornot moe, resetivey Setion 6 smmarizes te key finings, issses teir oiy signifiane an ones Te roofs of a roositions are in te Aenix Assmtions an Definitions a nit of onstream ott reqires one nit of te stream int an one nit of te onstream int a firm sies its on onstream int Te inmbent s onstant nit ost of roing onstream ott is enote by Te orresoning nit ost for te entrant is enote by Te inmbent an entrant s onstant nit ost of roing te stream int are enote by an, resetivey an enote te entrant s rofits en it makes te int an bys te int, resetivey Te timing in ea of te moes e eveo is ientia to tat of Saington 005, Te rovisions of te 1996 Teeommniations At rovie entrants it te otion of rasing te stream int from te inmbent at ries etermine by state imortant soia goas, ie ensring effiient make-or-by eisions 005, 1636 nee, or finings sggest tat it is no ess asibe to beieve tat regators o not ave s isretion 5

6 regators Let enote te rie te entrant ays te inmbent for bying te stream int Te entrant is nerstoo to make te effiient make-or-by eision if it rases te int from te inmbent en te inmbent is te east-ost sier < an roes te int itsef enever it is te east-ost sier > 3 Hoteing oe Saington 005 ses te stanar Hoteing moe of rie ometition it ifferentiate rots to evaate te entrant s make-or-by eision 1 His main fining is state in Proosition 1: Proosition 1: Saington Regaress of te estabise rie of te stream int: a te entrant refers to by te stream int from te inmbent en te inmbent is te east-ost sier of te int ie, > if < ; an b te entrant refers to make te stream int itsef en it is te east-ost sier of te int ie, > if < Proosition 1 reveas tat, itin te Hoteing frameork, te entrant aays makes te effiient make-or-by eision regaress of te eve of te int rie, Tis is te basis for te aim tat int ries are irreevant for te entrant s make-orby eision Saington s anaysis of te Hoteing moe emasizes an imortant rest tat as first reognize an erive in a ioneering artie by Cen 001 n a more genera setting, Cen sos tat a onstream firm in tis ase te entrant may strategiay eie to rase an int from a vertiay integrate firm in tis ase te 1 See Saington 005, an Tiroe 1989, for te genera strtre an assmtions nerying tis moe 6

7 inmbent in an effort to soften onstream ometition Te main iea is tat a vertiay-integrate firm i be ess aggressive onstream en its stream rofitabiity is irety inke to onstream rivas eman for its stream int Tis strategi effet ominates te entrant s make-or-by eision in te stanar Hoteing frameork Hoever, in te fooing ertran vertia ifferentiation moe, e so tat tis strategi effet oes not ominate te entrant s make-or-by eision for a vaes of 4 ertran Vertia Differentiation oe Te fooing is a sime qaity ifferentiation moe, ere e assme tat te inmbent roes te ig qaity goo an te entrant roes a oer qaity sbstitte goo n simiar fasion to te stanar Hoteing frameork, e assme tat a onsmer reqires ony one nit of te rot A onsmer s iniret tiity for te ig qaity goo is given by, V θ, ie er iniret tiity for te o qaity goo is given by V θ, ere > 13 a onsmer as a niqe θ, i atres taste eterogeneity in te oation an is assme to be niformy istribte on te interva [0, 1] We begin it tree observations First, note tat V > V for any θ 0,1] if, i imies tat goo is of iger qaity reative to goo an e mst ave < if any onsmers are to fin goo more attrative tan goo Seon, te onsmer it tiity θ 0 is inifferent beteen bying an not bying an 13 an an be interrete as measres of te onsmers eretion of qaity tat migt simy be base on greater famiiarity it te inmbent s rot vis-à-vis te entrant s rot 7

8 as taste arameter, ~ θ Tir, a onsmer tat is inifferent beteen te ig an o qaity rot mst ave a θˆ s tat ˆ θ ˆ θ, i imies tat ˆ θ Witot oss of generaity, normaize te oation of onsmers to 1 As s, eman for te o qaity rot is ~ ˆ θ θ, ie eman for te ig qaity rot is 1θˆ Te eman fntions are terefore given by: ; an 1 Te fooing roosition sos tat en te entrant is not te east-ost sier, its make-or-by eision is not ineenent of int ries in a ertran frameork Proosition n te eqiibrim of te ertran vertia ifferentiation moe: a Te entrant makes te int rater tan bys from te inmbent en < for ; an b Te entrant bys te int from te inmbent if an ony if > an < 14, 15 Proosition reveas tat te entrant i sti oose to make te int en > an > Sine te seon ineqaity an be 14 t is reaiy son tat < is a sffiient, bt not a neessary, onition for art b See te roof of Proosition, ase in te Aenix 15 t so be note tat Proosition an aso be erive from a sime ertran moe it inear emans, ere te eman fntions are seifie as α P P an α P P n oter ors, te assmtions tat rots are ifferentiate aong qaity ines an tat ea onsmer reqires ony one nit of te rot an be reaxe an e o sti obtain te same qaitative rests as in Proosition n aition, te qaitative rests in Proosition sti o if e make te inmbent te sier of te o qaity rot an te entrant te sier of te ig qaity rot 8

9 exresse as >, for sffiienty arge te entrant i make te int rater tan by te int even tog tis is not an effiient otome t foos tat ner te seifie onitions, te int rie is not irreevant for te entrant s makeor-by eision Tis ors bease for sffiienty arge it is more rofitabe for te entrant to ree its ost by making te int instea of softening onstream ometition by rasing te int from te inmbent 16 5 Cornot oe Te Cornot moe of ometition as been se extensivey in te iteratre on sabotage non-rie isrimination 17 As te inentives for te inmbent to engage in sabotage tyiay een on te eve of, it is instrtive to examine eter int ries are irreevant in tis frameork Hene, et inverse market eman be given by P A, ere A > 0, > 0 an is market ott, ere an enote te inmbent an te entrant s ott, resetivey Te fooing roosition sos tat int ries are not irreevant for te makeor-by eision in a Cornot frameork Proosition 3 n te eqiibrim of te Cornot moe: a Te entrant makes te int rater tan bys te int from te inmbent en te int from te inmbent en > < ; an b Te entrant bys 16 A nmeria exame of te rests in Proosition is resente in te Aenix 17 See, for exame, Weisman an Kang 001 an any 000 for a srvey of tis iteratre 9

10 Proosition 3 reveas tat te entrant i make te make-or-by eision on te basis of a omarison of te int rie,, it its on onstant nit ost of making te int, Te strategi effet resent in te Hoteing an vertia ifferentiation ertran moes, erein te entrant may by from te inmbent in orer to soften onstream ometition, oes not arise in te Cornot setting bease te inmbent takes te entrant s ott as given 18 Hene, for any tere is a otentia effiieny istortion in te make-or-by eision an ene int ries are not irreevant 6 Consion Te rimary objetive of tis aer is to examine eter int ries are irreevant for te entrant s make-or-by eision We fin tat eter int ries are irreevant eens on te artiar moe of onstream ometition Seifiay, ie int ries are irreevant in te Hoteing moe of rie ometition, tey are not neessariy irreevant in te vertia ifferentiation ertran moe an are not irreevant in te Cornot moe Tese rests aear to be onsistent it a groing boy of emiria resear tat sggests tat int ries o matter for te make-or-by eision 19 Tis emiria resear rovies some sort for te roosition tat firm beavior, at east in teeommniations markets, is more ikey to be araterize by te vertia ifferentiation ertran or Cornot moes tan by te Hoteing moe Frtermore, ie regators may oose to eart from ost-base int ries to rse a variety of bi oiy objetives, or finings sggest tat s eartres may istort entrants 18 Tis orresons to te imiting ase in i a one nit inrease in te inmbent s retai saes ases no isaement in te entrant s retai saes, or α 0 in Saington s terminoogy 005, See note 9 sra 10

11 11 make-or-by eisions in settings of ratia interest n oter ors, regators may not be abe to eart from ost-base ries it imnity n terms of ftre resear, tere are to avenes tat o seem to o artiar romise First, given te ifferenes tat arise in a rie-setting vis-à-vis a qantity-setting frameork, it o be instrtive to exore te artiar setting tat best araterizes firm beavior in instries sbjet to nbning oiies Seon, tis ine of resear o benefit from a more genera moeing frameork as oose to te rater seiaize moes tat e emoy in tis aer an tat Saington emoys in is artie APPNDX Proof of Proosition 1 See Saington 005 Proof of Proosition Case 1: Te ntrant ys te nt from te nmbent: Te rofit fntions are given by: 1 A1 A Te first-orer onitions it reset to an are given by: 0 A3

12 1 0 A4 Soving A3 an A4 simtaneosy yies te Nas ries: 4 3 A5 4 A6 Sbstitting A5 an A6 into te eman fntion for te o qaity rot yies: 4 A7 Sine >, 0 reqires te nmerator in A7 to be nonnegative or 0 Sbstitting A5 an A6 into A yies te entrant s ree form rofit fntion: 4 A8 0 imies tat te exression insie te arenteses of te nmerator in A8 is nonnegative Case : Te ntrant akes te nt: Te rofit fntions are given by: 1 A9 A10

13 13 Te first-orer onitions it reset to an are given by: 0 A11 0 A1 Soving A11 an A1 simtaneosy yies te Nas ries: 4 A13 4 A14 Sbstitting A13 an A14 into te eman fntion for te o qaity rot yies: 4 A15 Sine >, 0 reqires te nmerator in A15 to be nonnegative or 0 Sbstitting A13 an A14 into A10 yies te entrant s ree form rofit fntion: 4 A16 0 imies tat te exression insie te arenteses of te nmerator in A16 is nonnegative

14 14 Comaring A8 an A16 reveas tat > if an ony if < Aso, > sine > Tis imies tat > for any en < i estabises art a Note tat in te ase ere < te ineqaity os bease > an 0, > i imies tat te eft-an sie of te ineqaity exees te rigt-an sie of te ineqaity Te ineqaity os in te ase ere < bease te eft-an sie is non-negative ie te rigt-an sie is negative Finay, if >, ten < for sffiienty sma To see tis, observe tat < < Frtermore, sine > an 0 > >, a sffiient onition for < is < < Tis estabises art b Nmeria xame Te fooing is a nmeria exame tat is se to verify Proosition Te assme arameter vaes are son in tabe A1 Tabe A1 Parameter Vaes Use for Nmeria xame

15 Figre 1 ots θˆ an θ ~ as a fntion of te int rie,, assming tat te ~ entrant bys te int from te inmbent First, sine ˆ θ θ, for > 0 e reqire tat ˆ ~ θ > θ ˆ θ, ~ θ θ ~ θˆ nt Prie Figre 1 From Figre 1, tis onition is satisfie for 04, 0675 from Figre 1 e an aso see tat > 0 interior Nas eqiibrim for any 04, 0675 for any 04, 0675 Seon, sine 1θˆ, for 04, 0675 Ts e ave a niqe ~ n smmary, θ > 0, ˆ θ < 1 an ˆ ~ θ > θ en te entrant bys te stream int from te inmbent, ~ ie θ an ˆ θ in te ase ere te entrant makes te stream int Figre ots te entrant s ree-form rofit fntions, orresoning to eqations A8 an A16, it reset to te int rie, Note tat te rve is 15

16 above te rve for 04, 055 Te oosite is tre for 055, 0675 Tis imies tat te entrant i by te int from te inmbent enever 04, 055, oterise te entrant i oose to make te int From art b of roosition, te entrant i by te int from te inmbent as ong as < f e sbstitte te arameter vaes from tabe A1 into te rigt-an sie of tis ineqaity, e an verify tat 055 ntrant s Profit nt Prie Figre Figre 3 ots te entrant s ree-form rofit fntions, eqations A8 an A16, it reset to te int rie, Te ony ifferene beteen Figres an 3 is te assme arameter vae for te entrant s margina ost for roing te stream int, n Figre 0 4 ie in Figre Sine te inmbent s 16

17 margina ost for roing te stream int is 0, ten te imortant istintion beteen Figres an 3 is tat in Figre > ie < in Figre 3 ntrant s Profit nt Prie Figre 3 Note tat oering te assme vae for oes not affet te entrant s rve, bt it oes serve to sift te entrant s never intersets te rve ars Sine te rve rve in Figre 3, te entrant i oose to make te int rater tan rase it from te inmbent for any 019, 0675 Ts, art a of ~ Proosition is verifie For te eqiibrim in Figre 3, θ 0 30 an ˆ θ n smmary, te nmeria anaysis sos tat a te rests in Proosition an or ~ ie maintaining tat θ > 0, ˆ θ < 1 an ˆ ~ θ > θ 17

18 18 Proof of Proosition 3 Case 1: Te ntrant ys te nt from te nmbent: Te rofit fntions for te inmbent an entrant are given, resetivey, by P ] [ ] [ an A17 ] [ P A18 Te first-orer onitions it reset to an for A P are given by: 0 A A19 0 A A0 Soving A19 an A0 simtaneosy yies te Nas otts: A 3 ] [ A1 3 ] [ A A 0 imies tat 0 A in te nmerator of A Sbstitting A1 an A into A P yies: 3 ] [ A P A3 Sbstitting A an A3 into A18 yies te entrant s ree-form rofit fntion: 9 ] [ A A4 0 imies tat te term in braes in te nmerator of A4 is nonnegative

19 Case : ntrant akes te nt: Te anaysis for Case is simiar to Case 1 it te one exetion tat reaes : [ A ] A5 9 Comaring A5 an A4 ometes te roof of Proosition 3 19

20 RFRNCS Armstrong, 00 Te Teory of Aess Priing an nteronnetion, in artin Cave, Smit K ajmar, an ngo Vogesang, es, Hanbook of Teeommniations onomis: Vo 1, strtre, regation an ometition Amsteram: Nort-Hoan: orrea, an D Pinar 006 i-or-y Strategies in te Loa Loo Te Amerian onomi Revie Paers an Proeeings 96: 7-76 Cen, Y 001 On Vertia ergers an teir Cometitive ffets Ran Jorna of onomis 34: Crana, R, A ngraam, an H Singer 004 Do Unbning Poiies Disorage CLC Faiities-ase nvestment Te Jornas in onomi Anaysis & Poiy: ansrit 1136 isner, J an D Leman 001 Regatory eavior an Cometitive ntry, Presente at te 4 t Anna Western Conferene Center for Resear in Regate nstries Feera Commniations Commission 1996 mementation of te Loa Cometition Provisions in te Teeommniations At of 1996 First Reort an Orer, CC Doket No Feera Commniations Commission 003A n te atter of Revie of te Setion 51 Unbning Obigations of nmbent Loa xange Carriers Reort an Orer an Orer on Reman an Frter Notie of Proose Remaking, CC Doket No Feera Commniations Commission 003 n te atter of te Commission s Res Regaring te Priing of Unbne Netork ements an te Resae of Servie by nmbent Loa xange Carriers, WC Doket No , Notie of Proose Remaking Feera Commniations Commission 005 n te atter of Unbne Aess to Netork ements, Revie of te Setion 51 Unbning Obigations of nmbent Loa xange Carriers Orer on Reman, CC Doket No Hasman, J an J Siak 1999 A Consmer-Wefare Aroa to anatory Unbning of Teeommniations Netorks Yae La Jorna 109: Hazett, T 005 Rivaros Teeommniations Netorks Wit an Witot anatory Netork Saring A-rookings Joint Center for Regatory Sties Working Paer

21 Hazett, T an A Havenner 003 Te Arbitrage irage: Regate Aess Pries it Free ntry in Loa Teeommniations arkets Te Revie of Netork onomis 4: Kan, A, T Tariff, an D Weisman 1999 Te Teeommniations At at Tree Years: An onomi vaation of ts mementation by te Feera Commniations Commission nformation onomis an Poiy 114A: Kaserman, D an J ayo 1999 Regatory Poiies Toar Loa xange Comanies Uner merging Cometition: Garrais or See ms on te nformation Higay nformation onomis an Poiy 114: Lisky, A an J Siak 1999 ssentia Faiities Stanfor La Revie 515: any, D 000 Kiing te Goose tat Lai te Goen gg: Ony Te Data Knos Weter Sabotage Pays Jorna of Regatory onomis 17: Saington, D 005 On te rreevane of nt Pries for ake-of-y Deisions Amerian onomi Revie 955: Teeommniations At of 1996, Preambe, P L No , 110 Stat Te Revie of Netork onomis 1, Tiroe, J 1989 Te Teory of nstria Organization Cambrige A: T Press Vogesang, 003 Prie Regation of Aess to Teeommniations Netorks Jorna of onomi Literatre XL: Weisman, D 000 Te nffiieny of te ffiient-firm Cost Stanar Te Antitrst etin XLV1: Weisman, D an J Kang 001 nentives For Disrimination Wen Ustream onooists Partiiate n Donstream arkets Jorna of Regatory onomis 0: