FTTP Industry Structure: Implications of a Wholesale Retail Split

Fiber to the Premise (FTTP) exhibits characteristics of a natural monopoly industry. However, service level competition is possible in FTTP and can be achieved by a structural separation between network ownership and service provisioning (henceforth, referred to as a wholesale-retail split). A wholesale-retail split interferes with the ability of a network owner to price discriminate. While a vertically integrated entity can sell seven different economic goods (voice service, broadband data service, video service, voice-data bundle, voice-video bundle, data-video bundle and triple-play bundle), a dark fiber wholesaler can sell only one good (dark fiber access). A ‘lit’ wholesaler may be able sell the same number of goods as a vertically integrated entity. Significant economies of scope ensure that the marginal cost of provisioning the bundle is much lower than the sum of the marginal costs of provisioning the individual services). If almost all homes have a positive willingness to pay for data service, the bulk of the extractable economic surplus resides in the triple-play bundle. Since the wholesale-retail split does not interferes with the ‘dark fiber’ wholesaler’s ability to extract economic surplus from the triple-play bundle, the inability to price discriminate does not interfere with ability of a dark fiber wholesaler to extract economic surplus vis-à-vis a vertically integrated entity (or a ‘lit’ wholesaler) and the difference between the profits of a profit maximizing wholesaler and a profit maximizing vertically integrated entity) are modest, at best. In such markets, municipalities or communities that build out FTTP and choose to be wholesalers (i) can realize sustainable prices, (ii) are likely to create greater welfare (due to innovation spurred by retail competition) and (iii) are just as likely to recover costs (vis-à-vis vertically integrated entities). Therefore, contrary to the assertions of some current providers, it is not necessary to vertically integrate and exclude service level competitors in order to generate sufficient revenue to cover an investment in FTTP infrastructure. However, in markets, where a large proportion of homes have a zero willingness to pay for data service (and therefore, desire only video service), the profit maximizing ‘dark fiber’ wholesaler can be worse off due to its inability to set a video price independently of the bundle price – resulting in a lower optimal bundle price (vis-à-vis a vertically integrated entity) and lower profits. Interestingly, the welfare maximizing ‘dark fiber’ wholesaler can still create almost the same amount of welfare as a vertically integrated entity, though the distribution of welfare among consumer groups is markedly different. Further, in the presence of a strong (cable) incumbent, the ability to price discriminate gives the vertically integrated entity (or the ‘lit’ wholesaler) marginally greater ability to compete with the cable incumbent, thereby driving down prices and resulting in (marginally) lower profits for the incumbent (vis-à-vis an incumbent that competes with a ‘dark fiber’ wholesaler). However, if a large proportion of homes have zero willingness to pay for data services, not only is the ‘dark fiber’ wholesaler worse off (vis-à-vis a vertically integrated entity), but the lower bundle price set by the ‘dark fiber’ wholesaler makes the incumbent worse off as well (vis-à-vis the incumbent competing against a vertically integrated entity) resulting in bundle consumers enjoying a significantly larger consumer surplus. Finally, a municipal FTTP entrant that seeks to maximize welfare and competes with a profit maximizing (cable) incumbent not only creates welfare for its subscribers, but also enhances the consumer surplus experienced by the subscribers of the (cable) incumbent. For our model parameters, consumer surplus can almost double and service penetration can increase by as much as 60% due to such municipal entry - indicating that welfare maximizing municipal entry ensures that almost every home ends up being served.