William W. Sharkey

Competition, universal service and telecommunications policy in developing countries

Abstract Local telecommunications service has traditionally been provided by a monopoly under a regulated price structure. In most countries and jurisdictions, an explicit goal of regulation has been the provision of service to customers in high cost areas at ‘affordable’ prices and this has been achieved by cross-subsidies within the regulated monopoly. In recent years, however, changing technologies and an increased appreciation of the benefits of competition in traditional natural monopoly industries have generated powerful forces for deregulation of local telecommunications. These forces threaten the viability of this traditional method of universal service funding. In this paper, we empirically evaluate these tradeoffs with special attention to parameter values that are relevant for developing economies. Using a forward-looking engineering process model of the local exchange network, we generate cost data sets that we use to fit cost functions corresponding to various entry scenarios. These cost functions, in turn, are combined with models of firms’ competitive behavior that represent these entry scenarios and regulatory intervention to calculate market equilibria and compare them on the basis of social welfare. This analysis provides a simple characterization of the conditions under which urban-to-rural cross-subsidies may still prove to be a powerful tool for financing universal service under competition. The main conclusion of the paper is that these conditions are often met by developing countries.

Dynamic Pricing and Investment from Static Proxy Models

This paper evaluates the use of static cost proxy models in setting forward-looking prices such as the prices set according to the FCCs TELRIC methodology. First, it compares the time paths of prices and depreciation under traditional regulatory accounting with the prices and depreciation implied by various versions of TELRIC. When TELRIC prices are recomputed at intervals shorter than asset lives, the firm will generally not earn the target rate of return. In these cases, a correction factor must be applied to the TELRIC price path in order for revenues to exactly recover investment cost, including the target rate of return. Next, the paper considers a firms cost minimizing investment decisions under two different assumptions about asset obsolescence. In both scenarios, cost minimizing investment paths and implied utilization rates for the firms assets are derived under a variety of assumptions about the relevant input parameters. Some implications for TELRIC pricing are then derived.

Incentive Regulation and the Cost Structure of the Local Telephone Exchange Network

This paper combines an engineering process model of the cost of local exchange telecommunications firms with an analytical model of optimal incentive regulation (with ex post cost observability), to study empirically the properties of the optimal regulatory mechanism. Relying on detailed properties of the cost function, we examine three issues: (i) the extent of natural monopoly when informational rents associated with regulation are taken into account; (ii) the extent of incentive correction, which expresses the divergence of pricing under the optimal mechanism from optimal pricing under complete information; (iii) the implementation of optimal regulation through a menu of linear contracts. Our findings are that, for fixed territory, strong economies of scale allow local exchange telecommunications to retain monopoly characteristics even when the (informational) costs of regulation are properly accounted for, the incentive correction term is small in magnitude, and that optimal regulation can be well approximated through relatively simple linear contracts.

The Natural Monopoly Test Reconsidered: An Engineering Process-Based Approach to Empirical Analysis in Telecommunications

This paper suggests an extension of the traditional natural monopoly (cost-subadditivity) test as it has been implemented in telecommunications. We explore two dimensions of generalization that we believe are important when evaluating the relative performance of monopoly versus duopoly. First, by using a flexible engineering process model of the local exchange network, we are able to generate market structure-specific cost data which are used to estimate various duopolistic firm cost functions. Second, we combine these cost functions, which correspond to specific entry strategies, with appropriate models of firm behavior to calculate market equilibria. This allows us to perform, in addition to a standard strictly cost-based natural monopoly test, a comparison of monopoly and duopoly on the basis of aggregate social welfare achieved under those alternative market structures. Our application of the methodology to a stylized local exchange market directs attention to a possible conflict between these alternative testing criteria and highlights the crucial impact of the nature of competitive entry on the (social welfare) performance of deregulated markets.

An approach to the pricing of broadband telecommunications services

In this paper, we describe two cost allocation methodologies which may be used to determine prices for a regulated telecommunications supplier offering heterogeneous services on a broadband network. Both methodologies can be characterized by sets of plausible axioms that one could argue should be satisfied by any pricing rule. One of the approaches leads to the Aumann-Shapley pricing rule, which is well known in the literature. The other approach leads to a pricing rule based on the Shapley value of a related cooperative game. While these approaches are similar in motivation, they differ in the technical requirements which must be imposed on the underlying cost function, and we argue that Shapley value pricing is more appropriate in a telecommunications context. We are able to explicitly determine Shapley value prices for customers who differ from one another in terms of their arrival rates, service rates, costs of lost work, and the number of simultaneous channels which they require.

Weighted Aumann-Shapley pricing

Abstract. Cost allocation problems arise in many contexts in economics and management science. In a typical problem that we have in mind, a decision maker must decide how to allocate the joint cost of production among several commodities using prices. Furthermore, these prices must satisfy certain reasonable postulates among which is the requirement that total revenue associated with these prices must cover total cost. In this paper, we investigate a generalization of Aumann-Shapley pricing, called Weighted Aumann-Shapley pricing, that allows for asymmetric pricing of commodities even when those commodities affect costs in a symmetric fashion. Weighted AS pricing is a natural extension of (symmetric) Aumann-Shapley pricing, and may be considered a non-atomic analogue of Owens modified diagonal formula (with respect to the multilinear extension) for the weighted TU Shapley Value.

Strategic nonlinear pricing

The objective of this paper is to examine the role of nonlinear strategies in a standard oligopoly framework. We demonstrate that nonlinear pricing may indeed emerge as an equilibrium strategy, but only when firms produce differentiated products, when one firm retains market power due to a cost advantage, or as part of an equilibrium in mixed strategies. In addition, we examine the role of nonlinear pricing in a spatial-competition framework. Our main conclusion is that in highly competitive markets, nonlinear pricing strategies are not likely to emerge as an equilibrium.

Computational analysis of an auction for licensed and unlicensed use of spectrum

This paper employs simulation methods to evaluate the ability of three different auction mechanisms to determine an efficient license regime for radio spectrum as well as the efficient ownership of the associated rights. The two regimes explored are “licensed” spectrum, in which a winning bidder maintains exclusive rights to use the spectrum, subject only to technical restrictions, and “non-licensed” spectrum, in which multiple users are able to share spectrum on an open access basis. For each auction, we examine bidder incentives and provide detailed reports on both auction revenue and bidder surplus in a set of Nash equilibrium outcomes. Results are consistent with the preliminary conclusions of Bykowsky et al. (2008), that a market can be used to allocate spectrum between licensed and unlicensed use. When there is a clear market preference for either licensed or unlicensed use, all three auction mechanisms arrive at efficient outcomes. However, in the absence of such a preference, a first-price auction appears to be the preferred mechanism.

Computer Modeling of the Local Telephone Network

In this paper, we describe the structure and operation of an innovative computer-based model of the local exchange telephone network known as the HCPM. This model can be used in a variety of regulatory arenas, since it provides a regulatory agency with an independent source of information about the forward-looking costs of providing local telephone service. The model can also be used more broadly by governmental agencies in planning for infrastructure development, expanding telephone service to currently unserved areas, or, as in the case of the U.S., designing an efficient universal service program. The HCPM represents an advance over previous models in its ability to build plant to precise customer locations if data are available, while retaining the flexibility of being able to produce good results even with more highly aggregate location data such as those available from the U.S. Census.

The design of forward looking cost models for local exchange telecommunications networks

In the last few years great strides have been made in the development of algorithms that design telephone networks. As computational capabilities improve it is possible to produce better results, both from an engineering and an economic standpoint. This paper considers the design issues that cost model developers have addressed successfully. Many of these issues are illustrated by a detailed description of a model developed by FCC staff, known as the Hybrid Cost Proxy Model (HCPM). HCPM is capable of utilizing very precise customer location data. From these data, the model uses clustering algorithms to identify serving areas that satisfy appropriate engineering constraints. Within each serving area, the model uses a modified minimum-cost spanning tree algorithm to connect actual customer locations to a serving area interface. The same tree algorithm connects each interface point to a switch. Within each path, the model performs intensive integer searches to find the cost minimizing, yet engineering-feasible, choice of technology and electronics for that path. The result is a-low cost, feasible network plan that gives an appropriate estimate of the forward looking cost of providing wireline telephone service to a particular area. This estimate should prove particularly useful in the ongoing debate about the size and make-up of the Universal Service Fund, and for other regulatory purposes such as the pricing of interconnection and unbundled network elements.