-1- Entrance of Cable TV Service Provider into Broadband Internet Service Market : Service Bundling and Role of Access Charge By Jae-Hyeon Ahn, Jungsuk Oh, Sunghee Shim September, 2004

-2- Contents Ⅰ. Introduction research background and objectives Ⅱ. The Model basic setting and variables definition Ⅲ. Analysis Ⅳ. Conclusions results, limitation & further study

-3-  Introduction 1. Research Background 2. Research Objectives

-4-  Convergence of Network and Service  Bundling and Tying of Telecommunications Service  Conflict with Incumbent Player with Essential Bottleneck Facilities  Access Charge Issue Research Background Broadband Internet Service Market Incumbent (Bottleneck Facilities) Cable TV Service Market Entrant Bundling Ex. – Cable Service Provider (SO) & Telecommunications Service Provider (KT)

-5-  Modeling Competition in Broadband Internet Service Market  Incentives for Bundled Service  Impact on Incumbent Player  Access Charge Level that Maximizes Social Welfare Research Objectives Broadband Internet Service Market KT (possessing bottleneck facilities) Cable TV Market SO Bundling Modeling Analysis of Broadband Internet Market Analysis of Social Welfare Analysis of Broadband Internet Market Analysis of Social Welfare

-6- Ⅱ. The Model 1. Basic Setting 2. Variables Definition

-7- The Model – basic setting  Difference from previous research models Bundling One-Way-Access Previous Model Bundling One-Way-Access The Model + Cable TV Broadband Internet Cable TV Broadband Internet Essential facilities of the Incumbent Essential facilities of the Incumbent

-8- The Model – basic setting  Firm 1, 2, Market 1, 2  Market 1 – Cable TV Service Market - Monopolized by Firm 1  Market 2 – Broadband Internet Service Market - Classical Hotelling Location Model (competition of firm 1, 2) - Incumbent (firm 2) versus Entrant (firm 1) - Incumbent owning bottleneck facilities for broadband Internet service provision - Entrant paying access charge for using incumbent’s facilities

-9- The Model – variables definition  Cable TV Market  Normalization of consumer population to 1  Two groups of consumers - Consumers with willingness to pay of V H - Consumers with willingness to pay of V L  C M1 : unit cost of Cable TV service  Assumption: -> firm 1 will set its price at V H  Broadband Internet Service Market  Heterogeneous preference for service - [0,1] ~ uniformly distributed in [0,1]  Firm 1 is located at 0 and firm2 at 1  Firm 2 is regulated on its access price level  Firm 2 is an incumbent and possesses first-mover advantage

-10- The Model – variables definition  Variables definition  : Standal alone value (fixed value) of broadband Internet service  : General costs for broadband Internet service provision  : transportation cost  : Incumbent advantage parameter  : Prices of firm 1 and 2  : Access charge per unit demand  : firm 2’s cost of managing and repairing its bottleneck facilities  Consumer’ net utility located at - is a parameter representing for the incumbent’s advantage

-11- Ⅳ. Analysis

-12- Analysis 01 Full Market Coverage is sufficiently high that the market is fully covered No Bundling Case Bundling Case Analytic Framework  Incentives for Service Bundling  The Effect on the Incumbent Profit  Social Welfare Level  Role of Access Charge

-13- Analysis  When firm 1 does not take bundling strategy  Profit maximization problem of firm 1 and 2  Equilibrium prices and profits

-14- Analysis  Profit functions - Firm 1 - Optimal profit function independent of the level of access charge - Firm 2 - Optimal profit as a increasing linear function of access charge

-15- Analysis Firm 1’s broadband Internet demand having high reservation value in cable TV market V L Type Consumers 0 1 V H Type Consumers 01 Firm 2’s broadband Internet demand having high reservation value in cable TV market Firm 1’s broadband Internet demand having low reservation value in cable TV market Firm 2’s broadband Internet demand having low reservation value in cable TV market

-16- Analysis  When firm1 takes bundling strategy  Profit maximization problem of firm 1 and 2 - Firm 1 - Firm 2

-17- Analysis  Equilibrium prices and profits

-18- Analysis  Profit functions - Firm 1 - Optimal profit function independent of the level of access charge - Firm 2 - Optimal profit as a increasing linear function of access charge

-19- Analysis  Incentive for service bundling and its effect on the incumbent  Incentive for service bundling - A higher service differentiation leads to a higher incentive for service bundling by firm 1 - Incentives for service bundling is not affected by the level of access charge  Its effect on the incumbent - Incumbent’s profit and market share is reduced by the entrant’s bundling strategy

-20- Analysis

-21- Analysis  Social Welfare Analysis  When firm 1 doesn’t take bundling strategy - Total Consumer Surplus: - Social Welfare  When firm 1 takes bundling strategy - Total Consumer Surplus: - Social Welfare

-22- Analysis  The amount of decreasing in total consumer surplus as the increase of access charge = the amount of increasing in incumbent profit as the increase of access charge  Total social welfare is constant with respect to the level of access charge  The role of access charge - The redistribution of the total surplus between consumers and incumbent

-23- Ⅴ. Conclusion 1. Results 2. Limitations and further study

-24- Conclusion - results  Results Incentive for Service Bundling and its effect on the incumbent  Incentive for Service Bundling  Incentives for service bundling independent of the level of access charge  The higher differentiation, the higher incentives for service bundling  Its effect on the incumbent  The decrease of incumbent’s profit Social Welfare Analysis  Total Surplus and Access Charge  Total consumer surplus as a linear decreasing function of the level of access charge  Incumbent profit as a linear increasing function of the level of access charge  Total surplus being independent of access charge  Role of access charge  The redistribution of the total surplus between consumers and incumbent

-25- Conclusion – limitation and further study  Investment on infrastructure and equipment by players with essential facilities  Cross-entrance and interconnection issues  Access price determination and socially optimal access charge - Number of existing customer, network externality, degree of service differentiation, incumbent’s first- mover advantages  Integration of wireless and wireline markets, convergence between telecommunications and broadcasting industries  Price and access charge regulations

-26- Ⅵ. Appendix

-27- Appendix  Full Market Coverage Case Without Bundling Full Market Coverage Constraint Non-negative market share constraint With Bundling Always satisfied Full Market Coverage Constraint Non-negative market share constraint