TCOM 546 Session 1

Course Objective Provide a broad overview of economic and financial analysis of telecommunications systems –Microeconomic analysis –Financial and accounting methods –Telecommunications cost models Limited math involved –Minimize use of calculus

Course Texts The Economics of Network Industries, Oz Shy, Cambridge University Press, ISBN Financial Modeling, Simon Benninga, MIT Press, ISBN Supplemental readings

Evaluation and Grading Homework 25% Term paper/project25% Final exam 25% Class participation (quizzes) 25%

Homework Collaboration is permitted (encouraged) on homework and papers/projects But all graded work must be the original effort of the student submitting the material This means: –Two or more students can develop a solution approach for a homework problem together, –But each student must independently execute the solution Collaboration in tests or exams is not permitted

Sources Students are encouraged to use all available sources to answer a question or for a paper/project –All sources must be attributed and material reproduced directly must be enclosed in quotation marks Students are expected to have a personal computer and Internet access

Course Overview The subject matter will start at a general level (economic theory) and converge to more specific considerations over the semester Approximately the first third of the course will consider microeconomic theory – text for this is Shy: Economics of Network Industries

Course Overview (Continued) Middle part of class will deal with classical financial models – balance sheets, etc., with some spreadsheet examples – Text is Benninga Final part will deal with cost modeling from a user’s viewpoint – including a case study

Course Overview (Continued) Week 1: Introduction – Overview of the economics network industries, including welfare aspects and issues specific to telecommunications industries Week 2: Introductory example: Hardware – computers and compatibility Week 3: Telecommunications microeconomics– monopolies, new entrants and social welfare

Course Overview (Continued) Week 4: Telecommunications microeconomics continued – more detailed analyses Week 5: Broadcasting and information industries microeconomics Week 6: Introduction to financial statement modeling

Course Overview (Continued) Week 7: Financial statement modeling continued Week 8: Valuation using financial statement models Week 9: Financial analysis of leasing Week 10: Cost models of telecom from the buyer’s perspective

Course Overview (Concluded) Week 11: An example of cost modeling for a large telecommunications procurement Week 12: Course review and recap Week 13: Student presentations Week 14: Final Exam

Paper/Project Topics Students are expected to develop class paper/project topics themselves –Choice of topic subject to approval –If you can’t/don’t want to develop a topic, I will provide one for you You may not like it

Quizzes Quizzes will be given in class about every two weeks –They will last approximately half an hour They will address only material covered to date in class

Level Setting Experience with –Calculus? –Game theory?

A Question What is the single most important factor in determining the social utility of a telecom network?

A Question What is the single most important factor in determining the social utility of a telecom network? The number of connections it has

Distinctive Characteristics of Network Markets Externalities Systems/Complementarity Costs of change (lock-in) Economies of scale Barriers to entry

Externalities Multiple equilibria possible Initially few adopters Achievement of critical mass followed by rapid growth –Sigmoid (logistic) curve y = 1/(1+exp(-x)) Eventual near-complete market saturation

Two Equilibria Number of Adopters Marginal Utility or Cost Utility Cost “Nobody” uses “Everybody” uses

Complementarity Elements of system must interoperate successfully Requires employment of standards

Costs of Change Contracts (commitment) Operational familiarity Acquisition cost Transition cost –Resources committment –Dual operation –CPE changes

Economies of Scale Big networks are more cost effective than small ones –Traffic engineering/Erlang High fixed costs, low variable costs No stable multi-provider equilibria

Barriers to Entry Difficult to unseat an incumbent Specific (and critical) example: Last mile wiring

Natural Monopolies Characteristics of telecom systems class them as natural monopolies Natural monopolies tend towards higher prices and lower social welfare than optimal –Violate First Welfare Theorem, which states that equilibrium allocation in a free market is economically efficient –Existence of externalities also invalidates the First Welfare Theorem

Historical Approach Historical approach to optimizing social welfare under a natural monopoly has been government regulation of a monopoly provider –Limit ability of provider to exceed a “fair” price –Avoid costly duplication of resources (e.g., access wiring) by multiple providers

Problems with Regulatory Approach Provider unresponsive to customer needs and preferences –E.g., slow introduction of new technology Failure to control prices –Asymmetric information –Inflated production costs

Current Approach Attempt to introduce competition –First notable success was U.S. airline deregulation in 1979 –In telecommunications, mixed success 1984 break-up of the Bell System was quite successful in inducing inter-LATA communications competition 1996 Telecommunications Reform Act has so far been spectacularly unsuccessful in inducing intra- LATA communications competition

Year Relative Cost 0% 20% 40% 60% 80% 100% 120% 140% Commercial Business Line Commercial Long Distance Source: Bureau of Labor Statistics Telecom Price History

Homework Read Shy, Chapters 1 and 2 We showed graphically how there could be two equilibria in a market. Produce a graphical example with three or more equilibria. Does this example have any reality?