Prces and prce-cost margns of moble voce servces * Corrado Andn**, Rcardo Cabral***, and Henry Chappell**** August 2006 Abstract Ths paper examnes the determnants of prces and prce-cost margns for an nternatonal sample of 177 moble voce operators n 45 countres over the 1999-2004 perod. In markets for moble voce servces, t s lkely that frms wth large market share have substantal market power and hgher prces and prce-cost margns than frnge frms do. In fact, our emprcal analyss shows that market share has a postve and sgnfcant mpact on prces and margns, after controllng for market characterstcs and country and tme effects. However, we fnd no relatonshp between market share and prces for frms wth large market share. Fnally, hgh prce and hgh margn frms respond more smlarly and less pronouncedly to an ncrease n market share than low prce and low margn frms. JEL classfcaton: L11, L13, L40, L96 Keywords: telecommuncatons, prce settng behavor, market power * Please send correspondence to: Rcardo Cabral, Unversdade da Madera, Departamento de Gestão e Economa, Campus Unverstáro da Penteada, 9000-390 Funchal, Portugal. The authors gratefully acknowledge fnancal support from FCT, Portugal, attrbuted through the CEEAplA, as well as from ICP-Anacom, Portugal. The authors are grateful for the research assstance of Marna Fernandes and Antóno Afonso and for comments from Santago Budra, Joop Hartog, Steffen Hoerng, Reka Horvath, Eugéno Mravete, Robert Wrght, and from partcpants n the 7 th CEPR Appled Industral Organzaton Conference. The responsblty for any errors remans solely wth the authors. **Unversdade da Madera, 9000-390 Funchal, Portugal, e-mal: andn@uma.pt *** Unversdade da Madera, 9000-390 Funchal, Portugal, e-mal: rcabral@uma.pt **** Unversty of South Carolna, Columba, SC 29201, USA, e-mal: chappell@moore.sc.edu 1
1. Introducton From 1995 to 2005 the number of moble voce servces subscrbers (analog and dgtal technologes) grew from approxmately 91 mllon to 2 bllon. GSM (Global System for Moble communcaton) technology has experenced an even faster growth from 12.5 mllon to 1.7 bllon subscrbers n the same perod. No other consumer technology has seen such a wdespread dffuson n such a short tme-frame. By the end of 2005 moble revenues had reached 573 Bllon USD, representng more than half of the total for global telecommuncatons servces. By comparson, at the end of 2005 there were 1.2 bllon fxed network subscrbers worldwde generatng revenues of 424 Bllon USD. 1 Clearly moble voce servces moved from beng a nche product to a major ndustry n a very short perod of tme. Whle land-based telephone servces have long been regulated as natural monopolsts, the compettve envronment for moble operators has dffered. From the outset, dgtal moble telecommuncatons regulators n the US, Europe, and elsewhere have promoted market structures based on some degree of competton (Busse, 2000; Parker and Röller, 1997; Grzybowsk, 2005). Multple servce provders normally compete n markets for moble servces. Markets that were once prmarly local have expanded geographcally; provders often offer servce plans coverng areas that are natonal or nternatonal n scope. However, as total output and market szes have grown, a few large frms have acheved large market shares n many markets. Thus, whle growth has been accompaned by competton, that competton s not of an atomstc varety. Competton has featured olgopolstc nteracton, dfferentaton of products, and wnner-take-most outcomes typcal of goods featurng network externaltes. Ths paper offers an overvew of the state of competton n worldwde markets for moble voce servces. We wll nvestgate the dsperson of prces and prce-cost margns n 1 Sources: GSM World 2006 World Market Report, www.gsmworld.com seen Apr. 20, 2006; 2
order to assess the nature of competton across markets. Prce comparsons for moble voce servces are problematc due to the multdmensonalty of usage and non-lnearty of moble servces prcng plans. Most comparsons have focused on partcular aspects of the prcng plan, for example, consderng only local rates (CTIA, 2004) or prce per mnute n a package (.e., f all mnutes are used up) rather than prce per unt of actual usage, or the calculated prce for subset (basket) of possble calls (Telgen, 2003; Parker and Röller, 1997; Grzybowsk, 2005). In ths study we argue that a better measure of the prce of moble telecommuncatons servces s average revenue per mnute, one of the ndcators used n the FCC s 9th CMRS report (FCC, 2004) 2 and reported n Merrll Lynch s Global Wreless Matrx survey. On the bass of ths measure, the dfferences n the prce levels n the data we have gathered s qute large. In 2004, average revenue per mnute vared from 0,028 Euro per mnute offered by Chna Uncom to 0,45 Euro per mnute offered by Swtzerland s Swsscom. 3 Snce labor costs represent a small fracton of the operatng costs of moble operators (6,3% and 11,3%, respectvely for the above operators, but typcally under 10%), and nvestment costs n nfrastructure on a per subscrber bass are smlar, the substantal dfferences n prcng are surprsng, even consderng dfferences n usage patterns and dfferences n the sze of the frms. There are several possble explanatons for the observed dfferences n prce levels. In the presence of market power, exogenous demand-sde varables, for example ncome per capta, mght result n an equlbrum prce level that s hgher n some countres than others (see Panzar and Rosse, 1987). Other possble explanatons nclude varyng regulatory envronments. Most countres requre callng party pays (CPP) prcng, but the US, and ITU-T, 1999, World Telecommuncatons Development Report 1999. 2 See Paragraphs 168 through 172. Other ndcators used by the FCC are the US Bureau of Labor statstcs cellular telephone servces component of the consumer prce ndex, and Econ One s smulated average cost of monthly servce calculated across four typcal usage plans. 3 See dscusson n Secton 4 for characterzaton of the unt of output used n ths analyss, mnute of voce call. Chna Uncom counts on-net ncomng mnutes of calls twce. If one corrects for ths effect usng Merrll Lynch s estmate of the percentage of on-net ncomng calls (20%), Chna Uncom s adjusted revenue per mnute s 0,032. 3
Canada, Chna, and some other countres have adopted moble party pays (MPP) 4 prcng. Country regulatons also dffer n whether or not they requre number portablty. Prces could also vary because of cost or qualty dfferences that ultmately result n dfferences n noncooperatve dfferentated olgopoly (endogenous) equlbra, or because frms vary n ther success n colludng n dfferent countres. Of course there are other alternatve hypotheses that could explan the dfference n the levels of average revenue per mnute across countres. Past analyses and academc research have focused on the latter two hypotheses, namely market power and colluson. For example, the US congress has tasked the FCC to annually assess whether or not there s effectve competton n commercal moble rado servces, but FCC Commssoner Mchael J. Copps n the 8 th CMRS Report argues that the FCC has been unable to present a defnton or for that matter a test of effectve competton. Collusve behavor has long been consdered one of the gravest forms of economc msconduct, and there have been a number of recent fndngs wth regard to potentally collusve moble telecommuncatons markets. For example, n a study of moble telecommuncatons duopoles n US metropoltan servce areas, Parker and Röller fnd evdence of colluson and of mult-market contact colluson. Usng a dfferent methodology consderng prce plans, Busse (2000) also fnds some evdence of mult-market contact colluson n US metropoltan areas for moble voce servces, wth prces rsng between 7% and 10% above non-cooperatve levels. The European telecommuncatons regulatory agences have also started nqures on nterconnecton fees and roamng charges, and the European Commsson has recently recommended that roamng charges be cut to the level of natonal nterconnecton charges. Also recently, the French Competton Councl has fned 4 Regulatory aspects and hstorc legacy may explan some of the dfference n prcng between the US and other world markets. For nstance n the U.S. and n other countres prefxes are assgned by geographc area for both moble and fxed network telephones. Tradtonally, tarffs were typcally based on orgn and destnaton number prefxes, and therefore network operators were unable to charge dfferent prces for fxed network and moble network servces. As a result, when the moble servce was ntroduced, the US moble operators requred subscrbers to pay for ncomng calls (Moble Party Pays), gven ther own hgher margnal costs. 4
the French moble operators 534M for what t clamed was a collusve market share agreement. 5 In the academc lterature, assessng the degree of compettveness or, alternatvely, the degree of market power, has often nvolved measurement of prce-cost margns and proftablty, rather than analyss of prce dfferences across markets. Inferences about the exstence of market power are clouded by two opposng hypotheses (Feuersten, 2005). One branch of the lterature suggests that frms wll explot ther market power to extract rents. The Structure Conduct Performance Paradgm (SCPP), mples that market structure characterstcs such as ndustry concentraton wll predctably lead to dfferences n conduct and performance, although conduct tself may not be observed (Scherer and Ross, 1990). Snce the late 1970s, the New Emprcal Industral Organzaton (NEIO) approach has argued that conduct must be modeled wth explct assumptons on frm behavor and frm conjectures (Bresnahan, 1989). More recently, the market power lterature has been enrched by the consderaton of the dynamc aspects and strategc nteracton between frms (see Feuersten, 2005 for an overvew of the lterature). The second branch of the lterature s developed from the effcency hypothess, whch suggests that hgher allocatve and techncal effcency wll result n frms ganng market share and beng more proftable, and the ndustres beng more concentrated (Demsetz, 1973; Bos, 2003; Berger, 1995). Thus, accordng to ths lterature, the exstence of hgh prce-cost margns may not reflect abuse of market power but may smply result from dfferences n costs across frms. Gven ths possblty, emprcal fndngs that assocate market shares wth hgher prce cost margns have nconclusve mplcatons about the nature of compettve behavor. Despte the large lterature and emprcal analyses, ths paper s the frst, to our knowledge, to attempt to emprcally explan why there s such a wde dfference n the level 5 Adam Jones, Dec. 1, 2005, French top moble groups fned, Fnancal Tmes, London. See also the French Regulator decson (http://www.arcep.fr/textes/jurs/05-d-65.pdf). 5
of prces for moble voce servces across frms and countres, wth a partcular focus on the dfference of prces across frms n a gven country. Our tests are carred out usng a dataset contanng quarterly data on 177 frms n 45 countres from 1999 through 2004, created from the Merrll Lynch Wreless Global Matrx report. Ths paper s organzed as follows. Secton 2 revews the lterature. Secton 3 presents the data. Secton 4 develops the theoretcal model. Secton 5 presents the econometrc specfcaton and the econometrc results. Secton 6 concludes. In addton, Appendx 1 defnes our measures of revenues, output, prce, and proftablty. 2. Lterature revew Academc researchers and government regulators n ths sector have n the past focused on ssues of market power (domnance) and colluson. The tradtonal structureconduct-performance paradgm (SCPP) argued that whle conduct could not be observed, one could nfer performance through market structure characterstcs (Scherer and Ross, 1990; Bresnahan, 1989). Thus, for example, accordng to the SCPP, t was expected that a market structure characterzed by hgh levels of ndustry concentraton (measured, for example by the Herfndahl-Hrschman Index (HHI)), would create an envronment where conduct based on exercse of market power and colluson would be facltated, thus resultng n a defcent market performance,.e., hgh prce-cost margns, hgh producer surplus, and large deadweght welfare losses. The SCPP approach was crtczed for the lack of theoretcal justfcaton for usng market concentraton measures to analyze market performance and because market structure measures are endogenous. The new emprcal ndustral organzaton (NEIO) research approach seeks to explan frm and ndustry performance characterstcs such as output, prce, and proftablty, wthn a structure that s explctly derved from olgopoly theory. Typcally, n the NEIO models (Iwata, 1974; Bresnahan, 1982; Panzar and Rosse, 1987; Jaumandreu and Lorences, 2002), an estmable conduct parameter (or set of parameters), θ, s derved based on frm or olgopoly theory, and the hypothess of strategc behavor s then tested aganst 6
the null hypothess of perfect competton. Although these methods of estmatng market power, and n partcular Panzar and Rosse s H test (1987), have had wdespread use, they have been crtczed due to ther strong assumptons regardng the functonal form of demand and falure to consder the dynamc strategc behavor among frms. More recent research has focused on condtons for the sustanablty of colluson n dynamc strategc behavor games and n the development of tests for colluson n procurement auctons. See Feuersten (2005), Harrngton (2005) and Porter (2005) for a revew of the more recent lterature on the measurement of market compettveness. In ths paper, we prmarly follow the NEIO tradton, analyzng frm and ndustry conduct n the context of a Cournot-type model (Appelbaum, 1982; Bos, 2003). 3. Data The emprcal analyss developed n ths paper uses a dataset bult usng Merrll Lynch s Global Wreless Matrx 2Q04 report (herenafter ML dataset). The Merrll Lynch report contans quarterly data on 177 frms across 45 countres from the frst quarter of 1999 to the second quarter of 2004. Ths dataset ncludes several varables relevant to the analyss developed n ths paper, ncludng revenue per mnute, mnutes of use, market share, earnngs before nterest deprecaton and amortzaton (EBITDA) margn, and churn rates. The summary sample statstcs for the ML data-set are reported n Table 1. We elmnated observatons where market share or churn rate was zero, snce they correspond to nstances where the frm had not yet started operatng n the year the observaton was collected. Frms n the moble ndustry report ther fnancal and operatonal data n a structure that t s farly smlar, but there are often dfferences n how the varables are orgnally defned and reported by frms. For example, operators defne subscrber acquston and retenton costs dfferently and also account for them dfferently n ther fnancal reports, wth some bookng these costs upfront and some other operators deprecatng costs over a 7
perod of tme. Operators also employ dfferent defntons of mnutes of use, wth some consderng only outgong mnutes of voce calls, others consderng both ncomng and outgong, and yet others subtractng a part of the ncomng mnutes of calls to avod double countng of on-net moble to moble mnutes of calls. The number of subscrbers and therefore the churn rate s also subject to dfferent defntons, as operators grant subscrbers dfferent grace perods before cancelng subscrptons. Merrll Lynch comples the Global Wreless Matrx based on company-reported numbers, and attempts to ncorporate adjustments to standardze the varables across companes to the extent possble. Appendx 1 provdes a characterzaton of our measures of revenue, output, prce, and proft. 4. Theoretcal Analyss We seek to dentfy factors affectng the mean and the shape of the condtonal dstrbuton of prces and prce-cost margns n moble voce telecommuncatons servces. Specfcally, the emprcal specfcaton of our prce-cost margn equaton s derved from a Cournot-type dfferentated olgopoly model smlar to those of Appelbaum (1982), Parker and Röller (1997), and Bos (2003). Our prce equaton specfcaton has the same set of ndependent varables as the margn equaton. If prces and margns are responsve n smlar fashon to the same varables, ths would suggest that much of the varaton n margns s prce-drven. 4.1. A Cournot-type dfferentated olgopoly model Assume the unt of output s the same representatve mnute of outgong moble voce call, but output s perceved as havng dfferent qualty across frms. Assume further that each frm s demand functon depends only on total output,.e., n p ( Q) = p Q = q j, but j= 1 that the demand functon vares across frms,.e., the equlbrum prces per unt of output across frms n a gven market need not be the same thus allowng for dfferent levels of prces for output perceved as beng of dfferent qualty varetes across frms. Thus, each 8
frm maxmzes: π = p ( Q) q CT ( q ), Q = n j= 1 q j where Q s total (qualty unadjusted) ndustry output (mnutes of voce calls) n a gven market, defned as beng the sum of each ndvdual frm s output, p, s the prce for frm s mnute of representatve voce calls, whch depends on total output. Further, lke Bos (2003) we assume constant margnal costs. Assumng a dfferentated olgopoly,.e., each frm n equlbrum sells ts unt of output for a dfferent prce, each frm maxmzes ts profts gven ts own perceved demand curve, p (Q) : dπ dq dp ( Q) dq = q + p ( Q) c dq dq = 0 Multplyng and dvdng the frst quotent by Q/p, dπ 1 p ( Q) dq = q dq dq Q dq + p ( Q) c = 0 Q dp ( Q) p ( Q) and notng that dq Q dp ( Q) p ( Q) measures the percentage change n total demand n response to a gven percentage change n frm s prce,.e., frm s prce elastcty of total demand, η, the expresson can be rewrtten as: 1 η p ( Q) (1 + γ ) q + p ( Q) c = 0 Q where γ = dq dq s frm s conjecture about the reacton of the other frms to a change n ts own output. The above expresson can be rewrtten as: 9
p c p 1 = s (1 + γ ) η where the left hand term s the Lerner ndex, and one can thnk of s as the (qualty unadjusted) market share of frm. Further, assumng lke Bos (2003) that each frms margnal costs are constant, and multplyng the left hand sde term by q, TR VC TR 1 = s (1 + γ ) η where TR and VC are frm s total revenue and varable cost, respectvely, whch s equvalent to π + FC 1 (1a) = s (1 + γ ) TR η where π and FC are frm s profts and fxed costs, respectvely. Expresson (1a) ndcates that the prce cost margns of the frm can be calculated from observed measures of profts, fxed costs, and total revenues, and that t s explaned by the prce elastcty of total demand plus a term that reflects the frm s market share and the frm s conjecture on how other frms react to a change n the frm s own output. Snce the conjecture s not observed, Bos (2003) argues that under the presumpton of collusve behavor t s lkely that hgher market shares are assocated wth a larger ncentve for collusve behavor (hgher γ ). However, contrary to Bos, we argue that n the estmaton of ths equaton, t s not possble to dentfy both the frm s prce elastcty of demand and the frm s conjecture. Therefore, rather than assume that the elastcty of demand s constant across countres and tme and rather than nferrng the conjecture from 1 market share (Bos, 2003), we estmate the jont term (1 + γ ) η, controllng for country and tme (years and quarters) effects, n essence assumng that the jont term s constant for the frms n a gven country n a gven perod. Thus, the equaton becomes: 10
π + FC (1b) = f ( s, c, y, q) TR where f s a lnear functon of s, c, y, and q, where s s the frm s market share, and c, y, and q are ndcator-varables for country, year, and quarter effects respectvely. Ths expresson allows for the measurement of the mpact of the market share on the frm s prce cost margns. 6 5. Emprcal Models and Results Our emprcal models consst of two stochastc equatons: a prce equaton and a prce-cost margn equaton. The estmaton methods nclude both ordnary least squares and standard quantle-regresson technques due to Koenker and Bassett (1978). The man objectve of the econometrc analyss conssts of lookng at the mpact of dfferent ndependent varables on both the mean and the shape of the condtonal dstrbuton of dependent varables, prces and prce-cost margns. Partcularly, quantle-regresson technques am at the dentfcaton of factors affectng the wthn-groups dsperson of prces, margns and revenues, and n contrast wth ordnary least squares estmates that measure mean responses of dfferent (market share) groups. 5.1. Prce equaton For the prce-equaton case, we base our estmaton strategy on the followng emprcal model: α α α α α α α + ξ (2) ln pcyq = 0 + 1msharecyq 1 + 2churncyq 1 + 3mpp + 4c + 5 y + 6q cyq where c, q and y are ndcator-varables for country, quarter and year effects respectvely, whle ξ s an unexplaned resdual. The dependent varable s the logarthm of the revenue per mnute. Snce revenue 6 Whle t would be possble to transform (1a) n a lnear functon by applyng logarthms, the transformaton would elmnate all observatons were the frm proftablty s negatve. Therefore, we 11
per mnute, market share, and churn rates are endogenous varables, we nclude both mshare and churn lagged (pror quarter data) to avod based estmates due to endogenety. We estmate two versons of model (2) whch manly dffer n the measure of the dependent varable. In the baselne analyss (whch we desgnate Defnton 1 see Table 3a n Appendx 2), all local currences are converted to euros at the 2004 annual foregn exchange rate. Defnton 1 s calculated usng hstorc nomnal prces (revenue per mnute) n local currences as estmated by Merrll Lynch dvded by the 2004 nomnal average exchange rate of the local currency to the Euro. In the cases where ML reports revenue per mnute n US dollars, ths amount s converted to the local currency frst by usng the average US-local currency exchange rate n the relevant quarter. We also run our analyss convertng quarterly prces by means of nomnal quarterly exchange rates to the euro (Defnton 2 Table 3b). To verfy that our results are not the beng drven by exchange rate fluctuatons, we also run the analyss only for the Eurozone countres avalable n the ML sample (.e., ncludes all Eurozone countres except Luxembourg) and present the results under Table 3c (Defnton 3). In none of our specfcatons do we adjust the revenues per mnute for any prce deflators such as the GDP deflator, other than the average effect captured n the country specfc controls. Merrll Lynch calculates the frms market share (mshare) as the rato of the number of subscrbers to total subscrbers n the country, rather than other alternatve measures. 7 As the ML dataset does not nclude any cost data we use the churn-rate data (rate of loss of subscrbers per month) as a proxy for the frm s margnal costs snce the so-called subscrber acquston and mantenance costs assocated wth subscrber churn consttutes one of the major cost factors of operators n mature markets. Moble operators churn rates of specfy (1b) as a lnear functon of the varables. 7 There are other forms of calculatng market shares (n terms of overall revenues and n terms of mnutes of carred traffc) and the number of subscrbers may depend on the operators defnton of actve and nactve subscrbers, but ths s typcally the varable most observed by operators, and one that s lkely to have more mpact on prcng power, snce subscrbers have to ncur n some transacton costs to change operators. 12
between 18% and 36% per year are qute common. 8 Recent US data shows that some of the natonal operators lose two of ther exstng customers for every three new customers and a fnancal analyst has consdered churn the largest cost factor of the ndustry 9, representng 20% of revenues. In fact, frms n ths ndustry often report subscrber acquston costs as a metrc for fnancal market evaluaton. Our argument s that a hgher level of churn wll lead operators to ncrease expendtures n order to generate addtonal mnutes of traffc, for example by offerng free mnutes of calls, whch generate addtonal traffc but also ncrease the operators margnal cost 10. Two opposng hypotheses are consstent wth the fndng of hgher churn rates. On the one hand, hgher churn would be assocated wth hgher margnal costs, and thus be expected to result n a hgher level of prces. On the other hand, a hgher churn rate mght sgnal to the operator that ts subscrbers are leavng to other operators wth lower prces, creatng an ncentve for the operator to respond by lowerng prces. In MPP (Moble Party Pays) countres, Merrll Lynch ndcates that the number of mnutes of calls may be overestmated by around 20%, due to the countng of mnutes of ncomng calls from own network (on-net), whch are free and not blled n most other countres. To control for ths we nclude n the prce equaton the mpp dummy, whch s expected to have a negatve sgn,.e., revenue per mnute s expected to be lower n countres where the traffc measure also ncludes ncomng mnutes of calls from own network, snce essentally n these countres one s countng these mnutes twce vs a vs non-mpp countres. 8 In some countres, and followng the ntroducton of moble number portablty, churn rates can even be hgher. Accordng to the Merrll Lynch Wreless Global Matrx 2Q2004, The average churn rate of Indan moble operators n the 2Q2004 was 7,5%, whch means that per year, not accountng for market growth, 90% of subscrbers change moble operators. Accordng to Mark Rockwell, Aprl 1, 2003, Overseas LNP: From Bengn To Catastrophc, WrelessWeek.com, followng the ntroducton of moble number portablty, monthly churn rates reached 10% n Hong-Kong. 9 Source: FCC 10th CMRS Report, paragraph 149, p. 56, quotng Tmothy Horan et al., Rasng Wreless Subscrber; Proftablty Outlook Improvng, CIBC World Markets. 10 It has been ponted out that churn could alternatvely be consdered as a fxed cost per subscrber,.e., a cost of dong busness, for example the costs assocated wth marketng or addtonal customer servce representatves. 13
Ordnary least squares Estmaton results based on ordnary least squares (OLS) are presented n Table 3a, 3b, and 3c of Appendx 2. The results of the baselne model (2) usng the average foregn exchange rate for 2004 (Table 3a - Defnton 1) suggest that a one percentage pont ncrease n the market share results n 0,23% ncrease n the prce (average revenue per mnute). Interestngly, for frms wth market shares below the mean of the sample (28,5%), a one percentage pont ncrease n the market share results n a 1,11% ncrease n the prce, whereas for frms wth market share above the mean the effect of the market share on prce s not statstcally sgnfcantly dfferent from zero,.e. the market share seems to have no ncremental mpact on prces. The results we obtan are robust across the dfferent specfcatons of how we treat varatons n exchange rates (see Table 3b wth Defnton 2). We obtan smlar results for Eurozone countres sub-sample, whch suggests our results are not beng drven by the effect of exchange rate fluctuatons. For Eurozone countres, we fnd that a one percentage pont ncrease n market share results n 0,46% ncrease n revenue per mnute, but for frms wth small market share t results n a 1,84% ncrease n revenue per mnute, whereas for frms wth large market share the effect of the market share on prce s not statstcally sgnfcantly dfferent from zero (see Table 3c Defnton 3). The result shows that frms wth lower market shares respond to ncreases n market share wth a sgnfcant ncrease n prces, whereas frms wth large market shares wll not change ther prces n response to margnal changes n ther market share. It could be the case that ncumbents wth large market shares are wllng to tolerate a loss n market share wthout lowerng prces, whereas small frms see rsng market shares as an opportunty to rase profts by rasng prces (thus competng less aggressvely). It may also be the case that frnge frms (presumably, new entrants) n ths ndustry are wllng to temporarly support a perod of low prces n order to compensate ther subscrbers for a lack of network externaltes. Once these frms market shares rse, creatng network effects for ther subscrbers, they are able to rase prces. Yet another alternatve explanaton s that the pattern of traffc (.e. the representatve mnute) may be substantally and systematcally 14
dfferent between small and large frms. If market share s always assocated wth a specfc pattern (or mx) of traffc, then the observed results may smply reflect the dfference n the perceved qualty of the good rather than dfferences n market power and/or effcency. As mentoned n Secton 2, the two branches of the lterature argue for ether a market power hypothess, where frms use ther market power to rase prces, and/or the effcency hypothess, where larger frms have lower costs and thus hgher prce-cost margns. The results suggest that at least for frms wth small market share, the ncrease n the prce-cost margns (see also results of margn equaton n Secton 5.2) s at least to some extent acheved through hgher prces. For all cases, country, year, and quarter effects are jontly sgnfcant, whch supports our hypothess that some of the dfference n the level of prces s explaned by country specfc effects such as ncome or wealth effects. As expected n countres where on-net ncomng call mnutes are blled and ncluded the measure of traffc (mpp=1), revenue per mnute s lower n comparson to most countres worldwde that do not nclude on-net ncomng calls n the measure of traffc, essentally snce on-net ncomng calls are double counted. The estmates of the coeffcent for the churn rate n the pror quarter, whle negatve for all specfcatons are not statstcally sgnfcant at conventonal levels, for both frms wth small and large market shares, whch seems to suggest that frms do not alter ther prcng strategy n response to changes n the churn rate n the prevous quarter. Quantle regresson Model (2) s also estmated usng quantle-regresson (QR) technques as descrbed by Koenker and Bassett (1978). A quantle regresson provdes complementary nformaton to that obtaned through ordnary least squares. It permts one to assess the mpact of a change n an explanatory varable not only on the mean but also on the shape of the condtonal dstrbuton of prces. Puttng t dfferently, QR technques allow estmatng the mpact of a specfc ndependent-varable change at several quantles of the prce dstrbuton. Specfcally, usng model (2), we fnd that an ncrease n market share results 15
ceters parbus n a reducton of the wthn-groups prce dsperson as the low-prce frms wll ncrease ther prce much more than hgh-prce frms (Fgure 1). Frms n the lowest decle of the condtonal prce dstrbuton respond to an ncrease of one percentage pont n the market share wth a 0,5% ncrease n prces, whereas frms n the hghest decle respond to the same market-share ncrease wth a 0,13% ncrease n prces,.e., low prce frms have a four tmes larger response to gans n market share. Smlar results are obtaned f one uses quarterly exchange rates and n the sample of Eurozone countres (see Fgures 2 and 3), although for Eurozone countres the dfference n responses s less pronounced (a two tmes larger response only). Our quantle-regresson results support and complement the results of the OLS analyss that showed dfferng behavour by frms wth large and small market shares. The quantle regresson ndcates, for frms wth low prces, an ncrease n the market share of frms has a more pronounced effect on prces than n markets where prces are already hgh. 5.2. Prce-cost margn equaton Both theory and prevous emprcal analyses n ndustral organzaton suggest that there s lkely to be a postve relatonshp between a frm s market share and ts prce-cost margn, both on market power and effcency grounds. Accordng to the model presented n secton 4, an ncrease (decrease) n the market share s assocated wth an ncrease (decrease) n the prce mark-up, ceters parbus. Ths occurs because cost or qualty dfferences affect both market shares and margns n equlbrum. An ssue n the analyss of prce-cost margns concerns the defnton of the left-handsde varable n equaton (1b). As explaned n Appendx 1 we use EBITDA (earnngs before nterest, taxes, deprecaton, and amortzaton) as our measure of prce-cost margns, and our estmaton strategy s based on the followng model, where we extend the margn equaton (1b) derved n Secton 4 model by ncludng a control for subscrbers churn costs, n order to make the analyss comparable to the prce equaton analyss of model (2): 16
ebtda α α mshare α churn α c α y α q + ξ (3) cyq = 0 + 1 cyq 1 + 2 cyq 1 + 3 + 4 + 5 cyq Ordnary least squares Our man emprcal result for model (3) s that the lagged market share has a postve statstcally sgnfcant effect on the ebtda margn. In the baselne model (3) usng the ML sample, an ncrease of one percentage pont n the market share results n an ncrease of 0,70 percentage ponts n the ebtda margn on the overall sample (see Table 4a). Moreover, for frms wth market share smaller than the average (28,5%), an ncrease of one percentage pont n the market share results n an ncrease of 1,87 percentage ponts n the ebtda margn, whereas for frms wth large market share a one percentage pont ncrease n the market share results n an ncrease of 0,43 percentage ponts n the ebtda margn, suggestng that the bulk of the ncrease n proftablty s acheved by frms wth low market shares. Further, we obtan consstent results f we consder a sub-sample ncludng only Eurozone countres (see Table 4b), f we specfy the model followng (1b),.e., wthout controllng for the churn rate, or f we use a log-lnear transformaton of equaton (1a), rather than equaton (1b) expressed n lnear form. Model (3) suggests that frms wth large market share have a smaller ncentve to ncrease market share than frms wth small market shares,.e., the ncrease n proftablty wth market share s larger for frms wth small market share than for frms wth large market share, ceters parbus. Further, model (2) ndcates that frms wth small market shares respond to a drop n market share by lowerng prces sgnfcantly whereas frms wth large market share do not change ther prces, suggestng frms wth large market share refran from competng aggressvely on prce maybe because frms wth large market share have less to gan than frms wth small market share by dong so. Of course there mght be other causes for ths result, ncludng bases related to dfferent underlyng patterns of traffc for large and small frms (as dscussed earler) or for example a more ntensve regulatory supervson of frms wth large market share. 17
Quantle regresson Our man emprcal result s that an ncrease (decrease) n the market share reduces (ncreases) the dsperson of margns (see Fgures 4 and 5). Indeed, we fnd that the ncremental mpact of market share on EBITDA margns s decreasng along the margns dstrbuton. Ths result s, n our vew, not surprsng as we focus on the market for moblephone servces, characterzed by few operators n each country, each one wth a relatvely hgh market share (mean of 28,5%). We deal wth an ndustry whose basc features are very dfferent from those for a compettve ndustry. In the context of ths dfferentated olgopoly, whch n terms of market structure s closer to the monopoly case than to the perfect competton case, t s reasonable to expect a negatve mpact of market share on the wthngroups dsperson of margns. As expected, a decrease n the market share reduces the EBITDA margn on average, although the dstrbutonal mpact s qute heterogeneous. In response to the same change, hgh-margn frms seem to reduce ther prce-cost margns much less than lowmargn frms. These results renforce and complement the pror results obtaned wth the prce equaton (2) and wth ordnary least squares. In theory, one expects to fnd frms wth low prce-cost margns ether f prces are low,.e., compettve markets, or n markets wth neffcent frms,.e., costs are hgh. The results ndcate that for frms wth low prce-cost margns an ncrease n the market share results n a hgher ncrease n the prce-cost margn than for frms wth hgh prce-cost margn, ceters parbus. Both hypotheses, market power ncrease and effcency mprovements are consstent wth ths result, but when consdered jontly wth the prce equaton (see Tables 3a, 3b, and 3c), the results suggest that at least part of the mprovements n our proxy of the prce-cost margn are attrbutable to prce ncreases, and that ths rsng effect of the margn s hghest n the lowest margn quantle. Of course, as specfed n our model, dfferences n prce could reflect dfferences n qualty, and hence could be consstent wth the effcency hypothess. 18
6. Concluson and polcy mplcatons Despte dffcultes nherent wth avalable data, our paper suggests some nterestng results. We fnd, as expected accordng to theory, a postve and sgnfcant effect between market share and prces and margns, after controllng for country, and tme effects. However, for frms wth large market shares (above the mean of the sample) there s no statstcally sgnfcant effect of market shares on prces and the effect of market shares on margns s less pronounced than for frms wth market shares below the mean of the sample. On the other hand, for frnge frms, there s a statstcally sgnfcant postve effect of market shares on prces and margns. Frms wth large market shares do not change ther behavor (.e., prce) n response to changes n market share whereas frnge frms do, apparently because ther ncentve to do so s relatvely smaller than that of frms wth small market shares,.e., the results suggest frms wth large market shares gan proportonally less (.e., lower ncrease n prce-cost margns) by competng aggressvely (e.g., on prce) to gan market share. In addton, the observed behavor of frms wth respect to prces and prce-cost margns produces some surprsng results. The most sgnfcant change n performance (n terms of changes n prces and changes n prce-cost margns) occurs n markets that were conventonally thought to have a better performance,.e., frms and/or markets wth low prces and low prce-cost margns. For example, frms wth prces (prce-cost margns) n the lowest decle respond to an ncrease n market share wth an approxmately 4 (2) tmes larger ncrease n prces (prce-cost margns) than frms n the hghest decle of prces (prce cost margns),.e., low-prce (low prce-cost margns) frms wll ncrease ther prce (prcecost margn) much more than hgh-prce (hgh prce-cost margn) frms, n response to an ncrease n market share. If the lowest prces and lowest prce-cost margns are found n the relatvely more compettve markets, the results suggest that t s n these markets that prces and margns rse most n response to an ncrease n market share of the frms. As for polcy mplcatons the paper suggests that, for ths partcular ndustry, the 19
Herfndahl-Hrschman Index seems an nadequate nstrument on whch to base horzontal merger polcy analyss. Accordng to our results, some ncreases n the HHI (those related to gans n market share by frms wth large market shares) would have mnmal mpacts on prces and margns, whle smaller ncreases n the HHI (caused by market share gans by smaller frms) would have more mportant mpacts on prces and margns. Furthermore, frms wth large market share of several EU countres have been found to have Sgnfcant Market Power (SMP) by the Natonal Regulatory Authortes, and as such have been submtted to a more strngent regulatory regme than frms wth small market share (e.g., n terms of prce settng behavor). However, our results suggest that t s the frms wth small market share,.e., those now granted non-smp status, whch alter ther behavor the most n response to changes n the market share. 20
References Appelbaum, E., 1982, The estmaton of the degree of olgopoly power, Journal of Econometrcs, V. 19, pp. 287-299 Berger, A., 1995, "The Proft Structure Relatonshp n Bankng: Tests of Market Power and Effcent Structure Hypothess", Journal of Money, Credt, and Bankng, V. 27, pp. 404-31 Bos, J., 2003, Improvng Market Power Tests: Does t matter for the Dutch Bankng Market?, Research Seres Supervson, No. 56, De Nederlandsche Bank, Amsterdam Bresnahan, T., 1982, "The olgopoly soluton s dentfed", Economcs Letters, V. 10, pp. 87-92 Bresnahan, T., 1989, Emprcal studes of ndustres wth market power, n Schmalensee and Wllg (edtors), Handbook of Industral Organzaton, Elsever Scence Publshers B.V., V. 2, pp. 1011-1057 Busse, M., 2000, Multmarket Contact and Prce Coordnaton n the Cellular Telephone Industry, Journal of Economcs & Management Strategy, V. 9, pp. 287-320 Campbell, G. and L. Mutschler, 2004, Global Wreless Matrx 2Q04: Sgns of Softness?, Global Securtes Research & Economcs Group, Merrll Lynch, 29 September 2004 CTIA (Cellular Communcatons and Internet Assocaton), 2003-2005, End Year wreless ndustry survey Demsetz, H., 1973, Industry Structure, Market Rvalry and Publc Polcy, Journal of Law and Economcs, V. 16, pp. 1 9 EC (European Commsson), 2004, Techncal Annexes of the Nnth Report on the Implementaton of the Telecommuncatons Regulatory Package CORRIGENDUM, Annex 1, COM (2003) 715 fnal ERG, 2004, ERG Common Poston on the approach to Approprate remedes n the new regulatory framework, ERG (03) 30rev1 FCC (Federal Communcatons Commsson), 2003-2005, 8 th, 9 th, and 10 th Annual Report and Analyss of Compettve Market Condtons Wth Respect to Commercal Moble Servces, Feuersten, S., 2005, Colluson n Industral Economcs A Survey, Journal of Industry, Competton and Trade, V. 5, pp. 231 234 Gagnepan, P. and P. Perera, 2005. "Entry, Cost Reducton and Competton n The Portuguese Moble Telephone Industry," CEPR Dscusson Papers 4993, Grzybowsk, L., 2005, Regulaton of Moble Telephony across the European Unon: An Emprcal Analyss, Journal of Regulatory Economcs, V. 28, pp. 47 67 Harrngton, J., 2005, Detectng Cartels. Johns Hopkns Unversty, (unpublshed). Iwata, G., 1974, Measurement of Conjectural Varatons n Olgopoly, Econometrca, V. 4, pp. 947-966 Jaumandreu, J. and J. Lorences (2002). Modelng prce competton across many markets (An applcaton to the Spansh loans market), European Economc Revew, V. 46, pp. 93-115 Koenker, R. and G. Bassett, 1978, Regresson Quantles, Econometrca, V. 46, pp. 33-50 Panzar, J. and J. Rosse, 1987, "Testng for monopoly equlbrum" Journal of Industral Economcs, V. 35, pp. 443-456 Parker, P. and L-H. Röller, 1997, "Collusve Conduct n Duopoles: Multmarket Contact and Cross- Ownershp n the Moble Telephone Industry", RAND Journal of Economcs, V. 28, pp. 304-322 21
Porter, R., 2005, Detectng colluson, Revew of Industral Organzaton, V. 26, pp. 147-167 Scherer, F. and D. Ross, 1990, Industral Market Structure and Economc Performance, 3rd ed. Houghton Mffn:Cambrdge, MA Schmalensee, R., 1989, Inter-Industry Studes of Structure and Performance, n Schmalensee and Wllg (edtors), Handbook of Industral Organzaton, Elsever Scence Publshers B.V., vol. 2, pp. 951-1007 Telgen, 2003, Report on Telecoms Prce Developments from 1998 to 2003, ECSC-EC-EAEC, Brussels Luxembourg, Prepared n September 2003 by Telgen for the European Commsson, Drectorate General for Informaton Socety 22
Appendx 1: Revenues, output, prce, and proft characterzaton In ths analyss, we am at analyzng the operators prcng behavor regardng usage of voce telephone servces,.e. to explan the dfference n the level of the operators average revenue (prce) per mnute, rather than focus on the consumers choce of one operator prcng plan over the same or other operators prcng plan. Our argument s that average revenue per mnute together wth the number of mnutes of traffc are the man determnants of moble operators revenues and profts,.e., they are akn to the operator prce and output varables, and n ths hypothess we are partly supported by the Merrll Lynch Global analysts, whch consder average revenue per mnute a good proxy for prce, and by the Federal Communcatons Commsson (2004), whch also uses average revenue per mnute as one of ts proxy for prces. On the other hand, other research (Telgen, 2003; Parker and Röller, 1997; Grzybowsk, 2005) has emphaszed the usage of prces based on hypothetcal baskets of moble telecommuncatons consumpton, snce t s argued that the unt of output (mnute) wll dffer across frms (see dscusson further below), but we beleve a measure of prce based on a basket of moble telecommuncatons consumpton ntroduces bases of ts own. Measure of Revenues: Operatng revenues net of data and handset revenues On the revenue sde, we focus exclusvely on the frm s reported moble operatng revenues,.e., we dscard non-recurrng revenues. Currently, n most countres, moble operators derve most of ther operatng revenues from voce traffc, whch n our context ncludes retal blled outgong calls (ncludng roamng) but also wholesale nterconnecton revenues for ncomng calls from other networks,.e., charges other telecom operators pay to the frm for the termnatng leg of the call to a gven subscrber plus roamng revenues, where applcable. The only other relevant sources of operatng revenues are moble handset sales and data traffc revenues. ML subtracts handset sales from the measure of revenue, resultng n what s known n the ndustry as the servce revenues. In the calculaton of average revenue per mnutes, ML further subtracts data traffc revenues from servce 23
revenues fgures. For the operators n the sample, data revenues represent typcally between 5% and 15% of the frms servce revenues. Thus, ML s measure of average revenue per mnute ncludes only voce traffc (outgong and ncomng). Measure of Output: outgong plus off-net ncomng mnutes of voce calls We consder that the relevant measure of output s the total mnutes of voce calls, defned, partally based n the ML methodology, as total duraton mnutes of blled outgong calls and ncomng calls from other networks rather than other alternatve varables. 11 Total mnutes of blled traffc (outgong and ncomng from other networks) captures both the change n the traffc usage of exstng subscrbers and the addton of new subscrbers to the network, and t s an often used ndustry metrc that s wdely reported. For countres (e.g., Australa, Fnland, New Zealand) that only report outgong traffc, Merrll Lynch adjusts traffc data by assumng that ncomng traffc s one thrd of total traffc, consstent wth traffc patterns n these countres and elsewhere. Merrll Lynch does not adjust traffc data n countres where on-net ncomng calls (termnatng calls from the same network) are also blled (so-called Moble Party Pays or MPP countres), but estmates that n these countres (US, Canada, Chna, Inda, Sngapore, Hong Kong) the number of mnutes may be overestmated by up to 20%. To account for ths effect we nclude a control dummy for ths group of countres. The use of voce call mnutes as a measure of output and demand for servces s nonetheless not a perfect measure. A gven subscrber s pattern of outgong and (other network or off-net) ncomng mnutes of voce traffc s lkely to vary wdely (e.g., busness calls, nternatonal calls, peak hour calls, roamng calls, local calls, etc). Furthermore, dfferent subscrbers are lkely to have dfferent dstrbutons of the dfferent types of calls, 11 Other alternatve measures of demand and output were avalable. For example, number of subscrbers (.e., subscrpton of a moble voce servce) s not a satsfactory metrc for the frm output or user demand snce t s too coarse a measure of usage, traffc per subscrber tends to ncrease over tme and could not be captured n ths measure, and any frm strategy drected at changng the traffc patterns of exstng subscrbers (that for example contrbuted to an ncrease n margnal costs) would not be captured f number of subscrbers was used as the metrc. Number of calls per subscrber could alternatvely be used as measure of output, but t s stll not as precse as the number of call mnutes. 24
dfferent operators are lkely to have a dfferent dstrbuton of subscrber types, and dfferent countres are also lkely to have dfferent dstrbutons of operators and subscrbers, leadng to what n essence are dfferent typcal voce mnutes among subscrbers, operators, and countres. Therefore, n ths analyss we are nterested n expected values or a representatve mnute of voce calls,.e., the measured unt of output s the same (mnute of voce call), but the perceved qualty of the unt of output and respectve prce may dffer across operators,.e., there s a dfferentated olgopoly. Dfferences n our measure of output (representatve mnute of outgong voce and off-net ncomng voce calls) between countres are controlled for by usng a country dummy n our model. Thus, our analyss, s smplfed snce we assume that the relevant output can be standardzed nto a unt of account that s a representatve mnute of outgong and off-net ncomng voce calls. We accept that whle we standardze the unt of output to the representatve mnute, we are unable to compare ts perceved qualty across frms,.e., dfferng levels of prces may result from dfferent levels of perceved qualty, for example because of systematcally dfferent proportons of outgong and ncomng calls or dfferent proportons of on-net and off-net outgong and ncomng calls. Measure of Prce: average revenue per mnute The relevant measure of prce s average revenue per mnute, whch ML defnes as the voce-only average revenue per user (ARPU) dvded by the number of mnutes per user. Merrll Lynch adjusts revenue per mnute by subtractng data and handset revenues from ARPU, so as to nclude n the calculaton of the revenue per mnute only voce traffc revenue (ncludng nterconnecton revenues from ncomng calls blled to thrd partes and roamng revenues). Note that t s lkely that the operators can only mperfectly fne-tune the average revenue per mnute (e.g., through defnton of dfferent prce plans or base mnute prces), although t s a measure that the operators often montor and report, and s followed by ndustry analysts. Indeed n some mature markets operators have managed to mantan or even ncrease average revenue per mnute, suggestng operators are keenly aware of the 25
mpact of average revenue per mnute on revenues and proftablty. Fnally, t should be noted that there s some double countng of revenues n the measure of average revenue per mnute, n the sense that for most operators some of the ncomng traffc generates nterconnecton revenues for the moble operators that are pad by other moble operators out of outgong call revenues. ML ndcates that n countres where the callng party pays nterconnecton revenues amount to about 20% of revenues. Thus, f two frms were to merge, ceters parbus, the combned frm revenues mght declne snce each frm would lose the nterconnecton revenues. Whle we would wsh to correct for ths effect, the necessary data s not avalable n the ML sample. Measure of economc profts: EBITDA There s a large lterature on the problems of usng accountng data and accountng measures of proftablty to estmate economc profts and prce-cost margns (Schmalensee, 1989). From an accountng perspectve, there s a dfference n proftablty f the nvestment s fnanced wth own captal or external captal (debt). Thus, we prefer a measure of proftablty that does not nclude nterest pad, whch means that our measure of proftablty does not vary dependng on the frm captal structure, excludes non-recurrent revenues and costs,.e. operatng profts, and for that matter a measure that also excludes taxes, whch dffer across countres,.e., our preferred measure of economc proftablty s the accountng operatng EBIT (operatng earnngs before nterest and taxes). An addtonal ssue n the dentfcaton of the left-hand-sde varable n equaton (1b) s what, f any, accountng data may be used as an estmate of the economc fxed costs. Whle subject to dfferng defntons and treatments, the deprecaton costs (plus the leased nfrastructure costs) represent an accountants estmate of the yearly mparment of the captal equpment, and are thus a proxy for the yearly nstallment of the long-run fxed costs, although one that s hghly crtczed n the academc lterature (Schmalensee, 1989), namely 26