Co-investments: a game theoretical simulation

One current and ongoing topic in the telecommunications industry is the question on how to
roll-out fibre-based broadband networks – also known as Next Generation Access Networks
(NGAN) – best. It has been economically proven that such a roll-out will bring about more
competitiveness and even social welfare in the market due to its correspondingly higher
levels of investment and innovation.

The current legacy copper networks are mainly owned by former national monopolists (i.e.
incumbents) from a time prior to the liberalisation of the telecommunications market
As can be seen in the Digital Scoreboard of the European Commission, this roll-out is not
taking place among Member States of the EU at the same pace and might potentially fail to
achieve the aim set in the Digital Agenda for Europe (DAE) until 2020 to reach at least 50%
broadband take-up in the EU with at least 100 Mbps.
In sum, there are three reasons for the slow-paced growth of NGAN deployment:
1. The irreversible costs (i.e. sunk costs) from deploying the network are very high.
2. Return on investment (ROI) is highly uncertain/risky and it depends upon the take-up
of consumers as well as their valuation of NGA services.
3. Significant positive externalities to third parties may undermine the appropriability of
ROI.

What is the role of the market and what is the role of the government?
 A trade-off between static and dynamic efficiency occurs.

A cooperative investment (also referred to as co-investment) is one potential method and

policy where at least two telecom operators jointly decide to deploy a NGAN whereby the
associated costs and risks are shared and hence reduced.
Assuming telecom operators do not co-invest but rather deploy their networks individually,
duplication of networks might occur. This is considered as economically inefficient. Even
though this situation seems impracticable, it might nevertheless be possible since firms in a
free market are able to make their own decisions.

Network facilities (upstream market) are sometimes regarded as being essential or

“bottleneck” facilities. Operators with strong market power (SMP), usually incumbents, are
hence obliged to provide access to interested market seekers (who are required to pay an
access fee) that would like to offer services in the retail level (downstream market) but are
dependent on such an upstream facility.
Assuming that two or more operators coincide to jointly deploy a NGAN, the facilitation to
“illegally” form some sort of cartel or any other form of anticompetitive collusive behaviour in
the downstream market is possible. This is particularly of interest since such a threat might
eliminate all the perks of a co-investment agreement by increasing prices for end-consumers,
setting higher market entry barriers (MEBs) for non-co-investing operators that were not
willing to invest, hamper competition and even reduce total welfare.

A possible question to be asked is to investigate whether such an assertion occurs and if so,
how to circumvent it. More importantly, the primordial and focal point of interest is to
determine whether a co-investment approach is conducive to more network coverage than
would have been the case with another alternative solution (e.g. benchmark could be
access-based regulation based on Long-Run Incremental Costs, LRIC).

Some papers have already tried to investigate the pros and cons of co-investments, e.g.
Krämer and Vogelsang (2016). From a game theoretical perspective, it would be interesting
to determine the Nash Equilibrium using Backward Induction. Necessary to that end, Phlips
(1995) offers an overview of some game theoretical studies conducted in the field of
competition policy with particular focus on collusion.
How could such a model look like?

1. Choose an adequate time structure for your model

2. Choose the adequate parameters for your model
3. Test the model
4. Apply backward induction and find the Nash equilibrium
5. Evaluate and conclude

For 1)
The time structure can take the form of a multi-stage game
- Stage 1: investment phase in t = 0 where co-investments might take place (but not
necessarily)
- Stage 2: retail phase in t = 1, …, T where firms compete in the retail market à la Cournot
(quantity-based) or à la Bertrand (price-based)

For 2)
Areas:
- Which areas would you like to investigate and how many? Examples are metropolitan, urban
or rural areas

Households:
- How many households are connected to each area? Remember that the bigger the area, the
higher the number of households, hence higher demand

Costs:
- How much is the infrastructure investment in each area? Remember to consider economies
of density to each network, that is, the higher the density of an area, the lower the costs

Sharing demand and costs:

- How many firms should participate in the model? Do they have the same market shares?
Example, should an incumbent and one market entrant share demand 50-50 (i.e. symmetric
pay-out) or 80-20 (i.e. asymmetric pay-out)? What could be the consequences of both
options, e.g. in terms of promoting incentives to invest?

Others:
- How high should the initial budget of each firm be?
- Should there be a limit regarding the consumers’/households’ willingness to pay, e.g. in
Bertrand competition?
- How many rounds shall be played? One-time shot (static) or iterated (limited or unlimited)?
- In case a ROI is envisaged: how high should the interest rate be?
- In case a firm did not co-invest and is required to pay an access fee to offer its services: how
much should this fee be?
o With this information you can establish the cost, revenue and profit functions for
each firm
 Parameter description Value
Firms 𝑖, 𝑗 ∈ {1, 2, … } 𝑎𝑛𝑑 𝑖 ≠ 𝑗 ≠ ⋯
Number of households (HH) in each area: 𝐴𝑟𝑒𝑎 𝐼 = ⋯ 𝐻𝐻
𝐴𝑟𝑒𝑎 𝐼𝐼 = ⋯ 𝐻𝐻
𝐴𝑟𝑒𝑎 𝐼𝐼𝐼 = ⋯ 𝐻𝐻
Development costs per area: (same price 𝑘 = ⋯€
for all areas OR different prices for each
area)
Cost share (for co-investments): 𝛼𝑖 = 𝛿𝑖
Demand share (at equal prices): (for 𝛿𝑖 = 0.75, 𝛿2 = 0.25 (asymmetric)
Bertrand competition) (depends on the 𝛿𝑖 = 0.5,0 𝛿2 = 0.50 (symmetric)
number of firms!)
Consumers’ willingness to pay: 𝑣 = ⋯€
Interest rate: 𝛾=⋯
Number of retail periods: 𝑇=⋯
Budget: 𝑏 = ⋯€

Notes:
- You can consider a consumers’ willingness to pay for two different scenarios: with and
without fibre-based technology
- In case of Cournot competition, you can use an inverse demand function to determine the
price function of each firm
- You can consider the implications of marginal costs for a network owner and an access
seeker; you can also consider different cost methodologies such as LRIC or LRIC+

 Please be aware that the form of the model, the chosen parameters as well as the
notes are to be seen as basic guidelines.
 Being creative and coming up with new ideas is welcoming.
References:
 Cambini, Carlo; Silvestri, Virginia (2013). Investment sharing in broadband networks.
Telecommunications Policy 37 (10), 861-878.
 European Commission (2010). Communication from the commission to the European
Parliament, the Council, the European Economic and Social Committee and the
Committee of the Regions – A Digital Agenda for Europe. Brussels, 26.08.2010
COM(2010) 245 final/2.
 European Commission (2016). Digital Agenda Scoreboard 2016 – Electronic
communications market indicators: definitions, methodology and footnotes on
Member State data.
 Krämer, Jan; Vogelsang, Ingo (2012). Co-investments and tacit collusion in regulated
network industries: experimental evidence. 23rd European Regional Conference of the
International Telecommunication Society, Vienna, Austria, 1-4 July 2012.
 Phlips, Louis (1995). Competition policy: a game-theoretic perspective. Cambridge
University Press.