Regulation, competition and firm productivity and performance in network industries: the case of mobile telephony in Europe

Abstract

This thesis is guided by two basic objectives. The first one is to understand how the regulatory measures governments have taken have affected competition in network industries. In particular, special attention is paid to differences in the switching cost regulation implemented by different governments in the European Union. The second objective is to gain a better understanding of how the customer base affects the competitive advantage of companies in network industries and,therefore, the ability to generate improvements in firm productivity and financial performance. Indeed, the aim is to study how factors external to the company, in particular, regulatory and technological matters, have an influence on the competitive advantages of both leaders and competitors in a network industry. In both cases, the empirical model involves a major network industry, namely, European mobile telephony, which has undergone significant technological and regulatory changes in recent years.The mobile telecommunications industry has played a decisive role in the development and growth of the European economy. Overall telecommunications expenditure within EU-27 accounted for more than 2.8% of gross domestic product(GDP) in 2009, with turnover from mobile services exceeding that of fixed network services. Moreover, growth has been concentrated in mobile telephony markets and other data services, and the penetration rate - the average number of mobile phone subscriptions - exceeds 100% in almost every EU member state (Eurostat, 2011). In network industries such as mobile telecommunications, the academic literature has widely explored pioneering advantages. Among others, pioneering companies with market share advantages have been shown to enjoy certain benefits originated from isolating mechanisms like technological leadership, pre-emption of scarce resources and the creation of buyer-switching costs (Lieberman and Montgomery, 1988). First, technological leadership is gained by scope economies in R&D and superior technological skills. The technology in the mobile telecommunications industry is available to all firms, and it is easy to identify and copy the innovations introduced by competitors. Although this situation should lead to pioneering operators rapidly losing their first-mover advantage, these first-movers have maintained their market share advantage (Fernández and Usero, 2007). Second, pioneers can pre-empt the scarce resources (e.g., favorable physical locations, inputs, plants and equipment or distribution and service systems)needed to develop the business. As mobile telecommunications is an equipment based service, the advantages for pre-emption are significant (Bharadwaj et al.,1993). For example, the location of base stations poses problems for firms that enter the market later, as fewer sites are available and local residents usually oppose their deployment in towns and cities. Pioneers can also take advantage due to their experience in the industry, even though all operators–regardless of when they enter the market–have the same technology. Pioneers could then sustain their market share advantages over their competitors. In network industries, an installed customer base is a key strategic asset because it could afford a sustainable competitive advantage over time that is difficult to imitate (Shankar and Bayus, 2003). Finally, buyer-switching costs serve to lock in customers. Switching costs -the costs realized when consumers’ change from one product to another - are mainly derived through compatibility, transaction, learning, psychological and uncertainty costs, as well as through loyalty schemes that lock in consumers (Klemperer, 1995). A direct implication of switching costs is that they convert homogeneous products before the purchase to heterogeneous ones afterwards due to the additional costs consumers face when switching (Klemperer, 1987; Grzybowski, 2005), which in turn could enhance firms’ market power over existing consumers who face such costs.The mobile telephony industry has significant consumer switching costs, thus providing greater market power to firms with a higher market share (Fuentelsaz,Garrido and Maicas, 2012). The non-portability of numbers, price discrimination and subsidized phones are the main switching costs in the mobile telecommunications industry. Non-portability keeps the customer captive due to the inconvenience of having to change telephone numbers when switching to another operator. A similar effect occurs with the high price operators charge clients who wish to terminate their contract but maintain their telephone number. In some cases, some operators use price discrimination inside and outside their network. Lastly, operators offer customers discounts on new phones at the end of their contracts.Some of these advantages allow market share leaders to exercise market power over their suppliers and customers and restrict competition in the industry.Indeed, all these advantages make it more difficult for competitors to compete on a level playing field. In general, government and regulatory agencies have introduced considerable changes in the mobile telephony industry to reduce leading companies’ market share advantages (Gómez-Barroso and Feijóo, 2009). The first step was the liberalization of the industry, followed by several regulatory interventions designed to improve competition, with significant benefits for end consumers in terms of greater choice, lower prices, improved quality and more innovation (BEREC, 2010). The academic literature presupposes that market share leaders enjoy first mover advantages, and so advantages are to be expected in their financial performance. However, to our knowledge there are no studies that empirically test this. Furthermore, it is to be expected that changes in the environment, especially in regulatory measures and the industry’s technological progress, will have a bearing on the competitiveness of network industries and on the competitive advantages of firms with a larger customer portfolio, as well as on competitors.Figure 1 shows the structure and organization of the thesis. The first chapter analyses how switching cost regulation affects competition at industry level.The second and third chapters focus on efficiency and financial performance at firm level. Specifically, these two chapters seek to answer the question of how the installed customer base allows firms to improve productivity and performance and,additionally, within this context it sheds more light on the impact of environmental factors, such as regulatory and/or technological ones.Regarding the first chapter, and according to Klemperer (1995),compatibility, size of discount and transaction costs are the three main sources of switching costs in the context of mobile communications. One of the main measures taken to reduce the magnitude of switching costs in the mobile industry was the introduction of Mobile Number Portability (MNP) (Shy, 2002; Lee, Kim, Lee, and Park, 2006; Grzybowski, 2008; Maicas, Polo, and Sese, 2009). Without MNP,customers would lose their current mobile number when they switch operators, being forced to inform all their current contacts of their new number. MNP is available throughout the European Union, but there are significant differences in how MNP has been implemented over the past decade regarding issues such as switching fees and periods. Although there are several descriptive studies on MNP implementation,the existing empirical literature does not provide clear evidence regarding the impact on competition of introducing MNP, possibly because there is no consideration for the rules and requirements put into place by NRAs during the implementation phase.This chapter aims to explain the differences in switching cost regulation and the implication it has on the level of industry competition in the mobile telecommunications sector.The second chapter examines productivity and the impact of specific factors on the productivity differences among leading mobile operators in the mobile industry. One of the most important issues after introducing competition in network industries is how to achieve efficiency and increased productivity, which could offer a competitive advantage over the other players in the industry. Improving productivity is becoming crucially important, particularly in mobile telecommunications, which have seen increased competition and market saturation in recent years. Moreover, improving the efficiency of the leading operators is becoming increasingly important due to the characteristics of the industry, where by leading players own the infrastructure in many countries, and the access of other players is dependent on the access prices the leading operators charge. Based on the above reasoning, the productivity improvements of the leading mobile operators in Europe are measured using a novel methodological approach, as suggested by Simar and Wilson (1999), which allows drawing valid productivity estimates following a bootstrap procedure. Moreover, a unique dataset of mobile operators from Western and Eastern Europe is used, whereby a study can be made of certain determinants related to the differences among the groups of countries to which mobile operators belong. The third chapter examines the financial performance change of both leaders and competitors in the mobile telephony industry. Leading market firms are those with the highest market share in an industry, and this could presumably lead to the creation of competitive advantages that can be translated into greater performance improvements over competitors. The competitive advantages associated with market leadership could be explained theoretically as emerging from positive network externalities, first-mover advantages and superior resources and capabilities.However, evidence is ambiguous as to whether leading players, by virtue of having a greater installed customer base, would be able to increase their financial performance any more than their competitors. Furthermore, the competitive landscape in which the majority of firms operate has become highly complex and significantly uncertain,and that can affect their competitive advantages (Sirmon, Hitt, Ireland, and Gilbert,2011). In most networks industries, such as telecommunications, video game consoles or operating system software, technological progress and government regulation are two of the main environmental factors that can alter the relationship between market share leadership and financial performance change. Technological progress can alter the position of leading companies and destroy the potential rents leading firms enjoy in the face of rapid technological changes (Suárez and Lanzolla,2007). On the other hand, firms with a large market share can exercise their market power and, in turn, governments may introduce regulatory measures to promote competition and avoid the distortive behavior of leading firms. Therefore, the third chapter additionally evaluates the impact that two environmental variables, namely,technological progress and switching cost regulation, have on the improvement of a firm’s financial performance.Finally, the general conclusions of the thesis are presented. This final section summarizes the key findings of the research carried out. We discuss the work’s contributions and the study’s limitations, ending with directions for future research.

Η παρούσα διατριβή καθοδηγείται από δύο βασικούς στόχους. Ο πρώτος είναι να καταλάβουμε πώς τα ρυθμιστικά μέτρα που έλαβαν οι κυβερνήσεις επηρέασαν τον ανταγωνισμό στις βιομηχανίες δικτύου. Ειδικότερα, δίνεται ιδιαίτερη προσοχή στις διαφορές στην ρύθμιση του κόστους αλλαγής που εφαρμόζεται από διαφορετικές κυβερνήσεις στην Ευρωπαϊκή Ένωση. Ο δεύτερος στόχος είναι η καλύτερη κατανόηση του τρόπου με τον οποίο η πελατειακή βάση επηρεάζει το ανταγωνιστικό πλεονέκτημα των εταιρειών σε βιομηχανίες δικτύου και ως εκ τούτου, η ικανότητα να βελτιώσει την παραγωγικότητα και τα οικονομικά της επιχείρησης. Ο στόχος είναι να μελετηθεί ο τρόπος με τον οποίο παράγοντες εξωτερικοί της εταιρείας, κανονιστικά και τεχνολογικά θέματα, επηρεάζουν τον ανταγωνιστικό πλεονεκτήματα τόσο των ηγετών στην αγορά όσο και των υπολοίπων ανταγωνιστών σε μια βιομηχανία δικτύου.