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Entry Deterrence and the Calculation of the Net Cost of Universal Service Obligations

  • Jaag Christian

    (Swiss Economics and University of St. Gallen)

This paper relates to the current discussion about how to measure the net cost and the unfair burden of universal service provision in network industries. The established profitability cost approach compares the profit of a universal service provider (USP) with and without a universal service obligation (USO). This paper argues that the net cost of universal service provision critically depends on the regulatory counterfactual and hence the USP’s strategy space without USO. On the one hand, a strong USO limits the USP’s means to position itself in the market, which offers cream-skimming opportunities and invites competition. On the other hand, a simple game-theoretic entry analysis shows that the USO may effectively serve as a valuable strategic commitment device to deter entry. Hence, the USO may be valuable to the USP despite causing inefficient operations. From a policy perspective, this constitutes a counter-intuitive result for the definition of the USO: the stricter it is regulated, the more detrimental it may be to competition and, therefore, the smaller is its burden on the USP.

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Article provided by De Gruyter in its journal Review of Network Economics.

Volume (Year): 10 (2011)
Issue (Month): 1 (March)
Pages: 1-19

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Handle: RePEc:bpj:rneart:v:10:y:2011:i:1:n:4
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References listed on IDEAS
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  1. Harstad, Ronald M & Crew, Michael A, 1999. "Franchise Bidding without Holdups: Utility Regulation with Efficient Pricing and Choice of Provider," Journal of Regulatory Economics, Springer, vol. 15(2), pages 141-63, March.
  2. Dixit, Avinash, 1980. "The Role of Investment in Entry-Deterrence," Economic Journal, Royal Economic Society, vol. 90(357), pages 95-106, March.
  3. A. Michael Spence, 1977. "Entry, Capacity, Investment and Oligopolistic Pricing," Bell Journal of Economics, The RAND Corporation, vol. 8(2), pages 534-544, Autumn.
  4. Boldron, François & Cremer, Helmuth & De Donder, Philippe & Joram, Denis & Roy, Bernard, 2007. "Social costs and benefits of the universal service obligation in the postal market," IDEI Working Papers 456, Institut d'Économie Industrielle (IDEI), Toulouse.
  5. Christian Jaag & Urs Trinkner, 2008. "Tendering Universal Service Obligations in Liberalized Network Industries," Working Papers 0013, Swiss Economics, revised Jan 2009.
  6. Christian Jaag, 2007. "Liberalization of the Swiss Letter Market and the Viability of Universal Service Obligations," Working Papers 0006, Swiss Economics.
  7. Valletti, Tommaso M & Hoernig, Steffen & Barros, Pedro P, 2002. "Universal Service and Entry: The Role of Uniform Pricing and Coverage Constraints," Journal of Regulatory Economics, Springer, vol. 21(2), pages 169-90, March.
  8. Martin J. Osborne & Ariel Rubinstein, 1994. "A Course in Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262650401, June.
  9. Crew, Michael A & Kleindorfer, Paul R, 1998. "Efficient Entry, Monopoly, and the Universal Service Obligation in Postal Service," Journal of Regulatory Economics, Springer, vol. 14(2), pages 103-25, September.
  10. Panzar, John C., 2000. "A methodology for measuring the costs of universal service obligations," Information Economics and Policy, Elsevier, vol. 12(3), pages 211-220, September.
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