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Real Options and the Costs of the Local Telecommunications Network

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  • Nicholas Economides

Abstract

The Telecommunications Act of 1996 invites entry in the local telecommunications networks whereby entrants will lease parts of the network ("unbundled network elements") from incumbents "at cost plus reasonable profit." A crucial question in the implementation of the Act is the appropriate measure of cost. This paper examines the economic principles on which the cost calculation should be based. I conclude that the appropriate measure of cost (maximizing allocative, productive, and dynamic efficiency) is forward-looking economic cost and not the historical, accounting, or embedded cost of the incumbent’s network. In calculating costs, demand and supply uncertainty, as well as the asymmetric position of incumbents and entrants should be taken into account. Close examination of the issue of uncertainty in the local telecommunications network reveals that (i) for most unbundled network elements, there is little demand uncertainty; and (ii) that those elements that face significant uncertainty, do not have sunk value. Thus, the incumbent does not face higher expected cost by investing. Moreover, the rewards of the incumbent can be higher because buyers prefer to buy services from the owner of the network. Finally, strategic considerations in oligopolistic interaction are likely to dominate any uncertainty considerations and will increase the incentive of incumbents to invest.

Suggested Citation

  • Nicholas Economides, 1999. "Real Options and the Costs of the Local Telecommunications Network," Working Papers 99-11, New York University, Leonard N. Stern School of Business, Department of Economics.
  • Handle: RePEc:ste:nystbu:99-11
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    File URL: http://raven.stern.nyu.edu/networks/real.pdf
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    Citations

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    Cited by:

    1. Nicholas Economides, 2003. "Telecommunications Regulation: An Introduction," Working Papers 03-22, New York University, Leonard N. Stern School of Business, Department of Economics.
    2. Clark, Ephraim & Easaw, Joshy Z., 2007. "Optimal access pricing for natural monopoly networks when costs are sunk and revenues are uncertain," European Journal of Operational Research, Elsevier, vol. 178(2), pages 595-602, April.
    3. Heatley, David & Howell, Bronwyn, 2010. "Overseas Investment: is New Zealand 'Open for Business'?," Working Paper Series 4054, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    4. Inderst, Roman & Peitz, Martin, 2014. "Investment under uncertainty and regulation of new access networks," Information Economics and Policy, Elsevier, vol. 26(C), pages 28-41.
    5. Evans, Lewis T. & Guthrie, Graeme A., 2005. "Risk, price regulation, and irreversible investment," International Journal of Industrial Organization, Elsevier, vol. 23(1-2), pages 109-128, February.

    More about this item

    Keywords

    telecommunications; regulation; cost; real options;

    JEL classification:

    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • D4 - Microeconomics - - Market Structure, Pricing, and Design

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