Transcript Essays in Theoretical and Empirical Industrial Organization

Competitive Nonlinear Pricing in
Duopoly Equilibrium: The Early U.S.
Cellular Telephone Industry
Eugenio J. Miravete
University of Pennsylvania & CEPR
Lars-Hendrik Röller
WZB, Humboldt University & CEPR
(Chief Competition Economist, European Commission)
This version: February 24, 2005
Introduction
Road Map
• Motivation
• Literature Review
• The Data
• Model Description
• Econometric Implementation
• Policy Evaluations
• Things that still need to be done.
Motivation
• Nonlinear pricing under competition:
– Abundant evidence that firms engage in price discrimination
practices even when they operate in competitive
environments.
– Business practices have not been matched by theoretical
models until very recently.
Identification Issues
• What are the basic estimation problems of the NEIO?
– Marginal cost data is very rarely available.
– Price-cost margins have to be estimated together with
demand and cost parameters.
– They change with consumption level in nonlinear tariffs.
– Difficulties concerning the identification of the actual
competition regime.
Our Approach
• How do we incorporate the features of second degree price
discrimination into the estimation of a structural equilibrium
model of nonlinear pricing competition?
– Nonparametric identification: Provided a given specification
of demand, there is a one-to-one mapping between the
distribution of types and the optimal nonlinear tariff.
– Then we can make use of the information contained in the
SHAPE of the tariffs offered by competing firms.
– We assume Nash equilibrium in nonlinear tariffs.
Our Approach
Modeling Choices
• Several approaches are possible to deal with nonlinear pricing
competition:
SingleDimensional
Types
Multidimensional
Types
Rochet and Stole (2002)
Exclusive Agency
Stole (1995)
Random Participation
Serious Identification
Issues
Common Agency
Rey (2000)
Martimort-Rochet-Stole
Better for models of
vertical product
differentiation
Horizontal Product Diff.
Suits best the available
information (spec. test).
Literature Review
• Second degree price discrimination (reduced form):
– Shepard, JPE´91: Full service vs. self-service gasoline.
– Borenstein, RAND´91: Leaded vs. unleaded gasoline.
– Cohen, 2000: Packaging size of paper towels.
• Non-uniform markup changes (reduced form):
– Borenstein, RAND´89: Airline pricing.
– Busse and Rysman, 2001: Advertisements in yellow pages.
– Busse, JEMS´00: Similarity of cellular phone tariffs.
Literature Review
• Second degree price discrimination (equilibrium models):
– Clerides, IJIO´02: Inter-temporal pricing of books.
– Leslie, 2000: Pricing of a Broadway theater.
– Cohen, 2001: Packaging size of paper towels.
– McManus, 2001: Pricing of specialty coffee (size), U.Va.
– Ivaldi and Martimort, Rev. Ec. et Stat´94: Power in France.
– Basaluzzo and Miravete, 2004.
• Linear Pricing (conjectural variations approach):
– Parker and Röller, RAND´97.
Goals
• Provide with an operationally feasible method of estimation for
competitive markets where price discrimination is common.
• Minimize the data requirements.
• Evaluate how non-uniform markups change with competition.
Who benefits the most?
– Incumbent vs. entrants.
– Large vs. small customers.
• Policy analysis:
– Mergers, pricing restrictions, and other counterfactual
evaluations.
The Data
Some Facts: World
• Cellular phones are quintessential part of IT revolution of the
1990s.
• Currently, there are 1.3 billion subscribers worldwide.
• The number of wireless phones will surpass the number of
fixed-line subscribes in 2002.
• It currently accounts for more than 30% of the $1 trillion total
worldwide telecommunications revenues.
Some Facts
Some Facts
Some Facts: U.S.
• United States, 2001:
– Market penetration of 45% with 136 million subscribers.
– Sales: $60 billion.
– Employment: 200,000 direct jobs.
• United States, 1988:
– 1.6 million subscribers.
– Sales: $2 billion.
– Employment: 9,000 direct jobs.
– Average monthly bill: $98.02.
Market Definition
• Technological constraint: Scarce radio spectrum.
• Solution:
– Service areas divided in small cells served by its own lowpowered transmitter. It allows this frequency to carry a different
call in a non-adjacent cell.
– A mobile telephone switching office maintains a continuous
transmission when customers move to a cell that uses a different
frequency.
• FCC design of the early US cellular market:
– Define 305 non-overlapping markets
SMSAs.
– Assign 50 MHz in the 800 MHz band for cellular services.
– Wireline license: fixed line carriers in that area (Block B).
– Non-wireline license: any other US citizen or company (Block A).
Market Definition: SMSA
• It includes a central city or urbanized area of at least 50,000
people.
• It also includes the county containing the central city and
other contiguous counties with strong economic and social
ties to the central city.
• US Census (1990):
– 76% of the population.
– 16% of the land.
Market Definition: SMSA-1980
Sources: Tariff Plans
• Cellular Price and Marketing Letter, Information Enterprises:
– Pricing plans information reported by firms between August of 1984
and August of 1988.
– Price plans are typically two-part tariffs with quantity discounts.
– The number of plans varies from 1 to 9.
– Plans normally include a peak-load component and airtime allowance.
• Our focus: Retail market and peak period.
Concavity of Tariffs
Sources: Market Size
• Cellular Business, various issues, 1984-1988:
– Cell sites.
– Start-up date.
• Remarks:
– Output level is not directly observable.
– Each cell site represents between 1,100 to 1,300 subscribers.
– In a sample of 22 observations in 8 markets between 1985 and 1987, the
correlation between number of cells and subscribers was about 0.92.
– Market shares of competing firms are not known (except for the above
mentioned markets).
Sources: Factor Prices
Sources: Demand
Cellular Phones and Security
The Model
Demand
• Duopoly. Horizontally differentiated products:
• Monopoly:
Distribution of Types
• Burr type XII distribution:
• Market specific markups:
Cost
• Cost function:
• Marginal cost specification:
Monopoly Solution
• The monopolist solves the following mechanism:
• Optimal tariff:
• Optimal purchase:
Monopoly: Stochastic Structure
• First stage quadratic approximation:
– Measurement errors: Optional two-part tariffs vs. fully nonlinear tariff.
• Interpretation of first stage coefficients:
How does the model work?
How does the model work?
0
AIRTIME
500
How does the model work?
How does the model work?
How does the model work?
Approximation Error
Approximation Error
Approximation Error
Identification of Structural Param.
• Highest consumer type:
• Distribution parameter:
• Marginal cost:
Participation Constraint
• Marginal consumer type:
• Determinants of participation:
Duopoly: Quadratic Tariffs
• Basic assumption:
• Redefinition of types:
Duopoly: Distribution of Types
• Joint Distribution of types (Sarmanov):
• Marginal Distribution of Types (Burr type XII):
Duopoly: Solution
• Duopolist 1 solves the following mechanism:
• Optimal tariff payment and purchase:
Duopoly: Stochastic Structure
• First stage regressions:
– Measurement errors: Optional two-part tariffs vs. fully nonlinear tariff.
• Interpretation of first stage regression estimates:
Identification of Structural Param.
• Highest consumer type:
• Marginal consumer type:
Identification of Structural Param.
• Distribution parameters (implements Nash perfection):
• Marginal cost:
Estimation
Further Identification Restrictions
• Reduced form parameters:
• Structural parameters of interest:
• Still need to fix:
Estimation of Demand Parameters
• Makes use of a smaller sample (of the largest markets) for
which the number of subscribers of both firms is available for a
couple of years.
• It is assumed that consumers do not differ in their substitution
pattern conditional on their observed characteristics.
• System estimation from the necessary conditions of
consumption:
Alternative Demand Estimates
2
b1b2
 0.11
Structural Estimates
Tariff Change After Competition
• Tariffs are uniformly lower for all levels of airtime usage.
• The reduction in the rate per minute is more important for
intensive consumers.
• Markups tend to be higher in the duopoly phase:
– Efficiency gains of competition vs. identification issues.
• Most of the gain is due to the increase in variety.
• There is very important unobserved heterogeneity:
– Very important differences of pricing across cities.
Tariff Change After Competition
Estimates & Market Characteristics
Total Welfare Effects
Elasticities
Passing Gains of Competition
Welfare & Market Characteristics
Policy Evaluations
Performance of Pricing Strategies
• Alternative Pricing Strategies:
– Two-Part Tariffs.
– Linear Pricing.
– Flat Tariff.
Performance of Pricing Strategies
• Alternative Pricing Strategies:
– Two-Part Tariffs: Achieve most of the potential profits of screening.
– Linear Pricing: Really bad.
– Flat Tariff: Excludes “too many” low valuation customers.
Things to do…
Performance of Pricing Strategies
• The paper could still be improved in several ways:
– Addressing a model of exclusive agency.
– Dealing with a real common agency problem.
– Estimation of demand using micro data.
– Explaining the number of tariff options offered by firms.
– Fitting the lower envelope of the predicted menu of two-part
tariffs:
– Taking the actual number of plans as given.
– Predicting the number of plans to be offered.