EEE 452: Engineering Economics and

Management

Lec 08: Telecommunications

Economics

M. Rokonuzzaman, Ph.D
Professor, ECE, NSU
[email protected]

1
 What is it?
It’s about the study of the way production and consumption of telecom services are organized to
maximize consumer and producer surpluses, by taking the advantage from economies of scale,
scope and dynamic efficiency or innovation—through competition or market forces.
1. The effect of industry structure and behaviors of firms in taking advantage of economies of scale and
scope , and innovation is investigated.
2. The consumption behaviors of different types of customers towards telecom services in creating consumer
surplus is studied.
3. Changes in industry structure and behaviors of firms to maximize consumer and producer surpluses
through Public policies and Regulations are conceived.
4. The way market power (preference of offerings at higher profit margin than competitors’) is created,
retained and exercised to set price to maximize profit by dominant operators—the study of market power
forms the foundation for determining which business practices warrants antitrust examination and
prohibition.
5. Focuses on strategic competition and how firms can shelter market power and economic profits from
competitors—resulting in erosion of competitive forces and growth of monopoly behaviors.
6. It looks into exclusionary strategies such as predatory pricing and raising costs to competitors. Predatory
pricing involves a firm setting prices to induce exit of rival firms—so that competition is reduced, and
market power is increased to take monopoly advantage.
 Where is economics?
Network externality
Scale advantage Scope advantage

Perceived value
Cost/unit

Cost/unit
Number of customers
Number of customers Number of products

Cost/Quality sensitivity
Innovation advantage
Pricing Options

Cost & quality

Cost & quality

Profit

Cost Quality
Quality Cost
P1 price P2

Early adopters……………. Laggards

Technology

3
Per unit cost of production and perceived
Perceived quality or utility

utility of services

Cost per unit of

service or customer

Customer base of telecom and broadband networks

4
• Natural Tendency of Monopoly: Due to scale and effect, per unit cost of
production keeps falling with the growth of customer base. As the
minimum efficient scale is virtually larger than the market size of any
country, so this scale effect keeps continuing without facing the limit. On
the other hand, due to network externality effect, perceived value of the
subscription of services from the network keeps increasing with the
growth of customers. In one hand, there is supply side economies of
scale; on the other side, network externality offers demand side economy
of scale. As a result, it’s being found that larger the operator lower cost
and better the perceived utility. This inherent characteristic of
telecommunication and broadband network is termed as the natural
tendency of monopoly. For this reasons, most of the countries, prior to
1980s, used to have single state owned monopoly in the telecom
industry.

5
 Monopoly’s Pricing

Willingness
to Pay
Profit

P1
P2
Pmin Prmax Pmax N1 N2 Nmin Customers

Sets the price to maximize profit

As price is lowered, marginal revenue and infra-marginal loss
take place
As price is lowered from P1 to P2 Due to profit maximizing, monopoly’s
Marginal revenue: (N2-N1)*P2 pricing is for profit maximizing.
Infra-marginal loss:N1*(P1-P2)
Dead-weight loss
6
Socially optimum quantity is not produced
7
Limitation of Monopoly: Despite the natural tendency that
monopoly offers the option offering the highest quality at the
least cost. It has a number of limitations, such as:
i. For profit maximization, monopoly sets the price higher
than the point where social welfare could have been
maximized.

ii. Monopoly does not risk investment to innovate,

slowing down the dynamic efficiency in offering better
quality at lower cost by taking the advantage of
technology.

iii. Monopoly often does not pursue supply driven

strategy to create the market of innovation.
iv. Due to information asymmetry, regulators often failed to
regulate the behavior of monopoly to maximize social well
fare

8
 Advanced or Rich Poor countries
countries
With more or less 100% Due to limited capital, they has small
tele-density, these network having very low tele-density,
countries wanted to get resulting in high cost of service delivery
rid off of demerits of due to very limited scale advantage.
monopoly.  
To address the capital scarcity, they
opened telecom industry to the entry
of private firms.

9
10
11
12
 Net Benefit from competition
Optimum competition,
State-owned maximum benefit
monopoly

Extreme competition may

turn net benefit negative

Level of competition

Figure 8: Level of competition keeps changing the net benefit from

competition in the telecom and broadband market.

13
 GP’s cost of production appears to be lowest, due to
having the largest customer base. Perceived value of
GP’s service is the highest. As a result, GP has attained
the price setting capability.
Cost of production of per unit

GP’s price point offering profit to GP;

competitors are supposed to take
of outputs

lower price (due to lower perceived

value) to incur loss

Teletalk Banglalink Robi GP

Operators’ positions with respect to respective customer
bases.
Figure 10: GP’s price setting capability in Bangladesh’s
Telecom industry

14
 Subsidy or loss Depends on:
1. Freely available
Target price point
customers
2. Willingness to pay
Profit
Cost per unit
3. Customers with other
Target cost point operators
4. Affinity of being and
remaining with other
operators
5. Price you charge

C1 C2 Customers

Figure 11: Challenges in reaching to profit

15
 Table II: Issues to be addressed by policy makers, regulators and operators

Policy makers & regulators Operators Affecting variables: in a constant state of

flux

Is the industry running at What are the ways to reduce  Industry structure
optimum level of competition? cost and increase quality to  Technology
gradually turn loss to profit and  Potential customers
to sustain it?  Service consumption level and
patterns
 Innovation level and scope
 Competition practices
 Policy and regulatory changes
 Taxes, duties and other compliance
issues
Is any operator gaining price Are they caught into  Geography and landscape
setting capability in making inescapable loss trap?
profit, while compelling
competitors to take lower price
to incur loss?

16
• Governing competition at an optimum level: As it has been explained, the net
benefit from completion does not keep increasing linearly with the level of
competition. The level of competition is often linked to the number of total
operators. Deciding the optimum number of operators and the scope of
operation of those operators is often a serious challenge. Moreover, the
optimum level us function of major factors such as (i) technology, (ii) competition
strategy of operators, (iii) market share of each operator, (iv) customer
preferences and service consumption behaviors, (v) policy and regulating
defining the boundary of each operator, (vi) geography, demography, customer
density, and potential customer base, and (vii) innovations. All these factors are
changing. Such changes should be taken into consideration in tracking optimum
point, and intervening with policy and regulatory responses to make sure than
market keep functioning at the optimum level of competition. To address this
vital issue, in-depth analytical work interpreting data within applicable theories
should be continually performed.

17
• Reaching and sustaining profitable operation: Once telecom service delivery used to be
highly profitable act. Before the market led reform, state-monopoly in every country used
to make healthy profit, giving the impression that it’s a highly profitable industry. But in a
competitive market, reaching and sustaining profit often a major challenge for the
operators. Upon receiving the licensee, operators proceed with the deployment of
network, making huge upfront capital investment. In a competitive market, deciding about
price points is a serious issue. For a monopoly, its straight forward. The monopoly keeps
lowering the reaching as long as the marginal revenue is higher than infra-marginal loss,
reaching profit maximizing price point. For in a competitive market, such option is not often
available to exercise. Often based on target customer volume, an operator sets the price.
Until and unless that customer volume is reached, cost does not get lower than the price
opening profitability, as shown in Fig. 11. For example, an operator sets a price point with
the target that once they acquire C1 customers, the cost of production will be lower than
the price, reaching to profit. Until, they reach this customer base, the operator is required
to keep giving subsidy, or incurring loss. In a competitive market, there is a risk of attaining
such targets. It may happen that before they reach C1, no customer is left as all of them
already been acquired by competitors, leaving the operator in inescapable loss trap.

18
 1. Willingness to pay
2. Freely available
Subsidy or loss
customers
Target price point 3. Customers with
Cost per unit

Profit competing operators

Target cost point 4. Affinity of remaining
with existing providers
5. Price you charge

C1 C2 Customers

Figure 11: Challenges in reaching to profit

19
• The competition situation gets more complicated when an incumbent
operator has already attained substantial market share, say 40
percent. In such a case, an aggressive operator to allure customers
practices massive subsidy, often taking the shape of predatory pricing.
Such practice is directed in reducing customer bases of incumbent
customer, consequentially increasing their cost of production. On the
other hand, by acquiring additional customers the aggressive operator
keeps lowering the cost of production by taking the advantage of
scale. Not always, an aggressive operator will succeed in reaching to
profit by pursuing such strategy. Before reaching profit, such strategy
runs the risk of running out of money to keep giving subsidy to offset
loss. Finding the executable pricing window and having adequate fund
to absorb loss till the revenue reaches profit are two major challenges

20
 WtoP, Price P1
Wiliness to Pay
(WtoP) for the
service.

P2
N1 N2

Cost per unit C1

Customers
Production function
having high economy
of scale effect
C2

N1 N2
Customers

Figure 12: Willingness to pay

and cost per unit varies with
customers

21
• Further explanation of challenges in reaching profit: The challenge of reaching profit in
a competitive market is explained further. Once a network is set up, certain willingness
to pay among customers is created about the service being delivered by the network, as
shown in Fig. 12. Due to high economy of scale effect, both production function and
willingness to pay characteristics look alike. By reducing the price, operator can increase
the number of customers. With the growing customers, the cost per unit of production
keeps falling—due to scale effect. The challenge is to keep reducing the price in
reaching to Prmin at which Npr customer is acquired meeting the condition that cost per
unit of product, Cpr, at that point is smaller than the price being charged—
consequentially taking the operator at profit. But, unfortunately, in a competitive
market economy, before reaching to this condition often competing operators succeed
in taking away all the customers. At this state, operators find in a position that both the
reduction and increase of price leads to increase of loss. The increase of price leads to
loss of customers to competitors, consequentially increasing the cost of production. On
the other hand, the decrease of price leads to infra-marginal loss exceeding the
marginal revenue. Such situation is called inescapable loss trap.

22
•• Acquiring
  the required number of customers is the main
challenge for the operator. The growth of customers not
only increases the revenue, but most importantly it reduces
the per unit of cost of production. In a competitive market,
customer acquisition is a key challenge. It depends on a
number of factors such as quality of the service affecting the
willingness to pay (WtoP), freely available potential
subscribers (FAS), subscribers with other operators (SwOs),
and the price being charged (P), as shown in the Eq. 3.
•  
• (3)

23
• In response to offering of the service at certain price point, operator’s customer base
start increasing, reaching to saturation at certain point, as shown in Fig. 13. Due to the
competition effect, often the N of a particularly operator could be far lower than the
total customers of the market. Due to the varying customer base, the possibility of
profitability will vary. Moreover, its often quite difficult to alluring subscribers from
other operators, even offering incentives like lower price or better quality of service. It
appears that by having optimum combination of quality of service, price and also
entry time, often a particular operator succeeds in attaining far higher customer base
than other competing operators. By succeeding in having high customer base, the
largest operator often attains the price setting capability to reach and maintain profit,
while compelling competitors to incur loss by taking lower price. Upon reaching this
saturation point, it becomes a serious difficulty for an operator to increase the
customer base. Up-gradation of technology and customer care, and price reduction
helps, but often not in proportionate to additional investment and infra-marginal loss.
Most of the small operators get caught with this situation, often with loss making
revenue.

24
Number of subscribers, N

Time
Figure 13: Subscriber growth patterns of a typical
operator

25
26
27
28
29
30
31
32
33
Evolving Industry Structure of Bangladesh?

Figure 10: Typical industry structure or value chain of telecom industry

34
1. International network: The international network basically connects networks of
individual countries, offering the opportunity of making calls to anywhere in the
world. The international network comprises of both terrestrial and undersea cables,
and also satellite. The journey started by laying copper cable between countries
through land and as well as under the ocean. The emergence of satellite
communication in the 1960s opened another channel for global connections. Over
the last 50 years, fiber optics cable has been gaining its importance in establishing
connection between national telephone networks. Extremely low latency, high
capacity and reliability, long life, low maintenance need, and very large economy of
scale advantage are the major factors under pining the strength of fiber optics cable.
Due to exponential growth of traffic, particularly due to Internet and popular
applications like Facebook, YouTube, audio streaming service, and VoIP applications,
the cost of sending each unit of traffic over the International network has been
rapidly falling. Moreover, competition pursuing innovation and supply driven strategy
is also diving down price at the user end.

35
2. International Gateway: It primarily consists of interface between the domestic networks of a
country with the international network. Starting from landing station for submarine cables,
ground stations for satellites, and MUX/DeMUX (multiplexer and de-multiplexer) from the
building blocks of Gateways. These gateways handle international voice calls and data, and
Internet data.
 
3. Domestic backbone network or backhaul: The domestic transmission network mostly consists
of fiber optics network. Majority of the cost, as high as 80 percent, of building such network is
incurred for civil works (cost for digging trances and right off way) and laying passive components
(like empty ducts, and dark fiber cables). The remaining 20 percent for is for active components
like laser, repeaters, multiplexer, de-multiplexer, and other electronics as well as power
components. Moreover, the operation cost is virtually negligible in comparison to the capital cost
in building such a network. As each pair of active fiber can carry up to terabits of data, such
network offers very high scale advantage. Often a single cable, comprising of dozens of fiber pair,
is sufficient to transport the whole traffic of a country. Due to the high capacity and scale effect,
and also capital need, it does not appear to be cost effective for each access network operator to
build individual domestic transmission network. The segmenting this segment from other
building blocks also decreases the entry barrier being faced by new access network operator.
Moreover, baring access network operator from owning domestic transmission also decreases
the acquisition of monopolistic market power. The separation of transmission from the remaining
building blocks reduces the chance that an operator will use it to exercise vertical foreclosure
strategy in weakening the competition force. 36
• 4. Interconnection exchange: In order to address the network externality issue, market

led reform has introduced the interconnection exchange. This exchange allows

seamless transfer of calls from one network to another. As a result, subscribers of one

network do not get isolated from the rest of the subscribers connected to other

networks. Such exchange can also play the role of number portability. Often the need

for having a number in order to change operator is perceived as switching barrier. To

address it, number portability is being introduced. It’s is a feature for allowing

subscribers to change network or operator by keeping the number unchanged.

Interconnection exchange between domestic Internet networks offering Internet

services (Internet Service Providers or ISPs) also reduces international traffic, as in

absence of it often Internet traffic needs to have detour through gateways located

outside the domestic boundary, turning every traffic international one.

37
• 5. Access network and devices: To the subscribers, access networks are known as telephone or internet

service providers. These networks offer subscription to consumers for offering voice, data or video services.

There used to be very distinctive five categories of access network providers: i. wire line voice providers or

PSTNs (public switched telephone networks), ii. Mobile or cellular operators, iii. Wire line Internet service

providers or Internet Service providers (ISPs), iv. Cable TV operators, and v. Wimax (WiFi) or broadband

wireless access (BWA) networks. Technology progression has been opening convergence opportunity. For

example, mobile access network has grown to offer broadband Internet services as well. As a result, WiMax

or BWA operators have virtually disappeared. Similarly, high data speed of 5G is opening the opportunity of

offering Cable TV equivalent video services, marginalizing the unique role of Cable TV network. Summarily,

the emergence of high speed mobile Internet is cornering the role of wire line ISPs. With these access

networks, diverse end user devices are connected. Some of the commonly used devices are mobile phone

handsets, Tablets, Personal Computers (PCs), and Televisions (TVs). Not only networks, but also access

devices are evolving in taking roles of other devices. For example, smartphones are gradually getting

popularity in consuming video content. As a result, there has been a tendency in convergence between

devices as well as networks. Such convergence is continually blurring the boundary of segmentation,

influencing the competition scenario.

38
 Uprising of Celluler Along With Market led
Reform
• There was a coincidence of market led reform and the
emergence of cellular telephone. As a result, the reform
started with the issuance of mobile network license.
Such issuance began without defining the structure of
the industry as a whole. As a result, in many countries,
new cellular license holders proceeded to deploy their
own transmission network. In certain countries, decision
was taken at a later stage to have a common 3 rd party
market in the transmission segment. As a result, the
optimal functioning of the market has been suffering
from the very beginning.
39
 Does technology change influence telecom
industry structure?

• WiFi is improving to handle voice calls using

smartphones.
• Smartphones are improving to take
advantages from WiFi.
• What will be likely implication of Voice over
WiFi network on the current industry
structure of Bangladesh?

40
Why do people buy telecom services?
Consumer Surplus
• The difference between the price
that a consumer is prepared to pay
and the actual price paid
• Related to the value we place on items
• Linked to the degree of utility
• Useful concept in analysing welfare gains
and losses as a result of resource allocation
• Emphasis on the MARKET demand – of those in the
market there are some who are willing to pay higher
prices than the market price

41
 Consumer Surplus
How can you
change?
Price
Consumer Surplus

Maximum Willingness to Pay for Qo

Po
What is paid

Qo
Quantity

42
Why do producers produce product?

Producer Surplus
• Difference between the market price
received by the seller and the price they
would have been prepared to supply at
• Price received – linked to factor cost +
element of normal profit
• Producer surplus = abnormal profit

43
 Producer Surplus
How can you
change?
Price

Producer Surplus

Po
What is paid

Minimum Amount Needed to

Supply Qo

Qo
Quantity

44
What do we talk about?

45
46
47
48
49
50
51
 Marginal Cost
Marginal Product and Average Product

• Marginal product is the additional output

that can be produced by adding one more
unit of a specific input, ceteris paribus.
c h a n g e in to ta l p ro d u c t
m a rg in a l p ro d u c t o f la b o r =
c h a n g e in u n its o f la b o r u s e d

• Average product is the average amount

produced by each unit of a variable factor of
production.
to ta l p ro d u c t
a v e ra g e p ro d u c t o f la b o r =
to ta l u n its o f la b o r 52
 The Law of Diminishing
Marginal Returns
• The law of diminishing
marginal returns states
that:
When additional units of a
variable input are added to
fixed inputs, the marginal
product of the variable input
declines.

53
• Marginal product is the slope of
the total product function.
• At point A, the slope of the total product
function is highest; thus, marginal
product is highest.

• At point C, total product is maximum, the

slope of the total product function is zero,
and marginal product intersects the
horizontal axis.

54
Total, Average, and Marginal Product
• When a ray drawn from the origin
falls tangent to the total product
function, average product is
maximum and equal to marginal
product.
• Then, average product falls to the left
and right of point B.

55
Total, Average, and Marginal Product
• As long as marginal product rises,
average product rises.
• When average product is
maximum, marginal product
equals average product.
• When average product falls,
marginal product is less than
average product.

56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
 Role of Technology..
Determining the Optimal Method
of Production
Price of output Production techniques Input prices

Determines Determine total cost and

total revenue optimal method of
production

Total revenue What is the

- Total cost with optimal method price of
=Total profit spectrum in
Bangladesh?
• The optimal method of production is the
method that minimizes cost. 83
84
85
 Where is optimum line?
• Methods of capacity expansion divide into three
general categories: the deployment of more
radio spectrum; more intensive geographic
reuse of spectrum; and increasing the
throughput capacity of each MHz of spectrum
within a given geographic area.

• Where is the optimum combination of spectrum,

cell cites, and technology of certain efficiency?
86
How do I offset voice revenue due to roll out
of data services?

87
88
• Defend—Despite showing the erosion trend, revenue flow and market shares of
existing products should be defended as much as possible. For example, roll out
of data services should be carefully adjusted to defend the voice revenue, so that
net profit does not suffer.
•  
• Build—Keep strengthening the growth of star products to offset the revenue
erosion of cash cow should be a key area of focus. In absence of strong growth in
revenues and market shares of stars, defense of cash cow alone will not succeed
to offset the erosion.
•  
• Pursue—It’s about pursuing new ideas of introducing services leveraging the
progression of technology as well customer preference. Despite the uncertainty, a
few of them will likely grow as star to offset the revenue loss of cash cow. In
absence of pursuing emerging services, operators run the risk of suffering net loss
of revenue as well as profit.

89
Challenges in Managing Product Portfolio
• Once telecom used to be the delivery of a single plain vanilla essential service: voice communication. In course of

time, telex and facsimile services were added. With the introduction of Internet as part of the telecom service, the

service delivery portfolio has been expanding rapidly. Often some of the emerging services are growing as substitutes

to once very popular ones. For example, e-mail with document attachment feature emerged as a strong substitute to

facsimile. Similarly, messaging service of social networking site has been eroding the usages of SMS (short messaging

service), once highly popular mobile communication service. Even conventional voice service has been suffering from

the erosion of usages due to the emergence of voice of Internet (VoIP) services. As a result, telecom services have

been showing typical S-curve like life cycle, as shown in Fig. 18. At the infancy period, services emerge facing the

uncertainty about adoption, revenue generation and profitability issues. A small fraction of them grow as stars,

showing strong revenue growth trend. A few of the stars grow as stable source of profitable revenue, taking the role

of cash cow. Due to the growth of substation effect from stars, cash cows start experiencing erosion of revenue,

consequentially leaving the market. As a matter of fact, unlike the past, the revenue contribution of telecom services

is at constant state of flux. Such dynamism of products’ life causes significant opportunities as well as pressure on

both competition strategy of operators and governance issues facing policy makers and regulators. Basically focus
90
should be on three basic areas:
Maturity stage of typical e-products

A small
fraction
Many
grows as
products
STARS
enter the Every product
market eventually
facing the retires as DOG
uncertainty
of A few stars
adoption: ? grow as
? Cash cows

Figure 18: Life cycle of typical e-products or telecommunication services

91
92
93
94
95
96
97
98
99