TCOM 546

Session 1

Course Objective

• Provide a broad overview of economic and financial analysis of telecommunications systems– Microeconomic analysis– Financial and accounting methods– Telecommunications cost models

• Limited math involved – Minimize use of calculus

Course Texts

• The Economics of Network Industries, Oz Shy, Cambridge University Press, ISBN 0 0521 80500 7

• Financial Modeling, Simon Benninga, MIT Press, ISBN 0 262 02437 3

• Supplemental readings

Evaluation and Grading

• Homework 25%

• Term paper/project 25%

• Final exam 25%

• Class participation (quizzes) 25%

Homework

• Collaboration is permitted (encouraged) on homework and papers/projects

• But all graded work must be the original effort of the student submitting the material

• This means:– Two or more students can develop a solution

approach for a homework problem together, – But each student must independently execute the

solution

• Collaboration in tests or exams is not permitted

Sources

• Students are encouraged to use all available sources to answer a question or for a paper/project– All sources must be attributed and material

reproduced directly must be enclosed in quotation marks

• Students are expected to have a personal computer and Internet access

Course Overview

• The subject matter will start at a general level (economic theory) and converge to more specific considerations over the semester

• Approximately the first third of the course will consider microeconomic theory – text for this is Shy: Economics of Network Industries

Course Overview (Continued)

• Middle part of class will deal with classical financial models – balance sheets, etc., with some spreadsheet examples – Text is Benninga

• Final part will deal with cost modeling from a user’s viewpoint – including a case study

Course Overview (Continued)

• Week 1: Introduction – Overview of the economics network industries, including welfare aspects and issues specific to telecommunications industries

• Week 2: Introductory example: Hardware – computers and compatibility

• Week 3: Telecommunications microeconomics– monopolies, new entrants and social welfare

Course Overview (Continued)

• Week 4: Telecommunications microeconomics continued – more detailed analyses

• Week 5: Broadcasting and information industries microeconomics

• Week 6: Introduction to financial statement modeling

Course Overview (Continued)

• Week 7: Financial statement modeling continued

• Week 8: Valuation using financial statement models

• Week 9: Financial analysis of leasing

• Week 10: Cost models of telecom from the buyer’s perspective

Course Overview (Concluded)

• Week 11: An example of cost modeling for a large telecommunications procurement

• Week 12: Course review and recap

• Week 13: Student presentations

• Week 14: Final Exam

Paper/Project Topics

• Students are expected to develop class paper/project topics themselves– Choice of topic subject to approval – If you can’t/don’t want to develop a topic, I will

provide one for you• You may not like it

Quizzes

• Quizzes will be given in class about every two weeks – They will last approximately half an hour

• They will address only material covered to date in class

Level Setting

• Experience with– Calculus?– Game theory?

A Question

• What is the single most important factor in determining the social utility of a telecom network?

A Question

• What is the single most important factor in determining the social utility of a telecom network?

• The number of connections it has

Distinctive Characteristics of Network Markets

• Externalities

• Systems/Complementarity

• Costs of change (lock-in)

• Economies of scale

• Barriers to entry

Externalities

• Multiple equilibria possible

• Initially few adopters

• Achievement of critical mass followed by rapid growth– Sigmoid (logistic) curve y = 1/(1+exp(-x))

• Eventual near-complete market saturation

Two Equilibria

Number of Adopters

MarginalUtility or Cost

Utility

Cost

“Nobody”uses

“Everybody”uses

Complementarity

• Elements of system must interoperate successfully

• Requires employment of standards

Costs of Change

• Contracts (commitment)

• Operational familiarity

• Acquisition cost

• Transition cost– Resources committment– Dual operation– CPE changes

Economies of Scale

• Big networks are more cost effective than small ones– Traffic engineering/Erlang

• High fixed costs, low variable costs

• No stable multi-provider equilibria

Barriers to Entry

• Difficult to unseat an incumbent

• Specific (and critical) example: Last mile wiring

Natural Monopolies

• Characteristics of telecom systems class them as natural monopolies

• Natural monopolies tend towards higher prices and lower social welfare than optimal– Violate First Welfare Theorem, which states

that equilibrium allocation in a free market is economically efficient

– Existence of externalities also invalidates the First Welfare Theorem

Historical Approach

• Historical approach to optimizing social welfare under a natural monopoly has been government regulation of a monopoly provider– Limit ability of provider to exceed a “fair” price– Avoid costly duplication of resources (e.g.,

access wiring) by multiple providers

Problems with Regulatory Approach

• Provider unresponsive to customer needs and preferences– E.g., slow introduction of new technology

• Failure to control prices– Asymmetric information– Inflated production costs

Current Approach

• Attempt to introduce competition– First notable success was U.S. airline

deregulation in 1979– In telecommunications, mixed success

• 1984 break-up of the Bell System was quite successful in inducing inter-LATA communications competition

• 1996 Telecommunications Reform Act has so far been spectacularly unsuccessful in inducing intra-LATA communications competition

Year

Relative

Cost

0%

20%

40%

60%

80%

100%

120%

140%

1983 1987 1991 1995 1999

Commercial Business Line

Commercial Long Distance

Source: Bureau of Labor Statistics

Telecom Price History

Homework

• Read Shy, Chapters 1 and 2

• We showed graphically how there could be two equilibria in a market. Produce a graphical example with three or more equilibria. Does this example have any reality?