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Evaluating market consolidation in mobile communications

Europe is experiencing a wave of mergers in the telecommunications industry. This column argues that an increase in market concentration in the mobile industry generates an important potential trade-off: while consolidation increases prices, investment per operator also goes up. Competition and regulatory authorities should be open to the potential trade-off between market power effects and efficiency gains from agreements between firms.

There is a wave of mergers in Europe's telecommunications industry that may lead to a consolidation of the EU telecommunications market. The European Commission has recently cleared mergers in mobile telecommunications in the Netherlands, Austria, Ireland, and Germany that would reduce the number of competitors in each from four to three, but in Denmark in 2015, concerns about the impact on prices and competition prevented a similar merger. In the UK, another potential four-to-three merger was blocked in 2016, and yet another proposed merger in Italy has recently been approved by the European Commission (subject to a divestiture requirement). Earlier decisions had dealt with, and approved, five-to-four mergers in Austria, the Netherlands, and the UK. Similar mergers are being debated outside Europe.

To merge or not to merge?

These mergers have inspired a debate about the relationship between market structure and market performance. Competition and regulatory authorities typically focus on the implications of mergers on price, as they are concerned that increased concentration implies higher prices for end users. They have paid less attention, however, to the impact that the mergers could have on efficiency and investment. Mobile operators argue that their revenues continue to decline due to increasing competition from global internet companies, such as Skype and WhatsApp, that offer alternative services. Operators also argue that they are investing large sums into their broadband networks to meet the demand for data traffic. Consolidation through mergers is, for them, an attempt to maintain profitability and keep up with investments.

This debate is particularly prominent in the EU, as the completion of the Digital Single Market is one of the top priorities for the European Commission. Addressing 'fragmentation' and the resulting smaller-scale operation in the telecoms sector is a pillar of the strategy. Fragmentation has been identified as one of the reasons that European telecoms companies have posted worse financial results than their US, Japanese and Korean counterparts.

But different stakeholders interpret fragmentation differently. For the Commission, fragmentation relates to access availability, quality, and prices that vary significantly across the continent, with telecoms markets defined by national borders. Mobile operators, instead, point out that there are about 40 mobile network operators in the EU. Many operate in just one or two countries. By comparison, in the US there are four nationwide mobile operators (AT&T, Verizon, Sprint and T-Mobile). While the Commission may be lenient over cross-border mergers, mobile operators appear more interested in within-country consolidation.

Old questions, new twist

Economics research has long examined the relationship between the competitive features of a market and prices. In this research, high concentration is generally associated with higher prices. As pointed out, however, by both Bresnahan (1989) and Schmalensee (1989) in their chapters in the Handbook of Industrial Organization, the price-concentration regressions used in the literature suffer from endogeneity issues. Similarly, extensive research tries to uncover the relationship between competition and innovation (Nickell 1996, Aghion et al. 2005, Blundell et al. 1999, Aghion and Griffith 2006, Acemoglu and Akcigit 2012). But empirical studies on this subject also face the issue that the relationship between competition and innovation is endogenous, in that market structure may affect innovation, but the reverse is also possible.

In recent research, we take advantage of two features of the mobile telecommunications industry (Genakos et al. 2017). First, the mobile industry is not a free-entry industry, as operators must be awarded spectrum licenses. Moreover, changes in competition due to mergers or entry occurred at different times in different countries, or did not occur at all. This means we can control for systematic differences between countries, and general changes over time. Second, regulatory interventions in relation to the termination rate regulation (Genakos and Valletti 2011, and 2015) affected both entry and growth in the telecommunications market. This allows us to construct instrumental variables to address the remaining endogeneity concerns.

Uncovering an important trade-off

We study the relationship between prices, investments, and market structure in the mobile telecommunications industry. We use an empirical approach by looking at the experience of 33 countries between 2002 and 2014. We collected what is, to our knowledge, the largest dataset of this type yet employed. To capture investment, we use the operator's capital expenditure (CAPEX) – that is, money invested to acquire or upgrade fixed, physical, non-consumable assets, such as cell sites or equipment. Our proxy for price is quarterly information on the total bills paid by three consumer profiles (high, medium, and low users) across operators and countries, provided by Teligen. The dataset spans a period long enough to capture changes in market structure, because there is entry via licensing, exit via mergers and organic growth through changes in the Herfindahl-Hirschman concentration index. This provides ideal variation in the data to assess how market structure affects prices and investments, holding other factors constant. Our panel data approach includes fixed effects to control for systematic differences between countries, general changes over time, and instrumental variables for the remaining endogeneity related to the variables used to proxy market concentration.

We find that increased market concentration in the mobile industry potentially generates an important trade-off. While a merger increases prices, investment per operator also goes up. Based on our estimates, compared to no change, a hypothetical four-to-three symmetric merger would increase end user bills by 16.3% on average, while at the same time capital expenditure would go up by 19.3% at the operator level. More realistic asymmetric four-to-three mergers between smaller firms in European countries would increase bills by 4-7% while increasing capital expenditure per operator by 7.5-14%.

Our evidence on total industry investment indicates that concentration does not change total investment significantly, and hence is not entirely conclusive. On one hand, it suggests that there are efficiencies, because theoretical models predict that total investment would decrease if there were no efficiencies. On the other hand, we cannot be sure whether the efficiencies from coordinating total industry investment in fewer firms stem only from savings in fixed costs, or whether they also involve marginal cost savings and quality improvements that benefit consumers. Additional research would be necessary, with more complete data on the underlying investment components of all operators, or based on in-depth individual case studies.

Efficiency should not be an afterthought

Our findings are not only relevant for the current consolidation wave in the telecommunications industry, but also more generally. They suggest that competition and regulatory authorities should be open to the potential trade-off between market power effects and efficiency gains from agreements between firms (Focarelli and Panetta 2003, Ashenfelter et al. 2105). Ceteris paribus, a merger will have static price effects that are to the detriment of consumers, but also dynamic benefits for consumers because investments enhance their demand for services.

In European merger control, merging parties face tough hurdles if they want to put forward an efficiency defence. Since the merging parties do not expect efficiencies to play a major role in decisions under the EC Merger Regulation, they would also generally submit poor efficiency defences that do not convince the regulator. We hope this negative self-fulfilling loop can be broken. The main pay-off from understanding the efficiencies that may arise from a horizontal merger would be insights into the competitive rivalry in an industry, which helps when gathering evidence on market dynamics and supply-side responses. This evidence deserves a central role in a unilateral effects assessment that justifies a departure from the constraints imposed by simple static models. It should not be an afterthought.


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