Competition and the stepping-stone theory in the broadband access market

We dynamically model the competition between a vertically-integrated incumbent firm and a facilities-free new entrant in the broadband market, where a new technology that allows for more value-added services is available to be invested in. Instead of focusing on one competitor’s investment choice as other research does, we entitle both firms with investment options: not only can the incumbent decide how much to spend on the upgrade of its existing network, but also the entrant can choose whether and when to invest on the construction of its own infrastructure. We find that the entrant’s ability to provide value-added services affects the incumbent’s investment choice. Under pure services-based competition the incumbent’s investment choice is always below the social optimum level, while this relationship becomes reverse under pure facilities-based competition. Our simulation results show that the incumbent invests no less than the social optimum level under the mixed situation with both services- and facilities-based competition. Moreover, the stepping-stone theory is supported that access regulation provides an impetus for the entrant to invest in their own facilities after entering the market based on leased lines. This result is also socially desirable because both the overall welfare and the consumer surplus are maximized in a regulated market under mixed competition.