The Economics of DSL: To Regulate or Not to Regulate

The DSL market exhibits a three-way competition, cooperation, and collusion relationship. Scores of competitive local exchange carriers (CLECs) compete with incumbent local exchange carriers (ILECs) for end-users. Both depend on the phone infrastructures of the local phone companies or the Baby Bells for offering their service. However, the ILECs, unlike the CLECs, are affiliated to the Baby Bells.

We argue that at the present time the DSL market is in a storming phase with many CLECs and price-sensitive end-users. As a consequence, self-interested Baby Bells will offer a lower Quality of Service (QoS) to a CLEC compared to its affiliate ILEC. We also argue that the Baby Bell will charge its affiliate DSL provider a lower service fee than the competing independent providers.

With the market now transitioning to a norming phase, with fewer CLECs and end-users becoming sensitive to QoS besides price, the Baby Bells will increase their QoS relative to the storming phase. A higher QoS is to capitalize on the value creation to end-users and to prevent leakage of demand to competing broadband technologies, such as cable and satellite. In addition, the Baby Bells will further increase the price disparity between their affiliates and competition. Consequently, vertical differentiation may take place in the marketplace with the CLECs catering to the lower end of the market with lower QoS and lower price while the ILECs catering to the higher end.

The proposed Tauzin-Dingell, Conyers-Cannon and Cannon-Conyers bills are the right legislation for a wrong phase. Any legislation for the norming and maturing phases should address ground-level issues arising from QoS and service fee discrepancies.

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