Worldcom Case - Create and answer a case study similar to the Worldcom Case (Chapters 5, 7, 8, 10) - Cases Available under Assignments tab on Blackboard that discusses how networks can lead to market power and how economies of scale and scope affect costs? When there are very large economies of scale and scope how does that affect prices to consumers and industry structure? How does that affect regulation? How do different regulatory policies affect competition and profits? Luyuan Wang
Final Paper:
The Merger Case of AT&T and T-Mobile Luyuan Wang Overview of the Telecommunication Industry:
Before 1970s, the telecommunication industry of the U.S. was controlled by AT&T. This means AT&T is the monopolist of the U.S. telecommunication industry before 1970s; it controlled nearly all aspects of the telephone business. This is because before 1970s, the U.S. government seen telecommunication industry as an industry that should be natural monopolies, and any competition in this industry should be wasteful and inefficient (United States Economy, 2011).
However, in the 1970s, because of the policy change of the U.S. government, the monopoly of AT&T was challenged by several new entrants, such as MCI and Sprint (Baye, 2006). Since then, the telecommunication market of the U.S. had turned from a monopoly market to an oligopoly market. Now the telecommunication industry of the U.S. is controlled by several large companies, such as AT&T, Verizon, Sprint, and T-Mobile. These four companies together controlled about 90 percent market share of telecommunication market (Wang, 2011).
In March 2011, AT&T announced its plan to buy T-Mobile USA for $39 billion from Deutsche Telekom. This merger will create the largest telecommunication company in the U.S. and reshape the industry (Sorkin & Merced & Wortham, 2011). However, in August, the Justice Department sued to block the merger between AT&T and T-Mobile.
The Market Condition:
As stated above, in today’s telecommunication industry, there are four companies controlled about 90 percent market share; they are AT&T, Verizon, Sprint, and T-Mobile. So the telecommunication market is an oligopoly market. Although every company in this market all produces telecommunication service product, each of the companies has its own network and most of the consumers could recognize each company from its brand and service, so their phone service and quality must be different. Therefore, in this oligopoly market, each company produces differentiated products. According to the data from Yankee Group Research, Inc., the following figure shows the wireless service provider market share of June 2011 in the Top U.S. cellular market areas.
We can know from Figure 1, AT&T and Verizon are the biggest two telecommunication companies in the U.S., and they together controlled more than 60 percent share of the U.S. wireless service market. The other two big companies, Sprint and T-Mobile, controlled almost 30 percent share of the market. From these data we can know that the four-firm concentration ratio in the telecommunication market is more than 0.9. This means the telecommunication market is highly concentrated and controlled by the four big companies, AT&T, Verizon, Sprint, and T-Mobile.Therefore, the U.S. telecommunication market is an oligopoly market controlled by four main big companies.
The Barriers to Entry and Networks Power:
According to Jones and George in Contemporary Management, barriers to entry could be built through three sources: economies of scale, brand loyalty, and government regulations. In this case, the four big companies may have large economies of scale. This means the companies would have a lower cost when they produce more products. This is because telecommunications firms’ major costs consist of the costs associated with its networks, administration costs, and sales and marketing costs. Most of these costs would not increase significantly with the increasing of its users. Therefore, for telecommunication companies, the fixed cost is very large, they need to spend lots of money on building a good network and employing and training professional employees, but the marginal cost for each additional user is quite small, and the more users they have, the lower average fixed costs they could get. So these big companies have a much lower average total cost than the new small entrant companies. This competitive advantage could prevent most of the new companies from entering this market.
In addition, the large number of users of these four companies may cause a great effect of brand loyalty. According to Baye in the Managerial Economics and Business Strategy, telecommunication service likes a two-way network; this means the value to each user depends directly on how many other people use the network. This kind of network could cause a great brand loyalty. It is because these four big companies have already had a large number of users in their networks, and these large numbers of users added an extremely high value to their networks. Therefore, because of the high value of existing networks to each user, no one wants to change his/her network first. If they change their existing networks to a totally new network first, because there could be only a small number of users in the new network, the change could means the users give up a high valued network and change to a valueless network. Therefore, this kind of network could bring the four big companies a great brand loyalty, and this could also create great barriers to entry in the telecommunication industry. Also, because the risk of losing contact with some friends when users change their phone number, most of the phone users would not like to change their phone number frequently.
In the telecommunication industry, the government regulation is the only factor that could not create barriers to entry. Actually, the Justice Department is trying their best to prevent the further concentration happened in the telecommunication industry, so they would not allow any mergers which could lead to the market concentration to happen, and encourage new companies to enter the telecommunication industry. However, the only thing the Justice Department can do now is to prevent this industry from higher concentration, but the truth is there have been very high barriers to entry in the telecommunication industry.
In these ways, the four companies could build great barriers to entry in the U.S. telecommunication market.
The Merger Between AT&T and T-Mobile:
Because AT&T and T-Mobile are all telecommunication companies, and they produce the same kind of product: telecommunication service, so the merger between these two companies is a horizontal merger. As I mentioned above, the merger between AT&T and T-Mobile would create the largest telecommunication company in the U.S. and reshape the industry. According to the market share data from Yankee Group Research, Inc., the market share of AT&T in June 2011 is 31.9 percent, and the market share of T-Mobile in June 2011 is 11 percent. If the merger between these two companies comes true, a new super big company, which has about 43 percent market share, would be created. We can see clearly from the data of Yankee Group Research, Inc. in the following table:
Table 1 shows us the HHI and the market share before the merger and after the merger. We can see clearly that the market share of the merger company after the merger is the combination of the market share of AT&T and T-Mobile before the merger. Actually, this increase of the market share could cause a higher market concentration and reduce the market competition. This influence will be reflected on the change between the pre-merger HHI and the post-merger HHI.
Firstly let’s concentrate on the pre-merger HHI. We can see that in all of the areas, the pre-merger HHI is higher than 1500, and in most of the areas, the pre-merger HHI is above 1800. This number means the market is already “highly concentrated”, and this will cause the Justice Department to block any mergers which will increase the HHI by more than 100. However, unfortunately, in all the areas, after the merger between AT&T and T-Mobile, the increase of HHI is higher than 100, this means the merger will definitely be blocked by the Justice Department.
Secondly, let’s focus on the post-merger HHI. We can notice that the post-merger HHI in every area is higher than 2000, this number is much higher than 1800. This means the Justice Department will view the merger between AT&T and T-Mobile as a merger that will lead the telecommunication market to “highly concentrated” in every area. Therefore, the merger will be blocked by the Justice Department.
Based on the analysis above, the merger obviously will make the users worse off, but make the merger company better off. The merger between AT&T and T-Mobile will make the whole telecommunication industry be less competition and more concentration. This change may lead to higher prices, lower service quality, and less innovation in every relevant market. These problems may result from the lack of competition in the telecommunication industry. In my analysis above, the barriers to entry, which include economics of scale and the two-way network power, may play an important role to an industry’s competition. According to the Five Forces Model, the difficulty of entry a market can contribute to the industry’s competition. The more difficult to enter an industry, the less competition in an industry.
In the other side, the merger will make the merger company better off. Firstly, because of the economics of scale, the merger could make the merger company get a lower cost than before. The merger can make the post-merger company have a larger number of users than before, the two merger companies can share some fixed costs, and the larger number of users can significantly reduce the average fixed costs than before. As I analyzed above, the marginal costs is extremely small for telecommunication firms, so the average total costs will be much lower than before due to the reduction of the average fixed costs. Secondly, because the merger makes the market less competition and more concentration, the telecommunication industry could have a higher price than before. Therefore, less average total costs and the higher market price work together can bring the post-merger company much more profits than before.
Therefore, we could also say that the larger economics of scale and the two-way network power an industry has, the less competition and higher prices this industry has.
Government Regulation:
As I stated above, the Justice Department wants to stop the merger between AT&T and T-Mobile. There are several reasons of why government wants to block the merger, but there is only one main purpose for the government to block it, it is to prevent the further concentration in this industry, and lower down the barriers to entry. In this way, the government could effectively increase the competition level in an industry and increase social welfare. So in most of the markets, like telecommunication markets, government designs regulations in order to prevent monopoly and to increase social welfare. However, this is not always true, before 1970s, the U.S. government seen telecommunication industry as an industry that should be natural monopolies, just as the electric industry, and any competition in this industry should be wasteful and inefficient. So AT&T is the monopolist company in the telecommunication industry until 1970s. In the 1970s, the monopoly of AT&T in the telecommunication markets was challenged by Federal Communications Commission’s new regulation which aimed to promote competition in these markets. So the new entrants in these markets were supported and encouraged by the new regulations made by U.S. government. As a result, these new regulations ended AT&T’s monopoly and turned the telecommunication markets to an oligopoly market (United States Economy, 2011). In this case, the government wants to increase social welfare and promote competition in the telecommunication industry, so to block the merger is mainly because of two indexes.
Firstly, four-firm concentration ratio. As my analysis above, the four-firm concentration ratio in the telecommunication market is very high. According to the market share data from Yankee Group Research, Inc., in the telecommunication market, the four-firm concentration ration is above 0.9. This means the telecommunication industry is highly concentrated and controlled by the four big companies, AT&T, Verizon, Sprint, and T-Mobile. So to promote competition, the government would not allow the merger to continually increase the market concentration in this industry, especially between two of the four big companies.
Secondly, HHI index. As the data stated above, in exactly all the areas local markets, the HHIs are above 1500, and most of the HHIs are higher than 1800, which means the market is “highly concentrated”. Also after the merger of AT&T and T-Mobile, the data shows that the post-merger HHI change is larger than 100, this number means the merger would significantly increase the market concentration in telecommunication market.
The highly concentrated market could make every company in this market charge a price that higher than its marginal cost of production, this means the value to society of an additional good is grater than the cost to produce that good (Baye, 2007, p. 510). So the best way to increase social welfare is to make these additional goods be produced. However, the merger could make the telecommunication industry become more concentrated, this could lead to a higher price than before, and therefore the deadweight loss, the loss of social welfare, would be greater than before. So the U.S. government would block the merger to prevent the larger loss of social welfare.
Conclusion:
The telecommunication market is controlled by four big companies, AT&T, Verizion, Sprint, and T-Mobile, so the telecommunication market is an oligopoly market. Because telecommunication service is a two-way network and large companies may have the competitive advantage of economics of scale, the market have great barriers to entry. Therefore, the horizontal merger between AT&T and T-Mobile will increase the market concentration and reduce the market competition. Due to the economics of scale and the less competition, the merger between AT&T and T-Mobile can actually make the two companies better off and bring them much more profits than before. However, the merger would make consumers worse off, because less competition means higher price, lower quality, and less innovation. By analyzing the pre-merger HHI and the post-merger HHI of some areas’ local markets, we can get the reasons of why the Justice Department wants to block the merger. Because of the merger, the HHI change is larger than 100, and the post-merger HHI is significantly larger than 1800, and also, the merger will increase the four-firm concentration ratio, which is already above 0.9 now. The more concentration may lead to a grater loss of social welfare, so this is the main reason of the Justice Department to block the merger.
Reference Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill. Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation. Goldblatt, H., & Chen, C. Y. (2000). No Deal Is a Good Deal for WorldCom and Sprint. Fortune, 142(3), 36. Retrieved from EBSCOhost. Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill. Merced, M. J. & Cane, J. & Protess, B. (2011). U.S. Moves to Block AT&T Merger with T-Mobile. Retrieve: Nov 23rd, 2011. Available: http://dealbook.nytimes.com/2011/08/31/u-s-moves-to-block-att-merger-with-t-mobile/ Sorkin, A. R. & Merced, M. J. & Wortham, J. (2011). AT&T to Buy T-Mobile USA for $39 Billion. Retrieve: Nov 23rd, 2011. Available: http://dealbook.nytimes.com/2011/03/20/att-to-buy-t-mobile-usa-for-39-billion/ United States Economy. (2011). The Role of the Government In the Economy. Retrieve: Nov 13th, 2011. Available:http://countrystudies.us/united-states/economy-6.htm Wang, G. (2011). AT&T/T-Mobile Merger: More Market Concentration, Less Choice, Higher Prices. Retrieve: Nov 23rd, 2011. Available: http://web.yankeegroup.com/rs/yankeegroup/images/2011AT%26T-T-Mobile-Merger-Report.pdf
Quiz Questions:
1. What is the main reason for AT&T to merger with T-Mobile?
A. economics of scale
B. economics of scope
C. cost complementarity
D. all of above
2. What is the main reason for Justice Department to block the merger?
A. pre-merger HHI is higher than 1800.
B. post-merger HHI change is larger than 100.
C. the four-firm concentration ratio is larger than 0.9
D. all of above
3. In this case, the Justice Government plays a role of
A. preventing the decrease of competition in the market
B. decreasing the competition of the market
C. making the consumers better off
D. making the companies better off
E. both b and d
F. both a and c
4. In a telecommunication network, the value to each user depends directly on ___?
A. the price of the service
B. the number of users of the network
C. the quality of the network
D. the technology of the network
5. Which of the following factor(s) could influence the barriers to entry?
A. economics of scale
B. government regulation
C. a two-way network
D. all of above
Answers: 1. A. AT&T and T-Mobile are all telecommunication companies, they produce the same product: phone service. So the merger could not provide them the economics of scope and cost complementarity. However, the merger could make the post-merger company have a larger output, that means they can have more users than before, so this could bring them a competitive advantage of economics of scale.
2. D. As I stated in the case, the main reason for Justice Department to block the merger is to prevent more concentration in the telecommunication industry. However, the HHI higher than 1800, the change of HHI higher than 100, and the four-firm concentration ratio larger than 0.9 all tell us that the telecommunication industry now is highly concentration, and it will be much more concentration after the merger. So all of these factors are the reasons for Justice Department to block the merger.
3. F. In this case, the government wants to block the merger case between AT&T and T-Mobile. Actually, as I stated in the case, the merger will make the companies better off and the customers worse off, so to block the merger will make customers better off. Also, the merger will lead to a higher market concentration; this means less competition, so to block the merger will prevent the decrease of the market competition.
4. B. As I stated in the case, the telecommunication network is like a two-way network. According to Baye’s Managerial Economics and Business Strategy, in a two-way network, the value to each user depends directly on how many other people use the network. That means in a telecommunication network, the value to each user depends directly on the number of users of the network.
5. D According to Jones and George in Contemporary Management, barriers to entry could be built through three sources: economies of scale, brand loyalty, and government regulations. As I stated in the case, the power of a two-way network could significantly contribute to users’ brand loyalty to a certain network. So the answer is all of above.
(Final paper end here.)
Five summaries:
1. The Proposed MCI WorldCom – Sprint Merger
This case is similar with my case; we all focus on the U.S. telecommunication industry. In this case, the author firstly introduces the telecommunication market in the U.S., and then he focused on the merger case between WorldCom and Sprint. By analyze the pre-merger, post-merger HHI, and the own price and the cross price elasticity of the big three, the author states that the Big Three controlled about 80% of the market share in 2001. He points out that the merger will make the competition be eliminated, sale of services in each of the relevant markets would be eliminated or lessened, prices would increase, innovation and quality services would decrease, and the barriers to entering will be increased.
2. Elasticity: elasticity of demand including Marginal revenue and the relationship with elasticity of demand. Also, elasticity of supply, cross price elasticity, income elasticity
In this paper, the author explain us clearly what the elasticity is, what the marginal revenue is, and the relationship between elasticity and marginal revenue. She also uses some examples to explain the price elasticity of supply, income elasticity, and the cross-price elasticity. The graphs are very helpful to understand her paper. Finally, she points out that understanding elasticity are and how to use them to make managerial decisions is important to firms, and also, rational customers can make purchase decisions with the help of elasticity.
3. GAPPkids Pricing Decision
Catherine's paper is about how GAPPkids, a retail store that sell kids apparels and accessories to increase their revenue by making pricing decision. She uses regression analysis to find Income elasticities of demand and price elasticities of demand, and using these two factors to make pricing decision. What she found out from her paper is, GAPPkids, does not need to increase or decrease the price of their products, since their products are relatively inelastic product/ luxury, which customers are willing to purchase at the current price since they are only a few substitute. GAPPkids should find good locations to build their stores, that is close to their target market, but far from the substitute market to help GAPP increase their kids product line.
4. Create and answer a case study similar to Memo 6 from Time Warner (Most Relevant Chapters 5, 8, and 11) that looks at whether profits can be increased by changing the price. The writer gives us his opinion to this question. Firstly, he explains what is profit, and then he analyzes the profit maximization decisions based on changing price. Secondly, he analyzes the profit maximization decision in monopolies and in perfect competition market. He uses some graphs to help state the profit maximization level in those two markets. Finally, he applies his profit maximization theory into real world case. He uses the example of “Cancer Drug that Few Can Afford” and “Netflix Pricing Wins and Losses” to prove his opinion of the profits. He explains the question very clearly and helpful. 5. Monopoly In this paper, the author focuses on monopoly and discuss some questions about the monopoly. Firstly, he introduce us the monopoly, and gives us the definition of monopoly. Also, he points out he four sources that may create monopoly, they are Economies of scale, Economies of scope, Cost Complementary, and Patents and Other Legal Barriers. Secondly, he discusses how to prevent the monopoly. He states that the U.S. Department of Justice's Antitrust division helps to promote competition and to block potential monopolies that are harmful to the public. Finally, he provides us some examples of monopoly. He uses examples to explain how monopoly could be harmful to our society.
Weekly posts:
Nov 13rd, 2011
This week, I will focus on the role of U.S. government regulation play in this industry. This is also the fourth question raised by the Teaching Notes.
As stated in this case, Justice Department wants to stop the merger of WorldCom and Sprint. There are several reasons of why government wants to block the merger, but there is only one main purpose for government to block it, it is to prevent the increased concentration in this industry, and lower down the barriers to entry. Actually, the case states that in the 1970s, the monopoly of AT&T in several telecommunication markets was challenged by Federal Communications Commission’s new regulation which aimed to promote competition in these markets. So the new entrants in these markets were supported by the new regulations made by government. As a result, these new regulations ended AT&T’s monopoly and brought competition to these telecommunication markets. So in most of markets, like telecommunication markets, government designs regulations in order to prevent monopoly and promote competition. However, this is not always true, before 1970s, the U.S. government seen telecommunication industry as an industry that should be natural monopolies, just as the condition in electric industry, and any competition in this industry should be wasteful and inefficient. In this case, government wants to promote and increase competition in telecommunication industry, so to block the merger is mainly because of two indexes.
Firstly, four –firm concentration ratio. As my analysis in previous weeks, the four-firm concentration ratio in many markets of telecommunication industry is very high. According the data given by the case, in almost all the markets of telecommunication industry, the four-firm concentration ration is above 0.8. In most of these markets, the ratio is above 0.9, some markets even get 1 in four-firm concentration ratio. This means the telecommunication industry is highly concentrated and controlled by three big companies, AT&T, WorldCom, and Sprint. So to promote competition, the government would not allow the merger to continually increase the market concentration in this industry.
Secondly, HHI index. As the data given by the case, in exactly all the subsidiary markets, the HHIs are above 2500, it is much higher than 1800, which means the market is “highly concentrated”. Also after the merger of WorldCom and Sprint, the data shows that the HHI change is larger than 100, this number means the merger would significantly increase the market concentration in telecommunication industry. So the U.S. government would block the merger.
Reference: Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill. Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation. United States Economy. (2011). The role of the government in the economy. Retrieve: Nov 13rd, 2011. Available: http://countrystudies.us/united-states/economy-6.htm
Nov 6th, 2011
The third question about WorldCom case in the Teaching Notes is about the marginal costs and the market power. This case dose not give us the detail data about telecommunication industry’s marginal costs, but as we know, telecommunication industry is not a manufacture industry, so it seems having a low marginal costs. In telecommunication industry, its products are a kind of service that let its users to communicate with their friends by phones, so telecommunication companies’ variable costs are very low. According to the Teaching Notes, Telecommunications firms’ major costs consist of the costs associated with its networks, administration costs, and sales and marketing costs. Most of these costs would not increase significantly with the increasing of its users. According to the definition, marginal cost is the change in the total cost that caused by the output changes of one unit. So the marginal costs of telecommunication firms should be very low.
Reference: Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill. Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 30th, 2011
The second question about WorldCom case in the Teaching Notes is about the barriers to entry in the whole telecommunication market. So this week I will focus on the barriers to entry of the whole telecommunication industry.
According to Jones and George in their book Contemporary Management, barriers to entry are factors that make it difficult and costly for a company to enter a particular task environment or industry. So the more difficult and costly to enter an industry, the higher are the barriers to entry. There are three main sources of barriers to entry; they are economies of scale, brand loyalty, and government regulations.
In this case, as my analysis in the last several weeks, there are many barriers to entry in the telecommunication industry of the U.S. Firstly, economies of scale. We know that economies of scale is associated with how largely a company produces, and normally, in economies of scale, the more they produce, the less they cost on every product. In this case, there are three companies that almost control the whole market of telecommunication industry; they are AT&T, WorldCom, and Sprint, so the four-firm concentration ratio is almost 1. So compare to new entry companies, the “big three” may have a competitive advantage due to their economies of scale.
Secondly, brand loyalty. I have mentioned in last week that telecommunication industry has a very special characteristic that the large number of users could be one of the most significant and useful competitive advantages for companies in this industry. That means the more users a company has, the easier for the company to get new users in the future. Because when customers choose telecommunication carrier, they may consider every carrier’s network and its cost. Normally, the more users in a carrier’s network, the more likely the network is considered good by new customers. Also, most of the phone users would not like to change their phone number frequently, because they are at a risk of losing contact with some friends when they change their phone number. So the brand loyalty in telecommunication industry is also very high. It is hard to imagine that a “big three” user would change to a new entry telecommunication carrier if this new carrier could not provide a significant lower price than “big three”.
Thirdly, government regulations. In this case, this is the only factor that would not cause more barriers to entry. As my analysis in last few weeks, in the mass market international long distance telecommunication services, before the merger of WorldCom and Sprint, the HHI of this market is higher than 1800, this means the market is “highly concentrated”, and this number will cause the Justice Department to block the merger which will increase the HHI by more than 100. However, unfortunately, after the merger of WorldCom and Sprint, the increase of HHI is higher than 100, this means the merger would be prohibited by Justice Department. However, the only thing the Justice Department can do is to prevent this industry from higher concentration, but the truth is there have been very high barriers to entry in telecommunication industry.
Reference: Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill. Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill. Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 23rd, 2011
This week, I will continue my analysis of the last three relevant product markets of telecommunication industry of the U.S. They are Interlata Private Line Services and Interlata X.25, ATM, and Frame Relay Data Network Services; Interlata Data Network Services Market, and Custom Network Services Market.
To enter the fifth relevant industry, Interlata Private Line Services and Interlata X.25, ATM, and Frame Relay Data Network Services, would also be very hard. This market is also highly concentrated by AT&T, WorldCom, and Sprint. Telecommunication market has a very special characteristic that the large number of users could be one of the most significant and useful competitive advantages for companies in this industry. So it is very hard for a new entry company to get market share from the “Big Three” because of the new entry company’s small number of users. This barrier could cost new entry companies several years to build a competitive advantage. Also, users’ brand loyalty could be another barrier to entry in this market. So the entry barriers are very high in this market.
The barriers to entry of the sixth relevant industry Interlata Data Network Services Market is similar with the fifth relevant industry. This market is also dominated by the “Big Three”, so it is also very difficult for a new company to enter this industry.
The last relevant industry is Custom Network Services Market. This market is also controlled by AT&T, WorldCom, and Sprint. In this market, only the “Big 3” could provide all the services required by large business customers because of their large networks, skilled and experienced staff, and technological expertise. The case mentions that in this market, the new entry companies must do very well and establish a high reputation to get contract from large business customers, but these things may cost new entry companies several years and may not be easy to get. So the barriers to entry is also very high in this market.
Reference: Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill. Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill. Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 13rd, 2011
Last week, I stated the relevant product markets of telecommunication industry in the U.S., and then I analyzed the barrier to entry of the first two relevant product markets. This week, I will continue my analysis of these relevant product markets.
The third relevant industry is mass market international long distance telecommunication services. As the Appendix A of this case shows, this market is concentrated by AT&T, WorldCom, and Sprint. Before the merger, the HHI of this market is higher than 1,800, which could make Justice Department concern this market, and also, after the merger of WorldCom and Sprint, the change of HHI would be higher than 100, which could cause the merger being prohibited by Justice Department. This market is not a perfect competition market, it is more likely an Oligopoly market, which are controlled by several big companies. So the high HHI could bring a great barrier of entry to this market. In addition, the case mentions that to enter this market, the new company needs to invest huge amount of money to “create a network, or resell services using existing providers.” This could be another barrier to enter this market.
The fourth relevant industry is international private line services market. Like the mass market international long distance telecommunication services, this market is also controlled by AT&T, WorldCom, and Sprint. However, it is also different from the previous market. As shown in the Appendix B of the case, in this market, AT&T does not compete in some countries’ market, like Armenia, Hungary and Jordan, this means in some countries’ market, the share of WorldCom and Sprint combine could be 100%. So the merger of WorldCom and Sprint may cause the HHI of some countries’ market go up to 10,000, which means the market structure will change to monopoly. This could make the entry of some countries' market be extremely hard.
Next week, I will complete my analysis on the rest relevant markets.
Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill. Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 8th, 2011
In this case, there are 7 relevant product markets in the telecommunication industry in the U.S. They are: “Tier 1” Internet backbone services market, mass market domestic long distance telecommunication services, market mass market international long distance telecommunication services, International private line services, interlata private line services and interlata X.25, ATM, and frame relay data network services, Interlata data network services market, and custom network services market.
This case indicates that the merger of WorldCom and Sprint may lead to higher prices, lower service quality, and less innovation in these relevant markets. In my opinion, these problems may result from the lack of competition in telecommunication industry. In my analysis of last week, the barriers to entry may play an important role in an industry’s competition. According to the Five Forces Model, the difficulty of entry can contribute to an industry’s competition. The more difficult to enter an industry, the less competition in an industry. So I will focus on the barriers to entry of these relevant industries in the following weeks.
In the first relevant industry, “Tier 1” Internet backbone services market, before the merger, WorldCom and Sprint together has 53% of the Internet traffic. In order to entry this market, new Internet companies must “establish and maintain adequate peering interconnections to provide Internet connectivity”. To establish the adequate peering interconnections, the companies must get a high level of customer traffic. However, with more than half of the Internet traffic, the merger of these two companies will make a higher barrier of entry in this market.
The second relevant industry is the mass market domestic long distance telecommunication services. This market is dominated by the “Big Three”, AT&T, WorldCom and Sprint. Together they get an 80% share in this market. In this market, brand recognition and the scale of network are very important. However, these two things need a large investment and a long period of time. So the barrier to entry is also obvious in this market. With the merger of WorldCom and Sprint, the economies of scale and scope will help them to get a lower cost, and then they will have a new low-cost competitive advantage, which will make the barriers to entry higher than before.
Reference:
Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill. Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill. Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 1st, 2011
This case mainly discusses the merger between two large telecommunication companies WorldCom and Sprint Corporation. I skimmed this case in this week. There are three points which are important in this case: firstly, Justice Department of the U.S. disagree with the merger between these two companies. Secondly, the merger between these two companies will cause market concentration and anti-competitive behaviors. Thirdly, the merger between these two companies will result in barriers to entry in the U.S. telecommunication market.
I come from China, so I am not very familiar with telecommunication companies in the U.S. Therefore, before going deeply in this case, it is necessary for me to understand the U.S.’s telecommunication market, and some concepts. I looked for some more information this week:
Firstly, I found an article about WorldCom and Sprint in BSU library database.
Goldblatt, H., & Chen, C. Y. (2000). No Deal Is a Good Deal for WorldCom and Sprint. Fortune, 142(3), 36. Retrieved from EBSCOhost.
This article claims that the WorldCom should concentrate on its “global business-only plan” and Sprint should merge a non-telecommunication company. This advice sounds reasonable. In order to maximize the effect of economies of scope, Sprint should merge a company that does the business that has some relationship with telecommunication but not telecommunication. Maybe in this way, Sprint could use its large number of user basis in the new business market, and also the new business may help Sprint in the telecommunication market. Also, focus on the global business-only plan may help WorldCom to improve its economies of scale.
Secondly, I checked the concept of “barriers to entry” in my Management textbook.
Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill.
According to this book, barriers of entry could be built through three sources: economies of scale, brand loyalty, and government regulations. In this case, because these two companies are all in the telecommunication market, the merger may cause a larger economies of scale, this means the company after merger would have a lower cost than before. This competitive advantage could prevent most of the new companies entering the telecommunication market. In addition, the large number of users of these two companies may make the effect of brand loyalty much larger than before. In these ways, the merger of the two companies could build a barriers of entry in the U.S. telecommunication market. So this may be the main reason of why the Justice Department wants to enjoin this merger case.
Luyuan Wang
Final Paper:
The Merger Case of AT&T and T-Mobile
Luyuan Wang
Overview of the Telecommunication Industry:
Before 1970s, the telecommunication industry of the U.S. was controlled by AT&T. This means AT&T is the monopolist of the U.S. telecommunication industry before 1970s; it controlled nearly all aspects of the telephone business. This is because before 1970s, the U.S. government seen telecommunication industry as an industry that should be natural monopolies, and any competition in this industry should be wasteful and inefficient (United States Economy, 2011).
However, in the 1970s, because of the policy change of the U.S. government, the monopoly of AT&T was challenged by several new entrants, such as MCI and Sprint (Baye, 2006). Since then, the telecommunication market of the U.S. had turned from a monopoly market to an oligopoly market. Now the telecommunication industry of the U.S. is controlled by several large companies, such as AT&T, Verizon, Sprint, and T-Mobile. These four companies together controlled about 90 percent market share of telecommunication market (Wang, 2011).
In March 2011, AT&T announced its plan to buy T-Mobile USA for $39 billion from Deutsche Telekom. This merger will create the largest telecommunication company in the U.S. and reshape the industry (Sorkin & Merced & Wortham, 2011). However, in August, the Justice Department sued to block the merger between AT&T and T-Mobile.
The Market Condition:
As stated above, in today’s telecommunication industry, there are four companies controlled about 90 percent market share; they are AT&T, Verizon, Sprint, and T-Mobile. So the telecommunication market is an oligopoly market. Although every company in this market all produces telecommunication service product, each of the companies has its own network and most of the consumers could recognize each company from its brand and service, so their phone service and quality must be different. Therefore, in this oligopoly market, each company produces differentiated products. According to the data from Yankee Group Research, Inc., the following figure shows the wireless service provider market share of June 2011 in the Top U.S. cellular market areas.
We can know from Figure 1, AT&T and Verizon are the biggest two telecommunication companies in the U.S., and they together controlled more than 60 percent share of the U.S. wireless service market. The other two big companies, Sprint and T-Mobile, controlled almost 30 percent share of the market. From these data we can know that the four-firm concentration ratio in the telecommunication market is more than 0.9. This means the telecommunication market is highly concentrated and controlled by the four big companies, AT&T, Verizon, Sprint, and T-Mobile.Therefore, the U.S. telecommunication market is an oligopoly market controlled by four main big companies.
The Barriers to Entry and Networks Power:
According to Jones and George in Contemporary Management, barriers to entry could be built through three sources: economies of scale, brand loyalty, and government regulations. In this case, the four big companies may have large economies of scale. This means the companies would have a lower cost when they produce more products. This is because telecommunications firms’ major costs consist of the costs associated with its networks, administration costs, and sales and marketing costs. Most of these costs would not increase significantly with the increasing of its users. Therefore, for telecommunication companies, the fixed cost is very large, they need to spend lots of money on building a good network and employing and training professional employees, but the marginal cost for each additional user is quite small, and the more users they have, the lower average fixed costs they could get. So these big companies have a much lower average total cost than the new small entrant companies. This competitive advantage could prevent most of the new companies from entering this market.
In addition, the large number of users of these four companies may cause a great effect of brand loyalty. According to Baye in the Managerial Economics and Business Strategy, telecommunication service likes a two-way network; this means the value to each user depends directly on how many other people use the network. This kind of network could cause a great brand loyalty. It is because these four big companies have already had a large number of users in their networks, and these large numbers of users added an extremely high value to their networks. Therefore, because of the high value of existing networks to each user, no one wants to change his/her network first. If they change their existing networks to a totally new network first, because there could be only a small number of users in the new network, the change could means the users give up a high valued network and change to a valueless network. Therefore, this kind of network could bring the four big companies a great brand loyalty, and this could also create great barriers to entry in the telecommunication industry. Also, because the risk of losing contact with some friends when users change their phone number, most of the phone users would not like to change their phone number frequently.
In the telecommunication industry, the government regulation is the only factor that could not create barriers to entry. Actually, the Justice Department is trying their best to prevent the further concentration happened in the telecommunication industry, so they would not allow any mergers which could lead to the market concentration to happen, and encourage new companies to enter the telecommunication industry. However, the only thing the Justice Department can do now is to prevent this industry from higher concentration, but the truth is there have been very high barriers to entry in the telecommunication industry.
In these ways, the four companies could build great barriers to entry in the U.S. telecommunication market.
The Merger Between AT&T and T-Mobile:
Because AT&T and T-Mobile are all telecommunication companies, and they produce the same kind of product: telecommunication service, so the merger between these two companies is a horizontal merger. As I mentioned above, the merger between AT&T and T-Mobile would create the largest telecommunication company in the U.S. and reshape the industry. According to the market share data from Yankee Group Research, Inc., the market share of AT&T in June 2011 is 31.9 percent, and the market share of T-Mobile in June 2011 is 11 percent. If the merger between these two companies comes true, a new super big company, which has about 43 percent market share, would be created. We can see clearly from the data of Yankee Group Research, Inc. in the following table:
Table 1 shows us the HHI and the market share before the merger and after the merger. We can see clearly that the market share of the merger company after the merger is the combination of the market share of AT&T and T-Mobile before the merger. Actually, this increase of the market share could cause a higher market concentration and reduce the market competition. This influence will be reflected on the change between the pre-merger HHI and the post-merger HHI.
Firstly let’s concentrate on the pre-merger HHI. We can see that in all of the areas, the pre-merger HHI is higher than 1500, and in most of the areas, the pre-merger HHI is above 1800. This number means the market is already “highly concentrated”, and this will cause the Justice Department to block any mergers which will increase the HHI by more than 100. However, unfortunately, in all the areas, after the merger between AT&T and T-Mobile, the increase of HHI is higher than 100, this means the merger will definitely be blocked by the Justice Department.
Secondly, let’s focus on the post-merger HHI. We can notice that the post-merger HHI in every area is higher than 2000, this number is much higher than 1800. This means the Justice Department will view the merger between AT&T and T-Mobile as a merger that will lead the telecommunication market to “highly concentrated” in every area. Therefore, the merger will be blocked by the Justice Department.
Based on the analysis above, the merger obviously will make the users worse off, but make the merger company better off. The merger between AT&T and T-Mobile will make the whole telecommunication industry be less competition and more concentration. This change may lead to higher prices, lower service quality, and less innovation in every relevant market. These problems may result from the lack of competition in the telecommunication industry. In my analysis above, the barriers to entry, which include economics of scale and the two-way network power, may play an important role to an industry’s competition. According to the Five Forces Model, the difficulty of entry a market can contribute to the industry’s competition. The more difficult to enter an industry, the less competition in an industry.
In the other side, the merger will make the merger company better off. Firstly, because of the economics of scale, the merger could make the merger company get a lower cost than before. The merger can make the post-merger company have a larger number of users than before, the two merger companies can share some fixed costs, and the larger number of users can significantly reduce the average fixed costs than before. As I analyzed above, the marginal costs is extremely small for telecommunication firms, so the average total costs will be much lower than before due to the reduction of the average fixed costs. Secondly, because the merger makes the market less competition and more concentration, the telecommunication industry could have a higher price than before. Therefore, less average total costs and the higher market price work together can bring the post-merger company much more profits than before.
Therefore, we could also say that the larger economics of scale and the two-way network power an industry has, the less competition and higher prices this industry has.
Government Regulation:
As I stated above, the Justice Department wants to stop the merger between AT&T and T-Mobile. There are several reasons of why government wants to block the merger, but there is only one main purpose for the government to block it, it is to prevent the further concentration in this industry, and lower down the barriers to entry. In this way, the government could effectively increase the competition level in an industry and increase social welfare.
So in most of the markets, like telecommunication markets, government designs regulations in order to prevent monopoly and to increase social welfare. However, this is not always true, before 1970s, the U.S. government seen telecommunication industry as an industry that should be natural monopolies, just as the electric industry, and any competition in this industry should be wasteful and inefficient. So AT&T is the monopolist company in the telecommunication industry until 1970s. In the 1970s, the monopoly of AT&T in the telecommunication markets was challenged by Federal Communications Commission’s new regulation which aimed to promote competition in these markets. So the new entrants in these markets were supported and encouraged by the new regulations made by U.S. government. As a result, these new regulations ended AT&T’s monopoly and turned the telecommunication markets to an oligopoly market (United States Economy, 2011). In this case, the government wants to increase social welfare and promote competition in the telecommunication industry, so to block the merger is mainly because of two indexes.
Firstly, four-firm concentration ratio. As my analysis above, the four-firm concentration ratio in the telecommunication market is very high. According to the market share data from Yankee Group Research, Inc., in the telecommunication market, the four-firm concentration ration is above 0.9. This means the telecommunication industry is highly concentrated and controlled by the four big companies, AT&T, Verizon, Sprint, and T-Mobile. So to promote competition, the government would not allow the merger to continually increase the market concentration in this industry, especially between two of the four big companies.
Secondly, HHI index. As the data stated above, in exactly all the areas local markets, the HHIs are above 1500, and most of the HHIs are higher than 1800, which means the market is “highly concentrated”. Also after the merger of AT&T and T-Mobile, the data shows that the post-merger HHI change is larger than 100, this number means the merger would significantly increase the market concentration in telecommunication market.
The highly concentrated market could make every company in this market charge a price that higher than its marginal cost of production, this means the value to society of an additional good is grater than the cost to produce that good (Baye, 2007, p. 510). So the best way to increase social welfare is to make these additional goods be produced. However, the merger could make the telecommunication industry become more concentrated, this could lead to a higher price than before, and therefore the deadweight loss, the loss of social welfare, would be greater than before. So the U.S. government would block the merger to prevent the larger loss of social welfare.
Conclusion:
The telecommunication market is controlled by four big companies, AT&T, Verizion, Sprint, and T-Mobile, so the telecommunication market is an oligopoly market. Because telecommunication service is a two-way network and large companies may have the competitive advantage of economics of scale, the market have great barriers to entry. Therefore, the horizontal merger between AT&T and T-Mobile will increase the market concentration and reduce the market competition. Due to the economics of scale and the less competition, the merger between AT&T and T-Mobile can actually make the two companies better off and bring them much more profits than before. However, the merger would make consumers worse off, because less competition means higher price, lower quality, and less innovation. By analyzing the pre-merger HHI and the post-merger HHI of some areas’ local markets, we can get the reasons of why the Justice Department wants to block the merger. Because of the merger, the HHI change is larger than 100, and the post-merger HHI is significantly larger than 1800, and also, the merger will increase the four-firm concentration ratio, which is already above 0.9 now. The more concentration may lead to a grater loss of social welfare, so this is the main reason of the Justice Department to block the merger.
Reference
Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Goldblatt, H., & Chen, C. Y. (2000). No Deal Is a Good Deal for WorldCom and Sprint. Fortune, 142(3), 36. Retrieved from EBSCOhost.
Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill.
Merced, M. J. & Cane, J. & Protess, B. (2011). U.S. Moves to Block AT&T Merger with T-Mobile. Retrieve: Nov 23rd, 2011. Available: http://dealbook.nytimes.com/2011/08/31/u-s-moves-to-block-att-merger-with-t-mobile/
Sorkin, A. R. & Merced, M. J. & Wortham, J. (2011). AT&T to Buy T-Mobile USA for $39 Billion. Retrieve: Nov 23rd, 2011. Available: http://dealbook.nytimes.com/2011/03/20/att-to-buy-t-mobile-usa-for-39-billion/
United States Economy. (2011). The Role of the Government In the Economy. Retrieve: Nov 13th, 2011. Available: http://countrystudies.us/united-states/economy-6.htm
Wang, G. (2011). AT&T/T-Mobile Merger: More Market Concentration, Less Choice, Higher Prices. Retrieve: Nov 23rd, 2011. Available: http://web.yankeegroup.com/rs/yankeegroup/images/2011AT%26T-T-Mobile-Merger-Report.pdf
Quiz Questions:
1. What is the main reason for AT&T to merger with T-Mobile?
2. What is the main reason for Justice Department to block the merger?
3. In this case, the Justice Government plays a role of
4. In a telecommunication network, the value to each user depends directly on ___?
5. Which of the following factor(s) could influence the barriers to entry?
Answers:
1. A.
AT&T and T-Mobile are all telecommunication companies, they produce the same product: phone service. So the merger could not provide them the economics of scope and cost complementarity. However, the merger could make the post-merger company have a larger output, that means they can have more users than before, so this could bring them a competitive advantage of economics of scale.
2. D.
As I stated in the case, the main reason for Justice Department to block the merger is to prevent more concentration in the telecommunication industry. However, the HHI higher than 1800, the change of HHI higher than 100, and the four-firm concentration ratio larger than 0.9 all tell us that the telecommunication industry now is highly concentration, and it will be much more concentration after the merger. So all of these factors are the reasons for Justice Department to block the merger.
3. F.
In this case, the government wants to block the merger case between AT&T and T-Mobile. Actually, as I stated in the case, the merger will make the companies better off and the customers worse off, so to block the merger will make customers better off. Also, the merger will lead to a higher market concentration; this means less competition, so to block the merger will prevent the decrease of the market competition.
4. B.
As I stated in the case, the telecommunication network is like a two-way network. According to Baye’s Managerial Economics and Business Strategy, in a two-way network, the value to each user depends directly on how many other people use the network. That means in a telecommunication network, the value to each user depends directly on the number of users of the network.
5. D
According to Jones and George in Contemporary Management, barriers to entry could be built through three sources: economies of scale, brand loyalty, and government regulations. As I stated in the case, the power of a two-way network could significantly contribute to users’ brand loyalty to a certain network. So the answer is all of above.
(Final paper end here.)
Five summaries:
1. The Proposed MCI WorldCom – Sprint Merger
This case is similar with my case; we all focus on the U.S. telecommunication industry. In this case, the author firstly introduces the telecommunication market in the U.S., and then he focused on the merger case between WorldCom and Sprint. By analyze the pre-merger, post-merger HHI, and the own price and the cross price elasticity of the big three, the author states that the Big Three controlled about 80% of the market share in 2001. He points out that the merger will make the competition be eliminated, sale of services in each of the relevant markets would be eliminated or lessened, prices would increase, innovation and quality services would decrease, and the barriers to entering will be increased.
2. Elasticity: elasticity of demand including Marginal revenue and the relationship with elasticity of demand. Also, elasticity of supply, cross price elasticity, income elasticity
In this paper, the author explain us clearly what the elasticity is, what the marginal revenue is, and the relationship between elasticity and marginal revenue. She also uses some examples to explain the price elasticity of supply, income elasticity, and the cross-price elasticity. The graphs are very helpful to understand her paper. Finally, she points out that understanding elasticity are and how to use them to make managerial decisions is important to firms, and also, rational customers can make purchase decisions with the help of elasticity.
3. GAPPkids Pricing Decision
Catherine's paper is about how GAPPkids, a retail store that sell kids apparels and accessories to increase their revenue by making pricing decision. She uses regression analysis to find Income elasticities of demand and price elasticities of demand, and using these two factors to make pricing decision. What she found out from her paper is, GAPPkids, does not need to increase or decrease the price of their products, since their products are relatively inelastic product/ luxury, which customers are willing to purchase at the current price since they are only a few substitute. GAPPkids should find good locations to build their stores, that is close to their target market, but far from the substitute market to help GAPP increase their kids product line.
4. Create and answer a case study similar to Memo 6 from Time Warner (Most Relevant Chapters 5, 8, and 11) that looks at whether profits can be increased by changing the price.
The writer gives us his opinion to this question. Firstly, he explains what is profit, and then he analyzes the profit maximization decisions based on changing price. Secondly, he analyzes the profit maximization decision in monopolies and in perfect competition market. He uses some graphs to help state the profit maximization level in those two markets. Finally, he applies his profit maximization theory into real world case. He uses the example of “Cancer Drug that Few Can Afford” and “Netflix Pricing Wins and Losses” to prove his opinion of the profits. He explains the question very clearly and helpful.
5. Monopoly
In this paper, the author focuses on monopoly and discuss some questions about the monopoly. Firstly, he introduce us the monopoly, and gives us the definition of monopoly. Also, he points out he four sources that may create monopoly, they are Economies of scale, Economies of scope, Cost Complementary, and Patents and Other Legal Barriers. Secondly, he discusses how to prevent the monopoly. He states that the U.S. Department of Justice's Antitrust division helps to promote competition and to block potential monopolies that are harmful to the public. Finally, he provides us some examples of monopoly. He uses examples to explain how monopoly could be harmful to our society.
Weekly posts:
Nov 13rd, 2011
This week, I will focus on the role of U.S. government regulation play in this industry. This is also the fourth question raised by the Teaching Notes.
As stated in this case, Justice Department wants to stop the merger of WorldCom and Sprint. There are several reasons of why government wants to block the merger, but there is only one main purpose for government to block it, it is to prevent the increased concentration in this industry, and lower down the barriers to entry. Actually, the case states that in the 1970s, the monopoly of AT&T in several telecommunication markets was challenged by Federal Communications Commission’s new regulation which aimed to promote competition in these markets. So the new entrants in these markets were supported by the new regulations made by government. As a result, these new regulations ended AT&T’s monopoly and brought competition to these telecommunication markets. So in most of markets, like telecommunication markets, government designs regulations in order to prevent monopoly and promote competition. However, this is not always true, before 1970s, the U.S. government seen telecommunication industry as an industry that should be natural monopolies, just as the condition in electric industry, and any competition in this industry should be wasteful and inefficient. In this case, government wants to promote and increase competition in telecommunication industry, so to block the merger is mainly because of two indexes.
Firstly, four –firm concentration ratio. As my analysis in previous weeks, the four-firm concentration ratio in many markets of telecommunication industry is very high. According the data given by the case, in almost all the markets of telecommunication industry, the four-firm concentration ration is above 0.8. In most of these markets, the ratio is above 0.9, some markets even get 1 in four-firm concentration ratio. This means the telecommunication industry is highly concentrated and controlled by three big companies, AT&T, WorldCom, and Sprint. So to promote competition, the government would not allow the merger to continually increase the market concentration in this industry.
Secondly, HHI index. As the data given by the case, in exactly all the subsidiary markets, the HHIs are above 2500, it is much higher than 1800, which means the market is “highly concentrated”. Also after the merger of WorldCom and Sprint, the data shows that the HHI change is larger than 100, this number means the merger would significantly increase the market concentration in telecommunication industry. So the U.S. government would block the merger.
Reference:
Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
United States Economy. (2011). The role of the government in the economy. Retrieve: Nov 13rd, 2011. Available: http://countrystudies.us/united-states/economy-6.htm
Nov 6th, 2011
The third question about WorldCom case in the Teaching Notes is about the marginal costs and the market power.
This case dose not give us the detail data about telecommunication industry’s marginal costs, but as we know, telecommunication industry is not a manufacture industry, so it seems having a low marginal costs. In telecommunication industry, its products are a kind of service that let its users to communicate with their friends by phones, so telecommunication companies’ variable costs are very low. According to the Teaching Notes, Telecommunications firms’ major costs consist of the costs associated with its networks, administration costs, and sales and marketing costs. Most of these costs would not increase significantly with the increasing of its users. According to the definition, marginal cost is the change in the total cost that caused by the output changes of one unit. So the marginal costs of telecommunication firms should be very low.
Reference:
Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 30th, 2011
The second question about WorldCom case in the Teaching Notes is about the barriers to entry in the whole telecommunication market. So this week I will focus on the barriers to entry of the whole telecommunication industry.
According to Jones and George in their book Contemporary Management, barriers to entry are factors that make it difficult and costly for a company to enter a particular task environment or industry. So the more difficult and costly to enter an industry, the higher are the barriers to entry. There are three main sources of barriers to entry; they are economies of scale, brand loyalty, and government regulations.
In this case, as my analysis in the last several weeks, there are many barriers to entry in the telecommunication industry of the U.S. Firstly, economies of scale. We know that economies of scale is associated with how largely a company produces, and normally, in economies of scale, the more they produce, the less they cost on every product. In this case, there are three companies that almost control the whole market of telecommunication industry; they are AT&T, WorldCom, and Sprint, so the four-firm concentration ratio is almost 1. So compare to new entry companies, the “big three” may have a competitive advantage due to their economies of scale.
Secondly, brand loyalty. I have mentioned in last week that telecommunication industry has a very special characteristic that the large number of users could be one of the most significant and useful competitive advantages for companies in this industry. That means the more users a company has, the easier for the company to get new users in the future. Because when customers choose telecommunication carrier, they may consider every carrier’s network and its cost. Normally, the more users in a carrier’s network, the more likely the network is considered good by new customers. Also, most of the phone users would not like to change their phone number frequently, because they are at a risk of losing contact with some friends when they change their phone number. So the brand loyalty in telecommunication industry is also very high. It is hard to imagine that a “big three” user would change to a new entry telecommunication carrier if this new carrier could not provide a significant lower price than “big three”.
Thirdly, government regulations. In this case, this is the only factor that would not cause more barriers to entry. As my analysis in last few weeks, in the mass market international long distance telecommunication services, before the merger of WorldCom and Sprint, the HHI of this market is higher than 1800, this means the market is “highly concentrated”, and this number will cause the Justice Department to block the merger which will increase the HHI by more than 100. However, unfortunately, after the merger of WorldCom and Sprint, the increase of HHI is higher than 100, this means the merger would be prohibited by Justice Department. However, the only thing the Justice Department can do is to prevent this industry from higher concentration, but the truth is there have been very high barriers to entry in telecommunication industry.
Reference:
Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 23rd, 2011
This week, I will continue my analysis of the last three relevant product markets of telecommunication industry of the U.S. They are Interlata Private Line Services and Interlata X.25, ATM, and Frame Relay Data Network Services; Interlata Data Network Services Market, and Custom Network Services Market.
To enter the fifth relevant industry, Interlata Private Line Services and Interlata X.25, ATM, and Frame Relay Data Network Services, would also be very hard. This market is also highly concentrated by AT&T, WorldCom, and Sprint. Telecommunication market has a very special characteristic that the large number of users could be one of the most significant and useful competitive advantages for companies in this industry. So it is very hard for a new entry company to get market share from the “Big Three” because of the new entry company’s small number of users. This barrier could cost new entry companies several years to build a competitive advantage. Also, users’ brand loyalty could be another barrier to entry in this market. So the entry barriers are very high in this market.
The barriers to entry of the sixth relevant industry Interlata Data Network Services Market is similar with the fifth relevant industry. This market is also dominated by the “Big Three”, so it is also very difficult for a new company to enter this industry.
The last relevant industry is Custom Network Services Market. This market is also controlled by AT&T, WorldCom, and Sprint. In this market, only the “Big 3” could provide all the services required by large business customers because of their large networks, skilled and experienced staff, and technological expertise. The case mentions that in this market, the new entry companies must do very well and establish a high reputation to get contract from large business customers, but these things may cost new entry companies several years and may not be easy to get. So the barriers to entry is also very high in this market.
Reference:
Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 13rd, 2011
Last week, I stated the relevant product markets of telecommunication industry in the U.S., and then I analyzed the barrier to entry of the first two relevant product markets. This week, I will continue my analysis of these relevant product markets.
The third relevant industry is mass market international long distance telecommunication services. As the Appendix A of this case shows, this market is concentrated by AT&T, WorldCom, and Sprint. Before the merger, the HHI of this market is higher than 1,800, which could make Justice Department concern this market, and also, after the merger of WorldCom and Sprint, the change of HHI would be higher than 100, which could cause the merger being prohibited by Justice Department. This market is not a perfect competition market, it is more likely an Oligopoly market, which are controlled by several big companies. So the high HHI could bring a great barrier of entry to this market. In addition, the case mentions that to enter this market, the new company needs to invest huge amount of money to “create a network, or resell services using existing providers.” This could be another barrier to enter this market.
The fourth relevant industry is international private line services market. Like the mass market international long distance telecommunication services, this market is also controlled by AT&T, WorldCom, and Sprint. However, it is also different from the previous market. As shown in the Appendix B of the case, in this market, AT&T does not compete in some countries’ market, like Armenia, Hungary and Jordan, this means in some countries’ market, the share of WorldCom and Sprint combine could be 100%. So the merger of WorldCom and Sprint may cause the HHI of some countries’ market go up to 10,000, which means the market structure will change to monopoly. This could make the entry of some countries' market be extremely hard.
Next week, I will complete my analysis on the rest relevant markets.
Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 8th, 2011
In this case, there are 7 relevant product markets in the telecommunication industry in the U.S. They are: “Tier 1” Internet backbone services market, mass market domestic long distance telecommunication services, market mass market international long distance telecommunication services, International private line services, interlata private line services and interlata X.25, ATM, and frame relay data network services, Interlata data network services market, and custom network services market.
This case indicates that the merger of WorldCom and Sprint may lead to higher prices, lower service quality, and less innovation in these relevant markets. In my opinion, these problems may result from the lack of competition in telecommunication industry. In my analysis of last week, the barriers to entry may play an important role in an industry’s competition. According to the Five Forces Model, the difficulty of entry can contribute to an industry’s competition. The more difficult to enter an industry, the less competition in an industry. So I will focus on the barriers to entry of these relevant industries in the following weeks.
In the first relevant industry, “Tier 1” Internet backbone services market, before the merger, WorldCom and Sprint together has 53% of the Internet traffic. In order to entry this market, new Internet companies must “establish and maintain adequate peering interconnections to provide Internet connectivity”. To establish the adequate peering interconnections, the companies must get a high level of customer traffic. However, with more than half of the Internet traffic, the merger of these two companies will make a higher barrier of entry in this market.
The second relevant industry is the mass market domestic long distance telecommunication services. This market is dominated by the “Big Three”, AT&T, WorldCom and Sprint. Together they get an 80% share in this market. In this market, brand recognition and the scale of network are very important. However, these two things need a large investment and a long period of time. So the barrier to entry is also obvious in this market. With the merger of WorldCom and Sprint, the economies of scale and scope will help them to get a lower cost, and then they will have a new low-cost competitive advantage, which will make the barriers to entry higher than before.
Reference:
Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. (2007). Managerial Economics and Business Strategy (6th edition). New York, NY: McGraw-Hill.
Baye, M. R. and Scholten, P. Justice Department Seeks to Enjoin Merger between WorldCom and Sprint Corporation.
Oct 1st, 2011
This case mainly discusses the merger between two large telecommunication companies WorldCom and Sprint Corporation. I skimmed this case in this week. There are three points which are important in this case: firstly, Justice Department of the U.S. disagree with the merger between these two companies. Secondly, the merger between these two companies will cause market concentration and anti-competitive behaviors. Thirdly, the merger between these two companies will result in barriers to entry in the U.S. telecommunication market.
I come from China, so I am not very familiar with telecommunication companies in the U.S. Therefore, before going deeply in this case, it is necessary for me to understand the U.S.’s telecommunication market, and some concepts. I looked for some more information this week:
Goldblatt, H., & Chen, C. Y. (2000). No Deal Is a Good Deal for WorldCom and Sprint. Fortune, 142(3), 36. Retrieved from EBSCOhost.
This article claims that the WorldCom should concentrate on its “global business-only plan” and Sprint should merge a non-telecommunication company. This advice sounds reasonable. In order to maximize the effect of economies of scope, Sprint should merge a company that does the business that has some relationship with telecommunication but not telecommunication. Maybe in this way, Sprint could use its large number of user basis in the new business market, and also the new business may help Sprint in the telecommunication market. Also, focus on the global business-only plan may help WorldCom to improve its economies of scale.
Jones, G. R., & George, J. M. (2008). Contemporary Management (6th edition). New York, NY: McGraw-Hill.
According to this book, barriers of entry could be built through three sources: economies of scale, brand loyalty, and government regulations. In this case, because these two companies are all in the telecommunication market, the merger may cause a larger economies of scale, this means the company after merger would have a lower cost than before. This competitive advantage could prevent most of the new companies entering the telecommunication market. In addition, the large number of users of these two companies may make the effect of brand loyalty much larger than before. In these ways, the merger of the two companies could build a barriers of entry in the U.S. telecommunication market. So this may be the main reason of why the Justice Department wants to enjoin this merger case.