by Kyle Wilson, Mo Xiao, and Peter F. Orazem

We are excited to feature this article, which appeared in Issue 30.1 of JEMS.

Abstract:

In a rapidly growing industry, potential entrants strategically choose which local markets to enter. Facing the threat of additional entrants, a potential entrant may lower its expectation of future profits and delay entry into a local market, or it may accelerate entry due to preemptive motives. Using the evolution of local market structures of broadband Internet service providers from 1999 to 2007, we find that the former effect dominates the latter after allowing for spatial correlation across markets and accounting for endogenous market structure. On average, it takes 2 years longer for threatened markets to receive their first broadband entrant. Moreover, this entry delay has long‐run negative implications for the divergence of the U.S. broadband infrastructure: 1 year of entry delay translates into an 11% decrease on average present‐day download speeds.

1. What makes the US Broadband industry (and specifically the years 1999-2007) an ideal setting in which to study the question of market entry and timing?

Identifying markets that are threatened by future entry is difficult, but the broadband industry offers a credible indicator of this threat. Installing a broadband network in a market incurs a substantial localized sunk cost. But, once an internet service provider’s central office is in place, it can be used to serve other nearby markets, thereby lowering the cost of entering these neighboring markets. Thus, a provider’s presence in a neighboring market serves as a reliable indicator of their likelihood of future entry into a given market.

Moreover, studying the period from 1999-2007 allows us to document the timing of entry during a period of tremendous expansion and market entry. This period shapes the competitive landscape of the U.S. Broadband industry.  During these years, broadband availability increased from 57% of U.S. zip codes to 91%. The 1999-2007 period allows us to capture the most important actions in a brand-new, high-stakes industry.

2. How does your focus differ from previous studies of entry threat / entry delay?

What primarily differentiates us from previous studies of entry threat is that most prior work investigates the effect of entry threat on the behavior of incumbents, who have been shown to respond strategically by adjusting prices, investment, or quality. In our paper, we instead focus on the behavior of potential entrants and show that entry threat lowers their probability of initial market entry. Further, we show that the resulting delay in entry has persistent effects on product quality, as markets entered later experience slower download speeds in the long-run, even after controlling for demand and cost shifters and contemporary levels of competition. We believe this link between entry delay and future product quality to be novel in this literature.

3. You suggest that potential competition may delay entry into broadband. What factors might accelerate entry into broadband?

While we do document this strategic effect of potential competition, market entry is largely driven by demand for broadband and its local cost of provision. For instance, we find that the probability of entry is higher in markets with greater population, higher incomes, and less rural area. These factors continue to contribute to the digital divide in the United States, as the Federal Communication Commission’s 2018 Broadband Deployment Report notes that 98.5% of the population living in urban areas had access to broadband (defined as 25/3 megabits-per-second of download/upload speed), compared to 77.7% in rural areas and 72.3% on tribal lands. Broadband entry can also be accelerated through government policy, including cost subsidies to providers, demand-side subsidies to consumers, and the facilitation of municipally owned broadband networks.

4. Does the possibility of delayed entry into broadband have any policy implications? 

We can see two policy implications here. First, the “threatened” markets actually have larger populations, are less rural, more densely populated, and have more businesses compared to the “unthreatened” markets. Entry threat in turn leads to entry delay and delayed improvements in broadband speeds. That is, the negative effects of strategic entry delay have larger incidence on markets which also have more favorable characteristics. In these left-behind markets, consumers suffered a lack of access, choices, and quality. We therefore suggest that public policies intended to encourage entry and competition should not restrict attention to preferences, cost, and technology considerations. Second, what we discover here is that internet service providers hesitated to enter a market because they were afraid another provider would also enter and lessen profitability. These providers really understood the negative effect of future competition on their future payoffs. A generic public policy that incentivizes all firms to enter, such as tax breaks or favorable right-of-way accommodation, may be less effective if it elicits a strong competition effect.  In similar markets, we encourage policy makers to consider targeted subsidies or auction rights to a firm to serve as a monopoly for some fixed term.

5. What are the most important managerial implications of this work?

Our emphasis is on “threat,” that is, something that could happen in the future.  We alert managers to be aware of the current competition as well as potential competition. This is especially important for industries with high sunk cost of investment and fast evolving technologies, as technology advancement could render future entry very likely, which lowers the payoff of heavy investment. In short, we urge mangers to be forward looking.

6. What directions might you suggest for further research? 

We have a more general direction and a more specific direction. In our paper, we show that choices made on the basis of transitory conditions can persist long after those conditions have changed. In other words, history matters. Generally, our study is an open call to industrial organization researchers to develop equilibrium, dynamic, and spatial approaches to study the effects of firm strategy and public policies. Specific to the broadband industry, it would be useful to see how disparate deployment and uneven access to the broadband infrastructure across the country affect the wellbeing of the population and economic performance. This is especially important in current times, as the pandemic has made the Internet indispensable in work, education, healthcare, and beyond.