Download Competition and coordination in the network economy

Competition and Coordination in the Network Economy1
Mingzhi Li, Kai Reimers, Jinghua Huang, Guoqing Chen
School of Economics and Management, Tsinghua University
Abstract
The network economy refers to the ecosystem that centers on the
Internet. It includes the network enablers (backbone providers, Internet
service providers, and the last mile providers) as well as all the market
participants whose activities are critically based on the Internet. Due to
the unique characteristics of the network economy, the market structures
in different segments of the network economy differ greatly. The
traditional beliefs held by economists that perfectly competitive markets
are the most efficient may not be true in all the layers of this emerging
network economy. We discuss the market structures and competition in
different layers of the network economy and the roles of the government
in coordinating economic interests of these segments.
Keywords: Network Economy; Network Externality; Standardization;
Competitive Advantage.
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Partly supported by Tsinghua-SEMeBusiness Laboratory, Tsinghua's Soft Science and 985 Key Projects on
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eBusiness, and the National Science Foundation of China (No. 79925001).
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Competition and Coordination in the Network Economy
Mingzhi Li, Kai Reimers, Jinghua Huang, Guoqing Chen
With the rapid development and diffusion of the information and
communications technology, the network economy is including richer
and richer contents. While the backbone providers, the Internet service
providers, and the last mile providers are the enablers of the network
economy, broadly speaking, all the market participants whose activities
are critically based on the Internet are also important market players in
this emerging ecosystem. Traditional economic theory believes that
perfect competition is the most efficient market structure. However, due
to the unique characteristics of the network economy, this may not be true
in all segments of the network economy.
To coordinate economic
activities and conflicting interests of these market players, the
government needs to play an important role.
The paper is organized as follows. In section one we discuss the new
characteristics of the network economy. In section two we look at the
fundamental differences in different segments of the network economy
and their most appropriate market structures. Then we discuss the
interrelated relationships among all the segments of the network economy
and the government’s role in coordinating different interests of them in
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section 4. The paper finishes in section five with concluding remarks and
policy recommendations
1. Layers of the network economy and its characteristics
The network economy refers to the ecosystem that centers on the
Internet. It includes the network itself and all the economic activities that
critically depend on the Internet. The major market participants of the
network economy includes: the backbone providers, the Internet service
providers, the last mile providers and all the firms who are using the
Internet as a medium to do business. The relationships among these
market players can be described as co-competitors: they are competitors
but they also need each other’s coordination. An end user needs to get
connected to an ISP through a last mile provider, and the ISP has to get
onto the Internet through a backbone provider. The Internet contents
providers (ICPs) are providing the contents to the end users.
A backbone is a collection of high-speed telecommunications lines
(what used to be called “trunk lines” or simply “telephone lines”) that are
connected by high-speed computers. It is made up of fast fiber-optic lines
that allow computers to transfer data at very high speed. Backbone
service providers are those companies that maintain their own backbone
lines. An Internet Service Provider (ISP) delivers access to consumers
and small- to medium-sized organizations. Last Mile Providers develop,
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maintain, and provide the physical connection (e.g., the telephone, cable,
or wireless connections) to consumers and small- to medium-sized
organizations. Internet Contents providers create a series of products,
such as news, financial information, education information, music and
video, games and other entertainment contents etc.
Compared with the traditional industrial economy, the Internet based
network economy has the following unique characteristics.
Network Externalities: network externalities exist when the value of a
product or service increases with the increase of the number of users. For
example, when more people are using one telecom network, the price of
the telecom service may decline due to economies of scale, and then all
the users get benefits from the lowered price. To the network service
provider, the existence of network externalities may make one big
network more efficient compared to several smaller ones providing the
same service.
Standardization: to make the network operate smoothly, standardization
is an important issue in the network economy. Industry standards
typically are set by the industry leaders. AT&T used to be the builder of
the US telecom industry standard before the seven baby bells were
spinned off. In the early period of an industry development, it is
important to have an industry standard. The China telecom used to play a
similar role in the telecom industry of our country.
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Interconnection: Interconnection is the most important characteristics of
the network economy. The virtual economy reduces transaction costs of
doing business, lessen limitations due to physical distance and time
constraints.
Personalized Service: the Internet shortens distances between firms and
consumers in the value chain and changes the traditional market
structures. The firms may face the consumers directly, therefore it is
much easier for them to get to know the consumers’ preferences and
design personalized products and services.
2. Market Structures and Competition in Different Layers of the
Network Economy
Since the network economy has multiple layers and has different
characteristics compared with traditional economy, we have to consider
the uniqueness of the network economy when we consider its market
structures. It is not appropriate to talk about “good” or “bad” of
monopoly and competition without taking this uniqueness into
consideration. We next discuss the most appropriate market structures of
these different layers and characteristics of competition in them.
Backbone Service Providers ——Oligopoly Markets
The backbone owners are controlling the trunk lines of the Internet
traffic. They make money out of leasing their bandwidths to ISPs or large
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enterprises. Currently China’s backbone service providers include:
Chinanet, UNINET、CNCNET、Jitong and Tietong, among which the
CHINANET owned by the China Telecom is the largest. Before
emergence of the other backbone providers, it almost controlled 100% of
China’s telecom lines. After the restructuring of China’s telecom industry
in 1999 and 2000, the landscape of backbone service providers market
have changed dramatically.
Building the Internet backbones has many similarities with that of the
traditional telecom trunk lines. First, it takes a huge amount of fixed
investment in setting up the basic infrastructure. Therefore there is a very
high barrier to entry in this industry. Second, providing the network,
telecom and telephone services has the characteristics of increasing
returns to scale and economies of scale. Although the initial investment in
building the network is huge, the additional cost of serving one more
customer is minimal. Based on these two features, we believe that the
characteristics of natural monopoly still hold in the market of backbone
services providers.
Although traditional economics advocates free competition, it is not
likely to have a full-scale competition in this layer of the network
economy due to the uniqueness of the network economy mentioned
above. It is common belief that monopoly market structure has the
problems of high price, low output level and causing social welfare loss.
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The oligopoly market structure is more realistic in the layer of backbone
service providers. Competition among several big firms may keep the
prices from reaching the monopoly level and enhance the quality of
services. However, the oligopoly market has such problems as collusion
among firms. It is the government’s role to correct market failure in the
oligopoly market.
ISPs ——High Speed, Reliable and High Value-Added Access
The function of an ISP is to provide access to the network. Therefore
the product and service of all the ISPs are not highly differentiated; there
is also almost no barrier to entry in this industry. Such a market is
unlikely to be dominated by a few large firms. The competitive advantage
of ISP lies in its ability of consolidating resources and providing high
speed, reliable and high value-added services. An ISP needs to build a
large customer base to take advantage of network externalities and
economies of scale. Recently two of China’ ISPs,163 and 169, were
integrated into one platform. This will make better use of the ISP
resources of the two previously separated platforms. The ISP 263 is also
considering cooperating with Cable Networks and providing Internet
access services jointly.
The
major
ISPs
in
China
includeYing-Hai-Wei、Oriental
Netscape、Netease、263 etc.. Some ISPs like 163 also provide their own
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Internet contents. We call these companies Access Service Providers
(ASPs).
The current problem in the ISP market is “fair and equal access”. Since
the China Telecom owns the majority of China’s Internet backbone
bandwidths, most ISPs need to lease bandwidths from it. The China
telecom is charging lower leasing fees to its own ISPs than to others. The
issue of equal and fair access remains to be solved.
ICPs ——Competitive Advantage Comes from Personalized product
and Service
It is said that the network economy is the “economy of attention”.. This
particularly refers to the layer of Internet contents providers. By the end
of 2000, there had been 122099 domain names registered, and the number
of web sites had reached 265405. Fierce competition in this market makes
the market of ICPs close to perfect competition. To draw attention of
viewers, ICPs need to provide personalized products and services that
satisfy the unique needs of the consumers.
Battle of the Last Mile——digital convergence of data, voice and
video
To be concrete, the last mile service is the physical connection from the
backbone to the end user. For example it may be the segment from the
local telephone exchange switches to a user’s home; it could also be the
part from a Local Area Network (LAN) to the end user. Currently the last
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mile service is almost 100% provided by the China Telecom. With the
rapid advancement of ICT technology, the last mile connection will no
longer be limited to phone line. Cable line, wireless phones will break up
the monopoly situation of telecom in controlling this segment of the
network. The so- called digital convergence of data, voice and video
networks will foster a competitive landscape in the last mile. This will not
only reduce interne congestion phenomenon but also will lower the prices
for Internet connection and benefit the consumers.
Business Activities centered on the Internet——Creating value using
the new medium
Besides the network enablers, the other major layer of the network
economy is the businesses that live on the opportunities provided by the
Internet, such as online intermediaries that provide a platform for
transactions between buyers and sellers. Internet also changes the way
traditional businesses are conducted. Some success stories include Dell
computer’s direct sale model and Cisco Systems’ B2B model. The
success of this layer of the network economy depends on choosing the
right business models and right execution.
3．
．The Interrelated relationship among layers of the network
economy
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We have discussed the different layers of the network economy. In fact,
these layers are not independent from each other. Coordination among
them is very important. The most important characteristic of the network
economy is “ability of interconnection”. The power of the Internet lies in
its being the network of networks. Each layer is playing different roles in
this huge network.
If we compare the Internet backbones to the superhighway, the ISPs
play similar roles as the side-roads to the highways. The ICPs are similar
to the economic activities on the highways such as traffics, transportation,
advertisements etc. The last miles can be compared to the numerous
tracks to the buildings besides the side-roads and the highways. To fully
make use of the functions of the highway systems, all the segments have
to be connected smoothly; this is also the power of the Internet and the
network economy.
The government plays an irreplaceable role in the network economy. It
needs to find balance between the interests of private parties and the
social welfare, it also should get involved in the task of setting up the
industry standards and regulating markets. We can learn lessons from the
practices of the governments of developed countries such as the United
States. To promote market efficiency, the Federal Communications
Committee (FCC) of the US ordered the dissolution of AT&T in 1980s.
In the most recent AOL and Time Warner merger case, the role of the
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FCC can also be seen clearly. The Ministry of Information Industry of
China ought to play a similar role in coordinating the interests of all the
parties involved in the network economy.
4. Conclusions
The network economy has new characteristics compared with the
traditional industrial economy. It is made up of different layers. It is not
likely to promote the market structures of perfect competition in each
layer, which is also not socially efficient. Each layer of the network
economy has its own appropriate market structure. The government is
playing an important role in coordinating the activities and interests of all
the parties involved.
Reference：
：
1. William W. Sharkey: The Theory of Natural Monopoly. Camgridge
University
Press, 1982.
2. Jean Tirole: The Theory of Industrial Organization. The MIT Press,
1984.
2. Zhou Qi-Ren，Convergence of the three networks and competition of
the networks
(in Chinese)《Cai Jing》 1998, 11.
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