Telecommunications and Economic

7/24/2019 Telecommunications and Economic

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4Economic Tools for TelecommunicationsProfessionals

The purpose of this chapter is to survey the primary economic tools destinedto influence telecommunications market planning during the era of deregula-tion. We may generally divide the array of these economic tools into twocategories: microeconomic and macroeconomic data analysis. Macroeconomic

analysis relates the determinants of aggregate market demand to the businesscycle. Microeconomic analysis involves the evaluation of supply and demandand market equilibrium, the computation of costs and profits, and estimationof economies of scale and projection of pricing. The principal concern of tele-communications firms during the early stage of deregulation will be pricingstrategy aimed at establishing and expanding market share.

We infer that the initial years of deregulation are likely to be turbulentbased upon the pattern of historical experience seen in large industries pre-

viously deregulated. We also presume that a key dynamic in telecommunica-tions deregulation will be the impetus to competition instigated by thecomputer industry. Asoneelement of the telecommunicationstriad, the com-puter sector remains untouched by the specter of regulation; the economics ofthe industry may change as computers supplant traditional services offered byits broadcasting and telephony cousins. Innovations in this industry will fuelchange in telephony and broadcasting in addition to new approaches to cus-tomer relations.

The synergiesof technological innovation and relaxed regulatory barrierspreventing cross-ownership further reinforce the implicit uncertainties associ-ated with identifying market winners and losers in the years ahead. Moreover,should the computer industry come to assumegrowing influencein such mat-

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68 Telecommunications Deregulation and the Information Economy

ters asprivacy, security, obscenity, and other noneconomic areas, theparadoxi-cal prospect of gradual deregulation in telephony and broadcasting may be

accompanied by government intrusiveness in the third sector. Such noneco-nomic contingencies may nevertheless have far-reaching economic conse-quences for the entire industry over the long run. Telecommunicationsprofessionals must therefore assert a collection of economic tools that bench-marks emerging competition with its consequent impact on future pricing.

For purposes of this discussion, the application of economic tools is fo-cused on telecommunications market planning. The use of microeconomictechniques to dissect market demand and provider response is emphasized inthis presentation, although the costs of providing universal service and inter-

connection remain implicit and embedded in such a review [1]. Web site eco-nomic research tools on telecommunications infrastructure are provided inAppendix C. Of primary concern in this segment is the linkage between eco-nomic opportunitiesresulting from passage of theAct and themarket researchmethodologies presented in Chapters 3 and 5 to 7. Those engaged in strategicplanning, market forecasting, and sales management require a collection oftools that will enablethem to seizeupon opportunitiesevolving from competi-tivemarket interactions.

4.1 Overview of Macroeconomic Analysis

4.1.1 Macroeconomic Tools for Telecommunications MarketPlanning

Although the primary focus of communications planners during deregulationwill be the microeconomic analysis of veteran and emerging product lines, anote should be included here regarding the macroeconomic characteristics of

the industry. The forecasting of broad long-term demand for all goods andservicesistied directly to thecourse of employment, interest rates, and cyclicalchanges in the economy. With variance as to sector and composition of prod-uct line, the correlation of these factorsvaries from industry to industry [2].

In the case of the telecommunications industry, the influence of macro-economic forces is manifested in the degree to which demand is dependentupon such factors as aggregate employment, income, and debt accumulation.We find in many communications products a relatively low correlation be-tween these variables and resultant demand [3]. If we dichotomize veteranfrom emerging product lines, we note that the use of the telephone is largelyimperviousto cyclical variations in the economy. We verify this by evaluatingmarket penetration rates. Stable ratespenetration rates that remain unaf-fected by transitions between prosperity and recessionsuggest that theseproductsand servicesremain ingrained fixtures.


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69Economic Tools for Telecommunicati ons Professionals

As time has passed, cable television subscription has come to resemblethese same characteristics [4]. Rates of computer adoption for businesses and

households imply the same phenomenon in recent years. The most profoundpostWorld War II example of high, sustained rates of adoption seeminglyunaffected by turns in the business cycle is television: in the nine recessionspunctuating this era, television sales sustained a geometric rate of adoptionindependent of recession or inflation. A dramatic recent example of the samedynamic is reflected in the videocassette industry [5]. In each case, we notethat nominal pricing, coupled with broad business and social acceptance, ledto ubiquitousand habitual use.

Telecommunications is thus differentiated from many other industries

whose demand is connected directly to movements in the business cycle. Thehousing, steel, durable goods, and automobileindustriesall anticipatedemand,in part, as a result of broader transitionsin the economy. For veteran productlines, communicationsplanners are concerned lesswith such empirical tests. I tshould be added, however, that to the extent that demand increases in thesecyclical arenas, consumption may beexpedited for communicationsservices.The lasting empirical lesson from these data isclear and concrete: Given time,individuals and organizationscometo rely on such products and services, un-

lessalternativesuperior productsare introduced.The introduction of new products and services, however, does bear a

comparatively closerelationship to shiftsin thebusinesscycle. When economicoutput growsrapidly, unemployment fallsand real wagesrise, and the numberof new adopters increases proportionately. It is in this environment that newcommunication servicesare most effectively introduced to market. Conversely,market contractions or recessions diminish the number of experimentersinclined to purchase newly introduced services, particularly if they are exotic

in nature. Marketers havelong known this market characteristic and adjustedtheir presentation of new products accordingly.Thetwo critical macroeconomic variablesto examine in considering pro-

spective demand for communications products and services are employmentand income. The decision to purchase, and continue to use, communicationsservicesischiefly afunction of thesevariables. To thisextent, thebusinesscycleisan important tool in estimatinglong-term demand; if thismethod of analysisis applied, however, the length of current and future business cycles must bepredicted. Generally, the lengthsof prosperi ty haveaveraged four to fiveyears;most recessionshaveaveraged under one year [6]. H owever, the precisetimingof recession and prosperity remainselusive, with recessionsoccurring in 1949,1954, 1958, 1960, 1970, 19731974, 1980, 19811982, and 19901991.The cycles have thus been irregular and governed by a confluence of eventsoften unanticipated or surprising. Nevertheless, oncethetransition from reces-


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sion to prosperity is clearly evidenced (see Figure 4.1), the impetus generatedby lower unemployment and rising income is a significant aid to aggregate

demand. Telecommunicationsplanners, even if committed to long-term capitalconstruction, cannot becompletely obliviousto thedynamicsof businesscycleforecasting; the point in time at which a new product is introduced can befortuitous or disastrous for a firm, especially during periods of acceleratedcompetition.

4.1.2 Other Issues inBusinessCycle Analysis

Oneissuehistorically dividesstrategic plannersin estimating aggregatedemandfor their products. This matter concerns the philosophy of adapting the busi-ness cycle as a macroeconomic tool to unfolding demand for new goods andservices [7]. One philosophical view holds that national or regional demandfor all services, telecommunicationsstaples included, is a function of nationalincome. In other words, if a forecaster anticipates rising national income, thepresumption is that national aggregate demand will thereafter rise proportion-

Time

Output

Secular growth trend

Trough

Trough

Peak

Decline

Growth

Growth

PeakGrowth

Peak = Prosperity

Trough = Recession*

Figure 4.1 Transitions in the business cycle. Note that in the postWorld War II era the

average expansion has lasted approximately five years. The longest periods of expansion

unpunctuated by recession are 19611970 and 19821990, which were marked by geometric

growth in telecommunications infrastructure and services, as defined by convergence. The

secular growth trend represents the average annual growth rate in the American economy

(which has averaged between 3.0% and 3.5% since 1945).

*Recession is defined as two or more consecutive quarters of negative growth in the Gross

Domestic Product.


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ately. An alternative outlook contends that there exists a family of businesscycles, in which one must select the appropriate cyclical model to predict

probable demand industry by industry. This perspective divides cycles byuniquecharacteristicsor attributesand categorizesthe following [8]:

Seasonal analysis, in which demand follows the contours (measuredmonthly or quarterly) of residential and business demand throughoutthe year;

Secular analysis, in which dataisexamined to elicit persistent underly-ing trendsindependent of national, regional, or other forces;

Three-cycle schema, in which three long-term forecasting waves areadjusted for 40 to 50 years (Kondratieff ), 40 months (Kitchin), orJuglar (dividing the Kondratieff wavein six increments). These cyclesare superimposed over one another to illustrate emerging short-termdevelopments.

The last of these techniques has been accepted in many academic circlesas appropriatebusiness cycle theory; its credibility and application to telecom-

munications may be a matter of dispute or conjecture, but a macroeconomicgrasp of long-term aggregatedemand could facilitate capital construction deci-sionsregarding infrastructure. Assuggested in Chapter 7, thekey to enhancingtheprobability of successin forecasting liesin applying all methodsof analysis,and then searching for areas of common agreement based on intersectinginferences.

Another issueof concern raised by analysisof thebusinesscycleconcernsthe influence of psychology on consumption. As illustrated in Figure 4.1, in-

comes rise as the economy ascends to its peak. This ascendancy influencespsychologythe attitudes, feelings, and confidenceof consumers and em-boldens them to emulation or experimentation, depending on their positionon the S-curve (discussed in Chapter 5). Significantly, data reveals that psy-chology plays a role in determining the timing of initial purchases (i.e., theirfirst experience with a new communications product). Thus, the state of thebusiness cycle at any moment indirectly influences the timing of such experi-mentation and can accelerate or decelerate consumption accordingly. Thisfac-tor is of less concern to telecommunications providerstied to long-term

building commitmentsbut of keen value to content developers, who mustconsider such information when delivering new products. Psychology is pro-foundly difficult to quantify, though attempts have been numerous, and itsvalue in illuminating consumer behavior in telecommunications remains un-clear at present [9].


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4.2 Overview of Microeconomic Analysis

4.2.1 Microeconomic Tools for Telecommunications MarketPlanning

Microeconomic tools are essential for communications market planners. Theapplication of these techniques varies considerably in terms of infrastructureprovision versuscontent development. While those firms engaged in the man-agement of infrastructureprincipally those involved in the telephony andcable television industriesmust allocate large sums of capital over time tosustain a customer base, many content developers can readily shift productlines to accommodate changes in market preferences. To this extent, content

developers extract competitive advantages vis-a-vis their own competitors byexploiting network economies of scale and scope [10]. Wenoted in Chapter 2that Sections 251 and 259 of the Act were written in such a way as to ensurethat proliferating networks would become integrated through complete andfair interconnection at pricing designed to assure universality. The translationof this feature of the Act into practical economic terms has meant that manyfirms (e.g., Internet providers) currently assume a quasi-free rider positionvia deregulation.

The following sections survey the fundamental techniques used to esti-mate supply and demand, costs and profits, equilibrium and elasticities, andthe dynamicsof pricing. While the application of thesetoolsappliesuniformlyto both service providers and content developers, the costs uniquely borneby network managers differentiate their planning agenda from those of othertelecommunicationsfirms.

4.2.2 Principlesof Telecommunications SupplyandDemand

A market consistsof buyers and sellers. Resultant transactionsare measured inprice. Prices are defined by the interaction of supply and demand in markets.Some markets are local in nature, while others are regional, national, or inter-national in scope. The geography of markets is an important characteristic intheevolution of telecommunicationsnetworks and the services they support.

If the intent of the Act is to encourage competitive markets, then wewould identify threeimportant overlaying characteristicsto market supply anddemand.

1. Thenumber of buyers and sellerswould besuch that no entity couldindependently influence levelsof price.

2. Fluctuations in pricing levels would have to remain unimpeded bygovernment sanction, regulation, or intervention of any kind.


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3. Movement of buyers and sellers would remain mobile over time (inother words, buyers would be free to select alternative providers at

any given moment). Suppliers, too, would befreeto movein and outof veteran and emerging product lines to secure their clientele.

As noted in Chapter 3, there exists a spectrum of competitiongradationsin thedegree to which markets exhibit these characteristics. In per-fectly competitive markets, optimal numbers of buyers and sellers moving ingreat mobility often produce substantial fluctuationsin pricing. In any event,it is not government that influencesthecourse of pricing over thelong run.

We have established that in the telecommunications triad of the tele-

phony, broadcasting, and computer sectors there exists significant variation incompetitivestructure. Whilethecomputer industry remainsfully unregulated,its counterparts are significantly regulated even after enactment of deregula-tion. Within telephony and broadcasting, someelements of theAct havemodi-fied or relaxed regulations (as elaborated in Chapter 2), but governmentinfluence over local telephony has remained entrenched. The commitment byfederal and stategovernmentsto universal servicehasperpetuated an unfetteredinterference in market transactions. Whatever the underlying public interest

spirit or motive, the fact remains that market supply and demand are influ-enced by government edict. We must therefore diagram intersecting supplyand demand according to the typeof market activity in which that enterpriseis engaged. In areas denoted by competitive market transactions, as illustratedby the principles above, we diagram prevailing supply and demand as illus-trated in Figure4.2. Wemay refer to thesetting of pricesin such environmentsascompetitive market price determination [11].

The interaction of supply and demand defines price, with supply and

demand curves ever changing. Thus, price will ordinari ly remain a constant ifgovernment assertsitsregulatory powers to that end. Pricestabil ity, or predict-ability, will be sacrificed in the short run if deregulation is manifested in theway itssponsors intended, but greater congruencebetween market supply anddemand will beattained in thelong run. Theeffect of this congruence would,in theory, lead to equilibrium price, the state in which buyers want to buy thesamequantity that sellers are prepared to sell. Therefore, if a seller sets a pricehigher than equilibrium, surpluses occur; if a seller sets a price too low, excessdemand ensuesand shortagesinevitably follow. Surpluses, in short, beget sub-sequent declines in price. Shortages induce higher prices to the point ofequilibrium.

We may generally conclude that the standard application of supply anddemand analysisisappropriateto pricing for content providers. Thosecommu-nications firms that supply content for infrastructuretelephony, television,


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5 15 2010

Output

Price

8

6

4

2

Excess supply

Equilibrium

{Surplus}

{Shortage}

Excess demand

Figure 4.2 Dynamics of market supply and demand. Prices set above the equilibrium point

generate surpluses, while prices set below precipitate shortages. Price reductions in the

form of sales lower excess supply to the equilibrium point over time; price increases

mitigate excessive demand until equilibriumis attained. Shifts in lines of supply and demand

tend to be more dynamic in instances of excessive supply or demand, with competitors

entering and leaving the marketplace at accelerated speed.

and computersthrive, survive, or die by the prevailing dynamics of supplyand demand. Those who manage, control, design, or create networking infra-structureoperate, however, in afundamentally different environment. Costsofgenerating content for infrastructure tend to belabor-intensive; costs of devel-oping that infrastructurearecapital-intensiveand typically requireasubstantialtime horizon to gain profitability. In short, the cost of labor is decisive incontent development; the cost of capital is key in infrastructure development.

Thus, economiesof scope(cost savingsthrough multifaceted serviceprovision)coupled with economies of scale (the decline in per-unit costs as productionrises) are essential for network managers. Reducing network costs per sub-scriber while exploiting profit potential from an expanding array of value-added network servicesiscri tical to theemerging deregulated environment (seeFigure 4.3).

Large network providers obviously hold at least a short-term advantageduring theearly stages of deregulation. These firmsare best able to exploit thefundamental principles of economies of scope and scale; they are best posi-tioned financially (see Chapter 8), as a result, to engage in vertical integrationby absorbing competitors[12]. Moreover, there existsan intrinsic comparativeadvantagefor largenetwork providers; theaddition of each subscriber increasesthe value of the network for veteran users [13]. We thus note the economicformula for success in network provision: the exploitation of economies of


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Quantity

Phase 1 Phase 2 Phase 3

Costsperunit

Economies

of scale

Diseconomies

of scale

Long-run average

cost curve

Figure 4.3 Hypothetical telecommunications services model: costs per subscriber. In the

long run, the average cost curve for servicing telecommunications subscribers falls due to

economies of scale; later, costs of servicing subscribers rise in response to diseconomies

of scale (that is, as the firm expands, monitoring costs increase while costs of managing

and sustaining employee productivityalso rise). In response, the firmseeks to exploit econo-

mies of scope by designinga new product line and generating added revenue. This phenom-

enon takes hold in phase 3 of the long-run average cost curve.

scope and value combined with value-added multiple services. When thesefactorsare juxtaposed to vigorous marketing, thusleading to expansivemarketshare, a strategy is set in motion that relegates short-term pricing strategy to asecondary concern. What matters to network providers in the short term ismarket share and competitivethreat; the law of supply and demand takesover

in the long run to define market winners and losers. Despite the comparativeadvantage of size that some firms enjoy, the risks of committing long-termcapital while network innovationsadvance rapidly are considerable.

Closely allied to capital risk is the problem of user-churn, the frequencywith which consumers move from provider to provider for their communica-tion needs. With theprospect of proli ferating competition, with new technolo-gies supplanting veteran product lines, user-churn generates both threat andopportunity in theActs aftermath. Theimportanceof user-churn asrelated tomarket share and strategic planning is discussed in Chapter 6, but one mustsimultaneously contemplate risks of capital and user-churn when projectinglong-term plans. The need to satisfy consumers at their basic level of need hasnow assumed a significance never before entertained by common carriers. Inthe absence of predictable cash flow, it is not feasible to raise or borrow thecapital required to build and maintain state-of-the-art infrastructure. It is for


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this reason that customer-led customizationone tool for satisfying the con-sumers basic communication requirementsis now regarded as a strategic

priority in some telecommunicationsfirms(see Chapter 10).

4.2.3 PriceElasticityof DemandinTelecommunications

The measurement of changes in quantity demanded in relation to changes inprice is called price elasticity. Simply, firms need to estimate how responsiveconsumerswill bewith respect to fluctuationsin pricing. Elasticity iscalculatedby dividing the percentage change in quantity taken by the percentage change

in price. In defining elasticities at various pricing points, a firm is able tocompute grossrevenuesin relation to the number of unitssold. Thus, analysisof elasticity serves two goals: (1) to gain a keener sense of the sensitivity ofconsumers to current and prospective changes in price and (2) to facilitateforecasting revenuesin theface of competitivepressures in pricing.

Figure4.4 diagramstherelationship between pricechanges, demand elas-ticity, and total receipts. The calculation of elasticity will yield one of threeresultsin each application: a value greater than 1, equal to 1, or less than 1. A

value less than 1 indicates inelasticity, meaning demand is not responsive tochanges in price. A value greater than 1 defines elasticity, suggesting that de-mand fluctuateswith changesin price. Unitary elasticity occurswhen the com-putation equals 1. I f price elasticity of demand yields a value greater than 1,then a rise in price will generate less revenue. If the demand for a product issaid to be inelastic, then an increase in price will produce more revenue. Insituations where demand is unit elastic, the percentage change in quantityequalsthepercentage change in price.

Obviously, there is spectrum of demand for communications productsthat isvariously elastic or inelastic. Telephoneservice for most people isgener-ally inelastic, since it is regarded as a staple of modern living. Cable televisionservice has cometo assume the same role for many Americans in recent years.For workers involved in occupations where mobility is crucial, cellular tele-phones are regarded as a necessity. On the other hand, interactive televisionservice remains comparatively exotic, and thus pricing is highly elastic. Theinelasticities associated with many staples represent potential opportunities forfirms to increase prices. Yet, under conditions of emerging competition, the

capacity of firms to raise prices while controlling market share is severely con-strained. In part, unfolding inelasticitiesof demand for certain servicesinspiredframersof theAct, who sought to mitigatehigher pricesthat would accompanymonopolistic or oligopolistic market structures.


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Figure4.4 Price elasticity and total revenue. The illustrations indicate that as price is raised

aggregate revenue expands by rectangleCand decreases by rectangleBunder conditions

of (a) unit elastic, (b) inelastic, and (c) elastic market environments.

4.2.4 ProfitMaximizationinTelecommunications

A communications firm, like any enterprise, maximizes profit by increasingsales and minimizing cost. The difference between revenue and costs consti-tutes its profit. In competi tive market structures, a firm would compute itsmarginal revenueand marginal costsand identify that level of output at whichthe two are equal. Marginal revenue is defined as the change in total revenueprecipitated by a one-unit changein output level. M arginal cost, or incremen-tal cost, represents the increase or decrease in total costs a firm bears resultingfrom the output of a unit more or less. Simply, prices are defined from theintersection of supply and demand, and the calculation of marginal costs andrevenues identifies appropriate output levels. The extent to which a firm sells


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its outputs maximizes its revenue; the difference between revenue and coststhusdeterminesprofit.

The measurement of profit is vital to evaluating a firms strategic vision.The computation of profit, the demonstration of profitability, is essential inconveying a firms credibility to stockholders and potential investors. We willnote in Chapters 8 and 9 that profitability means survivability in the long-term murky waters of deregulation.

The computation of profit margin provides communications firms withavaluable tool in justifying their strategiesto potential investors. Profit marginis the ratio of income to sales and is measured in two formats.Gross profitmarginisreflected by thepercentagereturn that a company earns over thecost

of goods or services sold; i t is computed by dividing gross profit (sales minuscostsof goodssold) by total sales. Thegrossprofit afirm earnsessentially coversoperating expenses, including administrative expenses, taxes, and interest.N etprofit margin, or return on sales, reflectsthepercentageof net incomegeneratedby each sales dollar. The standard computation of net profit margin resultsfrom dividing the income statement figure for net income after tax by totalsales[14]. Both computationsare illustrated in these expressions:

GrossProfit Margin GrossProfit/SalesNet Profit Margin Net IncomeAfter Tax/Sales

Both calculations provide investors and competitors with important cluesabout thevalue-added desirability of communicationsproducts. In an environ-ment of rising competition, the firm that generates a product that providesvalue-added attributesislikely to generateahigher profit margin. In this sense,thedetermination of profit marginsis significantly more important than gross

profits.

4.2.5 Determinants ofSupplyandDemand

Empirical evidence consistently pinpoints the following criteria as determi-nants or independent variables driving consumer and business demand forcommunicationsservices. Theseinclude(1) income, (2) tastesand preferences,(3) prices of complementary and substitute goods, (4) future expectations re-garding market prices, and (5) the number of buyers. These criteria, coupledwith current market prices, determine aggregate demand for a product [15].

In the case of supply, the following criteria, apart from price, drive thesupply providersare will ing to introduceto market. Theseinclude(1) cost, (2)technology, (3) number of sellers, (4) prices of other products (or substitutes)that sellers could introduce, and (5) future expectationsabout market price.


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Methodologically, a firm would isolate each of these variables in relationto any given product and apply correlation analysis to determine theextent to

which each is influential. A linear equation would then be designed to expressthedemand function appropriate to that product. From thepoint of providers,similar equationscan bedesigned to estimatethesupply generated by competi-tors and the resultant impact on pricing. Demand and supply functions areused in all industries and havegained renewed consideration in telecommuni-cationsfollowing passage of the Act.

4.3 Telecommunications Demandandthe SubstitutionEffect

The degree to which consumers select from among alternatives to satisfy theircommunicationsneedsmay bedescribed asthesubstitution effect [16]. Themeasurement and forecasting of dynamic substitution will grow in importancein the telecommunications industry as deregulation unfolds. Multiple factorsdefine the dynamics of substitution, but we may generally conclude that thedifferentiation of elastic from inelastic preferencesfor segmented marketsreveal

much about the future of communicationsneeds.Few will disagreethat food and milk are, in principle, inelastic staplesfor

most consumers. It is reasonable to conclude, also, that video cameras andvacations represent preferences best characterized as elastic in nature, with re-sultant wider price fluctuations. Consumers essentially do not reduce theirconsumption of necessities, regardless of changes in price. Price elasticity issubstantially related to variation in income for luxury items. In the communi-cationspalate, the issue of substitution becomes a complex and nebulous one

amid rapid technological change. Theneed of individualsand organizationstocommunicate rapidly has grown exponentially in recent years, but consumerswill alwayssearch out lower cost alternativessubstitutes. H ow doesonemea-sure and project the course of substitution over time? Too many unknownsmakesuch forecasting highly complex, but in differentiating each communica-tions product or service, we may deduce the determinants of market demandasoutlined in Table 4.1 [17].

In distinguishing luxurious from necessary communicationsservices,

there will exist substantial variation among income, occupational, and otherstratified groups (although these differences are likely to diminish over time,for reasons outlined in Chapters 1 and 5). Where market demand is elastic,consumerswill havemultiple alternativesavailable; thismight eventually mean,for instance, using Internet telephony as a substitute for local or long-distance


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Table 4.1Determinants of Market Demand

Elastic MarketDemand Inelastic MarketDemand

Luxury Necessity

Many substitutions available Little or no substitutions available

Price represents large fraction of income Price represents small fraction of income

Long-run time horizon Short-run time horizon

telephone service. In markets characterized by a range of available substitutes,thepriceconsumers bear tendsto represent ahigher fraction of income, partic-ularly as they seek higher value-added services. The longer the time horizon,thegreater the propensity toward elasticity; astimepasses, new alternativesareintroduced to market, and consumers are able to select the most desirablealternative. Consumers alter their tastesand preferences, aswell, in responsetoemerging substitutes. The use of e-mail, for example, hasdiminished the needto communicate by letter [18].

It has been demonstrated, too, that longer versus shorter time horizonsplay a significant role in fulfilling the social benefits of elasticity and substitu-tion. For example, in theshort run only larger organizationscould afford com-puters, fax machines, and related communications equipment. The long-runtime horizon had the effect of reducing the cost of these items, which madethem more readily available to first, small businesses, and later households.The dispersed benefitsof these technologiescannot be measured exclusively ineconomic terms and havemeant substantial improvement in thequality of life

for many people [19].The economics of substitution can be expressed through cross-price

elasticity, or the degree of responsiveness of consumers to changes in price fora particular product relative to changes in price for available substitutes. Forpurposes of this measurement, available substitutes may be either identical orcomplementary in nature. As noted earlier in this chapter, it is obvious thattechnological innovation threatensveteran product lines; therefore, forecastingcross-priceelasticitieswill assumeaheightened priority for telecommunications

firmsin thefuture. There isexpansiveempirical evidencethat consumerstodayexplore the desirability of substitutes in a way that their predecessors did not.Therefore, it behoovesthemodern communicationsprovider to maintain closescrutiny on those firms instigating such changes, especially in thearea of com-puter innovations.


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4.4 Telecommunications Indifference Curves

Deregulation, even if not fully realized in the manner anticipated by sponsorsof theAct, islikely to havetwo primary effects on telecommunicationssupply:(1) there is likely to be a rapidly expanding, possibly explosive, growth in thenumber of veteran and emerging product lines, as technological innovation issubstantially encouraged; and (2) there is likely to be added network capacity,anticipating growing consumption. The two forces are interactive and willinstigateprofound shiftsin thescopeof servicesavailable. Where asinglecabletelevision provider was formerly entrenched, the presence of DBS, MMDS,and cooperative community ventures will expand choice and diminish price.

Whereasingleprovider assumed control over local telephony, multiple provid-ersmay emerge, perhapseven from industrieshistorically unrelated to telecom-munications (e.g., electric utilities). Where television content had beenpresided over by broadcasting networks, cable television, computer, and otherconcernsmay interveneto providealternativeprogramming. In theseinstancesand other prospectivecases, consumersmay experienceastonishing choicespre-viously unimagined.

As consumers brace for choice and newly formed substitutions, indiffer-

ence curves will inevitably become an important tool for communicationsfirms. Both content and infrastructure providers will seek out the benefits ofmeasuring the extent to which consumers satisfy their communications needsby choosing from among proliferating choices. Theindifference curvemeasuresbundled choices from among alternatives to satisfy needs and desires. In otherwords, for each dollar a consumer commitsto satisfying basic communicationsneeds (see Figure 4.5), how will he or she allocate that sum for telephony,television, and other services?

Consumers may opt for a simple bundle of telephony and television ser-vice, or shift to theInternet for delivery of all services, or select asingleproviderthat can supply a menu of options unique to his tastes. The dynamic interac-tion of thedeterminantsof supply, asoutlined, guaranteesno simpleanswer asto theextent to which consumers will augment or simply substitute their pref-erencesfor communications.

The problem is a profoundly complex one when innovations are intro-duced so readily to market. As cellular phones, Internet service, interactivetelevision, and other servicesaugment veteran product lines, how will thecon-sumer reallocate his communications budget? Or, is it conceivable that theneed and desire for information management and transmission are so ravenousthat todays emerging services will become tomorrows staples? A general re-sponseto thesequestionscannot beformulated, but themeasurement of reallo-cated communications budgets can be diagrammed through the use of


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Figure 4.5 Hypothetical indifference curve, which measures the hypothetical combinations

of alternative services that satisfy ones telecommunications requirements. An implicit ques-

tion posed by the curve concerns whether consumer demand for communications services

will continue to rise or remain relatively constant, compelling different choices along theindifference curve.

indifference curves; a firm would design indifference curves for each targetedmarket segment. Indifference curves gain a renewed importance in this indus-try asderegulation isimplemented.

4.5 A CommentonEconomic Tools for Telecommunications

Limitations of space herein prevent a fuller treatment of the economic toolsthat are appropriate to evaluating and predicting thecourse of thetelecommu-nications industry during deregulation. Appendix C lists a full array of re-sources, including Web sites, that will permit thereader to track the corporateapplications of these tools. Seminal research in the field is now under way,precipitated by the enactment of deregulation, and organizations such as the

International CommunicationsForecasting Conferencesponsor innovativemi-croeconomic forecasting methods[20].

It can be stressed, despite the uncertainties and constraintsof price mea-surement and prediction, that an appropriate complement of economic toolsfor communicationsmanagers and planners would include[21]:


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1. Business cycle analysis, with special emphasis on the relationship be-tween thebusinesscycleand consequent national incomeand itsrela-

tionship to communicationsconsumption;2. Supply and demand analysis, with emphasison thedesign of demand

functionsappropriate to market segments;

3. Computation of market price equilibrium points;

4. Application of substitution analysis;

5. Calculation of elasticities, particularly with respect to emerging prod-uct lines.

Particularly in the case of firms that previously operated in monopolymarkets, afresh perspectiveon equipping managers and strategic planners withthese skills would greatly improveorganizational communication and camara-derie. The need to sensitize all members of the firm to the economic realitiesof deregulation has asserted itself. There is now a manifest requirement toconvert the esoteric jargon of economics into a common organizationallanguage.

References

[1] SeeHeldman, Peter, Robert Heldman, and ThomasBystrzycki,Competi tive Telecommuni -cations: H ow to Thri ve Under t he Telecom Act, New York: McGraw-Hill Co., 1997.

[2] Valentine, Lloyd, and Dennis Ellis,Business Cyclesand Forecasting, eighth edition, Cincin-nati, OH: Southwestern Press, 1991, pp. 130168.

[3] SeeGasman, Lawrence,Telecompeti ti on: T heFree M arket Road to the I nformation H ighway,Washington, D.C.: Cato Institute, 1994.

[4] Belisle, Patti, Cable Television, Communication Technology Update, Boston, MA: Focal

Press, 1996, pp. 3545.

[5] Brown, Dan, A Statistical Updateof Selected American CommunicationsMedia, Com-

muni cati on Technology U pdate,Boston, MA: Focal Press, 1996, p. 350.

[6] Valentine and Ellis,op. cit., pp. 59105.

[7] Case, Karl, and Ray C. Fair, Pri nciples of Economics, Englewood Cliffs, NJ: Prentice-Hall

Inc., 1992, pp. 586629.

[8] Valentine and Ellis,op. cit., pp. 106128.

[9] Whiteley, Richard, and DianeHessan, Customer Centered Gr owth, Reading, MA: Addison-Wesley Press, 1996, pp. 146190.

[10] Egan, Bruce, I nformation SuperhighwaysRevisited: TheEconomicsof Multimedia, Norwood,MA: Artech House, 1996, pp. 166168.


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[11] Colander, David,Economics, Chicago, IL: Irwin Press, 1995, pp. 548568.

[12] Dolan, Edwin, and David Lindsey, M icroeconomics, Chicago, IL: Dryden Press, 1992,pp. 420423.

[13] Egan,op. cit., pp. 166167.

[14] Argenti, Paul, T he Port able M BA D esk Reference, New York: John Wiley & Sons, 1994,pp. 321322.

[15] Frank, Robert, M icroeconomics and Behavior, New York: McGraw-Hill Inc., 1991,pp. 134158.

[16] Colander, op. cit., pp. 502506.

[17] Frank,op. cit.

[18] See Tansimore, Rod, In I ts Image, Telephony, April 21, 1997, pp. 6470; and Ernst,

Daniel, Consumer Services, Tele.com, Nov. 15, 1996, pp. 5762.

[19] See Strassman, Paul,I nformation Payoff: The Transformation of Work in the Electronic Age,New York: The Free Press, 1985, for a discussion of social (and quali ty-of-li fe) benefitsarising from integrated use of information and communication technologies.

[20] Consult Web site references listed under the University of Michigan (see Appendix C) toidentify institute resources committed to price and market share forecasting.

[21] See Hawkins, D. I ., Roger Best, and Kenneth Coney,Consumer Behavior: I mpli cati ons forM arketing Str ategy, Homewood, I L: Irwin Press, 1996, Section Four, for a discussion ofthe integration of microeconomic techniquesinto marketing and strategic planning.

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