Professional Documents
Culture Documents
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ters as privacy, security, obscenity, and other noneconomic areas, the paradoxical prospect of gradual deregulation in telephony and broadcasting may be
accompanied by government intrusiveness in the third sector. Such noneconomic contingencies may nevertheless have far-reaching economic consequences for the entire industry over the long run. Telecommunications
professionals must therefore assert a collection of economic tools that benchmarks emerging competition with its consequent impact on future pricing.
For purposes of this discussion, the application of economic tools is focused on telecommunications market planning. The use of microeconomic
techniques to dissect market demand and provider response is emphasized in
this presentation, although the costs of providing universal service and interconnection remain implicit and embedded in such a review [1]. Web site economic research tools on telecommunications infrastructure are provided in
Appendix C. Of primary concern in this segment is the linkage between economic opportunities resulting from passage of the Act and the market research
methodologies presented in Chapters 3 and 5 to 7. Those engaged in strategic
planning, market forecasting, and sales management require a collection of
tools that will enable them to seize upon opportunities evolving from competitive market interactions.
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sion to prosperity is clearly evidenced (see Figure 4.1), the impetus generated
by lower unemployment and rising income is a significant aid to aggregate
demand. Telecommunications planners, even if committed to long-term capital
construction, cannot be completely oblivious to the dynamics of business cycle
forecasting; the point in time at which a new product is introduced can be
fortuitous or disastrous for a firm, especially during periods of accelerated
competition.
Output
Peak
Growth
Trough
Peak
Decline
Trough
Secular growth trend
Growth
Time
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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3. Movement of buyers and sellers would remain mobile over time (in
other words, buyers would be free to select alternative providers at
any given moment). Suppliers, too, would be free to move in and out
of veteran and emerging product lines to secure their clientele.
As noted in Chapter 3, there exists a spectrum of competition
gradations in the degree to which markets exhibit these characteristics. In perfectly competitive markets, optimal numbers of buyers and sellers moving in
great mobility often produce substantial fluctuations in pricing. In any event,
it is not government that influences the course of pricing over the long run.
We have established that in the telecommunications triad of the telephony, broadcasting, and computer sectors there exists significant variation in
competitive structure. While the computer industry remains fully unregulated,
its counterparts are significantly regulated even after enactment of deregulation. Within telephony and broadcasting, some elements of the Act have modified or relaxed regulations (as elaborated in Chapter 2), but government
influence over local telephony has remained entrenched. The commitment by
federal and state governments to universal service has perpetuated an unfettered
interference in market transactions. Whatever the underlying public interest
spirit or motive, the fact remains that market supply and demand are influenced by government edict. We must therefore diagram intersecting supply
and demand according to the type of market activity in which that enterprise
is engaged. In areas denoted by competitive market transactions, as illustrated
by the principles above, we diagram prevailing supply and demand as illustrated in Figure 4.2. We may refer to the setting of prices in such environments
as competitive market price determination [11].
The interaction of supply and demand defines price, with supply and
demand curves ever changing. Thus, price will ordinarily remain a constant if
government asserts its regulatory powers to that end. Price stability, or predictability, will be sacrificed in the short run if deregulation is manifested in the
way its sponsors intended, but greater congruence between market supply and
demand will be attained in the long run. The effect of this congruence would,
in theory, lead to equilibrium price, the state in which buyers want to buy the
same quantity that sellers are prepared to sell. Therefore, if a seller sets a price
higher than equilibrium, surpluses occur; if a seller sets a price too low, excess
demand ensues and shortages inevitably follow. Surpluses, in short, beget subsequent declines in price. Shortages induce higher prices to the point of
equilibrium.
We may generally conclude that the standard application of supply and
demand analysis is appropriate to pricing for content providers. Those communications firms that supply content for infrastructuretelephony, television,
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8
Excess supply
Price
{Surplus}
Equilibrium
{Shortage}
Excess demand
5
10
Output
15
20
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 equilibrium is 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.
Diseconomies
of scale
Economies
of scale
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Long-run average
cost curve
Phase 1
Phase 2
Phase 3
Quantity
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 productivity also rise). In response, the firm seeks to exploit economies of scope by designing a new product line and generating added revenue. This phenomenon takes hold in phase 3 of the long-run average cost curve.
scope and value combined with value-added multiple services. When these
factors are juxtaposed to vigorous marketing, thus leading to expansive market
share, a strategy is set in motion that relegates short-term pricing strategy to a
secondary concern. What matters to network providers in the short term is
market share and competitive threat; the law of supply and demand takes over
in the long run to define market winners and losers. Despite the comparative
advantage of size that some firms enjoy, the risks of committing long-term
capital while network innovations advance rapidly are considerable.
Closely allied to capital risk is the problem of user-churn, the frequency
with which consumers move from provider to provider for their communication needs. With the prospect of proliferating competition, with new technologies supplanting veteran product lines, user-churn generates both threat and
opportunity in the Acts aftermath. The importance of user-churn as related to
market share and strategic planning is discussed in Chapter 6, but one must
simultaneously contemplate risks of capital and user-churn when projecting
long-term plans. The need to satisfy consumers at their basic level of need has
now assumed a significance never before entertained by common carriers. In
the absence of predictable cash flow, it is not feasible to raise or borrow the
capital 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 consumers basic communication requirementsis now regarded as a strategic
priority in some telecommunications firms (see Chapter 10).
4.2.3 Price Elasticity of Demand in Telecommunications
The measurement of changes in quantity demanded in relation to changes in
price is called price elasticity. Simply, firms need to estimate how responsive
consumers will be with respect to fluctuations in pricing. Elasticity is calculated
by dividing the percentage change in quantity taken by the percentage change
in price. In defining elasticities at various pricing points, a firm is able to
compute gross revenues in relation to the number of units sold. Thus, analysis
of elasticity serves two goals: (1) to gain a keener sense of the sensitivity of
consumers to current and prospective changes in price and (2) to facilitate
forecasting revenues in the face of competitive pressures in pricing.
Figure 4.4 diagrams the relationship between price changes, demand elasticity, and total receipts. The calculation of elasticity will yield one of three
results in 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 to
changes in price. A value greater than 1 defines elasticity, suggesting that demand fluctuates with changes in price. Unitary elasticity occurs when the computation equals 1. If 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 is
said to be inelastic, then an increase in price will produce more revenue. In
situations where demand is unit elastic, the percentage change in quantity
equals the percentage change in price.
Obviously, there is spectrum of demand for communications products
that is variously elastic or inelastic. Telephone service for most people is generally inelastic, since it is regarded as a staple of modern living. Cable television
service has come to assume the same role for many Americans in recent years.
For workers involved in occupations where mobility is crucial, cellular telephones are regarded as a necessity. On the other hand, interactive television
service remains comparatively exotic, and thus pricing is highly elastic. The
inelasticities associated with many staples represent potential opportunities for
firms to increase prices. Yet, under conditions of emerging competition, the
capacity of firms to raise prices while controlling market share is severely constrained. In part, unfolding inelasticities of demand for certain services inspired
framers of the Act, who sought to mitigate higher prices that would accompany
monopolistic or oligopolistic market structures.
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Figure 4.4 Price elasticity and total revenue. The illustrations indicate that as price is raised
aggregate revenue expands by rectangle C and decreases by rectangle B under conditions
of (a) unit elastic, (b) inelastic, and (c) elastic market environments.
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its outputs maximizes its revenue; the difference between revenue and costs
thus determines profit.
The measurement of profit is vital to evaluating a firms strategic vision.
The computation of profit, the demonstration of profitability, is essential in
conveying a firms credibility to stockholders and potential investors. We will
note in Chapters 8 and 9 that profitability means survivability in the longterm murky waters of deregulation.
The computation of profit margin provides communications firms with
a valuable tool in justifying their strategies to potential investors. Profit margin
is the ratio of income to sales and is measured in two formats. Gross profit
margin is reflected by the percentage return that a company earns over the cost
of goods or services sold; it is computed by dividing gross profit (sales minus
costs of goods sold) by total sales. The gross profit a firm earns essentially covers
operating expenses, including administrative expenses, taxes, and interest. Net
profit margin, or return on sales, reflects the percentage of net income generated
by each sales dollar. The standard computation of net profit margin results
from dividing the income statement figure for net income after tax by total
sales [14]. Both computations are illustrated in these expressions:
Gross Profit Margin Gross Profit/Sales
Net Profit Margin Net Income After Tax/Sales
Both calculations provide investors and competitors with important clues
about the value-added desirability of communications products. In an environment of rising competition, the firm that generates a product that provides
value-added attributes is likely to generate a higher profit margin. In this sense,
the determination of profit margins is significantly more important than gross
profits.
4.2.5 Determinants of Supply and Demand
Empirical evidence consistently pinpoints the following criteria as determinants or independent variables driving consumer and business demand for
communications services. These include (1) income, (2) tastes and preferences,
(3) prices of complementary and substitute goods, (4) future expectations regarding market prices, and (5) the number of buyers. These criteria, coupled
with current market prices, determine aggregate demand for a product [15].
In the case of supply, the following criteria, apart from price, drive the
supply providers are willing to introduce to market. These include (1) cost, (2)
technology, (3) number of sellers, (4) prices of other products (or substitutes)
that sellers could introduce, and (5) future expectations about market price.
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Table 4.1
Determinants of Market Demand
Elastic Market Demand
Luxury
Necessity
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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 question posed by the curve concerns whether consumer demand for communications services
will continue to rise or remain relatively constant, compelling different choices along the
indifference curve.
indifference curves; a firm would design indifference curves for each targeted
market segment. Indifference curves gain a renewed importance in this industry as deregulation is implemented.
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1. Business cycle analysis, with special emphasis on the relationship between the business cycle and consequent national income and its relationship to communications consumption;
2. Supply and demand analysis, with emphasis on the design of demand
functions appropriate to market segments;
3. Computation of market price equilibrium points;
4. Application of substitution analysis;
5. Calculation of elasticities, particularly with respect to emerging product lines.
Particularly in the case of firms that previously operated in monopoly
markets, a fresh perspective on equipping managers and strategic planners with
these skills would greatly improve organizational communication and camaraderie. The need to sensitize all members of the firm to the economic realities
of deregulation has asserted itself. There is now a manifest requirement to
convert the esoteric jargon of economics into a common organizational
language.
References
[1] See Heldman, Peter, Robert Heldman, and Thomas Bystrzycki, Competitive Telecommunications: How to Thrive Under the Telecom Act, New York: McGraw-Hill Co., 1997.
[2] Valentine, Lloyd, and Dennis Ellis, Business Cycles and Forecasting, eighth edition, Cincinnati, OH: Southwestern Press, 1991, pp. 130168.
[3] See Gasman, Lawrence, Telecompetition: The Free Market Road to the Information Highway,
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 Update of Selected American Communications Media, Communication Technology Update, Boston, MA: Focal Press, 1996, p. 350.
[6] Valentine and Ellis, op. cit., pp. 59105.
[7] Case, Karl, and Ray C. Fair, Principles of Economics, Englewood Cliffs, NJ: Prentice-Hall
Inc., 1992, pp. 586629.
[8] Valentine and Ellis, op. cit., pp. 106128.
[9] Whiteley, Richard, and Diane Hessan, Customer Centered Growth, Reading, MA: AddisonWesley Press, 1996, pp. 146190.
[10] Egan, Bruce, Information Superhighways Revisited: The Economics of 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, Microeconomics, Chicago, IL: Dryden Press, 1992,
pp. 420423.
[13] Egan, op. cit., pp. 166167.
[14] Argenti, Paul, The Portable MBA Desk Reference, New York: John Wiley & Sons, 1994,
pp. 321322.
[15] Frank, Robert, Microeconomics 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 Its Image, Telephony, April 21, 1997, pp. 6470; and Ernst,
Daniel, Consumer Services, Tele.com, Nov. 15, 1996, pp. 5762.
[19] See Strassman, Paul, Information Payoff: The Transformation of Work in the Electronic Age,
New York: The Free Press, 1985, for a discussion of social (and quality-of-life) benefits
arising from integrated use of information and communication technologies.
[20] Consult Web site references listed under the University of Michigan (see Appendix C) to
identify institute resources committed to price and market share forecasting.
[21] See Hawkins, D. I., Roger Best, and Kenneth Coney, Consumer Behavior: Implications for
Marketing Strategy, Homewood, IL: Irwin Press, 1996, Section Four, for a discussion of
the integration of microeconomic techniques into marketing and strategic planning.