1

Co-investment in Fiber Broadband Network: A Simulation

based on rural areas in Germany

Introduction:

Internet plays a key-role in the society, not only as a mere mean of communication but
also as driver for information sharing for business purposes. As a matter of fact, Internet is of
great importance for individuals, companies, institutions and governments. With specific
regard to Germany, people mainly use “the net” to enjoy media contents, to use social
networks, to do online banking, to do e-shopping and to share information, among others.
The government, companies and institutions have shifted many of their operations from a
personal to a virtual base, to better – or supposedly more efficiently - interact with their
groups of interest. (European Commission, 2017)

Table 1: The common usages of the internet in Germany in 2017

Source: Europe's Digital Progress Report (EDPR) 2017 Country Profile Germany. European Commission.

Considering the relevance of bandwidth coverage as well as penetration in Europe, the

European Commission has settled ambitious objectives for the upcoming years. For
instance, they plan to achieve a 50 % 100 Mbit/s coverage (High Capacity Networks) by
2020. (European Commission, 2017) Similarly, the German Government set back in 2014
the objective of providing a connection of at least 50 Mbit/s Country wise by 2018. (European
Commission, 2017)
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The available data provided by the European Commission on its Digital Board shows that
eight out of ten Europeans go online weekly. Besides, three out of four households used
fixed broadband, one out of four households use at least 30 M/bits considered as fast
broadband. Moreover, 10% of the households uses 100 M/bps or even faster. To be
mentioned is also that the usage of internet has reached the 63% of the low educated, low
income and elderly people. Moreover, 66% of Europeans buy products online, and 20% of
Europeans businesses are highly digitalized. (European Commission, 2017)

However, there are challenging figures considering that 7% of rural households have no
access to fixed broadband, and 60% of the European households have no access to 30
M/bps considered as fast broadband. Besides 24% of the households in Europe do not have
access to a fast broadband. (European Commission, 2017)

In fact, it is important to consider that Germany is one of the leading countries in the
Europe in terms of broadband development, being above the EU-28 average in the Digital
Economy and Society Index (DESI) 2017. The mentioned index takes into account
connectivity in relation to human capital and integration in the digital technology.
Nevertheless, Germany has showed average performances relative to the use of Internet;
unfortunately, analogous observations cannot be done when it comes to the advance of
digital public services, which remain below the European average. (See Graph 1) (European
Commission, 2017)

Graph 1 – Relative Performance of Germany Compared to the EU by dimension

Source: Europe's Digital Progress Report (EDPR) 2017 Country Profile Germany. European Commission.
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Considering the same dimension Germany ranks 11 out of 28 European member states on
the Digital Economy and Society Index (DESI) 2017 ranking. (European Commission, 2017)
(See Graph 2)

Graph 2 – Digital Economy and Society Index (DESI) 2017 Ranking

Source: Europe's Digital Progress Report (EDPR) 2017 Country Profile Germany. European Commission.

It is important to clarify that the current copper-based networks have a limited download
speed of 24 Mbit/s, hence anything better than that can be considered as “fast”. The
European Commission recognizes that “[…] Germany is leading regarding spectrum
assignment, facilitating the development of advanced mobile technologies in rural areas.”
(European Commission, 2017)

Moreover, as seen on Graph 3 Germany has 99% of households’ coverage with fixed
broadband, 86% of 4G coverage (average of operators), spectrum with 100% spectrum of
the target, 82% of households covered with NGA and a penetration of 31% of subscriptions
to fast broadband. (European Commission, 2017) (see graph 3)

Graph 3 – Digital Economy and Society Index (DESI) 2017 Ranking

Source: Europe's Digital Progress Report (EDPR) 2017 Country Profile Germany. European Commission.
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Co-investment:

Co-investment in this context is defined as a cooperative agreement among two firms at

the upstream level, deciding in which areas they want to deploy Fiber-Broadband-to-Home
infrastructure, also called Next Generation Access Network (NGAN), in order to share risks
and costs. In general, it is accepted that rolling-out of such infrastructure increases the level
of investment, innovations and boosts economic growth in a society due to its higher speed,
capacity and reliability. In fact, leading to increased welfare for the agents in an economy.

In particular, these kinds of investments require enormous irreversible costs, also called sunk
costs, that allow firms to compete at the retail level on equal grounds. The reason for that it’s
that managerial decisions will not be affected by the infrastructure-investment costs since the
firms face a Marginal Cost equal to zero at the retail phase. (Krämer & Vogelsang, 2016)

Moreover, an additional key issue is the higher cost of deploying fiber in rural areas, and
the difficulty of increasing the penetration rate of high-speed broadband connection, due to
the low population concentration which hinders the exploitation of Economies of Density. The
Regulators of the fiber-connection markets want to increase the network coverage and the
consumer welfare, and have decided to allow competing network operators to close binding
agreements before deciding where and to which extent deploy a network. As a consequence,
the market could be served using two duplicated networks, yet being inefficient, it is allowed
in a free-market economy; or served by a co-invested network where risks and costs are
shared. In both cases, the regulators’ concerns regard the issue that co-investment at the up-
stream level could generate collusive behavior at the down-stream level and duplication
could generate unilateral effects. (Krämer & Vogelsang, 2016)

In order to provide a new approach for assessing the effects of co-investments at the
investment phase on the retail level conditions (Krämer & Vogelsang, 2016) used a Game
Theoretical Approach. Interestingly, they found that cooperation at the investment phase
leads to tacit collusion; in other words, facilitates collaboration at the retail phase.

There are many examples where Telco operators have cooperated in building and running
networks, which highlights some common characteristics. These include:

 Agreement between the parties on the development of new network infrastructure.

 Sharing of the risk of investments in network infrastructure.
 Mutual or shared obligations on the parties relating to the operation of networks and
the provision of access to them. (Berkley Research Group, 2017)
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The co-investment agreements that are in practice can be grouped into three general
models:

• Joint Venture models: In these models, partners establish a new entity (“JVCo”) which is
jointly owned and controlled. JVCo builds the infrastructure which is used by both the
partners and rented to third parties on wholesale basis. (Berkley Research Group, 2017)

• Reciprocal access models: In these models, firms develop and operate their own network
infrastructure, usually in geographically separate areas and make access contracts with each
other that allows them to serve customers via each other’s network infrastructure. (Berkley
Research Group, 2017)

• One-way access models: These models are based on the provision of wholesale access.
The fundamental difference between this type of co-investment model and the reciprocal
access model is that only one party builds the network and provides access to the other
party. (Berkley Research Group, 2017)

To overcome these difficulties the regulatory framework should indeed provide appropriate
incentives for companies to invest in new network infrastructure and should promote entry of
firms which qualify to Co-Invest. These incentives can be in form of “regulatory holiday”
which means regulator refrains from enforcing the general market regulations on the co-
investing firms. (Berkley Research Group, 2017)

Methodology and Simulation design

The main objective of this simulation is to determine whether co-investment at the

wholesale level leads to cooperation at the retail one, ending up in abnormal profit generation
upon the equilibrium desirable price. In this respect, the concept of Productive Efficiency
helps to determine the price at which the firm is producing the maximal amount of output
given its installed capacity at its minimum average cost.

Besides the Lerner Index will serve as a tool of measuring the deviation of the firms from
the optimal assumed level. The amortization cost was of the infrastructure spread over 8
years which is considered as break-even or pay-back period of 8 years. In these order of
ideas the Lerner Index will be calculated for each firm individually and for each of the retail
periods subtracting from the price settled by each firm the annual cost of amortization
(average cost) per year and the Long Run Incremental Cost incurred in this period due to the
rental requirements that must be attained.
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As a matter of fact, when considering a drawback of this simulation is that the effect on
the network coverage is not substantiated, due to the fact that a must serve obligation was
applied.

This simulation is based on a game theoretical approach aiming to observe the

behavior of a duopoly both at the upstream (investment phase) and downstream level (retail
phase). Consequently, the market will be composed by two firms, the incumbent and the
entrance seeker which will serve the households of rural areas of Kreis Kleve in Germany
offering a homogenous product delivered to the consumers.

The firms will be fictively represented by two randomly chosen players among a pool of
graduates with an economic and/or financial background.

The roles:

- Regulator: the regulator will determine the minimum and maximum price which the
firms can set, and as mentioned before allows co-investment before the firms
decide on its infrastructure deployment.
- Incumbent: for the mere purpose of this simulation, it has been presumed that the
incumbent is offered the first mover advantage, and a higher reputation and
reliability in the market since when establishing the same price as the entrant
seeker the majority of the demand prefers the product offered by the incumbent.
- Entrant: the entrant is the firm that will be given the possibility to co-invest together
with the incumbent.

The simulation has two phases:

A. In the investment phase: the players will be allowed to make their investing
decision. The main assumption is that the regulator will give the first mover
advantage to the Incumbent. Although, in order to balance the apparent
disadvantage of the new entrant it has been decided to give total investing freedom
to the latter. More precisely, the incumbent will have to invest in as many
households as the entrant will have decided not to cover. As a matter of course,
that will lead to a forced increase in the incumbent’s investment, which may have
the drawback of increasing its investment-related risks. In fact, the main reason
why two firms would invest together is to jointly share risks and reduce costs. As a
direct consequence, it could still be argued that profits will also be shared, but that
must be taken into account in order to lower risks.
Intuitively, as one treatment of the simulation at the investment phase
communication is going to be allowed and decisions will be made simultaneously.
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Besides another treatment is based on no communication allowed, in this case the

investment decisions are going to be made sequentially.

In the retail phase: the firms will compete on prices and more specifically a la
Betrand. The main justification for the choice of the mentioned completion model is
that any sort of competition on quantity would lead to misleading results. As stated
in the previous sections, firms “co-opete” in order to reach those household that
otherwise would not be covered due to lower profitability and high deployment
costs. In fact, one could easily debate that households could difficultly be
considered quantities that can vary over time, because of high deployment costs
and operational factors. For example, if firms competed a la Cournot they would
change their quantities over time to influence their economic rents. However, in this
case households cannot be (easily) reduced, therefore no influence can stem from
a change in quantities. Furthermore, it is assumed in this simulation that the total
infrastructure costs are fixed and don’t depend on quantities once the fiber network
has been laid down. Eventually, one could argue that the incumbent’s firm will be
always preferred to consumers, even in case of equal prices (Krämer & Vogelsang,
2016). As a consequence, it can be inferred that the demand will be split in a 51-to-
49 proportion, coherently with what said above in favor of the incumbent.

Parameters:

- Kh: infrastructure deployment cost per household. This cost equals to €2,700.00
(Broadband Commission, 2014)
- α: incumbent’s investment co-efficient
- β: entrance seeker’s investment co-efficient based on (1-α)
- K: firms’ sunk cost for deploying the network
- r: internal Rate of Return of the two competing firms. We assume that both rates
are equal to 12.5%, in order to achieve a break-even point in 8 years. (Diaz, 2015)
- p: firms’ probability of getting a portion of demand when retail prices are equal.
- P: retail price
- NSA: non served area (read as number of households not reached by respective
firms).
- N Mkt: network coverage (read as number of households served by each firm).
- RF: total renting fee for the respective firms. Due to the must serve obligation RF
always equates the competing firm’s wholesale revenue.
- AK: portion of sunk costs amortized every year (8 periods).
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Investment sunk costs

Based on what previously developed in “Co-Investments and Tacit Collusion in
Regulated Network Industries: Experimental Evidence” (Krämer & Vogelsang, 2016),
in this simulation the sunk costs were calculated as the product between the number
of households served by each company and the unitary investment cost of €2,700
(Broadband Commission, 2014). In the case of the incumbent, the number of
households is computed by adding its existing market share and the portion of co-
investment area it wish to reach with its own network. However, to balance the
incumbent’s advantage of being first-mover (in case of sequential moves) and to fulfil
the must-serve obligation, this is to invest in the remaining area subsequently to the
entrant’s investment choice.
Ki: Incumbent’s sunk cost
(1) Ki= KH [𝑁𝑖 + 𝛼(𝑁 − 𝑁𝑖) + (1 − 𝛼)(1 − 𝛽)(𝑁 − 𝑁𝑖)]

The entrance seeker sunk cost function has been devised similarly, although it differs
from the incumbent’s cost equation in the fact that its maximum investment depends
on the incumbent’s choice, in order to be also applicable to the sequential game
case. As already mentioned, depending on the communication in the investment
phase being allowed or forbidden, the players may be asked to make their choices
simultaneously or sequentially.
Kβ: Entrance seeker’s sunk cost
(2) Kβ = KH [𝛽(1 − 𝛼)(𝑁 − 𝑁𝑖)]

Average and Total Long Run Incremental Cost

Ci: Incumbent’s LRAIC
(𝑁∗𝑑𝑖−𝑁𝑖 𝑀𝑘𝑡)
(3) Ci = [ ] ∗ 𝐾ℎ ∗ 𝑟𝛽 Ni Mkt<Di and di≠0
𝑁∗𝑑𝑖

C𝛽: Entrant’s LRAIC

(𝑁∗𝑑𝛽−𝑁𝛽 𝑀𝑘𝑡)
(4) Cβ = [ ] ∗ 𝐾ℎ ∗ 𝑟𝑖 N𝛽 Mkt<D𝛽 and d𝛽 ≠ 0
𝑁∗𝑑𝛽

The average long run incremental cost Ci is equal to the interconnection charge for the
incumbent to the competitor’s (read formerly entrance seeker) network, spread over its
total demand. Such a cost would occur when the incumbent’s demand exceeds its
network capacity. The access fee here considered is based on the return the proprietor
of the line expects to receive from its infrastructure. In order to access the excess cost
for
In order to simplify the LRAIC equations, the current network shares of the firms have
been reduced as follows, based on what already shown in (1) and (2).
Ni Mkt: Incumbent’s network share
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(5) 𝑁𝑖 𝑀𝑘𝑡 = 𝛽 ∗ (𝑁 − 𝑁𝑖) + 𝛼 ∗ 𝛽 ∗ (𝑁𝑖 − 𝑁)

N𝛽 Mkt: Entrant’s network share

(6) 𝑁𝛽 𝑀𝑘𝑡 = 𝛽(1 − 𝛼)(𝑁 − 𝑁𝑖)

Having done that, in order to assess the final deviation from the initial (planned) total
fixed costs, the ALRIC of the 8 periods taken into account in this simulation have
been summed up. This measure shows the LRIC at the end of the 8th period.
Profit: revenues - costs
Consequently, in order to verify whether the firms will have succeeded or not in
recovering their investment costs, their cumulative profits at the end of the 8 periods
must be calculated. As a matter of course, revenues and costs must be added up.
To have a clearer understanding of the source of revenues, the income have been
split in wholesale and retail level. Intuitively, the revenues both firms are to generate
at the upstream level stem from renting the part of network that due to the demand
distribution determined out of the Bertrand competition will remain unemployed.
Differently, the duopoly generates revenues at the downstream level simply based on
the retail prices and the actual demand.
RIW: Incumbent’s revenues-wholesale
(7) 𝑅𝐼𝑊 = (𝑁𝑖 𝑀𝑘𝑡 − 𝐷𝑖) ∗ 𝐾ℎ ∗ 𝑟𝑖 Ni Mkt > Di

RIR: Incumbent’s revenues-retail

(8) 𝑅𝐼𝑅 = 𝐷𝑖 ∗ 𝑃𝑖

REW: Entrant’s revenues-wholesale

(9) 𝑅𝐸𝑊 = (𝑁𝛽 Mkt-D𝛽) ∗ 𝐾ℎ ∗ 𝑟𝛽 Nβ Mkt > Dβ

RER: Entrant’s Revenues-retail

(10) 𝑅𝐸𝑅 = 𝐷𝛽 ∗ 𝑃𝛽

Having computed costs and revenues, profits can also be calculated. Although for
the scope of the simulation profits have been considered as the pure difference
between all sorts of revenues and costs the two firms incur, it’s pivotal to draw the
attention to the a further element. In fact, according to the chosen breakeven period
of 8 years mentioned in the previous sections, the sunk cost will as a direct
consequence be divided by 8 (AK= amortized sunk cost per year).
πi: Incumbent’s profits
(11) 𝜋𝑖 = 𝑅𝐼𝑊 + 𝑅𝐼𝑅 − 𝐴𝐾𝑖 − 𝑅𝐹𝑖

π𝛽: Entrant’s profits

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(12) 𝜋𝛽 = 𝑅𝐸𝑊 + 𝑅𝐸𝑅 − 𝐴𝐾𝛽 − 𝑅𝐹𝛽

Lerner Index
The main objective of this simulation is to find out whether co-investing leads to tacit
collusion. Competing firms a la Bertrand (price competition), it has been thought out
to use the Lerner Index as the main indicator for uncompetitive behaviors.
However, the main limit of this index is intrinsically its requiring the computation of
Marginal Costs. In fact:
(13) LI: (𝑃 − 𝑀𝐶)/𝑃

However, it could be argued that for such a type of investment, MC would be equal to
0. As a matter of fact, based on the fixed characteristic of the deployment costs, the
cost functions (excluding duplication) would lead to a first derivative equal to 0.
Understandably, the first derivative of a constant must be equal to 0.
Therefore, aiming at avoiding misleading results, the Lerner Index was then devised
as follows:
𝐷−𝑁 𝑀𝑘𝑡 𝑁 𝑀𝑘𝑡
𝑃− ∗𝐾ℎ∗𝑟 − ∗𝐾ℎ/𝑛
𝐷 𝐷
(14) 𝐿𝐼: 𝑃

The basic idea behind such a formula is that while prices can be easily assessed, the
costs to calculate are to be considered as a weighted average. More precisely, both
the access surcharge and the amortization of sunk investment cost are weighted
depending on the share of line that necessarily has to be rented due to lack of
capacity.
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References
Berkley Research Group. (2017). Co-Investment and Commercial Offers. Retrieved from
https://www.vodafone.com/content/dam/vodafone-images/public-policy/reports/pdf/co-
investment-commercial-offers-100417.pdf

Broadband Commission. (2014). The state of Broadband 2014: Broadband for all. Retrieved from
http://unesdoc.unesco.org/images/0023/002346/234675e.pdf

Diaz, V. (2015). Backhauling with fibre? Retrieved from

http://www.corning.com/media/worldwide/coc/documents/Fiber/FSwin15pp3334.pdf

European Commission. (2017). Europe's Digital Progress Report (EDPR) 2017 Country Profile
Germany. Retrieved from European Commission: https://ec.europa.eu/digital-single-
market/en/progress-country

Krämer, J., & Vogelsang, I. (2016). Co-Investments and Tacit Collusion in Regulated Network
Industries: Experimental Evidence. Boston.

Hovenkamp, H., 1986. Chicago and its Alternatives. Duke LJ, p.1014-1029.
Schrepel, T., 2017. A New Structured Rule of Reason Approach for High-Tech Markets.
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Appendix
Antitrust law seeks to make enterprises compete fairly. It has had a serious effect on
business practices and the organization of industry. Premised on the belief that free
trade benefits the economy, businesses, and consumers alike, the law forbids several
types of restraint of trade and monopolization. This fall into four main areas:
agreements between or among competitors, contractual arrangements between sellers
and buyers, the pursuit or maintenance of Monopoly power, and mergers.
Antitrust law is a collection of different level government laws that regulates the
conduct and organization of business corporations, generally to promote fair
competition for the benefit of consumers. The concept is called competition law in many
English-speaking countries. In the late eighteenth century the united states introduce first
antitrust law. The main statutes are the Sherman Act 1890, the Clayton Act 1914 and the
Federal Trade Commission Act 1914. ``These Acts, first, restrict the formation of cartels
and prohibit other collusive practices regarded as being in restraint of trade. Second, they
restrict the mergers and acquisitions of organizations that could substantially lessen
competition. Third, they prohibit the creation of a monopoly and the abuse of
monopoly power`` ( Schrepel, T., 2017). The scopes of antitrust laws, and the degree to
which they should interfere in an enterprise’s freedom to conduct business, or to
protect smaller businesses, communities and consumers, are strongly debated. One
view, mostly closely associated with the Chicago School of economics suggests that
``antitrust laws should focus solely on the benefits to consumers and overall
efficiency, while a broad range of legal and economic theory sees the role of antitrust laws as
also controlling economic power in the public interest`` (Hovenkamp, H., 1986, p.1014-1029 )
The sixth major revision of the German Act against Restraints of Competition was enacted in
1998 and entered into force in January 1999. One of the main objectives of the
revision is the harmonization with EU competition law. To bring German law into line with
EU law standards, (a) prohibitions on cartels, the abuse of a market-dominating
position, and recommendations were explicitly introduced; (b) a supplementing general
exemption was added; (c) all covered mergers are now subject to pre-merger-
notification; and (d) the definition of mergers was harmonized through the introduction of
the acquisition of control. In the main investigation procedure, not only prohibitions, but
also clearances of mergers, are subject to publication and explanation.
Bundeskartellamt is an independent higher federal authority which is responsible to
enforce the antitrust law in Germany under the Federal Ministry for Economic Affairs and
Energy
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Authors:
Dilip Giri (16318)
Juan Felipe Pineda (22531)
Massimo Manuel Bruognolo (22154)
MD Nasim Ahmed Chowdhury (11735)
Shehneela Naveen (16078)
Shubam Gupta (22714)