Evaluating a mobile telecommunications merger in. Portugal *

Transcription

1 Evaluating a mobile telecommunications merger in Portugal * Corrado Andini** and Ricardo Cabral*** November 2006 Abstract An alication of earlier econometric results of an international samle of 177 mobile oerators in 45 countries to the eventual Portuguese Otimus-TMN merger case, where a duooly would emerge, suggests that, if international results are alicable to the Portuguese case and to a merger case, rofit margins would increase by 11.6 ercentage oints and rices would increase by 3.8%. As a result, social welfare would increase by a net 253 million euro er year, and this gain would be entirely catured by the roducers. In addition, consumer surlus would be reduced by 108 million euro er year, of which 107 million euro er year would corresond to surlus transfers from consumers to roducers. JEL classification: L11, L13, L40, L96 Keywords: telecommunications, merger olicy, duooly * The authors are grateful for comments by Henry Chaell and Paulo Guimarães. The oinions exressed in the aer are the exclusive resonsibility of the authors. **Universidade da Madeira, Funchal, Portugal, andini@uma.t *** Universidade da Madeira, Funchal, Portugal, rcabral@uma.t 1

2 1. Introduction Following raid mobile telecommunications industry growth and increased number of cometitors, since the industry has seen firm exit and growing consolidation. For examle, in 2000 Telefónica and Sonera jointly entered the German market with an investment of 8.6 billion euro alone in the UMTS licenses, only to exit it in 2002 after their subsidiary Grou 3G/Quam failed to make any significant inroads. In Portugal, likewise Oni Way exited the market in 2002 after sending 100 million euro in UMTS license alone. Similar industry exits occurred throughout Euroe. On the other hand in 2005 T-Mobile (Austria) acquired Tele.ring in Austria, reducing to 3 the number of cometitors in a within border merger, and France Telecom (Orange) acquired Amena in Sain in a cross border merger. In the US, two mergers in 2004 (Verizon acquired AT&T) and 2005 (Srint acquired Nextel) reduced the number of national cometitors from 6 to 4. According to Cooer (2004) the US CR6 increased from 55% in 1997 to 85% in Fox (2005) argues that the US mobile telecommunications industry is more concentrated today (HHI of 6000 based on radio sectrum licenses) than when there was only a duooly. A reference for allowing market forces to determine outcomes and for a less rominent role for regulation in this sector has meant that regulators have, on the one hand, attemted to create conditions that facilitated new entry and the sustainability of fringe firms, and on the other hand have generally acceted with minimal remedies the reductions in the number of cometitors resulting from the growing industry consolidation. In this context, the recent decision of the National Regulatory Authority (Autoridade da Concorrência) of Portugal to authorize a merger between two oerators (Otimus and TMN) resulting in a duooly where the merged firm has a market share of aroximately 65%, while ath breaking at EU and US level, is but an additional ste in recent international trends towards further industry consolidation. Nonetheless, this decision and the similar decisions in other countries that receded 2

3 it, raise at least two imortant questions from an economic ersective, which we seek to exlore in this aer. First, what is the effect of the merger to consumer surlus and to social welfare. Second, to what extent is the merger efficiency- versus market ower-seeking. The analysis is an alication of the econometric results of earlier research (Andini et al, 2006) to the above mentioned Portuguese merger case. We consider only voice mobile services, which reresent aroximately 80% of the 3 billion euro revenues of the industry (2004 data), i.e., the analysis does not consider the effect of the merger on data services and handset sales rices and outut. Our econometric results, if extensible to the Portuguese market and to a merger case (see Section 3), suggest that the merger increases both industry efficiency and market ower, i.e., growing industry consolidation will result in higher industry efficiency but higher long-term equilibrium rices than if industry consolidation were not occurring. Alternatively, it suggests that the ast increase in the number of cometitors in this industry has resulted in lower consumer rices but that it has been achieved at the cost of a loss in efficiency. Worryingly, the estimated consumer surlus redistributional effects constitute nearly one third of the estimated net gains of the merger. 2. Merger analysis The estimation results of Andini et al (2006) based on ordinary least squares (OLS) are resented in Table 1 and 2 of Aendix 1. 1 To summarize, the econometric results of a samle of 45 countries including Portugal suggest that a one ercentage oint increase in the market share results in a 0.7 ercentage oint increase in margins and in a 0.23% increase in the rice (average revenue er minute). If we consider the Eurozone countries sub-samle (which excludes Luxembourg), or an OECD sub-samle using Purchasing- Power Parities the effects are even larger. A one ercentage oint increase in average market share results in a 1.1 (0.74) ercentage oint increase in average margins and a 1 Please refer to Andini et al (2006) for a more detailed overview of the econometric results, descritive statistics, and a characterization of our measures of revenue, outut, rice, and rofit. 3

4 0.46% (0.41%) increase in average revenue er minute, resectively. The estimation of social welfare, consumer surlus, and roducer surlus changes has been an imortant tool in guiding merger analysis in the last decades (Brito and Catalão- Loes, 2006; Motta, 2004). It allows a quantitative assessment of each merger case. We estimate the imact of the merger by calculating the effect of the resulting increase in average market share in the Portuguese market on average margins and average rices. If the number of firms in a given market falls from 3 to 2 through a merger then the average market share increases by 16.7 ercentage oints. By multilying this change in average market share through our coefficient estimates we obtain an estimate of the exected average margins and rice changes. Our emirical results suggest that, if average market share in our international samle were to increase from 33% to 50%, average margins would increase by 11.6 ercentage oints and average rices will increase by 3.8%. Since ours is a static model that assumes long-run equilibrium, in fact we are redicting that after a transitional eriod, average rices under a duooly would be 3.8% higher than if the market structure had not changed (three-firm oligooly). For that, it suffices that rices do not fall nearly as fast as under a three-firm oligooly. For comarison, Parker and Röller (1997) find evidence of collusion under a duooly for US metroolitan areas, with estimated rice-cost margins of 35% imlying rices are 23% higher due to collusion. Busse (2000) estimates that under duooly multimarket contact results in 7% higher rices through collusion. Valetti (1998) and Stoetzer and Tewes (1996) argue that the rice evolution before and after the introduction of additional cometition in the UK and Germany, suggests there was collusion under duooly. Hausman (2002) argues that a limited number of firms (4 or 5) would suffice to assure a satisfactory market erformance. Finally, Grzybowski and Pereira (2006), using confidential Portuguese mobile telecommunications data, estimate that the Otimus-TMN merger we analyze in this aer will result in an increase in average rices of between 6% and 7% deending on the level of assumed marginal cost reductions. We use our econometric estimates and the estimated imact on average margins and rices to analyze the effect on consumer surlus and roducer efficiency changes. 4

5 Change in Consumer Surlus We set out to clarify the imact of the merger on consumer surlus. This is accomlished by estimating the effect on rices and quantities in this industry. 1 st Half of 2004 rice data from ML indicates average (non-weighted) nominal rice equals er minute, and 2004 outut data from Portuguese Telecommunications Regulator, ICP-ANACOM, indicates total outut equals million outgoing lus off-net incoming minutes. 2 Alying the results of our international regression to the Portuguese market it is ossible to make a static comarison of a long-run equilibrium of a three-firm oligooly and a duooly. Prices would rise by 3.8% to er minute. The increase in average rices relative to the steadystate with three firms is attributable to increased market ower. 3 We calculate the variation in outut using a measure of the rice elasticity of demand sulied by Hausman (1997) and equal to 0.41 for the US mobile telecommunications market. The elasticity arameter ε is estimated by using a log-linear secification of the demand curve: Q = A P ε lnq = lna ε lnp (1) where A contains a number of demand shifters such as income, oulation, commute time, regulation, and year-secific effects, Q is the number of subscribers and P is the rice level. To use Hausman s estimate, we assume that the average traffic (minutes) er subscriber is constant. The formula above can then be used to estimate the change in outut. Since average rices increase by 3.8%, using the log-linear demand secification, total outut is exected to diminish by 1.5% or 220 Million minutes, roughly less 22 minutes er subscriber 2 Average revenue er minute in 2004 calculated using the regulator s (Anacom) annual statistic reort was or 14% lower rices than the non-weighted estimate using Merrill Lynch s first Half 2004 data. The difference may be exlained by falling rices in 2004, the use of weighted vs non-weighted estimates, and of course measurement discreancies. To maintain consistency in the use of the econometric results we use Merrill Lynch estimates. In any case, using Anacom data the order of greatness of the economic imact is similar, with redistribution of consumer to roducer surlus estimated at 92 million euro er year rather than 107 million euro er year. 3 The increase in rices resulting from increased market ower is not lager since there is also a reduction in marginal costs (see below). 5

6 er year. There are two effects from this increase in rice to consumers. The first is a transfer of surlus from consumers to roducers, associated to the final level of outut. The second corresonds to the loss of consumer surlus related to the marginal outut that is no longer consumed at the higher rice. With the rice and outut information it is ossible to estimate fairly recisely the redistributional effects exected from a merger that reduced the number of firms from 3 to 2 (see Figure 1) and the total loss in consumer surlus. Figure 1 about here As a result of a rice increase total industry outut falls to million minutes at the average rice of er minute. This results in a transfer of surlus from consumers to roducers of 107 millions of Euro er year, which using a 5% discount rate and infinite time horizon has a resent value of 2.1 billion Euro. In addition, there is an additional consumer surlus loss associated with outut no longer consumed that results directly from the rise in rices, and which is given by: LCS C = f Q( ) d = i f i A ε 1 ε A d = 1 ε f i (2) Using the log-linear secification we estimate the latter consumer surlus loss at 0.82 million euro er year. This is a relatively small consumer surlus loss articularly when comared to the transfer of consumer surlus to roducer surlus or when comared to the overall industry size (ca. 3 billion euro revenues in 2004). In summary, the consumer surlus is reduced by a total of million euro er year, with a resent value of 2.15 billion euro. The results suggest the merger will result in a large reallocation of resources from other economic activities to this industry which would not haen if three layers remained in the industry, i.e., the merger is detrimental to consumers. Change in Producer Surlus Following the merger average roducer surlus is exected to increase on the one hand due 6

7 to increased market ower (higher rices), and on the other hand due to imroved efficiency (reduced marginal costs). The market ower effect was estimated above and results in a redistribution of consumer surlus to roducer surlus. In addition, the average roducer surlus also increases due to gains in efficiency, which is larger than the loss in roducer surlus due to higher rices and lower outut. The efficiency gains can be associated, for examle, with lower urchasing costs, reduced ersonnel needs, or lower subscriber churning (subscrition cancellations) to other oerators. The estimation of the efficiency gains is made by comaring estimated rice-cost margins before and after the merger, considering that after the merger rices will be higher 3.8%. We have a measure of the initial non-weighted average rice-cost margin for the Portuguese mobile telecommunications market in 2004 (the average EBITDA of the oerators). This was 35.6%. This means the exected long-run final average margin in the Portuguese market increases to aroximately 47.2%. The estimation is made assuming that, at the relevant level of outut (ca million minutes er year), average marginal cost is constant re- and ost-merger. Since we know the initial and final average rice and average margins, it is ossible to estimate the reduction in average marginal costs using the equations: i ci i f cf = 35.6%, = 47.2% f (3) where the subscrit i is for the initial rice and marginal cost before the merger, and the subscrit f is for the rice and marginal cost after the merger (see also Figure 1). Equation (3) suggests that the merger is exected to result in a reduction in the marginal costs equivalent to 1.9 euro cents er minute. Considering the level of outut after the merger, the gains in efficiency (or synergies using business jargon) net of the loss in roducer surlus that results from higher rice levels and lower outut levels, result in a roducers surlus increase of 253 million euro er year. Thus, the roducers surlus increases by a total of 360 million euro er year, of which 30% or 107 million euro are the result of transfers from the consumers to the roducers. 7

8 In sum, the merger is welfare imroving and this result seems consistent with the recent anecdotal evidence of further industry consolidation. The market is driving further industry consolidation not only to imrove their market ower, but foremost because there are substantial efficiency gains to be had. Producers cature the entire efficiency gains and some surlus from consumers by raising rices. From a social decision maker ersective, using the 5% discount rate, the resent value of the roducers (Otimus-TMN and Vodafone) surlus increase is 7.2 billion euro Caveats There are a number of issues in this analysis, which we briefly discuss in this section. First, there is the issue of extending the results of the 45-country samle to the Portugal case. The OLS estimates are based on aroximately 1700 observations, and we are using them to draw inferences relative to the Portuguese market. Per definition, and if there are no a riori reasons to exect the sub-samle distribution to differ from the overall international samle, the exected resonse to changes in market share in the samle subset (Portuguese market) is the same as in the original international samle. If the oulation of observations in the international samle describes the Portuguese reality well, then one would exect the inferences to be aroriate. If not, then our inference will not be correct. The margin and rice equations coefficient estimates the Eurozone sub-samle and the OECD PPP subsamle, both of which include Portugal, are larger than those of the international samle, and the rice equation coefficient estimate is aroximately twice as large. Moreover rice data for Portugal suggests that in this eriod rices in Portugal fell less than in other Eurozone countries, suggesting that cometition in this market in this eriod was less intense than in other Eurozone countries. Thus, it may be the case that the Portuguese sub- 4 Private firms calculate the resent value of future revenue streams differently than a social decision maker maximizing total welfare. Following recent trends of not discounting future revenue streams and of considering a 7-year time horizon, the value of the merger for the firms in the industry 8

9 samle distribution bears more close resemblance to the Eurozone and OECD distributions than to the international distribution. Therefore, the inferences we make on the rise in rices in Portugal, and consequently on the surlus redistribution effects from consumers to roducers may be, if anything, under-estimated. In fact, the results of Grzybowski and Pereira (2006) estimated average rice increases of 6% to 7% - oint in the same direction. A second major issue is that in our international samle we are not able to distinguish market share gains resulting from mergers from those resulting from internal firm growth. Our samle data reflects a eriod of time where there were relatively few mergers, and most changes in market share resulted from internal firm growth atterns. Thus the inference assumes that the market after the merger will have a similar margin and rice erformance to that of markets where average market share grew due to internal firm growth, which may not be the case. A related issue is that we are also not able to control for the effect of merger remedies imosed by the Cometition Authority in order to authorize the merger. Third, our Cournot-tye model is essentially a static model that dearts from the hyothesis that the market is in long-run equilibrium. The inferences one can draw are also about the long-run equilibrium, after a transitional eriod, ceteris aribus. While a large number researchers today have serious issues regarding the old Structure-Conduct- Performance aradigm (Cabral, 2000), the fact is that the overwhelming ast IO emirical evidence used for olicy making and regulatory olicy has been based on similar models. Fourth, we use throughout the analysis non-weighted averages taken out of our original data samle and 2004 data simly because of data limitations. Thus, we attemt to consistently use the same data with the econometric results. Of course, there are differences in rices, outut, and margins between 2004 and But the order of greatness of the inferences has not changed significantly. Fifth, a seminar articiant ointed out new technologies may affect the cometitive is estimated at 2.5 billion euro. 9

10 dynamics in the mobile telecommunications market. However, the imact of new technology is likely to remain marginal in the next years. For examle, if the existing oerators remain dominant during only the next 7 years, the resent value of the merger to the roducers still remains quite high at 2.2 billion euro, and the resent value of the consumer surlus loss falls to 654 million euro, still significant amounts. Sixth, earlier literature has found evidence of collusion in duooly markets, which again, may not be well catured by our econometric results given the existing samle where there are relatively few duooly markets. Finally, we also do not consider redistributional effects resulting from tax olicy incentives, namely the differing treatment of debt versus own caital, which would result in a reduction of taxable income of the acquired firm. Both effects, were they to be found in the context of a ost-merger equilibrium, would be exected to result in an increased transfer of surlus from consumers and taxayers to roducer(s), resectively. 4. Conclusion We focus on the roosed merger between Otimus and TMN in Portugal, giving the combined oerator a 65% market share. We find that, given the size of the mobile voice telecommunications market, the merger would result in large consumer surlus losses, and large roducers surlus gains, artly catured from consumers. As a result of these surlus changes, overall welfare increases. The results raise imortant issues for a social decision maker on the trade-off between consumer welfare and social welfare maximization. 10

11 References Andini, C., Cabral, R., and Chaell, H. (2006) Prices and Price-cost Margins of Mobile Voice Services, aer resented at the 7 th CEPR Conference on Alied Industrial Economics and at the 33 rd Conference of the Euroean Association for Research in Industrial Economics. Brito, D. and Catalão-Loes, M. (2006) M&A: The Industrial Organization Persective, Kluwer Law International BV, The Netherlands. Busse, M. (2000) Multimarket Contact and Price Coordination in the Cellular Telehone Industry, Journal of Economics & Management Strategy, 9(3), Cabral, L. (2000) Introduction to Industrial Organization, MIT Press, Cambridge MA. Cooer, M. (2004) Remonoolizing Local Telehone Markets: Is Wireless Next?, white aer, Consumer Federation of America, July. Fox, J. (2005) Consolidation in the Wireless Phone Industry, NET Institute Working Paers, nº , NET Institute, October. Gagneain, P. and Pereira, P. (2005) Entry, Cost Reduction and Cometition in the Portuguese Mobile Telehone Industry", CEPR Discussion Paers, nº. 4993, Centre for Economic Policy Research, Aril. Grzybowski, L. (2005) Regulation of Mobile Telehony Across the Euroean Union: An Emirical Analysis, Journal of Regulatory Economics, 28(1), Grzybowski, L. and Pereira, P. (2006) Merger Simulation in Mobile Telehony in Portugal, NET Institute Working Paers, nº , NET Institute, October. Hausman, J. (1997) Valuing the Effect of Regulation on New Services in Telecommunications, Brookings Paers on Economic Activity: Microeconomics, Hausman, J. (2002) Mobile Telehone, in: Cave, M., Majumdar, S., and Vogelsang, I. (eds.), Handbook of Telecommunications Economics, North-Holland, Amsterdam. ICP-ANACOM (2004) Anuário Estatistico, available at: <htt:// (accessed: November, 2006). Motta, M. (2004) Cometition Policy. Theory and Practice, Cambridge University Press, Cambridge. Parker, P. and Röller, L.H., (1997) Collusive Conduct in Duoolies: Multimarket Contact and Cross- Ownershi in the Mobile Telehone Industry, RAND Journal of Economics, 28(2), Stoetzer, W. and Tewes, D. (1996) Cometition in the German Cellular Market? Lessons of Duooly, Telecommunications Policy, 20(4), Valetti, T. and Cave, M. (1998) Cometition in UK Mobile Communications, Telecommunications Policy, 22(2),

12 Aendix 1: Tables Table 1 Price equation (ML data-set) Deendent variable: logarithm of average revenue er minute. (1) calculated using 2004 nominal exchange rates to the Euro; (2) data in Euro; (3) calculated using annual Purchasing Power Parities to the USD. (1) (2) (3) Full samle Eurozone samle OECD Samle lgmshare (0.000) (0.000) (0.000) lgchurn (0.203) (0.602) (0.000) M (0.000) (0.000) Observations R-squared Robust values in arentheses. Regression controls include country, year and quarter effects; all are jointly significant at the 1% level, with excetion of quarter effects in equation (3), which are not jointly significant. Table 2 Price-cost margin equation (ML data-set) Deendent variable: ebitda margin (1) (2) (3) Full samle Eurozone samle OECD samle lgmshare (0.000) (0.000) (0.000) lgchurn (0.535) (0.800) (0.401) Observations R-squared Robust values in arentheses. Regression controls include country, year and quarter effects; country and year effects are jointly significant at the 1% level; quarter effects are not jointly significant at 5% level 12

13 Aendix 2: Figures Figure 1 : Welfare and distributional effects calculation P P f P i Surlus transferred from consumers to roducers C i C f Gross change in roducer surlus* D Q f Q i Q * Change in roducer surlus before subtracting loss in roducer surlus due to lower outut level. 13