This paper introduces an economic model to explain the relationship between traditional telephony services and VOIP services. In particular, we show that low income families have not benefited from VOIP services and VOIP could be a substitute for long-distance calls but complementary to local services.
RESEARCHES & DISCUSSIONS Voice Over Internet Protocol (VOIP) providers is generating the game of telecommunication market Based on the available advanced technologies and smart soft-wares, new entrants can reduce initial investment and production costs to compete with incumbent local exchange carriers (ILECs), which dominate the telecommunication market for a long time due to economy of scale and scope This paper introduces an economic model to explain the relationship between traditional telephony services and VOIP services In particular, we show that (1) low income families have not benefited from VOIP services; and (2) VOIP could be a substitute for long-distance calls but complementary to local services Specifically, we implement an empirical analysis of bundling telecommunications services that are carried out with pooled cross sectional time-series data for all states of the United States of America in the period 1995-2006 Finally, we offer a brief overview on current situation of VOIP services in Vietnam Keywords: competition, complement, substitution, telecom, VOIP Introduction 52 The bundling game between Telecommunication companies (Telcos) and Cable TV is creating a new convergent trend called triple play including TV, broadband network and telephony This is leading to a new dynamic competitive environment in digital communications The traditional service providers are now playing two main roles as incumbents as well as rivals In other words, the giant incumbents in telecom industry are striving to increase the cable television market share where cable TV companies have dominated the market for a long time Meanwhile, cable TV companies have also developed new technologies to implement bundling triple play services and become stronger competitors in telecom services Otherwise, by using the available advanced technologies based on the global network, many new service providers could enter the market and compete with the incumbents in traditional services For instance, on the one hand, VOIP providers are offering a bundling of voice services with a comparative price or free of charge in some cases such as Vonage, Skype, Guzimo, Yahoo voice, Google voice and so forth On the other hand, internet protocol television (IPTV) providers and Telcos are soaring to capture the market share of the dig- ital video on demand, telephones and television Therefore, the telecom and cable TV markets have become more dynamic, complicated and competitive in the past few years By building an economic model, the paper analyzes the relationship between traditional telephony services and VOIP services We will provide some evidences to prove that (1) low-income households have not widely used VOIP services even though VOIP telephone is supposed to be cheaper than traditional telephony; and (2) VOIP services could be a substitute for long-distance calls but complementary to local services Specifically, by collecting data from all states of the USA in the period 1995-2006, we implement an empirical analysis of bundling telecommunications services to test our hypotheses We also provide a summary of VOIP services in Vietnam and compare them with the services operating in the US This paper is organized into six sections Section provides the introduction, while Section presents a review of some main prior studies of telecommunication market Theoretical model is presented in Section Section implements an empirical study The VOIP services in Vietnam are presented in Section Finally, Section summarizes the study’s results and assert some limi- Economic Development Review - April 2011 * Post & Telecommunication Institute of Technology (PTIT) in HCMC RESEARCHES & DISCUSSIONS tations that are challenges for future research Literature review In general, consumers would like to maximize their utilities under a budget constraint However, in the internet telephony market, the prices are continuing to decrease, hence the current prices of telephone services are more likely to be under their expected expenditure It is not easy to persuade them to switch from an existing provider to a new one in a short time For instance, many consumers are not ready to switch from fixed line services to VOIP services The replacement of traditional telephony with the new technological applicability such as VOIP is not easy For instance, Fowler (2002) analyzes the simplification of User’s life: New technologies are a tough sell unless users can perceive tangible benefits Consumers not respond to “technological elegance”, but to concrete improvements and documentable savings Replacing something such as the Plain Old Telephone Service (POTS) is a difficult challenge because it is familiar, exceedingly reliable, easy to use, and matching users’ requirements In the telecom market, network access and network interconnection are main issues for a new entrant to enter this market These problems are considered as a major barrier to the telecom competition In reality, ILECs usually find many reasons to postpone new entrants to connect to their network, especially in countries where the telecom market is still a monopoly or an oligopoly Vogelsang (2003) analyzes the differences between an access model and an interconnection model, in other words, one-way access and two-way access Loomis and Swam (2005) investigate the telecom competition between ILECs and CLECs in the US They find significant inter-modal competitive impacts resulting from wireless and high speed development The rapid emergence of VOIP is considered as a real threat to traditional fixed line telephone since VOIP providers enable to reduce production cost by absorbing technological novelty to create advanced services However, internet telephony also brings negative effects on a creative destruction Murillo and McKnight (2005) study the impact of internet telephony on the Universal Service program in the US They find out many causes leading the process of creative destruction They are debating in the US whether VOIP is an information service or telephone application This issue becomes more complicated because if it is considered as a telecom service, then it should be subjected to any or all of the various common carrier regulations In this case, ILECs can easily dominate the telecom market driving new VOIP entries out of the market (Shin, 2006) The major issue of VOIP services is quality However, this problem is able to overcome due to technological innovations and intelligent softwares Internet telephony is changing in traditional communication cultures For instance, Skype is considered as one of prior businesses in VOIP services Tapio (2005) analyzes the success of Skype in both technological solution and businesswise Additionally, VOIP services are requiring the new regulatory framework Goncalves (2005) studies this issue and uses Skype as a case study Skype has proven to be increasingly popular among business users because of low cost, less time, simplicity, and productivity improvement Skype has continued its meteoric rise in international call market share, which now has 25% of the international calling market and is serving up some 520 million minutes of calls a day (John Norris, RCR Wireless, Jan 6, 2011) Specifically, in January 2011, after the release of video calling on the Skype users for iPhone, Skype reached a record 27 million simultaneous online users (Vlad Savov, www.engadget.com, Jan 11, 2011) The VOIP progress is conditioned by the regulatory framework designed for it Feijoùo et al (2007) analyze main VOIP development scenarios that represent an adjustment of the specific regulatory intervention in basic issues such as interconnection, numbering, operator obligations and user rights As a result, VOIP could achieve greater market shares and generally replace traditional telephony whenever both technical and regulatory issues have been already solved Model In this part, we mainly focus on the impact of VOIP services on the telecommunication industry In order to simplify our model, we assume that there are only providers of telephone services The existing one called Firm has a monopoly power in supplying local networks (for example Verizon) Another new one called Firm (for in- Economic Development Review - April 2011 53 RESEARCHES & DISCUSSIONS stance Vonage) enters the telephone market by using VOIP technology to provide telephone services with lower prices to compete with the former one We consider consumer behavior corresponding to available telephone services including traditional telephone and VOIP calls If they switch to the new provider (VOIP calls), they have to face substantial costs of switching The switching costs include an additional cost of using electricity for service, learning costs and initial investments such as adapters, special phones and connection fee as well as service quality Obviously, the switching costs make consumers more dependent on the traditional phone services Another important technical issue, VOIP providers can only provide the VOIP services for subscribers who have already used a broadband internet access In other words, the normal fixed line telephone or cell phones are not completely substituted by internet phones We consider how much subscribers have to pay monthly for using the traditional phones A user usually pays fixed fee for using the local line (Fll) and pro base rate for using long-distance calls which are calculated by summation of all price per minute (depending on the distance between sender and receiver) multiplied with total minutes of calling Hence, the total monthly expenditure of long-distance calls is equal to Because the payment for using long-distance calls is variable, a subscriber has his or her reservation value of using long-distance calls (R) She/he is not willing to pay higher for the reservation value Subjecting to the budget constraint for long-distance calls, the expenditure on such a kind of service is more sensitive in price Therefore, if consumers have high demand and low reservation value of longdistance calls, then they will have higher potential to switch to VOIP services, which are usually fixed in price for unlimited long-distance calls (FVOIP) However, to come with a final decision in shifting services, it requires consumers to consider many elements such as service quality, prices, conveniences, compatible with consumers’ existing terminal equipments and so on One of the most important factors is a switching cost (S) It is playing an essential role in transferring to the VOIP telephone or staying with the traditional one 54 Economic Development Review - April 2011 We consider subscribers’ decision to switch to the new provider or staying with the existing one as follows If consumers’ total expenditure on longdistance calls is not greater than the reservation value, then they will stay with the current provider ( ≤ R) In this case, consumers are satisfying with the traditional services even though they have to pay higher monthly prices If the reservation value is smaller than the total expected demand for long-distance calls, consumers will consider the switching cost (i.e > R) In this case, there are no shifting services if the following condition is satisfied (R - PVOIP – S < =0) Otherwise, consumers will transfer to the new entrant (R- PVOIP – S > 0) Therefore, the new entrant could only provide the internet phone for consumers who have low reservation value but high expected demand for long-distance calls In other words, consumers have to meet two conditions before deciding to switch to the new entrant Furthermore, the reservation value of each consumer has strictly depended on her or his income According to data collection from Federal Communications Commission (FCC-2005), telecommunication services account for about 2% of total households’ expenditure during period between 1981 and 2003 It means that the reservation value of each consumer has been stable during the long period The higher-income households have greater reservation value and vice versa Hence, the low-income families would not only like to use cheaper services than the high-income ones but also have high demand for new services However, the fact that whether this demand is satisfied or not will be a question Proposition 1: The low-income households could be less potential for switching from a traditional phone to a VOIP phone The reservation value of low-income families is smaller than that of high-income ones Therefore, if low-income households have high demand for long-distance calls, then the first necessary condition is satisfied ( > R) However, the second necessary condition for switching services may be not met (R - PVOIP – S > 0) The second condition is the main factor making low-income families less potential to use the cheaper phone services In reality, according to the Reference Book of Rates, Price Indices, and Household Expenditures for RESEARCHES & DISCUSSIONS Telephone Service published by FCC-2006, low-income households have received the subsidy programs for using wire-line telephone services These programs are called the Lifeline and LinkUp programs Throughout the Lifeline and LinkUp programs, low-income households only has to pay $10.65 for local service and $13.70 for connection charges per month, as compared to $24.74 for local service and $42.71 for connection charges paid by residential subscribers without subsidy, respectively From these figures, we easily recognize that the second condition is not easily satisfied In other words, low income households are staying with the current provider due to facing with high switching cost Another technical issue of using VOIP telephone is the fact that it requires users to have available high speed internet access Most of low-income households are not able to meet this requirement due to their budget constraint Proposition 2: VOIP could be a substitute for long-distance calls but complementary to local services Feijo et al (2007) analyzed the possibility of VOIP as a substitute for traditional telephony on both sides including demand and supply However, in this paper we emphasize the greater ability of VOIP as a substitute for long-distance phones but as complementary to local calls First, VOIP considered as a substitute for long-distance phones including domestic and international phones is a recent trend Again, the rapid increase in international call market of Skype is a very good example Second, VOIP could be a complementary to local services Obviously, an increase in volume of VOIP services leads to a rise in the volume of local telephone calls because almost of VOIP toll telephone traffic must use the local telephone networks Now, we consider more details of demand functions and cost structures in the model This model is expanded in the telecoms market with one ILEC (Firm 1) and another VOIP provider (Firm 2) The model with two providers has been developed by Bijl and Peitz (2004) They analyze a situation of one-way access Their model considers the providers who are mainly different in terms of the property of local-loop Firm owns the local loop network and the other does not Meanwhile, in our model, Firm may own a local loop network The profit functions of Firm and 2, are respectively as follows: p 1= l 1Q 1( p 1, p 2, q 2( p 2) ) * ( p 1- A V C 1) + ( l1)Q21(p1,p2,q2(p2)) * (r1-AVCr1)-FC1 (1) and p 2= l 2Q 12( p 1, p 2, q 2( p 2) ) * ( r 1- A V C r2) + ( l2)Q2(p1,p2,q2(p2)) * (p2-AVC2)-FC2 (2) Where Q1(p1,p2,q2(p2)): quantity demand for Firm 1’s services Q2(p1,p2,q2(p2)) : quantity demand for Firm 2’s services Q21(p1,p2,q2(p2)) : quantity demand for Firm 2’s services accessing to Firm 1’s local loop networks Q12(p1,p2,q2(p2)) : quantity demand for Firm 1’s services accessing to Firm 2’s networks p1,p2 : prices of Firm and Firm 2, respectively q2(p2): quality of services of Firm l1: A proportion of consumers that are a “high type” using Firm 1’s services 1- l1 : A proportion of consumers that are a “low type” using Firm 1’s services l2: A proportion of consumers that are a “high type” using Firm 2’s services 1- l2 :A proportion of consumers that are a “low type” using Firm 2’s services AVC1, AVC2 : average variable costs of Firm and Firm 2, respectively FC1, FC2: Fixed cost of Firm and Firm 2, respectively r1 and r2 : line rental charge of Firm 1’s networks and Firm 2’s networks, respectively Intuitively, the demand for Firm 1’s services comprises two types of consumers The high-type consumers are willing to pay for high quality Meanwhile, the low-type consumers are not willing to so Without threat of entry, the incumbent (Firm 1) will set a higher price to sell only to high income consumers After appearance of the rival (Firm 2), the incumbent has to lower its prices to sell to both types The new entrant is playing an important role in changing the demand structure of Firm Proportion l1 decreases as the demand for Firm 2’s services increases At the current time, the incumbent dominates the local networks, so it can set the line rental fee (also called interconnection charges; access charges or termi- Economic Development Review - April 2011 55 RESEARCHES & DISCUSSIONS nation charges) for its rival But it does not need to purchase access charges from its rival This case can be called the one-way access framework However, in the future the incumbent might have to pay the access charges for using its rival network Moreover, each provider needs to invest in the infrastructure system to provide its own subscribers with better services As a result, each provider has to interconnect with other providers to ensure its consumers be able to call all users This case is called the two-way access framework The concept one-way and two-way access frameworks are studied by many authors Armstrong (2002) explains carefully those concepts We now consider the high-type consumers with the quantity of demand function (Q1(p1,p2,q2(p2)) In many other studies, the high-type consumers can be explained in many different meanings such as high demand, high value quality and so on In this paper, we consider the high-type consumers as the high-income users The demand of high-income users for voice services depends not only on the prices but also on the quality of services Although, Firm offers a very comparative price, the number of users of Firm seems not to be fluctuated significantly since the quality services of Firm are unstable or insecure In other words, the subscription demand for Firm is not elastic However, the quantity of demand for Firm can be affected by the new entrant, because many users from Firm can use service provided by Firm as a complementary service Therefore, the prices and quality of services can affect on Q1 as Intuitively, if quality of services (q2) increases, the more Firm 1’s users will switch to Firm 2’s services The demand of low-income consumers for using Firm 1’s services has a positive relationship with p2 and q2, but has a negative relationship with p1 Observing two profit functions, the market shares of Firm is accounting for a higher proportion than Firm since Firm dominates the market for a long time The market demand for using voice services between two providers will depend on their prices However, the FC1 is higher than FC2, meanwhile AVC1 is smaller than AVC2 Because Firm is 56 Economic Development Review - April 2011 willing to enter the voice market, it has to spend huge money on advertisement as well as the rental line For instance, Verizon is considered as Firm (Vietnam Post and Telecommunication – VNPT for the case of Vietnam) and Vonage is Firm (FPT Telecom for the case of Vietnam) Vonage’s strategy is obtaining the market share instead of the profitable objective at the movement For each new line, Vonage spent around $239 on marketing cost (Wall Street Journal, August 02, 2006), while customers only have to pay $24.99 per month plus month free Intuitively, the quality services of Firm are more reliable and better than Firm 2, therefore p1 is more expensive than p2 for identical services Given p1, Firm offers p2 that is cheaper and more available services than Firm 1, such as unlimited calls in US, Canada and other European countries The rental fee or leased price ri (i=1,2) is regulated by law, in current time, therefore r1 is more concerned than r2 since Firm wants to charge the rental fee Unfortunately, the rental price is often set by regulation, hence Firm cannot raise network accessing fee as well as network interconnection charges to bar Firm from entering the market In future, when Firm 2’s networks broadly develop, it will require a line rental for using its networks Both providers want to maximize their profit given a counterpart price By taking First Order Condition from Equation (1) & (2), we could find a unique pair (p1*,p2*) Hence, at a certain time, there exist two equilibrium prices in the voice market Consumers are trading off between quality of services and prices For consumers with high income it is not necessarily best to switch from Firm to Firm 2, but consumers who have a limited budget or emphasize cost reduction may consider switching to a new provider To sum up, the above model could be used to explain that VOIP service is a substitute for long-distance phones but complementary to local services Empirical study The data on telecommunication services revenue over the period 1995-2006 are collected from the Federal Communications Commission (FCC) The number of subscribers of fixed phones, cell phones and their corresponding prices are col- RESEARCHES & DISCUSSIONS lected from FCC and CTIA-The Wireless Association The price variables used in the analysis are the average local monthly bill of cell phones and average monthly bill of wire-line providers The income per capita and population of each state are collected from the US Bureau of Economic Analysis (BEA) The data present greater aggregation than would be desirable: they include all subscribers and sales volumes but not clarify the more detailed sales of the telecommunications services as well as pricing tariff for each state In this study, we examine annual demand for bundling telecommunication services across states of the US over the period 1995-2006 To simplify the model of telecommunication services demand across states as well as to compromise with the available data, we consider wire-line services and wireless services as two major sources contributing to the demand for telecommunications services Therefore, the empirical model can be written as follows: ln(Bst)= b0 + b1 ln(w_lessst)+ b2 ln (w_linest) + b3 ln(popst) + b4 ln(incst) + b5 INT + b6 VOIP (1) i i i ln (B st )= m0 + m1 ln( w_less st ) + m2 ln( w_line st ) + i i m3ln( pop st ) + m4ln( inc st ) + m5VOIP (2) n n n B w _ less ln ( st )= s0 + s1 ln( st ) + s2 ln( w_line st ) + n n s3ln( pop st ) + s4ln( inc st )+ s5VOIP (3) where the variables in above equations are: Bst: telecommunications revenues of state s in year t B sti : telecommunications revenues of state s in year t for consumer’s income per capita less than $26,000 n B st : telecommunications revenues of state s in year t for consumer’s income per capita of at least $26,000 w_linest : total expenditure on wire-line services of state s in year t w_lessst : total expenditure on wireless services of state s in year t incst : Consumer’s income per capita of state s in year t popst : Population of state s in year t l: low personal income per capita less than $26,000 h: high personal income per capita at least $26,000 INT: refers to the dummy variable of internet access It equals for internet access available after 1996 and otherwise VOIP refers to the dummy variable of Voice over internet protocol It equals for VOIP service available after 2001 and otherwise b, a, m and s: coefficients of regression models, respectively In Model (1), we consider the effect of wireless and wire-line services on the total telecommunications sectors We use Model (1) to test our hypothesis that VOIP services have a negative effect on the total telecommunications revenues We use Model (2) and Model (3) to test our hypothesis that a low-income person has less opportunities for using VOIP services than a high one Here, we consider a low-income household who earns less than $26,000 per year The low-income figure is considered as equal to 75% of US per- Table 1: Bundling telecommunications services regression (dependent variable: a translog bundling revenues) Model(1) Model(2) Model (3) Constant -9.2722 (0.5046) - 9.0327 (0.7724) -9.3429 (0.7003) ln(w_less) 0.1591 (0.0177)*** 0.1857 (0.0166) *** 0.1743 (0.0229) *** ln(w_line) 0.1173 (0.0114) *** 0.0479 (0.0177) *** 0.1371 (0.0142) *** ln(pop) 0.6969 (0.0224) *** 0.7439 (0.0234) *** 0.6627 (0.0287) *** ln(inc) 0.4907 (0.0352) 0.4320 (0.0660) *** 0.5285 (0.0522) *** INT 0.0365 (0.0158) *** - 0.1478 (0.0161) *** -0.0816 (0.0236) *** -0.1720 (0.0204) *** 0.9918 0.9942 0.991 VOIP R *** Standard errors in parentheses next to coefficients are robust to heteroskedasticity * Significant at 10% ** Significant at 5% *** Significant at 1% Economic Development Review - April 2011 57 RESEARCHES & DISCUSSIONS sonal income in 2005 Estimated results Table presents the estimates for our empirical models Model (1) includes two dummy variables, those are, INT and VOIP, reflecting the effects of new technological adaptation on development of telecommunication industry As shown in Table 1, many parameter estimates are consistent with a priority theoretical expectation In order words, the wire-line and wireless services have positive effect on the total revenues The more income, the more demand of new value added services that consumers are more likely to reach The larger the population, the higher the demand for telecommunication services The internet access has played a significant role in developing telecommunication sector Particularly, it created high demand for broadband services and many value added services throughout IP Finally, VOIP coefficients are negative ones and those are also consistent with our first hypothesis Now, we examine the second hypothesis Coefficient of VOIP in Model (2) is – 0.0816 meanwhile that of Model (3) is – 0.1719 It means that a highincome person has used VOIP much more than that of a low one leading to a stronger negative impact on the total telecommunication revenue Notably, we also see that the coefficient of VOIP in Model (1) is - 0.1478 ranging between the above figures as a result of pooling all cross sectional time-series data for all states and in period 19952006 Therefore, this has consolidated our Proposition The other significant result of empirical analysis is that evolution of technological innovation could lead to positive and negative effects on both demand and supply side As shown in Table 2, coefficient of internet is positive, whereas that of VOIP is negative The results show that VOIP services have not been available for all consumers VOIP service is rapidly emerging in the global economy and it is changing many traditional behaviors of customers as well as social welfare For instance, 10 years ago, almost consumers in developing countries were unable to make an inter- 58 Economic Development Review - April 2011 national call to their relatives or friends in developed countries due to high charges and that was why the call back or collect call services used to be popular at that time However, with VOIP services, now many customers in developing countries can make an international call at a cheaper price than that of their counterparts in developed countries VOIP services in particular and value added services based on IP will rapidly take off as new wireless networks such as Wi-Max The new convergent trend of telecommunication and digital television industries may lead to the new process of acquisition and merger between both sectors Meanwhile, VOIP services seem to be diversified in both software and hardware terms so as to improve services and create more demand For instance, Google Voice becomes a very strong VOIP provider competing with similar services such as Skype When it introduces a free service that gives callers a new phone number that can access to different normal phones they own and send them an email transcript of voicemails they received (Wall Street Journal, Aug 28, 2010) VOIP services in Vietnam By law whenever customers in Vietnam would like to use cheaper long-distance calls via VOIP, they have to access local providers by using fixed line phones or mobile phones The main providers include VNPT (dial 171), Saigon Postel (dial 177), Viettel (dial 178), EVN Telecom (dial 179) and FPT Telecom (dial 176) Recently, the market shares of VOIP services account approximately for 60% of total long-distance calls in Vietnam (VnMedia, 10 April, 2008) However, the internet users have not been accessed to all VOIP services offered by internet providers such as Google or Yahoo voice in Vietnam like in the US because of current regulations Obviously, VOIP in Vietnam is really a substitute for long-distance calls but complementary to local services This is the same situation as we find in the US Conclusion The VOIP services have truly created the new game in the telecom market VOIP services are rapidly emerging as a result of successful implica- RESEARCHES & DISCUSSIONS tion of innovative technology and software as well as business strategies This paper introduces the dynamic internet telephone market and its impacts on the voice market It provides some evidences (1) a low income person has less opportunities for using VOIP services than a high one; (2) VOIP services could be the greater possibility of VOIP as a substitute for long-distance calls but as a complementary to local services Specifically, the results of empirical analysis also consolidate the hypotheses and drive some other significant results such as evolution of technologies could have both positive and negative effects on development of telecommunications industry and market segments There are some limitations that need further investigating First of all, we have not accessed the current data of all states of the US Secondly, our model is able to explain the current situation of VOIP providers in Vietnam, but we have not found the data to test the hypotheses These issues are challenges for future researchn References Armstrong, M (2002), “Theory of Access Pricing and Interconnection”, in Handbook of Telecommunications Economics, Amsterdam: North Holland Clarke, Richard N et al (2004), “Assessing the Economic Gains from Telecom Competition”, NBER Working Paper Series Creswell, J (2004), “Don’t Believe the VoIP Hype”, Fortune, 149(1), pp 42 – 42 de Bijl, Paul & M Peitz (2004), “Local Loop Unbundling: One-Way Access and Imperfect 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demand for Firm 2’s services Q21(p1,p2,q2(p2)) : quantity demand for Firm 2’s services accessing to Firm 1’s local loop networks Q12(p1,p2,q2(p2)) : quantity demand for Firm 1’s services. .. demand for telecommunication services The internet access has played a significant role in developing telecommunication sector Particularly, it created high demand for broadband services and many... whereas that of VOIP is negative The results show that VOIP services have not been available for all consumers VOIP service is rapidly emerging in the global economy and it is changing many traditional