Appendix M: Strategic Use of the Regulatory Process Eli M. Noam, Entertainment Law and Media Regulation

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1 Appendix M: Strategic Use of the Regulatory Process Case Discussion: Regulatory Competition How much should Comcast invest in the regulatory process? How much AT&T? Case Discussion AT&T-- wireline and wireless telecommunications firm-- wants to challenge Comcast by providing video service over its DSL broadband networks and fiber Comcast Wants to voice telephone market (VOIP), but may face regulatory restrictions if it does. Comcast is active in cable TV, portals, cable networks 1

2 Questions for Analysis 1. What is the cost to Comcast of 1 year of regulatory delay of its entry into telecom service? 2. What is the value to Comcast to delay AT&T for 1 year from entering video services First, let s look at the value (NPV) of Comcast s proposed project Then, we ll see how much it is worth to Comcast to avoid delays or competition Calculating NPV n c NPV = I + i i = + i 1(1 r) where: -I= initial investment -C i =cashflow in year i -r=discount rate -n=time horizon of the project Assumptions on Comcast Cash Flow from VOIP YEAR Net $- $- $- $50 $100 $200 $200 $200 Earnings (#mil) NPV $ Discount 12% 2

3 NPV= $361 mil However, Comcast may face regulatory obstacles. What if it were delayed for one year? Comcast Cash Flow with 1 year regulatory delay Net Earnings Stream ($mil) NPV $ YEAR $- $- $- $- $50 $100 $200 $200 $200 Discount 12% The cost to Comcast of 1 year of regulatory delay of its entry into telecom service is ($361.09m - $322.40m) = $38.69m Similarly, AT&T wants to enter video market. If AT&T enters the video market, Comcast would lose some cable profits 3

4 Negative Impact on Comcast From Entrance of AT&T YEAR Loss of Cable $10 $10 $100 $130 $200 $300 $300 $300 Profits ($mil) NPV $ Discount 12% AT&T as a competitor, is worth a negative $693m. How much is the benefit to delay AT&T s entry? -The negative net present value of this project is $693m Negative Impact on Comcast from Entrance of AT&T, with 1 year of regulatory delay for AT&T YEAR Loss of Cable $-0 $10 $10 $100 $130 $200 $300 $300 Profits ($mil) NPV $ The NPV for Comcast of delaying AT&T s entry is $183m Discount 12% 4

5 Conclusion: Impact on Comcast of 1 year delay of its own project: $39mil 1 year delay of AT&T s project: $183mil How much then should Comcast spend on regulatory process? Offensively, maximum $39 mil on VoIP Defensively, maximum $183 mil on IPTV But what is optimum, not maximum? Optimal spending is where Spending = benefit and benefit = impact of spending on probability of success, times the value of success, i.e E(V)= P V d P v d C = 1 Example Regulatory Probability PV of benefits Possible Delay (year) of Delay benefit 1 1/3 $9.05 M $3.02M 2 1/3 $8.18M $2.73M 3 1/3 $7.41M $2.47M PV of expected benefit $8.22 5

6 Two firms involved in nonmarket competition Firm A desires an outcome X of worth n to it Firm B desires an outcome Y of worth N to it V = the change in Net Present Value of firm A or B due to nonmarket strategy p 0 : Initial probability of reaching outcome X from status quo p x : Probability of outcome X Levy, Ferdinand K., The Managerial Economics of Civil Litigation, Management Science, Vol. 31 Issue 3, Mar., p323 The probability of success for the firm, p, is a function of costs, C i C a = spending by firm A to increase probability of gaining outcome X C b = spending by firm B to increase probability of gaining Y Firm confers with its lawyers and lobbyists to estimate probabilities of success as the firm increases its investment Levy, Ferdinand K., The Managerial Economics of Civil Litigation, Management Science, Vol. 31 Issue 3, Mar., p323 Levy, Ferdinand K., The Managerial Economics of Civil Litigation, Management Science, Vol. 31 Issue 3, Mar., p323 6

7 Spending The firm s legal experts make estimates based on the strength th of the case, the law, the complexity of the case, and the spending by the other side References Total probability: p x = p 0 + α(c a ) β(c b ) References Expected Benefit Expected benefit for company A is: E(V) = p x V = (p 0 + α(c a ) β(c b )) V Reaction Functions t is a variable that expresses the strength of each firm s legal team and their outlooks on success The respective reaction functions for A and B are: C a = ( t) C b C = (1/ t) b Ca 7

8 Spending So, firm A will spend up to the point: de ( V ) dc a or dp V a = 1 = dc a Case Discussion: AT&T Now let s look at AT&T Value to AT&T Based on the difference in NPV, the cost to AT&T of 1 year of regulatory delay of its entry into video service is $ $84.82 =$22.81m How much will AT&T spend? AT&T could spend up to $22.81m to prevent delay to its video service 8

9 Similarly, AT&T gains $[ ] by delaying Comcast for one year from entering VoIP Both companies will try to delay each other, and speed up their own projects. This works out to four outcomes. 1. Comcast enters, AT&T delayed 2. Both Comcast and AT&T enter 3. Both Comcast and AT&T delayed 4. Comcast delayed, AT&T is not Is success certain? We ll use a simple model of the process to estimate the chance of fcomcast s success A Simple Model of Regulatory Investment The likelihood of regulatory success is: P A (approved) = P o +bδi(δ I = $invested by A - $invested by B) 9

10 Regulatory Investment I= P o + b x P 0 : basic probability of approval, assume 50% b: multiplier: assume.04% How much more must Comcast spend to raise the chance of success by 1%? dpa = dδι b Regulatory Investment In this linear relation, each $2,500,000, that Comcast spends more than AT&T will increase Comcast s chances of regulatory success by 1% What chance does Comcast have to succeed? Since the difference between what Comcast and AT&T would spend is greater than $12.5 million, Comcast only needs to spend $35.31m for a 100% chance of success 10

11 Regulatory Investment E(reward) for Comcast = $27.8m * 50% = $13.9m E(reward) for AT&T = $11.28m * 50% = $5.64m Regulatory Investment Comcast will spend $27.8m AT&T will spend $11.28m Regulatory Investment Benefit of investment = E(reward) - reward some delay Comcast = $129.81m - $63.37m = $66.44m Regulatory Investment Benefit of investment = E(reward) - reward some delay AT&T = $118.91m - $84.82m = $34.09m 11

12 Regulatory Competition The more money Comcast invests in the regulatory process the more AT&T will invest Regulatory Competition In order for AT&T to succeed over Comcast, AT&T must outspend Comcast at least $44.5m to $27.8m in order to achieve a regulatory success rate of.834, which is greater than the Comcast success rate of.830, when Comcast spends $27.8m and AT&T spends $11.28m Spending: Example Comcast spends $27.8m AT&T spends $44.5m 50% + (2%($44.5m-$27.8m)) =.834 or 83.4% chance of success for AT&T, which is greater than the success rate of.830 or 83.0% for Comcast if Comcast spends $27.8m and AT&T spends $11.28 Game Theory Game theory can be applied to the Comcast and AT&T cases, similar to the classic prisoners dilemma scenario 12

13 Prisoners Dilemma Explained -Based on a point System that reads (A,B) with (A) representing Comcast and (1,4) the best situation for (A) and (4,1) the worst, where in (4,1) Action of Approved Delayed Comcast is A\Action of B (A, B) delayed while Approved 2,2 4,1 AT&T (B) Delayed 1,4 3,3 is not Possible Scenarios for Comcast and AT&T Comcast Project AT&T Project Approved Approved Com $102.06m AT&T $ (2,2) Delayed Com $129.81m AT&T $84.82m (1,4) Delayed Com $63.37m AT&T $118.91m (4,1) Com ($102.06m) AT&T ($107.63m) (3,3) Possible Scenarios for Comcast Optimal scenario for Comcast is (1,4) where AT&T experiences one year of regulatory delay and Comcast s project is approved, NPV = $129.81m, with Comcast gaining $27.8m and AT&T losing $22.81m Possible Scenarios for Comcast NPV Comcast with entrance of AT&T in Video over DSL NPV Comcast with entrance of AT&T in Video over DSL with one year of regulatory delay for Comcast NPV Comcast with entrance of AT&T in Video over DSL with one year of regulatory delay for AT&T NPV Comcast with entrance of AT&T in Video over DSL with one year of regulatory delay for Comcast and AT&T $102.06m $63.37m $129.81m $102.06m 13

14 Cash Flow to Comcast NPV of the Comcast project with AT&T entry is $102m, factor in 1 year of regulatory delay and Comcast NPV drops to $63.37m, a loss of $38.7m, equivalent to ~38% of $102.06m prior to regulatory delay Cash Flow to Comcast cont. NPV of the Comcast project with the entrance of AT&T experiencing 1 year of regulatory delay is $129.81m, or $27.8m more than the NPV of $102.06m with no delay, and $66.44m more than the NPV of $63.37m with Comcast delay Cash Flow to Comcast cont. Thus, the optimal scenario for Comcast is one in which AT&T experiences 1 year of regulatory delay, preventing it from entering the Video over DSL market Comcast Investment How much should Comcast invest in the regulatory process? 2 Components Comcast should invest $27.8m in the regulatory process: (1) to block AT&T and (2) towards getting its own project approved 14

15 Comcast Investment cont. How much should Comcast invest in preventing Verizon from blocking AT&T? Comcast must invest the the difference of NPV (2,2) and NPV (1,4) Comcast Investment cont. Comcast investing NPV(1,4) - NPV (2,2) = NPV of Comcast with entrance of AT&T with one year of regulatory delay for AT&T- NPV of TW with entrance of AT&T Comcast Investment cont. NPV(1,4) - NPV(2,2) = NPV $129.81m - NPV $102.06m = $27.8m -Thus Comcast should invest $27.8m in the regulatory process to protect AT&T from blocking Comcast Comcast Investment cont. Comcast investment strategy is to delay AT&T, which if successful will provide $27.8m to Comcast, and to prevent itself from being delayed, which if successful will save Comcast from $38.7m in losses 15

16 Comcast Investment cont. In the worst case scenario Comcast experiences one year of regulatory delay, loses $38.7m, AT&T enters the Video over DSL market, and Comcast NPV is $63.37m Comcast Investment cont. Best case scenario AT&T enters the Video over DSL market, experiences one year of regulatory delay, Comcast benefits with $27.8m more than the original value with an NPV of $129.81, a difference of $66.44m between best and worst case for Comcast Option: Co-operation Comcast and AT&T can reduce spending towards governmental regulation by instead agreeing not to oppose each other This would allow Comcast to enter AT&T s market and AT&T to enter Comcast s But government might not agree Option: Co-operation Although self regulation does not provide the optimal scenario (delaying the other company) for Comcast or AT&T, it does however prevent both companies from reaching their worst case scenarios (being delayed) 16

17 Questions for Analysis 4. Where should Comcast invest in the regulatory process? 17