Complementarities and the Demand for Home Broadband Internet Services

Abstract

Before the deregulation of Digital Subscriber Line (DSL) services by the FCC in 2005, phone companies were required to share their DSL bandwidth with independent DSL providers. However, despite the large number of independent providers that entered the market, phone companies accounted for 95.3% of all DSL subscribers in 2005. A common explanation for this is based on supply-side factors such as the costs faced by these providers to lease the telephone lines from the phone companies with whom they then had to compete with, as well as price discounts offered by the local phone companies. In this paper, we look for a demand-side explanation for this market outcome. In particular, we study the demand for home broadband Internet services to understand the factor(s) that may have contributed to the competitive advantages of phone companies in the broadband market and use household panel data for the years 2003-2005 prior to the deregulation for our empirical analysis. Given the large shares of the local phone companies, investigating choices of households within the broadband category alone might lead us to the conclusion that households have a much stronger preference for DSL provision from local phone companies - a conclusion that would have been at odds with the accolades received by independent providers for their service. Since local phone and cable companies offer bundled price discounts and the convenience of a single bill across their services, and since these services could be intrinsic substitutes or complements, we investigate the demand for broadband services in conjunction with related services such as cable television and local telephone. We find evidence of strong complementarities between consumption of broadband (cable modem and DSL) and of those related categories. The main source of such complementarities, in our data, is the convenience benefit to consumers from having a single provider for multiple services. Based on counterfactual experiments, our results also indicate that the share of phone companies on the broadband market would have been 48% smaller without complementarities stemming from such a single-provider effect, while in comparison it would have been 19% smaller if there was no price discount offered on the bundle of DSL local telephone.