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The Effect of Competition on the Price and Quality of Triple-Play Bundles: Evidence on the Brazilian Telecommunications Market Tainá Leandroa,c Victor Gomesb December, 08, 2019 Declarations of interest: ‘none’ _______________________________ a University of Brasília, Brazil. c National Regulatory Agency for Private Health Insurance and Plans (ANS), Rio de Janeiro, Brazil. Rua Augusto Severo, 84, Glória, Rio de Janeiro – RJ. CEP: 20021-040. Corresponding author. E-mail: [email protected]. b University of Brasília, Brasília, Brazil, Campus Universitário Darcy Ribeiro, Caixa Postal 04587, Brasília, DF. ABSTRACT: This empirical study seeks to estimate the effect of competition on the price and quality of triple-play bundles, by applying the difference-in-differences empirical model to data on the three largest telecommunications groups in Brazil. Results show competition promoted reduction in prices, up to 7.7%. Only one group reacted to competition by increasing the price of its services. However, at the same time, it improved the quality of pay TV and broadband services bundled in its triple-play offers. We also show that a tax exemption implemented during the period led to a 15% reduction in prices of one of the assessed groups. Keywords: Competition, telecommunications, broadband, triple play, quality JEL classification: L15, L52, L86 1. Introduction In Brazil, bundles of broadband, pay TV, and landline call services, known as Triple Play, have been increasingly adopted by service providers – in 2016, the service was available in 63% of cities. This commercial strategy has ambiguous effects on the telecommunications market, as such services may provide consumers with benefits or lead to less competition in wholesale and retail markets (Burnett, 2014; BEREC, 2010). However, the literature on telecommunications bundles in the Brazilian market is scarce, in part due to the lack of data on the supply and demand for this type of service. The present study seeks to fill this gap, by estimating the effect of competition on prices and quality of triple-play bundles offered by the three major Brazilian telecommunications companies – Oi, NET and Telefônica. To this end, a dedicated cross- sectional database was created holding information on offers, by municipality, made available by telecommunications companies that sell triple-play. Besides prices and average discounts for this type of service, information was also collected on product characteristics. Hence, this allowed the assessment of several aspects related to the quality of services which, together with prices, are a key element of competition among economic groups in differentiated product markets (OECD, 2013). Following the empirical analyses performed by U.S.1 and Brazilian antitrust authorities (DEE/CADE, 2015a, DEE/CADE, 2015b), two difference-in-differences models were devised, controlling for demographic and economic characteristics of local markets that could explain fluctuations in prices and in the quality of services.2 Both models adopted dummies for the number of rivals in each municipality as proxies for the level of competition. The first model assumes that companies react to competition by changing only their prices. The impact of competition on price was estimated by ordinary least squares (OLS) with robust errors, while controlling for the characteristics of triple-play bundles. Results suggest both Oi and Telefônica reacted to the presence of competitors by reducing the prices of their triple-play bundles. However, this effect was more marked for Telefônica: the presence of two competitors caused prices to decrease by up to 8%. Net, in turn, reduced prices to compete with Telefonica and Algar. However, the presence of Oi had a positive impact (less than 1%) on the price of their services. This counterintuitive result could indicate asymmetric competition: Oi reduced the price of its services to compete with NET, but not vice-a-versa. With regard to NET, the present study also investigated the effect of the government policy providing incentives for broadband services, known as Popular Internet.3 Results reveal that this tax exemption program had a marked impact on the prices of triple-play bundles, reducing them by approximately 15%, a rate significantly higher than that associated with the presence of competitors (less than 1%). It should be noted that, in municipalities where Oi was the sole triple-play provider, the firm offered pure triple-play bundles, whereby consumers were unable to purchase Pay TV services separately.4 This commercial strategy accounts for a price hike of around 6%, indicating that tying does indeed have negative consequences for the final consumer. 1 Concentration Act between Staples and Office Depot, 1997. 2 See also Miller and Weinberg, 2017. 3 This program grants tax exemptions in exchange for lower-priced services in municipalities, as a strategy for introducing broadband services to the rural interior. 4 The economic literature usually adopts “pure bundling” or “tying” for the sale of two or more goods or services jointly, without the possibility of purchasing the products separately (OECD, 2015). The second model, in turn, assumes that companies react to competition by changing their prices and the quality of their services. As the quality of triple-play packages is multidimensional, comprising broadband, landline calls and pay TV, a system of simultaneous equations was estimated using linear regression with instrumental variables and robust errors. The model was applied only to NET, since this company had the largest variation in quality of services between local markets. Results indicate that the presence of Oi had a positive effect on speed of broadband services, whereas GVT had a negative impact. This suggests that NET sought to differentiate their bundled services by offering different speeds from those provided by its competitors. Regarding pay TV, NET did not change the characteristics of this service to compete with GVT or Algar, but competed with Oi by increasing the number and image quality of television broadcast channels included in its pay TV packages. The remainder of the paper is organized as follows. Section 2 provides a review of the previous literature on triple-play bundles and of the impact of competition on the price and quality of telecommunications services. Section 3 outlines the triple-play market in Brazil, whereas Section 4 describes the database used for the empirical analysis. Section 5 details the empirical method employed in the analysis. Section 6 discusses the identification strategy and results for the first model, which estimates the impact of competition on price only. Finally, Section 7 addresses the results obtained for the second model, which estimates the impact of competition on both price and quality of bundled services. Section 8 reports the conclusions drawn. 2. Previous literature Economic theory states that bundling has two main possible consequences: efficiency gains or anticompetitive effects (Burnett, 2014; BEREC, 2010; OECD, 2014). On the one hand, this commercial strategy allows operators to better allocate fixed costs and has potential positive effects on the market if it enhances consumer choice (OECD, 2015; 2014; and 2011).5 On the other hand, it may rise the barriers to entry or marginalize players who cannot offer some component of the bundle (Nalebuff, 2004; OECD, 2011 and 2015; BEREC, 2010). These effects reduce overall well-being and can lead to higher prices or lower quality of final services to consumers. Since the theory concerning the impact of bundling is ambiguous, empirical research are crucial to evaluate the effects of this commercial strategy on the telecommunication market. Some studies investigated whether triple-play bundles alter households’ payoffs, making individuals less likely to switch their service provider (Prince and Greenstein, 2014; Burnett, 2014; Lee, 2017; Lunn and Lyons, 2018).6 Some analyses have focused on firms' incentives to bundle, especially if adopted as a strategy to price discriminate (Crawford and Shum, 2007 and Macieira et al., 2013).7 5 Bundles are associated with benefits such as unified billing, discounts for consumers and further possibilities for innovation. 6 Prince and Greenstein (2014), Burnett (2014) and Lee (2016) investigated whether triple-play bundles altered households’ payoffs, reducing churn, in the telecommunication market of the US, UK and South Korea, respectively. The studies found that bundling makes individuals less likely to switch their service provider, possibly because of changes in switching costs. Lunn and Lyons (2018), however, found mixed evidence for the Ireland triple-play market: bundling was associated with lower switching preferences for landline customers, but had a positive association for broadband users. 7 Crawford and Shum (2007) and Macieira et al. (2013) test whether bundling reduces consumer heterogeneity, allowing firms to price discriminate, in Pay TV and triple-play markets, respectively. Both studies found a discriminatory effect associated with bundling. Other investigations specifically address how triple-play affects the competition between operators. Pereira et all (2013), after performing the SSNIP test using a cross- nested logit model, concluded that bundles of telecommunication services are a relevant product market in the sense of competition policy. In Brazil, Leandro and Gomes (2017), adopting a nested logit model to estimate the demand for broadband, found that

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