Entry threat, entry delay, and Internet speed: The timing of the U.S. broadband rollout

• Published date: 01 February 2021
• Author: Kyle Wilson,Mo Xiao,Peter F. Orazem
• DOI: http://doi.org/10.1111/jems.12407
• Date: 01 February 2021

J Econ Manage Strat. 2021;30:3–44. wileyonlinelibrary.com/journal/jems © 2020 Wiley Periodicals LLC

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Received: 17 December 2018

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Revised: 1 October 2020

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Accepted: 13 October 2020

DOI: 10.1111/jems.12407

ORIGINAL ARTICLE

Entry threat, entry delay, and Internet speed: The timing of

the U.S. broadband rollout

Kyle Wilson

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|Mo Xiao

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|Peter F. Orazem

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1

Department of Economics, Pomona

College, Claremont, California

2

Department of Economics, University of

Arizona, Tucson, Arizona

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Department of Economics, Iowa State

University, Ames, Iowa

Correspondence

Mo Xiao, Department of Economics,

University of Arizona, Tucson, AZ 85721.

Email: mxiao@eller.arizona.edu

Abstract

In a rapidly growing industry, potential entrants strategically choose which

local markets to enter. Facing the threat of additional entrants, a potential

entrant may lower its expectation of future profits and delay entry into a local

market, or it may accelerate entry due to preemptive motives. Using the evo-

lution of local market structures of broadband Internet service providers from

1999 to 2007, we find that the former effect dominates the latter after allowing

for spatial correlation across markets and accounting for endogenous market

structure. On average, it takes 2 years longer for threatened markets to receive

their first broadband entrant. Moreover, this entry delay has long‐run negative

implications for the divergence of the U.S. broadband infrastructure: 1 year of

entry delay translates into an 11% decrease on average present‐day download

speeds.

1|INTRODUCTION

The U.S. broadband industry has been plagued by the problem of “digital divide.”The Federal Communications

Commission (FCC) reported in 2015 that 53% of rural Americans but only 8% of urban Americans lack access to high‐

speed Internet.

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This inequality is often attributed to socioeconomic differences in populations and cost differences

across terrains, as broadband providers prefer highly‐populated, more affluent markets with potential for growth.

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Meanwhile, if multiple providers enter the same location, competition will erode profit. Broadband providers then face

the task of balancing the underlying demand and cost shifters with competition intensity, leading to highly strategic

local market entry decisions. Since the advent of the industry, Internet service providers (ISPs) have sought to optimally

locate and expand while responding to their rivals' attempts to do the same, and these interactions have given rise to the

competitive landscape we face today.

We examine the early U.S. broadband industry and its aftermath under the lens of “path dependence,”the de-

pendence of economic outcomes on the path of previous outcomes, rather than simply on current conditions

(Arthur, 1989; David, 1985). In the early 2000s, the Internet industry is in its infancy. Potential entrants, whether they

are telecommunications veterans or new start‐ups, roll out their network gradually and strategically. Looking for the

next market to enter, a potential entrant must anticipate the actions of potential rivals in the marketplace. Entry timing

depends on the countervailing forces of expected competition, preemption incentives, and cost differences. A potential

entrant may delay entry, anticipating that rival entry lowers the expected profitability of a local market. Or, it may

accelerate entry to preempt competitors, especially if an early mover can make an irreversible investment in building

capacity, if consumers have switching costs or inertia, or if the new entrants face financial constraints.

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A firm may also

simply spill over to a neighboring locale if nearby network facilities give rise to a cost advantage. In this paper, we

establish a setting that offers the opportunity to identify markets which face a credible threat of entry, and we estimate

the impact of such a threat on firm actions. We discover a strong “entry delay”effect, suggesting that in the short‐run,

the expected competition effect outweighs the combined effects of preemption and cost advantages. More important, we

find that this delayed entry into a local market early in the evolution of the industry has a direct effect in the market in

the long run, as subscribers there face slower download speeds more than a decade later.

We use the FCC's bi‐annual Form 477 data from 1999 to 2007 on the evolution of local market structures of

facilities‐based broadband providers at the zip code level. This data does not contain information on firm identities,

which limits our ability to analyze firm‐level heterogeneity along the lines of Mazzeo (2002). Nonetheless, the FCC's

Form 477 data is the most complete data available for the early period of the U.S. broadband industry, and allows us to

generate interesting insights about firms' entry strategies. In examining the data, we define a potential entrant to be

threatened when a neighboring market houses at least one of its rivals. We then use the timing of entry into the market

to understand how a firm's entry strategy is affected by the threat of future competition. Furthermore, we investigate

whether the timing of entry has long‐run implications for the current state of the industry. Specifically, we estimate the

extent to which delayed initial entry into a market affects the download speeds available in 2013 using detailed speed

data from the National Telecommunications and Information Administration's (NTIA) National Broadband Map.

The empirical strategy we adopt is as follows: we construct a latent variable representation of a market's profit-

ability, which depends on observable market characteristics that affect demand and costs, and critically, whether or not

a market is threatened by future entry. We then estimate the effect of entry threat on the probability of entry into a

market, and on the length of time elapsed until a market is eventually entered. Lastly, we estimate the effect of the

number of years of entry delay on the download speeds available in a market more than a decade later.

Within this framework, we recognize that whether or not a market is threatened is determined by previous entry

into neighboring markets. Therefore, if characteristics of neighboring markets which induced entry there are correlated

with unobservable characteristics in the market of interest, then entry threat is endogenous. Additionally, if, as we

claim, a prospective entrant into a market considers the market structure of neighboring markets when making its entry

decision, then it must be true that incumbents in neighboring markets have engaged in a parallel exercise that

incorporates their expectations about entry into the market of interest. This selection of entry threat further aggravates

the endogeneity problem of our entry threat indicator.

We address these problems with two remedies. First, we allow markets close to one another to have spatially

correlated error terms. Second, we instrument for entry threat using the market attributes of nearby markets. Speci-

fically, these nearby markets are the second‐order neighbors (i.e., neighbors of neighbors) of the market of interest.

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These attributes directly affect entry into the second‐order neighbors themselves, which then allows them to more

easily enter neighboring markets and therefore, by definition, affects the threat of entry into the market of interest. At

the same time, these attributes can be considered exogenous to a potential entrant's decision to enter the market of

interest, as long as attributes of markets which are two or more zip codes away do not directly affect entry into the

market of interest.

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In other words, we assume that firms do not enter a market because, at some future date, they plan

to enter a market two zip codes away. During the years we study, the industry was in its infancy, leaving firms with

tremendous uncertainty over firm turnover and future profitability. It is therefore reasonable to assume that firms do

not have a perfectly forward‐looking plan for broadband rollout.

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Using these instruments, we estimate parameters of

the model, including the extent of spatial correlation, in a generalized method of moments (GMM) framework

developed by Pinkse and Slade (1998).

We find evidence that potential entrants place significant consideration on the possibility of future competition

when making their entry decision. First, we demonstrate that our measure of entry threat is, in fact, credible: threa-

tened markets are 8 percentage points more likely to be entered in the long run. However, in the short run, a market

which is threatened by the entry of competitors is 20 percentage points less likely to be entered than its unthreatened

counterpart. This is a substantial effect, as it represents the net of three separate effects: a threatened market may be less

likely to be entered because firms are unlikely to maintain market power; but on the other hand, it may be more likely

to be entered due to preemptive motives; and finally, a threatened market, by definition, has firms nearby that can spill

over due to economies of scale. Following this, we show that an open threatened market will, on average, wait about

2 years longer before being entered by its first broadband provider.

This delayed entry turns out to have important implications for the long‐run development of broadband infra-

structure. We find that for each additional year that initial entry is delayed, the download speeds available in 2013 fall

by 11%. A priori, the expected direction of this effect is ambiguous. One might imagine that markets which experience

delayed initial entry would receive the latest technology and therefore would have access to faster speeds today.

However, nearly all markets in the U.S. had received their initial entrant by 2007, and the prevailing speeds of that time

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do not even meet the FCC's current definition of broadband. Instead, we argue and provide evidence that markets

which experience delayed entry take longer to become competitive and therefore lack the sustained competitive

pressure necessary to spur investment in quality improvements.

These findings fill in a relatively sparse empirical literature on the effects of entry threat on firm strategies. The

theoretical literature is well developed, and has shown that firms facing the threat of a rival's entry have incentives to

act preemptively. Notable studies have developed different mechanisms to explain why incumbents do not delay costly

competitive actions until actual entry happens. For example, Spence (1981) shows that firms have incentives to enter

early and invest to deter competition, and that early entrant advantages are magnified by learning. Milgrom and

Roberts (1982) stress the importance of reputation and asymmetric information in deterring entry. Klemperer (1987)

showed that firms adopt pricing strategies which take advantage of consumers' cost of switching to a new entrant.

Because identifying entry threat is difficult, there are only a handful of empirical studies on the effects of entry threat on

incumbents' behavior. Ellison and Ellison (2011) propose that an incumbent firm's investment may be non‐monotone in

“market attractiveness”if investments are undertaken to preempt rivals from entering, because preemption is impossible in

the most attractive markets. They then find evidence of this behavior in the pharmaceutical industry. Dafny (2005)similarly

finds evidence of strategic investment behavior to deter potential entrants in the hospital industry. Goolsbee and Syverson

(2008) find that incumbent airlines cut prices dramatically in response to the potential entry of Southwest,and confirm that

this action was motivated by preemption rather than accommodation of their future competitor. Prince and Simon (2014)

extends Goolsbee and Syverson (2008)tothenon‐price dimension. They find incumbents' on‐time performance actually

worsens in response to Southwest's entry threat and actual entry, and attribute this counterintuitive result to incumbents'

incentives to differentiate from the high‐performing potential entrant.

Most recently, Shapiro (2016) shows that pharmaceutical firms strategically delay the introduction of new versions of

drugs until just before patent expiration of the original drug so their reformulated drugs compete directly with newly‐

entered generic drugs instead of the incumbents' own original version of the same drug;

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Wen and Zhu (2019)findthat

when Google threatens to implement a new native app in its Android operating system, developers of similar existing apps

shift innovation toward improving their unthreatened apps and developing new apps. These e mpirical findings point to a

common theme: the incumbents' actions when facing entry threat depend on whether the entry threat can be deterred. If

entry threat cannot be deterred, the incumbent faces a lowered expected profit stream as if entry threat is actual entry.

This insight carries over when we study potential entrants facing entry threat from other potential entrants.

Potential entrants, like incumbents, may be incentivized to quickly enter a threatened market in an effort to preempt

their rivals. But, they may also be motivated to delay entry, fearing that the market may become competitive and

therefore less profitable in the future. Which of these effects dominates is therefore an empirical question, depending

on the strength of the entry threat. Seamans (2012) shows that incumbent cable television providers, acting as potential

entrants in this case, were more likely to begin offering Internet service in areas where the local government might

provide Internet service in the future. Conversely, in our setting, we find that the effect of expected future competition

dominates. We provide evidence that even after controlling for factors that influence demand and costs, ISPs delay entry

into markets that are threatened by future entry of rivals.

More broadly, our work relates to the literature on the effects of market structure on quality provision. Theory

predictions on the effect of market structure on quality provision is less clean cut than that on prices. Matsa (2011)

shows that supermarkets facing more intense competition have better product availability. Mazzeo (2003)) finds

average flight delays are shorter in more competitive markets; Prince and Simon (2017), however, find airline mergers

have negligible impacts on airlines' on‐time performance measures. More relevant to broadband, Wallsten and

Mallahan (2010) and Molnar and Savage (2017) find that competition in wireline ISPs increases wireline Internet speed.

Our work adds a new angle to this line of work: we focus the past strategic actions of firms, which translate into

meaningful differences in the quality of Internet access available more than a decade later. Our results hold even after

controlling for current market structure.

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In other words, firms' past actions, which determine past market structure,

have independent effects on both the market structure and firm performance we face today.

2|THE EVOLUTION OF BROADBAND INTERNET

AND THE DIGITAL DIVIDE

The 1996 Telecommunications Act was passed with the goal of encouraging competition in local telecommunications

markets, largely by removing barriers to entry and by requiring incumbent firms to lease their lines to competitors. The

WILSON ET AL.

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