Application Of Transaction Cost Economics To Vertical Integration In Telecommunication

Vertical integration has been an issue in telecommunication industry for decades. The local telephone industry was thought to be naturally prone to monopoly. Still today telecommunication markets around the world consist of operators organized as vertically integrated silos. Transaction cost economics (TCE) has been applied to study issues relating vertical integration in many fields. TCE suggests that the total cost that is the sum of transaction cost and production cost sometimes favor market procurement and sometimes internal supply. Firm vertically integrate to economize this total cost.Fiber technology has been deployed throughout telecommunication networks. More and more firms are deploying fiber to fulfill the ever increasing bandwidth demands of the customers. Fiber deployment increases the economy of scale for bandwidth. IP and the Internet create a large variety of services. Earlier the bandwidth was used only for voice so its specificity was high. Introduction of multiple services using the same bandwidth has lowered bandwidth specificity.Basic transaction cost model presented by Williamson is extended to observe the effects of aforementioned factors to the organization structure of telecommunication markets. Fiber deployment will increase the production cost difference. This will increase the market procurement range. Similarly the decrease in bandwidth specificity will increase the market procurement range. A mathematical model is developed to observe these effects.It has been observed that all effects favor market procurement to internal supply. Hence future telecommunication markets will be gradually divided into two groups. One group will consist of bandwidth providers and the other will consist of service providers. Thus the future telecommunication markets will be vertically disintegrated. British Telecom (BT) has initiated a comprehensive fiber deployment plan as a result of which it has started selling bandwidth to other telecommunication operators. BT wholesale is working as a separate department earning huge revenues in the sale of bandwidth to other operators.