Investment in Next Generation Networks and the Role of Regulation: A Real Option Approach



1 - Introduction

The current regulatory debate in the telecommunications industry in Europe and
elsewhere is dominated by the issue of next generation networks (NGN). The term refers to
the installation of high-speed physical infrastructures, largely based on optical fibre, and to
the use of platforms based on IP (Internet Protocols) for the transmission of integrated
services for voice, data and video. Under many respects the NGNs represent a dramatic
technological shift in the provision of telecom services: new networks enable a bandwith up
to 100 megabits per second, as compared to the maximum of 20 megs currently available
on DSL platforms. On the other hand, NGNs require massive investments by telecom
operators, of the order of several billion euros in a single country, in the face of a
widespread demand and regulatory uncertainty. Demand uncertainty arises because the new
networks are instrumental to a host of new services for residential and corporate customers,
such as Internet TV, e-government, e-health, e-learning and so on, whose acceptance with
final customers is still to be ascertained. Regulatory uncertainty arises because, at this
stage, it is still unclear whether regulators are going to carry over current obligations on
traditional services to NGNs or to apply more lenient rules - even, possibly, a regulatory
forbearance as in the US - taking into account that, differently from traditional networks
built at the time of the state monopoly, NGNs do not exist yet. A summary of the regulatory
debate in Europe will be provided below. Investment in NGNs has been relatively subdued
until now: operators want to know the future regulation of NGNs and to have a better guess
of demand perspectives, before committing a vast amount of resources to the new
networks.

This paper purports to examine the investment decision in NGNs by telecom operators,
in the light of high demand uncertainty. To do so we exploit the real option theory, which
allows us to include the postponement of investment among the options available to firms.
Once the base case is defined and calibrated, different regulatory solutions will be analysed
and their implications for the timing of the investment discussed.



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