Convergence in the Digital Economy; An IO Analysis of the Effects of Changing Internet Architecture on Business

Abstract

In this paper we use a novel IO model to show changes in market power that indicate the character of convergence in the digital economy. We show how changing business strategies, including shifts in investment practices, accommodate modular approaches to business by realigning relationships between content and carriage. We assess the ways in which indicative U.S. and European network operators invest in content related businesses such as CDN and cloud services, and how content firms accommodate and encroach upon infrastructure business practices.

Business practices in the digital economy have been strongly affected by recent changes in the structure and dynamics of the internet that facilitate more modular business models. This forces us to redefine the scope of the industry and break away from common categories of digital business that were determined by public policy, regulation and engineering approaches focusing on the layered model of the internet. By breaking away from assumptions about how “telecoms/transport” stands in contrast to “content/functionality” we can have a better picture of both value added and of competitive strategies. Recent court rulings, such as that of the D.C. Circuit Court in Verizon vs. FCC and the decision by France’s ARCEP in Cogent vs. France Telecom illustrate the significance of these new business practices.

Strategic decisions in the digital economy are increasingly based on tangible investments in converged facility to deliver network functionalities and content. The character of this dynamic is best represented by some aspects of modularity theory, which captures the interrelationships among business practices and the architectures of digital networks. We present a model that formalizes an element of that dynamic by capturing the relationship between the extent of commitment by key firms to network operations and content delivery. This contrasts with the normal two-sided market approaches because it accounts for a myriad of interconnecting and semi-autonomous commercial functions that adjust to new business models as the structure of the internet and the dynamics of the digital economy shifts.

Hence, we assess the extent of network engagement for each company by judging the proportion of investment in each element, the proportion of revenue generated from different parts of the business, and the strategic direction the firm is taking. We show the vectors that describe the move towards convergence over the period 2008-2013 and relate these movements to patterns of investment in networks. Our findings reveal the significance of the shift in the digital economy that occurs as content providers invest in digital traffic transport and engage in new institutional arrangements with content delivery networks, internet exchanges, and customer access technologies.

The theory considers an IO model to analyze strategic behaviors by content and carriage firms carriage firms and what the impacts are on investments by key players. This model presents comparative static predictions that are tested with an empirical model using investment data drawn from the annual reports of firms from six countries in infrastructure, content and digital services. Early indications are that this approach both captures recent convergence trends and indicates trajectories of those trends. We also believe that we can come to a better understanding of the relationship between internet policy and formal IO approaches to competition in the digital economy.

Keywords: IO model , internet, market power, digital economy, strategic behaviour

JEL Classification: D40, D57, E65, L96