Strategic Investments with Spillovers, Vertical Integration and Foreclosure in the Broadband Access Market

We analyze competition between two firms (ISPs) in the retail market for broadband internet connectivity. One of the firms is vertically integrated and controls the input market for local broadband access. The vertically integrated firm may undertake an investment that increases the quality of the input (upgrading to broadband). The retailers’ ability to offer value-added services (broadband services) when the input quality is improved differs. We analyze the effect of a price cap on the input offered by the vertically integrated firm. The total effect on consumer surplus and welfare critically depends on which firm that has the highest ability to offer value-added services. A price cap may have negative effects on the investment incentives. However, if the vertically integrated firm has much higher ability to offer value-added services, an access price cap may increase investment incentives.