COMPETITIVE EFFECTS ON QUALITY COMPETITION: A Study of the U.S. Internet Service Provider Market

Abstract

A central focus of much Industrial Organization (IO) literature has been understanding the effects of competition on market entry, pricing, and quality strategy. This paper attempts to understand the effects of competition in the market for Internet Service Provision in various markets around the U.S., both at the census block group level and the census tract level. Much of the study of these companies has been limited by lack of financial data on firms and nonexistence of historical data on prices facing the consumers of these services. This work instead combines data on local competition with a study of service quality, demographic information on local populations, and geophysical data I have constrained and modified to the market level. This paper leverages the empirical framework described in Bresnahan and Reiss (1991) to model market entry and produce estimates of fixed cost effects on market entry. First, I use available data on demographic characteristics and create geophysical and infrastructural variables as proxies for Fixed Costs (FC) to model the various influences on firm presence and quality provision. I then perform two methods of first-stage correction of market competition using instrumental variable regression and ordered probit estimation of the number of competitors in a given market. I use these new variables in the second-stage to model competitive effects on actualized and advertised quality competition and highest quality of service offered in a given market. After accounting for the endogeneity of firm presence, results show a negative influence of competition on quality provision. These results suggest that in a modern, more saturated internet market, companies may compete on price at the expense of quality. Finally, the implications of this trend are discussed, and avenues for future research are outlined.