Unbundling the local loop

We study competition for high bandwidth services in the telecommunications industry by introducing the possibility of unbundling the local loop, where leased lines permit the entrant to provide services without building up its own infrastructure. We use a dynamic model of technology adoption and study the incentives of the entrant to lease loops and compete "service-based", and/or to build up a new and more efficient infrastructure and compete "facility-based", given the rental price. We show that the incumbent sets too low a rental price for its loops; hence, the entrant adopts the new technology too late from a social welfare perspective. The distortion may appear not only on the timing of technology adoption but also on the type (quality) of the new technology to be adopted. We also show that while regulating the rental price may suffice to achieve socially desirable outcomes, a sunset clause does not improve social welfare.