Nash Equilibrium And The Oligopoly Situation In Indian Telecom Industry

Abstract

The recent problem faced by Vodafone Idea because of its inability to pay its statutory dues has once again shifted the focus of economists on a very important question: What is the reason that one of the most successful and important sectors of India: The Telecom industry started facing troubles? What led to a situation of a price war between the firms? What led to a steep decline in the number of players in the market that has led to prospective risk of duopoly? All these problems emerged after the entry of a new player in the market which is also known to be the disruptive force in this sector: Reliance Jio.

Although, it is a well-established fact that the telecom sector in India represents the situation of an oligopoly market. But what lacks in the research is how these players affect each other. This paper aims to check if nash equilibrium can be seen in the oligopoly situation of the Indian Telecom Industry or not by emphasizing how the entry of Reliance Jio has affected the strategies of the other players. The research has been conducted using secondary data from the TRAI website and newspaper articles.

Objective of Study

The study aims to check whether a situation of nash equilibrium is seen in the oligopoly situation of the Telecom industry in India with a special emphasis on the effect of entry of Jio in the Telecom market.

Literature Review

Turocy & von Stengel (2001) mentioned that the objective of the study in game theory is the game. The players involved in a game are arranged based on preferences, the information, the strategies they follow, and how they influence the results. Kerk (n.d.) explained the dominant strategy as the best choice for a player for every possible choice by the other player.

Shaked and Sutton in their paper, 'Relaxing Price Competition Through Product Differentiation', conducted his analysis using a three-stage non-cooperative game. According to this analysis, in the first stage, Firms choose whether or not to enter the industry. Then they observe which Firms have entered and which have not entered the market. In the second stage, each Firm chooses the quality of its product and after observing its rivals' qualities, in the final stage of the game, each firm chooses its price. This three-stage process is intended to capture the notion that the price can be varied at will, but a change in the specification of a product involves modification of the appropriate production facilities.

According to Reed Hilgon and Thomas Nagle (1998), a prisoner's dilemma accurately represents a typical profit/loss scenario which shows that pricing is more like a game of poker i.e. the way our competitors respond to our strategies and how we respond to theirs.

Rohit Prasad, in his book 'Game Sutra: Rescuing Game Theory from the Game Theorists' says that a prisoner's dilemma is a phenomenon of the pursuit of self-interest leading to sub-optimal outcomes for all. The phenomenon manifests in many situations, including price competition in oligopolistic industries, where it leads to price wars of the kind we are seeing in telecom services.

Introduction

Economists have always been more excited about an oligopoly structure than any other type of market structure. The reason behind this might be the increasing number of industries that form an example of this structure (Airlines, Virtual Currency, Telecommunications, Oil and Gas, etc) or because, in this structure, the interdependence among the players in the market is the maximum. A. Cournot, A French mathematician, philosopher, and economist applied mathematical models to form a Cournot Model and J. Bertrand gave Bertrand Model that concentrated on the pricing part of the competition. Later on, after researches by many brilliant minds, Game theory started to be used in the analysis of an oligopoly market structure.

Telecom Industry in India

The telecommunication industry in India started as a monopoly. But after LPG reforms in the year 1991, the government recognized the need for opening the sector to private players. The major players in this sector are Reliance Jio, Bharti Airtel and Vodafone Idea with their market share as 32.14%, 28.43%, and 28.89% respectively as of December 2019. This shows a situation of the competition among 3 key players in the market. But, it was not always like this. Mergers and Acquisitions, Bankruptcy, etc are some cases that have become common in this sector recently. Up to 2016, India's telecom sector was dominated by around 10 to 15 firms but by 2019, only 3 major firms are left in the market.

To understand the reason we look on 5 September 2016, the day Mukesh Ambani announced the revolutionary idea of making voice calls completely free and sharply reducing the prices of internet facility. Due to a sudden fall in the prices, many customers changed their telecom operators and went to Jio. Anupam Srivastava stated that Reliance Jio's existence has posed a challenge of survival to other telecom operators in India by sharply reducing the tariffs (Bhatia and Palepu, 2016). The effect of this company on other competitors started showing from Day 1 only as Bharti Airtel which was the number 1 operator in India at that time, lost its share price by 6.4% on BSE.

Then by the end of the quarter, a sharp dip in the revenue of Bharti Airtel warned the economists of the changes taking place in the telecom market. The entry of Jio in the telecom industry had wide effects on the whole economy as the unemployment due to various telecom service provider firms shutting down or merging or getting bankrupt lent the employees in these companies jobless. Reliance Communication blamed Reliance Jio for bringing 'creative disruption' by offering free voice and data services (Economic Times, Nov 15, 2017).

Customers were impressed by the low-cost efficient service of Jio. On the other hand, to cope with the competition, Vodafone and Idea decided to merge to obtain a greater market share and a larger revenue share on 31st August 2018, almost 2 years after Jio entered the market.

Hypotheses

H0: Nash equilibrium cannot be seen in the oligopoly situation of telecom industry in India

or

HA: Nash equilibrium can be seen in the oligopoly situation of telecom industry in India

Techniques Used

Kinked Demand Curve Model

We apply the kinked demand curve theory given by Paul M. Sweezy which suggests that under oligopolies, price rigidity exists because if one of the firms tries to increase the price of the product, none of the other competitors follow suit and, in the end, the firm loses its market share. But if the firm decides to reduce the price, all the competitors will follow him. So there is price rigidity in the market which can be explained with a kinked demand curve which is highly elastic above the prevailing price and inelastic below the prevailing price.

Similarly, in the telecom industry, the lower prices of Jio have made the industry understand that offering lower prices lures the customers. The Kinked demand curve also suggests that under an oligopoly with undifferentiated products, the possibility for collusion is more. This leads to the industry accepting one player as the market leader and the others following it. In this case, Jio has emerged as the market leader and its pricing strategy has forced the other firms to reduce their price.

Theoretical Analysis

Before understanding the concept of the Prisoner's Dilemma or Nash Equilibrium, one thing that needs to be understood is the concept of game theory and its use in economics. Game theory studies how different players in a game take decision when their actions are interdependent. This concept came after the 1944 publication of Theory of Games and Economic Behaviour by John von Neumann and Oskar Morgenstern. Game Theory includes the process of enumerating the different strategic options of all the players in the game and analyzing them to finalize our strategy. Game theory can be further divided into cooperative and non-cooperative game theory. In this paper, our focus is limited to non-cooperative game theory.

The term 'noncooperative' means this branch of game theory explicitly models the process of players making choices out of their interest. Cooperation can, and often does, arise in noncooperative models of games, when players find it in their own best interests (CDAM Research Report LSE, 2001, pp. 6-7). Under the non-cooperative game theory, the Prisoner's Dilemma is a popular example used to understand the concept. Under the Prisoner's Dilemma, two thieves are arrested and put in separate rooms with no means of communication. They can either confess against each other or remain silent. The results of their actions can be as follows:

• If both of them confess, both will be given a sentence for 5 years
• If both of them remain silent, they will be imprisoned for 3 years
• If anyone of them confesses against the other, then the one who confesses goes free and the other is imprisoned for 12 years

Herein if the payoff matrix is used to describe the situation, we obtain the following:

Now, the dilemma here is created when it is realized that both the prisoners if cooperate i.e. remain silent, get the most optimum solution (3+3=6 years of imprisonment). However, if this is seen from an individual point of view, confessing always gives both the prisoners an advantage. If Prisoner A confesses or remains silent, the best thing to do for Prisoner B is to confess. Similarly, whether prisoner B confesses or remains silent, confessing is the most profitable solution to A. Nash equilibrium is a situation in which no player can do better by changing his strategy if he knew the strategy of the other players. Under the prisoner's dilemma game, the Nash equilibrium is obtained when both the Prisoners confess. Say, for example, Prisoner A does not confess while Prisoner B confesses, Prisoner A will get 12 years instead of 5 years. So, he is worse off if he moves away from the Nash equilibrium. And so, he is unlikely to change his decision.

Oligopoly is defined as a market with few large firms collectively controlling large market share and aware of interdependence of their profits and impacts of each firm's strategic decision on their profits and market shares (Lim, 1999). Now, since they are interdependent, two types of market situations can be seen. Either both the firms will collude i.e. they will cooperate to set the price of a product higher than the market-clearing price and act as a monopoly to earn higher profits or they will act for their interest which will lead to the production of output which is much more than the demand leading to the firms offering those products at lower prices, thus earning smaller profits. So, it is better for firms to cooperate. But there's a high chance that these firms might deviate from this decision to improve their market shares.

Here, the situation of a prisoner's dilemma comes into play. Let's say in an oligopoly, the firms decide to offer their goods at almost similar prices. Now, they have the option to either stand by the agreement or to break it and reduce the price of his own good. If all the firms in the oligopoly cooperate, then they will have a security of fixed market share and regular income. Although if anyone of them deviates from the agreement and reduces the price of its good, then the firm offering lower price will be able to capture a large portion of the market and the other firms shall bear the brunt of this step. And if all the firms deviate from the agreement, then the prices of the goods will eventually be low, leading to smaller profits for all the firms without significantly affecting the market share.

Along these lines, the concept of Nash Equilibrium can also be well illustrated with the same example. Let's assume that A knows that B and C will cooperate since A is a rational being and works in his self-interest, it will definitely reduce its price to capture a larger market share. And if A is aware that B and C will deviate, still A will deviate from the agreement to save its market share. So, even if A knows the strategy of his competitors, he has no motive to change his strategy. This is called the Nash Equilibrium.

Using the prisoner's dilemma example and the present situation, if we take into account only the major players of the industry i.e. Reliance Jio, Vodafone Idea, and Bharti Airtel, we find that all the three firms are offering their services at almost equal prices to the customers. So, indirectly they are cooperating with each other. Now looking from the perspective of Vodafone Idea or Bharti Airtel, whether Jio reduces or increases its price to the customers, the most optimal step for Vodafone Idea or Bharti Airtel is to reduce their price. This is because if Jio reduces its price and so does Vodafone Idea/Bharti Airtel, then they all will again offer their services at almost equal prices, the only change is that these prices will be relatively cheaper than before. And so there will be no significant impact on the market share of all these firms.

On the other hand, Jio keeps its prices constant or increases it and Vodafone Idea/Bharti Airtel reduce their price, consumers will be attracted to the services of the firm offering lower prices since they are rational and the market share of such a firm will improve as it will have a new customer base shifting from Jio to Vodafone Idea/Bharti Airtel. In both cases, the step of reducing their price by Vodafone Idea or Bharti Airtel is the most optimum strategy and thus won't be affected even if the other competitor comes to know the strategy of the first competitor. This shows that the Nash Equilibrium can be seen in the oligopoly situation of the Indian Telecom Industry.

If we see the real-world situation as to how the other firms in the market, i.e. Vodafone Idea and Bharti Airtel reacted to the entry of Jio, we find the following:

• Initially, the competitors reported against Reliance Jio for the violation of TRAI Act by offering freebies. Bharti Airtel even blocked the Point of Interconnection (POI) which resulted in failure of calls by the Jio users.
• Bharti Airtel shifted its focus from customers who were buying plans of less than ₹ 35 a month to customers paying better to the firm i.e. users having a higher ARPU (Average Revenue Per User). What the company had in mind was that by letting go of the users who recharge for less than ₹ 35 a month mostly use the network for receiving calls and don’t contribute much to the revenue. But, leaving them would mean ease in congestion which in turn could improve quality of service for high-paying users.
• Vodafone also adopted the same strategy and started focusing on customers providing a higher ARPU
• Both Vodafone India and Bharti Airtel increased their spending on ads by 50% and 30% respectively.
• But the immediate step taken by these firm when they came to know about the new entrant in the market was the most predictable solution for these rival firms: bringing down the prices of the services offered by them and matching their prices with the price of Jio’s services. Airtel slashed its 3G and 4G mobile internet charges by 80%.

Even the present schemes of the three players can be used to draw a conclusion:

• Reliance Jio: The ‘All in one’ plan offers unlimited voice calling and data for a month (essentially 28 days).
• Airtel: Airtel along with providing unlimited calling on any network in India and internet, is also providing exclusive benefits like free subscription to Wynk Music, Airtel Xtream, anti-virus protection, device protection, etc.
• Vodafone Idea: The firm has also started providing unlimited calls to any network and internet.

A proper analysis of the prices depicts the following:

Even after an increase in prices of the mobile and data services after repeated directions from the telecom regulatory authority, Jio still has the advantage of offering services at prices lower than its competitors.

What can be expected in the future?

Jio will most probably not increase its prices in the future, and the other firms will have to continue at lower prices because of the competitive pressures. Not following the above-said criteria will result in the other firms losing their subscriber base and will hamper their ARPU growth.

The companies will have to work more efficiently and draw relevant strategies to offer attractive deals that can help in retaining the customers as the majority of their revenue is accounted for from mobile services (voice and data). This is specifically true for Vodafone Idea as more than 80% of its revenue is from mobile services. On the other hand, Airtel is in a position to handle the competition better since it has other segments that serve as its source of revenue like Airtel business, home services, DTH, and tower infrastructure.

But since mobile services still account for 50% of its revenue, Airtel can’t let go of the stress totally. Moreover, with the recent launch of Jio Fiber (landline and broadband services, free TV, DTH connection and free OTT (over the top) connection (Jio TV, Jio Cinema), Airtel might have to compete with its rival in other segments as well.

Conclusion

From the above analysis, it can be concluded that the Nash Equilibrium can be seen in the oligopoly situation concerning the telecommunications sector in India. As far as the topic of Jio is concerned, then it is no surprise that the entry of this firm has disrupted the telecom industry and is responsible for the sudden change in the strategies of its competitors as well as driving out some of the biggest players in the market towards losses.

But the only logical prediction that can be made about their future actions is that none of the two major players in the oligopoly (Vodafone Idea and Airtel) have been able to control the market and Jio has been the dominant player in this regard. The two firms are not powerful enough to influence the price of the industry as is Jio with its ground-touching tariffs and quality of services that make it a clear choice in front of the customers. Furthermore, the situation of Prisoner's dilemma stands between the rivals Vodafone Idea and Airtel wherein the two, if cooperate can save their position in the market but in case they decide to break this implicit agreement between themselves, they can lose a large part of their market share to Jio.

But what impact it has on the economy itself can also not be ignored. The reduced prices, the cut-throat competition, heavy marketing, and branding, shutting down of companies, mergers, and acquisitions, all of these led to a reduction in the contribution of the telecom industry to the GDP of India.