Strategic Bypass Deterrence

In liberalized network industries, entrants can either compete for service using the existing infrastructure (access) or deploy their own infrastructure capacity (bypass). In this paper, we demonstrate that, under the threat of bypass, the access price set by an unregulated and vertically integrated incumbent is compatible with productive efficiency. This means that the entrant bypasses the existing infrastructure only if it can produces the network input more efficiently. The incumbent lowers the access price compared to the ex-post efficient level to strategically deter inefficient bypass by the entrant. Accordingly, from a productive efficiency point of view, there is no need to regulate access prices when the entrant has the option to bypass. Despite that, we show that restricting the possibilities of access might be profitable for consumers.