In the advent of postal market liberalization in several European countries this analysis provides an understanding in which dimensions entering firms will compete with the incumbent and how incumbents may act when they anticipate entry. These insights are valuable as a regulatory framework has to be set up in every country in order to ensure Universal Service, as required by European Regulation. The present model considers entry in a market with vertical differentiation and a geographical dimension where the incumbent firm is required to meet the Universal Service Obligation (USO). That is the obligation to provide a minimum standard, to cover the entire geographic area and to set a uniform, non-discriminatory price. In equilibrium the entrant will offer a higher quality than the incumbent and it will limit its geographical coverage to low-cost areas such as densely populated areas. The limited geographical entry prevents tough price competition, but the incumbent will raise its quality. Thus, the incumbent's customers enjoy higher quality and the entrants' customers receive even higher quality. While consumers benefit the entrant replicates the distribution network. Considering these costs the welfare effect is ambiguous. The experience from already liberalized markets, e.g. Germany, and the model results imply that one can expect a quality increase by the incumbent and an even higher level of service by the entrants. This effect may be realized prior to the effective liberalization date if the incumbent anticipates entry. Since market entry entails only limited specific investments, anticipated entry or potential competition should force the incumbent to raise its quality. Further, the prospect of higher quality may justify the cost borne by the entrants in replicating the distribution network.

Keywords

regulation, liberalization, postal services