Regulating Competition in Oligopoly:
The Case of Telecommunications in
Brazil
Mario Possas
Institute of Economics, Federal University of Rio de Janeiro, Brazil
Av. Pasteur, 250 – Urca, Rio de Janeiro- RJ, CEP 22.290- 240, Brazil
Tel 55- 21- 295- 1447
e- mail: possas@ie.ufrj.br
Jorge Fagundes
Cândido Mendes University, Rio de Janeiro, Brazil
Av. Rui Barbosa, 532/1201 – Flamengo, Rio de Janeiro- RJ, CEP 22.290- 240, Brazil
Tel 55- 21- 552- 7860
e- mail: fagundes@ie.ufrj.br
João Luiz Pondé
Institute of Economics, Federal University of Rio de Janeiro, Brazil
Av. Pasteur, 250 – Urca, Rio de Janeiro- RJ, CEP 22.290- 240, Brazil
Tel 55- 21- 295- 1447
e- mail: ponde@ie.ufrj.br
Regulating Competition in Oligopoly: The Case of Telecommunications in Brazil
Abstract
The paper discusses the transition from active regulation in natural
monopolies to the “reactive” regulation required by oligopolistic market structures.
The typical anticompetitive risks that characterize the transition period in Brazilian
telecommunications sector are analyzed and some preventive measures indicated,
which should be implemented both by regulators and antitrust authorities.
I. INTRODUCTION
Public
utility
sectors,
including
telecommunications
services,
were
traditionally organized in natural monopolies, capable of operating with lower
production costs than a competitive market structure. In order to protect
consumers from their market power, however, prices have been regulated through
either the nationalization of the companies or conventional regulation by
specialized agencies.
Changes in technological and market conditions in the telecommunications
services, usually organized in private or public monopolistic structures, have
produced a structural change, whereby competition through newcomers coexists
with the need for market regulation in segments still monopolized. As a result, this
sector has been simultaneously caught under regulatory regimes and competition
policy rules, determined by the antitrust legislation of each country. It has been a
difficult task to harmonically integrate these two dimensions, although both of
them are necessary to limit the monopolistic market power as well as to strengthen
competition.
In this context, the role of competition policy is essential to avoid strategic
use of dominant position from incumbent firms –by restricting competition in
their markets or by improving such position through mergers or strategic alliances
with competitors. On the other hand, since public utility sectors are still partially
regulated, it is important that regulation criteria be consistent with the objective of
promoting competition.
This article intends to provide a first assessment of the consequences of the
implementation of a transitional regulatory structure for stimulating competition
and/or economic efficiency of the telecommunication services sector in Brazil, a
country where little if any regulation in the economic sphere has been experienced
besides direct state intervention . In other words, to promote a change, as brief and
effective as possible,
from
a natural
monopolistic
structure
(also
under
government control in Brazilian case) to a situation where some competition
exists, in the limited sense of a non- monopolistic market structure (and almost
always an oligopolistic one). Generally, the new challenge does not consists of
regulating (only) monopolistic structures anymore, but also oligopolistic ones,
either in the previously monopolistic sectors now open to competition, or in the
sectors that still have a monopolistic structure but are now vertically related to
others, and are therefore oligopolistically interdependent (in a strategic way) with
the open ones, as is the case in telecommunications.
The following section provides a general theoretical approach to the nature
and importance of the regulation of such “transition” towards a competitive
structure, or more precisely, towards deregulation in public utilities. The third
section points out the importance of competition policies aiming at improving
competitive conditions in telecommunications services markets. The Brazilian case
is presented in the fourth section, summing up the present institutional
competition policy criteria along with the privatization and regulatory processes in
Brazilian telecommunications services, followed by a discussion of the structural
conditions in different markets that could originate competition problems. Some
such problems are briefly discussed, where preventive or repressive actions from
the regulatory agency are deemed necessary. This involves a special concern in
continuous monitoring of structural conditions as well as potential anticompetitive
actions and requires, at the institutional level, an integrated action with
competition policy agencies.
II. FROM NATURAL MONOPOLY TO COMPETITION: RATIONALE AND
CONSEQUENCES TO REGULATION
(a) Theoretical references
Reasons usually put forward by the literature to support public regulation of
economic activities are related to the so- called “market failures”, of which natural
monopoly is the most easily recognized as a candidate to active regulation. In spite
of having its economic analytical support now widely spread and accepted, such
kind of state intervention paradoxically no longer has its empirical preconditions
as often found as before.
Economic literature traditionally considers natural monopoly to be the only
kind of market structure that allows for a theoretically supported public regulation,
assuming that unit cost reduction due to operation of a single production unit
(plant or firm) offset the costs and risks of its regulation. Regulatory policy is
usually centered on price setting at minimum average costs for a given demand;
and on blocking entry in the market(s) so as to allow either expected gains from
efficiency increases or, in some cases, the adoption of cross subsidies.
The presence of a natural monopoly is presumed in face of significant scale
or scope (in case of multi- product) economies relative to market size, at a
minimu m average cost pricing level (corresponding to minimum efficient scale);
or, more technically, whenever long run cost is significantly subadditive at that
quantity (single or multi- product).
In such cases, regulation is often regarded as the only solution to avoid three
lower welfare alternatives 1: free operation of a private monopoly; free operation of
several private firms at sub- optimal scales and higher costs, although at lower
margins; and state- owned production at an efficient scale but subject to
inefficiencies
resulting
from
a politically biased
and/or
a low incentive
management as for productivity and quality improvement.
Basically, regulation consists of maintaining capitalist production - thus
keeping at least part of the incentives which private property and market system
are supposed to entail - while at the same time restricting the autonomy of
decisions, replacing profit seeking behavior by administrative rules in the decision
making of the regulated company. In general, such rules may be classified in three
categories 2: limitations to entry in and exit from a market; specifications
concerning quality of output; and criteria for price determination.
Once accepted that the main motivation for regulatory intervention comes
from the structural features of the industry and/or market that significantly
hamper the competition process, public utilities could at first be able to exhibit an
endogenous drive capable of rendering unnecessary any regulation 3. By definition,
one can immediately conclude that a movement away from the natural monopoly
situation will take place whenever the settlement of another efficient plant
becomes feasible through market growth, fixed costs reduction and/or variable
1 VISCUSI et alii (1995), ch. 15.
2 WEYMAN-JONES (1994).
3 We do not intend to give a complete account of possible reasons for regulation policies: for
example, such social dimensions of regulation as universal access to public utility services are left
aside.
costs increase. 4
(b) From natural monopoly to oligopoly
The change of a natural monopoly into a competitive structure, from the
demand side, is mainly due to a high rate of growth of demand, leading to a market
size that is large enough to make sustainable (in the contestable markets jargon) a
structure with more than one efficient size operating unit. From the supply side,
technical progress is no doubt the most relevant variable, although input price
decreases may also have important effects. The deterioration of a natural
monopolistic position may result from three kinds of technological change:
(i)
a decrease in scale economies and/or in fixed costs in proportion to variable
costs due to technical innovations, within the existing stock of technologies;
(ii)
a radical process innovation, allowing the same output to be produced with
a completely new technology, involving lower minimum scales and sunk
costs;
(iii)
the emergence of new substitute products and resulting changes in market
boundaries, so that a natural monopoly eventually becomes a monopoly of
a specific product variety within a larger market, composed of a greater
product mix and many rival producers.
As a consequence, the evolution of the parameters which rule the operation
of a regulated sector should be subject to frequent monitoring by regulatory
agencies and policy makers. As discussed in VISCUSI et alii (1995, ch. 15), changes
in conditions determining the existence of a natural monopoly, that may
eventually lead to open it to competition, put difficult challenges to regulation.
Foremost decisions are those concerning the amount and scope of
regulation to be pursued. In an “orderly” scenario this takes place whenever
demand and/or supply changes bring about the feasibility of one more efficient
supplier, within a reasonably delimited market. In this case, the main challenge for
the regulator is, when analyzing these changes, to find the appropriate timing for
removing regulation, so as to:
(i)
take
advantage
of the
increasing
competitive
pressures
to replace
administrative controls by market mechanisms, leading producers to
4 VISCUSI et alii (1995), p. 482.
spontaneously adopt welfare promoting behavior;
(ii)
discourage
monopolists
to
adopt
entry- deterring
strategies
towards
newcomers;
(iii)
adapt to the new context, or else eliminate, cross subsidy mechanisms
directed to groups of consumers.
Regulation becomes even more difficult in a “disorderly” scenario, in which
transition from a natural monopoly proceeds amidst the emergence of new
products/services or a change in important features of existing products. The
introduction of competitive pressures in this case goes along with less sharp
boundaries between markets and with firm diversification strategies, which turns
the regulation more complex.
Not only the timing for regulation weakening or even removal must be
decided, but also the definition as to which products should be under the scope of
regulation; what controls should be set on entry into new markets - e.g. as to
permission or prohibition for a regulated monopolist to enter into a market under
deregulation -; and how to avoid the so- called “cream- skimming” that takes place
once a possibly inefficient newcomer enter a more profitable market, leaving the
less profitable one to the incumbent.
(c) Implications for regulation
In any of these conditions for a public utility sector in transition from a
natural monopoly, three possibilities for policy arise: to keep regulation
unchanged; to fully “deregulate” it, allowing free entry; or some partial
“deregulation”. In the latter case, short run anticompetitive risks associated with
immediate “deregulation” would be avoided through elimination or reduction of
restrictions to entry, along with holding a strong control on prices. One possible
policy would be to set minimum and maximum price limits, while letting them free
to fluctuate within this band; another is to allow price changes except when under
suspicion of anticompetitive conducts 5. On the other hand, minimization of long
run risks require a gradual removal of controls on firms strategies concerning
growth, investment and diversification and to direct regulatory policy towards the
5 When the problem amounts to the dominant position of the former monopolist, its prices may be
put under control while the new entrants’ may be left free.
shaping of the new market structures.
Such partial deregulation policy is desirable when: (i) the change in market
structure is a gradual process instead of a one- shot event; and (ii) there is
uncertainty as to the future evolution of cost and demand conditions, so that any
forecast of future competitive conditions in this market is difficult and not much
reliable. It seems sensible to assume, from now on, that this is the most frequent
case, and as such to take it as a reference for the following discussion. This is the
usual choice in actual situations, where for whatever political or economic reason a
gradual - sometimes very long - transition to competition, or to deregulation , is
preferred 6. This situation may in general be expected to stabilize (if at all) not in a
competitive market structure, but in an oligopolistic one.
It is worth noting that to regulate such oligopolistic structures - no longer
natural monopolies, it should be stressed - is in general not desirable in itself from
an economic efficiency standpoint, but a requirement imposed by institutional
preconditions; i e., by the fact that the sector has already been under some kind of
regulation. Given the regulation, it may (in principle) increase the level of social
efficiency of the market either setting the price or rate (as well as quality
parameters), or controlling entry. It is easy to conclude, in particular, that price
regulation usually implies some entry control, since any price above average cost
may attract inefficient (with cost above minimum level) entrants.
In the first place, partial regulation on prices will usually keep some
relatively flexible controls - for instance, upper and lower price limits - so as to
prevent respectively, after entry took place, collusion and consequent abuse of
market
power
through
monopolistic prices, and
competitors. The latter depends
predatory
prices against
on possible financial advantages for the
incumbent (former monopolist), and/or its dominant position in some market
allowing to finance predatory prices elsewhere.
Partial price regulation may in some cases be rightly asymmetric in face of
newcomers and incumbent, keeping control solely on the latter in order to avoid
market power abuses against the former. However, this policy option may cause
distortions - such as when regulatory policy intends to preserve a cross
6 For example, when a soft transition is intended toward deregulation so as to minimize lobbies or
to face a political stalemate, or when the regulatory agency feels very uncertain as to the actual
conditions of demand and cost in the regulated market(s).
subsidization by the incumbent from a market open to competition toward
another in which it holds a monopoly. In the presence of scope economies this
may entail an inefficient entry from a hypothetical single- product firm trying to
profit from the higher price set by the incumbent in that market to subsidize a
price lower than cost in the other (monopolized) market 7.
Secondly , partial regulation may also involve entry restrictions on some
markets; for example, when
transition
regulatory policy still preserves a
monopolistic position in a market, from which the regulated incumbent could be
able to perform a predatory control on other non- regulated markets, so that to
forbid its entry in these other markets is justifiable. In the literature this subject is
called the separation problem of markets in which the former monopolist
incumbent might possibly operate, forbidding its permanence or entry in some or
all of the non- regulated ones.
Possible competitive gains from preventing abuses of market power from a
monopolist in a regulated market toward non- regulated ones - whatever the
discriminatory practice involved (predatory pricing, vertical foreclosure, etc.) should be weighed against the disadvantage of excluding from the latter an
important potential competitor.
(d) Regulatory problems during transition
Two basic groups of problems may be faced by the regulation of
oligopolistic industries with some competitive potential, according to the
literature: those emerging in situations where regulated prices are set above costs
(more often) and those associated with prices below costs. In both cases entry and
exit are supposed to be forbidden by the regulators.
In the first case, typical problems are:
(i)
productive inefficiency, where costs are higher and quality of products or
services lower than the expected outcome of free entry, due even to extraprice collusion;
7 This is the “cream- skimming” practice mentioned above. It can theoretically be prevented if
regulators impose Ramsey pricing (whereby margins over unit costs in each market are inversely
proportional to respective demand price- elasticities), which entail sustainable market shares for the
incumbent but at the same time may cause the politically desired (for regulatory policy) low prices
to become unfeasible in the subsidized market.
(ii)
excessive product differentiation , advertising included (not necessarily
through quality), induced by the impossibility of price competition.
In the second case (prices below costs), a cross- subsidization policy is
typically employed to make such activity economically feasible. This policy usually
entails welfare losses in the diverse markets involved, which may in principle be
justified by other policy objectives (such as distributive equity). Low profits that
normally result may create difficulty to investments needed to increase efficiency
in such activities and may even rise capital costs to the point that the firm’s
productive capacity as well as its productive, technical and innovative performance
deteriorate, to the eventual long run damage of product quality, variety and prices,
and therefore to the consumer’s detriment
(e) The importance of transition
A point deserving to be stressed is that, in a good number of cases,
regulators of a sector in which a former natural monopoly is being dismantled
should concentrate their attention in a careful management of the transition
toward new market structures. During this period, public intervention may not only
affect the pace or the smoothness of the transition, but the point of arrival itself. In
other words, such transition cannot be reduced to a shift between two equilibrium
structures, whose actual trajectory does not affect the final or “long run” result.
Partial regulation features not only follow a transition; but they are one of the main
factors conditioning the market structures that will eventually emerge in such
sectors.
Strategies adopted by regulated firms during the transition phase have in
consequence a decisive role. Under sunk costs, increasing returns accruing from
technological learning and network externalities, as is usually the case in
telecommunications services, the making of competitive positions by the agents
follow irreversible paths. Although various market structures could initially be
possible, the evolution of the real one consists of a sequential elimination of
alternative paths, part of which is effected by entrepreneurial decisions that do not
necessarily lead to a satisfactory result from the standpoint of social welfare.
Once assuming the role of establishing restrictive parameters to strategic
behavior of firms during the transition, regulatory agents enter a twilight zone
between conventional regulation and antitrust policy. The main issue ceases to be
the speed in which the former natural monopoly is divested, and shifts to such
ambiguous problems as which kind of oligopoly will eventually emerge and how its
configuration may - and should - be conditioned. As we shall see below, this brings
forward some original normative problems, in the sense that while traditional
regulation intends to substitute for (non- existing) competition, while competition
(antitrust) policy intends to look after its preservation, the management of
transition involves the construction of competitive environments.
(f) Strategy
The preceding discussion emphasized that, among the determinants of the
dynamics of sectors that are leaving the position of natural monopolies, the
strategies adopted by incumbent firms that are already established or in the
process of becoming established form the basis for the market structures that will
be shaped - and also, the type of regulation that will prove most efficient during the
transition into the eventual oligopolistic structure. Technological trends, changes
in market boundaries and the different capabilities and assets accumulated by
firms in the past interact and generate opportunities and stimulate that make them
redimension the scope of their activities.
Business strategies can be part of defensive movements towards a raise - real
or expected –in competitive pressures, especially the entry of new competitors in a
market where monopoly was institutionalized. The variety of actions that can be an
instrument of what is generally called strategies of entry deterrence is very wide, as
illustrated by the proliferation of models based on game theory to study the
conditions of many of their modalities.
An important aspect stressed by the authors is the capacity of an established
firm’s behavior of having a permanent effect on the market structure. In this
context, such behaviors may have an anticompetitive character, for they represent
an obstacle to the construction of a competitive environment in which greater
pressures may threaten the dominant firms. This seems to justify an effort, to be
taken by the regulatory agencies, to discourage their proliferation.
On the other hand, strategies of diversification and vertical integration whether or not involving strategic alliances -, as well as mergers and acquisitions,
are sure to have causes other than the prospect of rising future profit by means of
creating difficulties to real or potential competitors. At least three motivations can
be imputed to these strategies in order to change them into instruments for
efficiency improvement:
(i)
the use of opportunities created by technological learning inside the firms,
that lead to accumulation of different capabilities potentially used for the
expansion in new markets. Initially propose by PENROSE (1959), this subject
has been retaken by neoschumpeterian authors such as DOSI, TEECE and
WINTER (1992) - in an approach that relates the growth path of firms with a
greater schumpeterian efficiency in the competitive process;
(ii)
the minimization of coordination problems, expressed in transactions costs
(WILLIAMSON,1985), to the extent that the presence of asset specificity
makes the market interfaces between production chain links a source of
contract conflicts and dissentions;
(iii)
the necessity of exploring synergies or opportunities for interactive learning
for the development of technologies that present any degree of systemic
complexity, so that the vertical integration or the diversification may
constitute a means of building the indispensable channels for the exchange
of information and tacit knowledge.
In all three cases, we have business strategies that can be called pro-
competitive, meaning that they are an essential part in the process of innovation or
discovering new forms of organization provided by competitive dynamics. One of
the challenges in the regulation of the transition from natural monopoly into
competition within an oligopoly structure is to distinguish between possible
anticompetitive elements and the search for rising efficiency in the actions
undertaken by the dominant firms. The experience accumulated by the institutions
responsible for the application of antitrust policies can be useful in the discussion
of this topic.
III. COMPETITION POLICY IN REGULATED SECTORS IN TRANSITION
The increasing liberalization in sectors of public utilities, including
privatization of public monopolistic firms, by removing institutional barriers to
entry in some of its segments and by the constitution of regulatory agencies,
determines the emergence of several competition problems. The presence of sunk
costs, market power and the possibility of strategic behavior on part of incumbents
implies that such market structures are not contestable, and so liberalization alone
is not sufficient to ensure a greater level of competition.
Several anticompetitive risks can arise, as referred to before, from the
occurrence of vertical restrictive practices along the productive chain to possible
movements of concentration of market structures through alliances, joint ventures,
acquisitions and mergers among groups that are competitors - or potential
competitors - in the industry, in their various segments.
(a) Control Over Vertical Conducts
A large part of the antitrust problems concerning vertical conducts in
regulated sectors are conditioned by the vertical structure of these sectors. There
are four possible industrial structures in these sectors (ARMSTRONG AND DOYLE,
1995):
(i)
integrated monopoly, in which a single firm is responsible for the supply of
all services;
(ii)
structural separation with liberalization, where there is competition in some
markets and the monopolist does not operate in the competitive markets;
(iii)
vertical integration with liberalization, where the natural monopolist is
allowed to operate in the markets subject to competition. The account
separation, in which the monopolist must keep distinct account structures
for monopolist and competitive services, may or may not be required; and
(iv)
joint ownership, in which the supply of services characterized as monopolist
is accomplished by a firm whose property is shared by the firms which
operate in the competitive sectors.
In all cases, the existence of monopoly power in the providing key inputs for
the service supplied in markets open to competition demands the presence of
permanent monitoring of the behavior of the monopolist firm.
However, the
importance of the regulating mechanisms and towards protecting competition
differ depending on the kind of vertical structure of the sector.
In the case of integrated monopoly, the problem derived from vertical
anticompetitive practices is obviously irrelevant, since the concern of the regulator
is only related to the prices of final services. In the case of structural separation
with liberalization, all the competitors in the liberalized market are in equal
conditions regarding the provision of basic input. The problem is basic regulation,
involving the determination of access price - the prices of services under monopoly
- to promote efficiency in sectors open to competition. The last alternative (joint
ownership) is not a problem from the antitrust view, if the control of the monopoly
firm is equally shared among the firms that operate in the competitive segments,
except for the existence of asymmetric power related to the process of decisions
making regarding prices, quantities and quality of services provided by monopolist
- this can determine the necessity of monitoring by regulatory and antitrust
agencies.
It is the third alternative which shows the greater risk from the viewpoint of
competition: in this case the monopolist provide vital inputs for its rivals in the
markets of final services, so that the emergence of practices directed to the deter
entry in these markets and/or for rising rival’s costs becomes highly likely. Under
these circumstances, the operating firm is interested, by taking restrictive actions,
in preventing the entry of new firms, or reducing the competitiveness of
newcomers in downstream markets, whether or not these markets are subject price
regulation.
Specifically, vertically integrated incumbents with dominant position or
monopoly of the basic network are able to adopt vertical anticompetitive behavior,
such as:
i) predatory prices in downstream markets; and
ii) discriminatory actions which raise costs of real or potential competitors -,
such as access price discrimination and/or raise entry barriers in the market
of final services, tied selling and exclusive dealing.
These strategies prevent uniform conditions of competition between the
dominant firm and its new - or potential- competitors (level plying field) in
downstream markets, making it difficult for competitors to have the same access
costs as those faced by the monopolist firm in these markets 8.
(b) Concentration Ventures
Although the so- called vertical anticompetitive conducts or practices ( and
so, in a smaller degree, the horizontal, connected to several types of collusion)
represent by far the greater risk of market efficiency losses resulting from opening
the public utilities regulated sectors to competition, they do not exhaust the
reasons for pro- competitive concerns for regulators during the transition process.
It is usual in antitrust law and practice to evaluate the potential risks of mergers
and acquisitions or other contracts that may limit competition, either directly
affecting the structure or not.
In the first place, as in any other economic activity subject to private
strategies and, in particular, to the present conditions of strong competitive
pressure over most markets, there may be incentives to acquisitions, mergers or
joint ventures in regulated markets or those vertically related to regulated markets,
increasing concentration and consequently the risk of collusive actions.
In these cases, besides the particularities of a legal complex regulatory
regime that would necessarily involve at the same time general aspects of
competition policy and specific aspects of regulation, they pose at first problems
similar to those that are already dealt with by the regulatory institutions and by the
technical and legal experience of antitrust policy. The specific aspects are due to
the oligopolistic competition.
In the second place, and even more important, we must consider the
possibility of loosening the competitive pressure over regulated markets due to
collusive conducts that are always possible, but become more likely in the
segments of higher concentration and/or smaller dynamism of demand and
technology, and that are particularly made easier by setting criteria and rules or
even rates by the regulatory agency. In these cases, there is a strong tendency to
“managed competition” to evolve, expressed in three most important risk factors9:
i) a tendency as to regulators to feel “ responsible “ for maintaining the
8 For example, in the case of telecommunication, an integrated operator could rise the costs of its
opponents in the markets of final services - such as access to Internet - through the offer of low
quality inter- connective services.
9 Cf. STANBURY (1996), referring to regulation of telecommunications services in Canada.
existing market structure, trying to assure, as much as possible, the
profitability of the newcomers - this can involve a certain degree of division
in the market by approximate shares;
ii) a sometimes excessive concern with the financial/economical destiny of the
newcomers, who tend to be over protected, on similar grounds to those of
“infant industries” - obviously paid by the users of the services - against the
pre- existing advantages in the late monopoly, under the pretext that if one
or more of them should fail, this would cause a greater evil in the
interruption of these services;
iii) creation of opportunities for the strategic use of regulation by the firms.
There are often situations which favor typical behavior of rent seeking by the
regulated firms, both incumbents and new comers, even when they are
aggressive, in order to reap economic rents from the regulatory system by
using strategies of eliminating rivalry in the search for regulating criteria
which are mutually more advantageous.
One typical form of regulatory action that can bring benefits to the regulated
firms and induce horizontal anticompetitive strategies (price and extra- price
collusion) is to allow for exceptions, under certain circumstances, in the regulation
law of the sector or even in the competition law for segments and especially for
certain firms. Aiming to make changes easier and to flexibilize the regulatory
pressure, this device can also create competitive asymmetries among firms and,
more than precipitate a predatory competition, can generate incentives to the
strategic use of regulation, toward making tacit collusion viable.
IV. THE BRAZILIAN CASE
IV.1. Competition Policy In Brazil
a) Concentration Ventures
Article 54 of The Antitrust Brazilian Law No. 8884/94 aims to avoid excessive
market concentration that might strongly reinforce market power and induce
overpricing and/or hamper static and dynamic economic efficiency gains creation
and/or diffusion. Its main section states that any action that may limit or otherwise
restrain free competition, or result in the control of relevant markets (20% or more
of a relevant market) for specific products or services or in which at least one of the
firms engaged has a turnover equal to or over US$ 400 million, must be submitted
to CADE - Administrative Economic Protection Council (Brazil’s antitrust agency) for approval 10 .
CADE is the agency which effectively decides whether a requirement
concerning a concentration venture (e.g. a merger) shall or shall not be approved.
It is an independent office and its members are either lawyers or economists. The
FTC’s Horizontal Merger Guidelines is used as an important analytical frame, which
means that CADE’s procedures consist of balancing the potential adverse
competitive effects of a merger or acquisition
against its potential static and
dynamic efficiencies .
Article 54 also states that CADE may authorize any transactions referred to
in its main section - those limit or restrain competition -, provided they meet the
following requisites: (i) they shall be intended to increase productivity; improve the
quality of a product or service; or cause an increased efficiency, as well as foster
technological or economic development; (ii) the resulting benefits shall be fairly
allocated among participants, on one part, and consumers or end- users, on the
other; (iii) they shall not drive competition out of a substantial portion of the
relevant market for a product or service; and (iv) only the action strictly required to
attain the envisaged objective shall be performed.
One should note that, according to Brazilian antitrust law, CADE could, as
far as mergers and
acquisitions
are concerned,
approve operations
with
performance commitments. The imposition of performance commitments upon a
party presupposes that the transaction has been approved, for they function as a
necessary condition for its the approval. In these cases, CADE Board will define the
performance commitments to be assumed by any interested parties that have
submitted transactions for review pursuant to Article 54, so as to ensure
compliance with the conditions above mentioned.
(b) Anticompetitive Conducts
10 It should be noticed that, as opposite to other legislation, Brazilian Law does not demand
previous notification of planned transactions, though not accomplished yet, even though nothing
prevents firms from doing it.
Articles 20 and 21 of Law 8884/94 deal with procedures related to presumed
anticompetitive conduct. Article 20 sets forth the types of conducts which shall be
deemed, in accordance with the Brazilian legislation, violations of the economic
order: (i) to limit, restrain or in any way injure free competition or free enterprise;
(ii) to dominate a relevant market of a certain product or service; (iii) to increase
profits on a discretionary basis; and (iv) to abuse of one’s dominant position
11
.
Two remark’s related to this article are important: (i) infractions to the economic
order are any conducts which, even though do not generate the anticompetitive
effects foreseen in the article, are able to produce them; and (ii) article 20 introduce
the notion of dominant position, present in European tradition. As to article 21, it
should be noted that: (i) the conducts referred to do not constitute an exhaustive
list of anticompetitive actions described in article 20; (ii) they only typify situations
that may violate the economic order, in case they are described in the premises of
article 20.
Thus, in accordance to this antitrust law, no conduct shall be deemed illegal
per se (with only a few exceptions). The system adopted in Brazil concerning
antitrust violations rests upon the “rule of reason”. The judgment of most actions
pursuant to Articles 20 and 21 of Law No. 8884/94 requires a careful analysis of the
structural characteristics of relevant markets in which they occur. Depending on
such characteristics, a conduct may or may not be deemed a violation of the
economic order. Additionally, the language itself used in the statute indicates that
the authorities shall be focusing their attention primarily on the effects of a
conduct not on a single competitor, but on the relevant market structure.
IV.2. Structural and Institutional Changes in Telecommunications Services
With only a few exceptions, telecommunications services in Brazil have been
rendered by public companies from Telebrás System, consisting of 27 local carriers
and one long distance - national and international – carrier (Embratel), each of
them a monopoly in its market area. The sector is being restructured at present,
and this involves two basic processes:
11 The dominant position referred to in (iv) is presumed when a company or group of companies
control 20% of a relevant market, this percentage being subject to alteration by CADE for specific
sectors of the economy.
i)
privatizing the public operators and liberalizing markets, through the
removal of institutional entry barriers; and
ii)
building a regulatory structure, able to manage the transition from state
monopoly into more competitive market structures, as well as establishing
the rules of the game in which telecommunications services firms will
operate in the future.
In this section, we will discuss mainly the following up presented by the
conduction of the transition, in terms of market structures which shall emerge in
the segments of traditional and cellular telecommunications markets 12 .
Privatization of the Telebras System will be preceded by its deep reform, and
this will have a decisive impact on market structures to be formed. Basically, the
General Law of Telecommunications (Law number 9.472/97), from now on called
LGT, determines:
i)
the creation, from the old Telebrás system, of three regional operators,
(“Teles”) operating local and long distance wired traditional services within
specific region, with no competition among them;
ii)
that Embratel will continue to provide long distance services all over the
country and also international services;
iii)
the creation, from Telebras existing subsidiaries, of ten wireless (cellular)
operators, operating in specific areas and under the so- called A frequency
band; and
iv)
the
creation
of
a
Regulatory
Agency:
ANATEL
(National
Telecommunications Agency).
Until privatization is completed, these services provided by Embratel and
the other local public carriers will be submitted to a new legal status - called public
regime - through franchise granted by the government, containing obligations
related to the continuity and the quality of the services. This regime determines
well distinctly conditions and a very strict regulation. The difference between
public juridical regime, in general for (former state- owned) incumbents, and
private juridical regime, for newcomers, constitutes one of the major institutional
innovations
of
the
new
regulatory
system,
which
is
being
set
in
telecommunications services in Brazil, with important consequences in the level of
12 For a more detailed description of the regulatory mark being developed, see IOOTY (1998).
competition and in public policies 13 .
After the privatization of “Teles” (regional operators) and of Embratel as well
as the ten cellular regional operators (A Band), the competition will be gradually
introduced through the following measures:
i) expedition of authorization for the entry of a new competitor in each of the
three regions, to exploit the services of traditional telephony under private
regime;
ii) expedition of authorization - also in private regime - for the entry of a new
competitor in long distance services provided by the privatized Embratel;
iii) concession, through bidding, of one license for operating cellular services
in each of the ten areas defined at the time of privatization. The newcomers
will operate under the frequency range called B band; and
iv) from December 31, 2001, total liberalization for entry of new competitors in
the markets of wired telephony.
Thus, one can conclude that in traditional telecommunication services
(wired), the market structures after privatization will be, initially, a duopoly , in both
segments - national (international and inter- regional long distance) and regional
(intra- regional and local). With new authorizations after Dec. 31, 2001, when the
beginning of “effective competition” in the various segments is foreseen, there will
be the possibility of new entries - and then a lower market concentration - resulting
from the competitive dynamics of each market.
In the case of cellular services, there will be no difference between the
13 Basically, the differences between both regimes are: a) Conditions of entry: in the public regime,
through franchise bidding; in the private regime, through authorization from the Agency, which
cannot be denied except in special cases; b) Regulation of prices and tariffs: in the public regime, the
contract for concession set tariffs and mechanisms for readjustment and revision; while in the
private regime, there is price freedom; c) Obligations of continuity and universalization: the
contracts of franchise in public regime will impose obligations of continuity and universatization of
services provided by privatized carriers, as opposed to what happens under private regime; d)
Degree of regulation and controlling: the contracts of franchise of services in public regime will
define
the
conditions
of provision
of telecomm unications
services,
the
obligations
of
universatization and continuity, and the tariffs and criteria for readjustment and revision; while in
private regime the freedom foreseen in the Constitution will be the rule, except for restrictions
imposed by government; and e) deadlines: the maximum deadline for any franchise is twenty years,
which may be extended only once, for an equal time period. On the other hand, the authorization is
only extinguished by annulment or similar event(more details in IOOTY, 1998).
regulation of newcomers and that of incumbents. This option seems to be justified
by the fact that such a service is not considered as essential, as well as by its
technical characteristics - especially smaller sunk costs - which make it easier for
new competitors to enter (IOOTY, 1998, p. 10).
IV.3. Competition and Regulation in Emergent Market Structures
As explained
above,
telecommunications
restructuring
in Brazil, in
particular in the local wired telephone markets - national and regional -, are
producing a transition from state monopolies to private duopolies, with the
possibility of less concentration in the near future. However, such a progressive
introduction of competition, as largely acknowledged in the literature based on the
experience of other countries, is not enough to prevent the emergence of
anticompetitive conducts and of inefficient market structures.
An important source of concern is the presence of asymmetric market
power among two kinds of firms: (i) incumbent firms (former state- owned in most
cases - the ones that will purchase the old Telebrás system, including Embratel),
with high market power, originated from their dominant or even monopolistic
positions in the traditional wired local and long distance networks; and (ii)
newcomers to the new markets - e.g. value- added services (VASs) and Cable TV - or
to the traditional markets, but using new technologies, such as wireless
telecommunications and optical fiber.
These differences in market power can generate some antitrust and
regulatory concerns. Firstly, it is necessary to design mechanisms to prevent
incumbent firms to adopt strategies of entry deterrence in any markets. However,
since these asymmetric positions are associated with huge sunk costs incurred by
the incumbent firms - which now operate under a public franchise regime
(including
targets
for universalization
of services,
for example)
-, these
mechanisms should ensure the achievement of public policy objectives. As seen
above, such mechanisms are in part already present in the different franchise
regimes (public and private) created by Brazilian law (LGT).
It is important to note that price regulation of an operator with market
power do not prevent anticompetitive conducts. For example, price cap rules
restrain only the aggregate level of prices, leaving the operator with a significant
margin of freedom to set the prices of specific services. In this case, the operator
will be able to set prices in order to deter entry or to raise rivals’ costs in
downstream markets. The permanence of discriminatory price practices and of
cross subsidies among different segments of the telecommunications services
market under the new regulatory frame would allow inefficient market structures
to be settled in the more profitable segments, where prices are above average costs.
Secondly, even in face of new technologies, high rates of diffusion of the
traditional networks would lead newcomers to require access to them, opening the
stage for anticompetitive conducts by the incumbents. As a result, in addition to
the final telecommunication service market, there is also an interconnection
service market whose supply is the access to the traditional network: network
services. From the competition policy viewpoint, there are therefore two basic
relevant markets: (i) final services markets; and (ii) network services 14 .
Possible vertical discriminatory practices and concentration ventures in the
telecommunications services markets, resulting from incumbent strategies of
market power maintenance or enhancement - as well as by newcomers –, may
involve a wide range of anticompetitve actions 15 . The restructuring of Brazilian
telecommunications
services
has
avoided
legal monopolies,
implementing
duopoly as an initial market structure, but certainly can avoid neither the
emergence of market power asymmetries, nor the vertical and horizontal
anticompetitive practices related to such asymmetries. Since the general features
of these practices have already been discussed in section III, in what follows only a
few examples will be raised of telecommunications services markets where such
problems have been studied, as well as some very preliminary implications for the
Brazilian case. Typical cases are as follows:
• Refuse to Deal
The conflicts among companies related with interconnection problems access rules toward bottleneck (monopolized) segments - are one of the major
forms of refuse to deal in telecommunications services markets 16. The refuse to
14 Cf. EC, General Directorate of Competition , 1996.
15 See, for example, NOLL (1995); BAKER & BAKER (1983); and BESEN & WOODBURY (1983).
16 U.S. antitrust policy, as the Brazilian one, approaches the refuse to deal on the basis of the rule of
deal may be explicit, when interconnection is denied, but may also involve more
subtle forms, associated with low quality or high costs; these constitute a refuse to
deal as long as the vertically integrated firm has exclusive access to optimal
interconnection conditions
17
. Another important related issue is the quality of the
information about network characteristics delivered to competitors 18 . Certainly the
dominant operator has an incentive to use its own systems and products vis à vis
the competitor’s.
Such practices can be exercised, for example, when an carrier retains a
monopoly in the local network but is also operating, together with other
competitors, in long distance markets. More generally, the access to local network
is crucial to the long distance carriers as well as VAS´s providers.
The (future) absence of legal monopolies in the Brazilian case reduces, but
cannot eliminate, these problems, as long as dominant positions are and will be
present in the network operation. Given the difficulties in detecting and controlling
every possible competition problem directly through the law, in particular through
LGT, most devices preventing the abuse of dominant positions will have to be
established in the specific franchise contracts. As much important an instrument
of prevention and repression of anticompetitive conducts will be the surveillance
of ANATEL.
In the case of wireless network in Brazil, there has been an explicit concern
about interconnection. The norms of cellular mobile services have established the
principle of equal access in a non discriminatory basis, in defining that “traditional
wired services operators should provide interconnection to mobile services
providers; and the conditions of interconnection will be subject to free negotiation
among involved parties; their rates should be fair and isonomic (the agency will
decide on the conditions for interconnection in the case of disagreement among
the parties). It is also established that the interconnection (...) should be subject to
integrated planning among the parties” (IOOTY, 1998, p.12 ).
reason principle: the conduct is not condemned per se, being considered illegal only when it is
possible to prove the relation between the practice and the aim of creating or maintaining a
monopoly position.
17 There is a relatively large jurisprudence on this subject in U.S. See, for example, Eastman Kodak
Co. v. Southern Photo Materials Co., 273, US. 359, 375 (1927) and Otter Tail Power Co. v. United
States, 410 U.S. 366 (1973).
18 BAKER & BAKER (1983), p. 24.
• Discriminatory Practices
These practices are in most cases associated with price structure. It happens
when prices of a dominant firm in one market impose some competitive
disadvantage to competitors in a vertically related market. There are three main
possibilities: (i) predatory pricing; (ii) raising rivals’ costs; and (iii) tying.
In the first case, existing cross subsidies could be used to hold vertical
foreclosure strategies, in which prices of a dominant position carrier are set below
costs aiming at entry deterrence 19 . For example, a carrier with dominant position in
local network might use part of its profits generated in regulated activities to
subsidize predatory prices in the VAS´s markets, or even to forestall entry in such
markets.
In the second case, also called “price squeeze”, a dominant carrier could set
discriminatory prices for its rivals in another market segment. For example, a long
distance carrier could sell services for VAS providers at prices higher than those
charged
to their
own
subsidiaries
in the
same
market,
producing
cost
disadvantages for its competitors.
A third possibility is the so- called tying 20. It is considered a discriminatory
practice when an integrated firm sells bundles of services or products without an
economic or technical justification for not selling the components separately. In
this way, non- integrated competitors are potentially damaged since they cannot
sell the hole range of products/services or are forced to pay for something they are
nor interested in.
Although almost all such problems could be solved by a structural
separation of the monopolistic incumbent from other segments, there are some
economic efficiencies related to integration that should be taken into account. 21. In
19 In mainstream economic analysis, predatory pricing is found when a supplier sets prices below
costs with an intent to eliminate competition (HOVENKAMP, 1994, p. 298). This label is applied to
strategies implying the expectation of recouping present losses by means of future monopoly pricing
(ROSS, 1993, p. 56).
20 A tying is defined as the selling of a product or service being conditioned to the acquisition of
another product/service by the buyer. Brazilian law considers such arrangement illegal only if it
results in domination of a relevant market, in restraining competition or if it represents an abusive
exercise of a dominant position.
21 See NOLL (1995) for the main benefits of integration, such as: (i) transaction costs reduction; (ii)
the Brazilian case, the design of the emerging market structures contains some
degree of vertical integration, especially between local and long distance wired
telephone services, and also between wired and wireless (cellular) services, but
with explicit concerns to possible anticompetitive conducts. In fact, the LGT
confers Anatel powers in this field, very similar to CADE’s ones.
• Horizontal Concentration
As noted by SHEPHERD (1997) in his analysis of the structural perspectives
for introducing competition in telecommunications services markets, deregulation
should be managed carefully, because dominant positions can be easily built in
markets where regulatory mechanisms are untimely removed and/or where
mergers and acquisitions allowed without further analysis. Competitive pressures
on dominant firms could thus be reduced, giving them freedom to implement
anticompetitive strategies.
The detection, and eventually the repression, of such strategies are not easy
tasks, as shown by the ambiguous effects emerging from technical progress. In fact,
technological change was pointed before, as it is usually, as the main cause for the
transition from natural monopolies towards more competitive markets structures,
since it creates opportunities for profitable entries and change the degree of
product substitutability. However, even if the general direction of technical
progress is pro- competitive, the practical implementation of new technological
solutions will be essential to the degree of competitive threat effectively added by
newcomers, in face of the incentives incumbents have to adopt strategies allowing
them a greater control over the evolution of these technologies.
As a result, one can hold that if incumbents are active in pursuing the
reinforcement of their market power in the context of fast technological change,
the capacity of deregulation and competition policies to sustain or increase
competitive pressures will depend on the degree of tolerance of the regulatory and
antitrust authorities facing mergers and acquisitions of the kind mentioned above.
It goes without saying that the analytical issues involved in assessing the potential
protection of proprietary information; and (iii) improve investment safety in specific assets. But the
author recognizes that the relevance of these points for telecommu nication services far from clear
(p. 514).
anticompetitive effects of concentration increasing ventures could benefit from the
antitrust expertise and case experience on the subject.
In the Brazilian case, the presence of an institutional concern in preventing
eventual trends toward horizontal or vertical market concentration, through
mergers and acquisitions, is expressed in the prohibition, in the LGT, for the same
group of investors to get franchises in different regions during the privatization
phase, as well as in further restrictions to mergers.
• Franchise Bidding
As to services franchising, there are basically three relevant issues from the
competition policy viewpoint 22 . Firstly, there is the risk of coercive use of the
bidding process against the bidders, i.e. the possibility that an operator with
dominant position in one market employs its market power to reduce competition
in the bidding process or even to force the winner to give up its franchise under the
threat of retaliation. For example, an carrier having market power in a local wired
network could try to force the winner of a cellular service bidding process in some
other region to sell its franchise in the case of the latter being dependent on the
former for the provision of network services in the first region.
Secondly, dominant firms can cause trouble to a bidding process by abusing
of legal suits to government agencies or to the courts, with a view to deter
newcomers entry (“Sham litigation ”). In these cases, a major entry barrier is
related both to the time length needed for the administrative and legal conflicts to
be solved and to litigation costs 23.
The third question is related to a possible conflict between the objectives of
the regulation authorities and those of the antitrust law and agencies. Although, in
general, regulatory agencies take into account possible antitrust effects of their
actions - in the Brazilian case, particularly in telecommunications, they are
mandatory through law itself -, some situations may arise in which public interest,
as interpreted by regulatory policies, conflict with antitrust rules, raising severe
22 BAKER & BAKER (1983).
23 This procedure, for example, has been used in different situations by ATT in U.S. in terminal
equipment markets. The strategy was to provoke litigation on the basis of network damages
allegedly caused by competitors equipment using different technical standards.
bureaucratic and legal mismatching between regulatory and antitrust agencies.
V. CONCLUSIONS
This paper indicates that an important policy challenge is how to manage
the transition from active regulation in natural monopolies to the “reactive”
regulation required by oligopolistic market structures. Since this transition is
gradual, it will often require a step- by- step approach by the public agencies, whose
actions and procedures, given the market and technological dynamism of
telecommunications sector, are always partially uncertain.
Among the features of Brazilian telecommunications sector transition
discussed above, three points can be emphasized:
(i)
The policy main goal should be the introduction of competition (as free
entry and exit as possible) in the markets. If structural factors turn it
unrealistic in some market segments, a second best goal can be to
continuously improve its allocative, productive and selective efficiencies;
(ii)
Incumbent firms in most markets can – and possibly will – use their market
power to increase prices, forestall entry or predate against competitors. It is
therefore necessary to monitor their strategies and to prevent and punish
anticompetitive behavior;
(iii)
Market structures are still emerging in markets created by privatization and
restructuring, and their evolution should be oriented, whenever possible,
toward more competitive configurations.
Both tasks – to check anticompetitive practices and to direct the evolution of
market structures – require a large amount of capabilities and flexibility from
regulatory agencies. This means that a satisfactory regulatory policy cannot be a
once- and- for- all state decision of setting up an institutional structure with
predefined rules of the game before it really begins. In order to develop the
required capabilities, the agencies will have to learn and to respond creatively to
the events of the transition phase.
During this learning process it seems sensible to look for a broad variety of
sources of information and experiences. Not only the experience of other countries
in privatization and deregulation should be studied, but also the tradition of
competition policies enforcing a kind of “reactive” regulation (antitrust) on
oligopolies provides very useful insights. Despite telecommunications services
sector’s many specific features, an interaction between its regulatory agency
(Anatel) and the Brazilian antitrust authorities (CADE) can be very positive, since it
will make it possible to coordinate both institutions and to use CADE´s legal
authority
and
expertise
to
get a prompt
prevention
and
repression
of
anticompetitive practices.
The institutional learning of public agencies will be essential for the success
of
privatization
and
deregulation
process
in
Brazil,
particularly
in
telecommunications. In the transition from state- owned monopolistic companies
to private- owned oligopolistic ones, the opportunities to influence market
structures and firm behaviors provide a very efficient way to assure a good social
performance of telecommunication markets, but at the same time the risks and
costs of missing the target are very high.
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