Economic Concepts for
Telecommunications Regulation
ITU, Geneva 19 January 2009
Martin Cave
Warwick Business School, UK
Martin.Cave@wbs.ac.uk
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Agenda
1. Sources of market failure
Q&A
Break
2. Policy responses for economic regulation
Q&A
3. Instruments of social regulation
Q&A
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Economic Concepts for Telecommunications Regulation
Part 1. Sources of market failure.
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Defining the optimum position
Benefit,
Cost, Price
Marginal utility, willingness to pay
P*
Marginal resource cost
Q*
At Q*, marginal utility = marginal resource cost.
This is the optimum
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Call minutes
The competitive yardstick
Benefit,
Cost, Price
S
P*
D
Q*
If telecoms markets were fully competitive, we
would observe the optimum. But they are not….
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Call minutes
The problem of market power
Price per
minute P**
P*
D
Q**
Q*
The monopolist can make more money by raising price (to P**) and cutting output (to Q**). A basic tack of
regulation is to stop this happening.
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Call minutes
Where does market power come from?
A. Law and regulation
- statutory monopoly
- restrictions on availability of licences
- withholding spectrum
B. Features of the cost structure
(which vary between wireless and wireline networks)
C. Interconnection obligations.
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Fixed network cost structure
Contestable
Core
Backhaul
S1
S2
Access
S5
S4
S3
Scope for competition also depends on size of market
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Natural
monopoly
Wireless network cost structure
Total
cost
Capacity
expansion
Cost of
coverage
Mobile networks tend to be ‘natural oligopolies’, and
licensing policy often strengthens this trend
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Call minutes
Economies of scope and multi-service networks
Different services used to be provided by different networks:
telecommunications for voice calls, cable networks for broadcasting.
New digital networks can provide voice and data services cheaply on a
single network (economies of scope); this works against wireline
competition.
However, competition among different types of network (wireline,
wireless, satellite) impose additional competitive constraints.
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Interconnection and market power
interconnection
Caller
Origination
Termination
Receiver
To connect subscribers, competing networks must interconnect. Callers may have a choice of originating networks,
but the receiver’s chosen network must terminate the call. If the caller pays the whole cost of the call (calling party
pays), the receiver’s network can exploit its bottleneck control.
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Externalities I
A. Narrow sense
Telecoms services purchased by one customer may benefit others
- Network externality: by joining a network a subscriber creates calling
opportunities for existing customers
- Call externality: under calling party pays, receiver benefits from call.
Can be internalised by call rotation.
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Externalities II
B. Broad sense
Evidence that spread of (especially mobile) telecommunications speeds
up economic growth.
Possible conclusion: governments should subsidise (or avoid taxing)
mould-breaking network roll-out of mobile voice services(1990s,
2000s), and of mobile and high speed broadband services (2010s).
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Information problems
End users may make poor choices of service:
- Buy wrong mobile package/bucket
- Fail to find cheaper suppliers
- Be unaware of download restrictions
- Inadvertently buy international roaming.
Solutions: mandate provision of information and/or control quality of
service (see ‘net neutrality’ debate).
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Efficiency and equity
The focus has been on efficiency – ie. correcting for market failure – and
on the goal of replicating by regulation the competitive outcome.
Governments also have equity objectives which regulation can further:
- regional, urban/rural development policies
- encouragement of small business
- diversity.
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Economic Concepts for Telecommunications Regulation
Part 2. Policy Responses for Economic Regulation
ITU, 19 January 2009
Martin Cave
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Mandating interconnection
Interconnection is necessary with multiple networks to gain the efficient ‘any to any’
property.
The context and how it is done has major effects:
- The interconnecting operators may or may not also compete
- Charges, terms and conditions are important (eg. paid termination vs. bill and keep
or peering)
- It can be done in a way which is anti-competitive
- It can be discriminatory (eg. international roaming)
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Competition among fixed networks – infrastructure vs.
service competition
(Separate end-to-end
network)
(Separate end-to-end network)
Unbundled loop
Unbundled loop
Origination
Bitstream
Transit
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Access to web
Retail
Retail
The voice ladder
The broadband ladder
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Is infrastructure competition feasible or desirable?
Benefits
Costs
Product differentiation
Duplication of resources-infeasible in some
geographies
Less need for regulation
Loss of economies of scale
Exploits legacy networks
Continued need for regulation
More dynamic benefits
Harder to achieve social objectives.
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One means of finding a balance
The regulator can adopt the following approach:
-
Maximise entry (minimise barriers in wireless);
In fixed monopoly areas, allow/require resellers (ie entry into retail);
Encourage infrastructure competition where feasible;
Get competitors to ‘climb the ladder’- ie. take duplicated assets closer
to the customer
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Implementing infrastructure competition in fixed telecoms
Allow entry of all kinds
Identify wholesale products to which competitors must have access to
supply end users
Mandate access at set price and terms and conditions where
competitors need it
Review the situation at regular intervals, ceasing to mandate access
where at least some competitors have duplicated the assets.
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The European Union approach to deciding where to
regulate access
1. Carefully define the retail markets (note: are fixed and mobile voice
and data services in the same retail market?)
2. Ask if there is a competition problem without regulation (note:
answer is often ‘yes’ with fixed, ‘no’ with mobile).
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The European Union approach to deciding where to
regulate access (cont.)
3.
Look in the value chain for the least replicable input – at the top of the ladderprobably the local loop.
Suppose access to it were available to competitors on fair terms. Would the
competition problem go away? If yes, stop- the problem has been solved. If no,
repeat the process with next least replicable asset.
Continue until regulation has resolved the competition problem (note: in the
limit this might involve regulating the whole value chain, including retailing.)
4.
5.
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Regulatory remedies
Standard one is to set price and terms and conditions at which the
(wholesale or retail) service must be sold.
This will typically be a cost-based price, based on the average forward
looking cost of the provision of the service by an efficient operator –
known as Long Run Incremental Cost or LRIC
This can be calculated using a cost model, or proxied by international
bench-marching.
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Incentive regulation
Some regulators prefer to set a longer-term price trajectory or ‘price cap’, extending several years. This
gives the firm an initial incentive to increase efficiency. The benefits then go to end users.
Price,
Cost
Price set in advance
New price control for next period
Firm’s realised costs
2
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6
Years
Other/alternative remedies
Access prices can be set higher to encourage initial investment (see NGN slide below)
Access prices must be public (a ‘reference interconnect offer’).
All firms must pay the same access prices (no discrimination)
The access provider must not discriminate in favour of itself by setting its retail prices
at a level which drives out competitors.
The access provider must keep separate accounts for its access products.
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Next generation access (NGA) networks
Sub-loop
Duct
Unbundled loop
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Bitstream
Bitstream
Access to web
Access to web
Retail
Retail
Current generation
ladder
NGA ladder
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These offer high speed broadband
access. They can be telecoms
networks, upgraded cable or
(possibly) wireless. NGAs offer
different access points. There is
increased interest in mandating
access to passive assets such as
ducts.
Problems in regulating NGAs
The point about NGAs is that they do not yet exist – their costs are not yet
sunk.
Operators have to be persuaded to forego the option of delay and of
sweating the copper assets. This persuasion may involve:
- maximising competitive pressure
- offering regulatory concessions over new services
- allowing risk-adjusted (higher) returns.
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Regulating termination
As noted above, under calling party pays (CPP), each terminating operator is a
monopolist. This has led to regulation (heavily resisted by mobile operators!) of
termination at cost-based prices.
Currently, discussion is turning to alternatives based on lower regulated rates,
negotiated rates or the introduction of bill and keep. This is a major component of
the deregulatory project.
Watch this space!
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Regulating wireless networks
Apart from termination issues, mobile networks are potentially competitive.
The thrust of regulatory policy should be to remove barriers to entry, as continuous
entry upsets patterns of collusive behaviour.
It is helpful to make available as much spectrum as possible, rather than maximise
government revenues.
Un-utilised military spectrum can also be deployed.
In some countries problems with backhaul may require intervention.
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Is network separation helpful?
A vertically integrated network can be separated in many different ways:
-
Separate accounts (to pin down cost allocations and generate sound access prices)
Operational separation (to prevent non-price discrimination)
Ownership separation (to remove any motive for discrimination).
The latter two variants can have high costs, including the risk of discouraging investment, and so require
full justification.
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Encouraging sharing of assets
Mandating access to an incumbent’s facilities is a form of compulsory
sharing
‘Voluntary’ forms include:
- co-investment
- Long-term contracts to buy access services.
These can cover all assets: see ITU- Six degrees of sharing – Trends in
Telecommunications Reform 2008.
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Deregulation – the competition law alternative
Presumption of zero/limited regulation of mobile networks, if entry barriers can be
removed; rebuttable in special cases – e.g. international roaming, (possibly) onnet/off-net call charges .
The fixed services value chain (retail, transit etc.) can also be deregulated as
infrastructure competition develops.
Underlying dilemma is: how many competitors are needed before regulation is
removed? (In US, 2+ wireless; in EU 4).
Needs effective and speedy competition authority, to avoid excessive lags.
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Taxes
Issue must be seen as part of overall fiscal regime
Telecoms have positive externalities and are at crucial take-off point
This makes the end user welfare loss from taxation (or regulation) high
Also a risk of taxation above revenue-maximising level
This suggests need to seek alternative sources of tax revenue if any
exist.
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Economic Concepts for Telecommunications Regulation
Part 3. Instruments of Social Regulation
ITU, 19 January 2009
Martin Cave
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Arguments for intervention
A. Social
- Equity goals, such as the prevention of digital divide/regional inequalities
- Services for disabled/disadvantaged
- Citizenship motives
B. Economic
-
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Enhancement of GDP, regional balance
Call externalities, line externalities
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Line and call externalities
Line: existing subscribers benefit from new subscriptions. Hence case for
offering subsidies to marginal subscribers, reflecting the value of their
joining.
Call: both participants benefit from a call, but under CPP, only the latter
pays. Either subsidise the call or switch to Bill & Keep.
Revenues to finance correcting subsidies can come from a variety of
sources.
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The traditional ‘fixed line’ approach
Objective is to maximise fixed line penetration.
Achieved by below cost line rental (‘access deficit’) subsidised within
monopoly firms by ‘excessive’ long distance and international call
prices.
Goal is universal availability and take-up at geographically averaged
prices.
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Developing problems
High call charges lead to inefficient network utilisation.
Competitive entrants can ‘cream skim’ profitable heavy users – possibility
of ‘graveyard spiral’
Problems can be resolved by optional tariffs for all users, including
subsidised tariffs to low users.
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The wireless convulsion
Wireless take up in areas of fixed coverage is now nearly 100%.
Plus wireless reaches billions more, growing every year.
Universal service should be seen as wireline or wireless service.
Now recognised by, eg. European Commission.
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Universal service in a wireless world
Service for individuals, not household (but can be shared – see ITU 2008
Can be achieved by licence condition imposed on all/many operators.
Can be achieved by reverse auction process to choose a single retail or
wholesale universal service operator, or by spectrum auction.
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Pros and cons of coverage requirements
Pro:
- guarantees desired level of access
- pricing conditions can be imposed.
Con:
- bureaucratic process
- creates excuse to limit competition
- may be unnecessary: competition can do better, with appropriate
spectrum policy
- possibility of enforcement problems
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Broadband universal service
Examples: Switzerland, Australia (98%), Singapore (100%), municipal
investments
Historically, universal service decreed when spontaneous take-up is 6080%. Choice of operator should be technologically neutral
Can be done via reverse auction.
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