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Martin CaveWarwick Business School, UKMartin.Cave@wbs.ac.uk

Economic Concepts for Telecommunications Regulation

ITU, Geneva 19 January 2009

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Agenda

1. Sources of market failure Q & A

Break2. Policy responses for economic regulation

Q & A3. Instruments of social regulation

Q & A

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Economic Concepts for Telecommunications RegulationPart 1. Sources of market failure.

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Defining the optimum position

Marginal utility, willingness to pay

Marginal resource cost

Call minutes

Benefit,

Cost, Price

P*

Q*At Q*, marginal utility =

marginal resource cost. This is the optimum

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The competitive yardstick

Call minutes

Benefit,

Cost, Price

P*

S

Q*

D

If telecoms markets were fully competitive, we would observe

the optimum. But they are not….

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The problem of market power

Call minutes

Price per

minute

P*

Q*

D

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.

P**

Q**

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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

Backhaul

Access

Contestable

Natural monopol

y

Scope for competition also depends on size of market

Core

S1 S2

S3S4

S5

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Wireless network cost structure

Total cost

Capacity expansio

n

Cost of coverage

Call minutes

Mobile networks tend to be ‘natural oligopolies’, and

licensing policy often strengthens this trend

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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

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.

Caller Receiver

interconnection

Origination

Termination

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Externalities I

A. Narrow senseTelecoms 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 senseEvidence 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 RegulationPart 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)

The voice ladder The broadband ladder

Retail

Unbundled loop

Origination

Transit

Unbundled loop

Bitstream

Access to web

Retail

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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 kindsIdentify wholesale products to which competitors must have access to supply end usersMandate access at set price and terms and conditions where competitors need itReview 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 ladder- probably the local loop.

4. 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.

5. Continue until regulation has resolved the competition problem (note: in the limit this might involve regulating the whole value chain, including retailing.)

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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.

Firm’s realised costs

Price set in advancePrice, Cost New price control for

next period

2 4 6 Years

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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

Current generation

ladder

NGA ladder

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.

Unbundled loop

Bitstream

Access to web

Retail

Sub-loop

Duct

Bitstream

Access to web

Retail

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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) on-net/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 regimeTelecoms have positive externalities and are at crucial take-off pointThis makes the end user welfare loss from taxation (or regulation) highAlso a risk of taxation above revenue-maximising levelThis suggests need to seek alternative sources of tax revenue if any exist.

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Economic Concepts for Telecommunications RegulationPart 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- 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 60-80%. Choice of operator should be technologically neutral

Can be done via reverse auction.