Martin Cave

1
Economic Concepts for Telecommunications
RegulationITU, Geneva 19 January 2009

• Martin Cave
• Warwick Business School, UK
• Martin.Cave_at_wbs.ac.uk

2
Agenda

• Sources of market failure
• Q A
• Break
• Policy responses for economic regulation
• Q A
• 3. Instruments of social regulation
• Q A

3
Economic Concepts for Telecommunications
RegulationPart 1. Sources of market failure.
4
Defining the optimum position
Benefit, Cost, Price
Marginal utility, willingness to pay
P
Marginal resource cost
Call minutes
Q
At Q, marginal utility marginal resource cost.
This is the optimum
5
The competitive yardstick
Benefit, Cost, Price
S
P
D
Call minutes
Q
If telecoms markets were fully competitive, we
would observe the optimum. But they are not.
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The problem of market power
Price per minute
P
P
D
Q
Call minutes
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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Where does market power come from?

• Law and regulation
• - statutory monopoly
• - restrictions on availability of licences
• - withholding spectrum
• Features of the cost structure
• (which vary between wireless and wireline
  networks)
• C. Interconnection obligations.

8
Fixed network cost structure
Contestable
Core
Backhaul
S1
S2
Access
S5
S3
S4
Natural monopoly
Scope for competition also depends on size of
market
9
Wireless network cost structure
Total cost
Capacity expansion
Cost of coverage
Call minutes
Mobile networks tend to be natural oligopolies,
and licensing policy often strengthens this trend
10
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
Receiver
Origination
Termination
To connect subscribers, competing networks must
interconnect. Callers may have a choice of
originating networks, but the receivers chosen
network must terminate the call. If the caller
pays the whole cost of the call (calling party
pays), the receivers network can exploit its
bottleneck control.
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Externalities I

• 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.

13
Externalities II

• 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).

14
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

17
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
Unbundled loop
Unbundled loop
Origination
Bitstream
Transit
Access to web
Retail
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 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.

22
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.)

1. Look in the value chain for the least replicable
   input at the top of the ladder- probably the
   local loop.
2. 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.
3. 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.
Price set in advance
Price, Cost
New price control for next period
Firms realised costs
2
4
Years
6
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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.
Sub-loop
Duct
Unbundled loop
Bitstream
Bitstream
Access to web
Access to web
Retail
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.

29
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.

32
Encouraging sharing of assets

• Mandating access to an incumbents 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.

33
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.

34
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
RegulationPart 3. Instruments of Social
Regulation

• ITU, 19 January 2009
• Martin Cave

36
Arguments for intervention

• Social
• - Equity goals, such as the prevention of
  digital divide/regional inequalities
• - Services for disabled/disadvantaged
• - Citizenship motives
• Economic
• Enhancement of GDP, regional balance
• Call externalities, line externalities

37
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.

38
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.

39
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.

40
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.

41
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.

42
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

43
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.