Competition and Regulation in the Telecommunications Industry in ...

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Competition and Regulation in TelecommunicationsThis describes the different states that network industries were in at that moment intime. As the system evolves towards a more liberalised system, there are differentdemands on regulation in the different phases. The book differentiates between threephases:1. Monopoly2. Monopoly and Competition in some Markets3. CompetitionFigure 2.2: Path of Regulatory IntensityPhase 1 Phase 2 Phase 3RegulatoryIntensityPhase 1The problems associated with an industry in phase 1 of liberalisation are best dealtwith through the measures outlined in the previous sections: close regulation of themonopolist to ensure productive and allocative efficiency. Ramsey pricing would bethe preferred measure under perfect information, but is not possible due to theimpossibility to access accurate data for effective regulation. ROR has the problemsassociated with over investment in capital expenditure to increase the absolute levelof profits allowed and the lack of incentives for cost reduction. Regulatory lag could,however, provide limited incentives for cost reduction, as the rate of return would behigher for the period between rate reviews. PCR, on the other hand leads to efficientproduction, but lacks on the allocative side due to information asymmetries about thetrue efficiency potential of the firm.Phase 2TimeHere, there is introduction of competition in some parts of the operations. It ispossible that effective competition will never be possible in all parts of the operations,as duplication of some network components may not be viable in all fields. Intelecommunications, for example, fibre-optic backbones are existent on differentnetworks in some countries, but there hardly ever is any duplication of “the last mile”,i.e. the connection from the user’s premises to the local exchange. The viability forduplication of these parts is not given.In the second phase of liberalisation, there are three strands of activities that have tobe pursued: firstly the separation of the regulator from the monopolist, secondly theregulation of incumbent pricing and thirdly the regulation of interconnection.As to the independence of the regulator, it has to be ensured that there is no captureof the regulator for any of the parties involved in the market. This is important to instil22
Competition and Regulation in Telecommunicationsconfidence in any companies wishing to enter the market, providing them with thecertainty that they will have a level playing field.On the front of price regulation, the monopolist has the possibility to use rents frommonopoly markets to subsidise activities in the competitive markets and thus gain anunfair advantage. The importance therefore lies in analysing the level and structureof prices set by the monopolist.Network industries have a large part of their cost in fixed components, making theallocation of costs to services very difficult and arbitrary. Considerable effort thus hasto be expended towards the analysis of the cost structure and to the development ofa “fair” level of prices to be set by the incumbent in the competitive market.Deviations in both directions are potentially damaging: setting prices too low willdiscourage entry by firms even it they were more efficient than the incumbent. Shouldprices be set too high, then entrants will be able to enter even if they are less efficientthan the incumbent. Furthermore, it will jeopardise the profitability of the companyand thus the cross subsidies to unprofitable market segments necessary for universalservice obligations.Even in the most competitive telecomm markets, such as Germany 4 , not all aspectsof the network have been subjected to competition, such as the last mile. There isstrong controversy about the correct level of interconnection pricing between thenetwork components of Deutsche Telekom and its competitors. Once again, theincentives of the incumbent and competitors are opposed. If interconnection pricesare set too high, the monopolist will receive an overly high amount for theinterconnection services and thus deter entry by efficient companies. Should theprices be set too low, however, this will also attract inefficient entry. Furthermore, itwill discourage investment by the incumbent into new technologies, as entrantsconsequently do not carry a “fair” share of costs and risks of the investments andbenefit disproportionately from the incumbent’s investments.When interconnecting networks, there are different possibilities to design accessprices:• Efficient Component Pricing Rule (ECPR): this mechanism warrants entry aslong as the entrant is at least as efficient as the incumbent. It is assumed thatretail prices are fixed, i.e. that allowing the entrant access does not have aneffect on the incumbent’s price. The cost structure is defined by the averageincremental cost of access, b, the average incremental cost of providing thecompetitive part of the service, c, and the retail price of the service, p. Theoptimal access price is thus defined as: a = b + [ p - (b + c)]. In the context of along-distance telephone context, b would be the cost of connecting thecustomer from her home to the local exchange and c the cost of routing thecall on backbone infrastructure. The problem associated with the ECPR is thefact that allocative effects are being ignored, due to the assumptions of ahomogenous fixed product, a fixed coefficient of technology and the inability ofcompetitors to bypass the incumbent.• Ramsey access pricing: in the spirit of optimal pricing for society, Ramseyaccess pricing also takes some allocative effects into account. The formula forthe calculation of the access price changes to: a = b + σ(p – (b + c)). σ is what4 Purton (2000), SURVEY - FT TELECOMMS: Former monopoly loses significant market share23
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