5 Monopoly and Regulation - Luiscabral.net

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Box 5.2. A Tale of Two Market Deregulations. 6France and Germany provide an interesting contrast of the path towards telecommunicationsderegulation. Both countries started from a similar initial situation, with alarge, State-owned operator controlling virtually all of the country’s telecommunications.Both countries allowed new competitors to enter the market at about the sametime. Beyond this, the differences are more significant than the similarities.One of the most important steps in the deregulation process is the “interconnectiondecision,” that is, determining the amount of money a competitor has to pay in orderto use the incumbent’s local network. In France, a distinction was made between newcompetitors that built their own networks and those that didn’t: the latter were requiredto pay a higher access fee. No such distinction was made in Germany. This gavebare-bones resellers an advantage in Germany, at least during the first year. In fact,these firms did not have to make significant investments and nevertheless were able toaccess the Telekom network at the same price as other new entrants.The treatment of new competitors in Germany is more favorable in several respects.For example, German customers wishing to try a new long-distance carrier can do soby simply dialing the access code and then the desired number. They are billed in asingle Deutsche Telekom statement, who then transfers the corresponding amount tothe new competitor. No such “call-by-call” option is available in France.The most significant difference between Germany and France is, however, the level ofthe access fees. Before the interconnection decision was made in Germany, DeutscheTelekom asked for a fee of 6.5 pfennig per minute. Competitors pushed for a one-pfennigrate. The German regulator followed an unexpected route: it took the average of theaccess fee in 10 countries and came up with the value of 2.7 pfennigs. That this valuewas unexpectedly low is proved by the fact Deutsche Telekom’s stock dropped by 7.7%in a single day and a further 6% a few days later. After one year of competition, 51 newrivals entered the market to steal about one third of Deutsche Telekom’s long-distancebusiness. During the same period, France Telecom lost a mere 3% market share.Deutsche Telekom’s CEO claims his competitors are nothing but “arbitragers” whosimply use the low access fees to piggyback on Telekom’s network. In fact, few carriersinvested in their own network during the first year after deregulation. In December1998, the German regulator reacted to this problem by allowing Deutsche Telekom tocharge higher access fees to resellers who don’t build their own network, a distinctionthe French regulator made from the start.The importance of the interconnection decision shows in the numbers. WhereasDeutsche Telekom’s stock had its ups and downs, France Telecom’s shares soared 103%during the first year of full competition. In contrast, long-distance charges in Germanyhave fallen by nearly 90% in one year, and local competition exists in more than onedozen cities. Rates in Germany have gone from among the highest in the world toamong the lowest in the world. Rates in France have also dropped, but by much lessthan in Germany.12
However, it is far from clear that the ECPR will bring any clear benefit. Supposethat mobile phone operators are equally efficient, that is, c 1 = c 2 . It can be seen thatT &M 1 ’s optimal price is p 1 = p M , the monopoly price. Consistently with the ECPR, theaccess price would then be set at w 2 = p M − c 1 . At this wholesale price, the best thedownstream firm can do is to sell at p M for a margin of zero. Whichever amount M 2 sells,the manufacturer receives full monopoly profits; and consumers pay monopoly prices. Inother words, although the ECPR implies productive efficiency, it has no bite with respectto price levels. In fact, prices are set at the same level as an unrestricted monopoly. j,8Despite these limitations, the ECPR is popular among regulators. In March of 1999,Deutsche Telekom was barred from launching a low-cost online service unless it were alsoto lower its access fee. Says the president of the regulatory authority: “To prevent discrimination(in pricing), the unbundled-access charge would have to be lowered.” 9 Otherwise,online service competitors such as AOL Europe would be at a disadvantage as they don’thave any way of accessing customers other than through Deutsche Telekom’s local loop.Broadly speaking, this decision reflects the spirit of the ECPR.The most clear example of application of the ECPR rule is however given by NewZealand. The Telecom Corporation of New Zealand (TCNZ) is the main telecommunicationsoperator. In particular, it holds the monopoly over the local network. In the early 1990s,rival operator Clear Communications challenged TCNZ in Court, arguing that the latter’saccess charges were predatory, that is, were unfairly forcing Clear Communications out ofthe industry (cf Chapter 13). Clear Communications argued that Telecom ought to chargean access price in line with the actual cost of providing access. Telecom in turn wished toapply the ECPR rule, which, as seen above, may imply an access fee substantially higherthan the cost of providing access. Ultimately, the case was decided in London, where theLords of the Judicial Committee of the Privy Council upheld Telecom’s view. 10Summary• The monopoly model provides a good approximation to the behavior of dominant firms.• The degree of monopoly power is inversely related to the demand elasticity faced by theseller. • The main areas of competition policy are price fixing, merger policy and abuseof dominant position. • A high-power regulation mechanism provides strong incentives forcost reduction but little incentives for quality provision. In addition, it implies a high degreeof risk for the regulated firm and requires strong commitment on the part of the regulator.Key concepts• patent • copyright • network effects • Harberger triangle • allocativeinefficiency • excess burden • productive efficiency • rent seeking • residualj. To avoid this problem, some authors have proposed a solution whereby the upstream firm is subjectto a price-index cap. The price index includes both the final price set by the integrated firm and theaccess price charged to downstream competitors. This implies that, if the integrated firm wants toincrease the final price, it has to decrease the access price, and vice-versa.13
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Page 10 and 11: cap. A very high price cap implies
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