Developing Competition Policies in Telecom Sector

1. ITU – Morocco, Mon 19th Dec 2005Developing competition policies & strategiesInterplay of telecoms regulation & competition law Bharat K Vagadia Doc Ref: 00778/PN/863.1

2. Agenda • Why the pursuit for competition • Role of competition law and specific regulation • Approaches to regulation • Infrastructure V’s service based competition • Triggers for regulation • Structural separation options • Regulation in new era Doc Ref: 00778/PN/863.1

3. Why liberalise markets – competition policy aims? • Competition policy is an element of wider government involvement in the economy which is concerned in principle with state efforts to improve overall economic performance by making the economy more dynamic and efficient • Government cannot do this directly, so it has to approach it indirectly by acting on the business environment (promoting competition) and on the actions of firms seeking market power – effective competition lies at the heart of competition law….. • Telecommunications creates positive externalities - the value of the utility increases as more subscribers are added • Under a monopoly structure, because an operator is not usually allowed to discriminate between users, the monopolist restricts output in an attempt to maximize its profits – this reduces the total welfare of society • In addition the elasticity effects on subscribers and usage imply lower prices could also induce increases in the total market size and the associated positive network externalities for society Doc Ref: 00778/PN/863.1

4. Weak Regulation Competition Law Strong Independent Regulation Stage One Stage Two Stage Three Legal or de facto monopolies Dominant operator (s) with multiple small – weak entrants Multitude of competing operators, none being dominant High unregulated prices High historic costs Falling regulated prices Falling costs Low unregulated prices Low costs Strong regulatory forces Weak competitive forces Weak regulatory forces Strong competitive forces Regulatory evolution in the telecoms market post liberalisation Doc Ref: 00778/PN/863.1

5. REGULATIONS / DETERMINATIONS / PRINCIPLES LICENCE CONDITIONS INDUSTRY CODES LEGISLATION 1 2 3 4 Monopoly / Duopoly (1) Transition (2 & 3) Normalization (4) GOVERNMENT REGULATION INDUSTRY SELF REGULATION Retail price controls Controls on virtually all services Gradual relaxation of controls No controls, only normal competition safeguards SEVERAL COMPETITORS FEW COMPETITORS DUOPOLY Not relevant or arbitrary pricing of few services Gradual decontrol, unbundling, price caps Only bottleneck services controlled Access pricing – IXC & wholesale FULLY OPEN MARKET Universal service obligations Borne by incumbent operator Cost analysis and shared if material Cost analysis - possible competitive provision Implications for regulatory instruments Privatisation? Doc Ref: 00778/PN/863.1

6. Approaches to market liberalisation Model >> Pros >> Cons >> Examples >> Pursuit for More Competition Pursuit for Efficiency Doc Ref: 00778/PN/863.1

7. Forms of economic efficiency • Allocative efficiency • The efficient allocation of society’s resources to producing a particular product where social marginal benefit equals social marginal cost of producing last unit • Productive efficiency • Output produced at minimum cost possible - no wastage, efficient choice of inputs. Average industry cost is at minimum possible - structure of industry such that any scale opportunities are exploited • Dynamic efficiency • Operators strive to use best available technology and continually innovate to save costs and deliver new services • Rationing • If a firm needs to ration, then those with greater willingness to pay get served first e.g. selective versus random blackouts in electricity Doc Ref: 00778/PN/863.1

8. The theoretical benchmark – perfect competition • Competition between a large number of firms: • Drives price down to marginal cost (allocative efficiency) • Causes inefficient firms to exit the market and efficient ones to remain (productive efficiency) • Provides incentives for firms to invest in cost reduction (dynamic cost efficiency) through comparisons and entry/exit from the market • However, there is no such thing as perfect competition in the telecommunications sector • It would actually be “uneconomic” for there to be perfect competition in telecommunications • Telecommunications is in effect a natural monopoly - we have a market failure, which requires some form of regulation…. Doc Ref: 00778/PN/863.1

9. The two principal forms of regulation – ex post and ex ante • Competition Law – Ex post • Deals with problem after it has occurred • For occasional use in normally competitive markets • Focuses on actual abuse of dominant market position • Need strong competition law and enforcement agency • Sector-specific regulation – Ex ante • Attempts to deal with problems before they occur • For markets which are not effectively competitive • Includes potential abuses of market power where such an outcome is considered likely and the time taken to achieve redress through competition law would unduly distort market development • Generally accepted that regulation should be restricted to those markets where competition is not yet effective, and should be the minimum required to achieve effective competition and regulation should equally be removed where competition becomes effective Doc Ref: 00778/PN/863.1

10. Competition law – different forms • The concept of competition is one that dominates the functioning of free market economies • No consensus about what constitutes competition and accordingly it may be assigned different meanings and aims which in turn may be reflected in the competition laws adopted • There are various ways in which competition policies can be categorized • In an abuse based system there is no predetermined judgment but provision is made for control where it is against public interest • In a prohibitive system specific practices are forbidden but provision is made for the prohibition to be lifted if there are countervailing advantages • In a per se system specific practices are conclusively presumed to be against the public interest and therefore prohibited • Methods of enforcement • Systems can be categorized by how they are enforced i.e. are breaches of competition rule considered by civil, criminal, or administrative agencies Doc Ref: 00778/PN/863.1

11. The purpose of competition law • To protect the consumer • From excessive supernormal profits, or policies to prevent price competition, choice etc • To promote economic equity • Distribution of wealth, pro SME policies, rather than seek maximum efficiency • To promote other policies • Maintain employment, encourage regional development etc • For the EC there is the overriding consideration of establishing the common market • Removing barriers to trade between member states Doc Ref: 00778/PN/863.1

12. Different approaches to competition policy • For the US the aims appear to be: • the maximisation of consumer welfare by maximising allocative efficiency • promoting social and political values especially the avoidance of “bigness” and the concentration of economic power in a few hands • For the EC, historically its goal was to achieve economic cooperation through the unification of the national economies and competition policy was seen as being one means to that end so the policy stresses: • the need to keep the common market open and unified • the promotion of free competition as a regulator of economic activity • the maintenance of a certain degree of fairness especially through e.g. support for small and medium enterprises Doc Ref: 00778/PN/863.1

13. What is effective competition? • Possible definitions • The process of rivalry - How much rivalry? • The absence of restraints - How few restraints? • Where no firm can influence the market price - Implies all industries warrant intervention? • However, what matters are the outcomes for consumers that competition in a particular market delivers – not the particular form that the competitive process takes • Regulation should only be applied in those market situations in which intervention can improve social welfare • Consumer surplus • Producer surplus • Perfect competition is the theoretical benchmark, but in reality, most telecommunications industry structures are oligopolies, characterised by a few operators and decisions being made using game theory Doc Ref: 00778/PN/863.1

14. Market failure – the need for regulation • Natural monopoly • Industry where industry average costs are minimised when there is one firm • Interaction of scale economies and demand • Usually occurs when there are high fixed costs relative to variable costs • Creates conflict between productive and allocative efficiency • Productive efficiency requires a single firm • A single firm will price like a monopoly causing allocative inefficiency • Two possible outcomes • Many firms enter and get productive inefficiency • Only one firm enters and get monopoly pricing • Case for priceand entry regulation - restrict entry to get productive efficiency and control price to prevent monopoly abuse • The problem however is: Asymmetric information, Regulatory lag, Ratchet effects and the Regulator’s need to satisfy political demands around the distributional fairness of the outcome Doc Ref: 00778/PN/863.1

15. Pure service based competition Resale of incumbent’s end to end services Wholesale line rental, call origination, carrier selection and call termination Own long haul facilities, call origination, carrier selection and call termination Use of bitstream services to provide voice telephony using VoDSL Use of ULLs to provide voice telephony using VoDSL Alternative Networks (e.g. CATV) offering voice telephony as part of triple play package Pure infrastructure based competition Potential competitive positions in the market Example of Voice telephony Usually Progressive Over Time Doc Ref: 00778/PN/863.1

16. Requires less regulation. Less scope for regulatory failure and distortion in the market • SCB measures can undermine IBC and/or infrastructure investment e.g. CPS reduces incentives for CATV network investment LRIC price for bitstream DSL removes incentives for fixed incumbent to invest in broadband rollout Infrastructure V’s Services based competition (SBC) Factors for SBC • inherent natural monopoly of fixed access network supply • relatively poor prospects for investment in IBC for the fixed sector - access • SBC can act as a “stepping stone” to IBC, using CPS, WLR etc Complexities • inherent superiority of IBC where viable • the need to preserve incentives for infrastructure investment and avoid SBC measures which undermine IBC Doc Ref: 00778/PN/863.1

17. So when should one regulate? • What are correct triggers for imposition of regulation? • Goal should be to • replicate competitive market place? • or drive market to competition? • How • must divorce efficiency regulation from alternate policy goals • deal with competition problems distinct from other policy goals, e.g. universal service, broadband roll out • Overall goal • move to regime of markets dictating outcomes, with competition law as backstop Doc Ref: 00778/PN/863.1

18. European Union case study – regulatory triggers • 1993 -1998 • Progressive de-regulation and removal of monopoly protection • Focus on various specific problems • 1998 - 2003 • Continued focus on specific areas on ad hoc basis – e.g. terminal equipment, interconnection, leased lines • Application of SMP test – operators with significant market power – leading to imposition of obligations • Significant market power equals 25% of market for provision of particular service - arbitrary figure - potentially distortionary: lack of actual market power or real failure of market place, however obligations still imposed on operators • 2003 – present • More of a economic focus • Focus on access markets • Application of dominance test Doc Ref: 00778/PN/863.1

19. New EC Regime – 2003 onwards…. • Review of regime commenced one year after implementation of full liberalisation package • Reflection of speed of development of market place • Again, focus on access BUT looking at economic markets – focused on wholesale • competition law tests underpin determination on when to intervene • regulate only where player dominant in particular economic market AND competition law cannot solve problem • continual market reviews to assess dominance • Economic markets test - Similar to merger analysis but various questions arise: • risks – lack of uniformity • complexity of analysis – look at all markets? • Old regulatory “markets” still present – conflicts? • Information required is vast Doc Ref: 00778/PN/863.1

20. Legal process to assist in application of rules • Consideration needs to be given to: • Information asymmetry and how to address • Reversal of onus of proof – appropriateness depends on penalty scale, criminal sanctions, reversal less appropriate, civil scale or obligation to supply, possible reversal • Cost of process – how to ensure system only triggered where real commercial need? • Arbitration process rather than adversarial – BUT need third party input process to ensure best outcome • Speed of process – justice delayed is justice denied. Business planning not possible during lengthy review process • Sanction powers need to be determinative and create right incentives • Want to avoid gaming of the system with low barriers to commencement of process Doc Ref: 00778/PN/863.1

21. Competition law alone? • Ultimate goal – competition law as sole remedy • Pros • Ensures consistent application of rules across different sectors – crucial in age of convergence – particularly platform convergence – why regulate cable/telephony/satellite/mobile differently if moving into same space • Precedent available – thus legal certainty – key to investment decisions • Cons • Not always appropriate if on-going detailed oversight required – does not determine allocation of costs of resource required except on ad hoc basis • Information asymmetry – particularly hard if have to rely on “intent” or need visibility of cost basis utilised or to show non-discrimination Doc Ref: 00778/PN/863.1

22. What then is best practice? • Effective trigger to application of regulatory rules - replication of competitive market place but only where market failure • Focus on access markets • Cost orientation principles and means to avoid vertical integration issues • Flexible and fast moving regulatory regime • On-going oversight of problems in particular spheres • Prevent gaming of system while ensuring legitimate complaints • Application of effective sanctions – deter abuse, but proportionate • Ensure core access products available once trigger hit and unbundled elements available where applicable • Rapid processes for determination of answer to dispute – enforced once applied • Regulatory independence/access to sufficient resource to perform efficiently – decisions should stand up to scrutiny Doc Ref: 00778/PN/863.1

23. Access business Rest Accessseparation Incumbent operator Core and access network business Rest Network separation CATV business Rest CATV separation Mobile business Rest Mobile separation More drastic form of regulation - structural separation? • Legal separation - separate businesses with separate accounts but common ownership • Divestiture - separate businesses with separate ownership Doc Ref: 00778/PN/863.1

24. Potential benefits of structural separation Case for forced separation of fixed incumbent’s mobile subsidiary ?? Doc Ref: 00778/PN/863.1

25. Regulation in the new era Doc Ref: 00778/PN/863.1

26. Users worldwide (Mio.) 1800 Mobile phones 1600 Wired phones 1400 1200 1000 Mobile phones Mobile Internet 800 Fixed line Internet 600 400 Mobile Internet 200 0 1995 2000 2005 2010 The changing dynamics of telecoms Source: Vodafone Doc Ref: 00778/PN/863.1

27. Current Future Services Communication Control Services Services Services Services Services Fixed Network GSM GPRS UMTS Intelligent Packet Core Media Gateway IP Backbone Network GPRS Other access UMTS IP Technology developments will drive convergence of core fixed and mobile networks • Converges Circuit-switched and Packet-switched networks • Radio access agnostic with seamless mobility • Optimum choice of radio access bearer Doc Ref: 00778/PN/863.1

28. VOIP Mobile IP Network /Internet Multimedia PC WiFi Hotspot PDA Laptop PSTN to IP gateway The addition of VoIP on wireless access technologies The addition of VoIP on wireless access technologies further blurs the boundary between fixed and mobile Doc Ref: 00778/PN/863.1

29. Will there continue to be viable fixed market? Continuing Need for Fixed Infrastructure Website Access, Instant Messaging Some Multimedia instruction Central Education repository Education Homework submission Children create at home Interactive classroom at home (e.g. Remote grinds) Telemetry/remote procedures Info access Patient watch Diagnostics Health Appointment setting Medical record management E-mail (text) E-mail with large attachments Online archive of home movies, photos, music, video to share with friends Instant messaging Phone/internet on same line Full screen video calls Comms Video Call PC video conferencing E-mail (text) Access to “light” office resources Access to “heavy” office resources Home/office location equivalence Teleworking System access (text only) Limited participation In video conference Full participation in videoconference meetings Remote socialisation WWW (text) Interactive video entertainment (full screen sitting room system) Digital video recorder File swapping Personal video player Networked home – multiple devices Entertainment Gaming: online console…. Networked multiplayer… Community gaming 100 kb/s 100 Mb/s 10 kb/s 1 Mb/s 10 Mb/s Data transfer rate Over Time Data Source: Information Society Commission Doc Ref: 00778/PN/863.1

30. MNO / MVNO Revenues Mobile network GPRS / 3G GSM / 3G Fixed operators potentially to benefit Fixed operators expect to be able to gain revenue from Fixed-Mobile Convergence by integrating WiFi and cellular Handset will / may only use Mobile network when there is no other coverage FixedCo Revenues WiFi / Bluetooth fixed network ADSL (Broadband) DSL (Broadband) WiFi DSL (Broadband) or Leased line Residential DSL Broadband Access WiFi Corporate WLAN deployments Public WiFi Hotspots WiFi / Bluetooth WiFi Doc Ref: 00778/PN/863.1

31. End users Mobile Network Service Fixed Network service TV Broadcast e-services Content supply Next generation regulation - the challenge • Creating regulation that leads rather than lags technology and market developments, providing a catalyst for growth in network economies and information societies • Driving forces for change in communication sector include: Technological change – convergence / digitalisation Industry restructuring – shifting market boundaries Internationalization of markets Continuing liberalization of monopoly elements New policy - BB networks as foundation for information Economy / society Doc Ref: 00778/PN/863.1

32. Models of the “new” communication Regulator • Options: • Expand telecom to accommodate/promote convergence issues, e.g. broadband, e-commerce • Merge telecom and broadcast regulators • Merge telecom with other public utility regulators • Move telecom under the competition authority • Goal - enhancing consumer and viewer options • Consumer (Telecom & IT) • competition - services, price, quality • universal service/access, broadband rollout • Viewer (Media) • programme diversity • diversity of funding sources • content regulation • Telecom/ICT/Media convergence is about the enhanced capabilities of the broadband infrastructure network - wireline and wirless…. Doc Ref: 00778/PN/863.1

33. Thank You Doc Ref: 00778/PN/863.1