Handling Competition Issues in a Liberalized Telecom Market

1. Advocacy and Capacity Building on Competition Policy and Law in Asia (7up2 Project) 16-17 August 2005, Hanoi, Vietnam Advocacy and Capacity Building on Competition Policy and Law in Asia (7up2 Project) 16-17 August 2005, Hanoi, Vietnam Handling Competition Issues in a Liberalized Telecom Market Dong-pyo HongPh.D. in EconomicsKim & Chang, Korea

2. Characteristics of Telecom Markets • Network Economy • A good becomes valuable to a user when the users adopt the same good or compatible ones • A telephone users benefits when other users are connected to the same network • Fair competition issues : interconnection, network sharing • Economies of Scale • high fixed cost for constructing network • Natural monopoly due to decreasing cost function • Government has license for telecom business to avoid redundant investment • Generally a few service providers in market • Fair competition issues : entry barrier, predatory pricing, price regulation, collusion • Economies of Scope and High common costs • Providers can save cost by providing bundling service • Providers can distributing common cost across many services • Fair competition issues : cross subsidy, service bundling

3. Characteristics of Telecom Markets (cont’d) • Essential/Bottleneck facility • Elements of essential facility • (i)Control of the essential facility by a monopolist, (ii) a competitor’s inability practically or reasonably to duplicate the essential facility, (iii)the denial of the use of the facility to a competitor, (iv)the feasibility of providing the facility • Examples: local loop network in fixed telephony service (cf. scarcity of spectrum in mobile service) • Fair competition issues : interconnection, network sharing • Switching cost, lock-in and tipping • Cost and welfare loss in changing service providers • Inconvenience in number change, expenditure on new terminal, abandoning mileage service etc. • Fair competition issues : entry barrier, bundling • Universal service • Telecom service as public utility • Government should guarantee the widespread access to and affordability of basic telecom services (ex. residential service, emergence call etc.)

4. First-Mover’s Market Power Sustained/Fortified : First-movers maintain their market dominance by combining inborn advantages and derivative advantages. First-Mover’s Advantages Inborn (Absolute) Advantages: Holding essential facilities, Preoccupying markets and scarce resources (e.g. high-quality frequency, number etc.) Derivative (Secondary) Advantages: Economies of scale/scope, Brand power Fixed Service Market Dominant firm retains substantial market share and profits, based on its holding of essential facilities (local loops) Currently, the system of unbundling fixed network elements is not actively utilized Mobile Service Market Dominant firm has accumulated a substantial amount of profits by preoccupying markets and realizing economies of scale as a first-mover → Brand Power established → Consumers ‘locked-in’ Consumer-lock-in effect is deepening by structural entry barriers and consumers’ switching costs

5. Mobile market Profits from mobile telephone market invested in wireless Internet → advantage in wireless Internet service market Worries concerning transfer of market power to the IMT-2000 services in the future Limitation of new entrants Limitation in facility based competition due to matured market and lack of fund Leveraging market power in new service markets : First mover’s advantage in investment and marketing → transferred to new service market Fixed market In Korea, KT invested aggressively in VDSL using excess profits from monopoly markets such as LM (Land to Mobile) call and leased line markets, putting pressure on competitors through strong marketing In the last year, the number of KT subscribers increased while the number of Hanaro decreased

6. Effective Competition • Specific policies are needed to achieve ‘effective competition’ • Effective Competition • Active competition between suppliers • Absence of persistent excess profit • Absence of market power ☞ Market power: Ability to set prices independent of the behaviors of other carriers and the consumers • Benefits of effective competition • Satisfactory service quality, prices that reflect costs, innovative services, variety of choices, efficient provision of services, sufficient information for the consumers, etc. • Process of effective competition policy • Market definition • Market analysis: Whether the market is, or expected to be, effectively competitive • Examine whether the policy to promote competition is needed • Abolish or modify the existing policy as necessary, or introduce a new policy

7. Fair competition issues on network • Interconnection • Network Opening • Accounting Separation

8. Local Switch 3 Toll Switch Local Switch Toll Switch Local Switch 4 4 1 Local Switch 2 5 Local Area 2 Satellite Foreign Country Undersea Optical Fiber International Gateway Switch Local Area 1 Interconnection • Why necessary? • Telecom networks need to interconnect for social welfare • Essential facility (e.g. local loop) should be accessed by many other carriers for service provision

9. Interconnection (cont’d) • How to Regulate? • Mandate to negotiate interconnection in (upon request) • Obligation to treat interconnecting carriers indifferently • For example, a local carrier should treat other long-distance carriers in the same way as it treats its own long-distance subsidiary • Regulate the interconnection charge to be based on costs • Collocation of equipments or facilities required for interconnection • Obligation to provide information • Other topics • Interconnection between data networks (Internet interconnection), Opening of wireless Internet access

10. Network Sharing • LLU (Local loop unbundling) • Oblige a local carrier to allow other carriers to use its local loop (unbundled) • Unbundling fixed network elements • Oblige a carrier to provide unbundled network elements such as pole, duct and cable of local loop • Roaming • Sharing of mobile networks • MVNO (Mobile Virtual Network Operator)

11. Accounting Separation • Concept • Typically a telecom operator provides many services • Divide costs between different services to determine the cost of each service (Cost allocation) • Need to allocate joint and common costs • Purposes • Use the cost for (ROR) price regulation • Check if the cross-subsidies exist between the monopolistic service and the competitive service, etc.

12. Price Cap Regulation Price regulation which sets the price ceiling for the market dominant firm after considering price level, productivity, yet providing some degree of freedom for the firms to set price In the US and the UK, administrative(regulatory) costs have fallen, price have fallen and productivity increased - Cost reduction and incentive to rationalize management - Prevent cross-subsidization - Remove uncertainty by enhancing transparency of regulation - Reduce regulatory costs such as verifying production cost - Promote stable investment by regulating for a limited period

13. Price Regulations • Objectives and Principles of Price Regulation • Ex-ante vs Ex-post Regulation • ROR Regulation • Price Cap Regulation

14. Universal Service: Concepts • Universal service • In Korea, universal service is defined as “’basic (fundamental)’ telecom services that every user can be provided anytime and anywhere at affordable rates” • Currently, local telephony, local payphone service, insular service, emergency services, discount services of telephony to handicapped and low-income (See below for other countries) • Universal service policy • Promoting or maintaining universal availability of connections by individual households to public telecom networks (Source: Hank Intven (ed.), Telecommunications Regulatory Handbook)

15. Universal Service: Backgrounds • Access to telecommunications as basic rights of all citizens • Increasing need to solve ‘digital divide’ problems as the informatization of the society progresses • Network externality and universal service • Network externality: Benefit enjoyed by a network user increases as more users are added to the network • As the socially optimal network size may not be achieved through market functions, some subsidies for universal service may be welfare-enhancing

16. USO (Universal Service Obligations) • USO: Requirement on operators to provide universal service • The revenues from providing services, say, to uneconomic areas (at the same affordable price) may not cover corresponding costs • A regulator might decide to, or not to, set up specific mechanisms to recover the ‘costs’ from USO • In monopolistic era, USO was only implicitly imposed on the monopolist • The ‘costs’ were usually financed by cross-subsidies (i.e., high prices of long-distance services subsidized low prices of local telephony) • Since the introduction of competition, USO needed to be more specified • Cross-subsidies may distort competition • Clearer definition of universal service • How to finance the associated ‘costs’ • Competitive and technological neutrality

17. Universal Service : Funding Mechanisms • Mandatory service obligations • General taxes • Cross subsidies • Traditional approach • May entail inefficient price structure and distort competition • Access deficit charges • May lead to inefficient interconnection and distort competition • USF (Universal service fund) • Potential to improve efficiency and transparency • Administrative complexity

18. Universal Service Fund • Good USF (Intven) • Independent administration, transparent financing, market-neutral, targeted funding, subsidies should be relatively small, competitive bidding • Good collection mechanism needs to be designed (who should contribute to the fund on what basis, how to determine the amount of USF, who collects the contributions, etc.) • Cost models for USF • Subsidies to uneconomic areas • LRIC for improved efficiency • Competitive bidding process

19. Regulations in telecom industry in Korea • Price cap regulation • Non-price regualtion • Role Sharing between Regulatory and Competition Authorities

20. Price cap regulation Only KT’s local call and SKT’s mobile phone tariffs are liable to prior approval and other providers only notify their tariffs ※ Market Share: Local(KT,95.6%), Mobile(SKT, 57%) - Purport : to regulate consumer predation or predatory price to exclude competitors ↔ Need to allow more freedom in terms of means of competition (lift price regulation) - less price competition - too much competition in non-price area - less incentive for price reduction - price rigidity and incentive for cartel ※ price cap regulation

21. Non-price Regulation • Local loop unbundling • introduced in 2002 for local loop networks and broadband Networks • Number portability • Local Telephony : Implementing stage-wise from Jun 2003 to Dec 2004 • Mobile : Implementing in 6 months intervals in order of SKT(1st), KTF(2nd), and LGT(3rd) from Jan 2004 • Obligatory interconnection and provision of facility • Essential facility owners are required to provide interconnection • Long-Run Incremental Cost: Assess the connection charge most effectively • Universal service obligation • Universal Service Fund was Introduced in Jan 2000. • Review the possibility of including the broadband in universal service after 2005 • Obligatory donation and accounting regulation • Ban on cross subsidy of facility-based service operator • Differentiated frequency use cost • Advertisement, standardized contract, membership service and subsidy on phones

22. Role Sharing between Regulatory and Competition Authorities • Strengthened role of Korea Communication Commission(1995) - Power to approve dominant player’s tariffs, power to recommend business permit, enact notification on regulatory procedures - Examine the agreement regarding provision of facilities and interconnection - Investigate unfair practices and arbitrate consumer loss and damage - Authorize the agreement between telecom operators - Arbitrate disputes of network sharing and interconnection between operators • Agreed on general principle for role division - General abuse of dominant position, unfair trade practices, cartels  KFTC - Industry specific, technical areas reducing consumer welfare  MIT ※ OECD conducted an analysis on role division of competition and technical issues in 1998 - Often, regulatory agency deals with technological and economic issues and competition agency exclusively deals with competition law enforcement

23. Thank You!