TOPIC 16: SELECTED TOPICS: ANTITRUST AND TELECOMMUNICATIONS

Topic 16| Part 1 16 January 2013Date

ANTITRUST ECONOMICS 2013David S. EvansUniversity of Chicago, Global Economics Group

Elisa MariscalCIDE, Global Economics Group

2Overview

Antitrust and Telecom

Overview and Best Practices

Regulation of Prices

The Relations of the Mobile

Operator

Competition Issues

Antitrust and Payments

3 Overview and Best Practices

4Regulatory Approaches

The telecommunication sector, like energy, water and transport, is an industry which relies on physical distribution networks (i.e. network industries).

Telecommunications is almost everywhere subject to a combination of sector-specific regulatory rules and, in many countries where such legislation exists, to laws which govern competition in all sectors.Most network industries are clearly divisible into components subject to competition, e.g. retailing or generation of electricity, and parts likely to be monopolies, e.g. gas and electricity distribution and water and sewerage pipes.

• Technology changes very fast, with new products emerging (e.g. mobile, broadband) and new processes (e.g. fiber networks replacing copper ones, 4G mobile, etc.).

• The dividing line between monopoly and competitive activity is moving over time.

Telecommunications has departed from this model in two related ways over the last two decades.

5Evolving Regulatory Approaches

Traditionally telecommunications services were provided by a fixed network, connected to homes and business premises by wire.

Constructing a fixed network was very expensive, involving sinking massive resources before service could be started. For this reason, fixed telecommunications was regarded as a ‘natural monopoly’ not subject to competition.Services were often provided by state monopoly enterprises or, in the US, by a monopoly company whose prices were set in advance.

However, wireless or mobile networks—which are of primary interest to us here—have shown much greater competitive potential.

6Reasons to Regulate

In most countries, there are three or four networks each with access to its own wireless distribution network, vying with one another for the customer’s spending.

• Spectrum management.• Arrangements for interconnection and call termination.• Universal service.• Access to the mobile network by other providers.

This vastly reduces the need for regulation, even if it does not reduce it to zero. In particular, four types of intervention are often observed:

71) Spectrum Management

In most countries, spectrum licenses are only available from the government or spectrum regulator (the spectrum authority).

• In former times, spectrum was assigned by the method of ‘beauty contests’, in which the authority chose the licensees on preset criteria.

• More recently, ‘objective-based’ auctions are used. This means that a competitive process determines which firms are successful.

Thus spectrum licensing policy effectively determines the structure of the mobile industry.

With the growth first of mobile voice and now of mobile data, operators are dependent on new awards of spectrum to enable them to meet growing demand.

82) Interconnection and Call Termination

In order to ensure any-to-any connectivity, the operators are required to interconnect with one another.

• The operator serving the receiving party is entitled to charge the operator serving the calling party for termination call.

One scheme of charging is Calling Party’s operator Pays or CPP:

Operators might agree on almost any price for this reciprocal exchange. In practice, operators have been found to use their bottleneck control of access to their own set of customers to charge a high ‘monopoly’ price for termination.

In response, regulators have intervened to set an ex ante regulated price for mobile termination.

93) Universal Service and Coverage Requirements

In many countries, it is an objective of policy that as large a proportion of the population as possible has access to mobile voice service and in some cases to mobile data services.

To increase coverage beyond commercial limits, the government can require the spectrum authority of making spectrum awards to impose on one or more licensees the condition that the licensee fulfills an obligation to provide coverage for a particular percentage of the population or in a specified area.

The consequence of this will likely be lower auction revenues for that license.

Enforcement of license conditions could be, for example, by imposition of a fine, or by a prohibition on the recruitment of new customers until the coverage obligation is met.

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4) Mandating Access to the Mobile Network by Other Providers

In many countries, it is an objective of policy that as large a proportion of the population as possible has access to mobile voice service. The same ambition is being extended to mobile data services as mobile technologies offering greater bandwidth are installed. These policies reflect a desire for social inclusion.

In order to increase coverage, the government can require the spectrum authority at the time of making spectrum awards to impose on one or more licensees the condition that the licensee fulfills an obligation to provide coverage for a particular percentage of the population or in a specified area.

As before, the consequence of this will likely be lower auction revenues for that license.

Enforcement of license conditions could be by imposition of a fine, or by a prohibition on the recruitment of new customers until the coverage obligation is met.

11Regulatory Institutions

In some countries, there are separate regulatory and competition authorities for regulation and competition law.

In others, both competition and sectoral regulation are enforced by the same body. v

• On the one hand, sharing of responsibilities may lead to different decisions resulting from differences in the objectives in the relevant legislation and to situations of double jeopardy.

• The resulting regulatory uncertainty can be mitigated by informal or formal agreements.

• On the other hand, an economy-wide competition regulator is less likely than a sectoral regulator to be subject to regulatory capture.

Pros and cons of institutional arrangements

12 Regulation of Prices

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Regulation of Prices – Setting Ex-Ante Interconnection Prices

The regulatory approach: Much telecommunications regulation revolves around setting prices of retail services to prevent abuse of market dominance or even preempt monopoly power.

• It can work well when the market power the operator exercises is weak or is cancelled out by particular circumstances.

• It can work when companies are symmetrical.• Arrangement tends to be reciprocal.• Litigation can become a problem ex post if potential problems are not

foreseen, e.g. Mexico

The other (competition) approach: is to allow for prices to be determined by commercial negotiation or competition rules.

14Regulation of Prices – Cost Oriented Prices

• The goal of regulation in these circumstances is to achieve an outcome similar to that arising in competition (Prices equal to costs).

Widely used when there is a persistent bottleneck (as is the case, for example, with mobile termination or access to a fixed network’s monopoly local loop), and when there is no special reason for making retail prices depart from costs.

• This is the cost of providing the service in question, using new equipment and an efficient input combination.

• In the case of mobile termination, the LRAIC is the average cost of producing the termination service when it is added to other outputs produced by a mobile operator, notably the origination of mobile calls.

The definition of average cost which is normally used by a telecommunications operators is long run average incremental costs (LRAIC).

15Regulation of Prices – Retail Minus Prices

• For example, the wholesale price of an SMS, including origination and termination, is found by taking the Telco’s charge for a retail SMS, and subtracting from it the cost (normally the LRAIC) of the retailing activities which the Telco no longer has to incur because retailing is now done by the entrant.

In this method, the pivot for pricing the wholesale input is the retail price charged by the access provider.

As noted, the effect of this method of pricing access is to allow the access provider to keep all the profits associated with the end-to-end service.

• i) cases where the access seeker is simply a retailer or reseller.• ii) cases where it is considered desirable that retail prices contain an

element of cross-subsidy.

For this reason retail minus prices tend only to be used in special contexts. These include:

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Value Added Services Regulation – Ex Ante Regulation

VAS are commonly seen as non basic telecommunications services as they are additional services offered to end customers in addition to basic telecommunications.

In some countries these services are not regulated under telecommunications law in the sense that they do not require an individual or class license.

In other countries although they are subject to licensing this is done by a simple registration (class license/ authorization)

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Value Added Services Regulation – Ex Ante Regulation

• a) relations between the mobile operator and the VAS supplier,

• b) relations between the mobile operator and its own retail arm/services,

• c) consumer relations.

Given that value-added services may be provided either by the operator itself (self provision such as for example call waiting, voice mail facilities, etc.) or by a third party (e.g. premium content services) it would be important to consider four aspects where there may be (or not) possible regulation and the impact this might have on:

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Two-Sided Markets and the “Waterbed” Effect in Telecommunications

The “waterbed” effect is a phenomena typical of two sided markets, and occurs when pushing down prices through regulation on only one side of the market results in rebalancing on the other side.

Understanding and quantifying this phenomenon has important consequences for designing and implementing effective regulatory interventions for every two sided market.

Authors in the literature (Armstrong 2002, Vogelsang 2003, Peitz et al 2004) predict that mobile firms always have an incentive to set unregulated “high” F2M termination charges, while setting “low” profit maximizing M2M termination charges.

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Two-Sided Markets and the “Waterbed” Effect in Telecommunications

Most regulators around the world are concerned that termination rates are too high, and have intervened to cut them considerably. Generally, rates are set to the same level.

This is consistent with the theoretical results for F2M calls, but less with the “collusive” concern arising from M2M calls.

• Decrease price to fixed users, increase mobile prices,• Decrease profitability of mobile operators,• Decrease diffusion of mobile services.

There are some predictions made from the theory when the mobile sector is relatively small compared to the fixed sector:

Negative relationship between termination rates and price to mobile consumers describes what is known as the “waterbed” or “seesaw” effect.

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Two-Sided Markets and the “Waterbed” Effect in Telecommunications

• A cut in these rates could lead to lower retail prices and operators competing strongly as a result of lower termination rates.

In some cases there are conditions (uninternalized call externalities, and competition in linear prices) such that high M2M termination charges could be instrumental to lessen competition:

• In such cases, reduction in termination rates would reinforce the waterbed effect on mobile retail prices, which would therefore increase.

In other cases, regulation of termination rates relaxes intensity in competition:

21 The Relations of the Mobile Operator

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The Relations Between the Mobile Operator and the VAS Supplier

Regarding i) ability to obtain an agreement with the operator so as to host the services:

• In practice, hosting will depend on the nature of the “product” and its likely profitability if it will be of interest to the mobile network provider so as to agree to host the service in question.

• This of course raises the possibility that VAS providers are unable to obtain an offer from a network operator to host their service. However an offer to host does not necessarily lead to an agreement because of the way charges are agreed.

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The Relations Between the Mobile Operator and the VAS Supplier

Regarding ii) the prices that the network operator will charge at wholesale level for hosting the services:

There are at least two models for Telcos to charge VAS.

• In one the VAS provider sets its price, and the Telco adds its chosen transport fee.

• The other model implies that a retail price is agreed – possibly at a price point set or approved by the regulator.The most common practice is for a revenue

sharing approach. This means that a percentage of the revenue that accrues to the service is held by the network operator.

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The Relations Between the Mobile Operator and the VAS Supplier

Regarding iii) the prices that the network operator will charge at retail level to the end consumer.

Again these prices are commercially agreed. However there have been occasions where the retail prices of these services were regulated (directly or indirectly) because of exposure to very high bills as has been content for consumer protection purposes.the standard approach is that wholesale prices for value-added service providers for hosting their services are commercially agreed upon and are not based on the cost of providing the service but rather on the bargaining position of the parties.

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Relations Between the Mobile Operator and its Own Retail Arm/Services

The other aspect of concern is the possibility of preferential treatment that Telcos can display vis-à-vis their own retail arms. This is normally done in two possible ways:

• i) unfair cross subsidy to own services and • ii) undue discrimination

They may be important to consider in ensuring that operators that will host the MMO either are not allowed to offer their own service or if they are, competition is effectively protected by inserting appropriate conditions in their license and not rely only on competition provisions. Possible ex ante measures may include the following options:• Accounting separation,

• Non discrimination provisions,• Functional separation,• Structural Separation,• Outright prohibition

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Consumer Relations/Consumer Protection Issues. Quality of service (QoS)

QoS requirements normally cover call quality, dropped calls, etc.

QoS requirements dealing with complaints can be imposed or reported where the VAS provider is a licensee.

QoS requirements in terms of the provision of service as between the VAS and the Telco such as capacity to be used, specified repair times etc. can be agreed at a commercial level unless there are local regulations for QoS for the services to be supplied.

27 Competition Issues

28Competition Abuses and Remedies

i) Denial of access/refusal to deal.

ii) Pricing or discrimination abuses.

iii) Tying and bundling.

29Denial of Access / Refusal to Deal

Normally firms can choose whom they sell to, but if they are a monopoly or if the service which they produce is essential to supply in a downstream market in which the owner of the ‘essential facility’ is also active, then they can be forced to deal.

The idea is based on the principle that a dominant firm may be forced to deal if its refusal would cause serious harm to competition in the relevant market.

The most common case in refusal to supply cases concerns a company that has a dominant position in an upstream (network) market and enhances its profits by refusing to supply a firm in a downstream (retail) market.

30Denial of Access / Refusal to Deal

There are obvious cases where a company refuses outright to supply another company or to deal with it.However, there are other cases where it is not so obvious, because there is no outright refusal – the dominant party continuously finds reasons to delay concluding an agreement, or it seeks to impose unreasonable conditions on supply arrangements.In such cases the authority will have to determine if the conduct amounted to a “constructive refusal” to supply.

On the other hand, refusing to supply a firm which does not pay is lawful.

31Pricing and Discriminatory Abuses

Excessive prices.

Predatory Pricing.

A margin squeeze.

Price or Non-Price Discrimination.

Bundling and Tying.

32Excessive Prices

An offer of access would be of little value if it were only available at an astronomical price. Thus in some jurisdictions there is an express prohibition on excessive prices – in the European Union, on ‘unfair’ prices.

There are three ways to demonstrate excessive prices, which are:

• Price comparisons or benchmarking against other countries’ or regions prices,

• Profitability analysis, or return on capital employed, • Price-cost comparisons, or returns on sale.Identifying an excessive price is not

straightforward. It may be easier to set prices ex ante expressly on a cost or other basis than to use the law to attack them once they have been set.

33Excessive Prices - Remedies

If the price is not regulated, the authority can control the price directly (often by sector specific regulators).

If it is already constrained by regulation but at an excessive price, the authority would have to impose a lower limit.

Problem: Authority may lack sector specific expertise or information gathering to do it effectively (capture through exploiting information asymmetries).

34Predatory Pricing

Predatory pricing would occur where the prices charged by a dominant operator are below an appropriate measure of costs, with the apparent motive of driving out or weakening competitors and then raising prices.

In practice, for predatory pricing to be a successful strategy there must be high barriers to entry and/or exit.• If firms are able to enter and exit the market with little cost then each time

the dominant firm increases its price to recapture profits new entrants will be attracted into the market and cause prices to fall.There were only few proven cases of predatory

pricing. It is difficult in practice to distinguish predatory pricing from aggressively competitive below-cost pricing.

Proving the abuse involves a comparison of the costs of a service BUT what costs?

• Average avoidable costs; these usually exclude fixed investment.• Long run incremental costs, including capital costs.

35Predatory Pricing

In some jurisdictions (US but not EU) it is necessary to show that the firm alleged to be predatory can reasonably be expected to be able to recoup its costs in the predatory pricing phase by charging higher prices later.

Persistent losses would be a signal to investigate whether it was pricing in a predatory way. But such accounting losses would not be conclusive.

Remedies: A fine would normally be imposed under competition law. The offence can only be remedied by raising prices – which is unlikely to be popular.

36A Margin Squeeze

The classic illustration of a margin squeeze occurs when a dominant firm supplies both an input to another operator and competes with that operator in the retail market.

A margin squeeze arises when a firm sets wholesale and retail prices which generate a margin which is less than the costs of performing the activities covered by that margin. Conditions have to be satisfied:

• The ‘squeezing’ firm has to be dominant, but the ‘benefitting’ firm does not. • Choosing the cost test 1: which operator's costs should be compared with the

observed margin – those of the affiliated firm or those of the competing firm?.• Choosing the cost test 2: which definition of costs should be employed? A narrow

definition might be employed, focusing on variable costs and ignoring capital costs but capital costs can also be included.

• Is it necessary to show that the margin squeeze has an adverse effect on competition?Remedies: The squeeze itself can be remedied either by reducing the wholesale price or by increasing the retail price

37A Margin Squeeze

Upstream product

Firm 1 Competitor to Firm 1

Consumers

Dom

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nt F

irm

Dow

nstr

eam

Arm

Firm

2

Wholesale price

p1 p2

38Price or Non-Price Discrimination

The form of price discrimination is margin squeeze heading, in which the dominating firm charges a wholesale price to its competitors higher than its own retail prices.Non-price discrimination is the application of dissimilar conditions to equivalent transactions with different parties, with respect to non-price aspects of the transaction.Sectoral regulators or competition authorities have sought to deal with it through license conditions, regulations, etc.

Examples of such non price discriminatory treatment include:• Provision of a systematically poorer quality of service to other firms.

• Discriminatory (strategic) use or withholding of info on new services.• Disruption of service etc.• Use of delaying tactics with non-affiliated MMOs.Remedies: The authority can levy a fine or to

impose some form of separation, such as functional separation or ownership separation

39Bundling and Tying

This involves a decision by the firm to sell two or more products in combination rather than only individually.

Mixed bundling offers a buyer a discount if she buys both goods, but she can also buy them individually.

Tying occurs if the purchaser can only buy good A (the tying good) with good B (the tied good).

Competition problems arise if a firm both produces a monopoly and a competitive service.

• Any of the three strategies above (mixed or pure bundling or tying) can make life very difficult for a rival selling the competitive good.

40Bundling and Tying

Bundling occurs widely in telecommunications via offers to customers of double plays (voice and broadband), triple plays (voice, broadband and video).

Complications in the analysis arise if bundling leads to cost savings on the part of the operator.

Remedies: The typical remedy is either to require all goods to be sold separately or to place limits on the discounts associated with mixed bundling

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End of Antitrust and Telecom, Next class Antitrust and Payments

Antitrust and Telecom

Overview and Best Practices

Regulation of Prices

The Relations of the Mobile Operator

Competition Issues