Once the authorization process is underway the role of the regulator is to ensure non-discriminatory treatment of all players in the liberalized market. At the outset the market is unbalanced with the incumbent clearly the dominant vertically integrated player. It is likely that the tariff structure of the incumbent is un-balanced, where prices charged do not reflect the underlying costs of service provision so that some cross-subsidies are in operation. These cross-subsidies distort the market and provide incorrect incentives to new entrants. For instance, excessively priced international calls can lead to over-investment by newcomers.
There are numerous ways in which the incumbent can further distort competition (see Module 2 and Module 6) unless the regulatory authorities take action. These include:
- failure to deal with the requests of competitors for network interconnection in a timely or serious manner (typical responses are: “it is not technically possible,” “it will take a very long time,” and “it will be very expensive”);
- charging its retail arm lower fees than those paid by competitors;
- reducing retail tariffs to a level where new entrants cannot survive;
- making the sale of one product (to customers or competitors) conditional upon the purchase of a second product;
- offering discounts to customers who take a combination of products/services;
- entering agreements with distributors that preclude them from offering the products/services of competitors; and
- providing low-quality products/services to competitors.
These activities are known as price/margin squeeze, predatory pricing, tying, bundling and exclusive dealerships. While such activities may be proscribed in individual authorizations, they are also prohibited under the application of ex post competition law. In some cases, the competition agency is responsible for the application of competition law. In other cases, the sector-specific regulator has the authority or assumes the powers of the competition agency.
Generally, the focus of ICT regulation is “essential facilities.” New entrants are certain to require some inputs from the incumbent. Some of these inputs cannot be replicated economically or technologically by new entrants and no substitute can be found for them. These are “essential facilities” for new entrants and the “last mile” and interconnection disputes flow from this characteristic. Many of the above activities are prohibited by law or addressed in detailed ex ante licenses. There is a large body of analyses, case law, and remedies concerning anti-competitive behavior provided in the Toolkit that reflects various jurisdictions.
Regulators also need to promote the interests of consumers since the incumbent can set tariffs above costs where it holds a dominant position - for example, in line rental, local calls, and to some extent national calls, since new entrants initially target the international segment. Baskets, sub-basket and associated price caps have been constructed and linked to rates of inflation - (Retail Price Index(RPI)/Consumer Price Index (CPI) - minus some “X factor”[1] to take account of expected efficiency gains. The impact of these price caps is largely felt by new entrants who can rarely set prices above those of the incumbent. Increasingly sophisticated costing models (forward-looking, incremental) with significant information requirements have been developed to improve tariff-setting efficiency. Regulatory tariff setting is much less common in competitive mobile markets, especially where three or more operators have been authorized.
The growing availability of the Internet and broadband are changing the tariff landscape with customers frequently paying for access and not usage. For a flat fee, customers can obtain a broad range of services (such as Caller ID, conference calling, and call forwarding) plus unlimited national calls and/or free calls to on-net customers and even some credit for international calls. These practices are both a challenge to the previous principles of tariff setting and to the business models of incumbents.
Competition leads to the erosion of the dominant positions of incumbents. In these circumstances emphasis shifts from ex ante sector specific to ex post competition law-based regulation. Simple market share thresholds (e.g., 25 percent) often in broad markets have been used as means of identifying a dominant position, but competition policy has developed and become more sophisticated. In ex post regulation, the first step is the “definition of the relevant market.”[2] Where the identified market is considered sufficiently competitive, sector-specific regulation has been lifted. For definitional purposes, markets can be analyzed according to product, geographic location, type of customer, retail, wholesale, and time. Market definitions that are too narrow or too broad will fail to accurately identify dominant positions. Certain products in the market display clear signs of dominance, such as call termination on networks and thereby interconnection. For definitional purposes, markets need to be analyzed from the point of view of buyers and sellers, particularly in regard to whether a product is a substitute for the one under analysis. Additionally, the presence or absence of barriers to entry (such as essential facilities) is central to defining markets. Once again, there is a substantial body of analyses, methodologies, and ex post competition case law reflecting the experience in different jurisdictions in the Toolkit.
ENDNOTES
[1] The X-factor in the price cap formula is an efficiency target chosen to reflect the productivity growth potential of the regulated firm over the (forwards-looking) term of the price cap. See Toolkit Module 2, Section 5.11.3.
[2] http://ec.europa.eu/information_society/policy/ecomm/doc/info_centre/studies_ext_consult/review_experts/review_regulation.pdf