Competition oversight – What can be the role of the regulator in designing rules that limit anti-competitive behavior by the incumbent operator?

[Response by Sophie Trémolet and Diane Binder, October 2009]

A key objective of regulation includes controlling the incumbent operator’s market power in market segments that have not been opened to competition so as to ensure a leveled playing field for potential new entrants. Depending on the institutional set-up, anti-competitive behavior may also be monitored based on general competition law by a competition authority, in which case cooperation between the sector regulator and competition authorities should be organized.¹

Regulation functions limiting anti-competitive behavior from the incumbent operator may include the following:

• At the retail level, regulation of price levels and quality are two intertwined aspects of regulation to ensure that the incumbent operator does not abuse its market power by charging high prices or undercutting quality². There are four basic approaches to regulate the overall price level: rate of return regulation, price cap regulation, revenue cap regulation and benchmarking regulation.
• With respect to relationships with other suppliers, the regulation of access to the non-competitive component of an integrated incumbent firm by other firms (referred to as access regulation) is a key aspect requiring regulatory intervention. Under this approach, the regulator intervenes to fix the terms and conditions (including price and access conditions, such as point of entry and time restrictions) at which rival firms (usually new entrants) in the competitive component can access non-competitive services of the incumbent operator (which is usually the network owner). The pricing of access to essential facilities is important for the success of competition in the market for existing customers. There are three basic forms of access: exclusive use of unbundled facilities, one-way access (like in electricity sector where the competitive operator pays the network provider for transporting electricity) or two-way access (such as interconnection charges in the telecommunications sector). Access pricing³ options include the Efficient Component Pricing Rule⁴ (ECPR), global price caps and cost-based prices. The ECPR approach has been broadly applied to the water and telecommunications sectors, notably in England and Wales. The regulator must also assess the available capacity of the non-competitive component to make sure that capacity is sufficient to address requests. The regulator must constantly struggle against the incentives of the integrated firm to deny access.
• In the event that such regulatory tools are ineffective, structural separation⁵, or unbundling may be required in order to introduce competition in market segments that are potentially competitive. There are different degrees of structural separation that a regulator can promote to limit anti-competitive behavior: ownership separation⁶, joint ownership⁷, and operational separation⁸.

In all the tasks mentioned above, regulators in developing countries may need to pay specific attention to the challenges faced by poor customers in accessing service.⁹

If regulation of the main operator is to benefit the poor by ensuring availability, affordability and sustainability of basic services, regulators need to: i) provide a framework for competition so that a level-playing field can be maintained between the incumbent utility and small-scale operators, such as in the water and/or electricity sectors where they often operate informally; ii) create incentives for the dominant operators to extend services; iii) allow a flexible approach to service quality by the incumbent operator and others so as to adapt to customer demand; and iv) establish a tariff level and structure that encourage higher access to services without jeopardizing financial stability.

Resources

Restructuring Public Utilities for Competition
Washington, D.C, 2001.
OECD

Taking into account the poor in Water Sector Regulation
Water Supply and Sanitation Working Notes, Note n°11, Water Supply and Sanitation Sector Board of the Infrastructure Network, World Bank Group, August 2006.
S. Trémolet & K. Hunt

Access Pricing in the UK Water Industry: The Efficient Component of Pricing Rule – Economics and the Law
prepared by NERA for Northumbrian Water, March 2001.
R. Hern, H.L. Jung and S. Trémolet

ICT Regulation Toolkit
Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2.

Footnotes

1. See answer to the FAQ: “Competition Authorities – What are the potential functions of competition authorities and how can they collaborate with sector regulators?“
2. See Basic Forms of Regulation and Quality of Service for more details.
3. See Competition in Utility Markets for more details.
4. “Under ECPR current retail tariffs are used as the benchmark for access tariffs and a “rebate” is provided by the company for elements of the retail service that are not drawn on by the entrant. For example, a network access tariff would be calculated from the unbundled retail customer tariff, by deducting the avoidable costs of abstraction, harvesting and treatment, and customer service”. (NERA, 2001)
5. Refer to BoKIR Competition in Utility Markets for more details about structural separation.
6. Ownership separation is the vertical separation of non-competitive activity and the competitive activity. In this setting, the owner of the non-competitive component has no incentive to discriminate between competing firms in the competitive activity. (OCDE, 2001)
7. It is the joint ownership of the non-competitive activity by firms in the competitive component. Under this approach, each of the downstream competitive firms owns a share in the non-competitive activity, and therefore eliminates the incentive to discriminate among rivals. (OCDE, 2001)
8. Operational separation involves placing the non-competitive component under the control of an independent entity (separation of ownership and control). (OCDE, 2001)
9. See FAQ “What should regulators do to meet social objectives set by policy-makers?” in the Section “Social pricing and rural issues“.