How can a telecommunications regulator determine whether the interconnection tariffs a company proposes will encourage efficient entry by low cost suppliers?

You're in the section: Frequently Asked Questions -> Telecommunication Regulation – Interconnection -> How can a telecommunications regulator determine whether the interconnection tariffs a company proposes will encourage efficient entry by low cost suppliers?

[Response by Eric P. Chiang, May 2009]

Regulation is rarely a simple process, particularly when each regulatory decision affects many parties (e.g., incumbents, entrants, customers, and government), each of whom has an important stake in the outcome. If regulation falls prey to special interests or excessive influence by one or more stakeholders, overall efficiency and welfare can fall.

Often a key goal of a regulator is to promote an environment that best resembles one of a competitive market structure. Where technology makes this possible, competitive entry into markets should be a primary objective for policy makers and regulators. However, because the market share and infrastructure of telecommunications industries are typically held by few dominant operators, new entrants find it challenging to compete effectively. Regulation should be designed to reduce costs of service by allowing efficient entrants to serve customers and to encourage incumbents to reduce costs themselves. Once competition is healthy and market concentration is reduced, market forces will allow regulation to play a lesser role in the retail market. In fact, as competition increases, the need for retail regulation naturally falls as market forces help to ensure competitive prices and service quality.

In order for competition to emerge, interconnection agreements between different operators and service providers are needed. Over the past decade, several major multilateral initiatives were introduced to provide a basis for guiding the development of interconnection agreements, including the WTO Agreement on Basic Telecommunications Services (WTO, 1996)1 and The 1997 European Interconnection Directive. Both initiatives propose primary guidelines for efficient interconnection based on a few simple objectives:

  • Interconnection charges should be cost-based
  • Interconnection should be non-discriminatory
  • Agreements should be made public (transparency)

Though these objectives seem straightforward, many problems arise in their implementation. One problem arising with cost-based interconnection prices is that it does not allow new entrants to compete effectively when the incumbent engages in below-cost retail pricing (i.e., cross-subsidization); for example, when international calls subsidize domestic calls, entry into the domestic market is not attractive. In such cases, this can be resolved by 1) rate rebalancing, 2) opening the international calls market to competition (and probably eliminating the source of the cross subsidy), or 3) allowing for discounted (below-cost) interconnection rates.2 Clearly, the latter is not preferred because it would require ongoing regulatory intervention designed to manage competition, though may be necessary in countries with very unbalanced retail rates, such that the benefits resulting from competition can be experienced despite the inefficient (below-cost) interconnection pricing structure. In these cases, a gradual rate rebalancing with corresponding adjustments in interconnection charges might be ideal.

Another efficiency issue arises from the non-discrimination objective, i.e. that interconnection prices be non-discriminatory in rates or quality. New entrants often face start-up expenditures that existing firms do not face, which can create a competitive disadvantage. At the same time however, new entrants can also seize chances to ‘leap-frog’ companies already in the market by taking advantage of new technologies. Fair interconnection prices allow cost recovery for the company that provides the interconnection facility while at the same time keeping an incentive for technological innovation. Also, it is important to clearly define what is meant by non-discriminatory. Clearly if there are cost differences between interconnection services, it should not be considered discriminatory to charge difference prices for the different services. There may be good public policy reasons for charging the same rates for these different services, but allowing unequal prices in such circumstances should not be considered discriminatory.

Another debate is whether regulation should be applied 1) prior to interconnection (ex ante) by establishing guidelines for developing interconnection agreements or by requiring standard offers, 2) after interconnection (ex post) by handling disputes that result from an unregulated negotiation process, or 3) using some combination of the two, for example, establishing a default agreement should negotiations fail. The growing consensus is that ex ante regulation is preferred, based on the notion that incumbents and entrants often lack a level playing field when engaging in negotiations. Furthermore clarity in regulatory rules and on how regulators will resolve disputes should they occur add certainty to the negotiation process and narrow the range of possibilities that operators would consider as possible outcomes.3

A review of access pricing, interconnection pricing, and their effects on competition is provided by Jamison (2008). In sum, to ensure that an industry is regulated in a manner that encourages efficient entry by low-cost firms while discouraging entry by high-cost firms, interconnection prices should be designed in a way that provides a competitive market among incumbents and entrants that does not give either side an inherent, regulatory based advantage. In general prices for interconnection service should be set close to its incremental cost. Prices for access to an essential input, such as an unbundled local loop or a collocation facility, should follow a slightly different standard, namely one that embeds a similar profit margin in both the access service and the retail service. This encourages the incumbent provide adequate quality for its rival who is purchasing the essential input. Common types of cost-based interconnection prices include variations of long-run incremental cost4, while prices based on fully-distributed costs, wholesale pricing5, and others also exist. (Jamison, 2006)6

 

Resources

Methods for Increasing Competition in Telecommunications Markets
University of Florida, Department of Economics, PURC Working Paper, 2008.
Jamison, Mark A.

Cost Concepts for Utility Regulators
University of Florida, Department of Economics, PURC Working Paper, 2006.
Jamison, Mark A.

Competition in Telecommunications
Cambridge, MA: MIT Press.
Laffont, Jean-Jacques, and Jean Tirole

WTO Agreement on Basic Telecommunications Services
 1996.
World Trade Organization

Footnotes

  1. See the “Negotiating Group on Basic Telecommunications“.
  2. It should be noted that rate rebalancing will happen naturally if all markets are open to competition – in the previous example, entry into the domestic market is not attractive at below-cost prices, but entry into the international market is as this is where the price mark-up exists. If both markets are opened to competitors, prices in both markets will adjust to reflect prices. Only if the market with the above-cost prices is protected to keep generating revenue for the subsidized market is it necessary for the regulator to intervene and adjust interconnection rates as suggested under option 3).
  3. See How should a regulator resolve disputes related to interconnection? for more detail on the topic of dispute resolution.
  4. Long-run incremental cost (LRIC): an approach used to measure the forward-looking costs of producing services in the long run when all costs are variable (i.e., no fixed costs); the incremental cost of one service is calculated as the total cost of producing two services together less the stand-alone cost of producing the other service.
  5. Wholesale pricing: the bulk pricing of unbundled network elements or services from one operator to another for the purpose of interconnection or resale.
  6. See What are common cost models used for determining interconnection tariffs and how do they deal with common costs?, What can a regulator do when cost data for interconnection pricing is difficult to come by? and What is the difference between cost-based and retail-price based interconnection charges? in this note for more detail.