Transcript Slide 1

MARKET POWER AND ITS
IMPLICATIONS FOR MOBILE
TERMINATION
PRESENTED AT INTERNATIONAL TELECOMMUNICATIONS
SOCIETY BIENNIAL CONFERENCE, BERLIN, SEPTEMBER 4-7
2004
ROB ALBON AND RICHARD YORK
TELECOMMUNICATIONS GROUP
AUSTRALIAN COMPETITION AND CONSUMER COMMISSION
Caveat
• The views expressed are those of the
authors and do not necessarily reflect
those of the Australian Competition and
Consumer Commission.
2
Overview (1)
• On the surface there appear to be a number of
•
•
•
market failures in mobile markets.
In particular, there appears to be market power
in termination and various externalities.
However, mobile carriers and their consultants
in Australia and in other jurisdictions have
claimed that the free market outcome is
efficient.
They argue that termination charges set above
cost fund efficient subsidies to mobile
subscription.
3
Overview (2)
• Regulators in many countries have taken a
different view.
• They have argued that market failures in
mobiles give rise to a case for intervention.
• In particular, they favour regulation of mobile
termination charges to produce more efficient
and more competitive outcomes.
4
Overview (3)
• In the traditional public economics paradigm,
market failure provides a prima facie case for
intervention.
• Before intervention can be endorsed it has to be
determined that government can do better than
the market.
• There are two main complexities in proving the
case − second best considerations and the
efficiency costs of raising revenue to fund
subsidies.
5
Overview (4)
• We believe that the presence of substantial
market power in termination is clear.
• In our paper, we address arguments that the
mobile network externality justifies either:
− a laissez-faire approach to termination, or
− the addition of a network externality surcharge on a
regulated termination charge.
• We also consider the relevance of the fixed-line
network externality and of call externalities.
6
Overview (5)
Our broad conclusions are that:
• the free market outcome is inefficient,
• there is a strong case for regulation of
mobile termination, and
• The case for a network externality
surcharge on the regulated access charge
for mature networks is very weak.
7
What is ‘Market Failure’?
• The presence of market failure provides a
necessary − but not a sufficient − basis for
intervention.
• Market failure is interpreted in terms of the free
market failing to yield an efficient outcome.
• Simple interpretation of efficiency in terms of
Price ≠ long-run marginal cost
• Market power and externalities are examples of
market failures found in mobiles.
8
What Intervention Seeks to Achieve
• Intervention aims to achieve an ‘efficiency gain’.
• This is interpreted in terms of satisfaction of the
‘potential Pareto’ or ‘Kaldor-Hicks’ criterion.
• This is usually interpreted as a positive change
in the sum of consumer and producer surplus.
• Such a change results in gainers being able to
compensate any losers, while still remaining
better off.
9
An Example − Reducing Price to Cost
• In the following diagram the policy is a reduction
of price from P0 to P1, equal to TSLRIC cost.
• Quantity consumed increases from Q0 to Q1.
• Consumers gain by the sum of areas A and B.
• The producer loses by area A.
• The net gain (the ‘efficiency gain’) is area B
(+A +B −A = +B).
10
Effects of Reducing Price to Cost
Price,
cost
P0
A
B
TSLRIC
P1
Demand
Q0
Q1
Quantity
11
A Stronger Test is Sometimes Set
• We note that Crandall and Sidak use a much
tougher test − the Pareto criterion.
• Under that test any intervention that results in
losses to any party fails.
• It is almost inconceivable that any intervention
would result in gains without any losses. For
example, our simple example of price reduction
clearly fails.
• Use of this test could help explain their strong
deregulatory stance.
12
The Prima Facie Case for
Intervention (1)
•
•
•
Market failure provides only a prima facie
case for intervention.
There is an ‘imperfect’ market, but
government may not be able to do better!
The case for intervention has to be
proven.
13
The Prima Facie Case for
Intervention (2)
There are two main difficulties:
• Second-best − fixing one problem may
worsen another, and not result in a net
efficiency gain.
• Funding issues − must consider the
marginal deadweight loss (MDWL) from
taxation necessary to fund subsidies.
14
Marginal Deadweight Loss (MDWL)
from Taxation
Change in the deadweight loss
MDWL =
----------------------------Change in taxation revenue
• As the tax rate increases, the MDWL increases.
• The numerator rises at an increasing rate …
• … and the denominator rises at a decreasing
rate, reaching a peak at the ‘monopoly’ level.
• The MDWL becomes arbitrarily large.
15
Market Power in Termination (1)
• Empirical and in-principle argument suggests
mobile carriers have market power in
termination.
• Carriers and economists such as Crandall, Sidak
and Hausman emphasise substitutes.
• Yes, there are some weak substitutes, but
unregulated prices are typically two to three
times full TSLRIC costs.
• This simply could not happen without substantial
market power.
16
Market Power in Termination (2)
• This market power does not diminish with
the addition of more carriers into a market.
• Even small carriers have market power in
termination.
• Denial of this has been described by
Laffont and Tirole as a ‘common fallacy’.
17
It is worth recording here the common fallacy that small
players do not have market power and should therefore
face no constraint on their termination charges. This
fallacy results from a misunderstanding of the definition
of a market. A network operator may have a small
market share in terms of subscribers; yet it is still a
monopolist on the calls received by its subscribers.
Indeed, under the assumption that retail prices do not
discriminate according to where the calls terminate, the
network has more market power, the smaller its market
share: whereas a big operator must account for the
impact of its wholesale price on its call inflow through the
sensitivity of rivals’ final prices to its wholesale price, a
small network faces a very inelastic demand for
termination and thus can impose higher mark-ups … .
(Laffont and Tirole, 2000, p. 186)
18
The Mobile Network Externality (1)
• Individuals are willing to pay to subscribe to a
mobile network according to their (declining)
marginal private benefit (MPB).
• The source of the mobile network externality is
the willingness to pay by existing subscribers for
the addition of new subscribers to the network.
• The marginal external benefit (MEB) from
additional subscribers is also likely to get less as
the network matures.
19
The Mobile Network Externality (2)
• The total demand for subscription, the
marginal social benefit (MSB) is equal to:
MSB = MPB + MEB
• In a mature network the last subscriber to
join will be of no value to existing
subscribers.
• This is often suggested to be where about
80 per cent of the population subscribes.
20
From Externality to Intervention
• The existence of an externality does not
necessarily present even a prima facie
case for intervention.
• It must be relevant at the margin.
• That is, the marginal social benefit (MSB)
of another subscriber must exceed the
TSLRIC cost to the network operator of
taking the new subscriber on.
21
The Pigouvian Subsidy
• The Pigouvian subsidy is set equal to the
MEB.
• Payment of this subsidy will induce the
socially optimal number of subscribers on
to the network.
• This is illustrated in the following diagram.
22
P,C
MSB
Efficiency gain from the Pigouvian subsidy
P0
TSLRIC
A
P1
MEB
MPB
Q0
Q1
Q
23
The Pigouvian Subsidy is Inefficient (1)
• Where there are efficiency costs from
raising the necessary revenue the
Pigouvian subsidy will never be optimal.
• Some smaller subsidy will be optimal in
these circumstances.
• Determination of the efficient subsidy/tax
is a ‘balancing act’.
24
The Pigouvian Subsidy is Inefficient (2)
• The marginal efficiency cost of raising the last
dollar of revenue for the subsidy must be set
equal to the marginal efficiency gain from the
subsidy.
• In view of the possible need to subsidise some
intramarginal subscribers, there could be an
efficiency cost even before new subscribers are
on the network.
• This may mean that the efficient subsidy is zero.
25
Do ‘Competitive Bottlenecks’
Produce an Efficient Outcome? (1)
• The interaction of mobile carriers with oneanother has been described as one of
‘competitive bottlenecks’.
• They exercise (some) market power in
termination …
• … and compete away some of the profits in the
retail mobile market (eg, handset subsidies) in a
quest to attract new subscribers.
26
Do ‘Competitive Bottlenecks’
Produce an Efficient Outcome? (2)
• The more competitive is the retail mobile
market …
• … the greater will be the pressure to
exploit market power in termination.
• We contend that the termination tax will
always be too high.
27
Do ‘Competitive Bottlenecks’
Produce an Efficient Outcome? (3)
• The tax on termination could be driven to the
point where net revenue is maximised, and the
MDWL is infinite.
• At the same time, the marginal efficiency gain
from the subsidy will be falling; eventually
becoming negative.
• This is illustrated in the following diagram.
28
An Excessive Subsidy Could Result
in a Net Efficiency Loss (− > +)
MPB
MSB
+
Pigouvian Subsidy
TSLRIC
Excessive Subsidy
29
Do ‘Competitive Bottlenecks’
Produce an Efficient Outcome? (4)
• As the marginal efficiency gain from the subsidy
must be finite, and could be negative, the freemarket outcome cannot be efficient.
• That is the gainers (mobile subscribers) could
not compensate the losers (FTM callers) and still
be better off.
30
The Fixed-line Network Externality
• This is the benefit enjoyed by fixed-line
subscribers through having more mobile
subscribers to call.
• Like the mobile network externality this will
tend to favour subsidising mobile
subscription.
31
The Call Externality
• This is the benefit enjoyed by mobile subscribers
through receiving calls from fixed-line callers.
• This suggests a prima facie case for subsidising
FTM calling.
• Obviously, this is the opposite prescription from
that flowing from consideration of the network
externalities.
• It therefore represents a classic second-best
conundrum.
32
Conclusions (1)
• Mobile operators have substantial market
power in termination.
• The claim that the use of profits from
taxing termination to subsidise mobile
subscription is efficient is questionable.
• We have four reasons for believing this.
33
Conclusions (2)
• First, the case for a termination tax may
not even get off first base.
• In mature networks it is unlikely that the
mobile network externality is Paretorelevant.
• A subsidy would unambiguously damage
welfare in these circumstances.
34
Conclusions (3)
• Second, funding the subsidy requires
taxation of termination to raise the
revenue.
• The efficiency costs of this have to be
traded off with the efficiency gains from the
subsidy.
• It is possible that this trade-off could
dictate a zero subsidy.
35
Conclusions (4)
• Third, the competitive process in mobiles
has been depicted as ‘competitive
bottlenecks’, and this process is likely to
result in an inefficient outcome.
• It will entail an excessive tax on
termination, and pari passu, an excessive
subsidy on subscription.
36
Conclusions (5)
• Fourth, the existence of a call externality
enjoyed by mobile subscribers on FTM
calls they receive suggests a prima facie
case for subsidising termination.
37
Conclusions (6)
In summary, we are attracted to the
following perspective in view of the current
state of knowledge:
Looking at all these effects and tendencies together, the best
advice to regulators would appear to be to tax neither fixed
network users for network externalities in mobile networks, nor to
tax mobile users for network externalities in fixed networks, until
the future trends in substitution between mobile and fixed
networks become better understood.
(Bomsel, Cave, Le Blanc and Neumann, 2003, p. 24.)
38
Conclusions (7)
• In our view there is no ‘paradox’
surrounding the ‘free market’ in mobiles.
• Market failures in mobiles are just that,
and policy makers cannot rest easy in the
knowledge that they will be efficiently
accommodated under laissez faire
conditions.
39