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Contents
Introduction 3
Chapter 1: Technology Evolution and the Internet 4
Chapter 2: The practice of access pricing in telecommunications 32
Chapter 3: The economy of the cables and satellite in France 67
References 87
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Introduction
The juxtaposition of the words economy and digital fact refers to an 'economy of numbers. This mathematical vision which is more restrictive than the notion of 'computer economy' seems to prioritize the numbers on the other types of information.
Often the term digital economy returns in a reductive way to e-commerce leaving aside other components such as services, infrastructure and the underlying technology. More specifically, the term should refer to telecommunications, audiovisual, software, computer networks, computer services, services and content online. According to GfK, the digital market brings together information technology (computers, phones, players, GPS...) and communication (social networks, online... sales) services and would be 681 billion in 2009.
Digital brings together the Technologies of Information and Communication as well as all the techniques used in the processing and the transmission of information such as for example telecommunications, internet and information technology.
The digital sector means the sector of economic activity on the Technologies of Information and Communication and the production and sale of digital products and services.
The digital economy in the scientific sense of the term is the study of intangibles that are by definition non-rival goods to marginal cost zero. This definition induces new relationships, new models of Exchange/sharing, only possible by Internet, a new concept of private property. It is a complete sub-domain of the economy, not to be confused with the digital
sector which belongs to the classical economy, nor with the digitization of the economy, with inevitable process on all material goods and all services. As these intangibles are creations of the spirit of artistic or intellectual nature, digital economy brings new models and new possibilities for the knowledge-based economy for and the economics of culture.
In order to establish boundaries and facilitate learning, I have divided this book into tree
chapters: the fisrt chapter entitled technology Evolution and the Internet, the second chapter
entitled the practice of access pricing in telecommunications and third chapter entitled the
economy of the cables and satellite in France.
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Chapter 1: Technology Evolution and the Internet
1. The evolution of the web
The web today is a growing universe of interlinked web pages and web apps, teeming with
videos, photos, and interactive content. What the average user doesn't see is the interplay of
web technologies and browsers that makes all this possible.
Over time web technologies have evolved to give web developers the ability to create new
generations of useful and immersive web experiences. Today's web is a result of the ongoing
efforts of an open web community that helps define these web technologies, like HTML5,
CSS3 and WebGL and ensure that they're supported in all web browsers.
The color bands in this visualization represent the interaction between web technologies and
browsers, which brings to life the many powerful web apps that we use daily.
2. Evolution of major alternatives to traditional telephone networks
2.1. Emerging network technologies
In the traditional Industrial Organization framework, ‘‘Emerging Network Technologies,’’ by
Dale Hatfield, Bridger M. Mitchell, and Padmanabhan Srinagesh characterizes the basic
conditions of supply, as it is now evolving, in the telecommunications sector. At the same
time, it clearly shows how these basic conditions shape and are themselves shaped by the
structure, conduct, and policies in the sector. The authors take the traditional switched
telephone network as their starting point to show how emerging technologies will affect
message communication.
Following a detailed description of characteristics of traditional voice data and cable
television networks the authors discuss the architecture of public switched telephone networks
(PSTN), and its limitations in responding to changing demands placed upon it by alternative
media and new technologies. In contrast, the architecture and institutional approach of the
Internet has led to the emergence of a vision of an evolving network that conveys all
applications, whether they be voice, data, images, video, or multimedia. Similar pressures are
shown to have resulted on cable TV, commercial wireless, and satellite networks with
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corresponding responses. Finally, the authors address the effects of positive and negative
message externalities that have gained prominence in light of emerging message technologies.
The traditional PSTN is ideally matched to voice traffic. It is based on circuit switching and
time division multiplexing to prevent latency of traffic. In contrast, data traffic is based on
packet switching and statistical multiplexing, which involves the sharing of transmission
capacity. Thus, a data network can deal with bursting data traffic and is error free, but it
results in some latency. Because the traditional PSTN cannot handle data and multimedia
traffic well, it cannot make use of scale and scope economies from combining these types of
traffic.
On the traditional PSTN bandwidth is only available in fixed increments. Its dedicated
capacity cannot handle bursting traffic. There exist high costs of setting up calls. The access
network is largely analog and there is vulnerability to single point failures. New technologies
and more demand for network reliability therefore suggest changes in the PSTN architecture.
New but already established developments in traditional wire line architecture include
SONET/SDH, interoffice signaling and intelligent network (IN) features. The signaling
network SS7 is packet-switched. Additional service logic and associated databases connected
to signaling packet switches form the IN. Thus, the intelligence is contained in the network,
while user equipment is dumb. The integrated services digital network (ISDN) access network
has not been successful in the U.S. but is now widespread in Europe. The worldwide spread of
digital subscriber line (DSL) supports two parallel and quite different networks that have the
access lines in common.
In contrast to the PSTN the Internet uses routers with dumb functions. The intelligence is on
the edges and in the terminals. In contrast to traditional data networks the Internet is not
responsible for correcting errors. Rather, error correction is done by hosts. Voice over Internet
Protocol (VoIP) potentially has large capacity requirements. Again, the intelligence is in the
terminals. The authors expect that traditional telephone companies will disappear, as the
Internet architecture takes over.
The trends in the traditional PSTN are shaped by advances in cable TV and wireless, but these
influences are entirely mutual so that new cable TV networks (triple play) look more like the
new PSTN and, similarly, cellular networks are evolving into an equivalent structure. The
greater similarity of network structures and, therefore, network abilities in performing
services along with their parallel existence will increase competitive pressure among the
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different types of companies, even if competition within the fixed network types is limited by
near monopolies in the access networks, while wireless networks support oligopolistic access.
The authors predict increased competition at the ‘wholesale’ level between network
components of all networks. In our view, the intensity of such competition increases with the
level of player in the network hierarchy. Wholesale competition is strongly affected by
unbundling policy. Intermodal competition will be limited by differentiating demand and
supply characteristics that can be maintained for some time. Relevant demand characteristics
include quality of voice communication, reliability of service, and prompt and fault-free
delivery of messages.
The main differentiating factors on the demand side are speed, voice quality, and mobility and
on the supply side the relative access costs and usage costs (Vogelsang, 2003). For example,
wireless networks have low access and high usage costs, combined with low speed and voice
quality, and high mobility. In contrast, fixed networks have high access and low usage costs,
which they combine with high speed and voice quality and no mobility. The combination of
these factors gives fixed networks a limited niche for high demand customers outside their
mobility needs but lets them exit the low demand voice market, while wireless networks will
dominate low demand voice markets and compete with fixed networks for non-mobile voice
and low-speed data services. Wireless will continue its niche for mobile services.
Positive message externalities, as opposed to pure network externalities, lose importance
through reduction in calling prices, and the move to flat rates, and moves toward ‘single-
party’ forms of communication, such as web browsing, file transfers, etc. At the same time,
negative message externalities from unwanted.
calls and messages increase due to low cost of sending multiple messages to many receivers.
The authors show in a formal model that, as a result, welfare-optimal calling charges should
slightly exceed marginal costs.
2.2. Bandwagon effects .
The importance of network effects in telecommunications networks has been appreciated for
decades, but recognition of the role such or similar considerations have across the much
broader and longer value chain of information and communications industries is more recent.
Some authors note that owners of CD players, digital television sets and PCs benefit from the
latter, as do users of the Internet—in each case, the greater the spread of ‘hardware’
ownership or use, the more the ‘software’ that is available.
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Bandwagon effects have implications for the demand curve, creating the possibility that it is
upward sloping over a range, expressing the fact that, as more units are sold and bandwagon
effects come into play, marginal consumers’ willingness to pay increases. Provided a critical
mass of consumers is achieved, which depends on the size of the relevant community of
interest, sales will grow.
This has a powerful impact on pricing incentives and optimal pricing, and the author
exemplifies this by the telephone sector. Whereas call externalities can be internalized (e.g.,
by alternation of the roles of caller and called party), the same does not apply to subscriptions,
and this creates a possible basis for providing subsidies to get people on to the network,
thereby benefiting existing subscribers.
Devising optimal telephone prices involves the estimation of these externalities and also of
the complex demand relationship linking subscriptions and calls.
Jeffrey Rohlfs relates these considerations to the historical pattern of telephone prices in the
United States, pointing out inefficiency of (but popularity of) low subscription rates and
unmeasured local service. He also notes that since the externalities associated with calls to
Internet service providers (ISPs), unlike those associated with voice calls, cannot easily be
internalized there is a case for providing those at below cost.
2.3. Platform competition in telecommunications
Jeffrey Church and Neil Gandal,‘‘Platform Competition in Telecommunications,’’set out the
classification of networks into those which are direct, linking complementary inputs, such as
origination and termination assets for a telephone call and those which are indirect, where the
effect on consumers is achieved through the supply of complementary products, such as the
software available for PCs1. These networks then generate externalities, which influence both
consumer benefits and the competitive process, leading (possibly) to coordination problems,
standards wars, tipping equilibria, and consumer lock-in.
Business strategies in standards contests, involving pricing, marketing, and the creation of
open standards have been extensively analyzed. As to their efficiency, many results have been
found in particular cases—authors noting that ‘the tendency in theoretical literature is for the
equilibrium to be characterized by insufficient standardization or too much variety’ (emphasis
in original).
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A second strand deals with battles for compatibility. A firm owning a platform that is
dominant can extend its market power by denying compatibility to equipment produced by
rivals—either directly (e.g., refusing to allow a competitor’s equipment to be attached to its
physical network), or through the exercise of intellectual property rights. Manipulation of
interfaces has become a major issue in both communications and computer systems, attracting
the attention of regulators and the antitrust authorities—see the Microsoft cases in the U.S.
and Europe. Successful use of compatibility weapons can help a firm to extend its dominance
from one generation of technology to another. For example, ensuring that a rival’s superior
software is incompatible with the installed base of hardware assists the maintenance of that
hardware dominance into the next generation, by preventing rivals from breaking into either
sector.
Much attention has been paid, both theoretically and empirically, to the standard setting
process. Cooperative standards come into existence where no firm will earn higher profits by
refusing to participate in the common process. Cooperation is thus favored in situations where
a common standard will enhance consumer adoption and where no firm has acquired a
dominant position in the relevant
intellectual property. The technologies for wireless local area and wider area networks, such
as Wi-Fi and Wi-Max.
In Europe at least, mobile communications have been subjected to governmental standard
setting, with the adoption by the European Union of a harmonized GSM standard for second
generation wireless technology. In North America, by contrast, operators were free to choose
their own technology. This provides an interesting case study of the costs and benefits of the
alternative approaches, although the issue remains unresolved as yet.
Among the examples of platform competition that the authors consider is that between
satellite and cable television in the U.S. In this case satellite distribution sought to establish
itself in a market dominated by cable, assisted by various legislative and regulatory
interventions designed to prevent the new platform from being denied access to programming.
2.4. Broadband
Broadband is the area where the three platforms of DSL, based on the existing
telecommunications networks, cable, and wireless compete, in a marketplace to which
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governments attach the greatest importance, many of them seeing broadband diffusion as the
key to growth in the knowledge economy.
Robert Crandall, ‘‘Broadband Communications,’’ identifies these and other more advanced
networks, each characterized by different speeds (upstream and downstream) and areas of
application, drawing attention to the differences between DSL over copper and the hybrid
fiber coaxial cables on which cable relies.
A review of national experience of broadband penetration in the OECD area has showed, in
June 2003, Korea to be an outlier at the top, with the United States and Japan at the head of
the second quartile. The presence of a cable network accounts for a high, but normally
declining, proportion of subscribers, in most of the countries at the top of the diffusion league,
thus demonstrating the advantages which are derived from interplatform competition.
Robert Crandall describes the regulatory framework for the development of broadband in the
United States and the European Union. He cites studies by Hausman and others that argue that
regulatory requirements on incumbent telephone companies to unbundle network elements are
inappropriate because incumbents lack market power. Their effect has been to chill
investment by telephone companies, which would otherwise have challenged the cable
companies’ stronger market position in broadband. At the same time Hazlett suggests that
cable companies have themselves restricted the capacity they devote to broadband, because of
the threat of regulation. The Federal Communications Commission (FCC), is however seeking
to restrict, if not eliminate, mandatory access by competitors to incumbent’s future
deployments.
In Europe, some progress has been made in regulating the supply by dominant
telecommunications companies of a service known as wholesale broadband access, or
‘bitstream,’ which comprises of access to carriage on copper loops, digital subscriber line
multiplexers (DSLAMs) and backhaul on, for example, an ATM network. The pricing of this
service has proved problematic, not least because its costs are uncertain. For this reason,
several European regulators have favored an approach known as ‘retail minus,’ where prices
are set, in the style of the efficient component pricing rule (ECPR), on the basis of the access
provider’s retail price for a broadband service minus its costs of providing those services,
which the access sector provides itself. The ERG has mooted in the same document an
approach to broadband regulation in which competitors are encouraged progressively
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to replicate the incumbents assets, starting with backhaul and DSLAMs and possibly
culminating in replication of the local loop itself.
The diffusion of broadband is also leading to concerns about the ‘digital divide’ and to
discussion of the extension of universal service obligations to cover broadband.
With household take up rates of the order of 10–25 percent in the more advanced OECD
countries, and with access to broadband being increasingly expanded as a result of enabling
more and more exchanges to provide asymmetrical digital subscriber line (ADSL), there is
little appetite on the part of governments and regulators at this stage to provide subsidized
access to all.
The current focus on developing broadband competition is both widespread and
understandable. Competitive broadband suppliers based on cable or DSL technologies have
the potential, via new voice technologies, to break incumbents’ dominance in fixed voice.
They might also provide a basis for more competition in the roll-out of fiber to what is
sometimes referred to as next generation broadband.
As the diffusion of broadband accelerates, the success or failure of attempts to promote
competition will become more visible.
Yet, the danger is all too real that the quantity and intensity of regulatory debates in the older
economies, in telecommunications terms, such as that of the United States and Europe, will
lead them to decline as the newer economies, such as China, India, Japan, and South Korea,
bypass the regulatory regimes considered irrelevant and promote broadband diffusion actively
so that the largest numbers of persons in the world have eventual Internet connectivity.
2.5. Cable television
Thomas Hazlett begins his thinking, ‘‘Cable Television,’’ by noting Negroponte’s prediction
that while we were born into a world of making voice calls over wires and watching over-the-
air television, this would soon be reversed. While the use of cable to deliver television
programs has become the dominant mode of transmission in highly cabled countries in North
America and parts of Europe, even in the U.S.A.
satellite television represents a competing platform, and elsewhere new higher capacity digital
terrestrial transmission technologies are being developed.
After initially restricting cable growth in favor of traditional broadcasters—as the FCC put it
in 1966, restricting the role of cable to complement, rather than substitute for over�the�air
and services—from 1976 cable was subject to deregulation. First, the FCC dropped its rules
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preventing cable systems from carrying any but the closest broadcast TV stations; then the
courts struck down regulations on premium movie channels; then, in 1984, Congress passed
the Cable Communications Act, which simultaneously outlawed rate�fixing by local
authorities and restricted competition in video from telephone companies. This caused prices,
quality of service and subscriber numbers to grow.
The rise in prices itself contributed to a re�regulation via the Cable Act of 1992, which led to
rate regulation where effective competition was found to be lacking.
The author reports a complex series of reactions by cable companies, of which the most
prominent were reduced investments, efforts to switch subscribers to less regulated higher
tiers of service and overload of regulatory officials by requests for rate increases. Following
passage of the 1996 Telecommunication Act, cable rate controls were again abandoned from
1999.
The rapid alteration of policy over rate regulation was accompanied by extensive debate over
the degree to which cable operators, particularly multiple system operators (MSOs), were able
to exercise market power in other ways, as monopsonists in relation to program suppliers,
through vertical integration with the latter and by predation of rival operators or
‘overbuilders.’ Thomas Hazlett notes the difficulty of establishing whether a large buyer is
underpaying for programming in a heterogeneous product market characterized by keen
bargaining, and that there appears to be no rule that ownership ties between program makers
and cable operators are essential for the success of either.
As noted by Robert Crandall, ‘‘Broadband Communications,’’ cable operators now have a
major alternative revenue stream through the supply of broadband and, in some countries,
cable telephony. At the same time DSL and satellite offer increasing competition in the
delivery of cable’s traditional entertainment services.
The widening of the marketplace through convergence will attack market power in
previously separated services and should transfer the pressures on cable operators throughout
the world.
2.6. Wireless communications
Somes researchers note, the growth in mobile telephones used for voice over the last 10 years
has been spectacular, reaching by 2004 more than 80 percent inhabitants in many countries in
Europe and elsewhere, although lower in North America. But wireless technologies now
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extend much more widely; 3G, available in an increasing number of countries, provides high
bandwidth mobile services.
Short range nomadic services, known as Wi-Fi, provide broadband access in tens of thousands
of airport lounges, coffee shops and other locations throughout the world; and new fixed
broadband technologies provide high speed services over longer ranges, and appear to offer
good prospect for providing broadband in less densely populated areas, as well as providing
competitive services elsewhere.
By definition, wireless communications services for households and firms depend on
spectrum, for which they compete not only with broadcasting services, but also with the
whole range of spectrum-using activities, such as closed-group private mobile radio,
aeronautical radar and communications, defense, science, such as astronomy, and others.
Balancing these needs is accomplished using one of three methods—the traditional ‘command
and control’ process of allocating bands to particular uses by international agreement and then
assigning spectrum to individual firms or organizations by an administrative process; use of
market instruments, such as auctions and secondary trading; and creation of unlicensed
spectrum to which users satisfying certain conditions or the power of their apparatus can have
access.
Governments and regulatory bodies are moving gradually away from the first method in favor
of markets and—to some degree—unlicensed spectrum. The spectrum or license auctions
described are a step in this direction, but by themselves do little to eliminate imbalances in
spectrum allocation as the auctioned spectrum is tied to particular uses. To eliminate such
imbalances, liberalization of use is required, which itself requires a re-specification of license
conditions in the direction of restrictions on the ability of any licensee to impinge upon
spectrum utilized by a licensee in an adjoining frequency or geography. Such liberalization
has occurred in several countries.
Unlicensed spectrum has come into prominence through its widespread use of Wi-Fi. Because
of its short range and low power, users in adjoining sites need not interfere with one another,
giving the employed spectrum a zero opportunity cost.
In fact, about 9 percent of prime spectrum in the U.K. is set aside for unlicensed uses. A
number of new technologies exist, which permit more services to be provided in unlicensed
spectrums and several proponents of universal unlicensed spectrum have looked forward to
spectrum becoming a plentiful and free resource.
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Regulators have now to address themselves to the questions of the balance between licensed,
and increasingly marketable, spectrum and unlicensed spectrum.
It is, however, hard to see how technologies using the latter can compete in, for example,
wide-area point to multipoint communications, such as satellite or terrestrial broadcasting, for
which an interference-free channel is required to benefit from the low-cost distribution
method.
A second key issue discussed by the authors is the scope for competition in voice between
fixed and mobile networks. In some low- and middle-income countries without fixed
networks, mobile telephony has, temporarily or for longer, filled the gap. The pertinent
question for fixed and mobile operators in other countries is whether mobile is increasingly
attracting subscriptions and calls from fixed networks.
The authors cite chiefly European studies. The U.S. mobile market, where mobile operators
provide large, inexpensive call ‘buckets,’ may be more advanced.
Imminent technological change will affect both. 3G mobile networks have the capacity to
provide calls on a packet-switched basis, rather than the traditional circuit-switched method.
Equally, fixed networks are increasingly moving toward VoIP or Voice over DSL (VoDSL)
technologies—the latter using broadband connections.
The rates at which these new technologies are rolled out, themselves governed by competition
between fixed and mobile operators and within each group, will determine future trends.
Already, mobile revenues have overtaken fixed line revenues in many countries, such as the
U.K., even though the volume of fixed voice calls is far greater than that of mobile.
It is sometimes asserted that wireless communications are a regulation-free zone. But, despite
the lack of retail price regulation, this is hardly the case, as the authors show. First, regulation
through licensing determines the structure of the industry, in a way not encountered in fixed
networks. Second, regulators often determine choice of technology, either directly or
indirectly by imposing conditions, which only one standard can satisfy. Third, regulations
often require number portability, the unlocking, and transferability, of SIM cards and national
roaming, with the latter requiring access provision, normally temporary, by a new entrant to
an existing network. Finally, regulators increasingly examine and intervene in two wholesale
services provided by mobile operators—the termination of calls on the network and the
provision of international roaming, which enables a customer of a network in one country to
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make calls in another country— the subscriber’s operator compensating the visited country’s
operator for the services supplied, and recovering it as retail charges from its own customer.
International wholesale roaming charges in Europe are under scrutiny both by the group of
industry-specific regulators known as the European Regulators Group and, in the case of two
U.K. operators, by the Competition Directorate of the European Union. Analysis of the
market is complicated both by technological changes, which now allow an operator to
program its customers’ SIM cards so that they will seek a particular network when the
customer seeks access in a country, and by the growth of operators active in many countries,
or forming cross-country alliances.
Intervention in mobile termination charges is more widespread and has a longer history. In the
European Union where the CPP principle, under which the calling pay for termination, all
national regulators are investigating the termination, with a requirement to impose remedies
where they find dominance—a likely outcome if they declare each operator’s mobile
termination to be a separate market. As the authors point out, however, if all excess profits on
termination are ploughed back into attracting customers buying subscriptions and making
outgoing calls, it is the structure of termination charges and outgoing prices rather than the
level of profits, which is affected. But this requires very high levels of competition among
mobile operators which, given the small number involved, may not exist. Even if it does, it
will be inefficient.
Linking Gans, King, and Wright with Thomas Hazlett convinces us that the ‘Negroponte
switch’ whereby the public would consume television programs via land connections and
telephone connections via space has probably already taken place.
3. The Internet
Along with mobile telephony, the Internet has emerged as the single most simultaneously
creative and destructive influence unleashing the creation of new infrastructures, businesses,
business models, and economic concepts in the last decade.
In the 10 years that the electronic portals and gateways were made open to the world at large,
not only has a wave of Schumpeterian creative destruction changed businesses, but it also has
changed the sociology of how communications services are consumed. As the proportion of
people using the Internet increases, the proportion of people watching television drop, as
documented in a recent study by the Center for the Digital Future. What was once the passive
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activity of television watching now becomes interactive, conducted via the Internet, and
brings about not just economic but social change as well.
In 1994, about two million computers were connected to the Internet, as it was then used
mainly by academics, scientists, and corporate researchers. By 2000, about 70 million
computers were connected to the Internet. The Internet is a ubiquitous presence in the lives of
over three-fourths of the population living in the United States. In 2004, over 200 million
computers were connected to the Internet. An aspect of writing about the Internet for a
handbook that is essentially global in character, and for a phenomenon that permits global
connectivity on an unprecedented scale. The history of how the Internet has evolved has
surely affected its geography. Thus, the lessons of the U.S. experience apply generally to
other communications infrastructures that are being created around the world.
3.1. The economic geography of the Internet infrastructure
The origin of the Internet is dealt with in a number of other comprehensive histories, with a
variety of details about the individuals who were key players also provided, but the diffusion
issue has hardly merited attention. The author deals with six broad questions. The first is, why
did near geographic ubiquity arise in the United States after commercialization?
The second is, why did market forces encourage extensive growth? The third is, has the
Internet diffused disproportionately to urban areas? Fourth, is the Internet a substitute or a
complement for urban agglomeration and an influence on business location decisions? The
fifth question is, which policies mattered and were the effects intended or unintended?
Finally, are there lessons for other countries?
In dealing with the first question, given that Internet technologies had been available for
around 20 years, by the early 1990s, the role of standardization was critical. By the early
1990s, items of infrastructure, such as hubs and routers, Ethernet cards, and T�1 line were
available and hooked together, but the acceptance of the TCP/IP protocol voluntarily by the
various players made comprehensive interconnectivity possible. An aspect of the Internet is
its overlay structure, with many components being retrofitted to the existing network. The
computing, telecommunications, and the network equipment industries were mature and had
existed for some time. Since such assets were already available, the standardization of
components throughout the system quickly led to the realization of scale economies. The
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characteristics of the core physical elements of the Internet were malleability, deployment
ability, and retrofit ability. These led to high�speed infrastructure creation.
The second issue is the role of market forces and entrepreneurial organizations.
The Internet has spawned hundreds of ISPs, at the consumer or the retail end, who quickly
provided cheap access to millions of U.S. households. In fact, the growth of such
organizations, and the density of competing suppliers, is enormous. The ISP sector has shown
the classic patterns inherently noticed in the evolution of any industry. At the initial phase,
there are a small number of firms, which establish very strong positions to be followed by,
often, thousands of new entrants and then there is a shakeout, as the industry matures, leaving
the field to a smaller set of competent players.
The author goes into the demography of the ISPs and the strategy of the ISP firms. Such
demography dynamics have important implications for other countries. A key issue is,
however, why did the dynamics evolve the way they did? In our assessment, one reason why
these firms were able to quickly go into business is because of the pricing model they were
able to adopt. Based on the contents of the Computer Inquiry 2 (CI2) report of 1980, Internet
services were classified as an enhanced service, avoiding the telephony access charges, even
though the authors of CI2 had not at all then foreseen the arrival of the Internet in its present
form, and its objective was not to propel the growth of the Internet.
Internet Service Providers were, thus, able to provide Internet services to subscribers
at the price of a local phone call, which was essentially free since a fixed sum per month
permitted customers unlimited local calling. Thus, a pricing model permitting low�cost
service supply led to the set up of many ISP businesses that then provided connectivity to the
Internet. The grassroots origin of the Internet, as opposed to a top down imposition of the
phenomenon, has had major consequences in the diffusion of the Internet within the United
States. It has also had major consequences for the growth of Internet-based entrepreneurship,
which has been propelled by the architecture of openness that characterizes the Internet
phenomenon.
At the grassroots level of the consumer, the role of ISPs is paramount. Equally important,
however, is the role of the backbone network, which is the wholesale part of the network as it
were, since information originates from a variety of sources and is accessed by the ultimate
customer. This information is aggregated at the backbones so that it may be exchanged among
the servers and the ISPs. A variety of backbone networks carry traffic, in substantial
17
quantities, and there is interchange of such traffic. The interexchange of traffic between
backbone networks leads to the same sorts of interconnection issues that arise in voice
networks.
These were initially governed by self-regulated cooperative peering arrangements, eliminating
the need to monitor traffic.
The sociology of the Internet community created a system that included openness, fairness,
and a competitive ISP sector as core values. However, as some backbone networks have
gotten larger than others, the question of market power has arisen as bigger networks can
discriminate against smaller ones, highlighting the need for possible regulation of the Internet.
The author concludes that interconnection issues have not shaped the evolution of the Internet
phenomenon, as it has in voice telephony, and even the collapse of WorldCom, one of the
world’s largest backbones, with over 40 percent market share, did not affect the spatial shape
of the sector.
The next major issue has to do with broadband. Internet relies heavily on broadband. From a
geographic perspective, the key conclusion that the author reaches is that dial-up is still more
widely spread than broadband and broadband is available primarily in dense urban areas.
However, as he states, the regulatory environment is in a major flux, and the jury is out on
what will happen to universal broadband diffusion, across rural as well as urban areas of the
United States.
The comments that we make with respect to policies for broadband diffusion apply to the
Internet phenomenon as well, since the Internet is an add-on infrastructure on top of the
existing network. The basic telephony infrastructure is still relevant for the Internet. The issue
of the last mile still holds, we feel, since there is a very clear symbiotic relationship between
the evolution of the Internet, in diffusion as well as quality terms, and the evolution of the
fixed-line telephony network as a whole. The Internet does use preexisting infrastructure and
is embedded in the communications system of a country as a whole. The 14 S. Majumdar, I.
Vogelsang and M. Cave embeddedness of the Internet in the national communications
infrastructure is a key contingency that policy makers must keep in mind. A holistic policy
assessment must link Internet diffusion with the basic telephony regulatory issues.
Because now one can work from practically anywhere, and deliver products or services to any
location, the issue of whether the Internet has replaced urban clustering or not becomes highly
relevant. It is this area of concern that the author addresses next. In an era of progressive
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urban congestion, in parts of the world that are salubrious, the location of businesses based on
the usage of the Internet infrastructure becomes important. Since the Internet provides a
substitute for face-to-face communications, the necessity of locating one’s offices at the same
place where one delivers products or services no longer holds. Therefore, a new approach to
the whole question of spatial considerations in the engendering of economic activity is
required. This is an open research area.
In our view, the area of analysis should be further boosted by bringing in the issues of
outsourcing and business-to-business (B2B) commerce as the topics of salience in the twenty-
first century. Business-to-business commerce growth, responsible as it was for the boom, and
subsequent bust, was propelled by the very presence of the Internet, which provided for the
possibility of conducting commerce in manners that would have enhanced efficiencies.
Outsourcing too, as it is developing, would not have been possible had it not been for the
feasibility of information technology enabled services (ITES) to be provided over substantial
distance, in many cases these distances being several thousand miles. Both B2B and several
variants along the alpha-numeric theme, such as government-tocitizen (G2C) activities that
are engendered by the development of e-governance, and outsourcing are two extremely
important topics that now become significant and worthy of study given the spatial impact of
the Internet.
3.2. Economics of the Internet backbone
The Internet is akin to a standard telephone system in that there is a local layer of players, the
ISPs, and a layer of players similar to the longdistance operators, which are the Internet
backbone providers (IBPs). The IBPs operate the high speed hubs permitting data transfer
from far-flung servers to the local ISPs who then transmit it to their local customers. It is not
surprising that in 1997 the major IBPs were MCI WorldCom, GTE, AT&T, and Sprint. These
were the companies then dominating the U.S. long-distance telephony sector as well. In
common with the rest of the sector, the fortunes of these firms have reversed in the years
since 1997.
In a sense, the economic, strategic, and regulatory issues relating to IBPs and their
relationship with the ISPs are similar to those obtaining between a wholesaler and a retailer,
or an upstream producer supplying units to a firm that is downstream in the industry value
chain. With the Internet, the added complications arise from the fact that a variety of ISPs are
19
connected to each other, so that the network is much richer in terms of connectivity than a
standard telephone network. Thus, this complication, in fact, is an advantage since there are
many routing choices available for the traffic to pass, and the presence of many parties who
provide the data carriage helps bring competitive discipline to pricing. This feature of the
Internet, the ability of the ISP to connect with several IBPs, called multihoming, ensures that
no ISP is captive to any IBP.
With respect to the issues of market power that can emerge within the Internet backbone
segment, the author asks an important question, and one that has surfaced in various
regulatory proceedings given the various telecommunications mergers that have taken place:
Can the IBPs exercise market power so that ISPs have to pay more for carriage and eventually
pass on these costs to the ultimate consumer? The answer is a resounding ‘no’ for several
reasons. First, there is overcapacity in the sector, similar to the overcapacity in the trunking
segment of the long distance sector, and there is ease of entry and expansion. Following the
majors, firms, such as Quest, Level 3, and Williams were also able to create Internet
backbones. Second, the Internet operates on public standards and protocols, and these enhance
interoperability so that the possible absence of technical connectivity is hardly a moot point.
Connectivity is universal. There is also the possible commoditization of the backbone as a
whole.
The second major issue is whether IBPs can behave strategically by raising prices, as in
vertically organized market segments, or degrade quality. Nicholas Economides describes
some key features of the Internet as opposing the successful implementation of such
strategies. If the price of transit that is the carriage of traffic between an IBP and an ISP for a
consideration, increases there simply will be bypass. Other IBPs will be used, or if that is not
a feasible strategy, then ISPs will simply provide transit for each other, either commercially
for a price or via a peering arrangement whereby no charges are made for inter-ISP traffic
transfer, a strategy similar to a knock-for-knock agreement among automobile insurance
companies. For similar reasons, an IBP cannot price discriminate either. In a manner similar
to the above, service quality degradation is also not a viable strategy for the IBP since the
implications are farreaching and touch every part of the Internet. Capacity is now fungible,
and an ISP can easily switch between IBPs who provide the least cost data trunk routing
capacity.
20
The Internet portion of the overall communications infrastructure is extremely competitive,
both at the level of the ISPs and the IBPs, in the United States. While there has been concern
that IBPs, by virtue of their larger size, and smaller numbers, could exercise market power,
this is unlikely. Our view, based on the Internet, is that it is a sector that is organized in a
horizontal manner, as opposed to the traditional PSTN sector that still displays a vertical
structure. This feature of the Internet makes it a sector in which competition is enjoying its
full potential, since the opportunities for interconnection available to the various ISPs are
considerably greater than those which would be available to local telephone company. The
issue that arises is how is the network, which is inherently more complex, managed since so
many routing options are available.
3.3. Pricing traffic on interconnected networks: issues, approaches, and solutions
The overarching theme here is operations management. We have so far discussed the fact that
there is substantial capacity available in the Internet backbone. There may be
commoditization of the backbone. Nevertheless, traffic growth is equally substantial such that
congestion is likely. The next generation Internet developments, such as Digital Video over IP
(DVIP), will create greater traffic bursts that then create congestion problems. Equally, there
can be congestion problems in different parts of the network. The growth of ITES and
outsourcing will create peak periods for traffic transfer and that too on the particular routes
along which the bulk of the outsourcing businesses travel. Since the Internet is going to be the
primary network for not just communications needs, but also for conducting business
worldwide, the need for pricing schemes is paramount. Management of the Internet capacity
via an appropriate pricing scheme, so that resources are optimally allocated, then is an
important consideration.
The authors initially describe the optimal network resource allocation methods that are based
on advances in the computer science fields. The main congestion problem in computing
systems revolves around load balancing, and three main techniques are used. These are:
global knowledge, randomization, and feedback.
The problem that the authors note with these approaches is that they ignore the economic
consequences of load balancing. It is assumed that the value of each specific task is the same.
It is, however, eminently feasible that the value of each particular job will vary according to
21
the priorities of the particular user: authors use the case of a teenager downloading large
music files versus that of a researcher conducting major computations while connected via the
Internet for a remote site. Clearly, the economic and social cost-benefit trade-offs are
different.
Given the complexity of the Internet, optimality is difficult to attain; but the reduction of
negative externalities, via reduction of congestion, and the attainment of allocative efficiency,
so that those users whose valuations are the highest receive the largest allocations of
bandwidth, should be goals of a pricing scheme. A dynamic pricing scheme is described by
the authors. This is principally a usagebased pricing method wherein two important
components of the scheme are an ‘opportunity price,’ which is charging a user what the other
users on the network would have paid for that capacity, and a ‘priority price,’ which is the
price including an additional element paid for faster access or a higher priority.
In the overall Internet structure, another layer has now emerged. This the overlay network that
lies between the ISP and the IBP, and is best understood in the context of transactions that
happen in peer-to-peer (P2P) networks. Overlay networks consist of network nodes that
perform data aggregation tasks as the various customers, connected to the Internet via their
ISPs, conduct their transactions using the P2P framework. The data, for example, could relate
to all the users that have contacted a particular file�sharing scheme and who therefore
comprise a particular service network. Overlay networks are logical service networks
generated on top of the actual physical service network by users’ transactions.
The presence of these overlay networks, therefore, changes our assessment of the industrial
structure of the Internet. The industrial organization of the Internet has obtained a new
component. We now have to account for another link in the chain, as it were, and review the
competitiveness issues, if any, for this element of the network. General knowledge would
suggest that the existence of overlay networks has given rise to intellectual property rights
issues but at this point are unlikely to give rise to market power issues. The authors suggest
three, of several possible, applications of overlay networks: these are collaborative work,
distributed resource management, and access and task automation using software agents. All
of these applications are also clearly ones that are carried out across extreme geographical
distances, thanks to the economics of the outsourcing phenomenon. Clearly, dynamic resource
allocation in networks of ever increasing complexity, but surprising openness, generates
complexities in routing tables’ construction as well. Market power considerations are now not
22
so important, but what is important is traffic and operations management. In both cases,
appropriate mechanism design remains important.
3.4. Toward an economics of the domain name system .
The domain name phenomenon is sufficiently critical that a specialized United Nations
agency, the World Intellectual Property Organization (WIPO) is regularly involved in
proceedings and is a topic that now engages the minds of the United Nations as a whole.
One of the issues is identity. In particular, unique cyber identity is predicated on the
possession of a unique domain name, such as www.elsevier.com, and the trade in domain
names is a market worth $2.5 billion annually. Because domain names are marketable items,
other attributes associated with items that are traded, such as the basic demand and supply
conditions, need to be understood. The author remarks, and in our opinion quite validly, that a
great deal of policy has been made with respect to domain names without the basics of the
domain name as a resource being understood.
We should mention, first, a technical description of the domain name system (DNS), which is
then followed by sections highlighting the key demand side characteristics and the key supply
side characteristics. This characterization is important as it helps define the contours of an
industry segment that is actually turning out, as we describe later, to be most critical
component of the Internet space in an institutional sense.
On the demand side, the author defines two dimensions associated with the demand for
domain names. These are the purely technical demand, for the basic identification routines,
and the semantic demand. Semantic demand is the human side of demand, associated with
making a domain name appealing or memorable or unique. In a sense, the area of domain
name demand analysis merits greater attention using the frameworks that exist in the
consumer demand and marketing literatures on product variety. The semantic dimension also
has a public policy component to it, since the authentication function associated with the
semantic dimension is a signal either of quality or of particular status. Thus, how semantic
names are given to individuals, entities, and organizations is not a function of explicit demand
itself but also involves a process of implicit certification. In other words, there is a control
aspect to the awarding of domain names, and this attribute goes against the free�spirit nature
that has characterized the Internet phenomenon as a whole.
23
In a sense, the implicit certification of domain names helps breed trust among the Internet
using community, which is now almost the whole world, and the issue of trust in online
activities is a very large area of research. The issue of implicit certification, however, does
raise another important issue, who chooses the certifiers? This is akin to the question of who
regulates the regulators. As we further describe below, it is precisely this issue, over the
formation and jurisdiction of the Internet Corporation for Assignment Numbers (ICANN),
which has created a substantial turmoil in the Internet community throughout the world.
On the supply side, the author goes into detail about the structure of the domain name supply
industry, which has three components: the root servers, the registries, and the registrars. Root
servers maintain root zone files, and every top level domain name, such as www.elsevier.com,
cannot be accessed until it has been verified by the root server and advertised to the public at
large via the Web.
Having a domain name on the root zone file is the ultimate expression of market entry into the
Internet space. The political dimension now becomes important because other than three root
servers of which one is in Japan, one in Sweden, and one in the United Kingdom, all of the
others are based in the United States, and in the Internet space today capacity is not a
constraint but an identity is. Thus, even if there is a great deal of bandwidth and connectivity,
and the ability to actually enjoy the benefits of the Internet, there are significant controls over
identity. The fundamental problems are now institutional and not technical. It is not a
production problem but one of distribution.
The institutional issues that arise also relate to the registries and registrars. This is a vertical
market, with registry services coming upstream and registrar services coming downstream.
The original domain name registry was Network Solutions, Inc., which was acquired by
VeriSign, now the largest registrar. The author highlights the lack of competition in the
registry market, and the dominance of the main operator, which was allowed to charge for its
services by the National Science Foundation even though at the time there were no
alternatives.
We should also highlights the relationships between registry and registrar services as a
sensitive one for competition policy because now there is substantial growth in the secondary
market for names and the role of registrar services become important. If, however, there are
limited facilities at the registry level and almost total dominance at the root server level, then
24
there is a bottleneck in the Internet as well, just as there is in the local loop for fixed�line
telephony.
4. Institutional considerations
This section concentrate on the benefits and costs of different policies for the
telecommunications sector, where the policies include competition policy and regulation,
public ownership, privatization, and liberalization.
4.1. Bottlenecks and bandwagons: access policy in the new telecommunications.
‘‘Bottlenecks and Bandwagons: Access Policy in the New Telecommunications,’’ Gerald
Faulhaber differentiates between two interrelated access concepts, bottleneck access and
bandwagon access. These two effects provide for two different potential justifications and
policy directions for access policies. The telecommunications sector is an example of an
industry with both effects. These concepts are closely related to the differentiation between
one-way access, or vertical access and two-way access, also known as horizontal access or
interconnection, made in the access-pricing literature. Bandwagons are similar to network
effects. In spite of these similarities, the author uses bottlenecks and bandwagons to provide a
refreshingly new synthesis of policy insights.
These insights are aptly illustrated by the AOL-Time Warner merger decisions by U.S.
Federal Trade Commission (FTC) and the Federal Communications Commission (FCC). This
merger addressed both problems with the FTC focusing on the access to cable modems as
bottlenecks and the FCC on access to advanced IM services as bandwagons. The author
makes clear that bottlenecks and bandwagons present very different types of market failure
and require different regulatory and antitrust remedies.
The author’s discussion brings out that the difference between a bottleneck or essential
facility, and a simple monopoly is by no means trivial. Four properties in combination are
conventionally viewed as causing a bottleneck problem. They are: (1) sole ownership of a
resource by the bottleneck owner; (2) inability of others to duplicate it; (3) unwillingness of
the bottleneck owner to provide the facility on reasonable terms to competitors; and (4) harm
from this unwillingness to the competitive process. Property (2) requires natural monopoly or
some other barrier to entry (patent, copyright etc.). Property (3) hints at boycott, but would the
problem go away if the bottleneck owner charged the monopoly price for use of the
25
bottleneck input? Property (4) hints at a fixed proportions of input that downstream
competitors cannot substitute.
Since in the fixed proportions case the monopolist of an input can exercise all market power
(both upstream and downstream) in the price of the input, there should be no incentive for
boycott. Thus, the bottleneck problem seems to be how to take the market power out of the
input monopoly. Hence, the author questions if bottlenecks are really a problem if the input
monopoly is earned by innovation or superior efficiency rather than inherited from a
monopoly franchise. He further asks if there exists a feasible mechanism to correct the
problem, using price and terms of agreement. If not, then competition for the bottleneck may
be preferable to bottleneck regulation. This implies the questions, can the essential facility be
circumvented by final consumers (instead of competitors!), and are new technologies in sight
to replace the essential facility? Furthermore, in the absence of regulation, does bottleneck
access develop by itself?
In contrast to bottlenecks the monopoly property is not a necessary characteristic of
bandwagons but only a possible outcome. A bandwagon example of a sustainable oligopoly is
the growth of the Internet backbone through peering. The main property of bandwagons is the
mutual interdependence that is absent from bottlenecks. However, the mutual interdependence
of bandwagons is commonly not symmetric but rather depends on market shares. As a result,
market share conveys to a supplier an independent advantage like demand side economies of
scale.
The bandwagon property has been at the core of strategic use of network effects in creating
compatibility issues by dominant firms, such as Microsoft. Can therefore a market leader kill
competition through her refusal to interconnect? Such effect, known as market tipping,
depends on the shape of network effects curve and the market share of the dominant firm. For
example, Economides argues that for ISPs tipping may not occur before a market share is
close to 100 percent.
The new telecommunications are characterized by a high rate of technical change, a property
for which the serial monopoly hypothesis was developed. This hypothesis conjectures that
innovators, who monopolize a market, are themselves threatened by the following
generation(s) of innovations. Thus, static inefficiency is deemed necessary to generate the
next round of innovations. The author argues that, even if one accepts the serial monopoly
hypothesis in general, it is difficult to replace a current monopolist if network effects lead to
26
stickiness, say, because of difficult customer switching or barriers to entry. Network effects
combined with merger assets would make entry of the next serial monopolist nearly
impossible.
Also, there is little empirical evidence on the serial monopoly hypothesis in general. To the
extent that the serial monopoly hypothesis holds water, the problem of weak intellectual
property rights may call for anticompetitive practices as substitutes for such rights. However,
the author argues that improved intellectual property rights would be much better than lax
antitrust enforcement.
In future, essential facilities in telecommunications networks may become rare because of
technical progress and intermodal competition, but bandwagon effects may flourish because
of the convergence of the media.
4.2. Antitrust remedies and the institutional design of regulation.
Although the U.S. was for a long time the undisputed leader in the liberalization of the
telecommunications sector, it has by now fallen behind other countries in several areas, such
as mobile communications. We should also mention the main differences and commonalities
in policy that may be responsible for this shift. They observe that the U.S. and Europe differ
both in their approach toward the shift from regulation to competition policy tools and in their
competition policies. According to the authors, since the breakup of AT&T in 1984, the U.S.
has reduced the influence of antitrust policy on the telecommunications sector, while the EU
has increased that influence, particularly in its new framework.
While the European approach toward the relationship between competition policy and
regulation is based on a systematic design, the U.S. approach is driven by a diversity of
interests that work their way through the legislature, regulatory agencies, and courts. It is not
that these interest groups are absent in the EU.
However, their influence is more contained at the design stage of the general EU policies. As
a result, the EU approach, driven by the vision of convergence, has become uniform with
respect to the different parts of the telecommunications sector and is geared toward
competition on equal terms applied to relevant markets, while the U.S. approach has
enormous difficulties reconciling historic differences in the regulation of telephony, cable TV,
and wireless services. For example, the different regulatory treatment of broadband access via
27
DSL and cable modem is explained by their original assignment to the telephone and cable
sectors.
In spite of these differences, both EU and U.S. policies are shaped by the same vision, which
is that competition shall ultimately rule in the entire telecommunications sector. Pockets of
natural monopolies and network effects are viewed as ultimately vanishing. In the meantime
regulation is there to bring competition to all end-user areas of telecommunications. Thus,
regulation has shifted from the protection of end users to the protection of competition, and,
as the authors argue, of competitors. This protection can be associated with heavy-handed
regulation.
Such regulation creates direct administrative and network-related costs. The latter include
unbundling and interconnection costs, the establishment of number portability, and the like. In
addition, indirect costs arise in the form of distorted or reduced incentives for innovation,
investment, and cost reduction. Neither the U.S. nor the EU approach provides for an explicit
analysis of such costs. However, considering, for example, the extent of network unbundling
required in the U.S. relative to the EU reveals that the implicit judgment of the EU authorities
has been that U.S. unbundling has been going too far. As of this writing, though the U.S.
seems to be on course in reversing its policy on unbundling, as shown by the FCC’s Triennial
Order of 2003 and the Revised Unbundling Order of 2005.
Both antitrust remedies that can be ex ante and ex post, and ex ante regulation deal with
market failures. Generally, the ex ante remedies are more drastic and would therefore have to
concern more drastic market failures. The most prominent area of ex ante antitrust policies
concerns mergers. Mergers have a lot in common with the issues raised by regulation in the
presence of competition. In both cases, future market developments have to be evaluated
before remedies are applied and in both cases the remedies affect the future competitiveness
of the sector. In that sense, both policies are speculative and, according to the authors, need to
be evaluated more carefully than ex post policies, which correct observed market failures.
However, a status quo argument may be applied in favor of ex ante policies. Thus, in the case
of mergers the remedies, while potentially drastic, are less drastic than divestiture in ex post
policy would be. Similarly, an interconnection policy imposed on a currently dominant
incumbent is less drastic than the same policy on a quickly expanding entrant, who is
expected to become dominant in the future. The EU policy takes this difference into account,
for example, by excluding emerging markets from regulation.
28
The EU telecommunications framework is fully in line with the authors’ characterization of
regulation as ex ante and competition policy as ex post remedies. In fact, all the regulatory
remedies under the framework are explicitly formulated as ex ante policies. In contrast the
new German telecommunications law (TKG 2004) additionally introduces an intermediate
version of regulation, called ex post price regulation. Under this approach, dominant firms can
set prices on their own but have to announce these to the regulator in advance, who can either
simply accept them or postpone their enforcement and initiate a regulatory proceeding.
Furthermore, the regulator can collect any abusively excessive amounts collected by the firms
in the meantime. This section has been incorporated in the TKG 2004 among others as a way
to prevent full-blown regulation of the mobile sector, which so far is not regulated under the
market dominance provisions.
In fact, the fear may be justified that, while the EU framework may be able to move end�user
markets toward deregulation, the wholesale market regulation may be sticky and may even
perpetuate itself for call termination, although intermodal competition between fixed and
mobile networks will eventually gain full steam. If one applies ex ante price regulation to
workably competitive mobile sectors now there would be no reason to abandon it ever. There
is no foreseeable increase in replicability that could lead to a gradual softening of this
regulation in line with the ladder approach by Cave et al. (2001). Then only two deregulatory
options would exist. The first and most straightforward would be to move to a general
receiverpays principle. That would resolve the termination pricing issue and would put the
emphasis squarely on the qualitative conditions and location issues of interconnection. The
second would be to live with imperfect termination markets.
4.3. Telecommunications and economic development.
While a development gap in telecommunications between the high income countries and the
developing world is substantial generally and with respect to the digital divide, shows that
telecommunications in developing countries can be changing as much as or more than in
developed countries. The emergence of China and India as potential world leaders in the
telecommunications sector is an example of the latter phenomenon. At the same time, new
gaps emerge within the developing world between leaders and laggards.
We should also mention the strong relationship between institutional change and the evolution
of the sector. Countries that have privatized, liberalized, and created stable regulatory
institutions have also made greater progress in telephone and Internet penetration and
29
technical developments than the countries continuing government ownership of dominant
providers without opening telecommunications markets to competition. Competition, in
particular, is a more powerful driver of telecom expansion than privatization alone. Internet
services in developing countries expand best if left largely unregulated and with open access
to the public networks. Protecting established network providers often conflicts with the
introduction of more modern and cheaper services. This holds particularly for VoIP that is
forbidden in a substantial number of countries, in order to protect dominant network providers
from an erosion of long-distance and international telephone call charges. However, VoIP will
eventually emerge into a formidable competitor for established networks, whether forbidden
or not.
The authors point out the consequences of improved telecommunications sectors for the
economies as a whole, as improved telecommunications sectors enable developing countries
to export services thereby replacing white-collar workers in high income countries. This
suggests that countries that have not yet reformed their telecommunications sectors should see
their opportunities from joining the reform bandwagon. We should also mention, the reform
ability itself depends on a country’s institutional endowment so that reform in countries with
inadequate institutional endowments may not lead to the desired outcomes. It would therefore
be important to learn about reforms that either failed in the sense that they had to be
abandoned before completion or in the sense that, although completed, they did not yield the
desired outcomes.
Universal service policies in developing countries usually mean something quite different
from such policies in high income countries. In high income countries, universal service
concentrates on the access of individuals or household to basic or advanced services. In
contrast, in developing countries universal service policies largely concern the connection of
villages or remote areas to modern communications, including Internet access. Both have in
common an urban-to-rural cross-subsidization pattern along with a similar political-economy
drive.
4.4. Institutional changes in emerging markets: implications for the telecommunications
sector
Telecommunications utilities are characterized by large and sunk investments, by the presence
of economies of scale and scope and by products that are mass consumed.
30
The combination of these features has traditionally led to state ownership and/or government
regulation of the sector and has made pricing in the sector a politically sensitive issue. The
author particularly emphasizes the short-term political profitability of expropriating the sunk
costs in favor of low prices for the masses, requiring safeguards against government
opportunism in order to achieve investment in this sector. State ownership is then interpreted
as the result of the inability of the polity to commit not to expropriate private investments in
the sector. Viewed this way, continued state ownership would not necessarily reduce
investment if the alternative is a private sector suffering from massive government
interference.
Central to the author’s analysis is the institutional endowment of a country that determines
what governance and incentive structures for the telecommunications sector are feasible and
optimal for a country. The institutional endowment includes different political, legal, and
economic institutions and different populations, standards of living, and geography. In order
to prevent regulatory opportunism, the endowment needs to restrict a regulator’s discretion.
At the same time, the telecommunications sector, in particular, requires flexibility of
regulations to adapt to a quickly changing environment. Overcoming this tension and
achieving the right balance between restrictions and flexibility is the difficult task of sector
reform. The author uses the U.S. and U.K. as two different, largely successful models of
institutional endowments, where the U.S. takes a decentralized and the U.K. a centralized
approach.
The main feature of the U.S. regulation is that telecommunications regulators have discretion
to reform within statutory and due process limits, but they are monitored first by a court and
then by legislators who step in with new legislation, when regulators and courts, in
interpreting the current law, significantly deviate from what the legislative body wants.
Through the Telecommunications Act of 1996 this only occurred very late in the U.S.
telecommunications reform process, after competition in long-distance services and
telecommunications equipment and the divestiture of AT&T took place without legislative
interference. In contrast, in the U.K. the telecommunications reform process started with
legislation, the subsequent judicial reviews have been much less pronounced, government
rather than regulators took the principal regulatory decisions and licenses were a major
instrument of limiting regulatory discretion.
31
The author takes these observations as the starting point for developing theoretical ideas about
regulatory governance. He first concentrates on federal systems and brings out that the
conditions for a strong tradition of judicial review of regulatory decisions are that the division
of powers is real and that the judiciary cannot be manipulated by political parties. We should
also mention further hypothesizes that independent agencies will be favored in countries
where the legislative and executive branches are not necessarily dominated by the same party.
Under those circumstances, as the legislators cannot hope to implement the regulatory laws
themselves they have to rely on courts to interpret the laws so that regulatory agencies cannot
deviate too much from legislative intent.
Interestingly, in Germany, a country with no tradition of regulatory discretion, fairly
independent telecommunications regulation was introduced in 1998, along with the
liberalization of the telephone sector. This led to an unprecedented explosion of
administrative lawsuits challenging regulatory decisions. In Germany, the judicial control was
part of the existing regulatory endowment, but its major applications to the
telecommunications sector had to wait until a new regulatory institution was introduced that
involved discretionary decision making.
It is expected that the new telecommunications framework of the European Union will
increase the discretionary powers of the national regulatory authorities Vis-a`-Vis their own
governments and legislatures. This again can be interpreted under the author’s framework
from the separation of two main institutional decision makers, in this case the European
Commission on the one hand and the individual country legislators and their governments on
the other. It will be interesting to see how this plays out. For unified government systems
spiller particularly considers the properties of contract based regulation, showing how this can
lead to commitment, provided there is an independent judiciary to uphold contracts. Under
such a system reform can be achieved through contract renegotiations.
The institutional choice that allows technical progress, this note could mark the beginning. In
fact, the statement could be reversed. Technical progress and market growth substantially
reduce the governmental and regulatory expropriation problems, while at the same time
reducing governmental and regulatory abilities to finance and manage the sector. In light of
this, technical progress, market developments and the institutions that govern the
telecommunications sector mutually influence each other.
32
Chapter 2: The practice of access pricing in telecommunications
1. Introduction
In this chapter we seek to bring that theory alongside the practice of access pricing in
the telecommunications sector in OECD countries. We will focus on identifying which
services should be regulated, on how the regulation of specific services interacts with
the regulation of other services and on how the access prices relate to the prices of the
corresponding retail or end-user services.
Throughout we will seek to highlight where the theory and practice diverge.
As we saw we can distinguish one-way and two-way access problems. One way access
problems arise when the provider of the competitive service needs access to a non-
competitive service provided by another firm but not the other way around. In this
report we will focus on the following one-way access problems in telecommunications:
1. Access to call origination and termination at both ends of a call (for the purposes of
providing competing end-to-end local, long-distance or international calls);
Figure 1. One-way call origination and termination for voice calls
Source : OECD
2. Access to call origination for the purposes of providing Internet access services;
33
Figure 2. One –Way call origination for calls to Internet service providers
Source: OECD
3. Access to the physical (usually copper wire) local loop facilities (i.e., “local loop
unbundling”).
Figure 3 . One – way access to unbundled local loop
Source : OECD
Two-way access problems arise when the owners of bottleneck facilities must purchase
essential inputs from each other. This arises in telecommunications whenever
subscribers attached to one network desire to communicate with subscribers attached to
another network, as arises in the interconnection of two fixed, fixed and mobile or two
mobile networks. This is illustrated in Figure 4.
There are a number of other telecommunications services which may qualify as
“essential facilities” to which access is sometimes mandated but which will not be
discussed further in this report, including:
transportation from the point of interconnection to the local exchange (in the case where
the other network operator interconnects at a different level of the network);
Figure 4. Two-way interconnection: fixed-fixed, fixed-mobile, mobile-fixed
And mobile-mobile
Source: OECD.
2. access to certain leased lines (specifically those lines which cannot be economically
duplicated by competing operators and which are essential for competition);
3. access to rights of way (pipes and ducts), access to high sites (for antennas) or access
to space within an incumbent’s facilities (co-location);
4. access to numbering and electronic addressing resources;
5. access to roaming services on mobile networks;
6. access to conditional access services (i.e., video encryption/decryption devices for
interactive and pay television services).
2. Regulatory arbitrage and links between different access prices
Although we have carefully distinguished above between one-way and two-way access
problems, in practice it is not always possible or desirable to distinguish between traffic
that falls into the “one-way” or “two-way” category.
In particular, as we will see, distinguishing between these two types of traffic may give
rise to regulatory arbitrage (that is, a situation where an operator has an incentive to re-
route or re-label traffic in order to benefit from lower tariffs) or may lead to a distortion
of competition. Furthermore, it may not be possible to set different charges for call
origination and termination, as this may distort competition for end-users that generate
more calls than they receive (or vice versa).
35
Links between one-way and two-way call termination
Let’s focus first on a potential link between one-way call termination and two-way call
termination. The basic idea here is that whenever there are different charges for
terminating different streams of traffic, there will be an incentive for
telecommunications carriers to re-route or re-label their traffic to benefit from the lower
charges. Stricter regulatory intervention may be required to keep different streams of
traffic apart.
To see this, suppose that two-way call termination is priced less than one-way call
termination. For example, it might be that two-way call termination is not metered (as
would occur under a “bill and keep” agreement) whereas the cost of terminating a long-
distance call may be, say 4 cents per minute. Assume that the terminating company
cannot determine the ultimate origin of a call, but can determine whether the company it
is dealing with is licensed to provide local or long-distance calls.
In this circumstance there is a strong incentive for a long-distance operator to re-route
its traffic through local network operators, so as to be able to interconnect with the
incumbent local company and terminate calls at the lower rate for two-way termination.
The difference in termination charges induces regulatory arbitrage – a long-distance
company is induced to create a local network company that would possibly not
otherwise exist to “arbitrage” the difference in the one-way and two-way termination
charges. This is illustrated in Figure 5:
Figure 5. If two-way call termination is cheaper a long-distance operator may have
an incentive to route its calls through a local operator
Source: OECD.
36
For example, in the US there have been complaints from IXCs about unfair competition
from Internet telephony. On 19 April 2001 the FCC ruled that ISP Internet telephony
traffic is interstate access traffic and not subject to the reciprocal compensation
arrangements enjoyed by CLECs. However ISPs have been designated as “information
access” and therefore do not pay the same termination and origination fees as IXC voice
traffic. ISPs may therefore have a competitive advantage in the market for long-distance
telephony.
A variant of this problem has also arisen in the mobile market. The charges for
terminating international telephone calls were historically set using the international
accounting rate system. For various reasons, that system did not distinguish between
termination on fixed and mobile networks. As a result, in many cases the charge for
terminating international traffic on a mobile network (which is here the “one-way”
termination charge) is lower than the domestic fixed-to-mobile termination charge
(which is here the “two-way” termination charge). This provides a strong incentive for
domestic fixed carriers to seek to re-route their two-way termination traffic to make it
appear like “one-way” traffic – that is, to re-route traffic to domestic mobile networks
internationally.
This is known as “tromboning”. As an example, France Telecom pays 33 US cents to
terminate traffic on a mobile network for a fixed-to-mobile call, but for terminating
calls from neighbouring countries, France Telecom receives 8-9 cents per minute, of
which it passes 5 cents to the mobile operator for terminating the call. There is a strong
incentive for fixed network operators in France to route calls to French mobile networks
via foreign fixed networks. In addition, a related regulatory distortion can arise if the
regulatory regime differentiates traffic on the basis of the regulatory status of the
company requesting termination. Companies that are allowed access to the lower
charges have an advantage. In Figure 6, company A has an advantage because, having
the status of a local network operator it can terminate calls at the lower two-way rate
with B than can company C, which has the regulator status of a long-distance operator.
To prevent this type of distortion, the regulator may be forced to impose line-of-
business restraints on operators with a different regulatory status – the regulatory may
be forced to prevent operators which are able to interconnect on the same basis as local
operators (such as ISPs) from providing long-distance services.
37
Figure 6. An integrated local and long-distance operator may have an
advantage over a long-distance operator
Source: OECD.
Links between one-way and two-way call origination
The same effects can also be seen on the side of call origination, although here the
strategy that companies must employ to arbitrage differences in call origination charges
appears at first a little more artificial. As before, if the two-way tariff for call origination
is lower than that for one-way call origination, there is an incentive for carriers which
generate a lot of originating traffic to make their traffic appear as two-way traffic in
order to receive advantageous regulatory treatment. The additional difficulty here is that
the “two-way tariff for call origination” is not directly defined by the regulator, but is
the difference between the retail price for a local call and the regulated tariff for two-
way call termination.
To see this, suppose that one-way call origination and two-way call termination is
charged at, say, 4 cents per minute, whereas a local call is charged to end-users at 5
cents per minute. In this case, if a long-distance operator connects directly to the
incumbent it pays 4 cents per minute for one-way call origination. Alternatively, if it
interconnects through a subsidiary local network, the incumbent collects an additional 5
cents for the local call, but then pays the local network 4 cents for two-way call
termination. The long-distance operator is effectively able to obtain call origination at
the price of 5 – 4 = 1 cent per minute. It is true that the end-user must pay the additional
cost of a local call, but is more than compensated by the lower charges for the long-
distance transportation component. See Figure 7.
38
Figure 7. If two-way call origination is cheaper a long-distance operator may
have an incentive to route its calls through a local operator
Source: OECD.
This possibility for arbitrage between call origination and termination is particularly
important when local calling is free. In this case, if there is any positive two-way call
termination fee the long-distance operator, by interconnecting as a local operator, is
effectively able to obtain call origination services at a negative price (i.e., the
interconnecting operator is paid for call origination rather than having to pay for this
service).
Suppose that a long-distance firm needs access to a local loop operator to originate one
million minutes of long-distance calls. The one-way call origination charge is, say, 4
cents, and the two-way call termination charge (i.e., the charge at which calls are
exchanged between local networks is, say, 2 cents). Local calls are free (i.e.,
unmetered). In this case if the long-distance operator connects in the conventional way
it must pay $400 000 in call origination fees. However, if it connects through a
(subsidiary) local exchange company, the end-users will pay for an additional local call
(which is free) and the local loop operator will pay the long-distance operator $200 000
for terminating the call. The difference between these two approaches is $600 000.
Whenever the two-way call origination price (i.e., the retail price for a local call less the
two-way termination price) is lower than the one-way call origination price, operators
have an incentive to arbitrage these prices by re-routing or re-filing one-way call
origination traffic through a local network, effectively paying the two-way origination
charge.
39
In the US, the regulator was forced to address exactly this possibility when long-
distance operators began offering long-distance connections via a local operator.
Customers had to first dial a local number to obtain access to the IXC but, doing so,
effectively evaded the one-way call origination charges. The FCC soon blocked this
practice. The FCC ruled that local calls which are used to connect to inter-exchange
carriers will incur interstate access charges. Another example arises in Canada where,
mobile operators, which usually pay a per minute call origination fee to the ILECs, can,
by obtaining CLEC status, interconnect with the ILEC on the basis of bill-and-keep,
essentially obtaining call origination for free.
Links between two-way call origination and termination
We have discussed the problems that can arise when the regulator seeks to distinguish
one-way and two-way traffic. As we will see shortly, only a minority of OECD
countries attempt to enforce this distinction in practice. But, even in those countries
which do not distinguish between one-way and two-way traffic for interconnection
purposes, there remains the possibility of a significant distortion to competition when
the tariff for two-way call origination and two-way termination are not the same. There
are several models of two-way interconnection of networks. One of the key features of
those models was the assumption that individual subscribers called all other subscribers
with equal probability. As a result, as long as the per-call charges on each network are
the same, the calls between any two networks are always in balance, regardless of the
sizes of the two networks. When this assumption is combined with the assumption of
reciprocity (i.e., that the charges for two-way call termination are the same in each
direction), net termination revenue is always zero in equilibrium.
However, in practice, not all end-users of networks have balanced calling patterns.
Some end- seers generate significantly more calls than they receive.
Others receive significantly more calls than they generate.
Suppose, then, that different customers have different numbers of outgoing and
incoming cross-network calls. Putting aside the costs of providing telecommunications
service (i.e., assuming these costs are fixed and independent of traffic), the revenue
from two-way call origination is, as discussed before, the retail price (“P”) for a call less
40
the termination charge (“T”). On the other hand, since the termination charges are
assumed to be reciprocal, the revenue from two-way call termination is the same
termination charge, T. The total revenue from a customer therefore depends on the
relative proportion of call origination and termination services for that customer and the
relationship between the outgoing call revenue P – T and the incoming call revenue T.
Note that the outgoing call revenue P – T is larger than the incoming call revenue T if
and only if the retail price P is larger than twice the termination charge T. So, in the
case when the termination charge T is less than half the retail charge P, and assuming
both charges have the same structure (i.e., both are per call charges, or per minute
charges) then it is clear that the carriers will prefer customers who originate more calls
than they terminate. (Since P – T is larger than T.) In this case network operators will
actively seek call producers such as tele-marketers or private pay-phone companies and
will tend to eschew call sinks, such as paging networks or Internet service providers.
In the case when the termination charge T is more than half the retail charge P, the
reverse is true – carriers will prefer customers which terminate more calls than they
originate (since P – T is smaller than T). Network operators will eschew call producers
such as tele-marketers and will tend to actively pursue call sinks, such as Internet
service providers.
This effect is particularly strong in those countries with free local calling. In those
countries P is zero so the use of any positive metered call termination charges T always
creates a strong incentive for networks to eschew subscribers which originate more or
longer calls than they terminate and to actively recruit subscribers which terminate more
or longer calls than they originate.
41
Figure 8. The effect of call origination and termination charges
on incentives for targeting end-users
Source: OECD.
In the US, which has unmetered local calling, this problem has become critical.. The
FCC writes:
“We believe that this situation is particularly acute in the case of carriers delivering
traffic to ISPs because these customers generate extremely high traffic volumes that are
entirely one-directional. Indeed, the weight of the evidence in the current record
indicates precisely the types of market distortions identified above are taking place with
respect to this traffic. For example, comments in the record indicate that competitive
local exchange carriers (CLECs), on average, terminate eighteen times more traffic than
they originate, resulting in annual CLEC reciprocal compensation billings of
approximately two billion dollars, ninety per cent of which is for IS Pbound traffic.
Moreover, the traffic imbalances for some competitive carriers are in fact much greater,
with several carriers terminating more than forty times more traffic than they originate.
There is nothing inherently wrong with carriers having substantial traffic imbalances
arising from a business decision to target specific types of customers. In this case,
however, we believe that such decisions are driven by regulatory opportunities that
disconnect costs from end-user market decisions. Thus, under the current carrier-to
carrier recovery mechanism, it is conceivable that a carrier could serve an ISP free of
42
charge and recover all of its costs from originating carriers. This result distorts
competition by subsidizing one type of service at the expense of others.”
In effect, competition between ILECs and CLECs is somewhat analogous to the “I cut,
you choose” method for dividing a cake. The level of the two-way termination charge
determines how the total “cake” (the local call revenue) is divided between the
originating and terminating operators. Once this termination charge is set, CLECs can
decide which customers they target. They will naturally choose customers that bring
them a bigger slice of the cake. If the termination charge is higher than the origination
charge they will choose customers who terminate more calls than they originate and
vice versa.
In summary, the structure and level of two-way termination charges relative to retail
charges has little or no effect on the level of competition for the business of those end-
users which induce a balanced number of incoming and outgoing cross-network calls.
However, in the case of those end-users which induce an imbalance in the number of
incoming and outgoing calls (Internet service providers are a prime example) the
structure and level of two-way termination charges has important implications for
competition. In particular, when local calls have a low price relative to the termination
charges, rival local carriers have an advantage in competing for the business of call
sinks.
This problem of competitive distortion can be addressed only by correctly adjusting the
relative structure and level of call termination and retail charges, especially for those
end-users that generate imbalances in call flows. The termination charge should have
the same structure and should be exactly half of the retail charge (ignoring origination
and termination costs) at least for those end-users that generate imbalances in call flows.
Where the retail charge is too low relative to the termination charge, the problem of
competitive distortion can be resolved either by raising the retail charge or lowering the
termination charge. The US, which has unmetered local calling, has chosen to resolve
the problem by lowering the termination charge. The Netherlands, on the other hand,
chose to resolve the problem by raising the retail charge.
43
The “chain of access charges”
This section has emphasised a number of links between different access call origination
and termination charges. We are now in a position to put all these links together to form
a chain which we will call the “chain of access charges”.
This chain is illustrated in Figure 9. First, two-way call origination and oneway call
origination may be equalised in the desire to avoid regulatory arbitrage for call
origination (see (1) in Figure 9). Second, two-way call origination and termination may
be equalised in the desire to avoid the distortion of competition for end-users with
imbalances in outgoing and incoming calls (see (2) in
Figure 9. “The chain of access charges"
Source: OECD.
Figure 9). Third, two-way call termination and one-way call termination may be
equalised in the desire to avoid regulatory arbitrage for call termination (see (3) in
Figure 9). Finally, if all the other links in this chain are set equal, then clearly, one-way
call origination and termination must also be equal (see (4) in Figure 9).
If all the links in the chain are taken seriously, one-way and two-way termination
charges and one-way and two-way origination charges should all be equal. If, in
addition, reciprocity applies, all these charges should be equal to half the retail price of
44
a local call. Put another way, if all the links in the chain are important, all the access
charges for all the voice services of an end-user are linked to the structure and level of
the retail price for a local call.
Some of the implications of the chain of access charges deserve to be highlighted:
First, the chain of access charges is incompatible with an approach under which
access charges depend on the distance a call has been transported.
Those countries that maintain the chain of access charges must have access charges that
are independent of distance. This in turn gives rise to pressure to reduce the dependence
of retail prices on distance. In fact, there is strong evidence that retail charges are
becoming less dependent on distance. For example, in all the Scandinavian countries
(Iceland, Norway, Sweden and Denmark) there is no longer any distinction between
local and long-distance calling.
Second, the chain of access charges is incompatible with a difference in the structure
of local and long-distance services. Countries that maintain the chain of access charges
must maintain the same structure of charges for all types of calls. If long-distance calls
are charged per minute then so must be local calls and vice versa. On the other hand, the
chain of access charges is compatible with different access charges for different end-
users, provided the relationship between access charges and the local retail call price for
those end-users is maintained.
Third, the chain of access charges, combined with reciprocity, implies that local retail
charges must be twice the termination charges. If local calls are unmetered then the
one-way and two-way termination charges and one-way call origination charges should
all be zero (i.e., bill and keep for all forms of interconnection). In fact, the US FCC,
recognising the problems described above is currently exploring the possibility of
extending bill-and-keep for all forms of inter-carrier compensation.11 As we can see
from Figure 10, retail charges for local calls are around twice the termination charges in
many EU countries as this theory demands. Retail charges are more than twice the two-
way interconnection charge in Germany and the UK and significantly less than twice in
Japan. In Germany there is not yet competition for local calls (this will be introduced in
2002). It would be interesting to determine whether there is intense competition for
those end-users that originate more calls than they terminate in the UK and more intense
competition for call sinks in Japan.
45
2.1. Broad approaches to call origination and termination prices
Having examined reasons why countries would link the different theoretical access
prices, let’s turn now to look at what countries do in practice. It turns out that we can
group countries into two broad categories: those which maintain all the links in the
chain of access prices and those which distinguish between local and long-distance
access charges.
Countries which maintain the chain of access charges
A large group of countries choose to maintain all the links in the chain of access prices.
These countries set a single access charge, whether for call origination and termination
for one-way services (such as long-distance services) or for call termination for the two-
way interconnection of networks.
These access charges may be differentiated according to the time of day (peak, off-
peak), type of user (business, residential) or the number of network elements used, but
they do not differentiate according to the category of access service (call origination,
call termination, one-way or two-way).
46
Figure 10. Comparison of ratio between retail prices
and interconnection charges
1. The local interconnection charges are a weighted average of using 80% of the 5-
kilometre charge and 20% of the 20-kilometre charge.
2. The long distance interconnection charges are a weighted average, using 10% of the
5-kilometre charge, 30% of the 20-kilometre charge and 60% of the 50% kilometre
charge.
3. For the long distance retail charges, using the tariff that applies to a 100-kilometre
call as a proxy for long distance.
4. For the retail charges, using the time of day call profiles to average the charges into
peak and off peak.
5. For the retail charges, including call set-up charges assuming call duration of 2.5
minutes but no minimum call charges.
6. For the retail charges, excluding tax charges.
Source: Ovum “Interconnect: Quarterly Update October 1999” and OECD (2001a).
Most European countries fall into this category, including the eastern European
countries of Czech Republic, Poland and Hungary.12 All of these countries have
47
metered charges for local calls. In most cases, as we observed in Figure 10, the retail
price for a local call is around twice the access charge.
The principal drawback with this approach is that is significantly limits the discretion of
the regulator in the setting of individual access charges. The structure and level of
access charges is forced to be the same across a wide range of access services. Theory
suggests that if two different retail services have different elasticities of demand they
should have different access charges. But this is ruled out if the chain of access charges
is maintained. In addition, theory suggests that competition forces the structure and
level of retail prices to reflect the structure and level of access prices. The chain of
access charges therefore forces many different retail charges to have the same structure.
Maintaining the chain of access charges therefore risks either introducing a distortion to
competition or limiting the scope for innovative or efficient new retail tariffs. In fact, as
we will see in subsequent sections of this paper, those countries that have adopted this
approach have faced interesting competition issues when innovative new tariffs have
been introduced. The policy responses have either been to introduce new specific access
charges, to tolerate inefficient tariff structures, to tolerate inefficient competition, or, in
some cases, to prevent competition entirely.
In its submission for this study, the Netherlands recognises the straitjacket imposed by
the chain of access charges and argues for the need to set different charges for (one-
way) call origination and termination. The Netherlands writes:
“The Commission has reached the conclusion that a differentiated approach should be
adopted for the tariff regulation of terminating access and originating access. … [T]his
differentiated approach takes into account the special nature of terminating access,
while at the same time creating the possibility for tariff regulation to be influenced by
the effect of actual market conditions. … In the past, the tariffs for both terminating and
originating services were set based on the embedded direct cost approach used at the
time. The tariff difference between both types of services was exclusively due to the
fact that KPN incurred direct costs for originating services that were only relevant to
those services. No consideration was given to the specific nature of the terminating
service compared to the originating services, nor the possible effects of actual
developments in the market, on the way such tariff regulation could best be carried out.
48
The differentiated approach was implemented for the first time in OPTA’s decision for
KPN’s wholesale tariffs for the period 1 July 2001 to 1 July 2002.”
Countries which differentiate local and long-distance access
The second broad category which we can distinguish, groups those countries that
differentiate between local and long-distance services for the purposes of access
charges. The countries in this group include Mexico, New Zealand, Australia, the US
and Canada. All these countries have unmetered or free local calling. As noted earlier, if
all the links in the chain of access charges were maintained, it would be necessary to set
unmetered or zero call origination and termination charges, at least for those end-users
which enjoy free local calling.
Rather than set all access charges to zero, these countries have chosen to make a
distinction between one-way and two-way call termination (breaking links (1) and (3) in
Figure 10). This introduces more flexibility for the regulator, at the cost of having to
make arbitrary judgments as to what traffic qualifies as one-way or two-way and at the
cost of having to enforce these judgments.
The effects of these decisions have been emphasised earlier. As noted earlier, in these
countries IXCs and mobile operators have sought to route their origination traffic
through CLECs to lower origination charges. In addition, there have been complaints
from IXCs about unfair competition from IP telephony traffic, which is allowed to
connect at the lower termination rate for CLECs. Finally, the incompatibility of free
local calling and per minute termination charges has lead to a substantial distortion in
competition for Internet service providers in the US and New Zealand, and regulatory
intervention in the US and Australia.
2.2. Further notes on the structure of call origination and termination charges
Having introduced the notion of the “chain of access charges”, we are now in a position
to examine countries’ approaches to regulating specific access services in more detail.
Before we turn to this material, however, we first note some related policies that affect
the regulation of access charges.
49
Reciprocity
A requirement for reciprocity in termination charges can play a role in aligning the
incentives of networks to agree on a common termination charge. Reciprocity also
controls the “terminating network monopoly” problem discussed further below.
Some countries do impose a reciprocity requirement. The US Telecommunications Act
imposes on all local exchange carriers the duty to “establish reciprocal compensation
arrangements for the transport and termination of telecommunications”.
Most other countries do not have a rule imposing reciprocal charges. The Netherlands
writes that:
“The obligation to charge cost oriented terminating tariffs only applies to the regulated
firm (KPN) and not to others. Those others are free to decide on the price level for
terminating services within ‘the boundaries of reasonableness’. … Non-regulated firms
can hardly be forced to set the same charge for their terminating services as the
regulated firm has to for his. The regulator has not set any rules that require that the
terminating access prices should be the same for traffic in each direction.”
Nevertheless, most countries note that in practice agreements for twoway
interconnection of fixed-network traffic are almost always at reciprocal rates. It is
interesting to ask why this is the case. If the incumbent is allowed to charge different
prices for calls to different networks, a possible explanation is that the competing
networks are concerned that a higher termination charge would be passed on to end-
users in the form of a higher retail charge for calls to their networks. Conversely the
incumbent would be reluctant to pass on lower termination charges to its end-users on
the grounds that it makes calling the entrant’s network more attractive. This is discussed
further in the section on terminating network monopolies. When the Dutch regulator
allowed KPN to differentiate its retail tariffs according to the destination of the final
network, competing network operators chose to lower their termination charges to be in
line with those of KPN. The European Commission has recently expressed its concern
that termination charges for new entrants are often set on the basis of reciprocity.
50
Access price-caps
The problem of setting the prices of a natural monopoly can be simplified and made
more efficient by delegating the task of setting the individual prices to a regulated firm,
subject to a cap on an overall basket of prices. Allowing the regulated firm some
discretion in the setting of its prices allows it to make use of any private information
that it has about demand in order to set prices more efficiently.
Although no OECD country has yet chosen the global price cap approach, almost all
OECD countries make some use of price caps in the regulation of end-user prices. On
the other hand, the use of price-caps to control access prices remains, at this time, very
rare. At the time of writing, only the UK (Oftel) systematically uses price caps as a tool
for regulating access prices.
These caps are of the common “RPI-X” form. For example, the price cap on call
termination charges is RPI-10%. The price-cap on flat rate Internet access call
origination is RPI-7.5%.
Capacity-based pricing
In industries where the primary driver of the cost of a network is the network’s capacity
to carry traffic at peak times, it often makes sense to base the access prices on the
capacity allowed to competitors and not on usage. Capacity-based pricing is a form of
multi-part tariff, with the fixed part of the tariff proportional to the amount of capacity
to which the downstream competitor is granted access. In effect, the essential facility is
shared between many competing firms without any of those firms having to incur the
entire fixed costs of constructing the facility on its own.
In the telecommunications industry, network capacity is a key driver of costs over large
segments of the network. Capacity-based charging, if it can be made operational,
therefore seems a logical and efficient approach to pricing interconnection. Throughout
this report we have emphasised how the desire to promote competition pushes the
structure of retail tariffs to reflect access prices and vice versa. One of the primary
benefits of capacity-based charging is that it allows the competing firms to break away
from the tariff structure of the incumbent.
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Capacity-based charging systems have occasionally been promoted in the
telecommunications industry. Mercury, a new entrant in the UK, actively promoted
discussion of capacity-based charging in the mid 1990s.
Touche Ross (1994) reports that the interconnection arrangements between Teleport and
Nynex in the New York area at that time took the form of a capacity-based charge.
Capacity-based pricing schemes are becoming more common. As we will see later,
many countries have introduced a form of capacity-based pricing for Internet call-
origination services. A capacity-based interconnection system has also recently been
introduced in Spain, alongside the conventional per minute access charges. Spain notes:
“Up to August 2001, interconnection prices depended primarily on traffic volume. In
August 2001 a new, complementary model of interconnection prices based on capacity
was introduced, which will come into effect from 1 November 2001. Operators may
adopt one or both systems. This is expected to increase flexibility of operators’ final
prices, and to promote efficient investment.” Under this new capacity-based pricing
scheme the regulator “specifies the minimum units of capacity and the minimum length
of the interconnection contract, the interconnection services available and the monthly
prices per elemental capacity unit. Rights to capacity and minutes of interconnection are
tradable.”
There may be further movement in this direction in the future. OECD (2001a) notes that
“new entrants are arguing that the current per-minute based interconnection charges
should be replaced by capacity-based interconnection charges related to the capacity of
the facilities used to provide the terminating service. According to the capacity based
interconnection charging system, new entrants are charged by their contribution to peak
demand in the network which really determines the capacity of networks”.
Generic tests against discrimination or price squeeze
Although it is not common in the pricing of call origination and termination services,
some countries use a “retail-minus” approach to set access prices. A retail-minus
approach sets access prices on the basis of a fixed discount off the corresponding retail
prices. Under this approach, both the structure and level of retail prices is automatically
reflected in access prices.
52
Even when access prices are not directly linked to retail charges, as in the retail-minus
approach, there is often nevertheless, some sort of safeguard or protection against the
presence of a “price squeeze”. A price squeeze arises when the margin between final
prices and access prices is insufficient to allow an efficient downstream operator to
compete. A rule against price squeezes can be viewed either as a ceiling on access
prices or a floor on final prices, depending on which prices are within the control of the
regulated firm.
In Canada, for example, the CRTC has adopted a test known as the “imputation test” to
protect against anti-competitive pricing by the incumbent telephone companies. When a
telephone company seeks approval of new regulated prices, it must submit an
“imputation test” as part of the filing. In essence, this test requires the telephone
company to demonstrate the profitability of each of its retail services when accounting
for the essential inputs required to provide those services at the same price as those
services are sold to rivals.
The Dutch regulator OPTA also uses a “price squeeze” test. “In this test, the retail
services offered by the regulated firm are priced as if the regulated firm would have to
buy the underlying wholesale services on the same conditions as an interconnecting
operator… These wholesale-based retail prices are compared with the actual retail
prices the regulated firm uses or proposes. If the former are higher than the latter, a
price squeeze occurs – a situation for which a solution has to be found”.
Using this test it was found that competing operators were not able to provide a
competing local retail service on the basis of the wholesale services they had to buy
from the incumbent. The Netherlands notes that the regulator “is investigating ways to
come to a more structural link between access prices and retail prices, in order to
prevent possible anti-competitive effects of the present relation between the regulated
firms’ retail and wholesale tariff structures”.
Ireland also tests for a price squeeze and has addressed complaints in Internet access
and retail long-distance calls:
“Entrants have made repeated allegations that Eircom sets certain of its retail prices and
discounts at a level that places a price squeeze on service based competitors. The main
services where these questions have been raised are 1891 dial-up Internet access and
weekend national calls. In each case the ODTR has established that the price charged by
53
Eircom exceeded the fully allocated historic cost, as represented by the interconnection
charge applied to other licensed operators. However, the ODTR has instituted an
internal price monitoring process to ensure that any future changes to prices or
discounts can be scrutinised promptly.”
3. Call origination and termination for voice services
The previous section introduced different types of access services and highlighted
certain links between different services. We now turn to look at specific services more
closely to explore in more detail the way these access services are regulated.
In this section we focus on call origination and termination for voice services. Because
of the links between one-way and two-way services identified in the previous section
we will look at these services as a group. In subsequent sections we will look at call
origination for Internet service, local loop unbundling and call termination on mobile
networks. We start by identifying which call origination and termination services should
be singled out for regulation, and how countries approach this problem in practice. We
then look at how these services are priced, comparing the structure of the access prices
and the final prices.
3.1. Who is required to provide call origination and termination services?
In theory
What does the theory say about which call origination and termination services should
be required to be provided and by whom? This question is more complex than it may at
first appear. This complexity is reflected in the variety of practices in OECD countries.
Broadly speaking, call origination and termination should be mandated to and from a
given end-user when there is not effective and sustainable competition in the provision
of local loop services to and from that end-user.
In the case of fixed networks, effective competition in the provision of local loop
services is the exception rather than the rule. The scope for competition depends on both
the level of demand of each customer and in each geographic area and the economies of
scale and scope in serving the geographic area. In most geographic areas the level of
54
demand for all except the largest users is usually insufficient to overcome the
substantial economies of scale and scope in the provision of fixed-wire local loops.
Even where there is more than one fixed network infrastructure serving a region,
usually only the largest users are able to sustain two or more simultaneous fixed
connections to different networks.
On the other hand, in some geographic areas, especially the centre of large cities
(known as the central business district or CBD) the level of demand is typically high
relative to the economies of scale and scope. Some countries have special regulatory
provisions governing local loops in CBDs. Australia, for example, has recently removed
certain access obligations in CBDs.
It is important to distinguish between the scope for competition in call origination and
in call termination. We already saw that under a particular set of circumstances even
very small networks can have an effective monopoly over calls terminating with their
subscribers and can have the ability to exploit that monopoly. This problem of
“terminating network monopolies” arises when all the following conditions apply:
1. when there is no competition for call termination to a particular subscriber.
This is the most common situation since the economies of scale are more important for
call termination than for call origination. A new entrant firm might hope to attract a
proportion of the call origination business of existing customers away from the
incumbent. If the entrant’s share of the total call origination business is large enough, it
might be able to justify the installation of a competing local loop network. On the other
hand, if the new entrant firm has a small proportion of subscribers (say around 1%), it
would only hope to capture around 1% of the traffic terminating with any given
customer, which is unlikely to be sufficient to justify the installation of a competing
local loop network;
2. when the calling party pays the entire cost of the call (i.e., Calling Party Pays) (this is
the case for all except free-phone, 0800, or reverse charge calls in most OECD
countries);
3. when users care primarily about the price of the calls they originate and not the calls
made to them (this implies that “closed user groups” are not significant);
55
4. it is not possible or desirable to impose reciprocity (the requirement that termination
charges are the same on each network); and 5. when retail end-user charges for a call
from A to B do not depend directly on the level of the termination charges of the
terminating network B.
When these conditions apply, even very small networks have both the ability and the
incentive to raise the charges for termination on their networks and may need to be
regulated. This issue arises most clearly in the case of mobile termination in those
countries where the calling party pays for calls to mobiles. This issue is therefore
discussed more fully below in the section on mobile termination. But the issue also
arises in the interconnection of fixed networks. For example, the issue has arisen in the
interconnection of IXCs and CLECs in the US.
“[Another] major issue involves terminating access monopolies. This problem results
from the fact that an end-user typically subscribes to only one LEC. Hence, other
carriers seeking to deliver calls to that end-user have no choice but to purchase
terminating access from the calling party’s LEC. These originating carriers generally
have little practical means of affecting the called party’s choice of access provider.
Indeed, … a number of CLECs, whose terminating access charges are not regulated,
have taken advantage of this situation by charging terminating access rates that
significantly exceed those charged by rate-regulated ILECs… We find that absent
intervention, the current disputes between CLECs and IXCs over access rate levels
could disrupt the ubiquitous interconnectedness that consumers expect of the public
switched telephone network. We adopt, as an interim measure, a detariffing regime in
which CLECs may file tariffs establishing access rates only if the rates are at or below a
benchmark rate. Rates above the benchmark may not be tariffed. The benchmark is
designed to bring CLEC rates closer to ILEC rates over the three-year period that these
interim measures are in place.”
A similar situation also arose in the Netherlands. In that case, although interconnection
agreements with KPN were initially on the basis of reciprocal charges, when the
regulator intervened to lower KPN’s termination charges the other networks did not
follow suit, highlighting the lack of competitive pressure to lower these charges. As we
will see below, many other countries believe it is not necessary to regulate the
56
termination charges on “small” networks (networks which have only a small proportion
of connections to end-users in a geographic area).
In practice
How, in practice, do OECD countries designate which services should be provided by
which companies? As we will see below, most OECD countries focus primarily on
identifying the companies that must provide certain services. A minority approach is to
focus on the service.
In the EU, the approach in the new telecommunications regulatory framework (which
comes into effect on 25 July 2003) is to focus the burden of regulation on those
companies that are designated as having significant market power in certain markets.
Under the new framework, national regulatory authorities must define the relevant
markets according to the principles of competition law. (To assist this process, the
Commission has issued guidelines on market analysis and has recommended a list of
markets which can be subject to regulation.) Where a national regulatory authority
determines that a relevant market is not effectively competitive it is required to identify
undertakings with significant market power on that market. “Significant market power”
is interpreted as equivalent to the competition law concept of dominance. The national
regulatory authority can impose additional specific regulatory obligations on companies
which are designated as having significant market power (such as requirements for
transparency, non-discrimination, accounting separation, obligations of access to, and
use of, specific network facilities and price control and cost accounting obligations). In
Japan, access for call origination and termination must be provided by carriers whose
total share of the subscriber lines for each municipality or prefecture is over 50% (only
NTT East and NTT West qualify). In Korea, interconnection must be provided by
carriers whose share in the market is above 50%, whose revenue exceeds an amount set
by the regulatory Ministry and which provide “essential facilities for other carriers to
deliver telecommunications services”.
This approach, which focuses regulation primarily on companies with a dominant
position or “significant market power”, has the potential to focus attention on the right
companies, provided that the market is defined correctly. But the practice of defining
57
the relevant market on the basis of, say, the market share of the firm in the geographic
area in which the firm is permitted to operate, or the market share of a firm in a
municipality, may be misleading. Since telecommunications services to or from a given
subscriber are not a substitute for services to or from another subscriber, the correct
market definition is the market for services to or from a given customer. A firm may be
one of many competing for the business of a specific customer, and therefore may have
little or no market power, but may have the vast majority of subscribers in a geographic
region. On the other hand, a firm may be the exclusive supplier of local loop services to
a given customer, and may have an effective monopoly, even though it has only a few
local loops in the region in which it is licensed to operate.
In its recent review of competition in dial-up Internet access, Oftel finds that BT is
dominant in the market for call origination due to the fact that it has 81% of residential
lines and 86% of business lines in the national market.
However the “national market for exchange lines” is almost certainly an incorrect
market definition. BT may not be dominant in the provision of local loops to businesses
in certain areas and probably has an effective monopoly in certain other areas of the
UK.
A firm which is the exclusive supplier of local loop services to a given customer is in a
position to deny access by other telecommunications operators to that customer whether
or not that firm has a large share of the subscribers in the region in which it is permitted
to operate. In the UK, Oftel has designated both BT and Kingston Communications as
having SMP.
Kingston Communications is a small telephone company that provides services in the
Hull region of England. Would the market power of Kingston in the Hull region change
simply as a result of a change to a term in its license that allowed it to operate on a
nationwide basis?
Having focused regulatory attention on specific companies, there still remains the
question as to what services those companies should be required to provide. Most
countries require at a minimum, access to services necessary to provide end-to-end
services and any-to-any connectivity. Some countries go further to require access to
virtually all the services provided by the incumbent. For example, in Ireland, the
incumbent must offer wholesale service parallel to any retail service and, furthermore,
58
must offer any wholesale service for which demand exists.35 This approach is taken the
furthest by the US which requires ILECs to not only provide access to call origination
and termination but to provide access to individual network elements of the ILECs’
network. In addition, the ILECs have to provide a wholesale service corresponding to
all the retail services that they offer.
An alternative approach is that taken by Australia. Australia focuses not on the
companies that must provide certain services but the services that must be provided
(independently of the companies providing those services). In Australia all companies
which provide PSTN origination and termination services are subject to regulation for
those services. Australia notes:
“Generally, the service declarations by the ACCC are not company or operator specific
(this contrasts with the policy of dominant carrier regulation prior to 1997, which was
focussed on the incumbent Telstra). As such, unless otherwise exempted, the standard
access obligations apply to all firms that supply the declared services via their own
networks”. The risk with this approach is that companies providing services in a
genuinely competitive market will be unnecessarily regulated. However, companies
which do not wish the access obligations to apply to their services can apply to the
ACCC for an exemption.
The US regulatory regime combines elements of both of these approaches. All
companies which provide origination or termination services are under an obligation to
interconnect and, importantly, the FCC has the authority to determine the terms and
conditions upon which carriers provide such services. In addition, there are a number of
additional regulatory obligations on certain companies – those companies the regulatory
regime designates as “incumbent local exchange companies” (“ILECs”). These
companies are required to provide interconnection, unbundled network elements and
access to resale of their services.
Note that national competition authorities may have a role in the decision as to who is
required to provide access services to whom. In Mexico, for example, the
telecommunications law allows the competition authority to designate which firms in
the telecommunications sector are dominant. Once a firm has been designated as being
dominant certain additional obligations in the telecommunications law become
effective, such as provisions relating to control of prices. In Canada, also, the
59
competition authority has a role in deciding when access obligations should apply – the
CRTC has the right to forebear from regulating certain markets when this would be
consistent with the overall objectives of the telecommunications law. In developing its
criteria for the application of forbearance the “Commission adopted an approach that
largely reflected market tests advocated by the Competition Bureau”.
3.2. The relationship between access prices and final prices
The importance of ensuring that the structure of final prices is reflected in the structure
of the access prices and vice versa. This is illustrated in Figure 11. We look here at the
broad features of the structure of final prices and then compare that to the structure of
access prices.
Figure 11. Comparing the structure of access charges and retail charges
Dependence on:
Source: OECD.
60
Final prices
What is the broad structure of end-user or final prices in OECD countries?
In all OECD countries, virtually all calling plans for fixed networks feature a two-part
structure, with a fixed monthly charge and a usage charge that depends on various
components of usage (i.e., a per call fee and/or a per minute fee).
In the case of international and long-distance calls, the usage charge is usually a per-
minute charge with no call set-up charge. Although long-distance calls are
overwhelmingly priced on a per-minute basis, there is at least some tendency away from
a simple linear per minute charge for long-distance calls. For example, many companies
have introduced a cap on the price that can be charged for a particular call, or on the
total long-distance usage charge per month. For example, Telecom New Zealand has a
cap of $2 on the price of national long-distance calls. Under Telecom New Zealand’s
favorite places scheme, users can pay a fixed monthly charge for unmetered calls to a
specific destination. In Canada, BellSouth and Sprint offer a cap of $17 per month on
the total national long-distance bill. Telecom Italia offers a tariff option with unmetered
national calling. BT, which has metered local calling, offers unmetered local telephony
at off-peak times, for a fixed fee.
New tariff packages of this kind continue to be announced all the time. On 16
November 2001, France Telecom announced a plan where for 3 Euros per month, users
can have unlimited calling to any three designated national fixed line numbers
(including unlimited calling to certain Internet service providers).
On 4 December 2001, BT announced that customers would be able to pay a flat
monthly fee of almost 30 Euros for unlimited free evening and weekend calls to all
national and local landline numbers (together with discounts to local, international and
fixed-to-mobile calls during the day). In April 2002, WorldCom announced a new
service combining unlimited local and long-distance calling in the US for a flat monthly
fee of US$50-60 per month.
On top of this trend away from dependence on time, there is an even stronger trend
away from dependence on distance. In several OECD countries there is now no
distinction between local and long-distance calls – all national calls are the same price –
or, put another way, the size of the local calling area is the entire country. This applies
61
in Iceland, Norway, Sweden, Switzerland, Denmark and Ireland and is offered by some
new entrants in the UK and Italy.
Some operators have taken this principle further and price international calls at the same
rate as local calls. For example, one of the new entrants in the UK offers a package in
which calls to anywhere in the UK and the USA cost the same – in other words, it costs
the same to call next door as it costs to call New York.
In the case of local calls, practices vary. Most OECD countries have a system of
minimum fee (or “flag fall”) charges combined with per minute charges for local calls.
Australia has a pure flag-fall charge – local calls on Telstra’s network cost 22
Australian cents, regardless of the length of the call. The remaining countries have free
(unmetered) local calls (i.e., no per call or per minute charges – this applies to the US,
Canada, Mexico44 and New Zealand).
In many countries, different end-users face different prices for telecommunications
services, either because different prices are offered to different classes of consumers
(some telecommunications companies distinguish between business and residential
customers) or because the same class of consumers is offered a menu of tariff packages
and allowed to choose the one that best fits their needs (for example, many companies
offer “low user” options which allow end users to choose tariff packages with a lower
fixed fee and higher usage fees). When there are different charges between business and
residential customers there may be differences in the monthly rental charge, the usage
charges, or both. Despite the fact that underlying costs vary widely according (amongst
other things) to the density of the network, geographic differentiation of retail prices is
rare. Canada seems to be the only OECD country to practice systematic geographic de-
averaging of retail services. In Canada lines are grouped into 7 bands, according to
geographic density. The residential monthly rental for a local loop depends strongly on
both the province of Canada in which the subscriber is located and the geographic band
of the subscriber’s line.
Despite the lack of geographic differentiation, it is common practice to differentiate
final prices according to the time of the day or week at which the call is made. There are
commonly one, two or three different charging bands, corresponding to peak / off-peak
times.
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Access prices
Are access prices structured in a way that is consistent with the structure of retail prices
just outlined above?
In regard to dependence on distance, we are not aware of any countries where the access
charges depend on the distance a call has been carried before being handed off to the
terminating network. As long as access charges are not distance dependent, competition
provides a strong incentive to eliminate the distance component of end-user charges
(since the marginal costs of providing a long-distance call are largely independent of the
distance it has been carried). In other words, the absence of distance-dependent access
charges could be one of the primary factors behind the significant trend away from
distance-dependent retail charges. In regard to dependence on time, the majority of
long-distance and international calls are still priced to end-users on a per-minute basis.
This is consistent with the virtually ubiquitous practice of per minute access charges for
long-distance calls. All OECD countries (with the partial exception of Spain) charge
per-minute access charges for long-distance calls.
The introduction of capped or unmetered long-distance retail prices breaks this
symmetry between the structure of access and retail charges for long-distance calls. This
has given rise to competition concerns. For example, in the mid-1990s Telecom New
Zealand was charging its rival Clear roughly 2 cents (NZ) per minute for long-distance
interconnection per end. Telecom subsequently introduced a new retail tariff which
capped off-peak long-distance calls at NZ$ 5, independent of the length of the call. This
new tariff structure proved popular with customers but lead to complaints from Clear
that for calls longer than roughly 2 hours in duration the interconnection charges would
exceed the revenue Clear could obtain from the call.
Similar complaints arose in Australia when Telstra introduced a capped $3 off-peak
long-distance calling product. “AAPT alleged that it was providing a competing product
to Telstra’s $3 capped STD product at a loss because of the structure of Telstra’s
interconnection prices charged to AAPT. AAPT alleged that, through the capped rate
and disparities between peak and off-peak wholesale and retail charges, Telstra was
imposing a price squeeze on its competitors, and prevented AAPT from competing
effectively in the residential market for long distance national services. The ACCC
63
concluded that Telstra’s conduct did not contravene the competition rule.” In regard to
dependence on the identity of the end-user, as noted above, a few OECD countries
make a distinction between the end-users prices offered to business and residential
customers. In addition, many OECD countries offer tariff options that allow end-users
to select the basket of tariffs that they want. In contrast, it is rare for call origination and
termination charges to depend on the identity of the customer served. When access
prices are not differentiated according to the identity of the end-user, the scope for
competition for certain users can be restricted and the ability of the incumbent to offer
efficient tariff structures may be impaired.
Consider the following example. Suppose that a rival local loop provider wishes to
compete with the incumbent by offering its customers a choice of calling plans – one
choice, which is targeted at light users features a lower monthly rental fee and a higher
per call fee and the other, targeted at heavy users features a higher monthly rental fee
and little or no per call fee. Offering a menu of calling options in this way is
economically efficient – it could entice low-users onto the network (increasing
penetration), while offering more efficient calling plans to heavy users. The key
problem is that uniform access charges undermine the ability of the incumbent to raise
its usage charges on one group of customers. As Laffont and Tirole note “Uniform
access pricing deprives the incumbent of its ability to offer an efficient menu of tariffs
tailored to the needs of its clientele”. If long-distance companies are allowed to compete
for all customers, whichever calling plan they choose, and if access charges are
independent of the calling plan chosen by the subscriber, competition will drive down
the price for calls and therefore eliminate the contribution from usage charges towards
the fixed costs of serving this customer. Uniform access charges and competition are
incompatible with low-user calling plans. If uniform access charges are maintained
either the low-user calling plan must be eliminated or competition for these users must
be restricted.
Some countries have recognised this problem and have chosen to resolve it, not by
allowing access prices to vary with the identity of the end-user, but by restricting
competition. The UK, the Netherlands and France have all chosen to restrict
competition by preventing customers who chose a “light user” scheme for having a
choice of long-distance provider. Note that it is important to distinguish here between
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differentiation of access prices according to the identity of the final consumer (or end-
user) and differentiation of access prices according to the identity of the access seeker
(i.e., the rival or competing firm). In the submissions for this report many countries
argued that differentiation of access prices according to the identityof the access seeker
raises the potential for anti-competitive discrimination and is explicitly ruled out by
laws against discrimination. The Netherlands notes that “the regulated firm is not free to
differentiate his termination tariffs depending on his view of possible differences in the
business cases of access seekers”. Austria argues that two-part access tariffs “would
mean that operators would be discriminated according to their interconnection tariff
behaviour – smaller operators would possibly pay higher fees than larger ones resulting
in high market barriers for new entrants”.
These statements are correct if the access prices depend not on the identity of the final
customer but on the identity of the wholesale customer (the access seeker). It is at least
theoretically possible for the access prices to depend on the identity of the final
customer. As long as all companies serving a particular consumer face the same access
prices, access prices can differ between consumers while maintaining a level playing
field – discrimination is not possible. For example, the access charges for the provision
of long-distance service to a customer might consist of a fixed charge of $3 per month
and a usage charge of 0.01 cents per minute. An access seeker with 100 such customers
would pay a charge of $300 per month. Since these costs increase linearly with the
number of customers there is no discrimination against small operators.
In regard to geographic differentiation, as noted earlier, most countries maintain
geographically averaged prices. Consistent with this, most countries have chosen
geographically averaged call origination and termination charges.
An exception is Australia, which differentiates access prices according to geographic
location. Call origination and termination charges are divided into four zones – CBD,
Metropolitan, Provincial and Rural/Remote. The access charges are lower in the CBD
zone than in the Rural/Remote zone reflecting the higher density of the network. This
approach reduces the incentive for inefficient network duplication in low-cost areas, but
raises the risk that new entrants will target customers in low-cost areas to the exclusion
of entry in rural areas.
65
In regard to differentiation according to the time, most countries differentiate call
origination and termination prices in a manner that reflects the peak/off-peak banding of
retail prices. The Netherlands notes that the access charge for call termination
differentiates between three different time periods which are chosen to be identical to
those used by the regulated firm in its retail offer “to prevent price squeeze effects”.
However, this is not the case in all countries. Australia, Canada and Mexico, for
example, make no distinction between peak and off-peak in call origination and
termination prices, despite variation in retail prices. In these countries there is a risk
that new entry will be focused on end-users which produce most of their calls at peak
times.
Let’s turn now to look at the scope for competition in the transportation component of
local calls – that is, local calls which require both call origination and termination
services from the incumbent. Because the transportation component of local calls is
limited, not all OECD countries allow or encourage this form of competition. As
always, what is important is both the level and structure of access prices relative to
retail prices.
As already noted, a number of OECD countries have free local calling. Free local
calling is incompatible, on both the level and the structure, with call origination and
termination charges that have a per-minute structure. This conflict can be resolved
either by adjusting the access charges, the retail charges or by limiting competition.
Most of those countries that have free local calls (US, Canada, Mexico and New
Zealand) resolve this problem by limiting competition – these countries do not have
call-by-call competition for fixed local calls for end-users on free-local-calling plans.
Australia, on the other hand, which has per-call charges for local calls, resolves the
trade-off by introducing a special set of access charges for local calls. Specifically,
rather than use (cost-plus) per-minute charges for call origination and termination, in the
case of local calls, Australia relies on a retail-minus approach which sets access prices
on a per call basis. This retail minus approach maintains a close relationship between
final prices and access prices. Since local prices in Australia are not geographically
differentiated, are not differentiated according to peak/off-peak but do depend on the
identity of the customer (business/residential), the retail-minus approach ensures that
this same structure is reflected in the access prices.
66
Most OECD countries have metered local calls and per-minute access charges, so the
structure of the final prices for local calls matches that of the access charges. The
primary problem here is not so much the structure of access and retail charges, but the
relative level. The problem is that the desire to prevent distorted competition for call
producers or call sinks leads the regulator towards setting the call termination charge at
around half the retail charge – but this leaves no margin for rival companies to provide
local call services. The result is that in all except a few countries, the level of call
origination and termination charges has been too high to permit local competition.
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Chapter 3: The economy of the cables and satellite in France
1 INTRODUCTION
This chapter is a summary of the the economy of the cable and satellite in France.
2. THE CABLE INTO THE FRENCH AUDIOVISUAL AND TELECOMMUNICATIONS MARKET
Among the 23.5 million TV equipped french homes, nearly 10 million subscribe to an offer
of pay-TV, or slightly more than 42% of the total. This market consists of three major
segments : subscribers to the cable, satellite and Canal + analog radio. Canal + is also the
first operator with more than 3 million radio subscribers individual, far before CanalSatellite
(2.1 million subscribers), GST (1.1 million), or cable operators, certainly with 3.5million
subscribers, but the most important, Noos, has only a little more than a million subscribers.
However, the reminder of the importance of the historic radio premium channel must not
obscure the strong growth of the satellite, that close the penetration rates combined two
platforms satellite TPS and Canal satellite to cable operators, yet appeared ten years before
the digitization of the satellite started in 1996 (see chart).
Foyers abonnés au câble et au satellite 1995-2001
0
500 000
1 000 000
1 500 000
2 000 000
2 500 000
3 000 000
3 500 000
4 000 000
1995 1996 1997 1998 1999 2000 20010%
5%
10%
15%
20%
25%
Nombre d'abonnés au câble (tous services) Nombre d'abonnés au satellitePénétration du câble Pénétration du satellite
68
At December 31, 2001, networks of cable operators in France included 11.5 million taken
at term (or potential) and $ 8.5 million of marketable catch, favouring natural areas to
densely populated. Today nearly 37% homes are already physically connected to a wired
network, and almost 50% should be connected at the end of the construction of all networks.
A little more than 3.4 million households are recorded by the operators of the cable as a
cable service subscribers, approximately 13% of the total of french households and 40
percent of households connected physically to a cable network. This rate includes a strong
minority of subscribers ' antenna ' (about a million homes), i.e. homes for which the cable
serves only to carry chains microwave, sometimes augmented to a local channel signals. In
addition, end of 2001, the reception of digital television services, including the marketing
began in December 1996, concerns only 20% of homes subscribing to cable.
If low-flow type PSTN connections remain majority in France, subscriptions to Internet
access offers broadband by cable or ADSL grow, especially since the end of the year 2001.
Introduced late 1999, technology ADSL, boasting more coverage of the population, quickly
imposed: at June 30, 2002, access to Internet cable services had 233 579 subscribers,
while ADSL reached at this date the level of 650 421 individual subscriptions (or 73.5%
of market share); the Cape of the one million ADSL subscribers reached end 2002
The market of cable in France has nearly fifty operators. Among them, stand out four major
national players, implanted in several regions and covering all the 20 largest French cities.
Them four, these operators account to 30 June 2002% more than 92% of the marketable
catch of cable in France, and almost 90% of subscribers (all services). In terms of scope of
network and subscribers Park, Noos is the first french cable operator.
69
Market shares of cable operators by activity segment
To June 30, 2002 Absolute
value Noos FT Cable
NC
Numéricable
UPC
France Other Total
Marketable catch 8 687 822 33% 18% 26% 15% 8% 100%
Subscribe all services 3 545 166 30% 24% 21% 15% 10% 100%
TV subscribers 3 403 659 30% 24% 22% 13% 10% 100%
Digital Subscriber 741 561 54% 19% 24% 1% 2% 100%
Internet subscribers 233 579 55% 20% 10% 8% 7% 100%
Subscribers telephone 58 434 3% 0% 0% 97% 0% 100%
Sources: AFORM, operators
Cable turnover reached EUR 692,9 million for the year 2001 Since 1998, it is far
exceeded by the turnover of satellite broadcast, which reached EUR 1 142.3 million in 2001.
This difference is mainly due to the absence on the satellite equivalent to service the cable
antenna.
Evolution of the turnover of the french cable operators
(in millions of euros) 1998 1999 2000 2001 2001/2000
Noos 136.2 185.6 201.0 227.9 + 13.4%
France Telecom Cable 173.8 175.0 164.0 172.0 + 4.9%
NC Numéricable 119.7 126.8 136.0 141.0 + 3.7%
UPC France 3.7 29.1 71.6 93.7 + 30.8%
EST Videocommunication ND 22.7 26.4 30.6 + 15.8%
Other (estimate) 27.3 32.9 34.8 27.7 20.4%
Total 460,6 572,1 633.8 692.9 + 9.3%
Source: operators
The cable represents only 2% of the turnover of the telecommunications sector in
France. Compared to turnover other audiovisual activities, the economiy of the cable
remains fairly low weight:
- 3.7% of the total turnover of the audiovisual sector;
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- 3.9% of the total turnover of the market of television (cable, satellite, terrestrial
television broadcast, local and thematic channels).
Cable operators are, therefore, not able to influence the development of programs on offer
in chains, or participate for themselves in the competition for the exclusive audiovisual
rights acquisition of sport and cinema.
3 THE CABLE IN EUROPE AND THE UNITED STATES
The study of the conditions for the operation of the cable in other countries provides some
insight into the position of the cable in France. Despite the disparity of national situations
all cable operators are indeed submitted in recent years to the same underlying trends:
digitization of the networks, the arrival of new applications, and the increased competition
from other technologies (satellite, digital terrestrial television and ADSL).
Two main models of organisation of the market can be distinguished: one where the cord may
appear as the vector of main streaming of television content (case of the markets with a high
rate of penetration), and that where on the contrary the cable is only a secondary, even
marginal, technology over alternatives available on the market.
in December 2001 Belgium
United
States Germany Sweden
Share of households connected to
cable 97.8% 93.5% 84.6% 80.0%
Share of households subscribing to
cable 96.5% 69.0% 66.7% 69.9%
Number of subscribers to the cable 3 680 000 72 958 180 22 100 000 2 490 000
Trade penetration 98.7% 73.8% 78.8% 87.4%
in December 2001 United KingdomFrance Spain Italy
Share of households connected to
cable 52.8% 35.2% 16.7% 7.1%
Share of households subscribing to
cable 15.3% 14.0% 4.0% 0.8%
Number of subscribers to the cable 3 770 000 3 375 209 480 000 170 000
Trade penetration 29.0% 39.7% 24.0% 11.7%
Sources: NCTA, ITC, beeps.
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With the exception of the United Kingdom which is a special case, the countries where cable
enjoys the subscription in the highest household penetration are those where the rate of
coverage of infrastructure is the highest. These markets are characterized by a rate of
commercial penetration of the cable above 50% of the connectable, all activities combined. It's
the market of the cable in the United States, and Europe, those of the Germany, Belgium,
the Netherlands and Sweden (among others). In the United States, the cable represents the
majority reception of TV mode with nearly 73 million subscribers homes end of 2001 (over
two-thirds of American homes). The American cable generates an annual turnover of $ 43,66
billion, making US by far the first worldwide market of the cable.
The review of foreign markets on which the cable has experienced its greatest development
allows to make emerge a number of characteristics that promote the profitability of the
operators :
- The seniority of the implantation of the cable . The countries where the cable
has the largest penetration rates are those where cable operators market their
services since long. The cable was introduced while alternative distribution
technologies such as satellite were poorly developed. He often offered better over-
the-air reception. A progressive immune to competition development allowed
cable operators to amortize their investment in infrastructure without excessive
debt-stricken. A contrario, a too late launch of the cable, in a context of already
advanced, deregulation is not justification : in Italy, cable networks of the 1990s
construction projects were quickly abandoned when it turned out that it would be
more efficient to replace the satellite cable.
- The deployment of the network requires significant investments which cannot
be transformed into revenues in the long term. Several factors are involved in
determining the cost of infrastructure: the extent of the network building, the
choice of the technology used (HFCs, RC2, VHF...), and conditions of laying
cable (buried in France or air in the United States). Sprawl in time of work, giving
priority to the more densely populated areas is also an element to be taken into
account.
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- Also important to the economy of the cable, the system of distribution of
income among distributors and publishers of strings varies by country. In the
United States, the rate of penetration of the cable is sufficiently high to ensure that
operators are sometimes able to demand the payment of a royalty on the part of the
(TV) channels themselves, who pay to be part of the basic service, or to the
extended basic service. On the other hand, the organisation of the market of the
cable in other countries private operators revenues associated with their content
distribution strategy: while in the United States, operators benefit for a share of the
proceeds of the subscription of households and other sums paid by channels, cable
operators Europeans pay their suppliers of significant royalties for the
retransmission of content. In Germany, for example, subscribers pay a fixed fee to
cable operators to which is added a fee paid to the strings for content. The cable
operator is therefore not remunerated for the provision of services which
explains the low average revenue per user. Mustcarry obligations are also
forcing cable operators to distribute for free core of audiovisual services programs.
Operators intervening on markets for which programs premium on offer is
highly concentrated in the hands of a powerful player, as BskyB in the United
Kingdom, have every interest in trying to develop non-television services.
Operators like NTL and Telewest have thus seen dans phone the only way to
provide strategic differentiation in their reference market (respectively 44% and
69% of their subscribers subscribe to more than one service).
On almost all of the European markets, cable operators face competition from digital
satellite TV platforms and, sometimes, digital terrestrial television. The quality of the
services, the diversity of content and the prices they charge are often very attractive: they limit
the tariff margins for manoeuvre of cable operators and increase the costs of purchase of
programs that they must bear to remain competitive. In less than ten years, satellite is
therefore imposed on certain territories such as the dominant infrastructure on the
television market like England (BskyB in 1990), Italy (Telepiù in 1996) and the Spain
(Canal Satellite Digital and Via Digital in 1997). Regardless of the level of maturity of each
market, it appears that the arrival of interactive cable applications had a very significant
impact on the accounts of the operators. The digital switchover requires on the part of cable
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operators of considerable investment in network infrastructure upgrade and the grant of
the decoders in order to make the transition more accessible to households. However today
the demand for digital services mainly concerns access offers high-speed Internet, digital
offerings having not been a decisive interest on the part of households. The economic
balance that some were gradually managed to achieve in a simple analog cable activity
has been severed by investments associated with the introduction of new services, and its
restoration assumes an important work of adaptation on the part of the operators. Another
element having a negative impact on the development of the cable, the General fall of stock
prices has particularly affected operators, the confidence of investors being affected by their
financial difficulties and the low profitability of the sector. The discount has been accentuated
by the deflation of the bubble around the values related to information and communication
technologies. The fall in prices has contributed to the financing of investments and debts.
Especially, it postpones projects increase in capital and consolidation by redemptions of
operators, even delaying the prospect of a restructuring of the U.S. and European markets.
4 CABLE IN FRANCE OPERATING CONDITIONS: HISTORICAL HANDICAPS AND ECONOMIC
PROBLEMS
4.1 The historical construction of networks conditions wired in France
The decision to develop the cable in France was taken in the early 1980s under the aegis of
the Directorate General of Telecommunications of Ministry of PTT. The Plan cable included
cabling in ten years of 52 of the principal cities of France, with the objective of asking 10
million catches, all for a cost estimated at 20 billion francs of the time (more than EUR 3
billion).
The french audiovisual landscape has undergone a complete transformation in the ten years
between 1982 to 1992. The launch of the cable Plan in 1982 coincided with the announcement
of the creation of a fourth pay terrestrial channel, and the commissioning of the first tranches
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of its cable network follows a few months the start of the broadcast of the fifth and sixth
terrestrial channels: the request of the public to a greater variety of programs was
therefore largely satisfied without technology investments While the cable was in its
early years a technology without programs.
Proponents of the cable Plan made also the choice very ambitious networks fiber optic
star, expected to carry interactive applications for which there was not at the time of
suitable reception terminals. Technological volunteerism of the project resulted in costs very
important, amplified by the approximate control of construction of fiber networks: in many
cases, to hold the time and not exceed the budget envelope of origin, 100% fiber networks
provided originally became networks mixed fibre / coaxial cable.
The establishment of cable in France has also evolved: the accumulation of technical
difficulties for the laying of the cable Plan networks has led the Government to change in the
regime of the construction and operation of cable networks (in the Act on the freedom of
communication of 30 September 1986).
4.2 Regulation of the cable against the cable television
The rules applicable to cable operations includes certain obligations become today difficult
to justify, and that contribute to the difficulty in operating the cable operators:
- The threshold of the 8 million people : this rule whereby a same operator
networks cannot cover cumulatively more than eight million people was introduced by
the Act of 30 September 1986 in order to promote competition between operators. It
does not apply to other modes of distribution of more television, satellite and
digital terrestrial television (any more than the provision of access to the Internet via
ADSL), and would be difficult to implement for cable operators because of disparities
between the extent of networks in connectable catches and the individual enumeration
retained by law. However, the maintenance of this rule blocks any plans for a
merger of the operators, and limit the possibilities for rationalization of the plates by
the exchange of networks.
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- The regime of the public service concession : the Act of 30 September 1986
endorses the principle of local initiative for the construction of the networks cables,
allowing communities to balance the relationship with cable operators in their
favour, in requiring them to compliance with provisions of public service (payment of
a fee, financing of a local channel...). From the point of view of cable operators, these
clauses increase the cost of building the networks, without generating additional
revenue in return (even if it is arguable that local channels may encourage some
people to subscribe to the cable). However, the main criticism of the regime of the
public service concession operators is very difficult for them to enhance potential
infrastructure which they are not the full property investors. The improvement of
the conditions of operation of the cable will require at one time or another reform of
the public service concession, probably on the occasion of the transposition of the
texts of the package. Telecom
- The control of the service by local plans : the Act of 30 September 1986 had
planned the operation of cable networks is permitted by the CSA 'on proposals from
municipalities or groups of municipalities", which implied a right of scrutiny of the
communities of implantation of the networks on the evolution of the supply of
services. Although largely fallen into disuse, this provision is a brake on the reactivity
of cable operators compared with the expectations of the public or the evolution of the
editors of channels on offer; It also complicates the attempts of unification of plates (a
continuous physical network with a single head of network to serve a group of
neighbouring municipalities).
4.3 The operation of the cable
The ownership and management of the network infrastructure
The cable Plan was that all of the cable networks would be constructed by the DGT, ancestor
of France Telecom, which keep the property. By opening up the market of the cable to private
actors, under the regime of the public service concession, the Act of 30 September 1986 has
introduced a hybrid system in which an operator can be in charge of the technical and
commercial management of an infrastructure that it builds and maintains itself, or
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distribute services on an infrastructure leased to France Telecom. This situation poses
two types of difficulties to cable operators who are not yet out of the cable Plan: it
complicates relations with subscribers, by forcing the cable operator to delegate to a third
party physical interventions on the network, troubleshoot the connection for example. It
significantly increases operating expenses of cable operators, by forcing them to pay a rent
whose determination conditions seem not transparent (for example, the price it
corresponds only to the current use of the network, or part of the amount is intended to
cushion the initial investment of the cable Plan? and if so, what about successive impairment
occurred in the France Telecom accounts). In the past, the survival of the cable Plan raises
the problem of the limits of the activity of a historical telecommunications operator:
France Telecom today is owner of two local loops in many French cities (Lyon,
Marseille, Bordeaux...), resulting in a distortion of competition. It is also significant to
note that in 2000, the deployment of ADSL took place in priority in the cities where the local
cable company wanted to market a service of Internet access by cable.
The question of the number of available sockets : cable operators complain of not always
knowing exactly the number of shots actually built and operational on each of their
networks. The technical limitations of the networks themselves (points of termination with a
number of fixed irrespective of the number of dwellings to serve), sprawl in the time of the
installation of networks, and the constitution of networks by external growth contribute
to this uncertainty. With the ownership of their network operators strive to improve their
knowledge of their infrastructures, which directly affects the effectiveness of trade promotion
actions (including those that involve the doorstep of prospects). Operators subject to the
regime of the cable Plan also have difficulties in knowing the exact amount of outlets
operational networks that their praises France Telecom, which is an important variable in
the calculation of the annual cost of provision of infrastructure by the incumbent operator.
The importance of the difference between catches recorded by cable operators and the reality
on the ground is, however, impossible to assess with accuracy; Some cable operators argue a
proportion of 10% of the total connectable catch is approximately. 850 000 shots less
compared to the advertised figures.
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The digitization of the cable and new services
The development of the digital satellite is accompanied by the multiplication of the number
of channels available, highlighting the limitations of the analog cable. The digitisation of
networks has emerged as a strategic for cable operators in imperative, in order to remain
competitive with the competition from the satellite, and position themselves in emerging
markets of Internet access broadband and telephony. This evolution has a significant cost,
expressed by the work of upgrading networks and especially, by the purchase of digital
decoders intended to be leased to subscribers. However, the appetite of consumers for
digital cable and new services proved to be lower than expected, and the first orders of
digital decoders from the end of the 1990s brought longer than expected to be passed. In
addition, digitisation of networks has been the source of technical problems , which in some
cases have harmed the image of cable operators (in particular for Internet services). These
difficulties are that cable operators continue for some to commercialize an analog bouquet
(NC Numericable and UPC), or attempts to spread over time the conversion of subscribers to
the digital (Noos, FTC). Analog services are indeed easier to operate for operators offers
(no decoder to depreciate, billing simplified compared to the digital map), and a stable source
of income.
The issue of the transition from analogue to digital for cable operators is all the more crucial
that the cable will remain their main source of income for the future predictable. Internet
access by cable services have fewer than 250,000 subscribers, and telephone services are now
offered by a single operator (UPC France, with 50 000 subscribers). The first offers of access
Internet by cable operators have suffered from significant technical problems which caused
the number of subscribers for the first time to turn to ADSL when France Telecom began to
market end of 1999. Cable operators have put up recently one new strategy of marketing of
packages low-speed (but with the benefit of a permanent connection) or "means flow» for
subscribers to television services, in addition to their bouquet of channels. Moreover, the
cable-telephony suffers from multiple disabilities, of which the most important is the use by
traders in a circuit-switched: still do not have "all-IP" technologies, their services cannot
escape lasting infrastructure of France Telecom.
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Relationships with the editors of channels and the specific status of Canal +
Assembly of bouquets of channels attractive and interesting both for leads calls for specific
know-how that cable operators have put the time to acquire, taking into account inter alia
of the industrial culture or financial shareholders, the lack of exclusive content with high
added value to the cable (football and the premiere cinema being historically reserved for
Canal +), and the small number of channels available in the first years of the cable. On
this point, the offer has really exploded after the launch of digital satellite bouquets in 1996.
The profusion of brings supply elsewhere cable operators to market on digital networks offers
à la carte, in which viewers select strings of their choice within the framework of a budget set
in advance. From the point of view of the editors of channels, this system is not the most
interesting, because it the forces to make efforts of marketing directly with prospects, then
their string within a diverse bunch of analog or digital inclusion puts these efforts paid by the
cable operator. The persistence of the analog bouquets is also very interesting for strings
that are part : given their stability and the small number of strings that are referenced (15 to
20, against more than 100 potentially available to digital subscribers channels), these clusters
contribute more to the hearing strings and often allow them to collect royalties higher on
the part of operators.
Unlike the United States and other countries, where the amount of subscriptions to premium
channels is shared more or less equally between the editors of channels and cable operators,
Canal + benefits in France of a specific statute that does not benefit the cable operators.
Transported free of charge in analog under the rule of the must-carry channels (i.e.
enjoying exactly the same status as TF1 and France 2), digital Canal + distribution escapes
largely to cable operators. In fact, smart cards used to activate the decoders, programmed
and updated based on the type of subscription by cable subscribers, include a separate
encrypted compartment reserved for access to Canal +, independently of any intervention by
the cable operators. Canal + therefore directly manages the relationship with its digital
cable subscribers and merely to pay a modest sum (less than 2,5 EUR per month) to cable
operators, in order to contribute to the amortization of the decoder (which would benefit
if not for free). The distribution of Canal +, premium channel reference, does therefore not
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contribute significantly to the turnover of cable operators, who thus have no interest to
promote. Therefore, a whole marketing strategy based on the combination of the
advantages of Canal + and digital cable remains unexplored (as of combined offers Canal
+ / Internet broadband, or Canal + / thematic mini-bouquet à la carte, etc.), while these
initiatives might help to improve the rate of penetration of the cable. The difficulties of Canal
+ may however bring the situation to evolve, by promoting the search for synergies with
cable operators, after an agreement for a more balanced distribution of the revenue of the
chain.
Marketing and customer relations
The choice of the prospects good recruitment tools is very important in the case of the cable.
Territorial networks burst prevents operators to use the most powerful media
(television) and their promotional communications through essentially from non-media
(display and mailbox). It can be seen that local cable operators are generally above-average
penetration rate, due in part to their local roots and their strategy of direct contact with
prospects. Scattered networks of the major cable operators have prompted them to centralize
the customer relationship in the 1990s (call centers), but the mixed results of this approach
now lead them to supplement it by a presence on the ground (shops, doorstep). On the other
hand, offers from cable operators are often more complex than those of the operators of the
satellite, with different subscription levels mores, or offers differentiated according to
networks (even if large cable operators have made very significant efforts to unify their
commercial proposals, in particular for digital services). The management of the Park of
existing subscribers is often complex. The changes in the shareholding, the acquisition of
new networks, the cohabitation of analog and digital subscribers, etc., led to a proliferation of
articles and categories of subscribers, which increases the risk of errors in billing and
complicates communication operators.
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5 THE EVOLUTION OF THE COMPETITIVE AND REGULATORY CONTEXT
5.1 The launch of digital terrestrial television and its impact on the cable
Act of 1St August 2000 audiovisual contains provisions relating to the establishment of a
tender for digital terrestrial television.
The selection procedure of the services of televisions called to occupy channels reserved for
terrestrial digital broadcasting, launched by the CSA in July 2001, took a very important step
with the publication in October 2002 a list of 23 channels selected, who will share the 22
channels reserved for the private offer (11 other channels will welcome the public and local
channels). The progressive crossing of the legal steps for the launch of TNT (publication of
the decrees implementing the Act of 1St August 2000, call for applications of the CSA) should
not hide the important technical and commercial barriers which depends the actual DTT
launch.
- The first of these obstacles is the need to make very many rearrangements of
analogue frequencies before you start digital broadcasting. According to the national
agency of frequencies, the cost of these works is between 44 and 84 million euros,
depending on the magnitude of interventions to drive individuals. This first wave of
refitting of the frequency applies only to analogue reception: it is designed to ensure
that viewers continue to receive signals from analogue after the start of the TNT
television.
- The second wave of technical arrangements thereby concerning proper digital
reception, with probably interventions on millions of antennas, individual or
collective, to steer them in the direction of the transmitters or replace them completely
for the oldest of them. The amount of these works would also be in tens of millions of
euros.
- Finally, the third big obstacle to the launch of DTT is the absence to date of
candidate for the position of commercial channels of supply operator. Given the
importance of its fleet of radio subscribers, Canal + could have interest in being the
commercial DTT operator, to speed up the migration of its own customers to digital,
especially those who don't want to or can't take out a subscription to CanalSatellite.
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This scenario was seriously considered in 2001 by the Canal + group, before being
abandoned following the serious financial difficulties of the Group and its shareholder
Vivendi Universal. At present, there is no candidate said marketing of the pay
DTT, or this actor will be best placed to unite the efforts of communication
around the digital terrestrial television, including the concept and the potential still
unclear for a large majority of the French.
The resolution of technical and commercial issues outstanding warrant elsewhere in no
case the success of digital terrestrial public . The failure of the formulas of marketing of
DTT in other countries of Europe testify to the difficulty to impose an additional delivery
method when existing operators ready to meet the demand for programs of consumers via the
most effective technologies of cable and satellite.
The argument often advanced DTT programmes free of charge does not withstand
scrutiny , on the one hand because free programs will not final not very many, on the other
hand because economic free digital broadcast model is risky for additional channels.
Indeed, they will incur up to 4 million euros per year for the digital release of their signal
— a considerable sum for chains including budget is between 12 and 30 million euros for the
vast majority of them, and in the absence of the first years of any consideration of sales
(advertising or subscription charges) taking into account the weakness of the staff households
equipped to receive DTT.
From the point of view of cable operators, the launch of DTT poses two major difficulties:
- The interference of frequencies for cable networks : the problem is similar to
that of interference to analogue TV via DTT, the difference being close as
opportunities for redevelopment of frequencies of cable networks are limited. It
may happen that the digital frequency plan is saturated. In this case, the only solution
for the fuzzy operator will be to fully digitize its network to gain bandwidth thanks to
digital compression of the signal. The operation involves the purchase and
distribution of decoders to all former analog subscribers networks scrambled: an
expenditure valued at 100 million euros by the Aform, and cable operators cannot
afford today.
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- The rule of the must-carry digital channels Earth in clear by cable networks
introduced by the Decree of January 31, 2002. This rule will require cable operators
either to change deeply the economy of their digital packages, especially packages
cheap entry-level created to attract new subscribers, or push them to delay for as long
possible the digitization of analog to evade these obligations subscribers of
transport, even without other sources of income (video on demand) (, interactive
services, Internet access...).
5.2 The telecom package
The European Union issued in 2002 a series of directives that reforming the regulatory
framework for telecommunications. These texts have for objective the establishment of a
common legal regime for the establishment and operation of telecommunications
networks, regardless of the nature of the technologies implemented. The transposition of the
directives into french law should therefore lead to align the specific arrangements of the cable
of other telecommunication networks, and apply to cable operators the innovations of the
guidelines:
- The general authorisation regime: removal of the need to obtain prior
authorization for the establishment of electronic telecommunications networks and the
provision of electronic communications services. For cable, it means the
disappearance of the role of local communities in the construction of networks, and its
transfer to the operators themselves
- The regime of exclusive rights and the special rights granted to
telecommunications companies: according to the directives, the internal rules of a
Member State should no longer result in making more difficult the operation of a
network of electronic communications over another type, or to limit the number of
undertakings operating such networks. The application to the cable of this principle
implies the revision of several aspects of the regulation French: territorial
exclusivity of cable networks, the limitation to eight million inhabitants of the
coverage of cable operators, the questioning of the regime of the public service
concession, and finally the control services by local plans.
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- The obligations of broadcasting : the implementation of the rules of the telecoms
package should require harmonisation of the scope of the obligation of transport
chains (must-carry), which currently differs depending on the considered technology
(cable, satellite, TNT). Furthermore the telecoms package makes the legality of these
obligations "clearly defined general interest objectives": the transposition procedure
should provide an opportunity for a debate on the concept of general interest
applied to the audiovisual.
6 SCENARIOS FOR THE FUTURE OF THE CABLE
The problematic issues of competitive, regulatory environment and the operation of the cable
analysed in this study emphasize the need for structural sector changes. The scenarios
sketched here represent a contrasting approaches, a market solution, a political and
regulatory solution, and conversely, the consequences of the status quo. Two scenarios of
failure are main objective permanently eliminate the after-effects of the cable Plan, and create
an environment conducive to the improvement of the operational performance of cable
operators or service providers operating cable networks.
6.1 Scenario 1 - the consolidation of the cable
This scenario includes several variants, classified according to their financial difficulty
and their constant regulatory feasibility. The simplest option is to streamline networks
through exchange of plates, in order to promote the consolidation of operators in major
regional groupings with facilitation of the operations of maintenance and marketing of the
catch. At the level of cities, would be entrusted to a single operator the management of
city-centre network (often created the plan of cable) and that of the periphery, appeared
later, under the regime of the public service concession. Trade plates have the interest to be
achievable under the present, regulations at least as regards the concession network
(more), but are not the same benefits for all stakeholders : Noos is particularly interested in
a refocusing on the île-de-France, but provincial towns operators see no obvious gains to the
abandonment of their Parisian networks. To take all its meaning, the plates Exchange
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operation should involve all the actors of the cable, rather that take place via a succession
of bilateral transactions.
A second option would be consolidation between them to current actors of the cable after
the removal of the merger-regulatory barriers. The benefits of a merger are enough NET
with respect to the operating costs of the cable: marketing and communication, bargaining
power increased with content providers, service... The question of ownership of the
networks of the cable Plan would be at the centre of the consolidation process. In any
case, outside a very hypothetical rapprochement between Noos and UPC France,
consolidation options would place France Telecom at the heart of the shareholding of
the new ensemble (France Telecom has 27% of the capital of Noos, 100% of France Telecom
Cable, and 70% of the outlets operated by NC Numericable), however, the prospect of a
hegemonic France Telecom position on the market of cable is not acceptable to regulatory
authorities (in Paris and Brussels) It is not strategically nor feasible for the group. Fusion
guess so assignment prior or simultaneous Plan networks Cable NC Numericable and
France Telecom Cable, then a programmed France Telecom of the capital of France
Telecom Cable output.
The central square of France Telecom in the process leads to the third and last option, which
corresponds to the consolidation of the existing a new players entering, which would
provide fresh capital and would dilute the share of the current shareholders of the cable
in the capital of the merged entity. The major problem here is the shortage of candidates
for the takeover of the french cable, in a context of very strong decrease of the valuations of
the assets of media and telecommunications companies. Investment funds do not seem
convinced by the french cable (unlike other countries: Germany, Netherlands...), especially in
its regulatory aspects (public service concession). Actors industrial candidates to redeem
are not not more numerous; some, such as Liberty Media, could possibly be interested in the
folder, but do pass the redemption of all or part of the french cable of other strategic
objectives, or await clarification of the regulation of telecommunications to decide their
next move (alternative telecommunications operators: LDCom, Telecom development, etc., or
possibly an institutional investor such as the Caisse des dépôts).
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6.2 Scenario 2 - the separation of infrastructure and services
This scenario has for principle the resumption of all of the physical infrastructure of the
cable by a single operator ("France Cable"), which is responsible for their maintenance,
scanning them and their extension, under the control of the regulatory authority. That entity
then sells the bandwidth of networks to all service providers of cable television, Internet
access and telecommunications approved by the competent regulatory authorities (CSA or
ART), under conditions of transparency of fares.
Work for interconnection plates, upgrade networks and interoperable decoder specification
would be taken over by Cable in France, in association with services and content providers.
The idea is to provide these providers access Unified 8.5 millions of currently installed
connectable catches. The objective would be to open the cable market to new entrants,
editors of channels, providers of access to the Internet, etc. that far in were kept away, causing
an increase in the consumption of bandwidth and therefore a more efficient use of
infrastructure. This scenario assumes important initial work before services can be
marketed. It could be done in several stages, with the first phase devoted to the creation of
three or four regional entities, which préfigureraient the connection all networks at the
national level (this incremental approach would allow notably to verify the validity of a
separation of infrastructure and services from the point of view of the Community
authorities of competition). This scenario raises several questions, as its technical
feasibility, as for the cable operators will of commitsr (their shareholders would no doubt
support because the operation would allow them to deconsolidate the loss-making cable
distribution of their accounts activities), and the level of involvement of the regulator of
telecommunications in the control Cable of France (includes ensuring the implementation
of the investments necessary for the development of the capacity of the network).
6.3 Scenario 3 - the status quo and the technology of cable erosion
This scenario corresponds to the perpetuation of barriers to the approximation of cable
operators, at the same time further intensification of competition in the cable television
activities (arrival of TNT) and provision of Internet access (confirmation of the success of
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ADSL). The probability of this scenario depends on three factors : assignment or non-Plan
networks cable to cable operators France Telecom, the deadline for transposition of the
texts of the telecom package, and the actual launch of digital television terrestrial.
The absence of easing in the short term from the regulation of the cable would strongly limit
the ability of cable operators to seek a structural remedy for their individual difficulties;
quickly enough, the combination of the lack of new prospects and the erosion of the
market shares of the cable would eventually lead to a refusal of shareholders of cable
operators to continue to fund their operating deficits. In the event of liquidation of the
cable operators, under networks would return to local communities, which would then two
possibilities: either organize a tender to assign the operation to a new operatoror reassign
the capabilities of the network for purposes of general interest. In the first case, the
operation of the networks of Commons where the cord enjoys a strong location (40% of
subscribers or more) might interest prospective incoming, or regional operators of the type of
video is communication, without however operating conditions and the competitive
environment they are more favourable. in the second case, some municipalities might be
tempted by a takeover of cable networks in order to develop applications of general interest:
distance education, help for the elderly, municipal intranet linking public places, etc. The
temptation to use the network for this purpose will be stronger that offers pay TV services and
Internet access broadband would be well met by other operators on the territory of the
commune.
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References
Autorité des régulations des télécommunications, L’économie du câble en France, Etude réalisée par le cabinet JLM Conseil Pour l’Autorité de régulation des télécommunications(Rapport), Janvier 2003.
OECD, Acess pricing in Telecommunications, 2004.
Sumit MAJUDMAR, Ingo VOGLSANG and Martin. E. Cave, Handbook of
telecommunications economics, Volume 2, technology evolution and internet, ELSEVIER
2005.