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INERTIA, SWITCHING COSTS, AND COMPETITIVE DYNAMICS.
THE CASE OF LONG-DISTANCE SERVICES IN PERU.
Tania Begazo*and Paul Phumpiu**
* Economic Analyst of the Regulatory Policies and Strategic Planning Division, OSIPTEL
(Telecommunications Regulatory Agency), Lima - Peru
[email protected]
** Manager of the Regulatory Policies and Strategic Planning Division, OSIPTEL
(Telecommunications Regulatory Agency), Lima - Peru
[email protected]
L11 / L50 / L96
Inertia, switching costs, competition, long-distance
Abstract
This paper shows how the reduction of switching costs by regulation enforcement can
significantly change the competitive dynamics of an industry. Switching costs are important
because they may act as an entry barrier or as a tool to hinder the growth of new entrants. In
addition to, this paper also shows that consumer inertia may reverse or diminish the effect of
changing switching costs through regulation. Consumer inertia may be related to consumers’
perceptions which, in turn, can be affected by the position and strategy of the incumbent firm
in a market.
The market that we are going to analyze is the Peruvian market for domestic and international
long distance calls. In the last ten years this market has passed through three sequential stages:
(1) a private-owned firm monopoly, (2) a liberalized market with consumer carrier preselection as access mechanism, and (3) a liberalized market with both consumer carrier preselection and call-by-call as access mechanisms. Until May 1994, the State provided all longdistance services through a state-owned firm (ENTEL). Then this firm and the fixed
telephony state-owned operator were privatized. In the concession contracts, a limited entry
period was granted. This period ended in August 1998 with the liberalization of the fixed
telephony and the long-distance services markets. Already in a liberalized market, the
selection mechanisms for the long-distance carriers played a crucial role in determining the
competitive dynamics.
The Liberalization Guidelines in 1998 established two mechanisms for the users’ access to the
long distance carriers: pre-selection and call-by-call systems. The first mechanism had to be
applied for two years after the entry of the first competitor to the market. After this period,
both mechanisms had to co-exist. The carrier pre-selection system started in November 1999,
and the call-by-call system was implemented in April 2002. In this paper we compare the
development of competition under those three periods, taking into account that the main
difference between them are the characteristics for the consumers’ access mechanism
established by regulations. The evidence shows that competition has proven to be more
aggressive under the call-by-call system than under the carrier pre-selection system.
For our purposes, we develop, based on Salop’s model of product differentiation, a model in
which the incumbent firm can either prevail as a dominant firm or it may face weak or strong
competition from other firms. According to the model, it is considered that the entry of new
firms in the market can be thought of as one that is sequential and partitioned into groups.
The entry order will depend on the size, investment commitment and the potential threat to
the market share of the incumbent firm. We apply, in a qualitative way, the parameters of the
model to the Peruvian long distance market and describe the parameters related to market
switching costs and consumer inertia; the latter caused by historical market structure and by
the reaction strategy to potential competitors adopted by the incumbent firm.
The existence of inertia and switching costs is likely to make the task of gaining market share
by new entrant carriers quite challenging . It is conjectured that if switching costs are high,
one likely market outcome of this situation, will be the prevalence of the incumbent firm as a
dominant firm in the long distance market. This situation appears to hold during the carrier
pre-selection period of the Peruvian long distance market.
We show that the call-by-call system significantly reduces users’ switching costs, but
consumers’ inertia still persists. We explain this inertia as a result of some historical structural
market features and, also, as a result of the incumbent firm’s strategy. It is also shown that
consumer inertia has not reversed the effect of reduced switching costs introduced by the callby-call system, however, it has diminished this effect. Hence, the empirical evidence suggest
that in a progressive manner, there is a tendency towards the consolidation of a sound
competitive long-distance market, but to reinforce that trend the current consumer inertia
needs to be decreased by new market-oriented policies. This paper explores some policy
options.
References
[1] Beath, J., and Y. Katsoulacos, "The Economic Theory of Product Differentiation“,
Cambridge: Cambridge University Press, 1991.
[2] Ministry of Transport and Telecommunications, Supreme Decree N°020-98-MTC,
"Lineamientos de Política de Apertura del Mercado de Telecomunicaciones del Perú“
(Guidelines of the Telecommunications Market Liberalization in Peru), 1998.
[3] Phumpiu, P., “Shaping Competition in Long Distance Markets. The Case of Telecom
Services in Peru“. ITS, Argentina, 2001.
[4] OSIPTEL, “Compendio Estadístico del Sector de Telecomunicaciones: 1994-2002
(Statistics Yearbook of the Telecommunications Sector: 1994-2002), Estudios en
Telecomunicaciones, N° 11, 2003.
[5] OSIPTEL, “Informe sobre el desarrollo del mercado de larga distancia en Perú”
[Development of the Long-distance market in Peru], 2002.
[6] OSIPTEL, “Mercados de Servicios Públicos de Telecomunicaciones en Perú”,
(Telecommunications markets in Peru), Estudios en Telecomunicaciones, N°14, 2003.
[7] Salop, S., “Monopolistic Competition with Outside Goods.” Bell Journal of Economics
10: 141-156, 1979.