Download ACCC Discussion Paper—Review of Price Control Arrangements

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Mr Sean Riordan
Acting Director
Telecommunications Regulatory
Australian Competition and Consumer Commission
GPO Box 520J
Melbourne VIC 3001
[email protected]
RESPONSE TO REVIEW OF PRICE CONTROL ARRANGEMENTS
The Western Australian Government welcomes the opportunity to provide
comment on the discussion paper, Review of Price Control Arrangements,
issued by the Australian Competition and Consumer Commission.
In short, the WA Government strongly believes that the current arrangements
governing the prices of prescribed telecommunications services should be
maintained and enhanced. The attached submission makes the following
points:
1. Price increases for basic telecommunications services are likely to
adversely impact on consumer welfare as well as contributing to a
reduction in economic growth.
2. The impact of price increases is likely to be particularly severe in the
fledgling broadband service market.
3. The cost of relaxing price controls significantly outweighs the cost of
retaining current controls.
4. Facilities-based competition is unlikely to occur in many regional parts
of Australia.
5. Changes to the price control arrangements will increase incentives for
service providers to offer value added services.
6. Tightening the definition of the services subject to price control can
enhance the effectiveness of the current price control arrangements.
7. A specific price cap should apply to fixed-to-mobile calls and the price
cap on local calls via public payphones should be maintained.
Should you need clarification on any of the points made, please contact the
Department of Industry and Resources: Sheryl Siekierka (phone: (08) 9222
5677, email to: [email protected]) or Grant Coble-Neal (phone:
(08) 9222 5321, email to: [email protected]).
Yours sincerely,
CLIVE BROWN MLA
MINISTER FOR STATE DEVELOPMENT
Friday 24 September 2004
Submission to the ACCC
REVIEW OF PRICE CONTROL
ARRANGEMENTS
September 2004
Introduction
The Western Australian (WA) Government welcomes the opportunity to
provide comment on the discussion paper, Review of Price Control
Arrangements, (the Review) issued by the Australian Competition and
Consumer Commission (ACCC). In short, the WA Government strongly
believes that the current arrangements governing the prices of prescribed
telecommunications services should be maintained and enhanced. This
position is based on the need to ensure that the future needs of businesses
and consumers are adequately met.
Telecommunications prices are rising
According to the ACCC Telecommunications Report 2002-03, Report 2, (the
Report) PSTN1 prices increased for residential (household) and small
business consumers in 2002-03.2 The Report states on page 67 that the
cause of the price increase is in part due to
“…the relaxation of the price controls applying to Telstra. This has
particularly affected basic access prices…”
The Report goes on to state that
“…facilities-based competition for fixed line customers is
struggling to emerge outside the CBD regions of capital cities,
which provide the customer densities necessary to support cable
rollout by smaller carriers…”
Rationale for price control in telecommunications
In considering arguments based on efficiency, the ACCC should carefully
weigh the impact that telecommunications price changes have on the
efficiency of the entire economy against the efficiency outcomes realised
within the telecommunications industry.
The WA Government holds the view that telecommunications services are
essential for the efficient functioning of WA’s economy. This belief is
underscored by the ubiquity of telecommunications, which permeates virtually
every aspect of Australian economic and social life. Indeed, close analysis of
household and industry expenditure patterns reveals that the economic need
for telecommunications is as fundamental as the economic need for energy.
However, while the economic impacts of energy price increases are readily
appreciated, there is generally little understanding of what economic impact
telecommunications price increases would have on economic activity in WA.
Examining household and industry expenditure patterns, it is possible to glean
an indication of the potential economic impact. Table 1 presents average
household
budget
allocation
shares
for
energy,
health
and
telecommunications. Comparing telecommunications expenditure to other
politically sensitive budget items suggests the order of significance within the
total budget is similar to that of domestic energy fuel-power and petrol.
1
2
PSTN is an acronym for Public Switched Telephone Network.
See page 63.
2
Inspecting budget shares across Gross Income Quintiles, it is clear that
telecommunications, like energy consumption, accounts for a relatively larger
share for households with lower income.
Table 1. Australian household expenditure: energy, health and telecommunications
Gross Income Quintiles
Lowest
2
3
4
Average Budget Share (%)
Domestic fuel and power
8.05
3.83
2.49
1.78
Transport
30.17
17.46
14.78
13.87
Petrol
6.48
4.22
3.35
2.67
Household service and operation 16.90
7.75
5.41
4.31
Telephone and facsimile charges 7.95
3.73
2.67
1.91
Medical care and health expenses 10.78
5.76
4.04
3.56
Source. Household Expenditure Survey 1998-99, ABS catalogue 6535.0.
All
Highest households
1.16
10.46
1.84
3.04
1.29
2.65
2.03
13.40
2.68
4.69
2.14
3.69
Table 2 provides the industry overview of Western Australia’s dependency on
telecommunications. It is clear from the table that more than half of WA’s
economy is explained by the Services, Mining and Retail/wholesale trade
sectors. Table 2 also shows the total requirements coefficient, which
quantifies the need for communication services in terms of its share of
industrial output for each of these sectors. Within the Services sector (finance
and insurance, property and business services, education, cultural and
recreational services, and personal and other services) the share of
communications services in final output is six times larger than petrol and 1.7
times that of electricity, gas and water3. For the Retail/wholesale trade sector,
the share of communications services is nearly double that of the Services
sector. Given these magnitudes and the size of the Services, Mining and
Retail/wholesale sectors it is apparent that telecommunications price
increases would have a substantial impact on economic activity.
Table 2. Communications requirements by selected sector (WA)
Total requirements
Industry
Share of GSP4 (%)
coefficient (%)
Services
22.4
3.4
Mining
20.2
2.1
Retail/wholesale trade
9.8
6.5
Manufacturing
9.0
2.4
Construction
8.1
1.9
Health and community services
5.8
2.5
Transport and storage
4.7
3.8
Government
4.1
5.0
Agriculture, forestry and fishing
2.9
2.2
Electricity, gas and water supply
2.7
2.1
Accommodation, cafes and restaurants
1.6
3.9
Source. ABS Australian National Accounts, State Accounts Table 28, cat. 5220.0
2002-03 and Australian National Accounts, Input-Output Tables 1996-97, Table 6
cat. 5209.0.
3
The petroleum and coal products total requirements coefficient for the services sector is 0.6
while the electricity, gas and water total requirements coefficient is 2.0.
4
GSP is an acronym for Gross State Product.
3
Establishing
an
explicit
link
between
economic
activity
and
telecommunications service price changes requires a sustained research
effort. An indication, however, would be available from the volume (quantity)
prices implied by the ACCC’s method of calculating the various
telecommunications price indexes. Analysis of changes in volume measures
in conjunction with changes in industry revenue would provide a means of
establishing to what extent individual telecommunications carriers are able to
exercise market power at the expense of the national and State economies.
Consumers (both household and small business) have a limited range of
responses to price increases:
•
•
If substitution is not feasible, consumers either reduce call volumes to
stay within a prescribed budget or increase telecommunications
expenditure by reducing expenditure on other unrelated goods and
services.
If substitution is feasible:
o In response to a uniform price increase across the range of
telecommunications services, consumers may be able to reduce
telecommunications use in favour of increased transport. In
most cases, transportation and telecommunications are poor
substitutes.
o In response to a relative increase in fixed line prices, consumers
may be able to reduce fixed line use in favour of mobile
telephony. However, the increased fixed line price is likely to
adversely impact on Internet access via dial-up and broadband
(ADSL) 5 access.
The fledgling retail broadband market is likely to be particularly price sensitive
because most consumers have budget allocations that are defined by fixed
income. For example, a fixed line is required to support broadband access via
ADSL. For ADSL subscribers, an increase in fixed line rental will force a
reduction in broadband expenditure.
The incumbent, who has a virtual monopoly on fixed line access, could drop
the price of retail ADSL to offset the impact of the fixed line price increase on
consumers. The consequence is likely to have a substantial impact on
competition, as was evidenced earlier this year. In short, fixed line access is
an essential facility element6.
The obvious counter-argument is that increases in fixed line rental will
encourage an alternative carrier to build a duplicate network. There are,
however, several market failures that have not yet been fully explored by
Australian policy makers:
•
Facilities-based competition is not the most efficient outcome in
areas where the customer base is unable to support more than one
5
ADSL is an acronym for Asymmetric Digital Subscriber Line.
An essential facility element is a service that does not have a close (viable) substitute and is
part of a bundle of facility elements that make up a service bundle. Essential facility elements
are sometimes referred to as monopoly building blocks. See Hausman, J. (1999) ‘Regulation
by TSLRIC: economic effects on investment and innovation’, Multimedia und Recht.
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facilities provider. There are likely to be many areas of Australia, such
as regional WA, where this is the case.
•
Investment uncertainty, which is largely caused by the reality that
telecommunications infrastructure is sunk and irreversible. The main
implication here is that investing in telecommunications is highly risky
because the infrastructure cannot be easily reused or resold if the firm
making the investment exits the industry. In practice, service
providers impose a high hurdle rate of return on investment
proposals, resulting in less investment in infrastructure.
•
Non-price competitive forces in the presence of asymmetric
information with respect to the flow of relevant market information
between parties7. There are many examples of ‘signalling’ and
‘credible threat’ tactics being employed by the principal facility
providers8. Both the mobile telephone and broadband markets have
many examples, e.g. investment intentions surrounding the
deployment of fibre to the home. Such tactics increase uncertainty,
which by definition reduces the efficient operation of service markets.
Investment in new infrastructure generally occurs once service providers,
chiefly resellers, have established a sufficiently large and stable customer
base to ensure return on investment. The investment occurs as part of a cost
reduction strategy where service providers transfer customers off
infrastructure rented from wholesale service providers.
With respect to the previously noted investment in the CBD, new
telecommunications infrastructure is driven by competition in the data market.
While competitors may provide voice services via the new infrastructure, it is
data revenue, not voice revenue that is driving facilities-based competition.
In the absence of comprehensive policy reform to adequately address the
above three market failures, price controls on essential facility elements
should be retained as an explicit second-best option. In particular, the
objective should be to maintain an upper limit on prices, thereby acting as a
proxy for competition. The risk of the proposed strategy is minimal because
effective competition combined with technological change are likely to drive
service prices set by the market below the regulated price.
Regulatory responses in the presence of asymmetric information
To date, the discussion of telecommunications services subject to price
control implicitly assumes that the reason for price control and the precise
nature of the service are widely known and understood.
The economic analysis contained in the Review discussion paper explicitly
justifies the price control regime in the context of containing market power.
Another argument for regulation is to address inefficiencies created by the
7
Information asymmetry occurs when one party involved in a two-party transaction has more
or better information than the other party. For example, Telstra has better information about
its operational costs than the ACCC.
8
‘Signalling’ refers to tactics designed to convey information to competitors with the implicit
aim of limiting effective competition. ‘Credible threat’ refers to information conveyed that
supports the signal. An example of a credible threat is a capacity to engage in a substantial
capital program in specific geographic areas in a bid to destroy small competitors.
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existence of market failure. A principal source of market failure within the
telecommunications market is asymmetric information. An effective way of
dealing with the problems caused by asymmetric information is to place the
burden of proof on the market participants with the informational advantage.
The rationale for a regulatory approach with incomplete information is based
on the following principles:
•
A profit-seeking firm will always extract the maximum revenue it can
from the market. In the telecommunications industry, where carriers
sell services in multiple markets simultaneously, prices will rise the
most in markets where the price elasticity of demand is least elastic.
This means the price of telephone line rentals, local calls, and trunk
(STD) calls. Since market pricing depends on demand conditions as
well as supply characteristics, without effective competition or
regulation, there is no guarantee that telecommunications carriers will
price services according to marginal cost. Therefore, there is no
guarantee that the telecommunications market will price services
efficiently.
•
The ultimate regulatory objective is to ensure that economic
efficiency, which is the sum of consumer and producer surplus, is
maximised. Given asymmetric information, the ACCC should place
emphasis on enhancing consumer welfare (by increasing consumer
surplus).
•
For a service provided universally, a price reduction is always welfare
enhancing for the consumer.
•
A new service innovation may, or may not, be welfare enhancing.
The total welfare gain is dependent on consumer preferences, which
are not known to the regulator.
•
Any implied trade-off between a price reduction and a service
innovation only occurs at the margin within an optimisation
framework. The ACCC cannot observe this point other than by
monitoring market outcomes in areas where competition is fully
effective.
•
On the balance of probabilities, it is safer for the ACCC to rely on
price reductions as a means of enhancing consumer welfare.
•
Productive, allocative and dynamic efficiency are optimised when
competition is working effectively.
Given these principles, this submission argues for a two-tiered approach to
price control. In the first tier, universal maximum prices for essential facility
elements are retained absolutely at their current level (in real terms) as a
guarantee that prices cannot rise above a prescribed maximum. In effect, the
Tier 1 rule imposes a static price ceiling. The second tier applies a simple
dynamic pricing rule as a proxy for effective competition. Given that effective
competition is most likely to occur in metropolitan markets, the pricing rule
could be as simple as setting the maximum price equal to the average price
set by competitive forces in metropolitan areas.
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Net economic costs of price control arrangements
Section 5.3 of the Review discussion paper (Distributional Impacts) refers to
the need to consider the “…economic benefits and costs from the current or
any future price control arrangements...” In effect, the reference to
distributional impacts hints at the economic cost of imposing price controls
against the social benefit of equitable pricing for non-metropolitan consumers.
An explicit examination of the issue raises two fundamental issues:
•
Consumers in regional areas could be forced to pay more for
telecommunications services than their metropolitan counterparts as a
result of any ‘tariff rebalancing’.
•
There is a risk that the current price control regime is imposing an
economic cost that substantially outweighs the social benefit.
With regard to the first issue, regional and some metropolitan consumers are
already facing substantial disadvantage with respect to the availability and
cost of telecommunications services. Removing or relaxing price controls are
likely to exacerbate the disadvantages. In relation to the second issue, the
economic cost is likely to be small. On one hand, there is a risk that the price
levels set by the CPI-x formula could be set higher than the monopoly price.
However, the upper limit for a profit maximising monopolist (the worst possible
case) is the point where the price elasticity of demand is unit elastic. If the
imposed price ceiling is higher than the price implied by unit price elasticity,
then the price control is not effective at enhancing market efficiency by
reducing economic rents. On the other hand, a price set too low will give
service providers every incentive to provide convincing evidence that the price
ceiling should be increased. Given that the service providers have detailed
information about their own operational costs, service providers should bear
the burden of proof in arguing for an increase in the price ceiling. Removing or
relaxing a price ceiling that is lower than the monopolist’s profit maximising
price will impose a substantial cost in terms of reduced economic activity.
There are no circumstances in which it is reasonable for the ACCC to remove
price controls. The price control can simply be maintained, in real terms, at its
current level as a guarantee that prices cannot escalate above the specified
price if there is a sudden and unexpected reduction in competition.
In time, where competition is fully effective it is likely that the market price will
drop below the current level of prices set by the ACCC. This expectation is
based on a long history of well-documented efficiency gains derived from cost
reducing advances in telecommunications technology.
Indeed, the ACCC can build this expectation into its price control regime by
adopting the two-tiered pricing rule. That is, apply the market price
established in areas where competition is an effective disciplining mechanism
(e.g. metropolitan areas) to areas where competition is not effective (e.g. nonmetropolitan areas). The maximum price charged anywhere should be the
competitive metropolitan market price, which in turn will be equal to, or less
than the Tier 1 price ceiling.
In evaluating this strategy, the following issues are relevant:
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•
Profit seeking firms will always choose the strategy that minimises
cost.
•
The Universal Service Provider (currently Telstra) has a limited range
of responses to this regime, namely:
o Abandon unprofitable areas. Abandonment is effectively ruled
out under the universal service regime;
o Erode the quality of the service subject to price control. This
occurs by reducing maintenance expenditure, reducing staffing
levels etc; or
o Ruling out the first two options, choose the technology that
minimises cost.
With limited ability to abandon customers or erode the quality of service,
Telstra as the Universal Service Provider, would have to consider upgrading
its equipment since new equipment is inherently more efficient than aging
equipment. This response will occur even if the service area is unprofitable
since the Universal Service Provider will seek the strategy that minimises
losses9.
The ACCC’s regulation rule is simple: it should impose the competitive market
price, observed in metropolitan areas, on non-metropolitan regional areas for
services that are supplied universally. At the same time, the ACCC should
continue its price controls in metropolitan areas, either at the current price
level (in real terms) or continuing the CPI-x formula. Continuing advances in
technology
are
cost
reducing,
thus
ensuring
a
sustainable
telecommunications industry.
Definition of Service Subject to Price Control
To date, discussion of services subject to price control implicitly assumes that
the services are well defined. Unfortunately, definitions appear to be implied
and imprecise. The recognition that declining quality of service undermines
the price control regime means that the service must be precisely and
explicitly defined. This is reinforced by the discussion concerning voice over
internet protocol (VOIP) contained in section 5.4 New and emerging
technologies of the Review discussion paper. A new service platform, such as
VOIP could provide the platform for providing a PSTN equivalent service.
However, recent history shows that VOIP quality is substantially less than
carrier grade voice services. This kind of fundamental change therefore
requires a precise definition of the service in the interests of consumers and to
provide greater certainty for service providers.
Impact of price control arrangements on new and emerging technologies
The discussion on page 31 refers to allowing “…Telstra to price above-cost in
certain markets [which] may actually encourage it to invest in new and
innovative
technologies…”
In
the
context
of
the
Australian
telecommunications regulatory framework, this argument is tenuous. Past
economic studies in the US have analysed the effect of rate-of-return
9
It should be noted that the Universal Service Provider is paid a subsidy as compensation for
incurring a loss in unprofitable areas.
8
regulation and other types of ‘incentive regulation’ on capital investment. The
fundamental issue is that rate-of-return and incentive regulation is aimed at
ensuring an adequate return on invested capital10. According to his paper
Incentive regulation in the US telecommunications industry, Professor John
Panzar observes that the literature is inconclusive on the impact of such
regulation. Further, on page 14 Professor Panzar observes that:
“…a price cap regime operates by giving the firm the incentive to reduce
costs…’’
He then states that:
“…a price cap regime may be effective in allowing the firm to reduce costs…”
In our view there are two principles involved:
•
The need to ensure a flexible regime that facilitates the timely
adoption of appropriate technology for the benefit of consumers; and
•
The need to ensure essential services that offer real value to
consumers are set at prices that encourage adoption.
Precise service definition within the two-tiered price control system will allow
the first principle to be satisfied. Under this regulatory regime, the possibility of
national revenue loss caused by aggressive price cutting in metropolitan
areas will provide a strong incentive for service providers to avoid a price war.
Instead, competition is likely to occur on the basis of offering value-added
services. With respect to the second principle, it is necessary to establish a
test other than simply arguing historical precedent. Namely, regulation should
seek to address specific market failures. Although the current price control
regime is justified on social grounds, it may also be appropriate as part of the
solution to address market failure induced by natural monopoly. On this:
•
Natural monopoly is an empirical issue. While competition is clearly
sustainable in the CBD, other areas such as in parts of regional
Australia appear to have insufficient customers to support effective
facilities-based competition.
•
If natural monopoly exists as a result of insufficient scale, then
Australian telecommunications policy should be flexible enough to
reflect differences in competitive outcomes across geographic areas.
Price control arrangements could be justified as a means of imposing
a discipline on the incumbent in the absence of effective competition.
In our view, there is insufficient evidence to justify relaxing or removing the
current price controls.
Other Matters
Two other matters canvassed by the discussion paper are the impact of fixed
to mobile prices, and price caps on public payphones. In practice, increasing
numbers of consumers making fixed to mobile calls do so after being
redirected from the intended fixed line number to a mobile telephone without
10
See Panzar, J. (1999), ‘Incentive regulation in the US telecommunications industry’, in 1999
Industry Economics Conference, 3-16,
http://www.pc.gov.au/research/confproc/iec1999/iec1999.pdf.
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their prior knowledge or consent. Consequently, they are not in a position to
manage their call costs. This clearly impacts the most on consumers in the
lowest income group. A price cap specifically targeting fixed to mobile calls
would be an effective way of providing practical assistance to these
consumers.
With respect to payphones, the ACA’s report Payphone Policy Review (page
34) makes the qualified recommendation that the ACCC consider an increase
in the price cap on local calls from Telstra payphones. This recommendation
follows a discussion of falling payphone revenues and the impact that this has
on competition in the payphone market. The implied argument is that relaxing
the price cap will remove an inadvertent margin squeeze on non-Telstra
payphone providers. This argument appears to suggest that the price caps
would lead to a reduction in payphone availability. There are a number of
issues at play here:
•
Non-Telstra payphone providers are not compelled to supply
payphone services in unprofitable areas.
•
Telstra receives a universal service subsidy as compensation for
providing payphones in unprofitable areas.
As the ACA’s report makes clear, the key users of payphones are indigenous
communities, younger people, those living in rented accommodation,
unemployed people, those receiving government payments and those on
lower incomes. This leads to the conclusion (page 24 of the ACA’s report)
that:
“…This higher share of use is because the characteristics of these people
mean that they have poor access to other telephone services. This suggests
that payphones are important for social equity and the government should use
tools such as the [universal service obligation] to ensure that payphones are
provided in socially disadvantaged areas…”
Increasing the cost of local calls reinforces the disadvantage of those who rely
on payphones for their electronic communications, and so highlights the need
to think very carefully about rises in charges.
CONTACT OFFICERS:
Grant Coble-Neal
State Development Strategies
Department of Industry and Resources
2 Havelock Street
WEST PERTH WA 6005
Sheryl Siekierka
State Development Strategies
Department of Industry and Resources
2 Havelock Street
WEST PERTH WA 6005
Phone: (08) 9222 5321
Fax: (08) 9222 5612
Email: [email protected]
Phone: (08) 9222 5677
Fax: (08) 9222 5612
Email: [email protected]
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