Download Introducing Competition and its welfare implications in

ITS
Introducing Competition and its
Welfare Implications in Korean
Mobile Telecommunications Services
Duk Hee Lee & Dong Hee Lee
School of IT Business, Information and Communications University,
Daejeon, South Korea
August 24, 2003
Content
I.
Introduction
II.
Korean MTS and Social Welfare
III.
Estimating Consumer Surplus
IV.
Estimating Producer Surplus
V.
Total Social Welfare
VI.
Conclusions
Donghee Lee
2003-8-24
ITS
2
Introduction

ITS
Industrial change in telecommunications services
Natural Monopoly
Competition
• Technological advance in switching and
transmission
• Developed new services
• diversified and individualized demand
• Service Convergence



Rapid growth in the Mobile Telecommunications Industry
How has the change affected the social welfare?
How much benefits has been achieved from the services?
Donghee Lee
2003-8-24
3
Korean MTS and Social Welfare

ITS
Korean MTS market situation
Monopoly
Duopoly Competition
SKT
1984.4
Donghee Lee
SKT, STI
1996.4
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SKT, STI
KTF, KTM, LGT
1997.10
2001.12
4
Korean MTS and Social Welfare

ITS
Introducing competition
Quality↑
Consumer
benefits↑
subscribers↑
calls ↑
Operator
profits↑
Competition
Price↓
Source: KISDI (2001)

How much benefits from MTS have been achieved owing to introducing
competition?

What are the structural patterns of benefits btw consumers and service
operators over the time?
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Korean MTS and Social Welfare

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Empirical estimation of the benefits

Social Welfare in economic concept


Consumer Surplus : price elasticity, operator revenue
Producer Surplus : operators’ annual report
Price A
D Supply
Consumer
Equilibrium surplus
price Producer
surplus
E
B
0
Donghee Lee
C
Equilibrium
quantity
2003-8-24
Demand
Quantity
6
Korean MTS and Social Welfare

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Empirical evidence in some countries
Researcher
Time
Periods
Consumer
Surplus
Producer
Surplus
CS/GDP
U.S.
Hausman
(1997)
1989~1993
B$31 ~ B$50 per year
-
0.71%
UK
RA (2001)
2001
B$10.916 in 2000
B$1.172
1.32%
Australia
ACA (2002)
1995~2001
B$2.002 ~ B$4.307 in
2000-2001
-
0.30%
~0.65%
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Estimating Consumer Surplus

ITS
Alexander, Kern, and Neil(2000)

Critical assumptions:
Demand function for MTS is only affected by the service price
(for subscription and call)

Model: CS 
Pt X t
2
CS: consumer surplus
Pt : subscription price or call price at time t
X t : the number of new subscribers or the volume of
calls at time t
 : elasticity of demand
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2003-8-24
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Estimating Consumer Surplus

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Estimating elasticity (η) of demand

for the subscription

factors: subscription fee, handset price, handset subsidy,
income level, call price, other consumer product price
log N t   0  1 log(
PSt
P
GDPt
)   2 log( Ct )   3 log(
)  et
CPIt
CPIt
CPIt
 1 : Price elasticity of demand for subscription
 2 : Cross elasticity of demand for subscription
 3 : Income elasticity of demand for subscription
PSt : Subscription price (= subscription fee +handset price –
handset subsidy) at time t
PSt : call price (= basic fee + usage fee) at time t
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Estimating Consumer Surplus

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Estimating elasticity (η) of demand

for the call

Factors: call price, income level, subscription price, the
number of subscribers, and other consumer product price
log Qt   0  1 log(
PSt
P
GDPt
)   2 log( Ct )   3 log(
)   4 log( N t )   t
CPIt
CPIt
CPTt
1 : Cross elasticity of demand for call
 2 : Price elasticity of demand for call
 3 : Income elasticity of demand for call
PSt : Subscription price (= subscription fee +handset price –
handset subsidy) at time t
PSt : call price (= basic fee + usage fee) at time t
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Estimating Consumer Surplus
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ITS
Estimated elasticity of demand and consumer surplus
Before competition
(1996.1 ~ 1997.9)
After Competition
(1997.10 ~ 2001.12)
Elasticity of demand for subscription
-5.542
-0.615
Elasticity of demand for call
-0.898
-1.185
(Unit: USD Mil)
Donghee Lee
Year
Subscription CS
Call CS
Total CS
1996
66
913
979
1997
267
772
1,040
1998
619
1,268
1,887
1999
1,040
2,401
3,441
2000
774
3,070
3,844
2001
739
3,210
3,949
Total
3,506
11,634
15,140
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Estimating Consumer Surplus
ITS
< Yearly Trend of Consumer Surplus >
S ubscription C S
U S D M il
C all C S
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
1996
1997
1998
1999
2000
2001
< The Ratio of Consumer Surplus to GDP >
Year
1996
1997
1998
1999
2000
2001
CS/GDP(%)
0.21
0.35
0.58
0.90
1.01
1.06
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Estimating Producer Surplus

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Producer surplus

Economic concept




Donghee Lee
The dollar amount by which a firm benefits by producing a
profit-maximizing level of output.
If ∏E(economic profit) = TR - TC and TC = VC + FC,
then PS = TR – VC = TR – TC + FC = ∏E + FC (in the
short-run)
In the long run, PS = ∏E
TC already includes opportunity cost of capital that a firm
requires to do business. (Frank, 1999)
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Estimating Producer Surplus

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Total cost of MTS (TC)

Accounting Principle for telecommunications services

introduced in 1994 to provide:

useful accounting information for a fair competition among operators;
 proper telecommunication policy-making;
 reasonable and efficient decision-making of operator;


and then has been revised (KISDI, 2003).
Business cost + Return on invested capital (ROIC)

Business cost = Operating expense + Non-operating expense
(license fee, NUSC, loss from disposal tangible assets, tax)

ROIC = Rate base × Cost of capital (Required rate of return)

Donghee Lee
Rate base = (average tangible/intangible assets per year) + (average
inventory assets per year) + (relevant working capital)
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Estimating Producer Surplus
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Cost of capital estimated in other countries
Researcher
Method
Results
(real price, pre-tax WACC)
Hong Kong
NERA (2000)
WACC
CAPM
Incumbent: 9.78% ~ 15.33%
Entrant: 10.84% ~ 16.20%
UK
Oftel (2001)
WACC
CAPM
Low gearing: 13.55% ~ 16.95%
High gearing: 13.01% ~ 16.61%
WACC
CAPM
Pilot area: 10.0% ~ 10.2%
Extended zone & rest: 7.6% ~ 7.7%
for NUSC in 2000-2003
Australia
Korea
Donghee Lee
ACG (2000)
Referring to the several cases, we assume that
CoC of Korean MTS ranges from 10%~15% (12%~17%)
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Total Social Welfare

ITS
Results of estimation
(Unit: USD Mil)
Year
1996
1997
1998
1999
2000
2001
Total
PS (Low ROIC)
-105
-202
-442
-606
-207
767
-794
PS (High ROIC)
-239
-377
-704
-957
-585
413
-2,448
CS
979
1,040
1,887
3,441
3,844
3,949
15,140
Social Welfare
(Low ROIC)
873
838
1,445
2,835
3,638
4,717
14,346
Social Welfare
(Low ROIC)
740
662
1,183
2,484
3,259
4,363
12,692



PS is negative value until 2000
Cumulative total PS generated by MTS is amount to -$2,448 ~ -$794
million.
Thus, total social welfare is less than consumer surplus.
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Total Social Welfare

ITS
Structural change of social welfare
CS vs PS
USD (M il)
5,000
4,000
3,000
2,000
1,000
-1,000
1996
Donghee Lee
1997
1998
1999
PS(Low ROIC)
PS(High ROIC)
Social Welfare (Low ROIC)
Social Welfare (High ROIC)
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2000
2001 Year
CS
17
Total Social Welfare

The social welfare has been rapidly increased after
introducing competition in Korean MTS

Consumer surplus is much larger than producer
surplus.

ITS
Mobile operators inputted a huge amount of money for
establishing network facilities and promoting marketing
activities such as handset subsidy.
From 1998 to 2000, the amount of handset subsidy provided by five
mobile operators was about $5.7 billion

Consumers largely benefited from the service competition on
equipment, price, and quality among operators.
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2003-8-24
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Conclusion
ITS

The Korean mobile telecommunications market has rapidly grown
since 1997 when competition was introduced.

Measuring the effect on welfare,


consumer surplus estimated by using price-elasticity of demand
reached $15.1 billion during 1996~2001

Producer surplus estimated by using operators’ annual reports was
ranged from –$0.8 ~ -2.4 billion during the time period.
Due to the competition, consumer has benefited much more from
the MTS than the mobile operators in Korea.
Thank you !
Donghee Lee
2003-8-24
19