Competition and Regulation in the Telecommunications Industry in South Africa

Transcription

1 Competition and Regulation in the Telecommunications Industry in South Africa Prepared for the Competition Commission by James Hodge & Nicolas Theopold School of Economics, University of Cape Town March 2001

2 Table of Contents INTRODUCTION THE NATURE OF THE TELECOMMUNICATIONS INDUSTRY THE TELECOMMUNICATIONS MARKET Provision of Network Infrastructure Provision of Services Features of Networks FORMS OF INTERNATIONAL TRADE Provision of network infrastructure Provision of services ROLE IN THE ECONOMY Role as Intermediate Input Demand for Intermediate Inputs Medium for Content Providers Household Expenditure Item INTERNATIONAL REFORM OF TELECOMMUNICATIONS REGULATION THE RATIONALE FOR REGULATION Normative Theory of Regulation Positive Theories for Regulation DIFFERENT TYPES OF REGULATION Regulation under Perfect Information Regulation under Asymmetric Information INTERNATIONAL TRENDS IN TELECOMM REGULATION The move to incentive Regulation Liberalising Network Industries: a Three Stage Process CONVERGENCE IN TELECOMMUNICATIONS CURRENT REGULATORY FRAMEWORK BACKGROUND AND OBJECTIVES OF CURRENT REGULATION INDEPENDENT REGULATORY BODY SATRA TO ICASA FIXED LINE NETWORKS Local Access Long-distance Value-added Network Services (VANS) Private Networks (voice) MOBILE COMMUNICATIONS Cellular Satellite INTERCONNECTION, FACILITIES LEASING AND NUMBERING PUBLIC INTEREST CONSIDERATIONS Universal Service Human Resource Development MARKET STRUCTURE AND CONTESTABILITY ANALYSIS PROVISION OF CUSTOMER PREMISES EQUIPMENT (CPE) Relevant Markets Market Structure Contestability FIXED LOCAL ACCESS Relevant Market Market structure Contestability LONG DISTANCE Relevant Market Market structure i

3 4.3.3 Contestability MOBILE Relevant Market Market structure Contestability VALUE-ADDED NETWORK SERVICES (VANS) Relevant markets Market structure Contestability OTHER MOBILE SERVICES Relevant Markets Market Structure Contestability REGULATORY ISSUES FOR THE SA TELECOMMUNICATIONS INDUSTRY AND THEIR POTENTIAL EFFICIENCY/PUBLIC INTEREST IMPACT STRUCTURE Vertical separation of networks Vertical separation of services from networks Horizontal separation of mobile services ENTRY To Restrict Entry or Not Dealing with Entry Deterrence To Actively Assist Entry or Not Asymmetric regulation PRICING Final consumer prices Interconnection (Access) pricing QUALITY CONCLUDING REMARKS BIBLIOGRAPHY ii

4 List of Tables Table 1.1: A breakdown of the telecommunications market 2 Table 1.2: Cost characteristics of local access technologies for telecommunications 6 Table 1.3: Direct forward linkages - Telecommnuications share of intermediate input costs for sectors of the economy (1997) percentage of total intermediate input costs 13 Table 1.4: Structure of capital requirements for a fixed line network provider and an Internet service provider (2000) 13 Table 1.5: Direct backward linkages intermediate inputs into the communications industry (1997) percentage of total intermediate input costs 14 Table 2.1: State of European Deregulation (1998) 21 Table 3.1: Rollout Targets for Telkom in terms of License 30 List of Figures Figure 1.1: A telecommunications network 4 Figure 1.2: Household expenditure patterns (1995) 15 Figure 2.2: Path of Regulatory Intensity 22 Figure 3.1: Proposed path of deregulation 31 iii

5 Introduction The telecommunications sector in South Africa has undergone a partial deregulation in the past 5 years. It is at this point that there needs to be a decision on how to proceed with the process, while complying with liberalisation commitments for the sector in the WTO. Further, the Competition Commission recently received joint jurisdiction over a number of the publicly regulated sectors, including telecommunications. The purpose of this paper is to review the industry and its deregulation from a competition policy perspective. This involves understanding the various horizontal and vertical markets in the sector the regulation of entry & conduct, and how this regulation has evolved the level of actual and potential competition in the industry the impact of different regulatory choices on market structure, competition and performance in the industry The paper consists of five parts. Part one examines the vertical structure of the telecommunications industry and it s changing nature. Part two looks at the rationale for conduct regulation in the past and how this practice has evolved internationally. Part three describes the current regulatory practice in South Africa, including some of the public interest issues. Part four takes a hard competition analysis view of the different vertical stages of production, drawing out market structure, potential competitors, barriers to entry and the potential impact of entry. Part five then draws on the lessons of the other four chapters to put forward a position on the major regulatory issues that need to be decided. 1

6 1. The Nature of the telecommunications industry This first section explores the nature of the telecommunications industry as a starting point for competitive analysis. It begins by determining market separation both vertically (supply chain) and horizontally. This discussion includes a look at technological convergence and who are the current and future players in the market. It then explores the possible forms of trade in telecommunications and how that might impact the geographical scope of the market and contestability. Lastly, it examines the role that telecommunications plays in the broader economy. This may inform how to trade off efficiency and public interest considerations. 1.1 The telecommunications market The telecommunications industry concerns the provision of two-way, one-to-one communications of voice, data and video. It is distinct form the broadcasting market, which is typically a one-way, one-to-many communications service. However, convergence means that infrastructures developed for either market can be adapted to provide the other service. Given these economies of scope, it is often preferable to provide both services. For regulatory purposes it is important to understand the vertical stages of production and possible horizontal market divisions in telecommunications. Table 1.1 provides the commonly used breakdown for telecommunication, noting that the dynamic nature of the industry makes such definitions valid at a point in time only. Table 1.1: A breakdown of the telecommunications market Production Stage Description Sub-stages Horizontal divisions Provision of Network Provision of switching and customer premises fixed vs. mobile infrastructure transmission equipment PABX vs. phone infrastructure Local access Fixed vs. mobile Business vs. residential Voice/data vs. broadband video National Long Distance International Long Provision of services Provision of additional infrastructure and technical support to operate service over infrastructure Distance Line lease agreement Content value-added infrastructure Technical service provision Customer management (billing & customer support) basic voice vs. VANS vs. broadcast Fixed vs. mobile national long distance vs. international Business vs. residential Telecommunications production can roughly be divided into the provision of network infrastructure and the provision of services on that infrastructure. Typically a public monopoly is vertically integrated and so provides all parts of the production chain and all horizontal markets. However, in the context of deregulation it is important to focus on the various stages of production and not what individual firms do. In this way it is 2

7 easier to identify essential facilities and anti-competitive behaviour stemming from vertical integration. It is also easier to track where competition can feasibly survive without regulation Provision of Network Infrastructure Network providers operate the infrastructure on which various telecommunication services are run. Networks are made up of switches and transmission. The switches provide the routing of voice, data, and video signals through the network. The transmission medium can be separated into fixed line (twisted pair of copper wires, fibre optic, coaxial cable) or wireless (satellite, cellular radio, microwave, PCS). The big technological changes in network provision have been (Laffont & Tirole 2000): the rapidly decreasing costs of switches and transmission equipment the increasing capacity and speed of transmission mediums both in the transmission material (e.g. fibre optic) and the improved compression of signals (e.g. ADSL or asymmetric digital subscriber lines which increase speeds on copper paired wire) the increasing intelligence of the networks enabling them to improve their efficiency and begin to offer a wide variety of services beyond mere telephony (discussed below) the convergence of different industries due to the common use of digital format. The industries relate to the original purpose for which the networks were built telecommunications (voice), broadcasting (video) and computing (data) There are three different components to the network that can be seen as three different stages of production. These are local access, long-distance and international. Figure 1.1 below demonstrates how these three components interconnect to form a complete international telecommunications network. It looks at a mixed fixed line/mobile example. The local access network connects the customer premises to the local switch through the local loop. From the local switch there is an interoffice transmission facility to either other local switches or long-distance (national or international) points-of-presence. The long-distance networks then transmit the signal to another long-distance point-of-presence where it is distributed to a local switch and onto the other customer premises. What follows is a more detailed discussion of each component of the supply chain and the various technological platforms used. 3

8 Figure 1.1: A telecommunications network Customer premises Customer premises FIXED LINE Local Loop Local Switch Local Switch Long distance PoP Customer handset Customer handset Base Station Base Station MOBILE Local Switch Long distance PoP Customer premises equipment (CPE) The concern here is the retail supply of customer premises equipment and not the manufacture of the items. CPEs include fixed line telephones, mobile handsets, and PABXs (private exchange equipment for business use). Each of these can be considered a separate market. In the heyday of public monopoly, the customer premises equipment had to be supplied by the incumbent PSTN. This monopoly position, on what is essentially a service with no natural monopoly features, represented an opportunity for abnormal profits to be made. Almost without fail the first step in any deregulation process is to liberalise this part of the supply chain. Local Access Local access can now be provided by a number of different technologies, each with different cost structure and therefore different degrees of substitutability with the traditional public switched telephone network (PSTN). The focus below will be on fixed line (PSTN, data networks, cable TV) vs. wireless (fixed or mobile) options. Although local access is being handled as one stage of production, it should be noted that this stage can be broken down further. In particular, connection of premises to local loop local loop local exchange (switch) In the search for greater competition at the local access level, it may be desirable to further unbundle the production process and find ways to inject competition. For instance, the SA White Paper on telecommunications suggests allowing community groups and SMMEs putting in local loops that then connect to the Telkom PSTN. In the USA, Competitive Access Providers (CAPs) have emerged to connect large customers directly to the long distance networks points-of-presence (PoPs), 4

9 effectively bypassing the PSTN (these access lines are point-to-point and have no switching capacity) (Laffont & Tirole 2000). Fixed Line Within the group of network providers that use fixed line infrastructure, networks were historically built to focus on one of three different types of transmission voice, data or image. However, increasingly networks are offering all three. This is feasible because almost all networks now use a digital format. In voice, the traditional PSTN consists mainly of copper or coaxial cable transmission equipment at the local access level and switching equipment that allows two-way transmission between two individual points on the network by establishing a dedicated line between two points for the duration of a call. The transmission mediums have low capacity or network speed (measured in bits per second) making them inadequate for video transmission and a slow but adequate medium for data transmission. However, recent technological developments in data compression have substantially increased the speeds available on these wires (in particular the asymmetrical digital subscriber line systems ADSL and other DSL technologies). Upgrading the networks to provide greater speed does require additional investments in the local access infrastructure. An alternative is the use of fibre optic, which has a far greater network capacity. Due to the higher cost of fibre optic, it is only cost effective with large businesses and not residential homes in the local access component of the network. It is used extensively in the long-distance and international networks. Either way, it is increasingly possible for PSTN networks to be upgraded to offer video services too. In fact, growing use of capacity for data transmission (i.e. the Internet and intra-corporate transfers) make the investments in fibre optic or ADSL increasingly worthwhile, offering the springboard to broadcasting. Cable TV (CATV) networks (video networks) use a coaxial cable with broadcast quality network speeds as their transmission medium. Initially these networks were only focused on broadcast and so were established with one-way, one-to-many transmission (tree-and-branch structure), disqualifying one-to-one communication. However, where cable operators have entered telephony, they have upgraded their networks to handle two-way transmission. This has enabled the creation of the new pay-per-view television services, and also allowed them to actively enter the Internet providers and telephony market. Dedicated data networks may be private or public (Internet). Data can be run over any network and in fact, most local access to dedicated data networks occurs through either the PSTN, the cable TV network or a mobile service. As such, the discussion of data networks is largely a long-distance issue. However, larger businesses are increasingly being connected directly to these long-distance data networks making it worth a mention here. The switching equipment of data networks does not establish a dedicated line and instead routes packets of data on common usage lines from one point to another through the path of least resistance. This is efficient for data but as line traffic congestion can delay packets, this has previously been unsuitable for quality voice or image transmission. However, recent International Telecommunications Union (ITU) agreements on a common gateway protocol for passing multimedia from telephone networks to data networks should greatly improve the quality in the near future (ITU 1999). This will see priority being given to voice and image packets, avoiding the problem of congestion. 5

10 Table 1.2 examines the cost structure of different network types. As it reveals, the cost structure in fixed line networks (PSTN or cable) is geared towards sunk and fixed costs making it largely insensitive to traffic volumes. For this reason it is often noted that the marginal cost of making a phone call is negligible. In fact, the marginal cost/revenue decision for the PSTN operator is whether to connect a new customer or not (Laffont & Tirole 2000). If the new customer is expected to generate more revenue than it costs to install the line, then the PSTN will install the line. The result of this cost structure is that economies of scale and density are reasonably large and there is a large initial investment required to begin operating local access. The sunk costs are largely the trenches and ducts for wire that can make up to 40% of annualised costs (Caves 1995). Allowing the distribution through poles above ground does lower costs. These sunk costs are the reason that lower cost entrants are companies with a local transmission network already in place e.g. cable TV companies or electricity companies. In these cases there are economies of scope as many of the additional costs of rolling out a network are already incurred. The difficulty of course is allocating these costs between the different services. The other service that cable can enter once upgraded for telephony is data transmission. Cave (1995) notes that in the comparison of costs between cable and PSTN, the following conclusions may be drawn: Cost per home passed (the local loop) is higher for a CATV network The incremental cost of provision of a telecommunications service by a CATV operator with an established local loop is a small fraction of the total cost faced by a PSTN For the subscriber already connected to the CATV local loop the cost disparity with a telecommunications provider is even greater. Table 1.2 assumes that the cable provider already has a local loop in existence and is providing both video and telephony (hence exploiting their economies of scope). The conclusion one can draw is that cable can in all likelihood be considered in the same market for telecommunications once established. Table 1.2: Cost characteristics of local access technologies for telecommunications Fixed line CATV network Fixed wireless Mobile wireless Fixed/variable ratio High Medium Low Low Sunk/salvageable ratio Traffic sensitive/non-traffic sensitive High Medium* Low Low Low Medium* High High Economies of scale Medium Medium Small Small Economies of density Large Large Small Small Economies of scope Possible Yes No Possible Initial investment required Requires special handset Large Medium Small Small No No No Yes *Based on some economies of scope by offering video and telephony services 6

11 Reproduced from Cave (1995) If the PSTN were to exploit their potential economies of scope into video then part of the sunk costs allocated to telephony would be shared with other services. The PSTN has already lowered some of the costs by exploiting its ability to provide access to two-way transmission data networks (i.e. Internet or private data networks). The exponential growth in traffic volume has been associated with data and not voice. This enables PSTNs to operate at greater levels of capacity utilisation and so lower the unit costs. This is a strong reason for the better productivity performance of US telephone companies. Wireless Networks Wireless networks differ from fixed line in their use of the radio frequency spectrum for transmission. The local access process involves a handset for the subscriber transmitting to and from a base station using a specific spectrum that the network provider is licensed to use. The base stations are usually connected to each other or another network through a fixed line infrastructure. In local access there are two types of wireless networks fixed and mobile. The fixed wireless local loop is a recent addition and is being used to provide a last drop to the consumer for fixed line voice or data networks. It is similar to two-way radio where the physical coverage is very limited, and the receiving device (a telephone) is often fixed in location. The same receiving device as fixed lines is used. In terms of a market boundary for competition analysis, it is not designed to compete with the cellular networks but rather to provide a cheap alternative to using fixed wire as the last drop to the home. Therefore it would usually fall into the fixed telephony market (in fact it is usually rolled out by the PSTN as part of a mixed technology strategy Telkom is no exception). The cellular networks provide local access but also the added advantage of mobility. The subscriber is required to invest in a handset that cannot be used for fixed line or fixed wireless access (a switching cost). The current mobile networks are constrained in their network speed to offering voice and data services only. However, the socalled 3 rd Generation or Universal Mobile Telecommunications Services (UMTS) hope to achieve networks speeds that would enable the transmission of video too. The first networks of this kind are due to be operational in Japan in The cost structure of mobile is different to that of fixed lines (see table 1.2). The spacing of the base stations (and therefore the number required) is dependent on the traffic volumes. The result is that the initial investment required to establish a local access infrastructure is lower than that of fixed lines. It also means that there are lower economies of scale and density, making more network providers viable. A key question is the extent to which mobile competes with fixed line in the local access market (i.e. is a close enough substitute to be considered in the same market). This is crucial for competition and regulatory analysis. From a use and quality of product perspective, they clearly offer the same potential group of basic and advanced voice products but with mobile having the added feature of mobility. What may therefore determine whether they are in the same product market is the difference in price between the two or whether other services are bundled in too (in particular data services). If voice is bundled with data services then fixed line currently holds a broader array of products to mobile, where data is available but in a far more limited way due to screen size. The actual cost differential depends on the 7

12 relative density of subscribers. Wireless is cheaper at lower densities due to the low fixed costs, while fixed line is cheaper at higher densities. The cross-over point is estimated to be in the range of subscribers per km 2 from US and UK studies (Cave 1995). This makes mobile more expensive in urban and metropolitan areas with high subscriber rates. However, in many developing countries with low telephony density of use, cellular is proving to be a good substitute for fixed line (South Africa may well be a case in point). Rapid technological developments in mobile communications could make it even more substitutable. Mobile telecommunications also includes satellite personal communications services. Satellite makes use of more powerful devices to transmit to one of a number of earth stations, which in turn link to each other via one or more satellites. The greater distances the receiving equipment must transmit over, means they are larger and more expensive than cellular. However, the use of satellites enables the network to minimise the number of earth-based transmission stations. This will not be discussed because a) the first global start-ups have all failed, and b) the cost is so much higher than fixed line or mobile that it cannot be considered remotely in the same market. Other wireless communications also include the broadcasting group (radio, free-to-air TV and Pay TV) which are one-to-many operations without two-way capacity and so cannot offer telecommunications. Finally, one can include two-way radio and radio trunking. Two-way radio is often transmitted over very short distances and includes networks for emergency services and communication within a defined corporate space. Often the distances are short enough that no transmission stations are required, and the hand-held devices are sufficient. The longer distances are covered by radio trunking, which operate in a fashion similar to cellular networks. Neither are suitable for public local access telecommunications and so will not be discussed further. Long Distance (National and International) Local access networks connect to a long distance network through a point-ofpresence (PoP). The long-distance network is made up of these PoP exchanges and a transmission network. Given that these networks draw on a large pool of local access subscribers, they are able to get greater density of use in their transmission networks. As a result, most long distance networks use fibre optic when using a fixed line solution. Alternative transmission mechanisms include satellite and microwave (national only). Despite the choice of technologies available, a single market is defined as one for national long-distance and for international long distance. In addition, as most of these networks have sufficient network speed for broadcast quality, there is no real need to differentiate at the infrastructure stage between voice, data and video. As with local access, there are economies of scope in rolling out fibre optic longdistance networks. A substantial proportion of the costs are in paying royalties to landowners to pass the transmission cable through and putting in place infrastructure to carry the transmission medium (Cave 1995). If a new entrant already has a national infrastructure (e.g. railways, electricity grid), then some of these costs will be spared allowing a faster and cheaper rollout. 8

13 1.1.2 Provision of Services The network infrastructure is the basis on which services are provided. The increasing intelligence of telecommunications networks has permitted a proliferation of services that are feasible beyond the basic local, national and international telephony. The new telephony-related services include automatic callback, number/name identification, selective call rejection/acceptance, voice messaging, selective routing of calls, text messaging, fax, calling card, etc. In addition, the range of data/video services has proliferated with the most common including a full Internet offering ( , world-wide-web), EDI (electronic data interchange), paging, managed data network services, video-conferencing, database access and transactions, videoon-demand. Service provision can be split into two basic components value-added network services (VANS) and basic voice. From this point there can be further separation into wireless vs fixed line, local/long distance/international, and business/residential. VANS are described as including electronic data interchange, electronic mail, protocol conversion, database access, managed data network services, voice mail, store and forward fax, video conferencing, telecommunications related to publishing and advertising services and electronic information services, including Internet service provision. The provision of services occurs on top of the network infrastructure. Historically the network provider was also the provider of services. However, unbundling the service from the network is feasible and has been the path of most deregulation processes. A service provider who does not own the network offers the service by either leasing part of the network from the network provider and enhancing this with one or more service components, or interconnecting their own network to others in order to provide the service. The service component is added for essentially two reasons a) because the network provider does not offer the service (by regulation or choice), or b) the network provider is seen to be inefficient at that service and the service provider is able to offer it at lower cost or better quality. In terms of efficiency arguments, a number of possibilities emerge. It could be that a network provider is using dated or inefficient technology at points in the network which a service provider may choose to replicate and then lease or interconnect to other parts of the network to compete. This may be as simple as the credit and billing component, or internet access via the local telephone network but using a national data network. Alternatively, the large network provider may not be able to adequately price discriminate amongst all niches in the market and a service provider may lease excess capacity in the network for the purpose of niche resale. This is often the case with international or national telephony services providers. The internet provides another example of niche servicing an important component of what customers seek in service providers is member services such as home page news, links and community information. These can be tailored to niche markets while the cost can be kept the same by leasing lines. The additional components that service providers bring to the network are: Service-specific infrastructure this includes additions to the network infrastructure required to technically provide a particular advanced service. For example, in Internet services these would include a national points of presence (PoPs) network linking to the long-distance data network (Internet backbone), 9

14 linking to a server farm that would include a router, authentication server, firewall, mail hosts, proxy servers and local content servers. Some form of customer management systems this would include customer information, billing and customer support (call centre) Content some advanced services may have content that will be received by the customer (e.g. Internet, video-on-demand) A local example of separation of network and service provider is the cellular industry in South Africa. The network providers do not retail to the public but instead wholesale network access to a group of approved service providers. These providers in turn offer retail outlets to access customers, they stock and sell the phones, do the credit checks, link the customer to the network and perform all billing and debt collection. Horizontal market divisions in the service component can be taken from the divisions in the network markets and include: Local vs long distance vs international standard voice products Business vs residential the business market has greater capacity usage and concentration changing the cost and product package provided. Data vs. voice vs. video separation of voice products from Internet and other VANS from broadcast type products. Fixed vs mobile this would apply across all of the other divisions e.g. mobile Internet may be separated from fixed line by the more limited range of applications it supports (for now). A key question when examining the horizontal market divisions is product bundling and technological change. In terms of product bundling, most voice services offer the more advanced features as part of the service. Are these additional products or are they part of a basic voice service as most companies provide them? In terms of technological change, it needs to be recognised that product boundaries will continually change and so need to be reassessed periodically Features of Networks The pricing and competitive behaviour amongst network providers is influenced by a number of factors peculiar to network industries. First, the value of a network is related to the number of customers connected to that network. Therefore, it is in the interests of all competitors to interconnect with each other to gain access to as broad a customer base as possible in order to enhance the value of their respective networks. The ability to interconnect also means that firms can compete with other network providers on one part of their network without having to duplicate the entire network for instance, firms may compete on long distance telephony by building their own long distance infrastructure and interconnecting to a local network to reach the final customers. For service providers interconnection is key. Although the regulation stipulates that interconnection must occur, it is the terms of this interconnection that determine the pricing and competitiveness of alternative infrastructures. 10

15 1.2 Forms of international trade According to the WTO negotiating rules, trade in telecommunications services can occur through four possible modes of supply cross-border supply, consumption abroad, commercial presence and the presence of natural persons. These will be discussed in the context of network infrastructure and services Provision of network infrastructure Until recently, the most common form of trade between countries has been through cross-border supply of international network services. Trade occurs through the interconnection of networks in order to complete or route an international call. Included in this trade is the third-party routing of calls (e.g. Zimbabwe may route international calls via South Africa). Imports are considered to be outgoing calls that the network provider in the other country charges to be completed. Incoming calls or ones third-party routed by a country s network are considered exports. Cross-border supply is dominated by, but not limited to, interconnection charges for data, voice or video. The extent to which trade offers competition depends on whether the infrastructure of another country is able to service the South African market. This is likely with international services as satellites have broad footprints over whole regions and fibre optic networks often loop past many countries. It is possible for satellite communications to bypass all domestic infrastructure by passing signal distribution through a earth gateway station located in another country. With the growing liberalisation of communications services internationally, an increasingly important form of trade has become commercial presence. In order to provide communications services to consumers in a country beyond completing their international calls to another country, network and service providers need to have a physical presence in that country. All networks, with the exclusion of satellite, require investments in terrestrial transmission equipment and either physical lines or radio frequency. Even for satellite communication one still requires an earth station to link to the satellite, and authority for use of radio spectrum. Due to the growing importance of commercial presence as a means of service trade, the presence of natural persons also becomes important on the level of intracorporate transferees only. The high demands for human capital in production mean that companies entering a market may require to bring in their own technical expertise in order to build and maintain their network or service. However, there are no trade demands beyond inter-corporate transferees Provision of services The interconnection of networks globally means that many data and video services can be provided from another country in a cross-border fashion. It is common to find , e-commerce and web-hosting services for South Africans being supplied from servers in the USA. There is no doubt that domestic e-tailers compete with foreign ones. In terms of voice products, there is competition between service providers to route international calls through their networks. In particular, calling cards and call-back services are a means to capture consumption abroad. When a traveller makes use of a national calling card when making an international call, the call is routed through the network back home and in this way provides revenue and imports. Many 11

16 callback services have sprung up in countries like the USA whereby a customer from South Africa places a call as if they were in the USA through the callback operator calling them and connecting them to the number they wanted to call. Finally, in mobile telephony one can arrange international roaming agreements for mobile phone users to capture their consumption. Any calls that they make abroad will be routed back through the domestic network, allowing the domestic mobile network provider to capture some of the charges on that call. However, for basic voice products in the local access market, the competition must come from domestically situated firms. As such, provisions around foreign ownership limits will serve to restrict competition. 1.3 Role in the economy Communications services play a key role in any economy from being an important intermediate input to business, an enabling medium for a range of content providers, a significant item in household expenditure, and finally a source of demand for numerous manufacturing and service industries. What follows is a discussion of the role in the broader economy of communications services as a package of both network and service providers. This component is severely limited by the statistical data. This is particularly problematic in a dynamic industry as dated statistics tend to be widely off the mark. With telecommunications statistics, it is likely that dated statistics will underestimate the role of the sector in the economy Role as Intermediate Input The role of communications as an intermediate to business can be seen to have 2 dimensions a) as a cost item required to operate a business, b) as a strategic and competitive tool. As a cost item, communications does not appear that significant for most parts of the South African economy judging from the statistics in table 1.3 below. It represents only 0.1% of total costs in agriculture and mining, 0.4% in manufacturing industries and 4.4% in service industries. However, these figures definitely underestimate the cost importance of communications for two important reasons. First, the data network costs are accounted for under the section titled business services, along with other business service items. Second, the latest input-output data available for South Africa is 1997, which was based on the 1993 table which was based on the 1988 table. In each case, a new input-output table is created by adjusting the old one with new national accounts data. As a strategic competitive tool, communications are becoming more and more vital to businesses globally. Increased globalisation has resulted in the requirement to communicate and transmit vast amounts of data to suppliers, industry customers and affiliates internationally on a timely basis. The rise of electronic commerce, has now established a need in many industries to use communications networks to deal with the final demand of the household consumer too. In both cases, the need is for high speed, high quality communications services that are geared to the specific needs of the firm and which are available at a cost that does not make it prohibitive to communicate or put them at a competitive disadvantage to firms in other countries. What matters most for an economy is the availability of world-class communication services at a reasonably competitive price, even if they are not the cheapest. 12

17 Table 1.3: Direct forward linkages - Telecommnuications share of intermediate input costs for sectors of the economy (1997) percentage of total intermediate input costs Sector % of intermediate costs Primary 0.2 Manufacturing 0.4 Natural resource intensive 0.3 Labour intensive 0.5 Scale intensive 0.3 Knowledge intensive 0.6 Other 0.7 Services 4.4 Producer services 7.2 Consumer services 3.4 Infrastructural services 0.7 Community/social services 11.8 Source: Wefa SAM (1997) Demand for Intermediate Inputs Growth of the communications industry has some important trickle-down effects for certain parts of the economy and results in output and employment creation in these sectors. There are two sources of such demand investment demand and ongoing operations demand. Investment demand includes capital goods required by the industry to increase its size of operations. Table 1.4 shows the capital structure of the fixed line provider Telkom and an Internet service provider M-Web. For the network provider, it is clear that high tech capital goods (telecoms network equipment and data processing equipment) dominate the inputs (82%) resulting in few trickle-down effects for most developing countries that don t have these industries. The service provider has a similar structure of assets with most in network, computing and software equipment. Table 1.4: Structure of capital requirements for a fixed line network provider and an Internet service provider (2000) Item Network Provider Internet Provider (M Web) Telecoms network equipment Data processing equipment Software and licences Other equipment, vehicles, furniture Land & buildings Working Capital Total Source: Telkom Annual Report 2000, M-Web Annual Report 2000 However, there are larger multipliers for ongoing operations. Table 1.5 below presents the first-round direct and indirect output multiplier effects of a R1 increase in network provision 1. The multiplier effects are negligible for the primary sectors but 1 Data limitations prevent putting together a multiplier analysis for service providers. 13

18 significant for the manufacturing sectors - metal products and equipment (transmission and receiving devices); chemicals, rubber and plastic products (plastic casings for equipment); paper and printing (marketing and office materials). The largest gains are in other service industries, in particular, other communication or business service providers, distribution, transport and utilities. A second round of output and employment creation can be expected stemming from additions to wage and capital income created by the first-round effects. These figures are not high compared to agriculture or manufacturing. Part of the reason for this is a low participation of SA industry in communications equipment, with much derived demand going to imports from other countries. This may change with time and raise the average multiplier effect. Table 1.5: Direct backward linkages intermediate inputs into the communications industry (1997) percentage of total intermediate input costs Sector % of intermediate input costs Primary products 0.0 Manufacturing 20.0 Natural resource intensive 0.6 Labour intensive 2.6 Scale intensive 4.5 Knowledge intensive 12.1 Other 0.2 Services 80.0 Producer services 44.3 Consumer services 20.2 Infrastructural services 13.9 Community/social services Total intermediates/total input costs Source: Wefa SAM (1997) Medium for Content Providers What the analysis of communication services as an intermediate input or as a source of derived demand fails to convey, is that entire industries are based around the existence of communications services and would not exist otherwise - these are the content providers. Too often we view the communication services as a demand derived from growth in other industries or in household income. What we fail to appreciate is that innovation, cost reduction, quality improvement and independent expansion of communication services enable the growth and expansion of a large content industry that is transmitted over the communications infrastructure. This process is one where the communications industry itself creates demand through innovation and investment. The links to these content industries cannot be portrayed usefully by an input-output table. The content providers could most easily be classified according to voice, data and image/video content. Voice would include those companies producing content for radio broadcast - from music to programming. Video/image would be those producing 14

19 for television or education broadcast - from advertising to dramas. Finally, data content would be associated with those firms providing content for the Internet or private data networks - from online news corporations to electronic commerce. In all these industries, expansion of the network and lowering the costs of transmission expand the number of people connected to the network and therefore expand the market for content. Enhancing the speed and quality of the networks open up the opportunities for new content products to be introduced which also expands the market for content. An important question remains - how big are the multiplier effects on content providers stemming from improvements to the network and its expansion Household Expenditure Item Finally, communications enter the household consumption function. Communications does not represent one of the main items that households spend their income on, but at 2.4% of household income, it is still a significant item. In fact, as figure 1.2 shows, households on average spend more on communications than on investments/ savings, education, house operations, pensions and fuel/power. The size of expenditure is also sufficiently large that price movements in the sector will influence both the welfare of consumers and the price level the consumer price index. In fact, the 1995 survey probably underestimates the expenditure item as it would exclude the rise in cellular telephony and the Internet (both significant expenditure items). Figure 1.2: Household expenditure patterns (1995) 15

20 food housing income tax transport cloth/foot furniture/equip health insurance read/recr/hols drink/cigs personal care communications invest/savings education house operation pensions domestic workers fuel/power other Percentage of Expenditure Source: Statistics South Africa, Income and Expenditure Survey,

21 2. International Reform of Telecommunications Regulation 2.1 The Rationale for Regulation Regulation is the intervention of a government body in a market, through the use of price, access or product controls. Price controls occur in telecommunications, where Telkom has to get its tariffs approved by the South African regulator, ICASA. The same goes for access controls, as ICASA has the right to issue licenses for the different types of telecomm markets, as it has in Telkom for the fixed line market and MTN and Vodacom for the mobile phone market. There are two basic types of theories about regulation we can differentiate: normative theories outlining the response to market failures and positive theories describing the dynamics between policy makers and recipients of regulation Normative Theory of Regulation The normative theory postulates that regulation ought to be introduced when there is market failure. How market failure is identified and how it arises are the questions that remain to be answered. As to the identification of market failure, we identify four types of efficiency that have to be fulfilled to guarantee an efficient outcome: Allocative efficiency: occurs when goods are priced at marginal cost, hence sold at the true economic cost to the producer, without any rents that may have been derived from the market structure. Cost efficiency: when a firm or industry produces at the lowest possible cost level. In some industries, it may be possible that many competitors lead to allocative efficiency, but that the lack of scale effects means production is not cost efficient. Dynamic efficiency: when cost savings are implemented efficiently and there is no delay in the development and introduction of new products. Distributional efficiency: finding the socially desired trade-off between the maximisation of surplus and the distribution thereof. Having identified the different types of efficiency, the ways in which market failure arises have to be identified. Here, we identify three basic types: Externalities: any transaction has a cost and a benefit to it. These costs and benefits may well differ for the individual and the society. A car driver, for example, will not take into account her effects on pollution when planning a trip. When the social costs exceed the private costs, or the private benefits exceed the social benefits, the level of activity is too high. When social benefits exceed private benefits, allocation will be lower than desired. An example for the first would be car usage, an example for the second investment by firms who do not take into account the beneficial spill-overs for other companies. Taxes, in the case of over allocation, and subsidies in the case of under allocation may be used to rectify the situation. 17

22 Natural Monopoly: occurs when it is more expensive to have several companies providing the same product than it is to only have one. Public utilities, such as water and electricity and most other network industries are classic examples of natural monopoly. Single product monopolists will derive their advantage from economies of scale, whereas multi-product natural monopolies may also derive their advantages from economies of scope 2. Large specific investments and hold-up problems: when private activity invests large amounts in assets that may only be used for one purpose, there is a potential for the extraction of rents from a contract partner. If a pipeline company invests in a pipeline from an oil field to a refinery, this asset is only good for transportation between these two points. Once it is built, the investment is sunk. The oil field operators might be able to extract the sunk cost from the pipeline builders should they have other possibilities for the transportation of their oil. Private contracting may be costly in this case and regulation the preferred tool. Regulation must hence be used in sectors where competition is not sustainable due to one of the three reasons mentioned above. The success of regulation is to be measured by the efficiency criteria outlined Positive Theories for Regulation Regulation does not only exist to correct market failures. This is apparent from the fact that regulation continues to exist in sectors with no natural monopoly features. Regulation also exists because it is a powerful means to redistribute wealth in society. Regulation can be used to tax one group of consumers and redistribute to another without imposing a more transparent tax-subsidy approach (Posner 1971). Classic examples in telecommunications are cross subsidisation from long distance to local calls, from urban areas to rural areas and from business users to domestic users. An alternative to government using regulation for social welfare-improving redistribution, is for specific interest groups to capture the regulatory process through lobbying government. Stigler (1971) observed that companies demand regulation in an attempt to earn abnormal profits at the expense of consumers. Politicians are prone to interest group pressure since single voters are unable to monitor and coerce the policy maker. The successful pressure group in the regulatory game need not be companies only, but whoever it is they should have low costs of organisation and high potential payoffs relative to the competing interest groups. A good example for this is the success of EU farmers in extracting rents from the rest of the population, whereas consumers with a lower per-head payoff and a much larger membership find it difficult to extract benefits from policy makers. The same forces that drive politicians to regulate sectors, may also drive them to deregulate. If interest groups that are being adversely affected by regulation organise more effectively (or if the cost of the regulation to them increases enough to make them organise) then they may be able to reduce the level of regulation. In telecommunications, the advent of the Internet has meant that an inefficient 2 When the cost of producing two products together is less than producing them separately 18