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ITU Workshops onITU Workshops onSustainability in TelecommunicationSustainability in TelecommunicationThrough Gender & Social EqualityThrough Gender & Social Equality

Presentation #1:Presentation #1:

Overview of Price RegulationOverview of Price Regulation

OutlineOutline DefinitionsDefinitions What is price regulation?What is price regulation? Why is price regulation necessary?Why is price regulation necessary? Objectives of price regulationObjectives of price regulation

Financing objectivesFinancing objectives Efficiency objectivesEfficiency objectives Equality ObjectivesEquality Objectives

Pricing objectives: Finding the right Pricing objectives: Finding the right balancebalance

Outline 2Outline 2 Four approaches to pricingFour approaches to pricing

Discretionary price settingDiscretionary price setting Rate of return regulationRate of return regulation Incentive regulationIncentive regulation Price cap regulationPrice cap regulation

Rate rebalancingRate rebalancing The international accounting rates The international accounting rates

systemsystem

DefinitionsDefinitions

Natural MonopolyNatural Monopoly: Exists when : Exists when the costs of production are such that the costs of production are such that it is less expensive for one operator it is less expensive for one operator to supply all of the market than for to supply all of the market than for several to service parts of the several to service parts of the marketmarket

A natural monopoly results from the A natural monopoly results from the presence of two factors: presence of two factors: economies economies of scaleof scale and and economies of scopeeconomies of scope

Definitions 2Definitions 2

Economies of ScaleEconomies of Scale: Exist when the total : Exist when the total cost of a firm decreases as production cost of a firm decreases as production increasesincreases

Economies of ScopeEconomies of Scope: Exist when a : Exist when a quantity of each of two or more goods can be quantity of each of two or more goods can be produced by one operator for less than the produced by one operator for less than the cost of each good produced separately by cost of each good produced separately by different operatorsdifferent operators

ExternalitiesExternalities: Spill-over benefits/negative : Spill-over benefits/negative effects to one market from another & vice effects to one market from another & vice versaversa

Definitions 3Definitions 3

Characteristics of Competitive Characteristics of Competitive MarketsMarkets:: Several suppliers and consumers;Several suppliers and consumers; No dominant player in the marketplace No dominant player in the marketplace

so large it can affect prices;so large it can affect prices; No significant externalitiesNo significant externalities Free entry to and exit from the market;Free entry to and exit from the market; Absence of economies of scaleAbsence of economies of scale or or

economies of scope.economies of scope.

Definitions 4Definitions 4 Rate Rebalancing:Rate Rebalancing: Also ‘price Also ‘price

rebalancing’; moving prices for different rebalancing’; moving prices for different telecom services more in line with costs telecom services more in line with costs of provisionof provision

Price CapPrice Cap: : A rules-based form of price A rules-based form of price regulation that uses a formula to regulation that uses a formula to determine the maximum allowable price determine the maximum allowable price increases for a regulated operator’s increases for a regulated operator’s services for a specified year or number services for a specified year or number of years. of years.

Definitions 5Definitions 5

Accounting Rates: Accounting Rates: The charges The charges payable to interconnecting payable to interconnecting international operators under international operators under traditional settlement arrangements traditional settlement arrangements for mutual termination of traffic for mutual termination of traffic between their networks.between their networks.

What is Price What is Price Regulation?Regulation?

What it isWhat it is: Regulatory intervention : Regulatory intervention aimed at ensuring competitive prices aimed at ensuring competitive prices in telecommunication’s marketsin telecommunication’s markets

Effective price regulation replicates Effective price regulation replicates the effects of efficient competitionthe effects of efficient competition

Pricing affects several issues in Pricing affects several issues in telecom markets, particularly those telecom markets, particularly those related to access, interconnection, related to access, interconnection, competition policycompetition policy

Why is Price Regulation Why is Price Regulation Necessary?Necessary?

Competitive markets are difficult to create Competitive markets are difficult to create in the telecom sector due to the cost in the telecom sector due to the cost characteristics or ‘market failures’ inherent characteristics or ‘market failures’ inherent in telecom networks, which tend toward in telecom networks, which tend toward natural monopoly with economies of scale:natural monopoly with economies of scale: Fixed costsFixed costs: do not vary by volume of production: do not vary by volume of production A specific type of fixed cost is A specific type of fixed cost is sunk costssunk costs: costs that : costs that

cannot be changed or avoided even by ceasing cannot be changed or avoided even by ceasing production entirelyproduction entirely

Government intervention is justified to Government intervention is justified to correct market failures and improve social correct market failures and improve social welfarewelfare

Objectives ofObjectives ofPrice RegulationPrice Regulation

Financing ObjectivesFinancing Objectives Ensure a regulated operator earns enough Ensure a regulated operator earns enough

revenue to finance on-going operations as revenue to finance on-going operations as well as future investmentswell as future investments The smallest amount of revenue that meets the The smallest amount of revenue that meets the

financial objective is called the revenue financial objective is called the revenue requirementrequirement

Some forms of price regulation (Rate of Some forms of price regulation (Rate of Return regulation) prohibit operators from Return regulation) prohibit operators from earning in excess of their revenue earning in excess of their revenue requirementsrequirements Prevents excessive revenues linked to Prevents excessive revenues linked to

monopoly or dominant market behaviourmonopoly or dominant market behaviour

Efficiency ObjectivesEfficiency Objectives Price regulation must promote efficiency in Price regulation must promote efficiency in

the supply of telecommunication’s servicesthe supply of telecommunication’s services Efficiency may be measured in various ways:Efficiency may be measured in various ways:

Allocative EfficiencyAllocative Efficiency: : Achieved Achieved whenwhen the the prices of services reflect their relative scarcityprices of services reflect their relative scarcity..

Productive EfficiencyProductive Efficiency: (1) : (1) the most efficient the most efficient mix of inputs (capital, labour) for a given level of mix of inputs (capital, labour) for a given level of outputoutput; (2) ; (2) efficient production by minimizing all efficient production by minimizing all inputsinputs

Dynamic EfficiencyDynamic Efficiency: : Achieved when resources Achieved when resources move over time to their highest value usesmove over time to their highest value uses

Equality ObjectivesEquality Objectives The motivation for many regulatory The motivation for many regulatory

decisions on pricing policydecisions on pricing policy Concerned with the fair distribution Concerned with the fair distribution

of welfare benefits among members of welfare benefits among members of societyof society

Telecom regulators concerned with Telecom regulators concerned with two aspects of price equality:two aspects of price equality: Operator-consumer equalityOperator-consumer equality, and, and Consumer-consumer equalityConsumer-consumer equality

Equality Objectives 2Equality Objectives 2 Operator-consumer equalityOperator-consumer equality: The relative : The relative

distribution of benefits between customers distribution of benefits between customers and the regulated operator such that savings and the regulated operator such that savings from improved technological innovations are from improved technological innovations are shared equitably between the operator and shared equitably between the operator and consumersconsumers

Consumer-consumer equality:Consumer-consumer equality: The The distribution of benefits between different distribution of benefits between different classes of telecom consumers, i.e., between classes of telecom consumers, i.e., between businesses and residential customers or businesses and residential customers or between the wealthy and the poorbetween the wealthy and the poor

Finding the Right Finding the Right BalanceBalance

The main challenges of price regulation involve The main challenges of price regulation involve the design and implementation of low-cost and the design and implementation of low-cost and effective regulatory approaches that induce the effective regulatory approaches that induce the regulated operator to achieve the socially regulated operator to achieve the socially desirable objectives discussed above. … In desirable objectives discussed above. … In practice, there is often disagreement over practice, there is often disagreement over telecommunications price regulation because telecommunications price regulation because the three broad regulatory objectives … can the three broad regulatory objectives … can conflict with one another. … the regulator will conflict with one another. … the regulator will often have to make trade-offs between these often have to make trade-offs between these objectives in the course of implementing price objectives in the course of implementing price regulation.regulation. Intven 2000, 4-2.Intven 2000, 4-2.

4 Approaches to 4 Approaches to PricingPricing

Discretionary Price SettingDiscretionary Price Setting

An approach to price regulation An approach to price regulation characterized by below-cost prices for characterized by below-cost prices for connection, subscription and local callsconnection, subscription and local calls

Shortfalls are made up by higher-than-Shortfalls are made up by higher-than-cost international call prices and cost international call prices and sometimes also high long-distance sometimes also high long-distance pricesprices

The usual goal of this type of pricing is The usual goal of this type of pricing is affordable basic telephone servicesaffordable basic telephone services

Rate of Return Rate of Return RegulationRegulation

A rules-based form of price regulation A rules-based form of price regulation designed to balance an operator’s total designed to balance an operator’s total revenues against its total costsrevenues against its total costs

Provides an operator some certainty of Provides an operator some certainty of meeting its revenue requirement on an meeting its revenue requirement on an ongoing basisongoing basis

ROR regulation does not support the ROR regulation does not support the efficiency objectives of price regulation efficiency objectives of price regulation as effectively as other forms of price as effectively as other forms of price regulationregulation

Incentive RegulationIncentive Regulation

A regulatory approach that provides A regulatory approach that provides incentives and penalties to encourage an incentives and penalties to encourage an operator to meet regulatory goalsoperator to meet regulatory goals Operator often helps to set performance Operator often helps to set performance

targetstargets Regulator usually does not prescribe specific Regulator usually does not prescribe specific

management actionsmanagement actions Regulator restricts some activities of the Regulator restricts some activities of the

operatoroperator Types include Types include earnings sharing regulationearnings sharing regulation

Price Cap RegulationPrice Cap Regulation Preferred rules-based price regulation Preferred rules-based price regulation

todaytoday

Uses a formula to compute the highest Uses a formula to compute the highest allowable price increases for an allowable price increases for an operator’s services over a number of operator’s services over a number of yearsyears

Intended to offer incentives that mimic Intended to offer incentives that mimic competitive market forcescompetitive market forces

Rate RebalancingRate Rebalancing Telecom price structures in many Telecom price structures in many

countries are extremely unbalancedcountries are extremely unbalanced Some services (long distance & international Some services (long distance & international

calling) priced well above costscalling) priced well above costs Some services (like telephone connections, Some services (like telephone connections,

monthly subscriptions, local calls) priced monthly subscriptions, local calls) priced well below costswell below costs

Deficits subsidized by higher-than-cost servicesDeficits subsidized by higher-than-cost services In monopoly or noncompetitive markets, In monopoly or noncompetitive markets,

the regulator may be required to aligned the regulator may be required to aligned prices more closely with costsprices more closely with costs

International Accounting International Accounting RatesRates

Technological developments, telecom Technological developments, telecom sector liberalisation adversely affected sector liberalisation adversely affected accounting ratesaccounting rates

Charges grew to well above costs of Charges grew to well above costs of providing international service providing international service terminationtermination

Profits from high accounting rates Profits from high accounting rates provided major source of cross-provided major source of cross-subsidies to developing countriessubsidies to developing countries But led to major imbalances in accounting But led to major imbalances in accounting

rates’ payment from countries originating rates’ payment from countries originating more calls than they terminatedmore calls than they terminated