The Regulatory Balancing Act-Not so Difficult

I had written a post titled "Closing the Market Efficiency Gap-Regulation and Competition" wherein I has said that closing the Market Efficiency Gap demands putting in place sound laws and regulation modeled on international best practices but adapted to local context. This would ensures inter alia a level playing field which precludes vested interests from rent seeking behaviour that is detrimental to the economy as a whole.

In this post I has mentioned the likely mandating of a reduction in access charges for fixed line grid by the Italian firm Telecom Italia SpA by the Communications Regulator of Italy. This article also speaks about the general trend towards reduction in network access charges (both fixed line and mobile) across Europe as a result of conscious efforts of regulators to enhance penetration. It does mention that the Italian Regulator was under pressure from Telecom Italia's rivals.

It is now reported that the Italian Regulator's (Agcom) ruling has been put on hold by the European Commission on account of doubts as to whether the proper procedure of a separate market analysis of impact of cut was carried out. A quote from The European Commission er in charge of the digital agenda is enlightening and worth emulating by telecommunications' regulators:

"In departing from the approach announced last year for setting access prices in the Italian broadband markets, Agcom undermines the required regulatory certainty for all market players,” ...... “Regulation must aim at creating a level playing field for all operators.”

The lesson here is that a systematic and scientific approach to regulation can ensure that regulators meet the ultimate aim of consumer welfare and not fall prey to regulatory capture or political pressures.

A Discussion on Tariff Discounts for USF Supported Services

My esteemed colleague David Rogerson whose query had inspired my previous post on this subject titled "Ensuring Affordability of USF supported Services" has kindly shared his thoughts on the subject. My comments are a placed below his post.

Discount policy for Universal Access & Service Funds (UASF)

By David Rogerson

The objective of the UASF is to promote universal access and service (UAS).  It does this by subsidising network roll-out and customer access in situations where this cannot be achieved commercially.  The subsidy helps to extend the coverage of telecoms services and to make service affordable in these areas.  Such a policy not only benefits areas and customers that are newly connected to the network; it also benefits existing subscribers as they have increased opportunities to communicate with other network subscribers.  This is called a network externality effect. 

In some areas the benefits of USF subsidy, including both the direct benefits to the customers in the newly-connected area and the indirect network externality benefits experienced by all existing subscribers, will be maximised if a tariff discount is offered in the UAS area.  The reason is illustrated in Exhibit 1

Exhibit 1: Justification for tariff discount in UAS areas

The logic of Exhibit 1 may be described as follows:

• The tariff discount will increase demand in the UAS area, as lower prices are more affordable
• The increase in demand will (at least up to a certain point) increase profitability within the UAS area, since the costs of providing service are largely fixed whereas revenues are primarily a function of demand.  
• By setting the discount at the right level the amount of the subsidy required for the area may be minimised.  The level of the discount should theoretically be set at the level that maximises profits: beyond a certain point the loss of revenue from all subscribers in the UAS area paying the lower tariff will outweigh the increase in revenue from the additional subscribers who only come onto the network because of the discount.
• The increase in demand that results from the discount will have two other effects:
• It will increase the network externality benefits
• It will result in economic development within the UAS area . (Academic studies, including those of the World Bank, have shown a close correlation between GDP per head of population and telecom network penetration (i.e. subscribers per head of population).   
• Both of these additional effects are relevant in the construction of a discount policy:
• The increase in network externality benefits may be used to justify the discount policy in the first place
• The increase in economic development may be used to justify the reduction of the required discount level over time.  

A lot more work would be required in order to provide a detailed justification of the actual level of discount that should be provided.  Such work is beyond the scope of the present exercise.  However, based on the existing practice we may propose the taxonomy shown in Exhibit 2.  This suggests that the initial level of discount is established with reference to the ratio between average income levels in the UAS area compared with the nation as a whole; and the evolution of the discount level over time depends on the ratio between network penetration levels in the UAS areas compared with the nation as a whole.  Given that there is likely to be a time-lag between penetration increases and economic development, we further suggest that the discount level for each area is established for a period of 3-5 years at a time.

Exhibit 2: Evolution of UAS tariff discounts over time

My Comments:

David has presented  an interesting  and though-provoking analysis. Some additional considerations may be  as follows:

1. The assumption of incremental or marginal cost per additional subscriber being nominal (per se or compared to the loss of revenue on account of discounts) may not be applicable to all telecommunications services-take for example the case where the last mile involves copper line or OFC connectivity. 

2. Additional customers need not always translate into higher revenues as for example when customers in poor rural areas use the phone mainly to receive rather than make calls. A real example of this was seen in India where CDMA telephones were offered  by USPs with 3 year incoming free prepaid tariff plans (on voluntary basis) to lure more customers.(Additional upfront subsidy was paid for each additional customer added and  maintenance subsidy for customer  retention.) However, the USPs ended up having to pay for minimal recharges to avoid disconnection of these phones, which would have impacted the their subsidy disbursements under the USOF contract. The poor in rural areas would simply not make outgoing calls. They were happy to receive calls as for example from earning family members in urban areas.

3. However, there is no denying the network effect and positive externalities of  having hitherto unconnected citizens join the network. Hence, USF schemes must at times go beyond purely economic cost-benefit analysis at least in the short run and justification for the roll out or discounted tariff may have to encompass a wider socio-economic cost-benefit analysis. In any case, telecommunications services are proven to increase a nation’s competitiveness in the long run making a strong economic case for USF interventions.

4. In some cases as in the case of USOF’s Wire line Broadband scheme (discussed at  http://ictsforall.blogspot.in/search/label/Tariff   the discount strategy pays off in terms of giving customers a taste of a new service. While some subscribers may continue with an entry level plan, others do migrate to the available higher download (more costly) plans, giving the USPs revenues a boost and compensating for the discount and then eventual  withdrawal of subsidy.

5. The smart subsidy concept referred to in my earlier post at  http://ictsforall.blogspot.in/search/label/Tariff,   would thus take into account subsidy needed to fill the revenue gap, including that caused by discounted tariff.

6. If demand projections can be made with some degree of accuracy for the target area/population, an assumption about percentage of disposal income that would be spent on telecommunications (say 2.5-3%) could help us calculate the required discounted tariff to encourage subscription. As a USF Administrator, I would  be more concerned about using the modeled demand projections to calculate a tapering subsidy requirement keeping discounts fixed during the OBA contract period and leaving it to the USP to retain or dismantle discounts thereafter as per its business case. There could be customers who would not be able to afford the non-discounted tariff at least in the short/medium run. Thus, I may have to mandate that some discounted tariff plans continue beyond the contract period or I may have to subsidise these customers on an on-going basis even after the Output Based Aid contract comes to an end.