|Latin America I 1999
|Competition and Regulation in the UK Mobile Market
|Meirion James Board
The end of British Telecom’s monopoly involved the setting up of Oftel as a regulatory body focused on the regulation of the incumbent monopoly business. Oftel has since assumed a role akin to that of a competition authority now that competition in telecommunications services has set in. This article looks at how regulation and competition in the market for mobile telecoms in the UK have developed, and which of these positive experiences can be applied to Latin America.
In a competitive market, companies charge prices which better reflect costs. In the absence of competition, a monopolist can boost profits to levels above those required for the company to survive by raising prices above costs and will have no incentive to reduce the costs of production. The level of competition and market contestability are important considerations since companies with market power in a dominant position may still employ anti-competitive practices to maintain a profitable position. In its pursuit of seeking ‘the best deal for the customer in terms of quality, choice and value for money’, Oftel has imposed constraints on companies who continue to possess market power. In the mobile market this has principally been achieved through the dual mechanisms of licence condition enforcement and amendment, the former being a statutory duty of the Director General of Telecommunications (DGT). Tied Service Providers (TSPs) In 1985, shortly after the privatisation of British Telecom (BT), Vodafone and Telecom Securicor Cellular Radio (Cellnet) launched their cellular telephone networks. At the time it was the Government who decided that mobile airtime should be retailed by separate ‘service providers’ rather than the network operators. The purpose of this was to encourage the emergence of competing service providers which were independent of the network operating companies. Vodafone and Cellnet were therefore prohibited from entering into service contracts directly with the public, and were obliged instead to sell wholesale airtime on request to service providers. However, neither of the network operators were prevented from entering the service provision business, provided that these businesses operated as separate entities. The service provision businesses which are owned by the cellular telephone networks or their parent groups are known as Tied Service Providers (TSPs). In order to promote competition in the mobile market from the outset, the network operator licences incorporated five other pertinent provisions in addition to the prohibition on direct selling, and the requirement to sell wholesale airtime to service providers: · The Director General was empowered to deal with the unfair cross-subsidisation of TSPs from network operators. · The licence prohibited undue preference and undue discrimination. Network operators were also obliged to connect the customers of service providers, and to publish charges, terms and conditions which they are not to depart from. · The licence required the accounting separation of all distinct commercial licensee businesses, including the direct retailing of mobile airtime to end users through TSPs. This regulatory framework remained in place until new mobile network licences were awarded to Mercury One-2-One (One2One) and Orange Personal Communications (Orange) in 1991. Unlike Cellnet and Vodafone however, Mercury One-2-One and Orange were not prohibited by their licence conditions from retailing airtime directly to customers, but were obliged to sell wholesale airtime on request to service providers. However, in December 1993 and March 1994, when Vodafone and Cellnet respectively were awarded new licences, they were also permitted (under new licence conditions) to retail airtime directly to the public. Response to Anti-Competitive Behaviour In 1992 Talkland International, an independent service provider, supported later by several others, alleged that the incumbent mobile network operators were cross-subsidising TSPs unfairly. This argument suggested that, while a network operator might not be supplying wholesale airtime to a service provision company within its group preferentially, the parent group could tolerate losses or abnormally low profits from its service provision business funded by profit from the sale of wholesale airtime. If the gap between wholesale and retail prices is insufficient for a normal rate of return to be earned, then this could be construed as evidence of anti-competitive behaviour. The response of the Director General in 1994 was to introduce a new pro-competitive regulatory device in an attempt to monitor the behaviour of the established operators. Cellnet and Vodafone were thus required to submit quarterly returns to demonstrate compliance with a formula devised by Oftel to gauge the performance of TSPs in terms of achieving a minimum rate of return on subscriptions. The failure of a TSP to achieve a specified minimum rate of return could then be treated as evidence of cross-subsidisation, whereby the margins of independent service providers are unfairly squeezed. The ‘Oftel formula’ requires the two established network operators to specify the average cost of acquiring a new subscription and the average monthly profit from each subscription, for each TSP. The outcome of a consultation exercise in 1997 was that Oftel set the average subscription life at 27 months (formerly 35 months) and the required rate of return at 1.5% per month (formerly 2%). Oftel considered that a TSP might be in receipt of cross-subsidy if it consistently reports acquisition costs and revenues which require longer than the assumed 27 months to obtain a rate of return of 1.5% per month. Prior to the change in the Oftel formula in 1997, Cellnet service providers and BT Mobile managed to achieve the required 2% per month rate of return over 35 months, while Vodacall and Vodac (two of Vodafone’s service providers) consistently failed to do so. Since Oftel reduced the required rate of return and shortened the estimated life of the average subscription, both Cellnet and Vodafone have consistently failed to meet the specified standards. The Director General is at present consulting on the integrity of the evidence against the established operators, and on which of two alternative enforcement measures would be the most effective in securing fair prices for independent service providers. In addition to anti-competitive behaviour, the development of competition in the mobile market is affected by the physical constraint of limited electromagnetic spectrum availability. The current lack of spectrum availability limits the number of mobile network operator licence holders to four, acting as a barrier to entry from new operators. Auction of Licenses The UK Government recently announced its intention to promote further competition in the mobile market by holding an auction of licences for a ‘third generation’ of mobile networks. The new networks will enable users to browse the internet, use e-mail, download music and pictures and hold video-conferences on the move. Although the new networks are unlikely to become operational before 2002, the government is minded to ensure that the customers of new entrants can use these networks until the new networks are set up. The extent of entry, however, will depend in part on the size of the cost of building a new network, given that much of the initial set up costs will be sunk. The extent of parity of geographical coverage by the four network operators also exerts an influence on competition in the market. Figure 1 shows that One2One and Orange are now able to offer about the same population coverage as the two incumbents (with the exception that One2One do not offer coverage in Northern Ireland). Finally, as a result of licence modification, customers have been able to switch between the four networks since the beginning of 1999 without the difficulty of changing their mobile phone number. The removal of this barrier is another important step in the efforts to bring in effective competition between the four networks as customers’ ability to migrate between the networks is improved. However, customers who decide to switch networks may still be faced with the costs of a new phone and/or the cost of the early termination of a contract. But the trend towards pre-pay tariffs which do not involve a contract may reduce the disincentive to switch, unless the high initial cost of a handset acts as a deterrent. Benefiting from Competition The aforementioned description of how competition has evolved in the UK mobile market in the context of regulation leads to the question of the extent to which customers have benefited. .Reduction in Price The most notable way in which customers have benefited is from reductions in prices. The price of a minimum cost mobile package averaged across five categories of users (high business, average business, light business, high residential and light residential) fell every year between 1990 and 1998. Overall, this period saw prices fall by 68% after allowing for inflation. Interestingly, the largest annual price reductions occurred when One2One and Orange were awarded their licences in 1992 (19.2%), when the new entrants entered into service in 1993/94 (32.9%), and in 1997/98 when competition between the four operators intensified (18.2%). This is clear evidence that both residential and business mobile users have benefited from price competition, which has been stimulated by the entry of Orange and One2One into the market. Expanded Customer Choice The introduction of additional mobile services, for example innovative tariff packages such as pre-payment, has expanded customer choice in service provision. Orange’s provision of a per-second billing service is a good example of innovation by a new entrant, which has been adopted by the other participants. Competition and innovation of this kind have been facilitated in a market which is dependent on technological development, and where new technology develops quickly. ‘Gaming’ In summary, the interaction of regulation and competition has evidently allowed customers to benefit from mobile telephony service provision in the UK. Through initiatives such as the introduction of number portability and the use of the ‘Oftel formula’, the regulator has contributed to developing more effective competition which encourages economic efficiency and drives down prices. Nevertheless, regulation and competition are not perfect substitutes. A degree of ‘gaming’ can occur in a regulatory regime which raises regulatory uncertainty and acts to deter efficient outcomes by firms. Oftel stated in a recent publication that ‘Rivalry promotes a search for previously unidentified efficiency gains, ensures they are passed on to customers and stimulates innovation and choice in the process of seeking competitive advantage’. Whilst the UK mobile market is characterised by a degree of rivalry, the two incumbent parties continue to possess market power. This is partly because of the existence of switching costs and lower coverage by new entrants, but also because of the barrier to entry caused by limited availability of spectrum. However, increasing parity of coverage and the introduction of number portability ceteris paribus are likely to increase competition in the future, and help to ensure lower prices for customers. Finally, the prospect of a ‘third generation’ of network licences and indirect access to mobile networks should further expand customer choice in the future, and preclude the need for price controls. Regulatory Intervention The development of the market for mobile telephony in the UK since the mid 1980s has highlighted some key regulatory issues. However, the usefulness of applying the UK experience to that of Latin America will inter alia depend on similarities in industry structure and culture, and the political approach to regulation. The UK experience suggests that competition ought to be encouraged both in network operation and service provision where possible. Where effective competition is not possible, a role exists for regulation in protecting customers from exploitation. The extent of such regulatory intervention should be proportional to the degree of market power held by any incumbent(s). The prices charged by a monopoly supplier of services for instance may require controls to prevent the monopolist from making excessive profits at the expense of consumers. Conclusion Any regulatory authority also needs to be aware of the potential for firms with market power to adopt anti-competitive or collusive practices. Lastly, the UK experience advocates an amenable and enforceable licensing framework to support regulatory decision making.