Competition Regulation in Telecom a Report

8/6/2019 Competition Regulation in Telecom a Report

1/65

Competition and Regulation in theTelecommunications Industry in

South Africa

Prepared for the Competition Commission by

James Hodge & Nicolas Theopold

School of Economics, University of Cape Town

March 2001


2/65

Competition and Regulation in Telecommunications

i

Table of Contents

INTRODUCTION................................................................... ............................................................. ................. 1

1. THE NATURE OF THE TELECOMMUNICATIONS INDUSTRY .......................................................... 2

1.1 THE TELECOMMUNICATIONS MARKET........................................................................................................... 21.1.1 Provision of Network Infrastructure..................................................................................................... 31.1.2 Provision of Services ............................................................ ................................................................ 91.1.3 Features of Networks.......................................................................................................................... 10

1.2 FORMS OF INTERNATIONAL TRADE.............................................................................................................. 111.2.1 Provision of network infrastructure.................................................................................................... 11

1.2.2 Provision of services........................................................................................................................... 11

1.3 ROLE IN THE ECONOMY ............................................................................................................................... 121.3.1 Role as Intermediate Input ................................................................................................................. 121.3.2 Demand for Intermediate Inputs......................................................................................................... 13

1.3.3 Medium for Content Providers ............................................................... ............................................ 141.3.4 Household Expenditure Item ........................................................... ................................................... 15

2. INTERNATIONAL REFORM OF TELECOMMUNICATIONS REGULATION................................. 17

2.1 THE RATIONALE FORREGULATION............................................................................................................. 172.1.1 Normative Theory of Regulation ........................................................................................................ 172.1.2 Positive Theories for Regulation ................................................................... ..................................... 18

2.2 DIFFERENT TYPES OF REGULATION ............................................................................................................ 192.2.1 Regulation under Perfect Information................................................................................................ 19

2.2.2 Regulation under Asymmetric Information......................................................................................... 192.3 INTERNATIONAL TRENDS IN TELECOMM REGULATION............................................................................... 20

2.3.1 The move to incentive Regulation....................................................................................................... 202.3.2 Liberalising Network Industries: a Three Stage Process ............................................................ ....... 21

2.4 CONVERGENCE IN TELECOMMUNICATIONS................................................................................................. 25

3. CURRENT REGULATORY FRAMEWORK............................... .............................................................. 26

3.1 BACKGROUND AND OBJECTIVES OF CURRENT REGULATION ...................................................................... 263.2 INDEPENDENT REGULATORY BODY SATRA TO ICASA ......................................................................... 273.3 FIXED LINENETWORKS............................................................................................................................... 29

3.3.1 Local Access ....................................................... ................................................................. ............... 293.3.2 Long-distance ................................................ ........................................................ ............................. 313.3.3 Value-added Network Services (VANS).............................................................................................. 31

3.3.4 Private Networks (voice) ........................................................... ......................................................... 323.4 MOBILE COMMUNICATIONS......................................................................................................................... 32

3.4.1 Cellular............................................................................................................................................... 323.4.2 Satellite............................................................................................................................................... 33

3.5 INTERCONNECTION, FACILITIES LEASING ANDNUMBERING ....................................................................... 33

3.6 PUBLIC INTEREST CONSIDERATIONS ........................................................................................................... 353.6.1 Universal Service................................................................................................................................ 353.6.2 Human Resource Development........................................................................................................... 35

4. MARKET STRUCTURE AND CONTESTABILITY ANALYSIS............................................................ 36

4.1 PROVISION OF CUSTOMERPREMISES EQUIPMENT (CPE) ......................................................... ................... 364.1.1 Relevant Markets ........................................................ .................................................................. ...... 364.1.2 Market Structure................................................................................................................................. 364.1.3 Contestability...................................................................................................................................... 37

4.2 FIXED LOCAL ACCESS................................................................................................................................. 374.2.1 Relevant Market.................................................................................................................................. 374.2.2 Market structure ......................................................... .................................................................. ...... 394.2.3 Contestability...................................................................................................................................... 39

4.3 LONG DISTANCE ......................................................................................................................................... 424.3.1 Relevant Market.................................................................................................................................. 42

4.3.2 Market structure ......................................................... .................................................................. ...... 42


3/65


4/65


iii

List of Tables

Table 1.1: A breakdown of the telecommunications market _________________________________________ 2Table 1.2: Cost characteristics of local access technologies for telecommunications _____________________ 6Table 1.3: Direct forward linkages - Telecommnuications share of intermediate input costs for sectors of the

economy (1997) percentage of total intermediate input costs _____________________________________ 13Table 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 ____________________________________________________ 14Table 2.1: State of European Deregulation (1998)_______________________________________________ 21Table 3.1: Rollout Targets for Telkom in terms of License_________________________________________ 30

List of Figures

Figure 1.1: A telecommunications network _____________________________________________________ 4Figure 1.2: Household expenditure patterns (1995)______________________________________________ 15

Figure 2.2: Path of Regulatory Intensity ______________________________________________________ 22Figure 3.1: Proposed path of deregulation_____________________________________________________ 31


5/65


1

Introduction

The telecommunications sector in South Africa has undergone a partial deregulationin 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 thesector in the WTO. Further, the Competition Commission recently received joint jurisdiction over a number of the publicly regulated sectors, includingtelecommunications.

The purpose of this paper is to review the industry and its deregulation from acompetition 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 andperformance in the industry

The paper consists of five parts. Part one examines the vertical structure of thetelecommunications industry and its changing nature. Part two looks at the rationalefor conduct regulation in the past and how this practice has evolved internationally.Part three describes the current regulatory practice in South Africa, including some ofthe public interest issues. Part four takes a hard competition analysis view of thedifferent vertical stages of production, drawing out market structure, potentialcompetitors, barriers to entry and the potential impact of entry. Part five then drawson the lessons of the other four chapters to put forward a position on the major

regulatory issues that need to be decided.


6/65


2

1. The Nature of the telecommunications industry

This first section explores the nature of the telecommunications industry as a startingpoint for competitive analysis. It begins by determining market separation both

vertically (supply chain) and horizontally. This discussion includes a look attechnological convergence and who are the current and future players in the market.It then explores the possible forms of trade in telecommunications and how thatmight impact the geographical scope of the market and contestability. Lastly, itexamines the role that telecommunications plays in the broader economy. This mayinform 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-onecommunications 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 adaptedto provide the other service. Given these economies of scope, it is often preferable toprovide both services.

For regulatory purposes it is important to understand the vertical stages of productionand possible horizontal market divisions in telecommunications. Table 1.1 providesthe commonly used breakdown for telecommunication, noting that the dynamicnature 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 divisionsProvision of Networkinfrastructure

Provision of switching andtransmissioninfrastructure

customer premisesequipment

fixed vs. mobile

PABX vs. phone

Local access Fixed vs. mobile

Business vs.residential

Voice/data vs.broadband video

National LongDistance

International LongDistance

Provision of services Provision of additionalinfrastructure andtechnical support tooperate service overinfrastructure

Line lease agreement

Content

value-addedinfrastructure

Technical serviceprovision

Customermanagement (billing& customer support)

basic voice vs. VANSvs. broadcast

Fixed vs. mobile

national long distancevs. international

Business vs.residential

Telecommunications production can roughly be divided into the provision of networkinfrastructure and the provision of services on that infrastructure. Typically a publicmonopoly 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 focuson the various stages of production and not what individual firms do. In this way it is


7/65


3

easier to identify essential facilities and anti-competitive behaviour stemming fromvertical integration. It is also easier to track where competition can feasibly survivewithout regulation.

1.1.1 Provision of Network Infrastructure

Network providers operate the infrastructure on which various telecommunicationservices are run. Networks are made up of switches and transmission. The switchesprovide the routing of voice, data, and video signals through the network. Thetransmission 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 & Tirole2000):

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 oncopper paired wire)

the increasing intelligence of the networks enabling them to improve theirefficiency 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 threedifferent stages of production. These are local access, long-distance andinternational. Figure 1.1 below demonstrates how these three componentsinterconnect to form a complete international telecommunications network. It looks ata mixed fixed line/mobile example. The local access network connects the customerpremises to the local switch through the local loop. From the local switch there is aninteroffice transmission facility to either other local switches or long-distance (nationalor international) points-of-presence. The long-distance networks then transmit thesignal to another long-distance point-of-presence where it is distributed to a localswitch and onto the other customer premises. What follows is a more detaileddiscussion of each component of the supply chain and the various technological

platforms used.


8/65


4

Figure 1.1: A telecommunications network

Customer premises

Customer premises

Local

SwitchLocal

Loop

Local

Switch

Long

distance

PoP

FIXED LINE

MOBILE

Customer handset

Customer handset

Base

Station

Base

Station

Local

Switch

Long

distance

PoP

Customer premises equipment (CPE)

The concern here is the retail supply of customer premises equipment and not themanufacture of the items. CPEs include fixed line telephones, mobile handsets, andPABXs (private exchange equipment for business use). Each of these can be

considered a separate market. In the heyday of public monopoly, the customerpremises equipment had to be supplied by the incumbent PSTN. This monopolyposition, on what is essentially a service with no natural monopoly features,represented an opportunity for abnormal profits to be made. Almost without fail thefirst 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 withdifferent cost structure and therefore different degrees of substitutability with thetraditional public switched telephone network (PSTN). The focus below will be onfixed 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 notedthat 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 tofurther unbundle the production process and find ways to inject competition. Forinstance, the SA White Paper on telecommunications suggests allowing communitygroups and SMMEs putting in local loops that then connect to the Telkom PSTN. In

the USA, Competitive Access Providers (CAPs) have emerged to connect largecustomers directly to the long distance networks points-of-presence (PoPs),


9/65


5

effectively bypassing the PSTN (these access lines are point-to-point and have noswitching 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, dataor image. However, increasingly networks are offering all three. This is feasiblebecause almost all networks now use a digital format.

In voice, the traditional PSTN consists mainly of copper or coaxial cable transmissionequipment at the local access level and switching equipment that allows two-waytransmission between two individual points on the network by establishing adedicated line between two points for the duration of a call. The transmissionmediums have low capacity or network speed (measured in bits per second) makingthem inadequate for video transmission and a slow but adequate medium for datatransmission. However, recent technological developments in data compression have

substantially increased the speeds available on these wires (in particular theasymmetrical digital subscriber line systems ADSL and other DSL technologies).Upgrading the networks to provide greater speed does require additional investmentsin the local access infrastructure. An alternative is the use of fibre optic, which has afar greater network capacity. Due to the higher cost of fibre optic, it is only costeffective with large businesses and not residential homes in the local accesscomponent of the network. It is used extensively in the long-distance andinternational networks. Either way, it is increasingly possible for PSTN networks to beupgraded to offer video services too. In fact, growing use of capacity for datatransmission (i.e. the Internet and intra-corporate transfers) make the investments infibre optic or ADSL increasingly worthwhile, offering the springboard to broadcasting.

Cable TV (CATV) networks (video networks) use a coaxial cable with broadcastquality network speeds as their transmission medium. Initially these networks wereonly focused on broadcast and so were established with one-way, one-to-manytransmission (tree-and-branch structure), disqualifying one-to-one communication.However, where cable operators have entered telephony, they have upgraded theirnetworks to handle two-way transmission. This has enabled the creation of the newpay-per-view television services, and also allowed them to actively enter the Internetproviders and telephony market.

Dedicated data networks may be private or public (Internet). Data can be run overany 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, thediscussion of data networks is largely a long-distance issue. However, largerbusinesses are increasingly being connected directly to these long-distance datanetworks making it worth a mention here. The switching equipment of data networksdoes not establish a dedicated line and instead routes packets of data on commonusage lines from one point to another through the path of least resistance. This isefficient for data but as line traffic congestion can delay packets, this has previouslybeen unsuitable for quality voice or image transmission. However, recentInternational Telecommunications Union (ITU) agreements on a common gatewayprotocol for passing multimedia from telephone networks to data networks shouldgreatly improve the quality in the near future (ITU 1999). This will see priority beinggiven to voice and image packets, avoiding the problem of congestion.


10/65


6

Table 1.2 examines the cost structure of different network types. As it reveals, thecost structure in fixed line networks (PSTN or cable) is geared towards sunk andfixed costs making it largely insensitive to traffic volumes. For this reason it is oftennoted that the marginal cost of making a phone call is negligible. In fact, the marginalcost/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 morerevenue than it costs to install the line, then the PSTN will install the line. The resultof this cost structure is that economies of scale and density are reasonably large andthere 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 aboveground does lower costs. These sunk costs are the reason that lower cost entrantsare companies with a local transmission network already in place e.g. cable TVcompanies or electricity companies. In these cases there are economies of scope asmany 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 otherservice that cable can enter once upgraded for telephony is data transmission.

Cave (1995) notes that in the comparison of costs between cable and PSTN, thefollowing 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 CATVoperator with an established local loop is a small fraction of the total cost faced bya 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 andis 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 thesame 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

High Medium* Low Low

Trafficsensitive/non-trafficsensitive

Low Medium* High High

Economies of scale Medium Medium Small Small

Economies ofdensity

Large Large Small Small

Economies of scope Possible Yes No Possible

Initial investmentrequired

Large Medium Small Small

Requires special

handset

No No No Yes

*Based on some economies of scope by offering video and telephony services


11/65


12/65


8

relative density of subscribers. Wireless is cheaper at lower densities due to the lowfixed costs, while fixed line is cheaper at higher densities. The cross-over point isestimated to be in the range of 200-800 subscribers per km2 from US and UK studies(Cave 1995). This makes mobile more expensive in urban and metropolitan areaswith 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 inmobile 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 earthstations, which in turn link to each other via one or more satellites. The greaterdistances the receiving equipment must transmit over, means they are larger andmore expensive than cellular. However, the use of satellites enables the network tominimise the number of earth-based transmission stations. This will not be discussedbecause 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-airTV and Pay TV) which are one-to-many operations without two-way capacity and socannot offer telecommunications.

Finally, one can include two-way radio and radio trunking. Two-way radio is oftentransmitted over very short distances and includes networks for emergency servicesand communication within a defined corporate space. Often the distances are shortenough that no transmission stations are required, and the hand-held devices aresufficient. The longer distances are covered by radio trunking, which operate in afashion 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-of-presence (PoP). The long-distance network is made up of these PoP exchanges anda transmission network. Given that these networks draw on a large pool of localaccess subscribers, they are able to get greater density of use in their transmissionnetworks. As a result, most long distance networks use fibre optic when using a fixedline solution. Alternative transmission mechanisms include satellite and microwave(national only). Despite the choice of technologies available, a single market isdefined as one for national long-distance and for international long distance. In

addition, as most of these networks have sufficient network speed for broadcastquality, 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 long-distance networks. A substantial proportion of the costs are in paying royalties tolandowners to pass the transmission cable through and putting in place infrastructureto carry the transmission medium (Cave 1995). If a new entrant already has anational infrastructure (e.g. railways, electricity grid), then some of these costs will bespared allowing a faster and cheaper rollout.


13/65


9

1.1.2 Provision of Services

The network infrastructure is the basis on which services are provided. Theincreasing intelligence of telecommunications networks has permitted a proliferationof services that are feasible beyond the basic local, national and internationaltelephony. 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 rangeof data/video services has proliferated with the most common including a full Internetoffering (email, world-wide-web), EDI (electronic data interchange), paging, manageddata network services, video-conferencing, database access and transactions, video-on-demand.

Service provision can be split into two basic components value-added networkservices (VANS) and basic voice. From this point there can be further separation intowireless 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 publishingand advertising services and electronic information services, including Internetservice provision.

The provision of services occurs on top of the network infrastructure. Historically thenetwork provider was also the provider of services. However, unbundling the servicefrom 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 leasingpart of the network from the network provider and enhancing this with one or moreservice 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), orb) the network provider is seen to be inefficient at that service and the serviceprovider 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 anetwork provider is using dated or inefficient technology at points in the networkwhich a service provider may choose to replicate and then lease or interconnect toother parts of the network to compete. This may be as simple as the credit and billingcomponent, or internet access via the local telephone network but using a nationaldata network. Alternatively, the large network provider may not be able to adequatelyprice discriminate amongst all niches in the market and a service provider may leaseexcess capacity in the network for the purpose of niche resale. This is often the casewith international or national telephony services providers. The internet providesanother example of niche servicing an important component of what customersseek in service providers is member services such as home page news, links andcommunity information. These can be tailored to niche markets while the cost can bekept the same by leasing lines.

The additional components that service providers bring to the network are:

Service-specific infrastructure this includes additions to the networkinfrastructure 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),


14/65


15/65


11

1.2 Forms of international trade

According to the WTO negotiating rules, trade in telecommunications services canoccur through four possible modes of supply cross-border supply, consumptionabroad, commercial presence and the presence of natural persons. These will be

discussed in the context of network infrastructure and services.

1.2.1 Provision of network infrastructure

Until recently, the most common form of trade between countries has been throughcross-border supply of international network services. Trade occurs through theinterconnection 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 routeinternational calls via South Africa). Imports are considered to be outgoing calls thatthe network provider in the other country charges to be completed. Incoming calls orones third-party routed by a countrys network are considered exports. Cross-bordersupply is dominated by, but not limited to, interconnection charges for data, voice orvideo. The extent to which trade offers competition depends on whether theinfrastructure of another country is able to service the South African market. This islikely with international services as satellites have broad footprints over wholeregions and fibre optic networks often loop past many countries. It is possible forsatellite communications to bypass all domestic infrastructure by passing signaldistribution through a earth gateway station located in another country.

With the growing liberalisation of communications services internationally, anincreasingly important form of trade has become commercial presence. In order toprovide communications services to consumers in a country beyond completing theirinternational calls to another country, network and service providers need to have a

physical presence in that country. All networks, with the exclusion of satellite, requireinvestments in terrestrial transmission equipment and either physical lines or radiofrequency. Even for satellite communication one still requires an earth station to linkto 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 intra-corporate transferees only. The high demands for human capital in production meanthat companies entering a market may require to bring in their own technicalexpertise in order to build and maintain their network or service. However, there areno trade demands beyond inter-corporate transferees.

1.2.2 Provision of services

The interconnection of networks globally means that many data and video servicescan be provided from another country in a cross-border fashion. It is common to findemail, e-commerce and web-hosting services for South Africans being supplied fromservers in the USA. There is no doubt that domestic e-tailers compete with foreignones.

In terms of voice products, there is competition between service providers to routeinternational calls through their networks. In particular, calling cards and call-backservices 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 throughthe network back home and in this way provides revenue and imports. Many


16/65


12

callback services have sprung up in countries like the USA whereby a customer fromSouth Africa places a call as if they were in the USA through the callback operatorcalling them and connecting them to the number they wanted to call. Finally, inmobile telephony one can arrange international roaming agreements for mobilephone users to capture their consumption. Any calls that they make abroad will be

routed back through the domestic network, allowing the domestic mobile networkprovider to capture some of the charges on that call.

However, for basic voice products in the local access market, the competition mustcome from domestically situated firms. As such, provisions around foreign ownershiplimits will serve to restrict competition.

1.3 Role in the economy

Communications services play a key role in any economy from being an importantintermediate input to business, an enabling medium for a range of content providers,

a significant item in household expenditure, and finally a source of demand fornumerous manufacturing and service industries. What follows is a discussion of therole in the broader economy of communications services as a package of bothnetwork and service providers. This component is severely limited by the statisticaldata. This is particularly problematic in a dynamic industry as dated statistics tend tobe widely off the mark. With telecommunications statistics, it is likely that datedstatistics will underestimate the role of the sector in the economy.

1.3.1 Role as Intermediate Input

The role of communications as an intermediate to business can be seen to have 2dimensions a) as a cost item required to operate a business, b) as a strategic andcompetitive tool.

As a cost item, communications does not appear that significant for most parts of theSouth African economy judging from the statistics in table 1.3 below. It representsonly 0.1% of total costs in agriculture and mining, 0.4% in manufacturing industriesand 4.4% in service industries. However, these figures definitely underestimate thecost importance of communications for two important reasons. First, the data networkcosts are accounted for under the section titled business services, along with otherbusiness service items. Second, the latest input-output data available for SouthAfrica is 1997, which was based on the 1993 table which was based on the 1988table. 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 tobusinesses globally. Increased globalisation has resulted in the requirement tocommunicate and transmit vast amounts of data to suppliers, industry customers andaffiliates internationally on a timely basis. The rise of electronic commerce, has nowestablished a need in many industries to use communications networks to deal withthe final demand of the household consumer too. In both cases, the need is for highspeed, high quality communications services that are geared to the specific needs ofthe firm and which are available at a cost that does not make it prohibitive tocommunicate or put them at a competitive disadvantage to firms in other countries.

What matters most for an economy is the availability of world-class communicationservices at a reasonably competitive price, even if they are not the cheapest.


17/65


18/65


14

significant for the manufacturing sectors - metal products and equipment(transmission and receiving devices); chemicals, rubber and plastic products (plasticcasings for equipment); paper and printing (marketing and office materials). Thelargest gains are in other service industries, in particular, other communication orbusiness service providers, distribution, transport and utilities. A second round of

output and employment creation can be expected stemming from additions to wageand capital income created by the first-round effects.

These figures are not high compared to agriculture or manufacturing. Part of thereason for this is a low participation of SA industry in communications equipment,with much derived demand going to imports from other countries. This may changewith 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 intermediateinput 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/socialservices

1.6

Total intermediates/Totalinput costs

22.9

Source: Wefa SAM (1997)

1.3.3 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 theexistence of communications services and would not exist otherwise - these are thecontent providers. Too often we view the communication services as a demandderived from growth in other industries or in household income. What we fail toappreciate is that innovation, cost reduction, quality improvement and independentexpansion of communication services enable the growth and expansion of a largecontent industry that is transmitted over the communications infrastructure. Thisprocess is one where the communications industry itself creates demand throughinnovation and investment. The links to these content industries cannot be portrayedusefully by an input-output table.

The content providers could most easily be classified according to voice, data andimage/video content. Voice would include those companies producing content forradio broadcast - from music to programming. Video/image would be those producing


19/65


20/65


21/65


17

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 ofprice, access or product controls. Price controls occur in telecommunications, whereTelkom has to get its tariffs approved by the South African regulator, ICASA. Thesame goes for access controls, as ICASA has the right to issue licenses for thedifferent types of telecomm markets, as it has in Telkom for the fixed line market andMTN and Vodacom for the mobile phone market.

There are two basic types of theories about regulation we can differentiate: normativetheories outlining the response to market failures and positive theories describing thedynamics between policy makers and recipients of regulation.

2.1.1 Normative Theory of RegulationThe normative theory postulates that regulation ought to be introduced when there ismarket failure. How market failure is identified and how it arises are the questionsthat remain to be answered.

As to the identification of market failure, we identify four types of efficiency that haveto be fulfilled to guarantee an efficient outcome:

Allocative efficiency: occurs when goods are priced at marginal cost, hencesold at the true economic cost to the producer, without any rents that mayhave been derived from the market structure.

Cost efficiency: when a firm or industry produces at the lowest possible costlevel. In some industries, it may be possible that many competitors lead toallocative efficiency, but that the lack of scale effects means production is notcost efficient.

Dynamic efficiency: when cost savings are implemented efficiently and thereis no delay in the development and introduction of new products.

Distributional efficiency: finding the socially desired trade-off between themaximisation 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 andbenefits may well differ for the individual and the society. A car driver, forexample, will not take into account her effects on pollution when planning atrip. When the social costs exceed the private costs, or the private benefitsexceed the social benefits, the level of activity is too high. When socialbenefits exceed private benefits, allocation will be lower than desired. Anexample for the first would be car usage, an example for the secondinvestment by firms who do not take into account the beneficial spill-overs forother companies. Taxes, in the case of over allocation, and subsidies in the

case of under allocation may be used to rectify the situation.


22/65


18

Natural Monopoly: occurs when it is more expensive to have severalcompanies providing the same product than it is to only have one. Publicutilities, such as water and electricity and most other network industries areclassic examples of natural monopoly. Single product monopolists will derivetheir advantage from economies of scale, whereas multi-product natural

monopolies may also derive their advantages from economies of scope2

.

Large specific investments and hold-up problems: when private activity investslarge amounts in assets that may only be used for one purpose, there is apotential for the extraction of rents from a contract partner. If a pipelinecompany invests in a pipeline from an oil field to a refinery, this asset is onlygood for transportation between these two points. Once it is built, theinvestment is sunk. The oil field operators might be able to extract the sunkcost from the pipeline builders should they have other possibilities for thetransportation of their oil. Private contracting may be costly in this case andregulation the preferred tool.

Regulation must hence be used in sectors where competition is not sustainable dueto one of the three reasons mentioned above. The success of regulation is to bemeasured by the efficiency criteria outlined.

2.1.2 Positive Theories for Regulation

Regulation does not only exist to correct market failures. This is apparent from thefact that regulation continues to exist in sectors with no natural monopoly features.Regulation also exists because it is a powerful means to redistribute wealth insociety. Regulation can be used to tax one group of consumers and redistribute toanother without imposing a more transparent tax-subsidy approach (Posner 1971).

Classic examples in telecommunications are cross subsidisation from long distanceto local calls, from urban areas to rural areas and from business users to domesticusers.

An alternative to government using regulation for social welfare-improvingredistribution, is for specific interest groups to capture the regulatory process throughlobbying government. Stigler (1971) observed that companies demand regulation inan attempt to earn abnormal profits at the expense of consumers. Politicians areprone to interest group pressure since single voters are unable to monitor and coercethe policy maker. The successful pressure group in the regulatory game need not becompanies only, but whoever it is they should have low costs of organisation andhigh potential payoffs relative to the competing interest groups. A good example forthis 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 membershipfind it difficult to extract benefits from policy makers.

The same forces that drive politicians to regulate sectors, may also drive them toderegulate. If interest groups that are being adversely affected by regulation organisemore effectively (or if the cost of the regulation to them increases enough to makethem organise) then they may be able to reduce the level of regulation. Intelecommunications, 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


23/65


24/65


20

system is that the firm has no incentive to continually reduce cost. Inflated costis created through the attraction of capital rather than efficiency, an incentiveto inflate costs before a rate hearing and the need for very detailed regulation.

Incentive regulation: has been created to deal with the inefficiencies inherentin rate of return regulation. There are two basic types of incentive regulation:

o Price-cap regulation: imposition of a price ceiling on a basket of goods,adjustment of the ceiling with the formula CPI-X, where CPI is theconsumer price index and X is the average increase in efficiencyexpected. The potential problem with this mechanism is the uncertaintyabout the true level of cost and hence the crudeness of the mechanism.Errors in the index may lead to windfall gains for the firms or heavylosses. Furthermore the incentive to minimise cost can lead todecreased product quality and to the elimination of goods which do notshow potential for efficiency increases.

o Earnings Sharing: whilst price cap regulation achieves cost efficiency,earnings sharing attempts to strike a balance between cost andallocative efficiency. There is a sharing in the risk and rewards from anydeviation in the rate of return between consumers and producers. Theadjusted rate of return is determined by a sharing of the deviation from

the target rate of return ( ( * )a t tr r h r r = + , where 0


25/65


21

The results are robust in the way that different model specifications regarding inputand output prices, as well as using slightly different data sets do not change the basicresults that incentive regulation does have beneficial effects on efficiency.

A further result from the modelling is that those regulated companies with the highestexpenditures on research and development benefited most from the change to IR, aresult that is consistent with intuition.

Bergman et al (1998) note that more and more European countries have started touse price cap regulation, initiated by the United Kingdom, which introduced themeasure in 1988 due to a report by Stephen Littlechild, pointing out the productiveand dynamic inefficiencies inherent in ROR. Among other states, France, Germanyand Sweden also introduced PCR in the early 1990s.

Despite the positive effects on productive efficiency of PCR, there has been criticismof the system relating to strategic behaviour and allocative efficiency. The strategicbehaviour component relates to the timing of rate reviews. To maximise the costreduction incentives for the firms, the regulator has to increase the time betweenhearings, such as to allow some appropriation of the gains made by savings. This,however, increases the scope for the firm to act strategically: before adjustments,cost savings are not fully exploited, so as to signal a lower savings potential to theregulator. Once the new rates have been installed, maximum savings are beingexploited as they can be benefited from for the maximum possible time.

As to allocative effects, the problem is that the X-factor is backward looking ratherthan future oriented. The nature of negotiations between the regulator and the firmsdictates that X-factors are based on historical experience rather than future potential.It is the superior knowledge managers have in comparison to regulators that makes itpossible for companies to exploit extra profits.

Large segments of the telecomm industry are potentially competitive, though, and itis thus the aim of European policy to liberalise these markets, as effectivecompetition can replace regulation and ensure better market outcomes.

2.3.2 Liberalising Network Industries: a Three Stage Process

The table below illustrates the state of liberalisation of different public services inEurope as of spring 19983:

Table 2.1: State of European Deregulation (1998)

Germany France Italy Spain Sweden UKAir transport High Medium High Medium High High

Electricity Medium Low Low Medium High Very High

Postalservices

Medium Low Very Low High Very High Medium

Rail Low Low Very Low Very Low High Very High

Telecoms Very High High Medium High High Very High

3

Ibid. p.80


26/65


22

This describes the different states that network industries were in at that moment intime. As the system evolves towards a more liberalised system, there are differentdemands on regulation in the different phases. The book differentiates between threephases:

1. Monopoly

2. Monopoly and Competition in some Markets

3. Competition

Figure 2.2: Path of Regulatory Intensity

Phase 1

The problems associated with an industry in phase 1 of liberalisation are best dealtwith through the measures outlined in the previous sections: close regulation of themonopolist to ensure productive and allocative efficiency. Ramsey pricing would be

the preferred measure under perfect information, but is not possible due to theimpossibility to access accurate data for effective regulation. ROR has the problemsassociated with over investment in capital expenditure to increase the absolute levelof profits allowed and the lack of incentives for cost reduction. Regulatory lag could,however, provide limited incentives for cost reduction, as the rate of return would behigher for the period between rate reviews. PCR, on the other hand leads to efficientproduction, but lacks on the allocative side due to information asymmetries about thetrue efficiency potential of the firm.

Phase 2

Here, there is introduction of competition in some parts of the operations. It ispossible that effective competition will never be possible in all parts of the operations,as duplication of some network components may not be viable in all fields. Intelecommunications, for example, fibre-optic backbones are existent on differentnetworks in some countries, but there hardly ever is any duplication of the last mile,i.e. the connection from the users premises to the local exchange. The viability forduplication of these parts is not given.

In the second phase of liberalisation, there are three strands of activities that have tobe pursued: firstly the separation of the regulator from the monopolist, secondly theregulation of incumbent pricing and thirdly the regulation of interconnection.

As to the independence of the regulator, it has to be ensured that there is no captureof the regulator for any of the parties involved in the market. This is important to instil

Regulatory

Intens

ity

Time

Phase 1 Phase 2 Phase 3


27/65


23

confidence in any companies wishing to enter the market, providing them with thecertainty that they will have a level playing field.

On the front of price regulation, the monopolist has the possibility to use rents frommonopoly markets to subsidise activities in the competitive markets and thus gain anunfair advantage. The importance therefore lies in analysing the level and structureof prices set by the monopolist.

Network industries have a large part of their cost in fixed components, making theallocation of costs to services very difficult and arbitrary. Considerable effort thus hasto be expended towards the analysis of the cost structure and to the development ofa fair level of prices to be set by the incumbent in the competitive market.Deviations in both directions are potentially damaging: setting prices too low willdiscourage entry by firms even it they were more efficient than the incumbent. Shouldprices be set too high, then entrants will be able to enter even if they are less efficientthan the incumbent. Furthermore, it will jeopardise the profitability of the companyand thus the cross subsidies to unprofitable market segments necessary for universal

service obligations.

Even in the most competitive telecomm markets, such as Germany4, not all aspectsof the network have been subjected to competition, such as the last mile. There isstrong controversy about the correct level of interconnection pricing between thenetwork components of Deutsche Telekom and its competitors. Once again, theincentives of the incumbent and competitors are opposed. If interconnection pricesare set too high, the monopolist will receive an overly high amount for theinterconnection services and thus deter entry by efficient companies. Should theprices be set too low, however, this will also attract inefficient entry. Furthermore, itwill discourage investment by the incumbent into new technologies, as entrants

consequently do not carry a fair share of costs and risks of the investments andbenefit disproportionately from the incumbents investments.

When interconnecting networks, there are different possibilities to design accessprices:

Efficient Component Pricing Rule (ECPR): this mechanism warrants entry aslong as the entrant is at least as efficient as the incumbent. It is assumed thatretail prices are fixed, i.e. that allowing the entrant access does not have aneffect on the incumbents price. The cost structure is defined by the averageincremental cost of access, b, the average incremental cost of providing thecompetitive part of the service, c, and the retail price of the service, p. The

optimal access price is thus defined as: a = b + [ p - (b + c)]. In the context of along-distance telephone context, b would be the cost of connecting thecustomer from her home to the local exchange and c the cost of routing thecall on backbone infrastructure. The problem associated with the ECPR is thefact that allocative effects are being ignored, due to the assumptions of ahomogenous fixed product, a fixed coefficient of technology and the inability ofcompetitors to bypass the incumbent.

Ramsey access pricing: in the spirit of optimal pricing for society, Ramseyaccess pricing also takes some allocative effects into account. The formula for

the calculation of the access price changes to: a = b + (p (b + c)). is what

4

Purton (2000), SURVEY - FT TELECOMMS: Former monopoly loses significant market share


28/65


29/65


25

In the three phases of liberalisation, there are different challenges for the regulator. Inphase 1, classical regulation challenges are to be dealt with, i.e. achievingproductive, allocative and dynamic efficiency. Once competition is introduced inphase 2, the regulator has to deal more with the behaviour of incumbents andentrants toward each other and the abuse of market power by incumbents, and the

provision of fair access prices for entrants to non-competitive parts of the network.In phase 3, regulation becomes more light-handed and revolves around the fairdistribution of universal access obligations and the adherence to fair tradingpractises, since competition takes care of the other aspects of regulating price andentry.

2.4 Convergence in Telecommunications

Over the past decade, telecommunication has been subjected to a technologicalrevolution, decreasing natural monopoly characteristics of the industry and creatingnew markets in mobile telephony, the use of the Internet and wireless local loop

technologies.

Whereas in the past, the market to be regulated was clearly defined and regulation ofplayers revolved more around technical regulation, today the market boundarieshave become blurred. Competition has the potential to decrease the need forregulation in some of the more competitive markets, but has increased the potentialfor asymmetric regulation. Whereas in the past the emphasis was laid on efficiencyand principal-agent problems of inducing the correct behaviour in regulated utilities,nowadays the problems lie more in the area of dominance of incumbents, a lack ofmarket boundaries, the pace of technological change influencing cost and uncertaintyabout future technologies.

In the past, the more concentrated regulation of single sectors was by nature definingthe rules of play and creating competitive environments. In the present context,however, competition agencies have gained greater importance, observing themarkets and acting ex-post only if there is evidence of anti-competitive behaviour.

An example of classic sectoral regulation is that of OFTEL, the UK office fortelecommunications regulation. In Malaysia, on the other hand, regulation of theentire broadcasting industry has been attributed a single agency, dealing with alltelecommunications and broadcast issues.


30/65


31/65


32/65


28

The purpose of SATRA/ICASA is to regulate the industry in terms of theTelecommunications Act (1996) and pursue any new policy directions that areissued by the Minister of Communications as long as they are consistent withthe broad objectives expressed above and if prior consultation has takenplace. Many aspects of the Telecommunications Act provided only limited

guidance and regulatory principles and so much of the initial work ofSATRA/ICASA was to put some concrete guidelines together for the purposeof regulation. The regulatory aspects left to the discretion of the regulatorincluded interconnection, facilities leasing, GPMCS (global personal mobilecommunications services) and licence conditions.

Despite this show of independence, the Act permits the Minister ofCommunications to amend, withdraw or substitute any decision by theregulator. This provision has already been used by DoC to withdraw SATRAsguidelines on interconnection and facilities leasing. Further, the implication ofthe Minister setting policy means that the shape of deregulation is left to the

Minister. Although the White Paper provides guidelines for deregulation, it issubject to review by the Minister who also is entrusted with setting the datesfor which segments of the market are opened for competition, and the numberof new entrants. The regulator role is merely to call for tenders for licencesand issue licences according to fair and transparent criteria.

SATRA/ICASA has lost credibility in the industry as both independent andeffective through failure in a number of crucial regulatory episodes. The firstincident occurred shortly after the passage of the Act, when Telkom claimedthat the Internet was a basic service and therefore fell under its exclusivityagreement. Although SATRA eventually ruled that this was not the case,Telkom took the challenge to the courts ensuring that the matter dragged on

another 6 months.

The second major incident was the as yet unsuccessful issuing of a thirdcellular licence through a beauty contest process. SATRA made arecommendation for Cell C to be awarded the licence, going against theexternal consultants recommendations. One of the losing bidders, Nextcom,challenged the outcome and has succeeded in delaying the process in thecourts for over a year. In the process, it has been alleged that there waspolitical interference in the licensing process, eroding the credibility of SATRAas an independent body.

Finally, Telkom accused VANS operators of illegally providing telephony totheir clients in contravention of the Act. The action it took was to deny furthercapacity to them and in some cases withhold services. SATRA ruled againstthe unilateral action by Telkom but was duly ignored by the operator. Theissue has been partly resolved after AT&T threatened to take the issue to theWTO where South Africa has committed to an opening of the VANS sectorand to a telecommunications reference paper that upholds action against anti-competitive practice by industry players.


33/65


29

3.3 Fixed line Networks

3.3.1 Local Access

The attainment of social objectives played an important role in deciding how

to regulate the fixed line market. It was felt that rapid infrastructure rollout topreviously under-serviced areas was critical to the promotion of universalservice and economic empowerment. As these areas are generally either low-income or rural, the feeling was that immediate competition in fixed lineservices would not serve the objectives best. The reasoning was:

new entrants would target the more lucrative and easily establishedbusiness and long-distance markets first and not seek to rollout in theseunder-serviced areas,

competition in these markets would squeeze the profitability of Telkom andso limit its own ability to rollout in these unprofitable areas, and

the option of contributions to a universal service fund was not desirableuntil basic exchange infrastructure was in place in some areas to whichlow income households could be more cheaply connected.

This coincided with the need to restructure Telkom itself to face competition such as improving efficiency and rebalancing its tariffs to remove cross-subsidisation. It is also felt that the granting of an exclusivity period helped toraise the market value of Telkom allowing for a better price on the equity sale.

For these reasons, the Telecommunications Act gave Telkom a regulated

monopoly for five years, extendable to six, in the local access market. Toensure that the exclusivity period fulfilled the goals of infrastructure rollout andpreparing Telkom for competition, strict licence conditions were placed on thenetwork provider. The licence conditions included rolling out 2.81 million newlines over the exclusivity period, of which 2/3rds will be in under-servicedareas and for priority customers. It is estimated that this will require capitalinvestment in the region of R53 billion. The specific rollout targets arepresented in table 3.1 below. The only part of local access network that is notcovered by the exclusivity agreement is customer premises equipment (CPE),which was opened to full competition immediately on passing the Act.

Telkom wins an extra year of exclusivity if by the end of the fourth year it has

achieved a roll-out of 90% of its cumulative five-year total line target and 80%of its five-year under-serviced line target. This will be granted if Telkomaccepts a new five-year total of three million new lines and a proportionateincrease in its under-serviced line target. There are financial penalties forfailing to reach these targets. Telkom pays penalties of R450 per line for thefirst 100,000 and R900 per line for each extra line missed. If it misses PriorityCustomer targets the penalty per unit is R4,500, schools R900, publicpayphones R2,250 and villages R1,125.


34/65


35/65


31

Figure 3.1: Proposed path of deregulation

End of

Telkoms

exclusivity

Full

Competition

1 2 3 4 5 6

Swtiching Networks

International services

Local Loop

National long distance services

Telephony LL

Business LL

Resale

Licenced carriers

VANS

Cellular Networks

Radio (paging, trunking, etc

CPE

Represents Telkom exclusivity

Source: White Paper on Telecommunications

3.3.2 Long-distance

Long distance was bundled together with local access in the granting ofexclusivity to Telkom until a review of policy and a subsequent call from theMinister to proceed with licensing. The initial thinking in the White Paper wasto introduce the licenced resale of long distance facilities operated by Telkomby 2000. Two years later it was envisaged that the regulator could licencelong-distance carriers with their own facilities but who connected to theTelkom PSTN. Finally, a full service PSTN would be licenced by 2003.Currently the resale has not materialised and we await the decision on otherlicencing. Any licence holder would be eligible for universal service fundcontributions, human resource contributions and a licence fee of 1% ofturnover. There may be additional conditions attached but these are unlikelyto exceed any that Telkom would have to bear.

3.3.3 Value-added Network Services (VANS)

Value added network services by definition do not have facilities of their ownbut lease from network providers. The sector has been open since 1993 withlicence holders required to lease Telkom capacity and are prevented from theresale of capacity and of carrying voice traffic, until a date set by the Minister.The White Paper envisaged resale to commence in year 4 of exclusivity(2000) but it has not materialised. The licence conditions also include noundertaking of anti-competitive practices and adhering to practices thatprotect the customer. They are also eligible for a universal service and humanresource fund contributions.


36/65


37/65


38/65


39/65


40/65


41/65


42/65


43/65


44/65


45/65


46/65


42

South Africa does not have a cable TV operator, this is not a source of entrynow. It is also unlikely to be the case in the future, as a cable TV companywould only be interested in a small group of high income earners, plus thechoice of technology for pay TV in South Africa is satellite (Multichoice andSentech). The low teledensity in South Africa suggests that the entrant may

be tempted by the number of unserviced areas. However, the reality is thatthey are unserviced because they are the least viable group of potentialsubscribers. Therefore, unless the universal service funding was sufficient tomake these customers profitable, they are unlikely to be served by theentrant. Clearly entry at the residential level is unlikely to be significant unlessthere is significant incentives from the regulator for entry, including puttingrollout conditions in the licence, providing access to universal servicesubsidies, having favourable interconnection agreements and possiblylowering competition in long-distance through a duopoly policy to allow themto cross-subsidise services. Either way, the entrant is unlikely to get asignificant share of the local access market to act as a disciplining effect on

the incumbent. Rate regulation of the incumbent will be the primary tool forensuring the protection of consumers against abuse of dominance.

4.3 Long Distance

4.3.1 Relevant Market

The long distance market can be separated into national and internationalnetworks. It is also possible to talk of network providers and service providersin the long-distance market (unlike the local access market). There is little

reason for separating the market in any other way, as most long-distancenetworks are now fibre-optic and so can carry voice, data and broadcastquality. Choice of technology also matters less.

4.3.2 Market structure

The network infrastructure for long distance is predominately owned byTelkom, but other network providers exist. In the national long distancemarket, Transtel and Esitel (the telecommunications arms of Transnet andEskom), have considerable long-distance infrastructure that is used for privatepurposes and which Telkom can lease capacity for public purposes. Thisprivate network exists for historical reasons. In the international long-distance

market, there are a large number of international players that operate fibreoptic and satellite facilities that cover South Africa. They exist because theirinfrastructure is not located on South African soil and so cannot be regulated.Sentech holds capacity in satellite broadcasting services.

Despite other infrastructure providers existing, Telkom has exclusive rights tooperate a long-distance network in South Africa. Therefore these companiesare forced to lease to Telkom who then provides the public service. TheTelkom monopoly means that the prices of all other services that use long-distance networks (mobile, Internet, VANS) are determined by Telkom. If thismarket structure leads to cost inefficiencies, underinvestment or monopoly

pricing, then the impact affects the full range of telecommunications products.


47/65


48/65


49/65


50/65


51/65


52/65


53/65


49

million. The dominant operators are Radiospoor (40%), Autopage (25%),Paging Plus (10%). A handful of these operators do not provide services tothe public but operate their private corporate paging services only.

Radio Trunking

The first radio trunking licences in South Africa were only issued in 1993, ayear before the introduction of cellular networks. The expansion of the cellularnetworks has stunted the growth of radio trunking as they are directcompetitors in mobile communications services. There are currently 11licensed operators sharing a market of between 5000 and 7000 radios. Thesector is relatively small with revenues of R9 R12.5 million per annum. Thesector is dominated by 3 operators Fleetcall, Q-Trunk and One-to-One.

Wireless Data Services

There are currently only 2 wireless data network providers, Swiftnet and WBS.

4.6.3 Contestability

As with VANS, entry barriers are low to these mobile offerings. The fact thatthe same services are feasible over the cellular networks make this a highlycontested market.


54/65


55/65


51

Whether mobile networks should be separated from fixed networks(horizontal separation)

5.1.1 Vertical separation of networks

The issues around vertical separation of local access to other parts of thenetwork are relatively straightforward. The case for vertical separationessentially rests on reducing the opportunities for anti-competitive behaviourand so reducing the complexity of regulation. If a firm with essential facilities isvertically integrated (like Telkom), then they have tremendous scope forbehaving anti-competitively. This could occur by either granting lessfavourable access to competitors than to their own downstream service(different price, quality or customer access dialing5) or overpricing themonopoly component (local access) and cross-subsidising the long-distancenetwork to the detriment of competitors. If there is vertical separation, thenthere is little incentive for discriminatory access provision or cross-

subsidisation, which leaves the regulator to concentrate on ensuring that thereis no monopoly pricing of access only. The cost saving in this case is aregulatory one.

The economic argument against vertical separation is that it will destroy anyeconomies of scope that may exist between the two networks. If these aresignificant, then the potential efficiency cost may well outweigh the regulatorycost of closer supervision of the incumbent. An equally powerful argumentagainst vertical separation is the cost of undertaking the exercise when theincumbent is already integrated. The cost is not only the internal restructuringcost but also the time delays in the deregulation process.

There is no clear side on which the decision of vertical separation should fall.In the case of the UK, the desire to have a rapid privatisation intelecommunications led them to reject the vertical separation model6

(Armstrong et al 1995:215). In contrast, the USA adopted the verticalseparation model when they brought an antitrust case against AT&T in1974alleging anti-competitive behaviour against other long distance networks. Thecase was finally settled 8 years later and resulted in the separation of localaccess in 1984. More recently there have been attempts by some of theRBOCs (Regional Bell Operating Companies) to get permission to move intolong distance, which have been resisted by the regulator with the conditionthat greater local access competition must proceed it.

Considering that South Africa has already gone some way down thederegulation path without breaking up Telkom, suggests that it would bedifficult to do it at this point. It would also be difficult to get equity partnerconsent for the process, with the likely result that they will pursue the matter incourt causing further delays to the deregulation process. This reasoning islikely to rule the day, making it largely unnecessary to really evaluate thecosts and benefits of each policy in South Africa. The fact that this is not on

5

Forcing customers to dial an access code to use the competing long distance networks, thereby

raising switching costs.

6 Armstrong et al (1995) note that another reason for avoiding the breakup was that BT management

was opposed to the idea and the regulator needed their support for a rapid privatisation.


56/65


52

the table for discussion at the moment and that the models considered arejust the number of full facilities based competitors, supports this reasoning.

If there is to be vertical integration, then naturally there needs to be at leastseparate accounting to facilitate regulation of local access and competitionanalysis. However, given Telkoms history of conduct since the partialprivatisation7, there may be good reason to ensure that there is closecompetitive oversight of the interconnection process and agreements.

5.1.2 Vertical separation of services from networks

Even if there is no separation of networks, there is the possibility of separatingthe service component from the network component. The reasoning for thisroute is the same as for separating networks to remove the possibility ofanti-competitive practice by the owner of the essential facility. The argumentsagainst are also the same economies of scope and the cost of industryrestructuring. The range of services that could be separated include local

basic voice, long distance basic voice, VANS and broadcasting.

In the case of basic voice, local or long distance, there appears to be a strongeconomies of scope case against vertical separation. In the USA, where thepath to deregulation was vertical separation of markets, the RBOCs andAT&T were still permitted to offer basic voice. There are equally compellingreasons for not separating VANS and broadcasting from network provision.However, there is precedent for doing so from the UK where the incumbentwas prevented from entering broadcasting services on the basis of assistingentry of cable television companies into local access telephony. The USApursued the same route and also prevented the RBOCs from entering the

VANS sector initially.In the South Africa case, momentum may again decide the direction of policy.The existing regulatory regime does not restrict Telkom from enteringdownstream markets. However, it has not been that successful in doing so todate, suggesting that vertical separation may not be that necessary. However,Telkom has had little incentive to make a success of downstream services, asall service providers must lease their lines from it anyway. However, oncethere is facilities competition, there may be greater incentive for Telkom to notonly enter these markets but also behave anti-competitively.

Despite the momentum in regulation, it may be feasible to separate

VANS/broadcasting services at this point precisely because Telkom has notmade large inroads into the market.

5.1.3 Horizontal separation of mobile services

Horizontal separation of mobile services would require that no firm hasoperates or has holdings in both fixed local access and mobile. The case forseparation is twofold: a) as fixed local access is an essential facility, theprovider can discriminate against its mobile rivals, and b) that mobile is one ofthe few close competitors to fixed local access and so it may be desirable to

7 In particular their dealings with VANS operators, denying them additional capacity after alleging they

were providing clients with telephony and not just data services.


57/65


58/65


59/65


60/65


61/65


62/65


63/65


59

Concluding Remarks

There are many industry analysts who view the past 5 year exclusivity periodof Telkom to be a mistake by continuing to hamper downstream businesses.

These analysts will argue for complete liberalisation. Other groups of societywill view the universal service rollout and low loss of jobs as success pointsfor the policy, and will look to continue this in the form of an exclusiveduopoly. The WTO commitment ensures that we need to at least move to alimited entry policy. However, in the end, the policy framework forderegulation of the telecommunications industry is going to be a politicalprocess.

Ayogu and Hodge (2000) note that the distribution of gains and losses in thefull competition model favour the wealthy in society the businesses and theheavy users of telecommunications. The low-income groups are likely to bear

all the short-term adjustment costs (job losses) for some uncertain futurereward (jobs from downstream users of telecommunications and lower priceson future telephone use). Given the constituency of the government, thissuggests a gradual liberalisation approach may be preferred, where revenuemaximisation occurs and the gains can be transferred to the losers throughfiscal policy.

If the full competition model is to be adopted, it needs to be structured toprovide stronger universal service support and deliver downstream benefits tolow-income groups rapidly. This suggests maybe raising the USF levy andpursuing strict competition and regulatory enforcement in the sector to lowerprices and benefit downstream job creators.


64/65


65/65

Competition Regulation in Telecom a Report

Documents