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Exploiting Competitive Opportunities in Telecommunications

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1995
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AS COUNTRIES throughout the world open the telecommunications market to competition, they are finding that the hurdles they face are largely political and institutional. The good news is that practical ways exist to overcome the hurdles.

In most industrial and developing countries, telecommunications services have traditionally been delivered by a single government- owned provider. But the track record of these monoliths has not been impressive. They have rarely mobilized significant amounts of capital for the telecom network. They also have a poor record of responding to the evolving and varied needs of businesses and households.

Long waiting lists are common, especially in low-income countries. Registered waiting lists for new telephone service in 1994 represented 27 percent of the number of installed lines in developing countries, according to the International Telecommunications Union. The situation was most acute in sub-Saharan Africa, where the average waiting list was 60 percent of the number of installed lines. (In many cases, the waiting times exceed ten years.) Moreover, latent demand is even greater, because prospective users do not register on waiting lists until there is a realistic chance of receiving a telephone connection.

The large unfulfilled demand for telecommunications imposes a severe cost on firms and households. Indeed, for firms competing in international markets, the situation is acute. Studies have shown that both the quantity (lines per population) and the quality of telecommunications are critical for generating exports and attracting foreign investment. Exports of products characterized by seasonal demands (e.g., apparel) and requiring close contact with customers (e.g., auto parts) are particularly reliant on good communications.

In recent years, however, the picture has begun to change. Facilitated by unprecedented technological opportunities, the government monopoly model is being dismantled in response to huge suppressed demand and dissatisfaction with the monolithic approach (see chart). During the mid-1980s, many entities were reorganized; telecoms were separated from postal services; and operators were corporatized and, in some cases, privatized. Unbundling—the separation of businesses—also occurred in equipment, value-added services, data transmission, and cellular and private circuits. Then, in the late 1980s and early 1990s, competition finally came to network services (primarily domestic long-distance). The belief that telecommunications services are a “natural” monopoly—best provided by a single operator—has given way to a growing conviction that, even in the past, monopolies were “unnaturally” propped up by restrictions on new entrants.

A pluralistic market structure may represent the only realistic hope of more than doubling telecommunications investments in the developing world to over $60 billion a year—a conservative estimate of what is required to meet both existing unfulfilled demand and growing demand for conventional and new services (see table). When realized, these investments should provide good value, since telecom investments in developing countries show high economic rates of return. The rate of return of World Bank telecom projects, estimated at 27 percent, is substantially higher than the average for the Bank’s portfolio.

Veronique Bishop,

an Indian national, is Principal Financial Economist in the World Bank’s Cofinancing and Financial Advisory Services Vice Presidency.

Ashoka Mody,

a French and US citizen, is a Financial Analyst in the Infrastructure Division of the World Bank’s Europe and Central Asia Department.

But, for the promise to be realized, measures will be needed to make incumbent monopoly providers more commercially oriented and subject to the same basic rules as other providers. A regulatory environment that provides incentives for efficient investment, protects consumers, and ensures fair competition will have to be created, and conflicting interests will have to be handled with sensitivity during the transition period, especially those concerning traditional telecommunications workers. In other words, the chief obstacles are political and regulatory, not technological.

From government monoliths to nimble competitors

Source: Complied the authors from various sources.

Enterprise restructuring

The first step toward telecommunications reform is to make sure that enterprises are structured in such a way that economic incentives can come into play. This typically begins with corporatization and decentralization, followed by privatization. Where constraints to privatization exist, “contracting out” can be a viable alternative.

Corporatization. The major objective of corporatization is to convert the telecom company into an autonomous organization owned by the government but run on a commercial basis. When placed at arm’s length from the government, corporatized telecom operators can respond directly to the market. The goal, often not realized, is to make all public interest requirements explicit, thus eliminating the need to respond to ad hoc government prerogatives.

Decentralization. The next step typically is decentralization, which facilitates greater responsiveness to customers and increases managerial accountability. Indonesia, Mexico, and New Zealand have gone this route by establishing regionally based profit centers and separating the lines of business (e.g., international, domestic, and cellular services).

Privatization. After corporatization, a transfer of ownership to the private sector is usually needed to further insulate operations from political whims, ensure greater efficiency, create a level playing field for other private operators, provide the impetus for privatization in other sectors, and develop local capital markets. Post-privatization efficiency improvements benefit shareholders and labor. Consumers gain from rapid network expansion, but they often pay higher prices for services that had been heavily subsidized. However, sensitive political and social concerns often arise, centering around local ownership, the redistribution of ownership and rents to employees and other socioeconomic groups, and the availability of service to low- income consumers.

The privatization of Mexico’s telecom company, Telefonos de Mexico (Telmex), was designed with several objectives in mind: transferring part of the ownership to Telmex employees, attracting equity investment from experienced foreign operators while retaining Mexican control of the company, and developing the ability to raise capital using new international financial instruments. In privatizing Telecom New Zealand, the Government of New Zealand sought to limit foreign ownership to 49.9 percent, ensure coverage of local service areas, and, through a “kiwi” share, maintain leadership in policymaking.

Contracting out. Yet another method for increasing network size and improving efficiency is bringing in private initiative under the existing government operator’s umbrella. Such an effort has been undertaken in Thailand. To help meet the growing demand for telecommunications services, the Telephone Organization of Thailand has granted two concessions to private operators to build and operate a total of 3 million new telephone lines by 1996, at an estimated cost of $5 billion. Ownership will be transferred to the government upon completion of construction, and the private sponsors will earn returns through revenue-sharing arrangements. Similar schemes are being attempted in other developing countries.

Bringing in competition

Traditionally, the domination of telecommunications by a single provider rested on two justifications: economies of scale (when one provider can serve the market at a lower cost than two or more providers could), reinforced by economies of scope (when it is cheaper for a single provider to produce and deliver two or more services jointly than for separate entities to provide the services individually). But, with the changes in technology, economies of scale and scope are declining. In switching, or routing of calls, being small has little disadvantage in cost, thanks to digital technology of the type employed in computers. After being switched, calls were traditionally transmitted over underground copper cables, but wireless—microwave and satellite-based—technologies reduce the minimum efficient investment for long-distance communications. And radio-based cellular technologies that provide service to a small customer base in a local area are available at increasingly competitive prices. The one possible exception is optical fiber cables—once laid in the ground, their large capacities render parallel investments wasteful from a social viewpoint. Even in this area, however, new software makes it possible for competitors to “share” the fiber in transparent and fair ways.

How much competition can the telecommunications sector sustain? Although telecommunications markets with numerous suppliers are still rare, competition among a few providers can lower costs and prices. The theory of contestable markets says that even where economies of scale and scope favor a single provider, potential rivals that contest the market limit the risks of monopoly abuse. Thus, all entrants should be allowed to provide services, letting the market decide how many can operate profitably.

Long-distance competition. Competition—whether induced by the market or mandated by the regulator—begins with long-distance service because this segment has high profit margins, which are typically used to subsidize local service (the link from the customer to the nearest switch). Hence, so far, in developed and developing countries alike, long-distance service has been the main arena of competition. China recently licensed a second operator. Mexico will launch competition for long-distance services on January 1, 1997. But Chile has already moved toward a multicarrier, and potentially highly competitive, structure. Two companies had dominated the Chilean market: Compania de Telefonos de Chile (CTC) for the local service and Empresa Nacional de Telecomunicaciones (Entel) for long distance. But a third company, Telex-Chile, now controls about 25 percent of the long-distance traffic through its subsidiary Chilesat. Thanks to new legislation, CTC is expected to fight for a bigger long-distance share while Entel will expand its local operations; major international operating companies are also set to enter the fray.

Satellite technology offers further prospects for competition in many developing countries. Long-distance transmission of voice and data via satellite is used in Indonesia, but principally under the umbrella of the government- owned provider—although, as in other countries, the use of satellite transmission for private dedicated networks is increasing. Recently, Malaysia announced the acquisition of a satellite explicitly in the context of entry by a second telecommunications company. In the Philippines, Philippine Global Communications Inc. is expected to set up a domestic satellite network in the near future.

International communications. International competition will have a devastating impact on traditional rate structures. Until recently, international services were provided by a carefully managed cartel of national telecommunications authorities. By restricting other channels of international communications flows, national authorities had devised a system of high international service rates, which they shared (“settled”) according to arcane accounting rules. The resulting huge profits subsidized domestic, especially local, phone services.

But, in recent years, the cartel has begun to crumble. International services have traditionally been carried by publicly owned satellites, principally Intelsat, but the availability of alternative transmission services (e.g., other satellite services and undersea fiber optic cables) is making it easier to bypass the channels controlled by national authorities. In addition, most major telecommunications companies are forming alliances in response to powerful pressures from clients operating in the global marketplace—and there is growing competition among these alliances for the business of multinational companies.

Local competition. Although local services have so far been largely immune to competition, the picture is starting to change as local rates begin to rise (reflecting an end to cross-subsidization), cable network operators enter the fray, and wireless technology takes off. Indeed, the advent of radio-based cellular telephone networks—with their low capital costs—is introducing a major competitive element, especially in developing countries. By 1993, Sri Lanka had licensed three cellular operators (and is soon to add a fourth), which has decreased its tariffs to among the lowest in the world: connection costs of $100 and operating costs of 16 cents a minute. Compare those costs with the more typical ones charged by the monopoly provider in El Salvador: $1,000, and 35 cents a minute.

So far, cellular telephony has been used largely for mobile communications, but it can also be used for “fixed” telephones. In the coming years, it is expected that the cost of fixed radio connections for local calling areas (local loops) will plummet, making them competitive with traditional, wireline networks. In the United Kingdom, Ionica, an aspiring competitor to British Telecommunications and Mercury, plans to build local loops throughout the country using such radio technology. In Indonesia, Ratelindo, a joint venture between the state-owned operator and a private company, has been licensed to provide 280,000 fixed radio connections, principally in Jakarta.

Financial needs could be largeAnnual telecom investment requirements in developing countries(billion dollars)
Income group
LowLower-middleUpper-middleAll
New lines—ITU estimate11101132
Additional lines—to supply current wait list by year 200025411
Quality improvements and enhanced services26917
Total15212460
Investment as percentage of GDP1.51.81.11.4
Sources: International Telecommunications Union (ITU), World Telecommunications Development Report, Geneva, 1994; and authors’ calculations.
Sources: International Telecommunications Union (ITU), World Telecommunications Development Report, Geneva, 1994; and authors’ calculations.

Regulatory reform

At the same time as enterprise restructuring takes place and competition is introduced, three key types of regulatory reform should be undertaken to induce efficient investment, protect consumers, and ensure fair competition. Ideally, regulatory reform should precede or accompany privatization, yet, in practice, it is slow and follows such reform.

Rate rebalancing. Traditional cross-subsidies need to be eliminated so that new entry and competition can flourish in all network segments. In particular, as long-distance tariffs fall, local rates must rise to promote investment in that most unserved section of the network—the local loop.

Mexico has adopted a gradual approach to rebalancing rates and allowing new entry. In 1990, when Telmex was awarded a six-year monopoly, rates for local services were tripled or quadrupled, leaving further adjustment for later. Already, long-distance rates have fallen while local service rates have risen steadily. In the Philippines, by contrast, the authorities have chosen to encourage new entry immediately. For every lucrative link to the international gateway, new operators are required to provide 300 less profitable local exchange lines.

Price caps. To protect consumers from dominant providers, there has been increasing use of the “price cap” system, which sets the maximum allowable rate of price increase. Typically, this rate is the general rate of inflation in the economy (measured by the retail price index), minus the percentage by which productivity growth in telecommunications exceeds productivity growth in the rest of the economy (the “X” factor). The price cap system (first applied in the United Kingdom, where the current X factor is 7.5 percent) is increasingly being used in developing countries because it encourages efficiency improvements while allowing operators to better predict revenues. Studies also show that when a single operator dominates, price caps increase deployment of digital infrastructure and lower prices. One cautionary note: “lighthanded” or arm’s-length instruments such as price caps can become intrusive if exceptions and regulatory discretion increase.

Interconnections. Finally, new entrants need access to the network, which is turning out to be more a pricing than a physical problem. In practice, rough-and-ready norms for revenue sharing between different components of the network are adopted (Poland being a recent example). However, as the number of providers increases, and as networks become more complex, the basis for interconnection pricing will be tied more to the costs of interconnection. At this stage, best practice on access pricing is still evolving.

Looking ahead

The stream of technical advances will be best exploited when regulatory restrictions on new entry and operations are minimized. In the past, governments have often thought it fit to prepare the ground by restructuring and privatizing the existing operator before allowing competition. But, especially where telephone penetration rates are low, the early appearance of new players, operating on equal terms with the incumbent, can provide much- needed telephones, spur better performance from the incumbent, and reduce—but not eliminate—the burden of regulation.

For further details, see Exploiting New Market Opportunities in Telecommunications: Lessons for Developing Countries, by Veronique Bishop, Ashoka Mody, and Mark Schankerman, CFS Discussion Paper Series (forthcoming), World Bank, Washington, DC.

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Veionique Bishop and Ashoka Mody

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