Gender Perspectives in Introduction to Tariffs Gender Module #5 ITU Workshops on Sustainability in Telecommunication Through Gender & Social Equality

Presentation #1: Overview of Price Regulation

Outline Definitions Definitions What is price regulation? What is price regulation? Why is price regulation necessary? Why is price regulation necessary? Objectives of price regulation Objectives of price regulation Financing objectives Financing objectives Efficiency objectives Efficiency objectives Equality Objectives Equality Objectives Pricing objectives: Finding the right balance Pricing objectives: Finding the right balance

Outline 2 Four approaches to pricing Four approaches to pricing Discretionary price setting Discretionary price setting Rate of return regulation Rate of return regulation Incentive regulation Incentive regulation Price cap regulation Price cap regulation Rate rebalancing Rate rebalancing The international accounting rates system The international accounting rates system

Definitions Natural Monopoly: Exists when the costs of production are such that it is less expensive for one operator to supply all of the market than for several to service parts of the market Natural Monopoly: Exists when the costs of production are such that it is less expensive for one operator to supply all of the market than for several to service parts of the market A natural monopoly results from the presence of two factors: economies of scale and economies of scope A natural monopoly results from the presence of two factors: economies of scale and economies of scope

Definitions 2 Economies of Scale: Exist when the total cost of a firm decreases as production increases Economies of Scale: Exist when the total cost of a firm decreases as production increases Economies of Scope: Exist when a quantity of each of two or more goods can be produced by one operator for less than the cost of each good produced separately by different operators Economies of Scope: Exist when a quantity of each of two or more goods can be produced by one operator for less than the cost of each good produced separately by different operators Externalities: Spill-over benefits/negative effects to one market from another & vice versa Externalities: Spill-over benefits/negative effects to one market from another & vice versa

Definitions 3 Characteristics of Competitive Markets: Characteristics of Competitive Markets: Several suppliers and consumers; Several suppliers and consumers; No dominant player in the marketplace so large it can affect prices; No dominant player in the marketplace so large it can affect prices; No significant externalities No significant externalities Free entry to and exit from the market; Free entry to and exit from the market; Absence of economies of scale or economies of scope. Absence of economies of scale or economies of scope.

Definitions 4 Rate Rebalancing: Also price rebalancing; moving prices for different telecom services more in line with costs of provision Rate Rebalancing: Also price rebalancing; moving prices for different telecom services more in line with costs of provision Price Cap: A rules-based form of price regulation that uses a formula to determine the maximum allowable price increases for a regulated operators services for a specified year or number of years. Price Cap: A rules-based form of price regulation that uses a formula to determine the maximum allowable price increases for a regulated operators services for a specified year or number of years.

Definitions 5 Accounting Rates: The charges payable to interconnecting international operators under traditional settlement arrangements for mutual termination of traffic between their networks. Accounting Rates: The charges payable to interconnecting international operators under traditional settlement arrangements for mutual termination of traffic between their networks.

What is Price Regulation? What it is: Regulatory intervention aimed at ensuring competitive prices in telecommunications markets What it is: Regulatory intervention aimed at ensuring competitive prices in telecommunications markets Effective price regulation replicates the effects of efficient competition Effective price regulation replicates the effects of efficient competition Pricing affects several issues in telecom markets, particularly those related to access, interconnection, competition policy Pricing affects several issues in telecom markets, particularly those related to access, interconnection, competition policy

Why is Price Regulation Necessary? Competitive markets are difficult to create in the telecom sector due to the cost characteristics or market failures inherent in telecom networks, which tend toward natural monopoly with economies of scale: Competitive markets are difficult to create in the telecom sector due to the cost characteristics or market failures inherent in telecom networks, which tend toward natural monopoly with economies of scale: Fixed costs: do not vary by volume of production Fixed costs: do not vary by volume of production A specific type of fixed cost is sunk costs: costs that cannot be changed or avoided even by ceasing production entirely A specific type of fixed cost is sunk costs: costs that cannot be changed or avoided even by ceasing production entirely Government intervention is justified to correct market failures and improve social welfare Government intervention is justified to correct market failures and improve social welfare

Objectives of Price Regulation

Financing Objectives Ensure a regulated operator earns enough revenue to finance on-going operations as well as future investments Ensure a regulated operator earns enough revenue to finance on-going operations as well as future investments The smallest amount of revenue that meets the financial objective is called the revenue requirement The smallest amount of revenue that meets the financial objective is called the revenue requirement Some forms of price regulation (Rate of Return regulation) prohibit operators from earning in excess of their revenue requirements Some forms of price regulation (Rate of Return regulation) prohibit operators from earning in excess of their revenue requirements Prevents excessive revenues linked to monopoly or dominant market behaviour Prevents excessive revenues linked to monopoly or dominant market behaviour

Efficiency Objectives Price regulation must promote efficiency in the supply of telecommunications services Price regulation must promote efficiency in the supply of telecommunications services Efficiency may be measured in various ways: Efficiency may be measured in various ways: Allocative Efficiency: Achieved when the prices of services reflect their relative scarcity. Allocative Efficiency: Achieved when the prices of services reflect their relative scarcity. Productive Efficiency: (1) the most efficient mix of inputs (capital, labour) for a given level of output; (2) efficient production by minimizing all inputs Productive Efficiency: (1) the most efficient mix of inputs (capital, labour) for a given level of output; (2) efficient production by minimizing all inputs Dynamic Efficiency: Achieved when resources move over time to their highest value uses Dynamic Efficiency: Achieved when resources move over time to their highest value uses

Equality Objectives The motivation for many regulatory decisions on pricing policy The motivation for many regulatory decisions on pricing policy Concerned with the fair distribution of welfare benefits among members of society Concerned with the fair distribution of welfare benefits among members of society Telecom regulators concerned with two aspects of price equality: Telecom regulators concerned with two aspects of price equality: Operator-consumer equality, and Operator-consumer equality, and Consumer-consumer equality Consumer-consumer equality

Equality Objectives 2 Operator-consumer equality: The relative distribution of benefits between customers and the regulated operator such that savings from improved technological innovations are shared equitably between the operator and consumers Operator-consumer equality: The relative distribution of benefits between customers and the regulated operator such that savings from improved technological innovations are shared equitably between the operator and consumers Consumer-consumer equality: The distribution of benefits between different classes of telecom consumers, i.e., between businesses and residential customers or between the wealthy and the poor Consumer-consumer equality: The distribution of benefits between different classes of telecom consumers, i.e., between businesses and residential customers or between the wealthy and the poor

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

4 Approaches to Pricing

Discretionary Price Setting An approach to price regulation characterized by below-cost prices for connection, subscription and local calls An approach to price regulation characterized by below-cost prices for connection, subscription and local calls Shortfalls are made up by higher-than-cost international call prices and sometimes also high long-distance prices Shortfalls are made up by higher-than-cost international call prices and sometimes also high long-distance prices The usual goal of this type of pricing is affordable basic telephone services The usual goal of this type of pricing is affordable basic telephone services

Rate of Return Regulation A rules-based form of price regulation designed to balance an operators total revenues against its total costs A rules-based form of price regulation designed to balance an operators total revenues against its total costs Provides an operator some certainty of meeting its revenue requirement on an ongoing basis Provides an operator some certainty of meeting its revenue requirement on an ongoing basis ROR regulation does not support the efficiency objectives of price regulation as effectively as other forms of price regulation ROR regulation does not support the efficiency objectives of price regulation as effectively as other forms of price regulation

Incentive Regulation A regulatory approach that provides incentives and penalties to encourage an operator to meet regulatory goals A regulatory approach that provides incentives and penalties to encourage an operator to meet regulatory goals Operator often helps to set performance targets Operator often helps to set performance targets Regulator usually does not prescribe specific management actions Regulator usually does not prescribe specific management actions Regulator restricts some activities of the operator Regulator restricts some activities of the operator Types include earnings sharing regulation Types include earnings sharing regulation

Price Cap Regulation Preferred rules-based price regulation today Preferred rules-based price regulation today Uses a formula to compute the highest allowable price increases for an operators services over a number of years Uses a formula to compute the highest allowable price increases for an operators services over a number of years Intended to offer incentives that mimic competitive market forces Intended to offer incentives that mimic competitive market forces

Rate Rebalancing Telecom price structures in many countries are extremely unbalanced Telecom price structures in many countries are extremely unbalanced Some services (long distance & international calling) priced well above costs Some services (long distance & international calling) priced well above costs Some services (like telephone connections, monthly subscriptions, local calls) priced well below costs Some services (like telephone connections, monthly subscriptions, local calls) priced well below costs Deficits subsidized by higher-than-cost services Deficits subsidized by higher-than-cost services In monopoly or noncompetitive markets, the regulator may be required to aligned prices more closely with costs In monopoly or noncompetitive markets, the regulator may be required to aligned prices more closely with costs

International Accounting Rates Technological developments, telecom sector liberalisation adversely affected accounting rates Technological developments, telecom sector liberalisation adversely affected accounting rates Charges grew to well above costs of providing international service termination Charges grew to well above costs of providing international service termination Profits from high accounting rates provided major source of cross-subsidies to developing countries Profits from high accounting rates provided major source of cross-subsidies to developing countries But led to major imbalances in accounting rates payment from countries originating more calls than they terminated But led to major imbalances in accounting rates payment from countries originating more calls than they terminated