1. ITS Introducing Competition and its Welfare Implications in Korean Mobile Telecommunications Services Duk Hee Lee & Dong Hee Lee School of IT Business, Information and Communications University, Daejeon, South Korea August 24, 2003

2. ITS Donghee Lee 22003-8-24 Content I. Introduction II. Korean MTS and Social Welfare III. Estimating Consumer Surplus IV. Estimating Producer Surplus V. Total Social Welfare VI. Conclusions

3. ITS Donghee Lee 32003-8-24 Introduction Industrial change in telecommunications services Rapid growth in the Mobile Telecommunications Industry How has the change affected the social welfare? How much benefits has been achieved from the services? Natural Monopoly Competition Technological advance in switching and transmission Developed new services diversified and individualized demand Service Convergence

4. ITS Donghee Lee 42003-8-24 Korean MTS and Social Welfare Korean MTS market situation Monopoly SKT Duopoly SKT, STI Competition SKT, STI KTF, KTM, LGT 1996.41997.102001.121984.4

5. ITS Donghee Lee 52003-8-24 Korean MTS and Social Welfare Introducing competition How much benefits from MTS have been achieved owing to introducing competition? What are the structural patterns of benefits btw consumers and service operators over the time? Competition Operator profits↑ subscribers↑ Price↓ Quality↑ Consumer benefits↑ calls ↑ Source: KISDI (2001)

6. ITS Donghee Lee 62003-8-24 Korean MTS and Social Welfare Empirical estimation of the benefits Social Welfare in economic concept  Consumer Surplus : price elasticity, operator revenue  Producer Surplus : operators’ annual report Price Equilibrium price 0Quantity Equilibrium quantity A Supply C B Demand D E Producer surplus Consumer surplus

7. ITS Donghee Lee 72003-8-24 Korean MTS and Social Welfare Empirical evidence in some countries Researcher Time Periods Consumer Surplus Producer Surplus CS/GDP U.S. Hausman (1997) 1989~1993B$31 ~ B$50 per year-0.71% UKRA (2001)2001B$10.916 in 2000B$1.1721.32% AustraliaACA (2002)1995~2001 B$2.002 ~ B$4.307 in 2000-2001 - 0.30% ~0.65%

8. ITS Donghee Lee 82003-8-24 Estimating Consumer Surplus Alexander, Kern, and Neil(2000) Critical assumptions: Demand function for MTS is only affected by the service price (for subscription and call) Model: : consumer surplus : subscription price or call price at time t : the number of new subscribers or the volume of calls at time t : elasticity of demand

9. ITS Donghee Lee 92003-8-24 Estimating Consumer Surplus Estimating elasticity (η) of demand for the subscription  factors: subscription fee, handset price, handset subsidy, income level, call price, other consumer product price : Price elasticity of demand for subscription : Cross elasticity of demand for subscription : Income elasticity of demand for subscription : Subscription price (= subscription fee +handset price – handset subsidy) at time t : call price (= basic fee + usage fee) at time t

10. ITS Donghee Lee 102003-8-24 Estimating Consumer Surplus Estimating elasticity (η) of demand for the call  Factors: call price, income level, subscription price, the number of subscribers, and other consumer product price : Cross elasticity of demand for call : Price elasticity of demand for call : Income elasticity of demand for call : Subscription price (= subscription fee +handset price – handset subsidy) at time t : call price (= basic fee + usage fee) at time t

11. ITS Donghee Lee 112003-8-24 Estimating Consumer Surplus Estimated elasticity of demand and consumer surplus Before competition (1996.1 ~ 1997.9) After Competition (1997.10 ~ 2001.12) Elasticity of demand for subscription-5.542-0.615 Elasticity of demand for call-0.898-1.185 YearSubscription CSCall CSTotal CS 199666913979 19972677721,040 19986191,2681,887 19991,0402,4013,441 20007743,0703,844 20017393,2103,949 Total3,50611,63415,140 (Unit: USD Mil)

12. ITS Donghee Lee 122003-8-24 Estimating Consumer Surplus Year199619971998199920002001 CS/GDP(%)0.210.350.580.901.011.06

13. ITS Donghee Lee 132003-8-24 Estimating Producer Surplus Producer surplus Economic concept  The dollar amount by which a firm benefits by producing a profit-maximizing level of output.  If ∏ E (economic profit) = TR - TC and TC = VC + FC, then PS = TR – VC = TR – TC + FC = ∏ E + FC (in the short-run)  In the long run, PS = ∏ E  TC already includes opportunity cost of capital that a firm requires to do business. (Frank, 1999)

14. ITS Donghee Lee 142003-8-24 Estimating Producer Surplus Total cost of MTS (TC) Accounting Principle for telecommunications services  introduced in 1994 to provide: useful accounting information for a fair competition among operators; proper telecommunication policy-making; reasonable and efficient decision-making of operator;  and then has been revised (KISDI, 2003). Business cost + Return on invested capital (ROIC)  Business cost = Operating expense + Non-operating expense (license fee, NUSC, loss from disposal tangible assets, tax)  ROIC = Rate base × Cost of capital (Required rate of return)  Rate base = (average tangible/intangible assets per year) + (average inventory assets per year) + (relevant working capital)

15. ITS Donghee Lee 152003-8-24 Estimating Producer Surplus Cost of capital estimated in other countries ResearcherMethod Results (real price, pre-tax WACC) Hong KongNERA (2000) WACC CAPM Incumbent: 9.78% ~ 15.33% Entrant: 10.84% ~ 16.20% UKOftel (2001) WACC CAPM Low gearing: 13.55% ~ 16.95% High gearing: 13.01% ~ 16.61% AustraliaACG (2000) WACC CAPM Pilot area: 10.0% ~ 10.2% Extended zone & rest: 7.6% ~ 7.7% for NUSC in 2000-2003 Korea Referring to the several cases, we assume that CoC of Korean MTS ranges from 10%~15% (12%~17%)

16. ITS Donghee Lee 162003-8-24 Total Social Welfare Results of estimation PS is negative value until 2000 Cumulative total PS generated by MTS is amount to -$2,448 ~ -$794 million. Thus, total social welfare is less than consumer surplus. Year199619971998199920002001Total PS (Low ROIC)-105-202-442-606-207767-794 PS (High ROIC)-239-377-704-957-585413-2,448 CS9791,0401,8873,4413,8443,94915,140 Social Welfare (Low ROIC) 8738381,4452,8353,6384,71714,346 Social Welfare (Low ROIC) 7406621,1832,4843,2594,36312,692 (Unit: USD Mil)

17. ITS Donghee Lee 172003-8-24 Total Social Welfare Structural change of social welfare

18. ITS Donghee Lee 182003-8-24 Total Social Welfare The social welfare has been rapidly increased after introducing competition in Korean MTS Consumer surplus is much larger than producer surplus. Mobile operators inputted a huge amount of money for establishing network facilities and promoting marketing activities such as handset subsidy. Consumers largely benefited from the service competition on equipment, price, and quality among operators. From 1998 to 2000, the amount of handset subsidy provided by five mobile operators was about $5.7 billion

19. ITS Donghee Lee 192003-8-24 Conclusion The Korean mobile telecommunications market has rapidly grown since 1997 when competition was introduced. Measuring the effect on welfare, consumer surplus estimated by using price-elasticity of demand reached $15.1 billion during 1996~2001 Producer surplus estimated by using operators’ annual reports was ranged from –$0.8 ~ -2.4 billion during the time period. Due to the competition, consumer has benefited much more from the MTS than the mobile operators in Korea. Thank you !