1. PUBLIC POLICY TELECOMMUNICATIONS IN MEXICO TELEFONICA MÉXICO FRANCISCO GIL DIAZ APRIL 2008

2. TELEFONICA MEXICO PRESIDENCIA 2 The Network International Rankings Price Gauging Network Costs The Price Cap Local Area Dialing Costs Accounting Separation Apportionment Of International Settlements Regulatory Capture INDEX

3. TELEFONICA MEXICO PRESIDENCIA 3 The Network TELMEX is Mexico’s telecommunications hub. After 18 years of its privatization some service indicators have had remarkable improvements: phones are reliable, the network is modern, there is fiber optic all over the country and subscribers are not required to buy shares of TELMEX, bribe, pay a fortune and wait months for installation. 01

4. TELEFONICA MEXICO PRESIDENCIA 4 The Network But if this outcome is judged by what it should have been, by its unfulfilled potential, by its comparison with what other countries have accomplished in a short time despite starting at a much later date, we have a dismal failure. The national network was turned into the private sphere without putting in place the public policies, legislation and specially enforcement to prevent it to prey upon competitors and ultimately upon consumers. Beyond the disproportionate cash flows captured by the incumbent, lack of national competitiveness and an epidemic of depredatory practices, we have a State within the State. A power within itself that can influence and block policies to its advantage. 01

5. TELEFONICA MEXICO PRESIDENCIA 5 International Rankings Charts 1a, 1b and 1c and Charts 2a, 2b, 2c portray telecommunications indexes for Latin America. The first set show unadjusted ranks. The second set uses per capita income to “normalize” them. Mexico’s ranking then tumbles, to last, before last and third from last respectively, way below countries with per capita incomes far under it. 02 Jen ranks as top celebrity cover girl…

6. TELEFONICA MEXICO PRESIDENCIA 6 International Rankings 02 CHART 1a CHART 1b

7. TELEFONICA MEXICO PRESIDENCIA 7 International Rankings 02 CHART 1c CHART 2a

8. TELEFONICA MEXICO PRESIDENCIA 8 International Rankings 02 CHART 2a CHART 2b

9. TELEFONICA MEXICO PRESIDENCIA 9 International Rankings 02 CHART 2c Source: International Telecommunication Union, World Bank

10. TELEFONICA MEXICO PRESIDENCIA 10 Price Gauging Vincent Price High prices explain low quantities demanded. The poorest segment of the population, the one that never exceeds the 100 calls per month included in the monthly basic rent, pays 4.85 pesos per call, almost half a US dollar[1].[1] Notwithstanding the above, with a great sense of humor the incumbent dares to complain about alleged local monopolies that compete unfairly against it: cable operators that provide telephony, Internet and television, even though the latter rely on TELMEX for transportation and call delivery. But market shares and the number of firms are irrelevant under a monopolist supplier of an essential backbone and last mile termination. Imagine 2 possible situations. One a highway network owned by a single proprietor who charges for its use. To label its situation as a monopoly, does it matter if the owner owns no trucks or buses? The same would be true of an airport network owner with no airplanes. In both cases there will be monopoly prices for the final consumer. [1][1] It is not a price as such; it is arrived at by dividing the amount spent by consumers by the number of calls. 03

11. TELEFONICA MEXICO PRESIDENCIA 11 Price Gauging Another egregious example of favoritism: in the same year TELMEX was privatized, with no charge for the frequencies to be used, and through a direct grant sans competitive bidding, it was granted a concession to operate a nationwide wireless operation. 03

12. TELEFONICA MEXICO PRESIDENCIA 12 Price Gauging Under its prerogatives the government can tackle the monopoly problem by pricing services that are essential as if there were a competitive market. The concession title of TELMEX also contains provisions related to competitive requirements. However, legislation, international treaties and title provisions have not mixed with enforcement 03

13. TELEFONICA MEXICO PRESIDENCIA 13 Network Costs 04 Network Cost Structure Chart 3 is constructed such that equal distances from Mexico City to other cities are considered. One route is from Mexico City to a fixed line in Tepic compared with a Mexico City call to a fixed line in Compostela. There is interconnection to Tepic while TELMEX refuses to interconnect Compostela and collects what it labels a “resell charge”. Green labels are used to depict TELMEX’s costs and/or the charge made by a competitive provider.

14. TELEFONICA MEXICO PRESIDENCIA 14 Network Costs 04

15. TELEFONICA MEXICO PRESIDENCIA 15 Network Costs 04 Costs faced by a competitor are 26.6 centavos per minute under competition (Tepic termination) versus 83.8 centavos under the resell charge. It costs therefore 3.15 times more to deliver a call when TELMEX refuses to recognize that what it provides is an essential input. With TELMEX in control of 60% of the national backbone and 94% of last mile terminations, its charges prevail. If TELMEX’s costs, including a competitive return to capital, are taken into account, the interurban transit fee falls to 4 centavos per minute and the termination interconnection fee to 6 centavos. With these numbers the relevant comparison is between the 83.8 centavos already mentioned and 18.8 centavos, or a ratio of 4.5 times instead of the already high one of 3.15 times.

16. TELEFONICA MEXICO PRESIDENCIA 16 Network Costs 04 Regulatory paraplegia has also protected TELMEX from fulfilling a prerequisite for a competitive market: physical interconnection. Competitors wait up to two years. AVANTEL received its concession for local services in 1998 to achieve interconnection only 2 years later. GTM waits since February 2006 for the monopoly’s deference. Cable operators who provide broadband Internet, TV signals and telephony have suffered similar delays. 4 D’s that illustrate the behavior of a monopolist regarding interconnection: DENY --- DELAY --- DETERIORATE --- DUMP. TELMEX honors them all.

17. TELEFONICA MEXICO PRESIDENCIA 17 The Price Cap The powerful instrument provided by a required price cap revision of TELMEX has been neglected. The authorities have not taken into account TELMEX’s productivity increases. The pallid adjustments required in Mexico are striking when compared with what similar countries have imposed on the incumbent 05

18. TELEFONICA MEXICO PRESIDENCIA 18 The Price Cap Chile imposed a 30 percent adjustment in 1999 and is currently going over the next one. Peru required a 10.4 % adjustment over 2004-2007 with a further one of 6.4 percent per year for 2007-2010. The accumulated change will be 41 percent for the 6-year period. In Mexico the adjustment factor for the same 6 years is of only 3 percent. Chile and Peru post processes in the Internet while Mexico’s is a closed-door process with the result announced at its termination. 05

19. TELEFONICA MEXICO PRESIDENCIA 19 Local Area Dialing Costs expensive - the cost of one call... Because the marginal cost of transporting a call over long distances has fallen to practically zero, local area dialing zones (LAD) have been eliminated in most of the world. To benefit the incumbent (LAD’s) have not been eliminated in Mexico. Some LAD’S were eliminated in 2007 but even these timid regulatory efforts have been successfully challenged in court by TELMEX 06

20. TELEFONICA MEXICO PRESIDENCIA 20 Accounting Separation The avoidance of cross subsidies is a key competitive issue. TELMEX has never complied with its title’s or legislation requirements to apportion the costs of its diverse services. Some examples: — In 2005 it introduced a retail long distance tariff of 50 centavos while charging wholesale operators 75 centavos — TELMEX packages unlimited LD calls with its local service, an offer impossible to replicate by the other operators since they are forced to pay TELMEX for LD services in half of the LAD’s. 07

21. TELEFONICA MEXICO PRESIDENCIA 21 Apportionment Of International Settlements.. International Telecom International long distance settlements favored Mexico in the late seventies by 1 billion dollars. To benefit TELMEX the authorities devised a concept labeled proportional return. Under this formula an operator could not compete with TELMEX to capture incoming traffic, it had to accept to share the pie according to its proportion in outside calls. The starting rules (1996) stated that the system would last only three years, it went on for seven, and only because the government lost an arbitration panel before the WTO 08

22. TELEFONICA MEXICO PRESIDENCIA 22 Regulatory Capture Peter-Paul-Rubens-The-Capture-of … We have a perfect case of regulatory capture, of a giant economic machine created by a government, one that commands a cash flow of several billion dollars per year that has allowed it to prey upon suppliers, competitors and consumers. It has allowed it as well to branch out and to dominate or attempt to dominate other areas of economic activity. It is a case of lost welfare in a competitive global environment. In a flat world Mexico is surrounded by huge artificial mountains. 09

23. TELEFONICA MEXICO PRESIDENCIA 23 HOPE Hope on the Horizon

24. TELEFONICA MEXICO PRESIDENCIA 24 HOPE However, there is hope in the horizon, President Calderón has announced his firm intention of providing competitive conditions for all Mexican markets