1

Contents

Introduction 3

Chapter 1: Technology Evolution and the Internet 4

Chapter 2: The practice of access pricing in telecommunications 32

Chapter 3: The economy of the cables and satellite in France 67

References 87

2

3

Introduction

The juxtaposition of the words economy and digital fact refers to an 'economy of numbers. This mathematical vision which is more restrictive than the notion of 'computer economy' seems to prioritize the numbers on the other types of information.

Often the term digital economy returns in a reductive way to e-commerce leaving aside other components such as services, infrastructure and the underlying technology. More specifically, the term should refer to telecommunications, audiovisual, software, computer networks, computer services, services and content online. According to GfK, the digital market brings together information technology (computers, phones, players, GPS...) and communication (social networks, online... sales) services and would be 681 billion in 2009.

Digital brings together the Technologies of Information and Communication as well as all the techniques used in the processing and the transmission of information such as for example telecommunications, internet and information technology.

The digital sector means the sector of economic activity on the Technologies of Information and Communication and the production and sale of digital products and services.

The digital economy in the scientific sense of the term is the study of intangibles that are by definition non-rival goods to marginal cost zero. This definition induces new relationships, new models of Exchange/sharing, only possible by Internet, a new concept of private property. It is a complete sub-domain of the economy, not to be confused with the digital

sector which belongs to the classical economy, nor with the digitization of the economy, with inevitable process on all material goods and all services. As these intangibles are creations of the spirit of artistic or intellectual nature, digital economy brings new models and new possibilities for the knowledge-based economy for and the economics of culture.

In order to establish boundaries and facilitate learning, I have divided this book into tree

chapters: the fisrt chapter entitled technology Evolution and the Internet, the second chapter

entitled the practice of access pricing in telecommunications and third chapter entitled the

economy of the cables and satellite in France.

4

Chapter 1: Technology Evolution and the Internet

1. The evolution of the web

The web today is a growing universe of interlinked web pages and web apps, teeming with

videos, photos, and interactive content. What the average user doesn't see is the interplay of

web technologies and browsers that makes all this possible.

Over time web technologies have evolved to give web developers the ability to create new

generations of useful and immersive web experiences. Today's web is a result of the ongoing

efforts of an open web community that helps define these web technologies, like HTML5,

CSS3 and WebGL and ensure that they're supported in all web browsers.

The color bands in this visualization represent the interaction between web technologies and

browsers, which brings to life the many powerful web apps that we use daily.

2. Evolution of major alternatives to traditional telephone networks

2.1. Emerging network technologies

In the traditional Industrial Organization framework, ‘‘Emerging Network Technologies,’’ by

Dale Hatfield, Bridger M. Mitchell, and Padmanabhan Srinagesh characterizes the basic

conditions of supply, as it is now evolving, in the telecommunications sector. At the same

time, it clearly shows how these basic conditions shape and are themselves shaped by the

structure, conduct, and policies in the sector. The authors take the traditional switched

telephone network as their starting point to show how emerging technologies will affect

message communication.

Following a detailed description of characteristics of traditional voice data and cable

television networks the authors discuss the architecture of public switched telephone networks

(PSTN), and its limitations in responding to changing demands placed upon it by alternative

media and new technologies. In contrast, the architecture and institutional approach of the

Internet has led to the emergence of a vision of an evolving network that conveys all

applications, whether they be voice, data, images, video, or multimedia. Similar pressures are

shown to have resulted on cable TV, commercial wireless, and satellite networks with

5

corresponding responses. Finally, the authors address the effects of positive and negative

message externalities that have gained prominence in light of emerging message technologies.

The traditional PSTN is ideally matched to voice traffic. It is based on circuit switching and

time division multiplexing to prevent latency of traffic. In contrast, data traffic is based on

packet switching and statistical multiplexing, which involves the sharing of transmission

capacity. Thus, a data network can deal with bursting data traffic and is error free, but it

results in some latency. Because the traditional PSTN cannot handle data and multimedia

traffic well, it cannot make use of scale and scope economies from combining these types of

traffic.

On the traditional PSTN bandwidth is only available in fixed increments. Its dedicated

capacity cannot handle bursting traffic. There exist high costs of setting up calls. The access

network is largely analog and there is vulnerability to single point failures. New technologies

and more demand for network reliability therefore suggest changes in the PSTN architecture.

New but already established developments in traditional wire line architecture include

SONET/SDH, interoffice signaling and intelligent network (IN) features. The signaling

network SS7 is packet-switched. Additional service logic and associated databases connected

to signaling packet switches form the IN. Thus, the intelligence is contained in the network,

while user equipment is dumb. The integrated services digital network (ISDN) access network

has not been successful in the U.S. but is now widespread in Europe. The worldwide spread of

digital subscriber line (DSL) supports two parallel and quite different networks that have the

access lines in common.

In contrast to the PSTN the Internet uses routers with dumb functions. The intelligence is on

the edges and in the terminals. In contrast to traditional data networks the Internet is not

responsible for correcting errors. Rather, error correction is done by hosts. Voice over Internet

Protocol (VoIP) potentially has large capacity requirements. Again, the intelligence is in the

terminals. The authors expect that traditional telephone companies will disappear, as the

Internet architecture takes over.

The trends in the traditional PSTN are shaped by advances in cable TV and wireless, but these

influences are entirely mutual so that new cable TV networks (triple play) look more like the

new PSTN and, similarly, cellular networks are evolving into an equivalent structure. The

greater similarity of network structures and, therefore, network abilities in performing

services along with their parallel existence will increase competitive pressure among the

6

different types of companies, even if competition within the fixed network types is limited by

near monopolies in the access networks, while wireless networks support oligopolistic access.

The authors predict increased competition at the ‘wholesale’ level between network

components of all networks. In our view, the intensity of such competition increases with the

level of player in the network hierarchy. Wholesale competition is strongly affected by

unbundling policy. Intermodal competition will be limited by differentiating demand and

supply characteristics that can be maintained for some time. Relevant demand characteristics

include quality of voice communication, reliability of service, and prompt and fault-free

delivery of messages.

The main differentiating factors on the demand side are speed, voice quality, and mobility and

on the supply side the relative access costs and usage costs (Vogelsang, 2003). For example,

wireless networks have low access and high usage costs, combined with low speed and voice

quality, and high mobility. In contrast, fixed networks have high access and low usage costs,

which they combine with high speed and voice quality and no mobility. The combination of

these factors gives fixed networks a limited niche for high demand customers outside their

mobility needs but lets them exit the low demand voice market, while wireless networks will

dominate low demand voice markets and compete with fixed networks for non-mobile voice

and low-speed data services. Wireless will continue its niche for mobile services.

Positive message externalities, as opposed to pure network externalities, lose importance

through reduction in calling prices, and the move to flat rates, and moves toward ‘single-

party’ forms of communication, such as web browsing, file transfers, etc. At the same time,

negative message externalities from unwanted.

calls and messages increase due to low cost of sending multiple messages to many receivers.

The authors show in a formal model that, as a result, welfare-optimal calling charges should

slightly exceed marginal costs.

2.2. Bandwagon effects .

The importance of network effects in telecommunications networks has been appreciated for

decades, but recognition of the role such or similar considerations have across the much

broader and longer value chain of information and communications industries is more recent.

Some authors note that owners of CD players, digital television sets and PCs benefit from the

latter, as do users of the Internet—in each case, the greater the spread of ‘hardware’

ownership or use, the more the ‘software’ that is available.

7

Bandwagon effects have implications for the demand curve, creating the possibility that it is

upward sloping over a range, expressing the fact that, as more units are sold and bandwagon

effects come into play, marginal consumers’ willingness to pay increases. Provided a critical

mass of consumers is achieved, which depends on the size of the relevant community of

interest, sales will grow.

This has a powerful impact on pricing incentives and optimal pricing, and the author

exemplifies this by the telephone sector. Whereas call externalities can be internalized (e.g.,

by alternation of the roles of caller and called party), the same does not apply to subscriptions,

and this creates a possible basis for providing subsidies to get people on to the network,

thereby benefiting existing subscribers.

Devising optimal telephone prices involves the estimation of these externalities and also of

the complex demand relationship linking subscriptions and calls.

Jeffrey Rohlfs relates these considerations to the historical pattern of telephone prices in the

United States, pointing out inefficiency of (but popularity of) low subscription rates and

unmeasured local service. He also notes that since the externalities associated with calls to

Internet service providers (ISPs), unlike those associated with voice calls, cannot easily be

internalized there is a case for providing those at below cost.

2.3. Platform competition in telecommunications

Jeffrey Church and Neil Gandal,‘‘Platform Competition in Telecommunications,’’set out the

classification of networks into those which are direct, linking complementary inputs, such as

origination and termination assets for a telephone call and those which are indirect, where the

effect on consumers is achieved through the supply of complementary products, such as the

software available for PCs1. These networks then generate externalities, which influence both

consumer benefits and the competitive process, leading (possibly) to coordination problems,

standards wars, tipping equilibria, and consumer lock-in.

Business strategies in standards contests, involving pricing, marketing, and the creation of

open standards have been extensively analyzed. As to their efficiency, many results have been

found in particular cases—authors noting that ‘the tendency in theoretical literature is for the

equilibrium to be characterized by insufficient standardization or too much variety’ (emphasis

in original).

8

A second strand deals with battles for compatibility. A firm owning a platform that is

dominant can extend its market power by denying compatibility to equipment produced by

rivals—either directly (e.g., refusing to allow a competitor’s equipment to be attached to its

physical network), or through the exercise of intellectual property rights. Manipulation of

interfaces has become a major issue in both communications and computer systems, attracting

the attention of regulators and the antitrust authorities—see the Microsoft cases in the U.S.

and Europe. Successful use of compatibility weapons can help a firm to extend its dominance

from one generation of technology to another. For example, ensuring that a rival’s superior

software is incompatible with the installed base of hardware assists the maintenance of that

hardware dominance into the next generation, by preventing rivals from breaking into either

sector.

Much attention has been paid, both theoretically and empirically, to the standard setting

process. Cooperative standards come into existence where no firm will earn higher profits by

refusing to participate in the common process. Cooperation is thus favored in situations where

a common standard will enhance consumer adoption and where no firm has acquired a

dominant position in the relevant

intellectual property. The technologies for wireless local area and wider area networks, such

as Wi-Fi and Wi-Max.

In Europe at least, mobile communications have been subjected to governmental standard

setting, with the adoption by the European Union of a harmonized GSM standard for second

generation wireless technology. In North America, by contrast, operators were free to choose

their own technology. This provides an interesting case study of the costs and benefits of the

alternative approaches, although the issue remains unresolved as yet.

Among the examples of platform competition that the authors consider is that between

satellite and cable television in the U.S. In this case satellite distribution sought to establish

itself in a market dominated by cable, assisted by various legislative and regulatory

interventions designed to prevent the new platform from being denied access to programming.

2.4. Broadband

Broadband is the area where the three platforms of DSL, based on the existing

telecommunications networks, cable, and wireless compete, in a marketplace to which

9

governments attach the greatest importance, many of them seeing broadband diffusion as the

key to growth in the knowledge economy.

Robert Crandall, ‘‘Broadband Communications,’’ identifies these and other more advanced

networks, each characterized by different speeds (upstream and downstream) and areas of

application, drawing attention to the differences between DSL over copper and the hybrid

fiber coaxial cables on which cable relies.

A review of national experience of broadband penetration in the OECD area has showed, in

June 2003, Korea to be an outlier at the top, with the United States and Japan at the head of

the second quartile. The presence of a cable network accounts for a high, but normally

declining, proportion of subscribers, in most of the countries at the top of the diffusion league,

thus demonstrating the advantages which are derived from interplatform competition.

Robert Crandall describes the regulatory framework for the development of broadband in the

United States and the European Union. He cites studies by Hausman and others that argue that

regulatory requirements on incumbent telephone companies to unbundle network elements are

inappropriate because incumbents lack market power. Their effect has been to chill

investment by telephone companies, which would otherwise have challenged the cable

companies’ stronger market position in broadband. At the same time Hazlett suggests that

cable companies have themselves restricted the capacity they devote to broadband, because of

the threat of regulation. The Federal Communications Commission (FCC), is however seeking

to restrict, if not eliminate, mandatory access by competitors to incumbent’s future

deployments.

In Europe, some progress has been made in regulating the supply by dominant

telecommunications companies of a service known as wholesale broadband access, or

‘bitstream,’ which comprises of access to carriage on copper loops, digital subscriber line

multiplexers (DSLAMs) and backhaul on, for example, an ATM network. The pricing of this

service has proved problematic, not least because its costs are uncertain. For this reason,

several European regulators have favored an approach known as ‘retail minus,’ where prices

are set, in the style of the efficient component pricing rule (ECPR), on the basis of the access

provider’s retail price for a broadband service minus its costs of providing those services,

which the access sector provides itself. The ERG has mooted in the same document an

approach to broadband regulation in which competitors are encouraged progressively

10

to replicate the incumbents assets, starting with backhaul and DSLAMs and possibly

culminating in replication of the local loop itself.

The diffusion of broadband is also leading to concerns about the ‘digital divide’ and to

discussion of the extension of universal service obligations to cover broadband.

With household take up rates of the order of 10–25 percent in the more advanced OECD

countries, and with access to broadband being increasingly expanded as a result of enabling

more and more exchanges to provide asymmetrical digital subscriber line (ADSL), there is

little appetite on the part of governments and regulators at this stage to provide subsidized

access to all.

The current focus on developing broadband competition is both widespread and

understandable. Competitive broadband suppliers based on cable or DSL technologies have

the potential, via new voice technologies, to break incumbents’ dominance in fixed voice.

They might also provide a basis for more competition in the roll-out of fiber to what is

sometimes referred to as next generation broadband.

As the diffusion of broadband accelerates, the success or failure of attempts to promote

competition will become more visible.

Yet, the danger is all too real that the quantity and intensity of regulatory debates in the older

economies, in telecommunications terms, such as that of the United States and Europe, will

lead them to decline as the newer economies, such as China, India, Japan, and South Korea,

bypass the regulatory regimes considered irrelevant and promote broadband diffusion actively

so that the largest numbers of persons in the world have eventual Internet connectivity.

2.5. Cable television

Thomas Hazlett begins his thinking, ‘‘Cable Television,’’ by noting Negroponte’s prediction

that while we were born into a world of making voice calls over wires and watching over-the-

air television, this would soon be reversed. While the use of cable to deliver television

programs has become the dominant mode of transmission in highly cabled countries in North

America and parts of Europe, even in the U.S.A.

satellite television represents a competing platform, and elsewhere new higher capacity digital

terrestrial transmission technologies are being developed.

After initially restricting cable growth in favor of traditional broadcasters—as the FCC put it

in 1966, restricting the role of cable to complement, rather than substitute for over�the�air

and services—from 1976 cable was subject to deregulation. First, the FCC dropped its rules

11

preventing cable systems from carrying any but the closest broadcast TV stations; then the

courts struck down regulations on premium movie channels; then, in 1984, Congress passed

the Cable Communications Act, which simultaneously outlawed rate�fixing by local

authorities and restricted competition in video from telephone companies. This caused prices,

quality of service and subscriber numbers to grow.

The rise in prices itself contributed to a re�regulation via the Cable Act of 1992, which led to

rate regulation where effective competition was found to be lacking.

The author reports a complex series of reactions by cable companies, of which the most

prominent were reduced investments, efforts to switch subscribers to less regulated higher

tiers of service and overload of regulatory officials by requests for rate increases. Following

passage of the 1996 Telecommunication Act, cable rate controls were again abandoned from

1999.

The rapid alteration of policy over rate regulation was accompanied by extensive debate over

the degree to which cable operators, particularly multiple system operators (MSOs), were able

to exercise market power in other ways, as monopsonists in relation to program suppliers,

through vertical integration with the latter and by predation of rival operators or

‘overbuilders.’ Thomas Hazlett notes the difficulty of establishing whether a large buyer is

underpaying for programming in a heterogeneous product market characterized by keen

bargaining, and that there appears to be no rule that ownership ties between program makers

and cable operators are essential for the success of either.

As noted by Robert Crandall, ‘‘Broadband Communications,’’ cable operators now have a

major alternative revenue stream through the supply of broadband and, in some countries,

cable telephony. At the same time DSL and satellite offer increasing competition in the

delivery of cable’s traditional entertainment services.

The widening of the marketplace through convergence will attack market power in

previously separated services and should transfer the pressures on cable operators throughout

the world.

2.6. Wireless communications

Somes researchers note, the growth in mobile telephones used for voice over the last 10 years

has been spectacular, reaching by 2004 more than 80 percent inhabitants in many countries in

Europe and elsewhere, although lower in North America. But wireless technologies now

12

extend much more widely; 3G, available in an increasing number of countries, provides high

bandwidth mobile services.

Short range nomadic services, known as Wi-Fi, provide broadband access in tens of thousands

of airport lounges, coffee shops and other locations throughout the world; and new fixed

broadband technologies provide high speed services over longer ranges, and appear to offer

good prospect for providing broadband in less densely populated areas, as well as providing

competitive services elsewhere.

By definition, wireless communications services for households and firms depend on

spectrum, for which they compete not only with broadcasting services, but also with the

whole range of spectrum-using activities, such as closed-group private mobile radio,

aeronautical radar and communications, defense, science, such as astronomy, and others.

Balancing these needs is accomplished using one of three methods—the traditional ‘command

and control’ process of allocating bands to particular uses by international agreement and then

assigning spectrum to individual firms or organizations by an administrative process; use of

market instruments, such as auctions and secondary trading; and creation of unlicensed

spectrum to which users satisfying certain conditions or the power of their apparatus can have

access.

Governments and regulatory bodies are moving gradually away from the first method in favor

of markets and—to some degree—unlicensed spectrum. The spectrum or license auctions

described are a step in this direction, but by themselves do little to eliminate imbalances in

spectrum allocation as the auctioned spectrum is tied to particular uses. To eliminate such

imbalances, liberalization of use is required, which itself requires a re-specification of license

conditions in the direction of restrictions on the ability of any licensee to impinge upon

spectrum utilized by a licensee in an adjoining frequency or geography. Such liberalization

has occurred in several countries.

Unlicensed spectrum has come into prominence through its widespread use of Wi-Fi. Because

of its short range and low power, users in adjoining sites need not interfere with one another,

giving the employed spectrum a zero opportunity cost.

In fact, about 9 percent of prime spectrum in the U.K. is set aside for unlicensed uses. A

number of new technologies exist, which permit more services to be provided in unlicensed

spectrums and several proponents of universal unlicensed spectrum have looked forward to

spectrum becoming a plentiful and free resource.

13

Regulators have now to address themselves to the questions of the balance between licensed,

and increasingly marketable, spectrum and unlicensed spectrum.

It is, however, hard to see how technologies using the latter can compete in, for example,

wide-area point to multipoint communications, such as satellite or terrestrial broadcasting, for

which an interference-free channel is required to benefit from the low-cost distribution

method.

A second key issue discussed by the authors is the scope for competition in voice between

fixed and mobile networks. In some low- and middle-income countries without fixed

networks, mobile telephony has, temporarily or for longer, filled the gap. The pertinent

question for fixed and mobile operators in other countries is whether mobile is increasingly

attracting subscriptions and calls from fixed networks.

The authors cite chiefly European studies. The U.S. mobile market, where mobile operators

provide large, inexpensive call ‘buckets,’ may be more advanced.

Imminent technological change will affect both. 3G mobile networks have the capacity to

provide calls on a packet-switched basis, rather than the traditional circuit-switched method.

Equally, fixed networks are increasingly moving toward VoIP or Voice over DSL (VoDSL)

technologies—the latter using broadband connections.

The rates at which these new technologies are rolled out, themselves governed by competition

between fixed and mobile operators and within each group, will determine future trends.

Already, mobile revenues have overtaken fixed line revenues in many countries, such as the

U.K., even though the volume of fixed voice calls is far greater than that of mobile.

It is sometimes asserted that wireless communications are a regulation-free zone. But, despite

the lack of retail price regulation, this is hardly the case, as the authors show. First, regulation

through licensing determines the structure of the industry, in a way not encountered in fixed

networks. Second, regulators often determine choice of technology, either directly or

indirectly by imposing conditions, which only one standard can satisfy. Third, regulations

often require number portability, the unlocking, and transferability, of SIM cards and national

roaming, with the latter requiring access provision, normally temporary, by a new entrant to

an existing network. Finally, regulators increasingly examine and intervene in two wholesale

services provided by mobile operators—the termination of calls on the network and the

provision of international roaming, which enables a customer of a network in one country to

14

make calls in another country— the subscriber’s operator compensating the visited country’s

operator for the services supplied, and recovering it as retail charges from its own customer.

International wholesale roaming charges in Europe are under scrutiny both by the group of

industry-specific regulators known as the European Regulators Group and, in the case of two

U.K. operators, by the Competition Directorate of the European Union. Analysis of the

market is complicated both by technological changes, which now allow an operator to

program its customers’ SIM cards so that they will seek a particular network when the

customer seeks access in a country, and by the growth of operators active in many countries,

or forming cross-country alliances.

Intervention in mobile termination charges is more widespread and has a longer history. In the

European Union where the CPP principle, under which the calling pay for termination, all

national regulators are investigating the termination, with a requirement to impose remedies

where they find dominance—a likely outcome if they declare each operator’s mobile

termination to be a separate market. As the authors point out, however, if all excess profits on

termination are ploughed back into attracting customers buying subscriptions and making

outgoing calls, it is the structure of termination charges and outgoing prices rather than the

level of profits, which is affected. But this requires very high levels of competition among

mobile operators which, given the small number involved, may not exist. Even if it does, it

will be inefficient.

Linking Gans, King, and Wright with Thomas Hazlett convinces us that the ‘Negroponte

switch’ whereby the public would consume television programs via land connections and

telephone connections via space has probably already taken place.

3. The Internet

Along with mobile telephony, the Internet has emerged as the single most simultaneously

creative and destructive influence unleashing the creation of new infrastructures, businesses,

business models, and economic concepts in the last decade.

In the 10 years that the electronic portals and gateways were made open to the world at large,

not only has a wave of Schumpeterian creative destruction changed businesses, but it also has

changed the sociology of how communications services are consumed. As the proportion of

people using the Internet increases, the proportion of people watching television drop, as

documented in a recent study by the Center for the Digital Future. What was once the passive

15

activity of television watching now becomes interactive, conducted via the Internet, and

brings about not just economic but social change as well.

In 1994, about two million computers were connected to the Internet, as it was then used

mainly by academics, scientists, and corporate researchers. By 2000, about 70 million

computers were connected to the Internet. The Internet is a ubiquitous presence in the lives of

over three-fourths of the population living in the United States. In 2004, over 200 million

computers were connected to the Internet. An aspect of writing about the Internet for a

handbook that is essentially global in character, and for a phenomenon that permits global

connectivity on an unprecedented scale. The history of how the Internet has evolved has

surely affected its geography. Thus, the lessons of the U.S. experience apply generally to

other communications infrastructures that are being created around the world.

3.1. The economic geography of the Internet infrastructure

The origin of the Internet is dealt with in a number of other comprehensive histories, with a

variety of details about the individuals who were key players also provided, but the diffusion

issue has hardly merited attention. The author deals with six broad questions. The first is, why

did near geographic ubiquity arise in the United States after commercialization?

The second is, why did market forces encourage extensive growth? The third is, has the

Internet diffused disproportionately to urban areas? Fourth, is the Internet a substitute or a

complement for urban agglomeration and an influence on business location decisions? The

fifth question is, which policies mattered and were the effects intended or unintended?

Finally, are there lessons for other countries?

In dealing with the first question, given that Internet technologies had been available for

around 20 years, by the early 1990s, the role of standardization was critical. By the early

1990s, items of infrastructure, such as hubs and routers, Ethernet cards, and T�1 line were

available and hooked together, but the acceptance of the TCP/IP protocol voluntarily by the

various players made comprehensive interconnectivity possible. An aspect of the Internet is

its overlay structure, with many components being retrofitted to the existing network. The

computing, telecommunications, and the network equipment industries were mature and had

existed for some time. Since such assets were already available, the standardization of

components throughout the system quickly led to the realization of scale economies. The

16

characteristics of the core physical elements of the Internet were malleability, deployment

ability, and retrofit ability. These led to high�speed infrastructure creation.

The second issue is the role of market forces and entrepreneurial organizations.

The Internet has spawned hundreds of ISPs, at the consumer or the retail end, who quickly

provided cheap access to millions of U.S. households. In fact, the growth of such

organizations, and the density of competing suppliers, is enormous. The ISP sector has shown

the classic patterns inherently noticed in the evolution of any industry. At the initial phase,

there are a small number of firms, which establish very strong positions to be followed by,

often, thousands of new entrants and then there is a shakeout, as the industry matures, leaving

the field to a smaller set of competent players.

The author goes into the demography of the ISPs and the strategy of the ISP firms. Such

demography dynamics have important implications for other countries. A key issue is,

however, why did the dynamics evolve the way they did? In our assessment, one reason why

these firms were able to quickly go into business is because of the pricing model they were

able to adopt. Based on the contents of the Computer Inquiry 2 (CI2) report of 1980, Internet

services were classified as an enhanced service, avoiding the telephony access charges, even

though the authors of CI2 had not at all then foreseen the arrival of the Internet in its present

form, and its objective was not to propel the growth of the Internet.

Internet Service Providers were, thus, able to provide Internet services to subscribers

at the price of a local phone call, which was essentially free since a fixed sum per month

permitted customers unlimited local calling. Thus, a pricing model permitting low�cost

service supply led to the set up of many ISP businesses that then provided connectivity to the

Internet. The grassroots origin of the Internet, as opposed to a top down imposition of the

phenomenon, has had major consequences in the diffusion of the Internet within the United

States. It has also had major consequences for the growth of Internet-based entrepreneurship,

which has been propelled by the architecture of openness that characterizes the Internet

phenomenon.

At the grassroots level of the consumer, the role of ISPs is paramount. Equally important,

however, is the role of the backbone network, which is the wholesale part of the network as it

were, since information originates from a variety of sources and is accessed by the ultimate

customer. This information is aggregated at the backbones so that it may be exchanged among

the servers and the ISPs. A variety of backbone networks carry traffic, in substantial

17

quantities, and there is interchange of such traffic. The interexchange of traffic between

backbone networks leads to the same sorts of interconnection issues that arise in voice

networks.

These were initially governed by self-regulated cooperative peering arrangements, eliminating

the need to monitor traffic.

The sociology of the Internet community created a system that included openness, fairness,

and a competitive ISP sector as core values. However, as some backbone networks have

gotten larger than others, the question of market power has arisen as bigger networks can

discriminate against smaller ones, highlighting the need for possible regulation of the Internet.

The author concludes that interconnection issues have not shaped the evolution of the Internet

phenomenon, as it has in voice telephony, and even the collapse of WorldCom, one of the

world’s largest backbones, with over 40 percent market share, did not affect the spatial shape

of the sector.

The next major issue has to do with broadband. Internet relies heavily on broadband. From a

geographic perspective, the key conclusion that the author reaches is that dial-up is still more

widely spread than broadband and broadband is available primarily in dense urban areas.

However, as he states, the regulatory environment is in a major flux, and the jury is out on

what will happen to universal broadband diffusion, across rural as well as urban areas of the

United States.

The comments that we make with respect to policies for broadband diffusion apply to the

Internet phenomenon as well, since the Internet is an add-on infrastructure on top of the

existing network. The basic telephony infrastructure is still relevant for the Internet. The issue

of the last mile still holds, we feel, since there is a very clear symbiotic relationship between

the evolution of the Internet, in diffusion as well as quality terms, and the evolution of the

fixed-line telephony network as a whole. The Internet does use preexisting infrastructure and

is embedded in the communications system of a country as a whole. The 14 S. Majumdar, I.

Vogelsang and M. Cave embeddedness of the Internet in the national communications

infrastructure is a key contingency that policy makers must keep in mind. A holistic policy

assessment must link Internet diffusion with the basic telephony regulatory issues.

Because now one can work from practically anywhere, and deliver products or services to any

location, the issue of whether the Internet has replaced urban clustering or not becomes highly

relevant. It is this area of concern that the author addresses next. In an era of progressive

18

urban congestion, in parts of the world that are salubrious, the location of businesses based on

the usage of the Internet infrastructure becomes important. Since the Internet provides a

substitute for face-to-face communications, the necessity of locating one’s offices at the same

place where one delivers products or services no longer holds. Therefore, a new approach to

the whole question of spatial considerations in the engendering of economic activity is

required. This is an open research area.

In our view, the area of analysis should be further boosted by bringing in the issues of

outsourcing and business-to-business (B2B) commerce as the topics of salience in the twenty-

first century. Business-to-business commerce growth, responsible as it was for the boom, and

subsequent bust, was propelled by the very presence of the Internet, which provided for the

possibility of conducting commerce in manners that would have enhanced efficiencies.

Outsourcing too, as it is developing, would not have been possible had it not been for the

feasibility of information technology enabled services (ITES) to be provided over substantial

distance, in many cases these distances being several thousand miles. Both B2B and several

variants along the alpha-numeric theme, such as government-tocitizen (G2C) activities that

are engendered by the development of e-governance, and outsourcing are two extremely

important topics that now become significant and worthy of study given the spatial impact of

the Internet.

3.2. Economics of the Internet backbone

The Internet is akin to a standard telephone system in that there is a local layer of players, the

ISPs, and a layer of players similar to the longdistance operators, which are the Internet

backbone providers (IBPs). The IBPs operate the high speed hubs permitting data transfer

from far-flung servers to the local ISPs who then transmit it to their local customers. It is not

surprising that in 1997 the major IBPs were MCI WorldCom, GTE, AT&T, and Sprint. These

were the companies then dominating the U.S. long-distance telephony sector as well. In

common with the rest of the sector, the fortunes of these firms have reversed in the years

since 1997.

In a sense, the economic, strategic, and regulatory issues relating to IBPs and their

relationship with the ISPs are similar to those obtaining between a wholesaler and a retailer,

or an upstream producer supplying units to a firm that is downstream in the industry value

chain. With the Internet, the added complications arise from the fact that a variety of ISPs are

19

connected to each other, so that the network is much richer in terms of connectivity than a

standard telephone network. Thus, this complication, in fact, is an advantage since there are

many routing choices available for the traffic to pass, and the presence of many parties who

provide the data carriage helps bring competitive discipline to pricing. This feature of the

Internet, the ability of the ISP to connect with several IBPs, called multihoming, ensures that

no ISP is captive to any IBP.

With respect to the issues of market power that can emerge within the Internet backbone

segment, the author asks an important question, and one that has surfaced in various

regulatory proceedings given the various telecommunications mergers that have taken place:

Can the IBPs exercise market power so that ISPs have to pay more for carriage and eventually

pass on these costs to the ultimate consumer? The answer is a resounding ‘no’ for several

reasons. First, there is overcapacity in the sector, similar to the overcapacity in the trunking

segment of the long distance sector, and there is ease of entry and expansion. Following the

majors, firms, such as Quest, Level 3, and Williams were also able to create Internet

backbones. Second, the Internet operates on public standards and protocols, and these enhance

interoperability so that the possible absence of technical connectivity is hardly a moot point.

Connectivity is universal. There is also the possible commoditization of the backbone as a

whole.

The second major issue is whether IBPs can behave strategically by raising prices, as in

vertically organized market segments, or degrade quality. Nicholas Economides describes

some key features of the Internet as opposing the successful implementation of such

strategies. If the price of transit that is the carriage of traffic between an IBP and an ISP for a

consideration, increases there simply will be bypass. Other IBPs will be used, or if that is not

a feasible strategy, then ISPs will simply provide transit for each other, either commercially

for a price or via a peering arrangement whereby no charges are made for inter-ISP traffic

transfer, a strategy similar to a knock-for-knock agreement among automobile insurance

companies. For similar reasons, an IBP cannot price discriminate either. In a manner similar

to the above, service quality degradation is also not a viable strategy for the IBP since the

implications are farreaching and touch every part of the Internet. Capacity is now fungible,

and an ISP can easily switch between IBPs who provide the least cost data trunk routing

capacity.

20

The Internet portion of the overall communications infrastructure is extremely competitive,

both at the level of the ISPs and the IBPs, in the United States. While there has been concern

that IBPs, by virtue of their larger size, and smaller numbers, could exercise market power,

this is unlikely. Our view, based on the Internet, is that it is a sector that is organized in a

horizontal manner, as opposed to the traditional PSTN sector that still displays a vertical

structure. This feature of the Internet makes it a sector in which competition is enjoying its

full potential, since the opportunities for interconnection available to the various ISPs are

considerably greater than those which would be available to local telephone company. The

issue that arises is how is the network, which is inherently more complex, managed since so

many routing options are available.

3.3. Pricing traffic on interconnected networks: issues, approaches, and solutions

The overarching theme here is operations management. We have so far discussed the fact that

there is substantial capacity available in the Internet backbone. There may be

commoditization of the backbone. Nevertheless, traffic growth is equally substantial such that

congestion is likely. The next generation Internet developments, such as Digital Video over IP

(DVIP), will create greater traffic bursts that then create congestion problems. Equally, there

can be congestion problems in different parts of the network. The growth of ITES and

outsourcing will create peak periods for traffic transfer and that too on the particular routes

along which the bulk of the outsourcing businesses travel. Since the Internet is going to be the

primary network for not just communications needs, but also for conducting business

worldwide, the need for pricing schemes is paramount. Management of the Internet capacity

via an appropriate pricing scheme, so that resources are optimally allocated, then is an

important consideration.

The authors initially describe the optimal network resource allocation methods that are based

on advances in the computer science fields. The main congestion problem in computing

systems revolves around load balancing, and three main techniques are used. These are:

global knowledge, randomization, and feedback.

The problem that the authors note with these approaches is that they ignore the economic

consequences of load balancing. It is assumed that the value of each specific task is the same.

It is, however, eminently feasible that the value of each particular job will vary according to

21

the priorities of the particular user: authors use the case of a teenager downloading large

music files versus that of a researcher conducting major computations while connected via the

Internet for a remote site. Clearly, the economic and social cost-benefit trade-offs are

different.

Given the complexity of the Internet, optimality is difficult to attain; but the reduction of

negative externalities, via reduction of congestion, and the attainment of allocative efficiency,

so that those users whose valuations are the highest receive the largest allocations of

bandwidth, should be goals of a pricing scheme. A dynamic pricing scheme is described by

the authors. This is principally a usagebased pricing method wherein two important

components of the scheme are an ‘opportunity price,’ which is charging a user what the other

users on the network would have paid for that capacity, and a ‘priority price,’ which is the

price including an additional element paid for faster access or a higher priority.

In the overall Internet structure, another layer has now emerged. This the overlay network that

lies between the ISP and the IBP, and is best understood in the context of transactions that

happen in peer-to-peer (P2P) networks. Overlay networks consist of network nodes that

perform data aggregation tasks as the various customers, connected to the Internet via their

ISPs, conduct their transactions using the P2P framework. The data, for example, could relate

to all the users that have contacted a particular file�sharing scheme and who therefore

comprise a particular service network. Overlay networks are logical service networks

generated on top of the actual physical service network by users’ transactions.

The presence of these overlay networks, therefore, changes our assessment of the industrial

structure of the Internet. The industrial organization of the Internet has obtained a new

component. We now have to account for another link in the chain, as it were, and review the

competitiveness issues, if any, for this element of the network. General knowledge would

suggest that the existence of overlay networks has given rise to intellectual property rights

issues but at this point are unlikely to give rise to market power issues. The authors suggest

three, of several possible, applications of overlay networks: these are collaborative work,

distributed resource management, and access and task automation using software agents. All

of these applications are also clearly ones that are carried out across extreme geographical

distances, thanks to the economics of the outsourcing phenomenon. Clearly, dynamic resource

allocation in networks of ever increasing complexity, but surprising openness, generates

complexities in routing tables’ construction as well. Market power considerations are now not

22

so important, but what is important is traffic and operations management. In both cases,

appropriate mechanism design remains important.

3.4. Toward an economics of the domain name system .

The domain name phenomenon is sufficiently critical that a specialized United Nations

agency, the World Intellectual Property Organization (WIPO) is regularly involved in

proceedings and is a topic that now engages the minds of the United Nations as a whole.

One of the issues is identity. In particular, unique cyber identity is predicated on the

possession of a unique domain name, such as www.elsevier.com, and the trade in domain

names is a market worth $2.5 billion annually. Because domain names are marketable items,

other attributes associated with items that are traded, such as the basic demand and supply

conditions, need to be understood. The author remarks, and in our opinion quite validly, that a

great deal of policy has been made with respect to domain names without the basics of the

domain name as a resource being understood.

We should mention, first, a technical description of the domain name system (DNS), which is

then followed by sections highlighting the key demand side characteristics and the key supply

side characteristics. This characterization is important as it helps define the contours of an

industry segment that is actually turning out, as we describe later, to be most critical

component of the Internet space in an institutional sense.

On the demand side, the author defines two dimensions associated with the demand for

domain names. These are the purely technical demand, for the basic identification routines,

and the semantic demand. Semantic demand is the human side of demand, associated with

making a domain name appealing or memorable or unique. In a sense, the area of domain

name demand analysis merits greater attention using the frameworks that exist in the

consumer demand and marketing literatures on product variety. The semantic dimension also

has a public policy component to it, since the authentication function associated with the

semantic dimension is a signal either of quality or of particular status. Thus, how semantic

names are given to individuals, entities, and organizations is not a function of explicit demand

itself but also involves a process of implicit certification. In other words, there is a control

aspect to the awarding of domain names, and this attribute goes against the free�spirit nature

that has characterized the Internet phenomenon as a whole.

23

In a sense, the implicit certification of domain names helps breed trust among the Internet

using community, which is now almost the whole world, and the issue of trust in online

activities is a very large area of research. The issue of implicit certification, however, does

raise another important issue, who chooses the certifiers? This is akin to the question of who

regulates the regulators. As we further describe below, it is precisely this issue, over the

formation and jurisdiction of the Internet Corporation for Assignment Numbers (ICANN),

which has created a substantial turmoil in the Internet community throughout the world.

On the supply side, the author goes into detail about the structure of the domain name supply

industry, which has three components: the root servers, the registries, and the registrars. Root

servers maintain root zone files, and every top level domain name, such as www.elsevier.com,

cannot be accessed until it has been verified by the root server and advertised to the public at

large via the Web.

Having a domain name on the root zone file is the ultimate expression of market entry into the

Internet space. The political dimension now becomes important because other than three root

servers of which one is in Japan, one in Sweden, and one in the United Kingdom, all of the

others are based in the United States, and in the Internet space today capacity is not a

constraint but an identity is. Thus, even if there is a great deal of bandwidth and connectivity,

and the ability to actually enjoy the benefits of the Internet, there are significant controls over

identity. The fundamental problems are now institutional and not technical. It is not a

production problem but one of distribution.

The institutional issues that arise also relate to the registries and registrars. This is a vertical

market, with registry services coming upstream and registrar services coming downstream.

The original domain name registry was Network Solutions, Inc., which was acquired by

VeriSign, now the largest registrar. The author highlights the lack of competition in the

registry market, and the dominance of the main operator, which was allowed to charge for its

services by the National Science Foundation even though at the time there were no

alternatives.

We should also highlights the relationships between registry and registrar services as a

sensitive one for competition policy because now there is substantial growth in the secondary

market for names and the role of registrar services become important. If, however, there are

limited facilities at the registry level and almost total dominance at the root server level, then

24

there is a bottleneck in the Internet as well, just as there is in the local loop for fixed�line

telephony.

4. Institutional considerations

This section concentrate on the benefits and costs of different policies for the

telecommunications sector, where the policies include competition policy and regulation,

public ownership, privatization, and liberalization.

4.1. Bottlenecks and bandwagons: access policy in the new telecommunications.

‘‘Bottlenecks and Bandwagons: Access Policy in the New Telecommunications,’’ Gerald

Faulhaber differentiates between two interrelated access concepts, bottleneck access and

bandwagon access. These two effects provide for two different potential justifications and

policy directions for access policies. The telecommunications sector is an example of an

industry with both effects. These concepts are closely related to the differentiation between

one-way access, or vertical access and two-way access, also known as horizontal access or

interconnection, made in the access-pricing literature. Bandwagons are similar to network

effects. In spite of these similarities, the author uses bottlenecks and bandwagons to provide a

refreshingly new synthesis of policy insights.

These insights are aptly illustrated by the AOL-Time Warner merger decisions by U.S.

Federal Trade Commission (FTC) and the Federal Communications Commission (FCC). This

merger addressed both problems with the FTC focusing on the access to cable modems as

bottlenecks and the FCC on access to advanced IM services as bandwagons. The author

makes clear that bottlenecks and bandwagons present very different types of market failure

and require different regulatory and antitrust remedies.

The author’s discussion brings out that the difference between a bottleneck or essential

facility, and a simple monopoly is by no means trivial. Four properties in combination are

conventionally viewed as causing a bottleneck problem. They are: (1) sole ownership of a

resource by the bottleneck owner; (2) inability of others to duplicate it; (3) unwillingness of

the bottleneck owner to provide the facility on reasonable terms to competitors; and (4) harm

from this unwillingness to the competitive process. Property (2) requires natural monopoly or

some other barrier to entry (patent, copyright etc.). Property (3) hints at boycott, but would the

problem go away if the bottleneck owner charged the monopoly price for use of the

25

bottleneck input? Property (4) hints at a fixed proportions of input that downstream

competitors cannot substitute.

Since in the fixed proportions case the monopolist of an input can exercise all market power

(both upstream and downstream) in the price of the input, there should be no incentive for

boycott. Thus, the bottleneck problem seems to be how to take the market power out of the

input monopoly. Hence, the author questions if bottlenecks are really a problem if the input

monopoly is earned by innovation or superior efficiency rather than inherited from a

monopoly franchise. He further asks if there exists a feasible mechanism to correct the

problem, using price and terms of agreement. If not, then competition for the bottleneck may

be preferable to bottleneck regulation. This implies the questions, can the essential facility be

circumvented by final consumers (instead of competitors!), and are new technologies in sight

to replace the essential facility? Furthermore, in the absence of regulation, does bottleneck

access develop by itself?

In contrast to bottlenecks the monopoly property is not a necessary characteristic of

bandwagons but only a possible outcome. A bandwagon example of a sustainable oligopoly is

the growth of the Internet backbone through peering. The main property of bandwagons is the

mutual interdependence that is absent from bottlenecks. However, the mutual interdependence

of bandwagons is commonly not symmetric but rather depends on market shares. As a result,

market share conveys to a supplier an independent advantage like demand side economies of

scale.

The bandwagon property has been at the core of strategic use of network effects in creating

compatibility issues by dominant firms, such as Microsoft. Can therefore a market leader kill

competition through her refusal to interconnect? Such effect, known as market tipping,

depends on the shape of network effects curve and the market share of the dominant firm. For

example, Economides argues that for ISPs tipping may not occur before a market share is

close to 100 percent.

The new telecommunications are characterized by a high rate of technical change, a property

for which the serial monopoly hypothesis was developed. This hypothesis conjectures that

innovators, who monopolize a market, are themselves threatened by the following

generation(s) of innovations. Thus, static inefficiency is deemed necessary to generate the

next round of innovations. The author argues that, even if one accepts the serial monopoly

hypothesis in general, it is difficult to replace a current monopolist if network effects lead to

26

stickiness, say, because of difficult customer switching or barriers to entry. Network effects

combined with merger assets would make entry of the next serial monopolist nearly

impossible.

Also, there is little empirical evidence on the serial monopoly hypothesis in general. To the

extent that the serial monopoly hypothesis holds water, the problem of weak intellectual

property rights may call for anticompetitive practices as substitutes for such rights. However,

the author argues that improved intellectual property rights would be much better than lax

antitrust enforcement.

In future, essential facilities in telecommunications networks may become rare because of

technical progress and intermodal competition, but bandwagon effects may flourish because

of the convergence of the media.

4.2. Antitrust remedies and the institutional design of regulation.

Although the U.S. was for a long time the undisputed leader in the liberalization of the

telecommunications sector, it has by now fallen behind other countries in several areas, such

as mobile communications. We should also mention the main differences and commonalities

in policy that may be responsible for this shift. They observe that the U.S. and Europe differ

both in their approach toward the shift from regulation to competition policy tools and in their

competition policies. According to the authors, since the breakup of AT&T in 1984, the U.S.

has reduced the influence of antitrust policy on the telecommunications sector, while the EU

has increased that influence, particularly in its new framework.

While the European approach toward the relationship between competition policy and

regulation is based on a systematic design, the U.S. approach is driven by a diversity of

interests that work their way through the legislature, regulatory agencies, and courts. It is not

that these interest groups are absent in the EU.

However, their influence is more contained at the design stage of the general EU policies. As

a result, the EU approach, driven by the vision of convergence, has become uniform with

respect to the different parts of the telecommunications sector and is geared toward

competition on equal terms applied to relevant markets, while the U.S. approach has

enormous difficulties reconciling historic differences in the regulation of telephony, cable TV,

and wireless services. For example, the different regulatory treatment of broadband access via

27

DSL and cable modem is explained by their original assignment to the telephone and cable

sectors.

In spite of these differences, both EU and U.S. policies are shaped by the same vision, which

is that competition shall ultimately rule in the entire telecommunications sector. Pockets of

natural monopolies and network effects are viewed as ultimately vanishing. In the meantime

regulation is there to bring competition to all end-user areas of telecommunications. Thus,

regulation has shifted from the protection of end users to the protection of competition, and,

as the authors argue, of competitors. This protection can be associated with heavy-handed

regulation.

Such regulation creates direct administrative and network-related costs. The latter include

unbundling and interconnection costs, the establishment of number portability, and the like. In

addition, indirect costs arise in the form of distorted or reduced incentives for innovation,

investment, and cost reduction. Neither the U.S. nor the EU approach provides for an explicit

analysis of such costs. However, considering, for example, the extent of network unbundling

required in the U.S. relative to the EU reveals that the implicit judgment of the EU authorities

has been that U.S. unbundling has been going too far. As of this writing, though the U.S.

seems to be on course in reversing its policy on unbundling, as shown by the FCC’s Triennial

Order of 2003 and the Revised Unbundling Order of 2005.

Both antitrust remedies that can be ex ante and ex post, and ex ante regulation deal with

market failures. Generally, the ex ante remedies are more drastic and would therefore have to

concern more drastic market failures. The most prominent area of ex ante antitrust policies

concerns mergers. Mergers have a lot in common with the issues raised by regulation in the

presence of competition. In both cases, future market developments have to be evaluated

before remedies are applied and in both cases the remedies affect the future competitiveness

of the sector. In that sense, both policies are speculative and, according to the authors, need to

be evaluated more carefully than ex post policies, which correct observed market failures.

However, a status quo argument may be applied in favor of ex ante policies. Thus, in the case

of mergers the remedies, while potentially drastic, are less drastic than divestiture in ex post

policy would be. Similarly, an interconnection policy imposed on a currently dominant

incumbent is less drastic than the same policy on a quickly expanding entrant, who is

expected to become dominant in the future. The EU policy takes this difference into account,

for example, by excluding emerging markets from regulation.

28

The EU telecommunications framework is fully in line with the authors’ characterization of

regulation as ex ante and competition policy as ex post remedies. In fact, all the regulatory

remedies under the framework are explicitly formulated as ex ante policies. In contrast the

new German telecommunications law (TKG 2004) additionally introduces an intermediate

version of regulation, called ex post price regulation. Under this approach, dominant firms can

set prices on their own but have to announce these to the regulator in advance, who can either

simply accept them or postpone their enforcement and initiate a regulatory proceeding.

Furthermore, the regulator can collect any abusively excessive amounts collected by the firms

in the meantime. This section has been incorporated in the TKG 2004 among others as a way

to prevent full-blown regulation of the mobile sector, which so far is not regulated under the

market dominance provisions.

In fact, the fear may be justified that, while the EU framework may be able to move end�user

markets toward deregulation, the wholesale market regulation may be sticky and may even

perpetuate itself for call termination, although intermodal competition between fixed and

mobile networks will eventually gain full steam. If one applies ex ante price regulation to

workably competitive mobile sectors now there would be no reason to abandon it ever. There

is no foreseeable increase in replicability that could lead to a gradual softening of this

regulation in line with the ladder approach by Cave et al. (2001). Then only two deregulatory

options would exist. The first and most straightforward would be to move to a general

receiverpays principle. That would resolve the termination pricing issue and would put the

emphasis squarely on the qualitative conditions and location issues of interconnection. The

second would be to live with imperfect termination markets.

4.3. Telecommunications and economic development.

While a development gap in telecommunications between the high income countries and the

developing world is substantial generally and with respect to the digital divide, shows that

telecommunications in developing countries can be changing as much as or more than in

developed countries. The emergence of China and India as potential world leaders in the

telecommunications sector is an example of the latter phenomenon. At the same time, new

gaps emerge within the developing world between leaders and laggards.

We should also mention the strong relationship between institutional change and the evolution

of the sector. Countries that have privatized, liberalized, and created stable regulatory

institutions have also made greater progress in telephone and Internet penetration and

29

technical developments than the countries continuing government ownership of dominant

providers without opening telecommunications markets to competition. Competition, in

particular, is a more powerful driver of telecom expansion than privatization alone. Internet

services in developing countries expand best if left largely unregulated and with open access

to the public networks. Protecting established network providers often conflicts with the

introduction of more modern and cheaper services. This holds particularly for VoIP that is

forbidden in a substantial number of countries, in order to protect dominant network providers

from an erosion of long-distance and international telephone call charges. However, VoIP will

eventually emerge into a formidable competitor for established networks, whether forbidden

or not.

The authors point out the consequences of improved telecommunications sectors for the

economies as a whole, as improved telecommunications sectors enable developing countries

to export services thereby replacing white-collar workers in high income countries. This

suggests that countries that have not yet reformed their telecommunications sectors should see

their opportunities from joining the reform bandwagon. We should also mention, the reform

ability itself depends on a country’s institutional endowment so that reform in countries with

inadequate institutional endowments may not lead to the desired outcomes. It would therefore

be important to learn about reforms that either failed in the sense that they had to be

abandoned before completion or in the sense that, although completed, they did not yield the

desired outcomes.

Universal service policies in developing countries usually mean something quite different

from such policies in high income countries. In high income countries, universal service

concentrates on the access of individuals or household to basic or advanced services. In

contrast, in developing countries universal service policies largely concern the connection of

villages or remote areas to modern communications, including Internet access. Both have in

common an urban-to-rural cross-subsidization pattern along with a similar political-economy

drive.

4.4. Institutional changes in emerging markets: implications for the telecommunications

sector

Telecommunications utilities are characterized by large and sunk investments, by the presence

of economies of scale and scope and by products that are mass consumed.

30

The combination of these features has traditionally led to state ownership and/or government

regulation of the sector and has made pricing in the sector a politically sensitive issue. The

author particularly emphasizes the short-term political profitability of expropriating the sunk

costs in favor of low prices for the masses, requiring safeguards against government

opportunism in order to achieve investment in this sector. State ownership is then interpreted

as the result of the inability of the polity to commit not to expropriate private investments in

the sector. Viewed this way, continued state ownership would not necessarily reduce

investment if the alternative is a private sector suffering from massive government

interference.

Central to the author’s analysis is the institutional endowment of a country that determines

what governance and incentive structures for the telecommunications sector are feasible and

optimal for a country. The institutional endowment includes different political, legal, and

economic institutions and different populations, standards of living, and geography. In order

to prevent regulatory opportunism, the endowment needs to restrict a regulator’s discretion.

At the same time, the telecommunications sector, in particular, requires flexibility of

regulations to adapt to a quickly changing environment. Overcoming this tension and

achieving the right balance between restrictions and flexibility is the difficult task of sector

reform. The author uses the U.S. and U.K. as two different, largely successful models of

institutional endowments, where the U.S. takes a decentralized and the U.K. a centralized

approach.

The main feature of the U.S. regulation is that telecommunications regulators have discretion

to reform within statutory and due process limits, but they are monitored first by a court and

then by legislators who step in with new legislation, when regulators and courts, in

interpreting the current law, significantly deviate from what the legislative body wants.

Through the Telecommunications Act of 1996 this only occurred very late in the U.S.

telecommunications reform process, after competition in long-distance services and

telecommunications equipment and the divestiture of AT&T took place without legislative

interference. In contrast, in the U.K. the telecommunications reform process started with

legislation, the subsequent judicial reviews have been much less pronounced, government

rather than regulators took the principal regulatory decisions and licenses were a major

instrument of limiting regulatory discretion.

31

The author takes these observations as the starting point for developing theoretical ideas about

regulatory governance. He first concentrates on federal systems and brings out that the

conditions for a strong tradition of judicial review of regulatory decisions are that the division

of powers is real and that the judiciary cannot be manipulated by political parties. We should

also mention further hypothesizes that independent agencies will be favored in countries

where the legislative and executive branches are not necessarily dominated by the same party.

Under those circumstances, as the legislators cannot hope to implement the regulatory laws

themselves they have to rely on courts to interpret the laws so that regulatory agencies cannot

deviate too much from legislative intent.

Interestingly, in Germany, a country with no tradition of regulatory discretion, fairly

independent telecommunications regulation was introduced in 1998, along with the

liberalization of the telephone sector. This led to an unprecedented explosion of

administrative lawsuits challenging regulatory decisions. In Germany, the judicial control was

part of the existing regulatory endowment, but its major applications to the

telecommunications sector had to wait until a new regulatory institution was introduced that

involved discretionary decision making.

It is expected that the new telecommunications framework of the European Union will

increase the discretionary powers of the national regulatory authorities Vis-a`-Vis their own

governments and legislatures. This again can be interpreted under the author’s framework

from the separation of two main institutional decision makers, in this case the European

Commission on the one hand and the individual country legislators and their governments on

the other. It will be interesting to see how this plays out. For unified government systems

spiller particularly considers the properties of contract based regulation, showing how this can

lead to commitment, provided there is an independent judiciary to uphold contracts. Under

such a system reform can be achieved through contract renegotiations.

The institutional choice that allows technical progress, this note could mark the beginning. In

fact, the statement could be reversed. Technical progress and market growth substantially

reduce the governmental and regulatory expropriation problems, while at the same time

reducing governmental and regulatory abilities to finance and manage the sector. In light of

this, technical progress, market developments and the institutions that govern the

telecommunications sector mutually influence each other.

32

Chapter 2: The practice of access pricing in telecommunications

1. Introduction

In this chapter we seek to bring that theory alongside the practice of access pricing in

the telecommunications sector in OECD countries. We will focus on identifying which

services should be regulated, on how the regulation of specific services interacts with

the regulation of other services and on how the access prices relate to the prices of the

corresponding retail or end-user services.

Throughout we will seek to highlight where the theory and practice diverge.

As we saw we can distinguish one-way and two-way access problems. One way access

problems arise when the provider of the competitive service needs access to a non-

competitive service provided by another firm but not the other way around. In this

report we will focus on the following one-way access problems in telecommunications:

1. Access to call origination and termination at both ends of a call (for the purposes of

providing competing end-to-end local, long-distance or international calls);

Figure 1. One-way call origination and termination for voice calls

Source : OECD

2. Access to call origination for the purposes of providing Internet access services;

33

Figure 2. One –Way call origination for calls to Internet service providers

Source: OECD

3. Access to the physical (usually copper wire) local loop facilities (i.e., “local loop

unbundling”).

Figure 3 . One – way access to unbundled local loop

Source : OECD

Two-way access problems arise when the owners of bottleneck facilities must purchase

essential inputs from each other. This arises in telecommunications whenever

subscribers attached to one network desire to communicate with subscribers attached to

another network, as arises in the interconnection of two fixed, fixed and mobile or two

mobile networks. This is illustrated in Figure 4.

There are a number of other telecommunications services which may qualify as

“essential facilities” to which access is sometimes mandated but which will not be

discussed further in this report, including:

transportation from the point of interconnection to the local exchange (in the case where

the other network operator interconnects at a different level of the network);

Figure 4. Two-way interconnection: fixed-fixed, fixed-mobile, mobile-fixed

And mobile-mobile

Source: OECD.

2. access to certain leased lines (specifically those lines which cannot be economically

duplicated by competing operators and which are essential for competition);

3. access to rights of way (pipes and ducts), access to high sites (for antennas) or access

to space within an incumbent’s facilities (co-location);

4. access to numbering and electronic addressing resources;

5. access to roaming services on mobile networks;

6. access to conditional access services (i.e., video encryption/decryption devices for

interactive and pay television services).

2. Regulatory arbitrage and links between different access prices

Although we have carefully distinguished above between one-way and two-way access

problems, in practice it is not always possible or desirable to distinguish between traffic

that falls into the “one-way” or “two-way” category.

In particular, as we will see, distinguishing between these two types of traffic may give

rise to regulatory arbitrage (that is, a situation where an operator has an incentive to re-

route or re-label traffic in order to benefit from lower tariffs) or may lead to a distortion

of competition. Furthermore, it may not be possible to set different charges for call

origination and termination, as this may distort competition for end-users that generate

more calls than they receive (or vice versa).

35

Links between one-way and two-way call termination

Let’s focus first on a potential link between one-way call termination and two-way call

termination. The basic idea here is that whenever there are different charges for

terminating different streams of traffic, there will be an incentive for

telecommunications carriers to re-route or re-label their traffic to benefit from the lower

charges. Stricter regulatory intervention may be required to keep different streams of

traffic apart.

To see this, suppose that two-way call termination is priced less than one-way call

termination. For example, it might be that two-way call termination is not metered (as

would occur under a “bill and keep” agreement) whereas the cost of terminating a long-

distance call may be, say 4 cents per minute. Assume that the terminating company

cannot determine the ultimate origin of a call, but can determine whether the company it

is dealing with is licensed to provide local or long-distance calls.

In this circumstance there is a strong incentive for a long-distance operator to re-route

its traffic through local network operators, so as to be able to interconnect with the

incumbent local company and terminate calls at the lower rate for two-way termination.

The difference in termination charges induces regulatory arbitrage – a long-distance

company is induced to create a local network company that would possibly not

otherwise exist to “arbitrage” the difference in the one-way and two-way termination

charges. This is illustrated in Figure 5:

Figure 5. If two-way call termination is cheaper a long-distance operator may have

an incentive to route its calls through a local operator

Source: OECD.

36

For example, in the US there have been complaints from IXCs about unfair competition

from Internet telephony. On 19 April 2001 the FCC ruled that ISP Internet telephony

traffic is interstate access traffic and not subject to the reciprocal compensation

arrangements enjoyed by CLECs. However ISPs have been designated as “information

access” and therefore do not pay the same termination and origination fees as IXC voice

traffic. ISPs may therefore have a competitive advantage in the market for long-distance

telephony.

A variant of this problem has also arisen in the mobile market. The charges for

terminating international telephone calls were historically set using the international

accounting rate system. For various reasons, that system did not distinguish between

termination on fixed and mobile networks. As a result, in many cases the charge for

terminating international traffic on a mobile network (which is here the “one-way”

termination charge) is lower than the domestic fixed-to-mobile termination charge

(which is here the “two-way” termination charge). This provides a strong incentive for

domestic fixed carriers to seek to re-route their two-way termination traffic to make it

appear like “one-way” traffic – that is, to re-route traffic to domestic mobile networks

internationally.

This is known as “tromboning”. As an example, France Telecom pays 33 US cents to

terminate traffic on a mobile network for a fixed-to-mobile call, but for terminating

calls from neighbouring countries, France Telecom receives 8-9 cents per minute, of

which it passes 5 cents to the mobile operator for terminating the call. There is a strong

incentive for fixed network operators in France to route calls to French mobile networks

via foreign fixed networks. In addition, a related regulatory distortion can arise if the

regulatory regime differentiates traffic on the basis of the regulatory status of the

company requesting termination. Companies that are allowed access to the lower

charges have an advantage. In Figure 6, company A has an advantage because, having

the status of a local network operator it can terminate calls at the lower two-way rate

with B than can company C, which has the regulator status of a long-distance operator.

To prevent this type of distortion, the regulator may be forced to impose line-of-

business restraints on operators with a different regulatory status – the regulatory may

be forced to prevent operators which are able to interconnect on the same basis as local

operators (such as ISPs) from providing long-distance services.

37

Figure 6. An integrated local and long-distance operator may have an

advantage over a long-distance operator

Source: OECD.

Links between one-way and two-way call origination

The same effects can also be seen on the side of call origination, although here the

strategy that companies must employ to arbitrage differences in call origination charges

appears at first a little more artificial. As before, if the two-way tariff for call origination

is lower than that for one-way call origination, there is an incentive for carriers which

generate a lot of originating traffic to make their traffic appear as two-way traffic in

order to receive advantageous regulatory treatment. The additional difficulty here is that

the “two-way tariff for call origination” is not directly defined by the regulator, but is

the difference between the retail price for a local call and the regulated tariff for two-

way call termination.

To see this, suppose that one-way call origination and two-way call termination is

charged at, say, 4 cents per minute, whereas a local call is charged to end-users at 5

cents per minute. In this case, if a long-distance operator connects directly to the

incumbent it pays 4 cents per minute for one-way call origination. Alternatively, if it

interconnects through a subsidiary local network, the incumbent collects an additional 5

cents for the local call, but then pays the local network 4 cents for two-way call

termination. The long-distance operator is effectively able to obtain call origination at

the price of 5 – 4 = 1 cent per minute. It is true that the end-user must pay the additional

cost of a local call, but is more than compensated by the lower charges for the long-

distance transportation component. See Figure 7.

38

Figure 7. If two-way call origination is cheaper a long-distance operator may

have an incentive to route its calls through a local operator

Source: OECD.

This possibility for arbitrage between call origination and termination is particularly

important when local calling is free. In this case, if there is any positive two-way call

termination fee the long-distance operator, by interconnecting as a local operator, is

effectively able to obtain call origination services at a negative price (i.e., the

interconnecting operator is paid for call origination rather than having to pay for this

service).

Suppose that a long-distance firm needs access to a local loop operator to originate one

million minutes of long-distance calls. The one-way call origination charge is, say, 4

cents, and the two-way call termination charge (i.e., the charge at which calls are

exchanged between local networks is, say, 2 cents). Local calls are free (i.e.,

unmetered). In this case if the long-distance operator connects in the conventional way

it must pay $400 000 in call origination fees. However, if it connects through a

(subsidiary) local exchange company, the end-users will pay for an additional local call

(which is free) and the local loop operator will pay the long-distance operator $200 000

for terminating the call. The difference between these two approaches is $600 000.

Whenever the two-way call origination price (i.e., the retail price for a local call less the

two-way termination price) is lower than the one-way call origination price, operators

have an incentive to arbitrage these prices by re-routing or re-filing one-way call

origination traffic through a local network, effectively paying the two-way origination

charge.

39

In the US, the regulator was forced to address exactly this possibility when long-

distance operators began offering long-distance connections via a local operator.

Customers had to first dial a local number to obtain access to the IXC but, doing so,

effectively evaded the one-way call origination charges. The FCC soon blocked this

practice. The FCC ruled that local calls which are used to connect to inter-exchange

carriers will incur interstate access charges. Another example arises in Canada where,

mobile operators, which usually pay a per minute call origination fee to the ILECs, can,

by obtaining CLEC status, interconnect with the ILEC on the basis of bill-and-keep,

essentially obtaining call origination for free.

Links between two-way call origination and termination

We have discussed the problems that can arise when the regulator seeks to distinguish

one-way and two-way traffic. As we will see shortly, only a minority of OECD

countries attempt to enforce this distinction in practice. But, even in those countries

which do not distinguish between one-way and two-way traffic for interconnection

purposes, there remains the possibility of a significant distortion to competition when

the tariff for two-way call origination and two-way termination are not the same. There

are several models of two-way interconnection of networks. One of the key features of

those models was the assumption that individual subscribers called all other subscribers

with equal probability. As a result, as long as the per-call charges on each network are

the same, the calls between any two networks are always in balance, regardless of the

sizes of the two networks. When this assumption is combined with the assumption of

reciprocity (i.e., that the charges for two-way call termination are the same in each

direction), net termination revenue is always zero in equilibrium.

However, in practice, not all end-users of networks have balanced calling patterns.

Some end- seers generate significantly more calls than they receive.

Others receive significantly more calls than they generate.

Suppose, then, that different customers have different numbers of outgoing and

incoming cross-network calls. Putting aside the costs of providing telecommunications

service (i.e., assuming these costs are fixed and independent of traffic), the revenue

from two-way call origination is, as discussed before, the retail price (“P”) for a call less

40

the termination charge (“T”). On the other hand, since the termination charges are

assumed to be reciprocal, the revenue from two-way call termination is the same

termination charge, T. The total revenue from a customer therefore depends on the

relative proportion of call origination and termination services for that customer and the

relationship between the outgoing call revenue P – T and the incoming call revenue T.

Note that the outgoing call revenue P – T is larger than the incoming call revenue T if

and only if the retail price P is larger than twice the termination charge T. So, in the

case when the termination charge T is less than half the retail charge P, and assuming

both charges have the same structure (i.e., both are per call charges, or per minute

charges) then it is clear that the carriers will prefer customers who originate more calls

than they terminate. (Since P – T is larger than T.) In this case network operators will

actively seek call producers such as tele-marketers or private pay-phone companies and

will tend to eschew call sinks, such as paging networks or Internet service providers.

In the case when the termination charge T is more than half the retail charge P, the

reverse is true – carriers will prefer customers which terminate more calls than they

originate (since P – T is smaller than T). Network operators will eschew call producers

such as tele-marketers and will tend to actively pursue call sinks, such as Internet

service providers.

This effect is particularly strong in those countries with free local calling. In those

countries P is zero so the use of any positive metered call termination charges T always

creates a strong incentive for networks to eschew subscribers which originate more or

longer calls than they terminate and to actively recruit subscribers which terminate more

or longer calls than they originate.

41

Figure 8. The effect of call origination and termination charges

on incentives for targeting end-users

Source: OECD.

In the US, which has unmetered local calling, this problem has become critical.. The

FCC writes:

“We believe that this situation is particularly acute in the case of carriers delivering

traffic to ISPs because these customers generate extremely high traffic volumes that are

entirely one-directional. Indeed, the weight of the evidence in the current record

indicates precisely the types of market distortions identified above are taking place with

respect to this traffic. For example, comments in the record indicate that competitive

local exchange carriers (CLECs), on average, terminate eighteen times more traffic than

they originate, resulting in annual CLEC reciprocal compensation billings of

approximately two billion dollars, ninety per cent of which is for IS Pbound traffic.

Moreover, the traffic imbalances for some competitive carriers are in fact much greater,

with several carriers terminating more than forty times more traffic than they originate.

There is nothing inherently wrong with carriers having substantial traffic imbalances

arising from a business decision to target specific types of customers. In this case,

however, we believe that such decisions are driven by regulatory opportunities that

disconnect costs from end-user market decisions. Thus, under the current carrier-to

carrier recovery mechanism, it is conceivable that a carrier could serve an ISP free of

42

charge and recover all of its costs from originating carriers. This result distorts

competition by subsidizing one type of service at the expense of others.”

In effect, competition between ILECs and CLECs is somewhat analogous to the “I cut,

you choose” method for dividing a cake. The level of the two-way termination charge

determines how the total “cake” (the local call revenue) is divided between the

originating and terminating operators. Once this termination charge is set, CLECs can

decide which customers they target. They will naturally choose customers that bring

them a bigger slice of the cake. If the termination charge is higher than the origination

charge they will choose customers who terminate more calls than they originate and

vice versa.

In summary, the structure and level of two-way termination charges relative to retail

charges has little or no effect on the level of competition for the business of those end-

users which induce a balanced number of incoming and outgoing cross-network calls.

However, in the case of those end-users which induce an imbalance in the number of

incoming and outgoing calls (Internet service providers are a prime example) the

structure and level of two-way termination charges has important implications for

competition. In particular, when local calls have a low price relative to the termination

charges, rival local carriers have an advantage in competing for the business of call

sinks.

This problem of competitive distortion can be addressed only by correctly adjusting the

relative structure and level of call termination and retail charges, especially for those

end-users that generate imbalances in call flows. The termination charge should have

the same structure and should be exactly half of the retail charge (ignoring origination

and termination costs) at least for those end-users that generate imbalances in call flows.

Where the retail charge is too low relative to the termination charge, the problem of

competitive distortion can be resolved either by raising the retail charge or lowering the

termination charge. The US, which has unmetered local calling, has chosen to resolve

the problem by lowering the termination charge. The Netherlands, on the other hand,

chose to resolve the problem by raising the retail charge.

43

The “chain of access charges”

This section has emphasised a number of links between different access call origination

and termination charges. We are now in a position to put all these links together to form

a chain which we will call the “chain of access charges”.

This chain is illustrated in Figure 9. First, two-way call origination and oneway call

origination may be equalised in the desire to avoid regulatory arbitrage for call

origination (see (1) in Figure 9). Second, two-way call origination and termination may

be equalised in the desire to avoid the distortion of competition for end-users with

imbalances in outgoing and incoming calls (see (2) in

Figure 9. “The chain of access charges"

Source: OECD.

Figure 9). Third, two-way call termination and one-way call termination may be

equalised in the desire to avoid regulatory arbitrage for call termination (see (3) in

Figure 9). Finally, if all the other links in this chain are set equal, then clearly, one-way

call origination and termination must also be equal (see (4) in Figure 9).

If all the links in the chain are taken seriously, one-way and two-way termination

charges and one-way and two-way origination charges should all be equal. If, in

addition, reciprocity applies, all these charges should be equal to half the retail price of

44

a local call. Put another way, if all the links in the chain are important, all the access

charges for all the voice services of an end-user are linked to the structure and level of

the retail price for a local call.

Some of the implications of the chain of access charges deserve to be highlighted:

First, the chain of access charges is incompatible with an approach under which

access charges depend on the distance a call has been transported.

Those countries that maintain the chain of access charges must have access charges that

are independent of distance. This in turn gives rise to pressure to reduce the dependence

of retail prices on distance. In fact, there is strong evidence that retail charges are

becoming less dependent on distance. For example, in all the Scandinavian countries

(Iceland, Norway, Sweden and Denmark) there is no longer any distinction between

local and long-distance calling.

Second, the chain of access charges is incompatible with a difference in the structure

of local and long-distance services. Countries that maintain the chain of access charges

must maintain the same structure of charges for all types of calls. If long-distance calls

are charged per minute then so must be local calls and vice versa. On the other hand, the

chain of access charges is compatible with different access charges for different end-

users, provided the relationship between access charges and the local retail call price for

those end-users is maintained.

Third, the chain of access charges, combined with reciprocity, implies that local retail

charges must be twice the termination charges. If local calls are unmetered then the

one-way and two-way termination charges and one-way call origination charges should

all be zero (i.e., bill and keep for all forms of interconnection). In fact, the US FCC,

recognising the problems described above is currently exploring the possibility of

extending bill-and-keep for all forms of inter-carrier compensation.11 As we can see

from Figure 10, retail charges for local calls are around twice the termination charges in

many EU countries as this theory demands. Retail charges are more than twice the two-

way interconnection charge in Germany and the UK and significantly less than twice in

Japan. In Germany there is not yet competition for local calls (this will be introduced in

2002). It would be interesting to determine whether there is intense competition for

those end-users that originate more calls than they terminate in the UK and more intense

competition for call sinks in Japan.

45

2.1. Broad approaches to call origination and termination prices

Having examined reasons why countries would link the different theoretical access

prices, let’s turn now to look at what countries do in practice. It turns out that we can

group countries into two broad categories: those which maintain all the links in the

chain of access prices and those which distinguish between local and long-distance

access charges.

Countries which maintain the chain of access charges

A large group of countries choose to maintain all the links in the chain of access prices.

These countries set a single access charge, whether for call origination and termination

for one-way services (such as long-distance services) or for call termination for the two-

way interconnection of networks.

These access charges may be differentiated according to the time of day (peak, off-

peak), type of user (business, residential) or the number of network elements used, but

they do not differentiate according to the category of access service (call origination,

call termination, one-way or two-way).

46

Figure 10. Comparison of ratio between retail prices

and interconnection charges

1. The local interconnection charges are a weighted average of using 80% of the 5-

kilometre charge and 20% of the 20-kilometre charge.

2. The long distance interconnection charges are a weighted average, using 10% of the

5-kilometre charge, 30% of the 20-kilometre charge and 60% of the 50% kilometre

charge.

3. For the long distance retail charges, using the tariff that applies to a 100-kilometre

call as a proxy for long distance.

4. For the retail charges, using the time of day call profiles to average the charges into

peak and off peak.

5. For the retail charges, including call set-up charges assuming call duration of 2.5

minutes but no minimum call charges.

6. For the retail charges, excluding tax charges.

Source: Ovum “Interconnect: Quarterly Update October 1999” and OECD (2001a).

Most European countries fall into this category, including the eastern European

countries of Czech Republic, Poland and Hungary.12 All of these countries have

47

metered charges for local calls. In most cases, as we observed in Figure 10, the retail

price for a local call is around twice the access charge.

The principal drawback with this approach is that is significantly limits the discretion of

the regulator in the setting of individual access charges. The structure and level of

access charges is forced to be the same across a wide range of access services. Theory

suggests that if two different retail services have different elasticities of demand they

should have different access charges. But this is ruled out if the chain of access charges

is maintained. In addition, theory suggests that competition forces the structure and

level of retail prices to reflect the structure and level of access prices. The chain of

access charges therefore forces many different retail charges to have the same structure.

Maintaining the chain of access charges therefore risks either introducing a distortion to

competition or limiting the scope for innovative or efficient new retail tariffs. In fact, as

we will see in subsequent sections of this paper, those countries that have adopted this

approach have faced interesting competition issues when innovative new tariffs have

been introduced. The policy responses have either been to introduce new specific access

charges, to tolerate inefficient tariff structures, to tolerate inefficient competition, or, in

some cases, to prevent competition entirely.

In its submission for this study, the Netherlands recognises the straitjacket imposed by

the chain of access charges and argues for the need to set different charges for (one-

way) call origination and termination. The Netherlands writes:

“The Commission has reached the conclusion that a differentiated approach should be

adopted for the tariff regulation of terminating access and originating access. … [T]his

differentiated approach takes into account the special nature of terminating access,

while at the same time creating the possibility for tariff regulation to be influenced by

the effect of actual market conditions. … In the past, the tariffs for both terminating and

originating services were set based on the embedded direct cost approach used at the

time. The tariff difference between both types of services was exclusively due to the

fact that KPN incurred direct costs for originating services that were only relevant to

those services. No consideration was given to the specific nature of the terminating

service compared to the originating services, nor the possible effects of actual

developments in the market, on the way such tariff regulation could best be carried out.

48

The differentiated approach was implemented for the first time in OPTA’s decision for

KPN’s wholesale tariffs for the period 1 July 2001 to 1 July 2002.”

Countries which differentiate local and long-distance access

The second broad category which we can distinguish, groups those countries that

differentiate between local and long-distance services for the purposes of access

charges. The countries in this group include Mexico, New Zealand, Australia, the US

and Canada. All these countries have unmetered or free local calling. As noted earlier, if

all the links in the chain of access charges were maintained, it would be necessary to set

unmetered or zero call origination and termination charges, at least for those end-users

which enjoy free local calling.

Rather than set all access charges to zero, these countries have chosen to make a

distinction between one-way and two-way call termination (breaking links (1) and (3) in

Figure 10). This introduces more flexibility for the regulator, at the cost of having to

make arbitrary judgments as to what traffic qualifies as one-way or two-way and at the

cost of having to enforce these judgments.

The effects of these decisions have been emphasised earlier. As noted earlier, in these

countries IXCs and mobile operators have sought to route their origination traffic

through CLECs to lower origination charges. In addition, there have been complaints

from IXCs about unfair competition from IP telephony traffic, which is allowed to

connect at the lower termination rate for CLECs. Finally, the incompatibility of free

local calling and per minute termination charges has lead to a substantial distortion in

competition for Internet service providers in the US and New Zealand, and regulatory

intervention in the US and Australia.

2.2. Further notes on the structure of call origination and termination charges

Having introduced the notion of the “chain of access charges”, we are now in a position

to examine countries’ approaches to regulating specific access services in more detail.

Before we turn to this material, however, we first note some related policies that affect

the regulation of access charges.

49

Reciprocity

A requirement for reciprocity in termination charges can play a role in aligning the

incentives of networks to agree on a common termination charge. Reciprocity also

controls the “terminating network monopoly” problem discussed further below.

Some countries do impose a reciprocity requirement. The US Telecommunications Act

imposes on all local exchange carriers the duty to “establish reciprocal compensation

arrangements for the transport and termination of telecommunications”.

Most other countries do not have a rule imposing reciprocal charges. The Netherlands

writes that:

“The obligation to charge cost oriented terminating tariffs only applies to the regulated

firm (KPN) and not to others. Those others are free to decide on the price level for

terminating services within ‘the boundaries of reasonableness’. … Non-regulated firms

can hardly be forced to set the same charge for their terminating services as the

regulated firm has to for his. The regulator has not set any rules that require that the

terminating access prices should be the same for traffic in each direction.”

Nevertheless, most countries note that in practice agreements for twoway

interconnection of fixed-network traffic are almost always at reciprocal rates. It is

interesting to ask why this is the case. If the incumbent is allowed to charge different

prices for calls to different networks, a possible explanation is that the competing

networks are concerned that a higher termination charge would be passed on to end-

users in the form of a higher retail charge for calls to their networks. Conversely the

incumbent would be reluctant to pass on lower termination charges to its end-users on

the grounds that it makes calling the entrant’s network more attractive. This is discussed

further in the section on terminating network monopolies. When the Dutch regulator

allowed KPN to differentiate its retail tariffs according to the destination of the final

network, competing network operators chose to lower their termination charges to be in

line with those of KPN. The European Commission has recently expressed its concern

that termination charges for new entrants are often set on the basis of reciprocity.

50

Access price-caps

The problem of setting the prices of a natural monopoly can be simplified and made

more efficient by delegating the task of setting the individual prices to a regulated firm,

subject to a cap on an overall basket of prices. Allowing the regulated firm some

discretion in the setting of its prices allows it to make use of any private information

that it has about demand in order to set prices more efficiently.

Although no OECD country has yet chosen the global price cap approach, almost all

OECD countries make some use of price caps in the regulation of end-user prices. On

the other hand, the use of price-caps to control access prices remains, at this time, very

rare. At the time of writing, only the UK (Oftel) systematically uses price caps as a tool

for regulating access prices.

These caps are of the common “RPI-X” form. For example, the price cap on call

termination charges is RPI-10%. The price-cap on flat rate Internet access call

origination is RPI-7.5%.

Capacity-based pricing

In industries where the primary driver of the cost of a network is the network’s capacity

to carry traffic at peak times, it often makes sense to base the access prices on the

capacity allowed to competitors and not on usage. Capacity-based pricing is a form of

multi-part tariff, with the fixed part of the tariff proportional to the amount of capacity

to which the downstream competitor is granted access. In effect, the essential facility is

shared between many competing firms without any of those firms having to incur the

entire fixed costs of constructing the facility on its own.

In the telecommunications industry, network capacity is a key driver of costs over large

segments of the network. Capacity-based charging, if it can be made operational,

therefore seems a logical and efficient approach to pricing interconnection. Throughout

this report we have emphasised how the desire to promote competition pushes the

structure of retail tariffs to reflect access prices and vice versa. One of the primary

benefits of capacity-based charging is that it allows the competing firms to break away

from the tariff structure of the incumbent.

51

Capacity-based charging systems have occasionally been promoted in the

telecommunications industry. Mercury, a new entrant in the UK, actively promoted

discussion of capacity-based charging in the mid 1990s.

Touche Ross (1994) reports that the interconnection arrangements between Teleport and

Nynex in the New York area at that time took the form of a capacity-based charge.

Capacity-based pricing schemes are becoming more common. As we will see later,

many countries have introduced a form of capacity-based pricing for Internet call-

origination services. A capacity-based interconnection system has also recently been

introduced in Spain, alongside the conventional per minute access charges. Spain notes:

“Up to August 2001, interconnection prices depended primarily on traffic volume. In

August 2001 a new, complementary model of interconnection prices based on capacity

was introduced, which will come into effect from 1 November 2001. Operators may

adopt one or both systems. This is expected to increase flexibility of operators’ final

prices, and to promote efficient investment.” Under this new capacity-based pricing

scheme the regulator “specifies the minimum units of capacity and the minimum length

of the interconnection contract, the interconnection services available and the monthly

prices per elemental capacity unit. Rights to capacity and minutes of interconnection are

tradable.”

There may be further movement in this direction in the future. OECD (2001a) notes that

“new entrants are arguing that the current per-minute based interconnection charges

should be replaced by capacity-based interconnection charges related to the capacity of

the facilities used to provide the terminating service. According to the capacity based

interconnection charging system, new entrants are charged by their contribution to peak

demand in the network which really determines the capacity of networks”.

Generic tests against discrimination or price squeeze

Although it is not common in the pricing of call origination and termination services,

some countries use a “retail-minus” approach to set access prices. A retail-minus

approach sets access prices on the basis of a fixed discount off the corresponding retail

prices. Under this approach, both the structure and level of retail prices is automatically

reflected in access prices.

52

Even when access prices are not directly linked to retail charges, as in the retail-minus

approach, there is often nevertheless, some sort of safeguard or protection against the

presence of a “price squeeze”. A price squeeze arises when the margin between final

prices and access prices is insufficient to allow an efficient downstream operator to

compete. A rule against price squeezes can be viewed either as a ceiling on access

prices or a floor on final prices, depending on which prices are within the control of the

regulated firm.

In Canada, for example, the CRTC has adopted a test known as the “imputation test” to

protect against anti-competitive pricing by the incumbent telephone companies. When a

telephone company seeks approval of new regulated prices, it must submit an

“imputation test” as part of the filing. In essence, this test requires the telephone

company to demonstrate the profitability of each of its retail services when accounting

for the essential inputs required to provide those services at the same price as those

services are sold to rivals.

The Dutch regulator OPTA also uses a “price squeeze” test. “In this test, the retail

services offered by the regulated firm are priced as if the regulated firm would have to

buy the underlying wholesale services on the same conditions as an interconnecting

operator… These wholesale-based retail prices are compared with the actual retail

prices the regulated firm uses or proposes. If the former are higher than the latter, a

price squeeze occurs – a situation for which a solution has to be found”.

Using this test it was found that competing operators were not able to provide a

competing local retail service on the basis of the wholesale services they had to buy

from the incumbent. The Netherlands notes that the regulator “is investigating ways to

come to a more structural link between access prices and retail prices, in order to

prevent possible anti-competitive effects of the present relation between the regulated

firms’ retail and wholesale tariff structures”.

Ireland also tests for a price squeeze and has addressed complaints in Internet access

and retail long-distance calls:

“Entrants have made repeated allegations that Eircom sets certain of its retail prices and

discounts at a level that places a price squeeze on service based competitors. The main

services where these questions have been raised are 1891 dial-up Internet access and

weekend national calls. In each case the ODTR has established that the price charged by

53

Eircom exceeded the fully allocated historic cost, as represented by the interconnection

charge applied to other licensed operators. However, the ODTR has instituted an

internal price monitoring process to ensure that any future changes to prices or

discounts can be scrutinised promptly.”

3. Call origination and termination for voice services

The previous section introduced different types of access services and highlighted

certain links between different services. We now turn to look at specific services more

closely to explore in more detail the way these access services are regulated.

In this section we focus on call origination and termination for voice services. Because

of the links between one-way and two-way services identified in the previous section

we will look at these services as a group. In subsequent sections we will look at call

origination for Internet service, local loop unbundling and call termination on mobile

networks. We start by identifying which call origination and termination services should

be singled out for regulation, and how countries approach this problem in practice. We

then look at how these services are priced, comparing the structure of the access prices

and the final prices.

3.1. Who is required to provide call origination and termination services?

In theory

What does the theory say about which call origination and termination services should

be required to be provided and by whom? This question is more complex than it may at

first appear. This complexity is reflected in the variety of practices in OECD countries.

Broadly speaking, call origination and termination should be mandated to and from a

given end-user when there is not effective and sustainable competition in the provision

of local loop services to and from that end-user.

In the case of fixed networks, effective competition in the provision of local loop

services is the exception rather than the rule. The scope for competition depends on both

the level of demand of each customer and in each geographic area and the economies of

scale and scope in serving the geographic area. In most geographic areas the level of

54

demand for all except the largest users is usually insufficient to overcome the

substantial economies of scale and scope in the provision of fixed-wire local loops.

Even where there is more than one fixed network infrastructure serving a region,

usually only the largest users are able to sustain two or more simultaneous fixed

connections to different networks.

On the other hand, in some geographic areas, especially the centre of large cities

(known as the central business district or CBD) the level of demand is typically high

relative to the economies of scale and scope. Some countries have special regulatory

provisions governing local loops in CBDs. Australia, for example, has recently removed

certain access obligations in CBDs.

It is important to distinguish between the scope for competition in call origination and

in call termination. We already saw that under a particular set of circumstances even

very small networks can have an effective monopoly over calls terminating with their

subscribers and can have the ability to exploit that monopoly. This problem of

“terminating network monopolies” arises when all the following conditions apply:

1. when there is no competition for call termination to a particular subscriber.

This is the most common situation since the economies of scale are more important for

call termination than for call origination. A new entrant firm might hope to attract a

proportion of the call origination business of existing customers away from the

incumbent. If the entrant’s share of the total call origination business is large enough, it

might be able to justify the installation of a competing local loop network. On the other

hand, if the new entrant firm has a small proportion of subscribers (say around 1%), it

would only hope to capture around 1% of the traffic terminating with any given

customer, which is unlikely to be sufficient to justify the installation of a competing

local loop network;

2. when the calling party pays the entire cost of the call (i.e., Calling Party Pays) (this is

the case for all except free-phone, 0800, or reverse charge calls in most OECD

countries);

3. when users care primarily about the price of the calls they originate and not the calls

made to them (this implies that “closed user groups” are not significant);

55

4. it is not possible or desirable to impose reciprocity (the requirement that termination

charges are the same on each network); and 5. when retail end-user charges for a call

from A to B do not depend directly on the level of the termination charges of the

terminating network B.

When these conditions apply, even very small networks have both the ability and the

incentive to raise the charges for termination on their networks and may need to be

regulated. This issue arises most clearly in the case of mobile termination in those

countries where the calling party pays for calls to mobiles. This issue is therefore

discussed more fully below in the section on mobile termination. But the issue also

arises in the interconnection of fixed networks. For example, the issue has arisen in the

interconnection of IXCs and CLECs in the US.

“[Another] major issue involves terminating access monopolies. This problem results

from the fact that an end-user typically subscribes to only one LEC. Hence, other

carriers seeking to deliver calls to that end-user have no choice but to purchase

terminating access from the calling party’s LEC. These originating carriers generally

have little practical means of affecting the called party’s choice of access provider.

Indeed, … a number of CLECs, whose terminating access charges are not regulated,

have taken advantage of this situation by charging terminating access rates that

significantly exceed those charged by rate-regulated ILECs… We find that absent

intervention, the current disputes between CLECs and IXCs over access rate levels

could disrupt the ubiquitous interconnectedness that consumers expect of the public

switched telephone network. We adopt, as an interim measure, a detariffing regime in

which CLECs may file tariffs establishing access rates only if the rates are at or below a

benchmark rate. Rates above the benchmark may not be tariffed. The benchmark is

designed to bring CLEC rates closer to ILEC rates over the three-year period that these

interim measures are in place.”

A similar situation also arose in the Netherlands. In that case, although interconnection

agreements with KPN were initially on the basis of reciprocal charges, when the

regulator intervened to lower KPN’s termination charges the other networks did not

follow suit, highlighting the lack of competitive pressure to lower these charges. As we

will see below, many other countries believe it is not necessary to regulate the

56

termination charges on “small” networks (networks which have only a small proportion

of connections to end-users in a geographic area).

In practice

How, in practice, do OECD countries designate which services should be provided by

which companies? As we will see below, most OECD countries focus primarily on

identifying the companies that must provide certain services. A minority approach is to

focus on the service.

In the EU, the approach in the new telecommunications regulatory framework (which

comes into effect on 25 July 2003) is to focus the burden of regulation on those

companies that are designated as having significant market power in certain markets.

Under the new framework, national regulatory authorities must define the relevant

markets according to the principles of competition law. (To assist this process, the

Commission has issued guidelines on market analysis and has recommended a list of

markets which can be subject to regulation.) Where a national regulatory authority

determines that a relevant market is not effectively competitive it is required to identify

undertakings with significant market power on that market. “Significant market power”

is interpreted as equivalent to the competition law concept of dominance. The national

regulatory authority can impose additional specific regulatory obligations on companies

which are designated as having significant market power (such as requirements for

transparency, non-discrimination, accounting separation, obligations of access to, and

use of, specific network facilities and price control and cost accounting obligations). In

Japan, access for call origination and termination must be provided by carriers whose

total share of the subscriber lines for each municipality or prefecture is over 50% (only

NTT East and NTT West qualify). In Korea, interconnection must be provided by

carriers whose share in the market is above 50%, whose revenue exceeds an amount set

by the regulatory Ministry and which provide “essential facilities for other carriers to

deliver telecommunications services”.

This approach, which focuses regulation primarily on companies with a dominant

position or “significant market power”, has the potential to focus attention on the right

companies, provided that the market is defined correctly. But the practice of defining

57

the relevant market on the basis of, say, the market share of the firm in the geographic

area in which the firm is permitted to operate, or the market share of a firm in a

municipality, may be misleading. Since telecommunications services to or from a given

subscriber are not a substitute for services to or from another subscriber, the correct

market definition is the market for services to or from a given customer. A firm may be

one of many competing for the business of a specific customer, and therefore may have

little or no market power, but may have the vast majority of subscribers in a geographic

region. On the other hand, a firm may be the exclusive supplier of local loop services to

a given customer, and may have an effective monopoly, even though it has only a few

local loops in the region in which it is licensed to operate.

In its recent review of competition in dial-up Internet access, Oftel finds that BT is

dominant in the market for call origination due to the fact that it has 81% of residential

lines and 86% of business lines in the national market.

However the “national market for exchange lines” is almost certainly an incorrect

market definition. BT may not be dominant in the provision of local loops to businesses

in certain areas and probably has an effective monopoly in certain other areas of the

UK.

A firm which is the exclusive supplier of local loop services to a given customer is in a

position to deny access by other telecommunications operators to that customer whether

or not that firm has a large share of the subscribers in the region in which it is permitted

to operate. In the UK, Oftel has designated both BT and Kingston Communications as

having SMP.

Kingston Communications is a small telephone company that provides services in the

Hull region of England. Would the market power of Kingston in the Hull region change

simply as a result of a change to a term in its license that allowed it to operate on a

nationwide basis?

Having focused regulatory attention on specific companies, there still remains the

question as to what services those companies should be required to provide. Most

countries require at a minimum, access to services necessary to provide end-to-end

services and any-to-any connectivity. Some countries go further to require access to

virtually all the services provided by the incumbent. For example, in Ireland, the

incumbent must offer wholesale service parallel to any retail service and, furthermore,

58

must offer any wholesale service for which demand exists.35 This approach is taken the

furthest by the US which requires ILECs to not only provide access to call origination

and termination but to provide access to individual network elements of the ILECs’

network. In addition, the ILECs have to provide a wholesale service corresponding to

all the retail services that they offer.

An alternative approach is that taken by Australia. Australia focuses not on the

companies that must provide certain services but the services that must be provided

(independently of the companies providing those services). In Australia all companies

which provide PSTN origination and termination services are subject to regulation for

those services. Australia notes:

“Generally, the service declarations by the ACCC are not company or operator specific

(this contrasts with the policy of dominant carrier regulation prior to 1997, which was

focussed on the incumbent Telstra). As such, unless otherwise exempted, the standard

access obligations apply to all firms that supply the declared services via their own

networks”. The risk with this approach is that companies providing services in a

genuinely competitive market will be unnecessarily regulated. However, companies

which do not wish the access obligations to apply to their services can apply to the

ACCC for an exemption.

The US regulatory regime combines elements of both of these approaches. All

companies which provide origination or termination services are under an obligation to

interconnect and, importantly, the FCC has the authority to determine the terms and

conditions upon which carriers provide such services. In addition, there are a number of

additional regulatory obligations on certain companies – those companies the regulatory

regime designates as “incumbent local exchange companies” (“ILECs”). These

companies are required to provide interconnection, unbundled network elements and

access to resale of their services.

Note that national competition authorities may have a role in the decision as to who is

required to provide access services to whom. In Mexico, for example, the

telecommunications law allows the competition authority to designate which firms in

the telecommunications sector are dominant. Once a firm has been designated as being

dominant certain additional obligations in the telecommunications law become

effective, such as provisions relating to control of prices. In Canada, also, the

59

competition authority has a role in deciding when access obligations should apply – the

CRTC has the right to forebear from regulating certain markets when this would be

consistent with the overall objectives of the telecommunications law. In developing its

criteria for the application of forbearance the “Commission adopted an approach that

largely reflected market tests advocated by the Competition Bureau”.

3.2. The relationship between access prices and final prices

The importance of ensuring that the structure of final prices is reflected in the structure

of the access prices and vice versa. This is illustrated in Figure 11. We look here at the

broad features of the structure of final prices and then compare that to the structure of

access prices.

Figure 11. Comparing the structure of access charges and retail charges

Dependence on:

Source: OECD.

60

Final prices

What is the broad structure of end-user or final prices in OECD countries?

In all OECD countries, virtually all calling plans for fixed networks feature a two-part

structure, with a fixed monthly charge and a usage charge that depends on various

components of usage (i.e., a per call fee and/or a per minute fee).

In the case of international and long-distance calls, the usage charge is usually a per-

minute charge with no call set-up charge. Although long-distance calls are

overwhelmingly priced on a per-minute basis, there is at least some tendency away from

a simple linear per minute charge for long-distance calls. For example, many companies

have introduced a cap on the price that can be charged for a particular call, or on the

total long-distance usage charge per month. For example, Telecom New Zealand has a

cap of $2 on the price of national long-distance calls. Under Telecom New Zealand’s

favorite places scheme, users can pay a fixed monthly charge for unmetered calls to a

specific destination. In Canada, BellSouth and Sprint offer a cap of $17 per month on

the total national long-distance bill. Telecom Italia offers a tariff option with unmetered

national calling. BT, which has metered local calling, offers unmetered local telephony

at off-peak times, for a fixed fee.

New tariff packages of this kind continue to be announced all the time. On 16

November 2001, France Telecom announced a plan where for 3 Euros per month, users

can have unlimited calling to any three designated national fixed line numbers

(including unlimited calling to certain Internet service providers).

On 4 December 2001, BT announced that customers would be able to pay a flat

monthly fee of almost 30 Euros for unlimited free evening and weekend calls to all

national and local landline numbers (together with discounts to local, international and

fixed-to-mobile calls during the day). In April 2002, WorldCom announced a new

service combining unlimited local and long-distance calling in the US for a flat monthly

fee of US$50-60 per month.

On top of this trend away from dependence on time, there is an even stronger trend

away from dependence on distance. In several OECD countries there is now no

distinction between local and long-distance calls – all national calls are the same price –

or, put another way, the size of the local calling area is the entire country. This applies

61

in Iceland, Norway, Sweden, Switzerland, Denmark and Ireland and is offered by some

new entrants in the UK and Italy.

Some operators have taken this principle further and price international calls at the same

rate as local calls. For example, one of the new entrants in the UK offers a package in

which calls to anywhere in the UK and the USA cost the same – in other words, it costs

the same to call next door as it costs to call New York.

In the case of local calls, practices vary. Most OECD countries have a system of

minimum fee (or “flag fall”) charges combined with per minute charges for local calls.

Australia has a pure flag-fall charge – local calls on Telstra’s network cost 22

Australian cents, regardless of the length of the call. The remaining countries have free

(unmetered) local calls (i.e., no per call or per minute charges – this applies to the US,

Canada, Mexico44 and New Zealand).

In many countries, different end-users face different prices for telecommunications

services, either because different prices are offered to different classes of consumers

(some telecommunications companies distinguish between business and residential

customers) or because the same class of consumers is offered a menu of tariff packages

and allowed to choose the one that best fits their needs (for example, many companies

offer “low user” options which allow end users to choose tariff packages with a lower

fixed fee and higher usage fees). When there are different charges between business and

residential customers there may be differences in the monthly rental charge, the usage

charges, or both. Despite the fact that underlying costs vary widely according (amongst

other things) to the density of the network, geographic differentiation of retail prices is

rare. Canada seems to be the only OECD country to practice systematic geographic de-

averaging of retail services. In Canada lines are grouped into 7 bands, according to

geographic density. The residential monthly rental for a local loop depends strongly on

both the province of Canada in which the subscriber is located and the geographic band

of the subscriber’s line.

Despite the lack of geographic differentiation, it is common practice to differentiate

final prices according to the time of the day or week at which the call is made. There are

commonly one, two or three different charging bands, corresponding to peak / off-peak

times.

62

Access prices

Are access prices structured in a way that is consistent with the structure of retail prices

just outlined above?

In regard to dependence on distance, we are not aware of any countries where the access

charges depend on the distance a call has been carried before being handed off to the

terminating network. As long as access charges are not distance dependent, competition

provides a strong incentive to eliminate the distance component of end-user charges

(since the marginal costs of providing a long-distance call are largely independent of the

distance it has been carried). In other words, the absence of distance-dependent access

charges could be one of the primary factors behind the significant trend away from

distance-dependent retail charges. In regard to dependence on time, the majority of

long-distance and international calls are still priced to end-users on a per-minute basis.

This is consistent with the virtually ubiquitous practice of per minute access charges for

long-distance calls. All OECD countries (with the partial exception of Spain) charge

per-minute access charges for long-distance calls.

The introduction of capped or unmetered long-distance retail prices breaks this

symmetry between the structure of access and retail charges for long-distance calls. This

has given rise to competition concerns. For example, in the mid-1990s Telecom New

Zealand was charging its rival Clear roughly 2 cents (NZ) per minute for long-distance

interconnection per end. Telecom subsequently introduced a new retail tariff which

capped off-peak long-distance calls at NZ$ 5, independent of the length of the call. This

new tariff structure proved popular with customers but lead to complaints from Clear

that for calls longer than roughly 2 hours in duration the interconnection charges would

exceed the revenue Clear could obtain from the call.

Similar complaints arose in Australia when Telstra introduced a capped $3 off-peak

long-distance calling product. “AAPT alleged that it was providing a competing product

to Telstra’s $3 capped STD product at a loss because of the structure of Telstra’s

interconnection prices charged to AAPT. AAPT alleged that, through the capped rate

and disparities between peak and off-peak wholesale and retail charges, Telstra was

imposing a price squeeze on its competitors, and prevented AAPT from competing

effectively in the residential market for long distance national services. The ACCC

63

concluded that Telstra’s conduct did not contravene the competition rule.” In regard to

dependence on the identity of the end-user, as noted above, a few OECD countries

make a distinction between the end-users prices offered to business and residential

customers. In addition, many OECD countries offer tariff options that allow end-users

to select the basket of tariffs that they want. In contrast, it is rare for call origination and

termination charges to depend on the identity of the customer served. When access

prices are not differentiated according to the identity of the end-user, the scope for

competition for certain users can be restricted and the ability of the incumbent to offer

efficient tariff structures may be impaired.

Consider the following example. Suppose that a rival local loop provider wishes to

compete with the incumbent by offering its customers a choice of calling plans – one

choice, which is targeted at light users features a lower monthly rental fee and a higher

per call fee and the other, targeted at heavy users features a higher monthly rental fee

and little or no per call fee. Offering a menu of calling options in this way is

economically efficient – it could entice low-users onto the network (increasing

penetration), while offering more efficient calling plans to heavy users. The key

problem is that uniform access charges undermine the ability of the incumbent to raise

its usage charges on one group of customers. As Laffont and Tirole note “Uniform

access pricing deprives the incumbent of its ability to offer an efficient menu of tariffs

tailored to the needs of its clientele”. If long-distance companies are allowed to compete

for all customers, whichever calling plan they choose, and if access charges are

independent of the calling plan chosen by the subscriber, competition will drive down

the price for calls and therefore eliminate the contribution from usage charges towards

the fixed costs of serving this customer. Uniform access charges and competition are

incompatible with low-user calling plans. If uniform access charges are maintained

either the low-user calling plan must be eliminated or competition for these users must

be restricted.

Some countries have recognised this problem and have chosen to resolve it, not by

allowing access prices to vary with the identity of the end-user, but by restricting

competition. The UK, the Netherlands and France have all chosen to restrict

competition by preventing customers who chose a “light user” scheme for having a

choice of long-distance provider. Note that it is important to distinguish here between

64

differentiation of access prices according to the identity of the final consumer (or end-

user) and differentiation of access prices according to the identity of the access seeker

(i.e., the rival or competing firm). In the submissions for this report many countries

argued that differentiation of access prices according to the identityof the access seeker

raises the potential for anti-competitive discrimination and is explicitly ruled out by

laws against discrimination. The Netherlands notes that “the regulated firm is not free to

differentiate his termination tariffs depending on his view of possible differences in the

business cases of access seekers”. Austria argues that two-part access tariffs “would

mean that operators would be discriminated according to their interconnection tariff

behaviour – smaller operators would possibly pay higher fees than larger ones resulting

in high market barriers for new entrants”.

These statements are correct if the access prices depend not on the identity of the final

customer but on the identity of the wholesale customer (the access seeker). It is at least

theoretically possible for the access prices to depend on the identity of the final

customer. As long as all companies serving a particular consumer face the same access

prices, access prices can differ between consumers while maintaining a level playing

field – discrimination is not possible. For example, the access charges for the provision

of long-distance service to a customer might consist of a fixed charge of $3 per month

and a usage charge of 0.01 cents per minute. An access seeker with 100 such customers

would pay a charge of $300 per month. Since these costs increase linearly with the

number of customers there is no discrimination against small operators.

In regard to geographic differentiation, as noted earlier, most countries maintain

geographically averaged prices. Consistent with this, most countries have chosen

geographically averaged call origination and termination charges.

An exception is Australia, which differentiates access prices according to geographic

location. Call origination and termination charges are divided into four zones – CBD,

Metropolitan, Provincial and Rural/Remote. The access charges are lower in the CBD

zone than in the Rural/Remote zone reflecting the higher density of the network. This

approach reduces the incentive for inefficient network duplication in low-cost areas, but

raises the risk that new entrants will target customers in low-cost areas to the exclusion

of entry in rural areas.

65

In regard to differentiation according to the time, most countries differentiate call

origination and termination prices in a manner that reflects the peak/off-peak banding of

retail prices. The Netherlands notes that the access charge for call termination

differentiates between three different time periods which are chosen to be identical to

those used by the regulated firm in its retail offer “to prevent price squeeze effects”.

However, this is not the case in all countries. Australia, Canada and Mexico, for

example, make no distinction between peak and off-peak in call origination and

termination prices, despite variation in retail prices. In these countries there is a risk

that new entry will be focused on end-users which produce most of their calls at peak

times.

Let’s turn now to look at the scope for competition in the transportation component of

local calls – that is, local calls which require both call origination and termination

services from the incumbent. Because the transportation component of local calls is

limited, not all OECD countries allow or encourage this form of competition. As

always, what is important is both the level and structure of access prices relative to

retail prices.

As already noted, a number of OECD countries have free local calling. Free local

calling is incompatible, on both the level and the structure, with call origination and

termination charges that have a per-minute structure. This conflict can be resolved

either by adjusting the access charges, the retail charges or by limiting competition.

Most of those countries that have free local calls (US, Canada, Mexico and New

Zealand) resolve this problem by limiting competition – these countries do not have

call-by-call competition for fixed local calls for end-users on free-local-calling plans.

Australia, on the other hand, which has per-call charges for local calls, resolves the

trade-off by introducing a special set of access charges for local calls. Specifically,

rather than use (cost-plus) per-minute charges for call origination and termination, in the

case of local calls, Australia relies on a retail-minus approach which sets access prices

on a per call basis. This retail minus approach maintains a close relationship between

final prices and access prices. Since local prices in Australia are not geographically

differentiated, are not differentiated according to peak/off-peak but do depend on the

identity of the customer (business/residential), the retail-minus approach ensures that

this same structure is reflected in the access prices.

66

Most OECD countries have metered local calls and per-minute access charges, so the

structure of the final prices for local calls matches that of the access charges. The

primary problem here is not so much the structure of access and retail charges, but the

relative level. The problem is that the desire to prevent distorted competition for call

producers or call sinks leads the regulator towards setting the call termination charge at

around half the retail charge – but this leaves no margin for rival companies to provide

local call services. The result is that in all except a few countries, the level of call

origination and termination charges has been too high to permit local competition.

67

Chapter 3: The economy of the cables and satellite in France

1 INTRODUCTION

This chapter is a summary of the the economy of the cable and satellite in France.

2. THE CABLE INTO THE FRENCH AUDIOVISUAL AND TELECOMMUNICATIONS MARKET

Among the 23.5 million TV equipped french homes, nearly 10 million subscribe to an offer

of pay-TV, or slightly more than 42% of the total. This market consists of three major

segments : subscribers to the cable, satellite and Canal + analog radio. Canal + is also the

first operator with more than 3 million radio subscribers individual, far before CanalSatellite

(2.1 million subscribers), GST (1.1 million), or cable operators, certainly with 3.5million

subscribers, but the most important, Noos, has only a little more than a million subscribers.

However, the reminder of the importance of the historic radio premium channel must not

obscure the strong growth of the satellite, that close the penetration rates combined two

platforms satellite TPS and Canal satellite to cable operators, yet appeared ten years before

the digitization of the satellite started in 1996 (see chart).

Foyers abonnés au câble et au satellite 1995-2001

0

500 000

1 000 000

1 500 000

2 000 000

2 500 000

3 000 000

3 500 000

4 000 000

1995 1996 1997 1998 1999 2000 20010%

5%

10%

15%

20%

25%

Nombre d'abonnés au câble (tous services) Nombre d'abonnés au satellitePénétration du câble Pénétration du satellite

68

At December 31, 2001, networks of cable operators in France included 11.5 million taken

at term (or potential) and $ 8.5 million of marketable catch, favouring natural areas to

densely populated. Today nearly 37% homes are already physically connected to a wired

network, and almost 50% should be connected at the end of the construction of all networks.

A little more than 3.4 million households are recorded by the operators of the cable as a

cable service subscribers, approximately 13% of the total of french households and 40

percent of households connected physically to a cable network. This rate includes a strong

minority of subscribers ' antenna ' (about a million homes), i.e. homes for which the cable

serves only to carry chains microwave, sometimes augmented to a local channel signals. In

addition, end of 2001, the reception of digital television services, including the marketing

began in December 1996, concerns only 20% of homes subscribing to cable.

If low-flow type PSTN connections remain majority in France, subscriptions to Internet

access offers broadband by cable or ADSL grow, especially since the end of the year 2001.

Introduced late 1999, technology ADSL, boasting more coverage of the population, quickly

imposed: at June 30, 2002, access to Internet cable services had 233 579 subscribers,

while ADSL reached at this date the level of 650 421 individual subscriptions (or 73.5%

of market share); the Cape of the one million ADSL subscribers reached end 2002

The market of cable in France has nearly fifty operators. Among them, stand out four major

national players, implanted in several regions and covering all the 20 largest French cities.

Them four, these operators account to 30 June 2002% more than 92% of the marketable

catch of cable in France, and almost 90% of subscribers (all services). In terms of scope of

network and subscribers Park, Noos is the first french cable operator.

69

Market shares of cable operators by activity segment

To June 30, 2002 Absolute

value Noos FT Cable

NC

Numéricable

UPC

France Other Total

Marketable catch 8 687 822 33% 18% 26% 15% 8% 100%

Subscribe all services 3 545 166 30% 24% 21% 15% 10% 100%

TV subscribers 3 403 659 30% 24% 22% 13% 10% 100%

Digital Subscriber 741 561 54% 19% 24% 1% 2% 100%

Internet subscribers 233 579 55% 20% 10% 8% 7% 100%

Subscribers telephone 58 434 3% 0% 0% 97% 0% 100%

Sources: AFORM, operators

Cable turnover reached EUR 692,9 million for the year 2001 Since 1998, it is far

exceeded by the turnover of satellite broadcast, which reached EUR 1 142.3 million in 2001.

This difference is mainly due to the absence on the satellite equivalent to service the cable

antenna.

Evolution of the turnover of the french cable operators

(in millions of euros) 1998 1999 2000 2001 2001/2000

Noos 136.2 185.6 201.0 227.9 + 13.4%

France Telecom Cable 173.8 175.0 164.0 172.0 + 4.9%

NC Numéricable 119.7 126.8 136.0 141.0 + 3.7%

UPC France 3.7 29.1 71.6 93.7 + 30.8%

EST Videocommunication ND 22.7 26.4 30.6 + 15.8%

Other (estimate) 27.3 32.9 34.8 27.7 20.4%

Total 460,6 572,1 633.8 692.9 + 9.3%

Source: operators

The cable represents only 2% of the turnover of the telecommunications sector in

France. Compared to turnover other audiovisual activities, the economiy of the cable

remains fairly low weight:

- 3.7% of the total turnover of the audiovisual sector;

70

- 3.9% of the total turnover of the market of television (cable, satellite, terrestrial

television broadcast, local and thematic channels).

Cable operators are, therefore, not able to influence the development of programs on offer

in chains, or participate for themselves in the competition for the exclusive audiovisual

rights acquisition of sport and cinema.

3 THE CABLE IN EUROPE AND THE UNITED STATES

The study of the conditions for the operation of the cable in other countries provides some

insight into the position of the cable in France. Despite the disparity of national situations

all cable operators are indeed submitted in recent years to the same underlying trends:

digitization of the networks, the arrival of new applications, and the increased competition

from other technologies (satellite, digital terrestrial television and ADSL).

Two main models of organisation of the market can be distinguished: one where the cord may

appear as the vector of main streaming of television content (case of the markets with a high

rate of penetration), and that where on the contrary the cable is only a secondary, even

marginal, technology over alternatives available on the market.

in December 2001 Belgium

United

States Germany Sweden

Share of households connected to

cable 97.8% 93.5% 84.6% 80.0%

Share of households subscribing to

cable 96.5% 69.0% 66.7% 69.9%

Number of subscribers to the cable 3 680 000 72 958 180 22 100 000 2 490 000

Trade penetration 98.7% 73.8% 78.8% 87.4%

in December 2001 United KingdomFrance Spain Italy

Share of households connected to

cable 52.8% 35.2% 16.7% 7.1%

Share of households subscribing to

cable 15.3% 14.0% 4.0% 0.8%

Number of subscribers to the cable 3 770 000 3 375 209 480 000 170 000

Trade penetration 29.0% 39.7% 24.0% 11.7%

Sources: NCTA, ITC, beeps.

71

With the exception of the United Kingdom which is a special case, the countries where cable

enjoys the subscription in the highest household penetration are those where the rate of

coverage of infrastructure is the highest. These markets are characterized by a rate of

commercial penetration of the cable above 50% of the connectable, all activities combined. It's

the market of the cable in the United States, and Europe, those of the Germany, Belgium,

the Netherlands and Sweden (among others). In the United States, the cable represents the

majority reception of TV mode with nearly 73 million subscribers homes end of 2001 (over

two-thirds of American homes). The American cable generates an annual turnover of $ 43,66

billion, making US by far the first worldwide market of the cable.

The review of foreign markets on which the cable has experienced its greatest development

allows to make emerge a number of characteristics that promote the profitability of the

operators :

- The seniority of the implantation of the cable . The countries where the cable

has the largest penetration rates are those where cable operators market their

services since long. The cable was introduced while alternative distribution

technologies such as satellite were poorly developed. He often offered better over-

the-air reception. A progressive immune to competition development allowed

cable operators to amortize their investment in infrastructure without excessive

debt-stricken. A contrario, a too late launch of the cable, in a context of already

advanced, deregulation is not justification : in Italy, cable networks of the 1990s

construction projects were quickly abandoned when it turned out that it would be

more efficient to replace the satellite cable.

- The deployment of the network requires significant investments which cannot

be transformed into revenues in the long term. Several factors are involved in

determining the cost of infrastructure: the extent of the network building, the

choice of the technology used (HFCs, RC2, VHF...), and conditions of laying

cable (buried in France or air in the United States). Sprawl in time of work, giving

priority to the more densely populated areas is also an element to be taken into

account.

72

- Also important to the economy of the cable, the system of distribution of

income among distributors and publishers of strings varies by country. In the

United States, the rate of penetration of the cable is sufficiently high to ensure that

operators are sometimes able to demand the payment of a royalty on the part of the

(TV) channels themselves, who pay to be part of the basic service, or to the

extended basic service. On the other hand, the organisation of the market of the

cable in other countries private operators revenues associated with their content

distribution strategy: while in the United States, operators benefit for a share of the

proceeds of the subscription of households and other sums paid by channels, cable

operators Europeans pay their suppliers of significant royalties for the

retransmission of content. In Germany, for example, subscribers pay a fixed fee to

cable operators to which is added a fee paid to the strings for content. The cable

operator is therefore not remunerated for the provision of services which

explains the low average revenue per user. Mustcarry obligations are also

forcing cable operators to distribute for free core of audiovisual services programs.

Operators intervening on markets for which programs premium on offer is

highly concentrated in the hands of a powerful player, as BskyB in the United

Kingdom, have every interest in trying to develop non-television services.

Operators like NTL and Telewest have thus seen dans phone the only way to

provide strategic differentiation in their reference market (respectively 44% and

69% of their subscribers subscribe to more than one service).

On almost all of the European markets, cable operators face competition from digital

satellite TV platforms and, sometimes, digital terrestrial television. The quality of the

services, the diversity of content and the prices they charge are often very attractive: they limit

the tariff margins for manoeuvre of cable operators and increase the costs of purchase of

programs that they must bear to remain competitive. In less than ten years, satellite is

therefore imposed on certain territories such as the dominant infrastructure on the

television market like England (BskyB in 1990), Italy (Telepiù in 1996) and the Spain

(Canal Satellite Digital and Via Digital in 1997). Regardless of the level of maturity of each

market, it appears that the arrival of interactive cable applications had a very significant

impact on the accounts of the operators. The digital switchover requires on the part of cable

73

operators of considerable investment in network infrastructure upgrade and the grant of

the decoders in order to make the transition more accessible to households. However today

the demand for digital services mainly concerns access offers high-speed Internet, digital

offerings having not been a decisive interest on the part of households. The economic

balance that some were gradually managed to achieve in a simple analog cable activity

has been severed by investments associated with the introduction of new services, and its

restoration assumes an important work of adaptation on the part of the operators. Another

element having a negative impact on the development of the cable, the General fall of stock

prices has particularly affected operators, the confidence of investors being affected by their

financial difficulties and the low profitability of the sector. The discount has been accentuated

by the deflation of the bubble around the values related to information and communication

technologies. The fall in prices has contributed to the financing of investments and debts.

Especially, it postpones projects increase in capital and consolidation by redemptions of

operators, even delaying the prospect of a restructuring of the U.S. and European markets.

4 CABLE IN FRANCE OPERATING CONDITIONS: HISTORICAL HANDICAPS AND ECONOMIC

PROBLEMS

4.1 The historical construction of networks conditions wired in France

The decision to develop the cable in France was taken in the early 1980s under the aegis of

the Directorate General of Telecommunications of Ministry of PTT. The Plan cable included

cabling in ten years of 52 of the principal cities of France, with the objective of asking 10

million catches, all for a cost estimated at 20 billion francs of the time (more than EUR 3

billion).

The french audiovisual landscape has undergone a complete transformation in the ten years

between 1982 to 1992. The launch of the cable Plan in 1982 coincided with the announcement

of the creation of a fourth pay terrestrial channel, and the commissioning of the first tranches

74

of its cable network follows a few months the start of the broadcast of the fifth and sixth

terrestrial channels: the request of the public to a greater variety of programs was

therefore largely satisfied without technology investments While the cable was in its

early years a technology without programs.

Proponents of the cable Plan made also the choice very ambitious networks fiber optic

star, expected to carry interactive applications for which there was not at the time of

suitable reception terminals. Technological volunteerism of the project resulted in costs very

important, amplified by the approximate control of construction of fiber networks: in many

cases, to hold the time and not exceed the budget envelope of origin, 100% fiber networks

provided originally became networks mixed fibre / coaxial cable.

The establishment of cable in France has also evolved: the accumulation of technical

difficulties for the laying of the cable Plan networks has led the Government to change in the

regime of the construction and operation of cable networks (in the Act on the freedom of

communication of 30 September 1986).

4.2 Regulation of the cable against the cable television

The rules applicable to cable operations includes certain obligations become today difficult

to justify, and that contribute to the difficulty in operating the cable operators:

- The threshold of the 8 million people : this rule whereby a same operator

networks cannot cover cumulatively more than eight million people was introduced by

the Act of 30 September 1986 in order to promote competition between operators. It

does not apply to other modes of distribution of more television, satellite and

digital terrestrial television (any more than the provision of access to the Internet via

ADSL), and would be difficult to implement for cable operators because of disparities

between the extent of networks in connectable catches and the individual enumeration

retained by law. However, the maintenance of this rule blocks any plans for a

merger of the operators, and limit the possibilities for rationalization of the plates by

the exchange of networks.

75

- The regime of the public service concession : the Act of 30 September 1986

endorses the principle of local initiative for the construction of the networks cables,

allowing communities to balance the relationship with cable operators in their

favour, in requiring them to compliance with provisions of public service (payment of

a fee, financing of a local channel...). From the point of view of cable operators, these

clauses increase the cost of building the networks, without generating additional

revenue in return (even if it is arguable that local channels may encourage some

people to subscribe to the cable). However, the main criticism of the regime of the

public service concession operators is very difficult for them to enhance potential

infrastructure which they are not the full property investors. The improvement of

the conditions of operation of the cable will require at one time or another reform of

the public service concession, probably on the occasion of the transposition of the

texts of the package. Telecom

- The control of the service by local plans : the Act of 30 September 1986 had

planned the operation of cable networks is permitted by the CSA 'on proposals from

municipalities or groups of municipalities", which implied a right of scrutiny of the

communities of implantation of the networks on the evolution of the supply of

services. Although largely fallen into disuse, this provision is a brake on the reactivity

of cable operators compared with the expectations of the public or the evolution of the

editors of channels on offer; It also complicates the attempts of unification of plates (a

continuous physical network with a single head of network to serve a group of

neighbouring municipalities).

4.3 The operation of the cable

The ownership and management of the network infrastructure

The cable Plan was that all of the cable networks would be constructed by the DGT, ancestor

of France Telecom, which keep the property. By opening up the market of the cable to private

actors, under the regime of the public service concession, the Act of 30 September 1986 has

introduced a hybrid system in which an operator can be in charge of the technical and

commercial management of an infrastructure that it builds and maintains itself, or

76

distribute services on an infrastructure leased to France Telecom. This situation poses

two types of difficulties to cable operators who are not yet out of the cable Plan: it

complicates relations with subscribers, by forcing the cable operator to delegate to a third

party physical interventions on the network, troubleshoot the connection for example. It

significantly increases operating expenses of cable operators, by forcing them to pay a rent

whose determination conditions seem not transparent (for example, the price it

corresponds only to the current use of the network, or part of the amount is intended to

cushion the initial investment of the cable Plan? and if so, what about successive impairment

occurred in the France Telecom accounts). In the past, the survival of the cable Plan raises

the problem of the limits of the activity of a historical telecommunications operator:

France Telecom today is owner of two local loops in many French cities (Lyon,

Marseille, Bordeaux...), resulting in a distortion of competition. It is also significant to

note that in 2000, the deployment of ADSL took place in priority in the cities where the local

cable company wanted to market a service of Internet access by cable.

The question of the number of available sockets : cable operators complain of not always

knowing exactly the number of shots actually built and operational on each of their

networks. The technical limitations of the networks themselves (points of termination with a

number of fixed irrespective of the number of dwellings to serve), sprawl in the time of the

installation of networks, and the constitution of networks by external growth contribute

to this uncertainty. With the ownership of their network operators strive to improve their

knowledge of their infrastructures, which directly affects the effectiveness of trade promotion

actions (including those that involve the doorstep of prospects). Operators subject to the

regime of the cable Plan also have difficulties in knowing the exact amount of outlets

operational networks that their praises France Telecom, which is an important variable in

the calculation of the annual cost of provision of infrastructure by the incumbent operator.

The importance of the difference between catches recorded by cable operators and the reality

on the ground is, however, impossible to assess with accuracy; Some cable operators argue a

proportion of 10% of the total connectable catch is approximately. 850 000 shots less

compared to the advertised figures.

77

The digitization of the cable and new services

The development of the digital satellite is accompanied by the multiplication of the number

of channels available, highlighting the limitations of the analog cable. The digitisation of

networks has emerged as a strategic for cable operators in imperative, in order to remain

competitive with the competition from the satellite, and position themselves in emerging

markets of Internet access broadband and telephony. This evolution has a significant cost,

expressed by the work of upgrading networks and especially, by the purchase of digital

decoders intended to be leased to subscribers. However, the appetite of consumers for

digital cable and new services proved to be lower than expected, and the first orders of

digital decoders from the end of the 1990s brought longer than expected to be passed. In

addition, digitisation of networks has been the source of technical problems , which in some

cases have harmed the image of cable operators (in particular for Internet services). These

difficulties are that cable operators continue for some to commercialize an analog bouquet

(NC Numericable and UPC), or attempts to spread over time the conversion of subscribers to

the digital (Noos, FTC). Analog services are indeed easier to operate for operators offers

(no decoder to depreciate, billing simplified compared to the digital map), and a stable source

of income.

The issue of the transition from analogue to digital for cable operators is all the more crucial

that the cable will remain their main source of income for the future predictable. Internet

access by cable services have fewer than 250,000 subscribers, and telephone services are now

offered by a single operator (UPC France, with 50 000 subscribers). The first offers of access

Internet by cable operators have suffered from significant technical problems which caused

the number of subscribers for the first time to turn to ADSL when France Telecom began to

market end of 1999. Cable operators have put up recently one new strategy of marketing of

packages low-speed (but with the benefit of a permanent connection) or "means flow» for

subscribers to television services, in addition to their bouquet of channels. Moreover, the

cable-telephony suffers from multiple disabilities, of which the most important is the use by

traders in a circuit-switched: still do not have "all-IP" technologies, their services cannot

escape lasting infrastructure of France Telecom.

78

Relationships with the editors of channels and the specific status of Canal +

Assembly of bouquets of channels attractive and interesting both for leads calls for specific

know-how that cable operators have put the time to acquire, taking into account inter alia

of the industrial culture or financial shareholders, the lack of exclusive content with high

added value to the cable (football and the premiere cinema being historically reserved for

Canal +), and the small number of channels available in the first years of the cable. On

this point, the offer has really exploded after the launch of digital satellite bouquets in 1996.

The profusion of brings supply elsewhere cable operators to market on digital networks offers

à la carte, in which viewers select strings of their choice within the framework of a budget set

in advance. From the point of view of the editors of channels, this system is not the most

interesting, because it the forces to make efforts of marketing directly with prospects, then

their string within a diverse bunch of analog or digital inclusion puts these efforts paid by the

cable operator. The persistence of the analog bouquets is also very interesting for strings

that are part : given their stability and the small number of strings that are referenced (15 to

20, against more than 100 potentially available to digital subscribers channels), these clusters

contribute more to the hearing strings and often allow them to collect royalties higher on

the part of operators.

Unlike the United States and other countries, where the amount of subscriptions to premium

channels is shared more or less equally between the editors of channels and cable operators,

Canal + benefits in France of a specific statute that does not benefit the cable operators.

Transported free of charge in analog under the rule of the must-carry channels (i.e.

enjoying exactly the same status as TF1 and France 2), digital Canal + distribution escapes

largely to cable operators. In fact, smart cards used to activate the decoders, programmed

and updated based on the type of subscription by cable subscribers, include a separate

encrypted compartment reserved for access to Canal +, independently of any intervention by

the cable operators. Canal + therefore directly manages the relationship with its digital

cable subscribers and merely to pay a modest sum (less than 2,5 EUR per month) to cable

operators, in order to contribute to the amortization of the decoder (which would benefit

if not for free). The distribution of Canal +, premium channel reference, does therefore not

79

contribute significantly to the turnover of cable operators, who thus have no interest to

promote. Therefore, a whole marketing strategy based on the combination of the

advantages of Canal + and digital cable remains unexplored (as of combined offers Canal

+ / Internet broadband, or Canal + / thematic mini-bouquet à la carte, etc.), while these

initiatives might help to improve the rate of penetration of the cable. The difficulties of Canal

+ may however bring the situation to evolve, by promoting the search for synergies with

cable operators, after an agreement for a more balanced distribution of the revenue of the

chain.

Marketing and customer relations

The choice of the prospects good recruitment tools is very important in the case of the cable.

Territorial networks burst prevents operators to use the most powerful media

(television) and their promotional communications through essentially from non-media

(display and mailbox). It can be seen that local cable operators are generally above-average

penetration rate, due in part to their local roots and their strategy of direct contact with

prospects. Scattered networks of the major cable operators have prompted them to centralize

the customer relationship in the 1990s (call centers), but the mixed results of this approach

now lead them to supplement it by a presence on the ground (shops, doorstep). On the other

hand, offers from cable operators are often more complex than those of the operators of the

satellite, with different subscription levels mores, or offers differentiated according to

networks (even if large cable operators have made very significant efforts to unify their

commercial proposals, in particular for digital services). The management of the Park of

existing subscribers is often complex. The changes in the shareholding, the acquisition of

new networks, the cohabitation of analog and digital subscribers, etc., led to a proliferation of

articles and categories of subscribers, which increases the risk of errors in billing and

complicates communication operators.

80

5 THE EVOLUTION OF THE COMPETITIVE AND REGULATORY CONTEXT

5.1 The launch of digital terrestrial television and its impact on the cable

Act of 1St August 2000 audiovisual contains provisions relating to the establishment of a

tender for digital terrestrial television.

The selection procedure of the services of televisions called to occupy channels reserved for

terrestrial digital broadcasting, launched by the CSA in July 2001, took a very important step

with the publication in October 2002 a list of 23 channels selected, who will share the 22

channels reserved for the private offer (11 other channels will welcome the public and local

channels). The progressive crossing of the legal steps for the launch of TNT (publication of

the decrees implementing the Act of 1St August 2000, call for applications of the CSA) should

not hide the important technical and commercial barriers which depends the actual DTT

launch.

- The first of these obstacles is the need to make very many rearrangements of

analogue frequencies before you start digital broadcasting. According to the national

agency of frequencies, the cost of these works is between 44 and 84 million euros,

depending on the magnitude of interventions to drive individuals. This first wave of

refitting of the frequency applies only to analogue reception: it is designed to ensure

that viewers continue to receive signals from analogue after the start of the TNT

television.

- The second wave of technical arrangements thereby concerning proper digital

reception, with probably interventions on millions of antennas, individual or

collective, to steer them in the direction of the transmitters or replace them completely

for the oldest of them. The amount of these works would also be in tens of millions of

euros.

- Finally, the third big obstacle to the launch of DTT is the absence to date of

candidate for the position of commercial channels of supply operator. Given the

importance of its fleet of radio subscribers, Canal + could have interest in being the

commercial DTT operator, to speed up the migration of its own customers to digital,

especially those who don't want to or can't take out a subscription to CanalSatellite.

81

This scenario was seriously considered in 2001 by the Canal + group, before being

abandoned following the serious financial difficulties of the Group and its shareholder

Vivendi Universal. At present, there is no candidate said marketing of the pay

DTT, or this actor will be best placed to unite the efforts of communication

around the digital terrestrial television, including the concept and the potential still

unclear for a large majority of the French.

The resolution of technical and commercial issues outstanding warrant elsewhere in no

case the success of digital terrestrial public . The failure of the formulas of marketing of

DTT in other countries of Europe testify to the difficulty to impose an additional delivery

method when existing operators ready to meet the demand for programs of consumers via the

most effective technologies of cable and satellite.

The argument often advanced DTT programmes free of charge does not withstand

scrutiny , on the one hand because free programs will not final not very many, on the other

hand because economic free digital broadcast model is risky for additional channels.

Indeed, they will incur up to 4 million euros per year for the digital release of their signal

— a considerable sum for chains including budget is between 12 and 30 million euros for the

vast majority of them, and in the absence of the first years of any consideration of sales

(advertising or subscription charges) taking into account the weakness of the staff households

equipped to receive DTT.

From the point of view of cable operators, the launch of DTT poses two major difficulties:

- The interference of frequencies for cable networks : the problem is similar to

that of interference to analogue TV via DTT, the difference being close as

opportunities for redevelopment of frequencies of cable networks are limited. It

may happen that the digital frequency plan is saturated. In this case, the only solution

for the fuzzy operator will be to fully digitize its network to gain bandwidth thanks to

digital compression of the signal. The operation involves the purchase and

distribution of decoders to all former analog subscribers networks scrambled: an

expenditure valued at 100 million euros by the Aform, and cable operators cannot

afford today.

82

- The rule of the must-carry digital channels Earth in clear by cable networks

introduced by the Decree of January 31, 2002. This rule will require cable operators

either to change deeply the economy of their digital packages, especially packages

cheap entry-level created to attract new subscribers, or push them to delay for as long

possible the digitization of analog to evade these obligations subscribers of

transport, even without other sources of income (video on demand) (, interactive

services, Internet access...).

5.2 The telecom package

The European Union issued in 2002 a series of directives that reforming the regulatory

framework for telecommunications. These texts have for objective the establishment of a

common legal regime for the establishment and operation of telecommunications

networks, regardless of the nature of the technologies implemented. The transposition of the

directives into french law should therefore lead to align the specific arrangements of the cable

of other telecommunication networks, and apply to cable operators the innovations of the

guidelines:

- The general authorisation regime: removal of the need to obtain prior

authorization for the establishment of electronic telecommunications networks and the

provision of electronic communications services. For cable, it means the

disappearance of the role of local communities in the construction of networks, and its

transfer to the operators themselves

- The regime of exclusive rights and the special rights granted to

telecommunications companies: according to the directives, the internal rules of a

Member State should no longer result in making more difficult the operation of a

network of electronic communications over another type, or to limit the number of

undertakings operating such networks. The application to the cable of this principle

implies the revision of several aspects of the regulation French: territorial

exclusivity of cable networks, the limitation to eight million inhabitants of the

coverage of cable operators, the questioning of the regime of the public service

concession, and finally the control services by local plans.

83

- The obligations of broadcasting : the implementation of the rules of the telecoms

package should require harmonisation of the scope of the obligation of transport

chains (must-carry), which currently differs depending on the considered technology

(cable, satellite, TNT). Furthermore the telecoms package makes the legality of these

obligations "clearly defined general interest objectives": the transposition procedure

should provide an opportunity for a debate on the concept of general interest

applied to the audiovisual.

6 SCENARIOS FOR THE FUTURE OF THE CABLE

The problematic issues of competitive, regulatory environment and the operation of the cable

analysed in this study emphasize the need for structural sector changes. The scenarios

sketched here represent a contrasting approaches, a market solution, a political and

regulatory solution, and conversely, the consequences of the status quo. Two scenarios of

failure are main objective permanently eliminate the after-effects of the cable Plan, and create

an environment conducive to the improvement of the operational performance of cable

operators or service providers operating cable networks.

6.1 Scenario 1 - the consolidation of the cable

This scenario includes several variants, classified according to their financial difficulty

and their constant regulatory feasibility. The simplest option is to streamline networks

through exchange of plates, in order to promote the consolidation of operators in major

regional groupings with facilitation of the operations of maintenance and marketing of the

catch. At the level of cities, would be entrusted to a single operator the management of

city-centre network (often created the plan of cable) and that of the periphery, appeared

later, under the regime of the public service concession. Trade plates have the interest to be

achievable under the present, regulations at least as regards the concession network

(more), but are not the same benefits for all stakeholders : Noos is particularly interested in

a refocusing on the île-de-France, but provincial towns operators see no obvious gains to the

abandonment of their Parisian networks. To take all its meaning, the plates Exchange

84

operation should involve all the actors of the cable, rather that take place via a succession

of bilateral transactions.

A second option would be consolidation between them to current actors of the cable after

the removal of the merger-regulatory barriers. The benefits of a merger are enough NET

with respect to the operating costs of the cable: marketing and communication, bargaining

power increased with content providers, service... The question of ownership of the

networks of the cable Plan would be at the centre of the consolidation process. In any

case, outside a very hypothetical rapprochement between Noos and UPC France,

consolidation options would place France Telecom at the heart of the shareholding of

the new ensemble (France Telecom has 27% of the capital of Noos, 100% of France Telecom

Cable, and 70% of the outlets operated by NC Numericable), however, the prospect of a

hegemonic France Telecom position on the market of cable is not acceptable to regulatory

authorities (in Paris and Brussels) It is not strategically nor feasible for the group. Fusion

guess so assignment prior or simultaneous Plan networks Cable NC Numericable and

France Telecom Cable, then a programmed France Telecom of the capital of France

Telecom Cable output.

The central square of France Telecom in the process leads to the third and last option, which

corresponds to the consolidation of the existing a new players entering, which would

provide fresh capital and would dilute the share of the current shareholders of the cable

in the capital of the merged entity. The major problem here is the shortage of candidates

for the takeover of the french cable, in a context of very strong decrease of the valuations of

the assets of media and telecommunications companies. Investment funds do not seem

convinced by the french cable (unlike other countries: Germany, Netherlands...), especially in

its regulatory aspects (public service concession). Actors industrial candidates to redeem

are not not more numerous; some, such as Liberty Media, could possibly be interested in the

folder, but do pass the redemption of all or part of the french cable of other strategic

objectives, or await clarification of the regulation of telecommunications to decide their

next move (alternative telecommunications operators: LDCom, Telecom development, etc., or

possibly an institutional investor such as the Caisse des dépôts).

85

6.2 Scenario 2 - the separation of infrastructure and services

This scenario has for principle the resumption of all of the physical infrastructure of the

cable by a single operator ("France Cable"), which is responsible for their maintenance,

scanning them and their extension, under the control of the regulatory authority. That entity

then sells the bandwidth of networks to all service providers of cable television, Internet

access and telecommunications approved by the competent regulatory authorities (CSA or

ART), under conditions of transparency of fares.

Work for interconnection plates, upgrade networks and interoperable decoder specification

would be taken over by Cable in France, in association with services and content providers.

The idea is to provide these providers access Unified 8.5 millions of currently installed

connectable catches. The objective would be to open the cable market to new entrants,

editors of channels, providers of access to the Internet, etc. that far in were kept away, causing

an increase in the consumption of bandwidth and therefore a more efficient use of

infrastructure. This scenario assumes important initial work before services can be

marketed. It could be done in several stages, with the first phase devoted to the creation of

three or four regional entities, which préfigureraient the connection all networks at the

national level (this incremental approach would allow notably to verify the validity of a

separation of infrastructure and services from the point of view of the Community

authorities of competition). This scenario raises several questions, as its technical

feasibility, as for the cable operators will of commitsr (their shareholders would no doubt

support because the operation would allow them to deconsolidate the loss-making cable

distribution of their accounts activities), and the level of involvement of the regulator of

telecommunications in the control Cable of France (includes ensuring the implementation

of the investments necessary for the development of the capacity of the network).

6.3 Scenario 3 - the status quo and the technology of cable erosion

This scenario corresponds to the perpetuation of barriers to the approximation of cable

operators, at the same time further intensification of competition in the cable television

activities (arrival of TNT) and provision of Internet access (confirmation of the success of

86

ADSL). The probability of this scenario depends on three factors : assignment or non-Plan

networks cable to cable operators France Telecom, the deadline for transposition of the

texts of the telecom package, and the actual launch of digital television terrestrial.

The absence of easing in the short term from the regulation of the cable would strongly limit

the ability of cable operators to seek a structural remedy for their individual difficulties;

quickly enough, the combination of the lack of new prospects and the erosion of the

market shares of the cable would eventually lead to a refusal of shareholders of cable

operators to continue to fund their operating deficits. In the event of liquidation of the

cable operators, under networks would return to local communities, which would then two

possibilities: either organize a tender to assign the operation to a new operatoror reassign

the capabilities of the network for purposes of general interest. In the first case, the

operation of the networks of Commons where the cord enjoys a strong location (40% of

subscribers or more) might interest prospective incoming, or regional operators of the type of

video is communication, without however operating conditions and the competitive

environment they are more favourable. in the second case, some municipalities might be

tempted by a takeover of cable networks in order to develop applications of general interest:

distance education, help for the elderly, municipal intranet linking public places, etc. The

temptation to use the network for this purpose will be stronger that offers pay TV services and

Internet access broadband would be well met by other operators on the territory of the

commune.

87

References

Autorité des régulations des télécommunications, L’économie du câble en France, Etude réalisée par le cabinet JLM Conseil Pour l’Autorité de régulation des télécommunications(Rapport), Janvier 2003.

OECD, Acess pricing in Telecommunications, 2004.

Sumit MAJUDMAR, Ingo VOGLSANG and Martin. E. Cave, Handbook of

telecommunications economics, Volume 2, technology evolution and internet, ELSEVIER

2005.