It’s been over two decades that the agenda of the deregulation was adopted across nations, yet till this day regulation of the telecommunications sector continues to pose challenges. Only a few countries has been able to work out viable models of regulation of this sector while many countries still have public owned telecommunication systems (Grote, 2006). What remains a challenge in bringing about effective competition is the cost and economies of scale of incumbent networks. Hence empirical evidence shows no clear trends of changes in incentives vis-à-vis changes in the regulations on the sector.
The US telecommunication sector is characterized by changes in the regulatory setup governing private companies. As each state within the United States has the right and does exercise their individual regulations, a number of changes were required for the setup. This saw a move from return-on-investment regulation to price cap regulation. But as is pointed out by evidences, some of the states decided to revert back to the rate-of-return regulation. Therefore this paper is an attempt to share some insights into the regulation determination mechanism which is not always covered in theories put forward by economists.
Rate of return
Under this policy the regulator decides on the limit of profit a firm can earn. The fair value on return of capital of the firm is taken into consideration for determine the cap or limit. The price at which the firm charges it customers is thus calculated on the basis of the limit fixed by the regulator. This charge is expected to meet up the operating costs of the firm and also provide a fair return to the company. According to many economists this method provides low incentive for the firm to improve its productivity or lower its operating costs, as the additional profit thus earned does not accrue to the company. The amount is passed onto the customers in forms of mower prices of services offered. If there is any increase in costs, it is passed onto the customers and they are liable to pay for the increase. So under this system the uncertainties of the market is borne by the customers, who may benefit or end up paying more (Grote, 2006).
Rate of Return as a regulation was followed within US for many years. This approach of regulation the profit accruing capacity of a company and thus the price has certain advantages. For example it restricts the rent that can be charged by monopolies. As companies were regulated to a maximum cap the monopolies could not charge extra rent, as such earnings will not accrue to the company. Hence customers were not required to pay extra to a monopoly service provider. Such a regulation also induced a market stability which is necessary during the growth phase of the market for attracting investors. With the market regulated by the concerned authorities, it provided a level playing field for companies to expand into the US market and offer services to its customers (Rohlfs, 1996).
But this method of regulation also had its disadvantages. Since profit accruing to firms was capped in this method, there was little motivation for companies to better their productivity and keep a control on their costs. As there was no apparent monetary benefit of such move, it was not deemed necessary for companies. This was fine till the market was devoid of competition. But once competition was allowed in the market, it meant more frowns for regulators. As competition consolidated, regulators could no longer take into account only the cost factor for regulating the prices. They were required to consider the demand that existed in the markets and also take into account the competitive forces that were at play in fixing the cap. But the challenge was in measuring the quantum of demand that existed as there was no standardized system to measure the same and also competitive factors were difficult to agree upon. Hence it didn’t seem a reasonable approach to regulate a market without proper assessment of its cost implications.
Under this regulation, the concerned authority fixes the price that can be charged for services provided. This chargeable price is kept constant for a three-to-five year period. However, price adjustment due to inflationary tendencies within the economy and anticipated growth in production is also taken into account. As prices are fixed prior, a change in the level of productivity or if costs are reduced the benefit accrues directly to the firm. The firm is allowed to additional profits and they can decide on the mode of its sharing. Therefore the price cap model seems to be an effective model for increasing the efficiency of a firm and also its attempts to reduce cost. Some observers have also noted that information requirement under this system of regulation seems to be lesser than the requirement for rate of return regulation. But regulatory authorities often do not solely depend on price levels for fixing the upper cap. They do take into consideration cost history of the company and the revenue levels earned to estimate the projected gains of the company.
Under this regulatory setup, companies are not allowed to bring about price changes when such changes are in reciprocation to changes in the costs accruing to companies or with a change in demand. Thus the main drawback of this system is that it exposes the companies to market risks without allowing them much elbow room. Hence here the conclusion of the article cited that aggregate cost can lead to better regulatory mechanism can come in for criticism. For in the case of the price cap regulation, cost and demand are both taken into account and measured. But where the article helps take this debate further is by providing a model for evaluating the various components of the demand mechanism which can surely help regulators in better understanding market dynamism and the risks companies are exposed to. But examples from countries where the deregulation is unstable, companies may be forced to face higher marker risks than in countries where the market is moderately regulated. Hence there is scope to draw in the angle of market risk in deciding on successful regulation of the telecom industry. This aspect is something that the article has not focused on, for the fluctuations in demand and its components also forms a part of the market risk that a firm is exposed to.
The growing competition and the progress being made in the area of technology, puts out a case for deregulating the sector. The move should be towards allowing telecommunication companies to have their rates set freely and through the interaction of market forces, as required. Evidence to prove the efficacy of this approach is limited. But certain countries are trying out his method where firms face the risks thrown by the markets and prices are therefore fixed freely.
In a regulator setup when should network be unbundled by the regulator? The answer to this question lies in situation when an incumbent company can assert monopoly in the market due to the lack on unbundling. In the absence of regulator intervention, customers will thus be required to pay highly inflated charges for the final services, which do harm competition and customer welfare aspects. This brings out a very important economic approach when dealing with regulations. Such an approach mandates the use of regulation in the event of market failure. In the case of the telecommunication industry it will mean a monopoly control over the market by companies. Here the main focus is on consumer welfare and not competitor welfare. Hence regulation is mandated in a monopoly so that consumers do not end up paying more than what they are supposed to pay. This method also implies that network unbundling should not be undertaken in the absence of monopoly power. Also in such scenario mandatory access is not required. It is the market forces which should be allowed to set the prices and it no longer remains the prerogative of regulators. The telecommunication market should be allowed to determine prices and regulation should be relaxed overall. And unbundling should be done only when there is an opportunity for monopoly power. Elements like sunk cost should also then be taken into account because this sunk cost many a times acts as barriers to entry into the telecommunication market. While deciding on regulated prices, demand and the condition of its components should be carefully studied so that the prices thus fixed can cover both the fixed cost and the variable costs of the companies. This can help in the achievement of transfer of welfare to end users which are the ultimate motto of all regulation.
The above discussion throws light on the ups and downs that have plagued the telecommunication industry in the US. Regulation was introduced to achieve results of consumer welfare. Initially the rate-of-return regulation mechanism was adopted and the market operated accordingly. But with time fallacies were discovered in this approach and the regulatory authorities made a shift toward price-cap regulation. Even that seems to have its set of constraints. One of the shortcomings was in the way demand was being taken into consideration for the purpose of computing the cap ceiling. There was no proper method for evaluating the demand for telecommunication services and also evaluating the components of demand proved to be difficult. In this sense the article is a good attempt to present a mechanism for evaluation of demand. The article makes a strong case that for incentive regulation to be successful it will have to related to price indices as changes in such indices will highlight the change in composition of various important summations, like that of total service provided by companies, total value of services used by all customers or a particular sample as well as total valuation of capital goods that accounts for the capital stock used in production of the services. This article points that regulatory bodies use the total valuation of services consumed to determine incentives that will stimulate a company to increase its efficiency under the price cap regulation. But where the article could have expanded its scope is in taking a final call on whether regulation is required at all in today’s developing market scenario. Whatever be the regulation option used by the concerned authorities, it does constitute an interference in the natural market dynamics. Understanding some aspects of it will surely help in better computation of facts and figures necessary by the regulator bodies to work on the adequate cap which will not affect the motivation with which a company operates. But the article does not bring up the debate as to whether regulation is required at all. Why shouldn’t the market forces that are the demand expected to be generated in the market, unbundling of network and thus the services made available to the customers be allowed to determine for themselves the price that can be demanded from the customers. For whenever there is regulation there will always be a flip side. Either the firms will not find offers or regulations suitable for their own requirements or for certain regulations there will be elements that will be ignored or under studied when regulators decide upon how much a company should charge its customers. In today’s economic scenario and with the globalization and reforms trend currently being followed across many countries, market forces are much more powerful than they used to be. The regulator authorities should therefore step back and allow the market forces to determine what’s good for customers. The article is silent on this aspect and could have done by shedding some light.
Grote, D. “Regulation in the US telecommunication sector and its impact on risk”. The Center for Market and Public Organization. (2006).
Hausman, J. “Regulated costs and prices in telecommunications. The International Handbook of Telecommunication Economic. (2000). Web. 8 Nov. 2014. <http://economics.mit.edu/files/1030>
Rohlfs, J. “Regulating telecommunications”. Public Policy for the Private Sector. (1996) Web. 8 Nov. 2014. <http://siteresources.worldbank.org/EXTFINANCIALSECTOR/Resources/282884-1303327122200/065rohlfs.pdf>