Privatesector P U B L I C P O L I C Y F O R T H E The World Bank December 1995 Note No. 63 End of the Line for the Local Loop Monopoly? Technology, competition, and investment in telecom networks Peter Smith Local telephone service is the last bastion of a still frequently asserted public policy preference for monopoly provision of telecommunications. This Note challenges the rationale for that prefer- ence, addressing four issues: First, is local network competition feasible from a technical and cost point of view? Second, is telecommunications competition accepted by major investors? Third, how important is competition from a public policy point of view? And fourth, briefly, how can it be made to work? A traditional and now outdated view in the tele- Thus, the cellular operators installed about 35 communications sector is that competition percent of all new lines last year, a surpris- is suitable for terminal equipment, for value- ingly high percentage. These cellular opera- added services, and possibly for long-distance tors contributed significantly to the expansion telephone service after universal service is of telephone service in Sri Lanka—and dem- achieved—but not for local telephone service. onstrated the transition of cellular service from This position is usually accompanied by the a small, specialized, premium part of the mar- view that cellular mobile telephony is not local ket to a substitute for conventional service. telephone service (which it clearly is) but a separate “mobile” market segment. Feasibility and viability A modified traditional view is that local service To assess the feasibility and viability of local competition is appropriate only for large mar- network competition, we need to review two kets (such as the United Kingdom) and in rich groups of factors: first, technology and the cost countries that have already achieved universal characteristics of different technologies; and service (for example, Finland, New Zealand, second, the views of investors, since it is no and the United Kingdom). This is wrong. Even good being right about the technology if in- in a relatively small market such as Sri Lanka, vestors don’t believe in it. local network competition is beneficial. Sri Lanka has four cellular operators and some of The choice of technologies for the provision the lowest cellular telephone service prices in of local telephone service is now broader than the world. In 1994, the number of telephone ever. There are several wireless options: ana- lines in the country increased by about 47,000. log and digital cellular radio, digital cordless Of these, about 30,000 were conventional lines telephony (for example, Digital European provided by state-owned Sri Lanka Telecom— Cordless Telecommunications, or DECT), pro- a record increase. The remaining 17,000 lines prietary (noncellular) wireless local loop sys- came from the provision of cellular service. tems such as lonica (being installed in Finland), Industry and Energy Department ▪ Vice Presidency for Finance and Private Sector Development End of the Line for the Local Loop Monopoly? and mobile satellite. There are also fiber-optic many of these transactions, a policy decision cable TV options, and hybrid solutions com- has been made to continue monopoly rights, bining, for example, cable TV and DECT. sometimes on the basis of an investment bank’s recommendations. In Mexico, Argentina, and Figure 1 compares lifetime costs for two ge- Venezuela, for example, exclusivity periods of neric technologies: traditional underground six, seven, and nine years were granted. In copper cable and wireless. The figure is, of these and other cases, privatization advisers course, simplified and generalized, showing just have made recommendations that do not nec- one cost line for each technology. (The wire- essarily lead to the best public policy for the less cost curve is for Global System Mobile, or development of the telecommunications sec- tor as a whole. But do investors think that network competi- FIGURE 1 WIRELESS VERSUS WIRELINE: COMPARISON OF tion poses unacceptable risks? Apparently not. LIFETIME COSTS PER SUBSCRIBER In New Zealand, Telecom NZ was successfully privatized in a policy environment of open en- try in all market segments. In the Philippines, foreign investors such as NYNEX, Cable & Wire- less, and Telstra have entered—or are prepar- ing to enter—the market as competitors or Cost partners of competitors. In Mexico, a large domestic cellular operator with support from Wireless Bell Atlantic has proposed installing a fixed Underground copper cable wireless network to serve 1.5 million custom- ers. In southern India, US West has proposed a 0 500 telecom build-own-operate scheme and has not Subscriber density (subscribers per square kilometer) asked for an exclusive franchise. Other ex- amples show that investors have accepted com- Source: Evans and others 1995. petition in Australia, Malaysia, Sweden, the United Kingdom, and the United States and in the cellular market of almost every country. GSM, cellular.) Actual cost structures vary ac- Why competition is so important cording to the technology, market, topography, network configuration, and grade of service. Many of the benefits of telecommunications Nevertheless, the figure shows that in areas of competition are well known—lower costs, low subscriber density (fewer than 250 to 300 lower prices, greater innovation. Less recog- subscribers per square kilometer), wireless sys- nized and more important benefits, however, tems have lower costs. Furthermore, because particularly for developing countries with sig- wireless costs are falling relative to the costs nificant underinvestment in the sector, are in- of cable systems, the crossover point is mov- creased investment and better service. ing to the right. Thus, wireless systems are be- coming more competitive, in larger parts of the By way of comparison, the alleged benefits of market, every year. exclusive franchises are short-term stability in a difficult privatization environment (as in Ar- What do investors think? gentina in 1990), higher profits, and more in- vestment (“no one will invest unless you grant The issue of exclusivity often arises in the con- them a monopoly”). In some cases, it is true text of telecommunications privatizations. In that a very short period of exclusivity (say, one year) can contribute to stability in a difficult tant in many countries. Finland has authorized environment. But the second alleged benefit, duopolistic competition in the provision of both higher profits, is not, of course, a customer local and long-distance service, and Indonesia’s benefit. Thus, the question of whether compe- government has authorized Ratelindo to pro- tition or monopoly is the better public policy vide fixed wireless local loop service in the in an environment of underinvestment hinges Jakarta and Bandung areas of West Java. Local on which leads to more investment. This is network competition is also pending in India, really an empirical question. But it seems likely Mexico, and Sri Lanka and could become very that competition will stimulate more investment, important in China. because it opens more channels for investment, and it creates incentives to invest to meet de- mand—companies that do not invest will risk losing market share. This stimulus is exactly FIGURE 2 ANNUAL INVESTMENT BY PLDT, 1990–94 what is needed in countries with chronic under- investment in telecommunications—such as Millions of constant US dollars Bangladesh, India, the Philippines, and Sri 500 Lanka. Two examples from Ghana and the Phil- ippines confirm the expectation that competi- tion will stimulate investment in the sector. 400 Ghana, a small West African country with less than 20 million people and low per capita in- come, is regarded as a relatively high-risk loca- 300 tion by some foreign investors. In 1992, a small, mainly foreign-owned cellular operator, Mobitel, began operations in the capital, Accra. Mobitel’s business plan called for it to extend service to 200 Kumasi, the second main city, only when the 1990 1991 1992 1993 1994 required investment could be financed out of Source: Author's calculations based on PLDT annual reports. retained earnings. This decision changed in 1994. Mobitel rushed to provide service in Kumasi af- ter a new operator, Celltel, announced plans to provide service in both Accra and Kumasi within a few months. Furthermore, Mobitel has halved How to make it work its connection charges since Celltel began op- erations earlier this year. For competition to work, new entrants need reasonable interconnection, reasonable prices, In the Philippines, the threat of competition telephone numbers, and, often, radio licenses— similarly prompted a quick response from the in a sense, all technical issues with technical main telephone service provider, PLDT. Only solutions. But even more important is that the in 1993—after PLDT came to believe that the government must have the will to enforce rea- government was serious about authorizing new sonable rules of competition in the sector. This entrants to provide local telephone service on is particularly clear in the case of interconnec- a large scale—did it announce its “zero back- tion, where, in the absence of effective regula- log program.” PLDT’s investment program tion, “strategic” conduct by the incumbent turned sharply upward after 1993 (figure 2). telephone company can hinder or prevent new entry. For a new entrant to interconnect its net- These are not isolated examples. The issue of work with that of the incumbent, it needs in- local network competition is becoming impor- formation on the type of equipment that exists End of the Line for the Local Loop Monopoly? at different interconnection points. The incum- bent can impede interconnection by providing no information, wrong information, or changed information. It can make only a limited num- ber of interconnection points available, forc- ing the new entrant to send traffic along unnecessarily long routes. The incumbent may lease lines to new entrants that are incorrectly dimensioned and unreliable. And it may pro- vide revenue settlement arrangements that are unsatisfactory, and make payments late. In short, without effective regulation, an incum- bent can keep new entrants out of the busi- ness—and put them out of business. Conclusion This Note has made the case that local net- work competition is increasingly feasible from a technical and cost point of view, that it is increasingly accepted by investors, and that it offers important benefits from a public policy point of view—particularly its potential to The Note series is an open forum intended to stimulate investment. But in order to work, it encourage dissemina- must be supported by effective regulation. tion of and debate on Much work remains to be done in many coun- ideas, innovations, and best practices for tries to move toward a competitive telecom- expanding the private munications sector. Policymakers should be sector. The views encouraged to address the critical issues of this published are those of the authors and should transition—and discouraged from losing time not be attributed to the on counterproductive efforts to maintain mo- World Bank or any of its nopolies in this dynamic sector. affiliated organizations. Nor do any of the con- clusions represent References official policy of the Gareth Evans, Steve Carter, Stuart Macintosh, and others. 1995. “Key World Bank or of its Technological and Policy Options for the Telecommunications Executive Directors Sector in Central and Eastern Europe and the Former Soviet Union. or the countries they Paper prepared for the European Bank for Reconstruction and represent. Development. Coopers and Lybrand, London. Peter Smith and Gregory Staple. 1994. Telecommunications Sector Comments are welcome. Reform in Asia—Toward a New Pragmatism. World Bank Discus- Please call the FPD sion Paper 232. Washington, D.C. Note line to leave a OECD. 1995. Telecommunications Infrastructure—The Benefits of message (202-458-1111) Competition. Paris. or contact Suzanne Smith, editor, Room G8105, The World Bank, Peter Smith, Senior Telecommunications Policy 1818 H Street, NW, Specialist, Industry and Energy Department Washington, D.C. 20433, or Internet address ssmith7@worldbank.org. 9 Printed on recycled paper.