BENEFITS OF COMPETITION

Free and open competition benefits individual consumers and the global community by ensuring lower prices, new and better products and services, and greater consumer choice than occurs under monopoly conditions. In an open market, producers compete to win customers by lowering prices, developing new services that best meet the needs of customers. A competitive market promotes innovation by rewarding producers that invent, develop, and introduce new and innovative products and production processes. By doing so, the wealth of the society as a whole is increased. In a competitive environment, businesses that fail to understand and react to consumer needs face the loss of customers and declining profits.

In other words, competition rewards entrepreneurship, responsiveness, and enthusiasm; it punishes sluggishness and indifference. Because of the increasing importance of the telecommunications sector to the overall economy, countries can ill afford the sluggishness and indifference that so often characterize the provision of products and services under monopoly conditions. As developments in technology continue to produce efficient and exciting communications services, societies may be significantly disadvantaged if they forego the rewards of entrepreneurship and responsiveness associated with open, competitive telecommunications markets.

POLICY GOALS TO ACHIEVE COMPETITIVE MARKETS

In order to achieve the benefits of competition described above, governments and regulators must establish an appropriate policy framework to govern the telecommunications sector.

First, governments should remove legal barriers that protect existing monopoly providers from competition by new entrants.

Second, policymakers should take affirmative steps to promote competition in sectors of the market that were previously closed to competition. Examples of these steps include adopting policies that encourage multiple methods and modes of market entry.

Third, policymakers should consider introducing competitive safeguards to protect against the exercise of market power by incumbent carriers during the transition to competition. The most fundamental of these competitive safeguards involves regulation of the terms and conditions governing interconnection with the existing monopoly provider's network.

EFFECTS OF COMPETITION IN THE TELECOMMUNICATION SECTOR

The benefits of introducing competition in telecommunications markets are apparent in all segments of the telecommunications market. For instance, competition in the United States and many other countries in long distance and international telecommunications services has led to a dramatic decline in consumer rates for these services, as well as a dramatic increase in demand and a substantial increase in investment.

International telecommunications services can be particularly important to the development of a stable and robust economy linked to the global marketplace. The 1997 WTO Agreement on Basic Telecommunications Services ushered in a new era for telecommunications competition in many countries of the world. As part of that agreement, 72 countries have made commitments to open their telecommunications markets to foreign suppliers of basic telecommunications services. As these countries implement their commitments, dramatic change has occurred in their telecommunications markets. In many countries, there are several new providers of international and domestic telecommunications services, and prices are dramatically lower. As a result, increased competition has led to lower international settlement rates in many countries which, in turn, has led to lower calling prices for consumers. Lower calling prices means that people can afford to make more calls, more often, creating closer ties between family and friends in different countries and strengthening business relationships. Thus, introducing competition in international telecommunications markets produces benefits throughout a country's economy.

In addition, as part of the WTO Agreement, 49 countries made commitments to open their satellite service markets. These commitments have helped increase the ability of global and regional satellite providers to obtain the requisite authorizations for their systems. Similarly, in many countries private investment and competition in the provision of terrestrial wireless telecommunications infrastructure has led to declining prices for, and widespread use of, wireless telephone service.

In areas where teledensity can increase, moreover, price reductions may expand the number of households that can afford service. This increased demand may make build-out decisions more attractive. For example, in Chile, lower prices increased traffic by 260% from 1994 to 1997. In 1987, there were 6.7 phones per 100 households in Chile; this number rose to 11 in 1992 and to 15.2 in 1996.

As lower prices stimulate greater demand, an overall increase in revenues results despite additional providers in the market. In the U.S. long distance market, lower prices, in combination with an expanding market for services, have offset revenue loss from price reductions and the decrease in market share. For example, while AT&T's long distance market share fell from 90% in 1984 to 45% in 1997, its revenues increased from $35 billion to $40 billion during this same period. Thus, although AT&T lost market share, its revenues increased in a competitive marketplace.

The benefits from introducing competition in international and domestic telecommunications markets can be fully realized, however, only when market participants have the incentive to compete vigorously to attract the greatest amount of business. It has been the U.S. experience that these incentives exist only where there is open entry into the telecommunications services market. Where entry is limited, or where only one or two new entrants are allowed to compete against the incumbent carrier, the benefits of competition are limited as well. For instance, when cellular telephone service was first introduced into the United States in the 1980's there were only two licensees in each market. As a result, prices remained relatively high and demand was more limited. After additional licenses were authorized in each market, priced dropped, new services were introduced and demand exploded.

BUILDING A TELECOMMUNICATIONS SECTOR AS A PART OF ECONOMIC DEVELOPMENT

Developing countries face many infrastructure challenges. While roads, water, and electricity are obvious fundamental requirements, development of a strong communications and information system is vital for the country to survive and prosper. As global developments increasingly push competition and its benefits, developing countries can realize these benefits in part through encouraging the establishment of an indigenous telecommunications sector. And one highly effective way to achieve this is to promote and nurture the growth of small and entrepreneurial entities within that sector.

The United States' experience provides some insight. Historically, most of the cutting- edge commercial and technology breakthroughs in the United States have been developed by individual entrepreneurs or small businesses, from Alexander Graham Bell to Bill Gates. Additionally, America's 22 million small businesses produce more than half of the nation's gross domestic product, and businesses employing fewer than twenty people have created all - - 99.99 percent - - of the nation's new jobs in recent years.

Such a phenomenal success story is due not only to the free enterprise system and profit motive, but also to a carefully developed government policy of supporting and nurturing small businesses. The U.S. has implemented numerous federal programs to assist small businesses in harnessing the engines of economic growth and innovation - loan guarantee programs, technical assistance programs, investment programs, anti- discrimination regulatory programs, outreach efforts, information and training programs. Congress established the Telecommunications Development Fund, some $25 million, to invest in promising new telecommunications businesses.

Obviously the environment and situation of most developing countries is quite different from that in the United States, and overcoming an embedded monopoly telecom provider is something we've never had to do. Still, some basic steps - privatizing, establishing an independent regulator, developing helpful tax and labor laws, a willingness to waive regulatory and filing requirements to the extent possible - can produce great benefits. A developing country could make it a condition for foreign carriers and operators serving seeking to provide service to (or within) its territory to undertake efforts to promote or support indigenous and start-up businesses. Supporting the growth of small and entrepreneurial telecom businesses by various means can lead to permanent economic gains for developing nations' economies, and to full participation in the global telecom marketplace.

METHODS OF INTRODUCING COMPETITION IN THE TELECOMMUNICATIONS SECTOR

Restricting methods and modes of entry can cause investment distortions and result in higher prices to consumers. It is by allowing the marketplace to select preferred approaches that policymakers encourage efficient entry. Three methods are typically used to introduce competition into the telecommunications sector:

• Facilities-based competition
• Unbundling of network elements
• Resale

 Facilities-Based Competition

When a new entrant constructs a network using its own facilities to reach its customers (i.e., without using the incumbent carrier's network), that type of entry is commonly referred to as "full facilities-based competition." By developing a new network, a facilities-based competitor is not constrained by existing, possibly obsolete embedded plant and instead can install the newest, most efficient technology. As a result, the competitor will be able to supply new or additional services such as faster transmission and switching speeds or higher bandwidth capacity, and may be able to do so at lower costs than the incumbent. Facilities-based competitors not only directly benefit their customers but also create competitive pressure for the incumbent to upgrade its network. In addition, facilities-based entry allows the marketplace to drive competition with less regulatory presence.

As discussed more fully below, full facilities-based entrants still require interconnection for the mutual exchange of traffic with other providers. New entrants' customers need to be able to communicate with subscribers on other networks, especially the incumbent's network where the majority of users obtain their service. Without the ability to interconnect on fair terms, a new facilities-based competitor cannot survive.

 Use of Unbundled Network Elements

While full facilities-based competition has many advantages, it may not always be practical for a new entrant to construct an entire network. For example, it may be economically feasible to construct switching and long distance facilities but infeasible to construct local loops or "last mile" facilities that connect to customer locations. This might be due to economies of scale or the practical difficulties associated with acquiring needed rights-of-way. Thus, a second entry route is one in which the new entrant constructs portions of a network and purchases access to the relevant essential facilities of the incumbent provider's network, such as the local loop. This method of entry is referred to as using unbundled network elements, and typically must be required by law or regulation.

Entry through the use of unbundled network elements has a number of important advantages. First, it reduces entry barriers by allowing new entrants to begin offering service without having to construct an entire network. Second, on a longer term basis, it prevents the incumbent carrier from exploiting any residual monopoly power that may arise through remaining economies of scale or from the practical difficulties of obtaining needed rights-of-way, antenna sites for wireless systems, etc. Third, it allows new entrants additional avenues of innovation. For example, new entrants can purchase unbundled loops from the established carrier and use them with entirely different types of technologies (e.g., packet switches based upon Internet Protocol (IP)) than those employed by the incumbent carrier. In this arrangement, consumers benefit from these new and better services and additional choices that competition provides.

Regulatory intervention is necessary in order to require the incumbent carrier to unbundle its network and to price the resulting elements at economically efficient prices. More specifically, incumbents should be required to provide any requesting telecommunications carrier non-discriminatory access to elements of the incumbent's network on an unbundled basis on rates, terms and conditions that are just, reasonable, and non-discriminatory. Incumbents should be required to provide any reasonable method of interconnection, including physical collocation or virtual collocation, or interconnection at a point between the incumbent's and new entrant's network.

In the United States, the Telecommunications Act of 1996 identified a minimum list of network elements that incumbent local exchange carriers must unbundle. These network elements include: local loops, network interface devices, local and tandem switching capabilities, interoffice transmission facilities, signaling and call-related databases, operations support systems, and operator services and directory assistance facilities. In addition, new entrants should have access to pole lines, ducts, conduits, and rights-of-way owned or controlled by the incumbent.

 Resale

In the telecommunications context, resale occurs when competitors obtain a service at a discounted or wholesale rate from the underlying, established carrier and then sell the service to their own customers.

Resale can serve a multi-faceted role in promoting and sustaining competition in telecommunications services. Resale may be an effective entry vehicle for new entrants that may initially lack the necessary capital to build their own networks. Resale may also allow small competitors, which will not become facilities-based providers, to offer service.

In addition, resellers may stimulate usage of the incumbent's network, and thus may benefit the incumbent facilities-based provider and further growth of the entire sector. Moreover, this competition may help to keep prices lower for consumers, increase consumer choice, and ultimately stimulate economic growth.

Experience in the U.S. long distance market suggests that resale can yield significant public benefits. Resale competition takes the form of arbitrage, where a reseller purchases a large number of minutes at a quantity discount and resells them to small customers at prices lower than the retail prices otherwise available to those customers. By providing affordable prices for the customer, resellers stimulate demand and thus compel facilities-based carriers to bring their prices closer to actual costs. At the same time, the increased competition from resellers expands the availability of innovative services, such as new billing terms and alternative rate structures. In particular, resellers can create consumer value by creating different billing plans or targeting their marketing to under-served groups within the community. Many countries have committed to a policy of resale as part of the WTO Basic Telecommunications Agreement to provide market access for basic telecommunications services.

Resellers may resell an entire service without modification, which is referred to as Total Service Resale. Resellers may also choose to obtain some services from the underlying carrier and combine them with services that they provide themselves. For example, a carrier may offer long distance services using its own switching facilities but lease long haul facilities from the incumbent provider.

Resale also allows providers to offer bundles of different services without actually constructing the necessary facilities. By doing so, they can achieve certain economies in terms of marketing while providing a package of services for the convenience of their customers. For example, a local exchange carrier can offer long distance services without constructing long haul facilities. Similarly, a carrier offering both local and long- distance services could add mobile services to its package without constructing its own wireless network.

In many industries resale occurs as a natural part of the development of markets. However, in telecommunications, a dominant carrier may be required by law or regulation to make its services available for resale. In particular, a regulatory requirement may be necessary to force the underlying carrier to offer services at a wholesale rate. In a competitive market, however, some providers may find a source of revenue in the provision of services on a wholesale basis. This often occurs when the facilities-based carrier has excess capacity on its network. In the U.S. long distance market, some carriers have constructed nationwide fiber-optic networks with the intent of offering transmission services on a wholesale basis to other carriers.

Despite the obvious benefits of resale, it has limitations. First of all, the reseller is limited to a greater or lesser extent by the technical features and functions of the underlying carrier's network. This limits the ability of the reseller to innovate. Second, resale alone does not put competitive pressure on wholesale rates and services because the underlying carrier may not be subject to competitive pressures to innovate at the wholesale level. This means that the regulator must retain some degree of control over the pricing, terms and conditions of the wholesale offering.

INTERCONNECTION, THE KEY TO COMPETITIVE SUCCESS

The key to competition within telecommunications services is the ability of networks to interconnect. Interconnection allows communications to occur across networks, linking competitors so customers of different networks can communicate with one another.

For competition to be successful at maximizing consumer benefits and innovation in the telecommunications market, carriers that compete for customers must also provide competitors with access to those customers. Shared access to customers occurs through interconnection, and access to all customers is necessary both for successful entry and for continued competition. If the incumbent, with the vast majority of customers, does not interconnect with new entrants, it is unlikely that the new entrants will remain economically viable.

A regulatory framework is needed to aid in the transition from a monopoly environment to a competitive environment because a monopoly or dominant provider has a strategic interest to keep out or minimize competitors in its market. As a result, the monopoly or dominant provider has a strong incentive to limit interconnection. Therefore, a regulator that is independent of any operator and of inappropriate political influence should adopt rules that give new entrants bargaining strength equal to the incumbent's.

The price of interconnection (or transport and termination), for example, could serve as a significant barrier to entry for new networks. An incumbent monopolist has an incentive to demand a high price to terminate calls originating on a new entrant's network and pay nothing for calls originating on its own network. In the United States, transport and termination charges are reciprocal and based on the long run incremental cost of providing the transport and termination on the incumbent's network.

Thus, the primary purpose of mandated interconnection is to foster a competitive environment that is fair to all competitors. Because the incumbent service provider has the vast majority of customers, a new entrant must be able to interconnect in order to provide full access to its customers. Without the ability to interconnect, new entrants would be severely restricted in their ability to compete with the incumbent.

REGULATORY TOOLS FOR PROTECTING AGAINST THE EXERCISE OF MARKET POWER DURING THE TRANSITION TO COMPETITION

Special problems may arise when a telecommunications carrier with monopoly power in the provision of a particular service or facility wants to offer a competitive service that is dependent upon the use of the monopoly service or facility. This may occur, for example, where competition has been introduced in the long distance and international markets but the local market remains a monopoly. The two problems are cost- shifting/cross-subsidization and discrimination.

The first problem arises if the monopoly service is regulated on a rate-of-return (profit) basis. If so, there is an incentive for the carrier with monopoly power to shift costs from the competitive service to the monopoly service. Shifting costs in this manner artificially raises the price of the monopoly service and allows the carrier to charge below-cost rates for the competitive service. This results in the captive customers paying above- cost rates for the monopoly services and hampers the development of a viable market for the competitive services. An example of this situation could occur when a carrier with monopoly power in the provision of local facilities or services wants to enter the long distance market or information services market.

The second problem occurs when control over an essential service or facility necessary for a competitive service enables the monopoly carrier to discriminate in favor of its own competitive offering. For example, a carrier with monopoly power in the provision of local facilities or services has the incentive to discriminate in favor of its own long distance or information service. This discrimination may manifest itself in the form of better quality interconnection or faster installation times for needed facilities or services.

What follows is an overview of some of the tools that are available to policymakers and regulators to discourage or prevent cost-shifting/cross-subsidization and discrimination. These tools or techniques can be used alone or in combination. The more stringent techniques may be appropriate when and where the threat is greatest. Less stringent techniques may be appropriate as competition takes hold in the previously monopolized market.

 Outright Prohibition on Providing the Competitive Product or Service

One technique for preventing a carrier with monopoly power from cross-subsidizing and discriminating in the provision of a competitive service is to prohibit the carrier from entering the competitive market. Outright prohibitions have been and are being used in the United States. For example, the original agreement (Consent Decree) that led to the divestiture of the Bell Operating Companies from AT&T prohibited the former from certain activities, including the provision of certain long distance services and information services. Under the Telecommunications Act of 1996, the Bell Operating Companies are prohibited from offering long distance services and alarm services until certain conditions are met.

While outright prohibition prevents cross-subsidization and discrimination, it may also deny the public the benefits of possible economies of scale or scope that may be derived if the carrier is allowed to provide the competitive service. Outright prohibition may also deny the public the benefits of innovation that might come from the participation of the monopoly carrier in the competitive market.

 Price Caps for Regulated Monopoly Services

The incentive to shift costs from a competitive service to a monopoly service exists under profit regulation. Under price cap regulation, the prices of the monopoly services are capped (indexed to inflation and expected productivity increases). Price cap regulation has a number of advantages, including incentives for the carrier to be more efficient. It also discourages the monopoly provider from shifting costs from the competitive activity to the monopoly activity, because if the price of the monopoly service is capped, there is no incentive to shift costs from the competitive service to the monopoly service.

 Separate Subsidiary Requirement

Under this requirement, the carrier with monopoly power is allowed to provide the competitive service, but only through a separate subsidiary or affiliate. The separate subsidiary requirement is combined with an obligation that the monopoly carrier treat the affiliated company no better than it treats unaffiliated providers of the competitive service. In other words, the monopoly carrier must deal with the affiliate on an "arms- length" basis.

The regulator has the ability to control the degree of separateness. Examples of the requirements for separateness can include requirements that the monopoly provider and its affiliate:

• Maintain separate books of account
• Utilize separate officers and personnel
• Employ separate marketing activities
• Not share common equipment or facilities
• Adhere to certain restrictions on information flows that would unfairly benefit the competitive affiliate

 Tariffing Requirements

Tariffing is a fundamental technique traditionally used to protect users (both consumers and other carriers) against discrimination. Tariffing requires the regulated monopolist to file tariffs explaining its service rates, terms and conditions with the regulatory agency and to adhere to those rates, terms and conditions once the tariff is filed. Through the tariff and enforcement processes, which include opportunities for public comment, the regulator has some ability to prevent cross-subsidization and discrimination.

 Accounting Separation

A requirement to maintain separate books of account can be adopted even without the imposition of a separate subsidiary requirement. Accounting separation typically requires the regulated monopoly provider to set up and maintain separate books of account for the competitive activity and to adhere to prescribed methods of separating costs. This provides a degree of protection against cross-subsidization.

 Imputation Requirements

An imputation requirement obligates the regulated monopolist to charge the same amount for a service or facility provided to a competitive affiliate or operation that it charges to an unaffiliated provider, and to include that amount in the price it charges for the competitive service.

 Service Quality Reporting Requirements

A service quality reporting requirement obligates the regulated monopolist to collect date and report on the quality of the services provided to both affiliated and unaffiliated competitors. This helps regulators detect and correct discrimination in the provision of essential services or facilities to competitors.

 Resale Requirements

As discussed earlier, a resale requirement has a number of advantages in promoting competition. Resale can also help prevent cross-subsidization. For example, where a carrier has market power in the provision of switched services but there is competition in the provision of private lines, the carrier may try to increase the price of the switched service in order to cross-subsidize and thus under-price its private line offering. If the carrier is required to allow the resale of the private line offerings, however, entrepreneurs could combine the private lines with their own switching, and undercut the prices of the monopolist's switched service offering. This has the effect of discouraging the carrier with market power from engaging in cross-subsidization.  Unbundling Requirements

An unbundling requirement forces the regulated monopolist to make network elements available to competitors on an unbundled basis under rates, terms and conditions that are just, reasonable, and non-discriminatory. To provide incentives for entry, the price of an unbundled element should equal the long run incremental cost of providing the element. Unbundling was discussed earlier as a way of lowering entry barriers and promoting innovation, but it also guards against anti-competitive tying arrangements, which arise when the monopolist requires a customer (e.g., a competitor) to buy something unneeded as a condition of acquiring an essential facility or service.

 Comparably Efficient Interconnection Requirements

Technical interfaces are required between the monopoly carrier's network and the equipment and facilities used by competitors. Unaffiliated competitors can be seriously disadvantaged unless they are able to interconnect their equipment and facilities to the monopoly carrier's network on a basis that is as efficient as the monopolist offers to its own affiliate. A comparably efficient interconnection requirement places an obligation on the monopoly carrier to provide such interconnection.

 Network Interface Disclosure Requirements

A monopolist can also significantly disadvantage competitors in the process of changing the technical characteristics of the interfaces with which it interconnects with the providers of competitive services. It can do so by making the planned changes known to its affiliated operation far in advance of the notification, if any, that it gives to unaffiliated competitors. Network interface disclosure rules mandate that the monopoly carrier give reasonable advance notice to competitors before changing these interfaces. This gives the unaffiliated competitors a chance to adjust to the network interface changes in order to offer competitive services.

 Customer Proprietary Network Information Requirements

In the United States, Customer Proprietary Network Information (CPNI) refers to information that a carrier collects from its customers. For example, a monopoly local exchange carrier might observe that a large share of calls to a certain subscriber go unanswered or encounter a busy line. Such a customer would be a prime candidate for an answering machine or a network-provided voice-messaging service. The carrier collects this competitively significant information not by virtue of its success in the marketplace but, rather, by the fact that is it the only provider of local exchange services. This customer information would provide a significant and unfair advantage in the provision of competitive customer premises equipment (e.g., an answering machine) or a network-based voice messaging service. CPNI rules prohibit the sharing of information between the monopoly provider and its competitive affiliate or require the information to be shared on the same terms and conditions with competitors (subject, of course, to privacy considerations).

 Prompt and Sure Resolution of Disputes