World Telecommunications Economics
This book bridges the worlds of the economist, the engineer, the regulator and the manager. It outlines the technology of the subject in sufficient detail to provide an understanding of the industry's economics, and presents a comprehensive picture of the markets into which its products and services are sold.
Inspec keywords: telecommunication services; economics
Other keywords: strategic issue; econometric modelling; cost structure; welfare economic; telecommunication policy; supplier; market structure; forward planning; diversification; telecommunication service
Subjects: Administration and management; Telecommunication
Telecommunications is part of a wider industry which includes computing, information technology, films and broadcasting. It is concerned with the manufacture and supply of the means by which communication takes place within this wider group, the structure of which is illustrated in Table 1.1. This chapter presents the telecommunication economics which deserves special study, because (i) It is becoming a central component in many commercial and government processes, including finance, transport and the management of public services, (ii) The industry is dominated by powerful firms. Regulation is needed to protect consumer interests, (iii) Its economics exemplify issues, such as economies of scale, network externalities and cost allocation in a multiproduct industry, which arise in many other industries. (iv) It is widely seen as spearheading social change based on the use of new technology. Even on a minimal view it is a powerful facilitator comparable with transport and postal services.
Most telephone calls pass over the public switched telephone network or PSTN. Public means that access to the network is open to anyone willing to pay the prescribed charges. Switched means that the network has call routing equipment which enables a caller to reach any required destination on the PSTN. Some national PSTNs are owned by the government, others privately. Calls pass freely between them so that each telephone on any national PSTN can reach any other telephone in the world.
Traded goods pass through the economy in a cycle which starts with production and finishes with consumption, generating income on their way round. The national income, or gross domestic product, can be measured in three ways, each of which should give the same answer, within the limits of measurement error, since they are different ways of measuring the same flow. GDP is measured at factor cost.
The formal economic analysis of demand is based on a few propositions about consumer behaviour. Consumers are assumed to have limited resources so that there is a budget constraint on their expenditure. They derive utility from goods and services purchased. Utility is what the goods bought are worth to the consumer and is measured in cash terms for analytical purposes. Consumers are assumed to be rational and have the maximisation of utility as their expenditure objective. Each single additional purchase by the consumer is a marginal purchase and provides marginal utility. The marginal utility of an extra quantity of a particular good or service usually falls, and never rises, as the volume of purchases increases. Expenditure decisions are based on the marginal utility of the marginal purchase compared with its price. No more purchases will be made if marginal utility of an extra purchase is less than the price. A consumer's total utility is the sum of the utility of all purchases.
The enterprises run by self-employed workers are still very numerous, but the majority of the national output in developed countries is produced collectively, with the firm or state enterprise as the basic unit of supply. In the theory of the firm it is profit maximisation which provides the dynamic that drives markets and results in efficient resource allocation. Private firms in competitive industries fit this model reasonably well. Empirical evidence shows that they are fundamentally profit maximisers, within whatever framework of institutional constraints they operate.
This chapter has reviewed many features of the markets and suggested some ways in which they may be analysed. In terms of the Huber analysis of Section 1.9, there is much support for the view that networks are becoming increasingly pleuralistic, with competition, generally rather imperfect, becoming established in many areas of previous monopoly. There is no evidence that this is putting up costs. The arguments for natural monopoly have weakened, although they still retain some power in local networks and in developing countries. The separation of network operation from the services which are run over it, offers a possible way forward. Big operators still dominate most of the markets, however, and regulatory intervention is needed to keep them as open as possible. In terms of the discovery process, it is difficult for regulators to keep up with developments in the markets, which are highly innovative and growing rapidly, making deregulation the preferred alternative wherever practicable.
A factor limiting the cost minimisation of networks is the difficulty of forecasting demand and technological change. Telecommunications assets are not always long lasting, but there is ample room, in the fifteen-year life of a telephone exchange or the ten-year life of a satellite, for a cheaper technology to evolve. Additional calls are catered for mainly by the provision of extra plant or, as is often the case, the reconfiguration of existing plant to provide more capacity. For example, optical-fibre cables, which use digital transmission, make room for more lines in the duct network. No operator will have perfect foresight, but some will make better guesses than others. City networks may be immensely complicated and far from minimum cost, reflecting the combined effects of incremental growth and the difficulty of forecasting. Telecommunications networks are always suboptimal compared with what might be built for a mature market with static technology. Future-proofing may improve the cost characteristics of networks if they can allow for change. Analogue exchanges have been efficiently modernised by the installation of electronic control packages. New pieces of plant at either end of a cable can enable the same line to carry many times more information by increasing transmission capacity by using improved multiplexing methods. This can be done with optical fibre and with copper.
This chapter discusses welfare economics for telecommunications. Welfare economics considers resource allocation at the level of society as a whole and investigates whether, at this level, a different allocation of resources would bring about a greater aggregate benefit. Since utility is a subjective measure, the total benefit itself cannot be measured. This does not matter as long as there are theoretical and practical ways of judging whether the total may be increased with alternative arrangements.
Telecommunications equipment prices are set in more or less competitive markets. Most others, especially those for basic domestic network services, are to a greater or lesser extent set by monopolists or by administrative means. However they are set, the prices will guide the resource allocation of consumers and, through their purchasing behaviour, that of producers.
This chapter discusses the industrial structure and ownership in telecommunication network involving market liberalisation, privatisation, service quality under privatisation, and vertical or horizontal integration for the local telecommunication service provider. Liberalisation is an umbrella term used for the introduction of competition into product and service markets by relaxing entry restrictions, and into capital markets by privatisation. Privatisation and deregulation became widespread in many industries all round the world; telecommunications was among the privatisation leaders, but usually not the first. By the end of 1996, privatisations in around 40 countries had raised some $US 140 billion. The term privatisation covers a range of ten positions in the shift from full state to full private ownership. Private monopolies have sometimes been under greater pressure to improve standards, especially if the regulator becomes actively interested. By having power over the company, the regulator may become its most important customer for quality improvement.
Action is in the present and the future. Most management decisions have to be based on forecasts, for which history is an imperfect guide. Engineers want the figures for system planning, and regulators, especially in the UK and the US, want them as an aid to setting profits and prices. Operators use them extensively for business planning, budgeting, estimating the effects of regulatory constraints and other purposes.
The fact is that most costs are not known at all precisely by operators or regulators. There are two ways in which this view of the nature of the market is relevant to telecommunications policy: (i) The role of costs in regulatory profit controls, especially as regards the choice between rate of return limits and price caps. (ii) In market liberalisation, where new entrants probably have lower costs than those already in the market and use market prices as signals.
Regulation is itself not a perfect process. The regulators have an imperfect knowledge of the markets that they regulate and will make mistakes. Why regulate? is not a trivial question where imperfect competition exists and the deficiencies of regulation have become obvious or its cost excessive. Some American state regulators have opted for minimal interference or even none, leaving the efficient functioning of the market to be settled by such factors as the threat of entry, the behaviour of competitors, peer group comparisons and the wish of the dominant operator to avoid legal and regulatory action over market abuse. Practical problems arise in two regulatory areas. The first concerns the objectives of the regulators, arising from their position as agents. The second is whether their actions have unintended consequences which are perverse.
This chapter discusses universal service. Universal service is an umbrella term for many policies to enable poorer consumers, and those in rural and other areas which are expensive to serve, to join the telephone network. It has been a widespread regulatory objective in North America for many years and has less formal antecedents in the history of posts and telegraphs. The British magazine Punch wrote of a telegraph network that might reach every house.
Quantitative measures of industrial performance are useful to shareholders, managers, planners, consumers, regulators and research economists. Shareholders may consider selling their holdings and buying assets better suited to their needs. Those who own or run a business want to know how well it is doing and where its performance can most easily be improved. Consumers, regulators and researchers have an external focus and are more interested in quality, prices and ways in which the business can be pressured into giving better value for money. Researchers may want to analyse the dynamics of the industry with a view to enlarging understanding of how it works and where it is going. They will do this to assist in policy formulation if there are policy makers to advise. Financial institutions use analysts to appraise company performance. The emphasis may be on the current situation in a single company but more often it is comparative, of prices, productivity or service quality across time, industry sector or country. The principal dimensions of comparison are: a) one company over time; b) a cross-section of companies in one industry in a single year; c) cross-sectional international comparisons within the same industry; d) cross-sectional comparisons with companies in other industries.
The pronounced economies of scale shown by telephone networks and the reasonably predictable peaks of traffic produced by their users lend themselves to the mathematical modelling of costs and business levels. Forecasting has become a major occupation of economists working in the marketing, corporate planning and finance departments of the larger companies in many industries. It plays a large part in the work of economists in operating companies because of the need to build now for future service requirements. The emphasis on forecasting draws economists into areas of sophisticated statistical analysis and modelling. It also calls for judgmental skills since forecasting, like economics itself, is far from an exact science. Most good econometric forecasts owe at least as much to the assumptions under which the models are run as they do to the structure of the models themselves. The assumptions are termed exogenous variables because they are not determined by the model.
International trade strengthens competition in imperfect domestic telecommunications markets by opening them to goods and services from foreign operators and equipment suppliers. Extra competition reduces the market power of domestic producers, so that they are less able to make abnormal profits. Trade encourages countries to specialise in the production of goods and services where they have a comparative advantage, resulting in a more efficient use of resources and shared gains among the trading countries. Countries, companies and individuals have finite resources. The decision to use part of them in one way precludes their use in another. In the theory of international trade it can be shown that where markets are fully competitive, national wealth is maximised by specialising in products where the nation has the greatest lead, or comparative advantage, over its competitors.
Business strategy is a large and complex subject, the full extent of which is outside the scope of this book. Strategies for growth or survival must, however, have secure economic foundations if they are to succeed. With the acceleration of technological change and the spread of deregulation, a new range of strategic issues has emerged. This section examines issues, old and new, now faced by equipment suppliers and operators.
The dynamism of the world's telecommunications markets creates opportunities for a new range of entrepreneurial skills. There seems little doubt that in all countries men and women will readily be found to take them up, practical people as well as those looking to far horizons. Explorers and people of vision have an essential role but, on a company board, their advice has to be accepted within the limits of what is financially prudent. Realism requires a proper appreciation of what is difficult. Developed and underdeveloped countries have different perspectives on their problems, but the nature of the business is the same. Telecommunications services are potentially profitable at all stages of economic development. It takes a wilful act of politics to drive them into loss, although some governments have managed to achieve it through tough price controls.
