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Page Economist.com 1 of 5 Ready, steady whoops Sep 11th 1997 From The Economist print edition Agreeing to open markets is easy. The difficult part is creating true competition THE more electronic communications becomes the key industry of the economy, observes Columbia University s Mr Noam, the more important it is to have competition. If you want to see what competition can do, go to Finland. That country almost certainly has the world s highest ownership of mobile telephones (33 mobiles for every 100 people); the world s highest Internet (and probably modem) penetration; and more public payphones per head than almost anywhere else in Europe. It also has the second-lowest business call charges in the OECD (after Iceland) and the fifth-lowest residential (after the other Nordic countries). In this country with a population of a mere 5m, many of the largest companies have two network providers. Many people can choose between a fixed-line provider and several wireless services. Finland s experience suggests that competition pays, fostering low prices and innovatory service. The country has always had an unusual telephone system: in the 1930s it had more than 600 telephone companies, many of them customer co-operatives. Today it still has 52 local companies, which benchmark their services against each other. Two main groups compete head-on: Telecom Finland (still state-owned) and Finnet (a group of 46 local companies). Fine for the Finns Finland s success is built on a light regulatory touch. This summer telecommunications licensing was abolished. Anybody who wants to run a telephone service simply notifies the telecommunications ministry, and accepts a number of obligations (such as providing access to the emergency services). The goal, says Harri Pursiainen of the communications ministry, is that telecommunications services should eventually become like any other industry. The government may step in to share out scarce resources such as telephone numbers, and radio frequencies for cellular operators, but in all other respects special treatment should be unnecessary. Most countries are a long way from this Nordic nirvana. True, businesses can usually lease capacity for private use. A few countries, such as the United States and Japan, have long allowed competition for long-distance calls. And many countries allow competition in cellular telephony. But most forbid it for local voice calls. Finland, Britain, Australia and Hong Kong are among the few exceptions. That is about to change. New legislation is beginning to liberalise markets. In the United States, the 1996 Telecommunications Act allowed local telephone companies and long-distance companies to compete in each other s markets. In Japan, the government is breaking NTT, the local giant, into two national companies and a third which will compete internationally. In the European Union, http://www.economist.com/PrinterFriendly.cfm?story_id=599092 10/10/2005 Economist.com Page 2 of 5 most governments have promised to allow full competition from the start of next year. In addition, under a WTO agreement reached earlier this year, many developing countries are opening their markets to some degree of competition. These agreements are, at least theoretically, binding and irreversible: a new concept in trade negotiations. Five years ago, says David Hartridge, director of the trade in services division of the WTO, nobody would have thought it possible. What persuades countries to tear down national monopolies? According to Mr Hartridge, We told them that industry spends a lot more on telecoms than on oil and even the oil producers cartel has not distorted prices as much as telecommunications prices are out of line with costs. 19970913survey_out But, in an industry with so much distortion, change is bound to be agonising. Private and corporate users will eventually benefit although some domestic users may lose out at first. But would-be liberalisers face a number of obstacles: First, the giant government-backed (or -owned) monopolies have skewed prices. They have creamed off revenue from long-distance and international calls and business services to subsidise residential users, who mainly make local telephone calls. The most blatant imbalance is in international voice calls, where tariffs have been propped far above costs. In the long-distance market, profits have boomed as technology has cut the true cost of such calls to little more than that of a local call but prices have eased only slightly. A second problem is that the erosion of fat margins often means job cuts in what is usually one of the biggest white-collar employers in the country concerned. Britain s BT has shed almost half its workforce since privatisation in 1984. Telecom Finland got rid of 40% of its staff in the five years after 1989. Plenty of new jobs spring up in new telecommunications businesses as well, but the headlines mainly record those that disappear. Third, many countries are in the throes of privatising their telecoms services. The less competition the state-owned giant must face, the more attractive its shares will look, and the more money a government may hope to raise. And even when the national giant has been sold, it may still dominate the local stockmarket. A further difficulty is the tendency of telephone networks towards concentration. Nowhere has this http://www.economist.com/PrinterFriendly.cfm?story_id=599092 10/10/2005 Economist.com Page 3 of 5 been more apparent than in the United States. Last year s Telecommunications Act has been followed not by a burst of competition but by a series of court cases and a wave of merger proposals. The seven large local telephone companies have become five: SBC, the biggest, has acquired PacBell and flirted with acquiring AT&T; and Bell Atlantic is merging with Nynex to form America s second-largest telephone company. Go on, Sesame, open up Still, where competition is encouraged, it fosters new services and lower prices. Such competition takes two main forms: either companies build their own new capacity by laying fibre-optic cables, putting up wireless antennae or launching satellites; or they rent spare capacity on such networks from other companies, including the big telephone monopolists. The most striking new source of competition, the Internet, runs over a network provided by a group of companies separate from those that have developed most Internet applications and services. Eventually, this split between management the of the physical network on one hand and the development and marketing of specialised services for it on the other is likely to be replicated in the telephone industry. Many of the new entrants come from other industries, and bring new ideas and ways of doing things. In Germany, some are owned by big industrial companies: for example, debitel, which provides mobile-telephone services, is owned mainly by Daimler-Benz and by Metro, a big retail group. Since its launch in 1992, it has captured 17% of the German mobile market, partly by pioneering novelties such as marketing through Mercedes-Benz dealerships and offering a hotline for commuters to reserve parking spaces. As Klaus-Dieter Scheurle, Germany s newly appointed telecoms regulator, says: The small companies put pressure on the big ones to be innovative. Other new entrants are big telephone companies from other countries, resigned to losing market share at home and eager to gain it abroad. At present, that almost invariably means a joint venture, such as CEGETEL, run by Générale des Eaux in France with BT, Mannesmann of Germany and SBC to provide a wide range of telecoms services in France. The fact that we are dominant at home and a new entrant here means we feel a bit schizophrenic sometimes, admits Fran&ccedilla;ois Viviers, BT s regulatory boss in France. Such groupings may be ponderous, but at least their constituent parts will know a lot about manipulating different kinds of regulatory systems. A third group of competitors is made up of innovators, using novel technologies to leap into new markets. Examples include the various schemes to provide telephone and broadband services from satellites that orbit the earth (satellites that stay in a fixed orbit are already widely used to retransmit conventional telephone traffic). Several newcomers, such as Iridium, a consortium assembled by Motorola, have plans to switch telephone signals from one orbiting satellite to another, allowing people to make long-distance and international calls from a handset in places where local services are overpriced or non-existent. Such projects are feasible because satellites can now be mass-produced. But the initial cost is huge: Iridium, says Robert Kinzie, the venture s chairman, will spend $5 billion before it earns a cent. Another group of schemes aims to use satellites to offer high-capacity Internet access anywhere in the world. Teledesic, the venture with the highest profile (and the biggest cost a mind-boggling $9 billion), has the backing of Bill Gates of Microsoft, Craig McCaw, a pioneer of cellular telephony, and Boeing. Such schemes are a huge technological gamble. And they may be overtaken in middevelopment by less expensive ideas, such as using barrage balloons instead of satellites. Luckily for the telecommunications industry, its revolution has unfolded against the background of the longest-ever boom in the American stockmarket. A great deal of money is looking for exciting investments. Once these companies are built and running, their operational costs will be low, so when their capital cost has been repaid they should become hugely profitable. But many will go to http://www.economist.com/PrinterFriendly.cfm?story_id=599092 10/10/2005 Economist.com Page 4 of 5 the wall long before they reach that point. For their investors, that will be sad, but society as a whole will benefit: the cables and satellites will still be there, but free of the burden of their capital costs. The magic of competition works just as well in developing countries as in developed ones. In a study published in June, the ITU describes what is happening in the Asia-Pacific region, where more than 80 new companies have entered the industry since 1990: Asia-Pacific stands out as the realm of new operators. A region burgeoning with new carriers: small and not so small; some backed by powerful international operators, others driven by the adventurous spirit of local entrepreneurs; some concentrating in market niches, others spreading their wings across market segments; some working within the boundaries of one country, others becoming regional operators. These new entrants have had an unexpected effect. Vigorous competition has sharply reduced prices: for example, in New Zealand the average cost of a national long-distance business call has dropped by a quarter. The resulting stimulus to the market has benefited not just newcomers but incumbent carriers too, even when they have lost market share. In both Australia and New Zealand, the main carriers reported their highest-ever profits in 1996, in spite of increased competition (see chart). 19970913survey_out As for the new entrants, they have one huge advantage and face one huge threat. The advantage is simply that they are new: their costs are low, their bureaucracy minimal, their culture entrepreneurial. They have no unions to placate, and their sales force is slim. In all these ways, they differ from an established monopoly. You could run a hell of a business just on what the Bells spend on golf tournaments, says Wayne Perry, who worked with Mr McCaw to build McCaw Cellular, a giant mobile business now owned by AT&T. Japan s fairly new long-distance carriers, DDI and Telecom Japan, have revenues per employee three to seven times as large as those of giant NTT. No wonder BT, Britain s own giant, is looking at ways to split itself into smaller units, each operating as an independent cost-centre. The threat is the power of the incumbent monopoly over prices. The new entrants, with their slim http://www.economist.com/PrinterFriendly.cfm?story_id=599092 10/10/2005 Economist.com Page 5 of 5 overheads, can undercut the giant. But the giant has cash flow, brand and often a largely depreciated network on its side. These are deadly weapons in what has become a commodity business. In addition, the incumbent controls their biggest cost: that of connecting calls to the national network. So the new entrants usually nestle in under the lee of the giant, making a tidy living, but ensuring that their hefty rival does so too. Over time, the new entrants will help to drive prices inexorably towards costs. But for the moment, look at them as a source of new marketing ideas and new technologies, rather than aggressors in a price war that might well destroy them. Copyright 2005 The Economist Newspaper and The Economist Group. All rights reserved. http://www.economist.com/PrinterFriendly.cfm?story_id=599092 10/10/2005

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