Footnotes for Regulation of Access to Vertically-Integrated Natural Monopolies
[1] [1994] 5 NZBLC 103,552 (PC); [1995] 1 NZLR 385 (PC). A legal analysis of this case is found in Appendix F.
[2] The words `access' and `interconnection' are used synonymously in this paper. The word interconnection is most appropriate in the telecommunications context whereas the word access is perhaps more suitable for other industries and sectors.
[3] A natural monopoly exists when one firm can provide the entire market demand at a lower cost than can two or more firms. The term vertically-integrated natural monopoly is defined in paragraphs 13-15 below. Economic terms such as this one are defined in the Glossary, Appendix I.
[4] Strategic Result Areas for the Public Sector 1994-1997, December 1994, Section 2, `Enterprise and Innovation'.
[5] These sectors comprise a sizeable portion of New Zealand's GDP. In the four quarters to March 1995, `Communications' (which includes telecommunications and post) contributed 6.00% to New Zealand's GDP. `Electricity, Gas and Water' contributed a further 3.35%. Natural monopolies also arise in the transport sector which accounts for a further 6.75% of GDP.
[6] This paper uses the term `legal rights' to refer primarily to the parties' rights in interconnection negotiations and, in particular, to the set of terms and conditions that the monopolist can legally demand.
[7] In addition, the `threat of further regulation' creates further uncertainty and encourages the parties to approach the Government rather than negotiate with each other.
[8] Or the entity which controls the firm providing the natural monopoly service.
[9] For example, electricity distribution and gas transmission and distribution. Vertically-integrated natural monopoly structures may also arise in the water and sewerage reticulation industries. This document does not deal with natural monopolies that are not vertically-integrated, such as Trans Power, ports or airports.
[10] Note that in a context, such a telecommunications, where a range of services are provided with a single facility, there are significant problems allocating the `common' costs of the facility amongst the various services. This greatly complicates the assessment of whether or not the monopolist is earning monopoly profits. In particular, prices may be in excess of directly attributable costs across the monopolist's range of services even in the absence of monopoly profits.
[11] See paragraph 2.
[12] It should be emphasised that these options are not under consideration for the telecommunications sector. In particular, the Government has no plans to renationalise or to enforce structural separation upon Telecom.
[13] And, in addition, the significant costs of buying out private owners.
[14] Note that under options (b), (d) and (g), once the access regime is in place, compulsory arbitration would be invoked at the request of either party and not by the Government or another third party.
[15] As it is Government policy for the Kiwi Share terms and conditions to remain in place, this document does not review the merits of the obligations arising from the Kiwi Share.
[16] In addition, an invocation of the access regime would need to adequately distinguish between competitors and customers of the vertically-integrated natural monopoly.
[17] Based on s.73 of the Commerce Act 1986.
[18] Or the entity which controls the firm providing the natural monopoly service.
[19] Strictly speaking, once Clear's local network is established, it is possible that portions of this network would be a natural monopoly. If Telecom customers are to have access to Clear's customers, interconnection is also essential for Telecom. In effect, there is a `bilateral monopoly'. This question is explored further in the discussion of reciprocity in Appendix D.
[20] See Joskow, P.L., "Mixing Regulatory and Antitrust Policies in the Electric Power Industry: The Price Squeeze and Retail Market Competition" in Antitrust and Regulation: Essays in Memory of John J McGowan, MIT Press, 1985.
[21] See for example the discussion in Perry, M.K., "Vertical Integration", Chapter 4 in The Handbook of Industrial Organisation, Volume 1, Schmalensee, R. and Willig, R., eds, North-Holland, 1989, page 241-247. The following few paragraphs are a summary of a more detailed discussion in Appendix B.
[22] This term is explained in Appendix B.
[23] See, for example, the models of Tirole (1988), p187-198 and Hart and Tirole (1990).
[24] See Vickers, J., Concepts of Competition, Clarendon Press, Oxford, 1994. These efficiencies also extend to the incumbent monopolist. In other words, the presence of competition may force the incumbent to increase its own productive efficiency.
[25] For further discussion see: "Telecommunications Reform in New Zealand 1987-1994", Telecommunications Information Leaflet No. 5, Communications Division, Ministry of Commerce, March 9, 1995 or Galt, David, "Telecommunications Regulatory Structures in New Zealand", Presentation to ITS Interconnection Workshop, 10-12 April 1995; or, for a fuller presentation, the chapter by McCabe, Patrick G in Telecommunications in the Pacific Basin: an Evolutionary Approach, 1994.
[26] Blanchard, Carl, "Telecommunications Regulation in New Zealand: How Effective Is `Light-Handed' Regulation?", Telecommunications Policy 1994, 18 (2), p154-164.
[27] The elements of this light-handed regulatory regime for telecommunications can be found in statement of policy released by the Minister of State-Owned Enterprises, the Hon Richard Prebble on 17 December 1987: "The Government recognises that for effective competition with Telecom to occur competitors must be able to negotiate with Telecom for fair and reasonable access to Telecom's network. . . . The Government believes and expects that Telecom will formulate an interconnection policy which allows an efficient competitor to have a fair chance of competing with Telecom. The Commerce Act provides a set of rules which place restrictions on the abuse of dominant market positions. . . . If there is evidence that Telecom is acting anticompetitively and that the existing law is insufficient, pro-competitive measures will be considered. The Government, however, believes that it is important that the industry be permitted to develop with minimal regulations so that an objective assessment can be made about the performance of Telecom, the industry and the adequacy of existing competition laws."
[28] These regulations have subsequently been replaced by the Telecommunications (International Services) Regulations 1994.
[29] Telecom's productivity increased from 86 lines per employee in 1990 to 214 in 1994.
[30] A basket of residential telephone prices dropped 4.26% from 1990-1994 in New Zealand compared to a drop of 4.07% over the same time period in other OECD countries that have a competitive telecommunications market. A basket of business telephone prices dropped 11.09% over the same period compared to a drop of 8.57% in other OECD countries with a competitive telecommunications market.
[31] It should be emphasised that many, if not all, of these disputes have subsequently been resolved.
[32] In addition to these disputes, there have been a number of other lengthy disputes arising from contractual relationships between Clear and Telecom including disputes about additional points of interconnection; interconnection price adjustments; and availability of particular numbers or access codes.
[33] Clear also offered international toll services, initially by reselling Telecom's services. Later in 1991 Clear offered its own international toll services. Clear currently has 21% of the domestic long-distance (toll) market and 24% of the international toll market. In the year ended 31 March 1995 its total revenues were $240 million, placing it among the top 50 New Zealand companies (ranked by revenue). The most recent financial year was the second in which Clear has achieved a trading profit.
[34]Telecom v Clear [1995] 1 NZLR 385 (PC) at 394.
[35]Clear v Telecom (1993) 5 TCLR 166 (HC). The High Court modified the BW rule to take account of Dr Kahn's competitive parity principle that Telecom should not charge Clear more than it implicitly charges itself for the same service.
[36]Clear v Telecom (1993), 5 TCLR 413 (CA).
[37] The High Court noted (see footnote to paragraph 136) that "it has not been established to our satisfaction whether or not Telecom is currently earning monopoly rents."
[38] In his brief to the High Court, Professor Baumol stated: "The supplier of such a product component should not be forced by government intervention to receive for it less than the price that makes that supplier indifferent as to whether the other components of the final product are provided by itself (that is, the traffic carried over its own lines, from origin to destination) or whether, instead, those remaining components are supplied by others (the traffic is carried over a joint route operated in part by competitors). . . . Specifically, the efficient component pricing principle requires that (at a minimum) that component price equals the direct incremental cost of supplying the component plus contribution foregone by the supplier because of the competitor's use of the component." Clear v Telecom 5 TCLR 166 (HC) at 203.
[39] This model is simplified in two important respects. First, the monopolist produces at constant marginal cost and second, the monopolist only produces one product. As we will see later, the question of the correct access price in the context of a multiproduct monopolist with increasing returns to scale is more difficult.
[40] Baumol has argued that it also applies in competitive markets but, of course, these do not give rise to the same regulatory issues as markets involving a natural monopoly.
[41] "Any other uniform pricing rule will not have this property. In other words, the efficient component pricing rule is the only rule that ensures inefficient `cream-skimming' of some form will not occur. It does not, however, deal with the issue of competition and monopoly pricing in the final goods market. In general the rule would need complimentary restrictions to prevent abuse of market power by the access provider." King (1995), p11.
[42] See Dixit, A. and Pindyck, R.S., Investment Under Uncertainty, Princeton University Press, 1994
[43] There are other criticisms that we might mention. For example, the BW rule assumes that the incumbent and the competitor produce products that are perfect substitutes. If the products are not perfect substitutes the regulator may face significant information difficulties in determining the correct access price. Furthermore, if the incumbent can choose the degree of differentiation of his/her product the incumbent and if the weaker the degree of substitutability, the weaker the price control, the incumbent may seek to invest in excess product differentiation.
[44] See Vickers (1994).
[45] Inefficient entry may also be a problem where there is a degree of increasing returns to scale in the downstream market and all the entrants are identical. In this case simple models suggest that there will tend to be excessive entry. However, this result does not generalise to the case where the entrants are not identical. In this context competition plays a productive efficiency role in selecting the most efficient firms.
[46] Baumol, William J., "The Efficient Component Pricing Rule: Misapprehensions of Drs Tye and Lapuerta", mimeo, 1995.
[47] Baumol, W.J. and Sidak, J.G. "The Pricing of Inputs Sold to Competitors", Yale Journal on Regulation, Vol 12, p177. Note that constraining final product prices by regulation creates its own risks of inefficiencies. The risks of price control are discussed further in part II.
[48] Telecom have argued that the BW rule as adopted by the Privy Council, does not in fact allow the incumbent to be fully `indemnified' and therefore there will be some final price competition under the BW rule. They point out that when they lose a local service customer they are likely to lose that customer's toll business. If there are profits earned from that customer in the toll business that are not fully compensated in the access price then some price-cutting competition can be expected to result as each network competes for the total business of this customer. If it is true that the toll business of a customer follows his/her local business (a matter to be determined empirically) then, strictly speaking, the BW price would include the lost toll business profit. The access price in this argument is less than the full theoretical BW price and, as a result, some price competition and competing away of monopoly rents will occur. However it should be pointed out that Telecom may choose to apply the BW rule to access for long-distance service, in which case there would be no rents to be earned by the entrant in that business and the above argument does not apply.
[49] In the simplest economic models with linear demand functions and assuming the strategic interaction of the players in the final market can be captured in a `Cournot' game, the final price will move down one third of 50 cents.
[50] Can we modify the BW rule in such a way as to both (a) fully indemnify the incumbent and (b) permit competing away of monopoly rents? One idea might be to restrict the BW price to apply just to those sales that the entrant takes away from the incumbent. Any additional sales to the entrant might be at cost. For example, consider the above example again. Suppose that initially, the incumbent sells one unit to each customer. The incumbent can be fully compensated by an interconnection price of $7 on the first unit sold to downstream customers by the entrant. The interconnection price could then be $2 thereafter. The entrant could sell the first unit to the downstream customers at a price of $10 and subsequent units at a price of $6 and still make a profit of $1 per unit on every additional unit sold. Clearly, downstream consumers, which face are marginal price of $6 rather than $10 are better off. The problem with this line of argument is that if such price discrimination is possible, then why does the monopolist not engage in it himself? By offering a fee of $10 for the first unit and $6 for the subsequent units the incumbent could increase both his sales and his profits. We could apply the above argument again. The BW interconnection fee would be $7 on the first unit, $3 on subsequent units up to the amount that the incumbent sells and $2 thereafter. Clearly, the entrant will only be able to earn a profit if it is better at engaging in price discrimination than the incumbent. There seems to be no reason to make this assumption.
[51] Ergas (1995) summarises the advantages of the BW rule as follows: "The [BW rule] ensures that the incumbent firm will never be forced to operate at a loss. When retail prices are regulated (for example, so as to provide for a community service obligation), the rule protects (rather than undermines) the price structure which the regulators have set. It can nonetheless allow for entry when the entrant is more efficient than the incumbent, and indeed is consistent in this respect with the standard antitrust test for unreasonable exclusion. . . . Finally, the ECPR appears to be minimally invasive of the incumbent's property rights.". For further material on the Baumol-Willig rule see Kahn and Taylor (1994), Tye (1994), Baumol and Sidak (1995) and Armstrong and Doyle (1994).
[52] A number of interconnection arrangements in telecommunications have so far been reached. However, in each of these cases either: (a) there was considerable less at stake; or (b) the Government threatened action (as in the original toll bypass agreement with Clear where Telecom's privatisation was dependent upon a satisfactory agreement being concluded); or (c) the parties were prepared to go to arbitration (as in the non-code access case). A variety of arrangements have also been introduced enabling access to electricity distribution networks and a significant amount of electricity supply is now occurring. Significant competitive supply is yet to commence in gas.
[53] Uncertainty about underlying legal rights raises transactions costs. However, if transactions costs were zero, parties would not reach an agreement if there was not some agreement available which made at least one party better off. The failure to reach agreement is not necessarily a sign of high transactions costs.
[54] In addition, the monopolist has strong incentives to slow down the process for defining the legal limits by, for example, engaging in delaying tactics while the case is on trial and exhausting the rights of appeal.
[55] In 1992 the Commerce Commission made this comment: "The Act . . . does not deal particularly well with the problems that occur in an industry when a critical input, the PSTN, is a natural monopoly . . . Useful precedents have been established by the Courts in Australia and New Zealand on some aspects of section 36, but its power to establish viable commercial agreements is still untested.", Commerce Commission (1992), p83.
[56] As, in the absence of a rule to the contrary, Telecom could fully exploit its dominant position, Telecom did not stand to gain from a further clarification of rights. It, therefore, falls upon the competitor to initiate legal action.
[57] Other terms that might be important in the telecommunications context include (a) the standard of the interconnection interface, including for example, whether or not the competitor will be supplied with particular information such as call origination information; (b) the numbering scheme that will be allocated to the competitor and the issue of `number portability'; and (c) the number and location of `points of interconnection'. (Some numbering issues were resolved by the High Court in the case between Clear and Telecom).
[58] The cost to Telecom of maintaining litigation to delay the entry of a competitor may be significantly less than the cost of sustained effective competition.
[59] For example, s.89 could be used to force the parties into arbitration with instructions to resolve all of the outstanding terms and conditions in dispute.
[60] In the dispute between Telecom and Clear the High Court made the following comments:
"It has not been established to our satisfaction whether or not Telecom is currently earning monopoly rents. But we cannot take the evidence further. This Court is not a regulatory agency. We cannot pursue investigations as to whether: (1) Telecom's return on shareholder's funds contain monopoly rent; (2) particular segments of Telecom's business . . . contain monopoly rents; (3) Telecom has established excess capacity or wasteful capacity in its networks; (4) Telecom's operations are conducted in an inefficient manner" (1992) 5 TCLR 166 (HC) at 217.
In addition, the Privy Council commented:
"If inefficiencies due to a monopoly are to be excluded [from the interconnection price], a person faced with a request for supply will be required to survey the whole of his organisation to discover, for example, whether there is overmanning or inefficient use of plant . . . As the experts agreed and as the High Court found, such investigations are the function of regulatory bodies who can make decisive value judgments. They are the daily diet of a regulatory body" [1995] 1 NZLR 385 (PC) at 408.
[61] In addition, the `threat of regulation' (the third component with the light-handed regime) creates further uncertainty and may cause the parties to approach the Government rather than negotiate with each other.
[62] Certain shareholding requirements are also covered by the Kiwi Share, but these conditions are not relevant to the current discussion.
[63] In approving the release of this document the Government reaffirmed its commitment to these obligations.
[64] Whether or not Telecom would continue to provide telephone service at current prices to customers in remote areas in the absence of the Kiwi Share obligations is difficult to ascertain. Although the costs of supplying these customers is higher, such customers also tend to make more long-distance calls and tend to be the recipients of long-distance calls from other subscribers.
[65] Under the Electricity Act 1992, exclusive area franchises for electricity supply were removed on 1 April 1993 for consumers who used less than 0.5 Gwh of electricity in the 1992 calender year. The remaining franchise areas were removed on 1 April 1994. Under the Gas Act 1992, exclusive area franchises for gas supply were removed completely from 1 April 1993. Removal of the exclusive area franchises has enabled competition to commence in the retail sectors of the energy markets.
[66] Energy Brokers is owned by Eastland Energy, CentralPower, Hawke's Bay Power, Wairoa Power and Powerco.
[67] In part due to the greater ease with which disclosure requirements can be specified in these sectors.
[68] It should be noted that initial competition is likely to be confined to larger businesses in the CBD.
[69] Strategic Result Areas for the Public Sector 1994-1997, December 1994, Section 2, `Enterprise and Innovation'.
[70] The terms `price controls' or `price restraints' should not be understood solely as a reference to price regulation of the type appearing in Part IV of the Commerce Act. The term `price controls' or `price restraints' as used in this document is used to refer to a variety of regulatory arrangements that restrict or restrain in some way the range of terms and conditions that the monopolist can legally offer.
[71] Winston (1993) asserts that detailed regulation of rates in the railroad and trucking industries in the US stymied productivity growth and technological change.
[72] "Regulation of markets is subject to all of the problems that attend economic planning. The regulator operates with imperfect information. Regulatory policies may be second-best, reflecting rules of thumb, administrative procedures and institutional constraints. Even well-intentioned public policies can create incentives for inefficient private behaviour." Spulber, D.F., Regulation and Markets, MIT Press, (1989), p65.
[73] E.g., price ceilings in the US on natural gas and crude oil set below the market level have been blamed for discouraging the development of long-run natural gas and crude oil supplies. Winston (1993) points out that regulation of the wellhead price of natural gas below short-run market levels discouraged the development of long-run natural gas supply, creating artificial shortages. Similarly, regulation of crude oil and petroleum products in the US discouraged the development of long-run petroleum supplies. Winston, C., "Economic Deregulation: Days of Reckoning for Microeconomists", 31 Journal of Economic Literature 1263.
[74]This is discussed further in Appendix E. Regulation also tends to introduce inefficiencies because of lobbying and influence activities during the formation of the regulation itself. Legislators can, under pressure from well-organised lobbyists, impose regulation that favour the lobbyists at the expense of others and the economy as a whole.
[75] For example, some specific statutory powers exercised by a Minister.
[76] For example regulators often seek to expand their powers and the scope of the regulation.
[77] Although a regulator is under a legal obligation to act consistently.
[78] S. 73 of the Commerce Act 1986. In general it is desirable for such broad principles to be consistent with other cross-sectoral regulatory instruments such as the Commerce Act.
[79] "Pipeline Access Code" (1995), Pipeline Access Code Administrative Committee, The Australian Gas Association.
[80] Note that under options (b), (d) and (g), once the access regime is in place, compulsory arbitration would be invoked at the request of either party and not by the Government or another third party.
[81] In addition, detailed principles could be communicated by the Government to the Commerce Commission via s.26.
[82] Such as those suggested by Ralph (1995) or Laffont and Tirole (1995).
[83] See, for example, Baron (1989), King (1995), p21 and Laffont and Tirole (1993).
[84] In the sense of allocative efficiency.
[85] Long-run average incremental cost (plus some mark-up to cover fixed and common costs) is a particularly favoured pricing rule in the telecommunications context. See, for example, the recent paper by the UK telecommunications regulatory agency, Oftel, "Effective Competition: Framework for Action", July 1995.
[86] Although where the networks are technologically dissimilar, (e.g., in the interconnection of a cellular and a wire-based network) there may be a significant imbalance in the costs of handling a call in each network which is likely to be reflected in the charges. Note that the size of a network alone does not make it technologically dissimilar. `Reciprocal' rules are used for pricing the interconnection of international telecommunications and postal service operators even where the size of the national networks are vastly dissimilar.
[87] i.e., where the regulated price is an ordinary price-per-unit as opposed to two-part pricing or more sophisticated regulatory arrangements.
[88] Or, in certain circumstances short-run marginal cost.
[89] as measured by long-run average incremental cost.
[90] King (1995), p28.
[91] For example, the courts or the arbitrator could appoint an independent expert to audit and verify the cost estimates.
[92] While this may be a difficult assessment it is possible to say that the costs of programmes voluntarily borne by network operators such as Telecom's low income or "60's plus" programmes should be excluded and at least some attempt should be made to establish what access services would be voluntarily provided in the absence of any other constraints.
[93] See Baumol, W.J., Koehn, M.F. and Willig, R.D., "How Arbitrary is `Arbitrary'? - or, Toward the Deserved Demise of Full Cost Allocation", Public Utilities Fortnightly, Vol 120 (5), September 3, 1990, pp16-21; Cave, M., "Universal Service in Telecommunications: Issues of Cost Allocation", OECD, 1991; Garnham, N., "Universal Service in Telecommunications", part I in Universal Service and Rate Restructuring in Telecommunications, OECD, 1991; Mansell, R., "Telecommunications and Rate Restructuring: Issues, Patterns and Policy Problems for OECD Countries", part II in Universal Service and Rate Restructuring in Telecommunications, OECD, 1991; Xavier, P., "Universal Service Obligations: Their Provision in a Competitive Telecommunications Environment", OECD, 1992; Martin, I., "Practical Cost Estimation and Attribution Issues for CSOs", OECD, 1992.
[94] Bureau of Transport and Communications Economics, "The Cost of Telecom's Community Service Obligations", Report No. 64, 1989, Australian Government Publishing Services.
[95] Excluding the market in which the social obligation is applied. The markets with the lowest elasticities of demand may, in fact, be the markets upon which the social obligation is imposed.
[96] Or some combination of the items in the list.
[97] "For example, should `gas pipeline access to [a given city]' be an essential facility for competition? The answer depends upon the relevant market. If the market is `natural gas supplies' then access is clearly relevant. If, however, the correct market is `energy sources and fuels', then it is far from obvious that gas pipeline access is necessary to compete in this market. In the case of gas, interfuel competition in the end market appears to have been ignored. Teece (1990) compares US and German natural gas regulation and finds that the latter country has performed better as it has relied on interfuel competition to control the gas industry rather than explicit regulation." King (1995), p2.
[98] In addition, as the presence or absence of natural monopoly may change over time, declarations should be periodically reviewed. This may introduce problems of its own. For example, if the compulsory access arrangements can be revoked, say, once the market share of the entrant reaches a certain level, the entrant may prefer to continue to appear weak, merely for the sake of ensuring the access requirements remain in place.
[99] Ergas (1995).
[100] Areeda (1990), p852 suggests the following list of principles to limit the application of the regime:
- There is no general duty to share. Compulsory access, if it exists at all, is and should be very exceptional.
- A facility is essential only when the (i) the plaintiff cannot compete effectively without it and that duplication or practical alternatives are not available and (ii) the plaintiff is essential for competition in the marketplace.
- No one should be forced to deal unless doing so is likely substantially to improve competition in the marketplace by reducing price or by increasing output or innovation.
- Even when all these conditions are satisfied, denial of access is never per se unlawful; legitimate business purpose saves the defendant."
[101] However, the more factors to which the regulatory institution is required to comply, or take into account, the greater the possibilities of being subject to judicial review, undermining the certainty and predictability objectives.
[102]In the case of the telecommunications industry, an invocation of the access regime might specify the scope to include all interconnection issues, including but not limited to:
- technical standards for interconnection and network numbering;
- points of interconnection;
- supply of facilities for the purposes of the interconnection;
- supply by one carrier to the other of:
- information about traffic carried on the network concerned; or
- any other information necessary to ensure the efficient supply of telecommunications services by means of the facilities and networks concerned;
- charges payable for the interconnection or carriage, or for the supply of such facilities or information, or for related matters.
(See the Australian Telecommunications Act 1991, clause 154 (5).)
[103] Ergas (1995).
[104] Commercially sensitive information could be withheld.
[105] Ergas (1995)
[106] See for example, the survey by Perry (1989) and the chapter on Vertical Control in Tirole (1988). See also O. Hart and J. Tirole, "Vertical Integration and Market Foreclosure", Brookings Papers on Economic Activity 205 (1990); J.A. Ordover, S.C. Salop and G. Saloner, "Equilibrium market foreclosure", 80 American Economic Review 127 (1990); and J.A. Ordover, S.C. Salop and G. Saloner, "Equilibrium market foreclosure: Reply", 82 American Economic Review 698 (1992).
[107] Posner, R.A. and Easterbrook, F.H., Antitrust: Cases, Economic Notes and Other Materials, 2nd ed., 1981, St Paul: West Publishing
[108] "Regulation may prevent the firm from charging for access on a basis which allows it to fully secure the rents which its control of those facilities would otherwise give rise to. If it can `recoup' some part of these foregone rent through its control of the downstream layer, it will have incentives to engage in an upstream refusal to deal so as to prevent competitive entry downstream." Ergas (1995).
[109] "Transporters may also choose to tie to exploit market power opportunities created by perverse regulatory incentives. If the bottleneck is regulated, backwards integration may allow for cost inflation upstream and the collection of rents through an unregulated upstream affiliate. For example, AT&T was accused of using its manufacturing affiliate, Western Electric, for this purpose prior to divestiture, and the Bell operating companies were excluded from the equipment business for the same reason. (Noll and Owen, 1989)", Lyon and Hackett (1993), p383.
[110] "Transporters may choose to tie upstream supply with transportation to enhance efficiency by exploiting vertical economies of scope. These occur when it is cheaper to coordinate upstream and downstream production in a single firm than through arms-length contracts or markets. For example, Kaserman and Mayo (1991) estimate that arms-length contracting between electricity generators and distributors in the USraises costs by 11.95 percent relative to vertically integrated production. One important vertical economy results from the internalisation of network externalities. Such externalities occur when the actions of individual buyers and sellers impose external congestion or reliability costs on others. For example, if markets for wellhead gas supply and transportation are separated, individual wellhead producers lack incentives to maintain the systemwide pressure required to provide reliable service to downstream customers." Lyon and Hackett (1993), p383.
[111] "Both gas and electricity transmission require controls on the load moving through a pipeline or grid. This is particularly important in electricity transmission where excessive flows of power may overload the grid leading to a major shutdown (see Corey 1992). In electricity transmission, expanded use of the grid tends to reduce the efficiency of transmission line losses. While it may be technically feasible to internalise this effect within a single owner grid, the situation is made more complex if there are interconnecting grids. As current flows over the path of least resistance, it is impossible to `tell' the electrons to stay on one grid if they prefer to reach their destination by another path. By increasing the load on another interconnected grid, there is an externality between the grids. This problem is referred to as `looping' (see Doyle and Maher 1992)." King (1995), p26-7.
[112] Tirole (1988), p174.
[113] Perry (1989), p191.
[114] Perry (1989), p193.
[115] "Even if it were in the incumbent owner's interests to allow competing entry (because its owners' losses from increased competition in the downstream market would be outweighed by gains from access revenues and enhanced internal efficiency[115]), principal-agent problems may still lead the firm's managers to refuse to deal. Particularly in public enterprises with a history of public ownership, managers may be output or employment maximisers, more interested in retaining market share than in increasing shareholder value. Being risk-averse, the incumbent's managers may weigh the certain loss of a `quiet life' far more heavily than the uncertain gains which they could secure from operating in a competitive environment . . . As a result, the firm's managers may stall or obstruct access by the entrant even when such access would have been granted by the facility's owners." Ergas (1995).
[116] "Assume bypass is possible (although costly) upstream and that the downstream market comes close to being a `natural oligopoly'. Even with fixed proportions and full pricing freedom, it may then be in the interest of the essential facility's owner to exclude rivals by refusing to deal with them. This is primarily because vertical integration will (i) change the firm's incentives to engage in price-cutting in the input market and (ii) increase its ability to prevent such price-cutting from occurring downstream as well. Most of the downstream markets associated with the reticulation networks of public utilities are indeed likely to be imperfectly competitive while there is some, however limited, scope for by-pass of the up-stream layer. As a result, even in the absence of other regulatory distortions, the firms in control of these networks may face incentives to refuse to deal with rivals in circumstances where it would be socially desirable for them to do so." Ergas (1995), p6.
[117] Tirole (1988), p181.
[118] The Efficient Component Pricing Rule achieves this goal.
[119] Ergas (1995), note 9B.
[120] Ergas (1995), note 29.
[121] Ergas (1995), note 29.
[122] Telecom, gas transmission and gas and electricity distribution in New Zealand are all subject to the light-handed regulatory regime. This regime imposes price (and related) restraints on the monopolist through the operation of the Commerce Act.
[123] They were also forbidden from operating in the manufacturing and information industries (although there has been some subsequent relaxation of this last restriction).
[124] However, AT&T is subject to residual tariff regulation in the long-distance market.
[125] It should also be emphasised that where it is possible to receive some form of subsidy from the state the optimal prices may still be above marginal cost in order to minimise the distortions that arise from raising funds through the tax system.
[126] See Braeutigam, R.R., "Optimal Policies for Natural Monopolies", p1289 at p1338-1340.
[127]See Baumol and Sidak, "Toward Competition in Local Telephony", MIT Press, 1995
[128] Even if a capacity constraint exists it may be difficult to define. "In railroads, for example, `capacity' is a relatively poorly defined concept, since the volume of traffic which can be handled upon a given network depends not only on the number and origin/destination of trains but also on the speed at which they are operated". Ergas (1995), note 3.
[129] King (1995), p18.
[130] For example, the FERC mandated `first come, first served' rationing of access to gas pipelines in order 436 in 1985. See Alger and Toman (1990)
[131] King (1995), p21.
[132] King (1995), p21.
[133] This problem is similar to the problem of the design of optimal non-linear tariffs mentioned earlier.
[134] "The regulated firm's reward should increase with the downstream competitor's output or, equivalently, decrease with the level of the access price." Laffont and Tirole (1993), p263.
[135] Although B can purchase access into A's network at terms set by A
[136] i.e., if both the networks are fixed-wire networks, or both the networks are wireless networks.
[137] A study of telecommunications costs in New Zealand, commissioned by the Ministry of Commerce, suggests that the cost of a local call is likely to be less than the current full per minute charge. This matter is referred to in Appendix G.
[138] See for example, Feuille, P., "Final Offer Arbitration and the Chilling Effect", Industrial Relations, Vol 14 (3), 1975, p302; Stevens, C.M., "Is Compulsory Arbitration Compatible With Bargaining?", Industrial Relations, Vol 6, 1966; Bloom, D.E. and Cavanagh, C.L., "Negotiator Behavior Under Arbitration", American Economic Review, 1987, p353.
[139] Usually the parties cannot `reverse' or `renege' on concessions made in the pre-arbitration negotiations at the time when arbitration is commenced.
[140] A similar criticism can be made of conventional arbitration. Merely `splitting the difference' is no guarantee of economic efficiency.
[141] "No court should impose a duty to deal that it cannot explain or adequately and reasonably supervise. The problem should be deemed irremedial by antitrust law when compulsory access requires the court to assume the day-to-day controls characteristic of a regulatory agency. Remedies may be practical (a) when admission to a consortium is at stake, especially at the outset, (b) when divestiture is otherwise appropriate and effective, or (c) when ... a regulatory agency already exists to control the terms of dealing." Areeda, Phillip, "Essential Facilities: An Epithet In Need of Limiting Principles", 58 Antitrust Law Journal 841-869, p853.
[142] Arbitration may be less costly overall, but may be more costly to the parties, as the costs of the hearing in a legal action are subsidised by the state.
[143]Clear v Telecom 5 TCLR 166 (HC) at 212.
[144]Clear v Telecom 5 TCLR 166 (HC) at 213.
[145]Telecom v Clear 1 NZLR 385 (PC) at 406.
[146] On the former basis, Telecom earned 14.7% in 1994-95, while for the year ended closest to December 1994, the US average was 16.8%, and Bell Canada earned 13.4%. (Source: Salomon Brothers.) On the latter basis, Telecom's return was 19.0% in 1994. (Source: McIntosh Baring.)
[147] This figure includes a dividend of $110 million for the five and one-half months of Government ownership during the 1990-91 financial year, paid in March 1991.
[148] When the dividend is excluded the figure rises slightly to 16.2%.
[149] See Crook, J., "Telecommunications: The Progress of Competition and the Implications of Convergence", address to the Second Annual Utility Markets Summit, 27 April 1995, AIC Conference.
[150] See Crook, J., "Competition and Interconnection: Successes and Challenges - A Practical Perspective", presented at the ITS Workshop April 1995.
[151] Baumol and Sidak (1995), p57.
[152] Baumol and Sidak (1995), pp 42-44.
[153] See Baumol and Sidak (1995), p110.
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