Information Technology Reference
In-Depth Information
THE 'KIWI SHARE' AND
COMPETITIVE ENTRY
As consumers switch to the entrant, the incum-
bent loses revenues from which the unprofitable
(high-cost rural) services were subsidised. If the
incumbent is also subsidising line rentals from
calling revenues, even entry into calling markets
(e.g. long distance) may impede the incumbent's
ability to subsidise unprofitable access services
and remain financially viable. Such distortions can
be overcome only by levying a tax on the entrant,
equivalent to the amount the incumbent used to
extract from customers now served by the entrant,
in order to continue subsidising the unprofitable
services at the requisite level (Armstrong, 2001).
When an incumbent faces asymmetric univer-
sal service pricing obligations, an entrant seeking
to maximise its own profits would logically seek to
avoid any price or tax liability for universal service
obligations, thereby forcing the incumbent to bear
all of the costs uncompensated. If a tax can be
avoided, the entrant can selectively enter only the
most profitable (incumbent's capped prices above
cost) areas, and undercut the incumbent's prices.
If the incumbent did not face a 'universal
service' obligation, it would respond to selec-
tive entry by competing on price, down to the
higher of its own or the entrant's costs. With a
'universal service' obligation in place, however,
the incumbent's ability to respond is restricted.
If the incumbent cannot lower its prices, a single
entrant can charge approximately the same price
as the incumbent, without fear of invoking price
competition. As customers are induced to switch
from the incumbent, profits previously earned
by the incumbent and used to offset connections
charged below cost are now extracted by the
entrant as 'free profits' (although if there is more
than one entrant, they may compete amongst
themselves on price, thereby lowering prices to
the competitive level - but as the fixed and sunk
costs of infrastructure-based entry are substantial,
only limited entry is likely to occur, increasing
the likelihood that entrants may co-operate to
appropriate the profits).
Competitive interaction is underpinned by the
participants' actions, derived from strategic think-
ing - “the art of outdoing an adversary, knowing
that the adversary is trying to do the same to you”
(Dixit & Nalebuff, 1991:ix). The knowledge that
another party is constrained in its choices by dif-
ferent obligations necessarily affects the range
of strategies available to a party in selecting
the one that will, in its assessment, leave it best
off after the interaction has occurred. It would
be expected that Telecom's competitors would
utilise the knowledge that the 'universal service'
obligation distorts competitive interaction in order
to appropriate as large a proportion of the gains
available from competitive entry as possible.
Indeed, competitors' failure to take advantage of
the asymmetry for their own purposes would be
a deviation from expected behaviour warranting
further investigation and explanation.
Strategic Responses to
Asymmetrical Universal
Service Obligations
The incongruity of the asymmetric allocation of
universal service obligations on the prices of only
one firm in a competitive market is highlighted
by Farrell (1996). Requiring the incumbent to
charge above-cost prices in urban markets and
subsidise below-cost prices in rural markets in-
duces inefficient selective infrastructure-based
entry. As a consequence of the high margins on
offer, competitors will enter only in the low cost
urban markets (competitive entry will not occur
in the high-cost rural areas as at the prevailing
subsidised prices, losses will be made). Further-
more, competitors can enter in urban markets even
though their cost structures are higher than those
of the incumbent (i.e. it would have been more
efficient if the incumbent continued to serve the
urban market than the more costly competitor).
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