Strategic Interaction under Asymmetric Regulation - Adoption, Usage, and Global Impact of Broadband Technologies - page 28

The incumbent must respond by raising its
prices to all of its remaining customers in order to
cover the entry-induced losses incurred in fulfill-
ing the universal service obligation. If the entrant
follows the incumbent and raises its prices too, it
makes even higher 'free' profits'. If the entrant
does not also raise its prices, the incumbent loses
all low-cost consumers to the entrant, and must
exit the low-cost market. All incumbent costs
must then be recovered from the high-cost mar-
ket, where it faces no competition. Prices in the
high-cost market rise to at least their actual cost.
A division arises between competitive entrants
serving the low-cost market and the incumbent
serving the high-cost market, each charging prices
determined by their own costs, and removing any
vestige of a 'universal service' price across the two
markets. Moreover, if the entrants' technology is
more costly than the incumbent's (e.g. they cannot
capitalise upon economies of scale), then not only
are universal service prices eliminated, but total
welfare is lower, as the total cost of provision is
higher than if the incumbent served all consumers.
From a public policy perspective, therefore,
asymmetric levying of a 'universal service' ob-
ligation on the incumbent whilst simultaneously
preventing the incumbent from sharing the costs of
meeting the obligation with its entrant-competitors
actually induces the exact geographically-based
price differentials that the universal service obliga-
tion has been imposed to circumvent. It is therefore
implausible to assume that the government, given
its dual objectives of increasing competition in
the market and retaining universal service prices
to end consumers, could legitimately expect the
'Kiwi Share' to be borne by Telecom alone. If there
was any question of prices exceeding costs, then
the simplest solution was a ratchet on Telecom's
fixed line rental prices in the 'price cap'. If there
was an intention to selectively extract Telecom's
accumulated profits for consumer and taxpayer
purposes as a consequence of any other policy,
then this should have been explicitly and sepa-
rately levied. That neither of these was undertaken

is consistent with an expectation that Telecom
would incorporate 'Kiwi Share' costs in the prices
charged to both consumers and its competitors*.

Contesting in Court: Clear
v Telecom, 1991-94

When Telecom faced competitive entry in the
local calling market from Clear Communica-
tions 6 (hereinafter Clear) in 1991, the firm used
the Efficient Component Pricing Rule (ECPR)
to set interconnection prices (Blanchard, 1995).
The benefit of ECPR when the costs of social
obligations are imposed asymmetrically is that
the firm bearing the obligation alone can include
the social obligation costs into the interconnection
price charged to its rivals (Economides & White,
1995). Clear, however, contended that Telecom
alone should bear the 'Kiwi Share' costs, and al-
leged that any charge levied by Telecom above its
service delivery cost (i.e. excluding any compo-
nent to recover 'Kiwi Share' costs) constituted an
exertion of market power and was therefore illegal
under Section 36 of the Commerce Act 1986.
From a strategic perspective, Telecom's use
of ECPR in the presence of the 'Kiwi Share'
universal service obligation is rational. Clear's
assertion that entrants should not bear any of
costs of the social obligations assumes a political
distributive intention clearly inconsistent with the
government's 'universal service' objectives. It is
also inconsistent with the ambit of the Commerce
Act, which concerns itself with the long-term
welfare of consumers (a dynamic function of
total welfare) and not the distribution of pro-
ducer surplus amongst producers. Neither was
it signalled anywhere in the agreement between
Telecom and the government that there was any
intention to tax Telecom any differently than any
other market participant. These observations draw
into question Clear's strategic logic in using liti-
gation to contest the point, except perhaps to test
the Court's interpretation, in the absence of any
other New Zealand precedents, of the Commerce