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Article Excerpt
The Study in Brief
The cellular telephone's convenience and commercial usefulness has changed social and business communication. Yet Canada's pace in adopting cellular telephony lags most developed countries: Canada was the twenty-sixth among the 30 OECD nations to introduce digital cellular, and is currently twenty-eighth in per capita cellular subscriptions.
Neither is Canada adapting as quickly as many developing countries, where cellular phones already dominate in local voice service and new investment in wireline is largely confined to building data network capacity. Within a few years, cellphones will become the preeminent communication device for email, voice and digital photography in many countries; over the same horizon, Canadians will be relatively slow to share in the benefits of cellular provision of these services.
One of the causes of Canadians' slowness to adopt cellular telephony is our regulatory policy: in particular, long-standing cross-subsidies maintain artificially low wireline prices, reducing cellular's relative competitiveness and incentives to invest in better quality, expanded cellular coverage.
Because relatively few Canadians have "cut the cord," replacing their wireline service with cellular only, the Canadian Radio-television and Telecommunications Commission (CRTC) believes that cellular service is not an effective competitor with wireline service. Accordingly, the CRTC has maintained regulatory control over retail and wholesale wireline rates and set local retail rates at very low levels--undermining the cellular market. Further, the CRTC's recent decision on voice over Internet protocol (VoIP) telephony effectively limits competition between VoIP service providers and incumbent local carriers, and will result in higher-than-otherwise prices for VoIP and slower and less extensive rollout.
What to do? First, the CRTC should use an alternative to universal low prices for local wireline service to address any equity issues associated with local phone service. Second, the CRTC should acknowledge that despite being differentiated products, wireline and cellular services compete with each other and should be freed to do so. Third, policymakers should reconsider foreign ownership restrictions in the context of this competitive marketplace.
Without these regulatory improvements, Canadians may find themselves largely bypassed by the generation of cellular services that are at the cutting edge of telecommunications technology in every other OECD country.
The increasingly ubiquitous use of cellular telephones has changed the patterns of both social and business communication fundamentally, for it is now generally expected that those who have cellphones will always be available to receive business or personal calls. As a result, most developed countries are at, or rapidly moving toward, the point where there are more cellular than wireline subscribers, where the majority of voice calls are carried on the cellular networks, and where the development of wireline networks is concentrating on data and Internet traffic because voice traffic alone is no longer sufficient to sustain ubiquitous subscription to wireline local access services. In developing countries where there was not much investment in wireline infrastructure in the second half of the twentieth century, cellular phones already provide the most common form of local voice access, and new investment in fixed-wire networks is largely confined to providing data capability.
Canada lags behind most OECD countries in the adoption of cellular telephony. Among the 30 OECD countries, Canada was the twenty-sixth to introduce digital (2G) cellular technology and is currently twenty-eighth in per capita cell phone subscriptions. Thus, even compared to other countries with universal wireline service, Canada has been slow to adopt cellular telephony. So while in many countries analysts are predicting that within a few years cell phones will be the pre-eminent communication device used by consumers for email, voice calls and digital photography, over the same period a smaller proportion of Canadians will receive the benefits of a cellular subscription that provides all of these services.
In this paper we argue that one of the causes for the slowness of Canadians to adopt cellular telephony is our regulatory policy. In particular, Canada's longstanding use of subsidies to maintain artificially low wireline prices has reduced cellular penetration. Thus fewer Canadians have "cut the cord" to replace their wireline service with cellular only. This has led the Canadian Radio-television and Telecommunications Commission (CRTC) to conclude that cellular service is not an effective substitute for wireline service. As a result, the CRTC believes the only competition that matters for assessing the competitiveness of local voice-access markets is that provided by local wireline networks. And since there are few competing providers of wireline services, the CRTC has maintained regulatory control over retail and wholesale rates and, in particular, has set retail local rates at levels that are very low by international standards. Market definition and regulatory pricing are related in this instance because recognition of the convergence between the markets for cellular and wireline telephony would also require the recognition of the wider competitive market of which wireline telephony is a part.
The CRTC's recent decision on voice over Internet protocol (VoIP) telephony is an extension of this view of competitive conditions. In its decision, the CRTC (2005a) establishes a regulatory regime that protects various VoIP service providers from competition from incumbent local exchange carriers (ILECs). The CRTC believes it is protecting competition by protecting VoIP "competitors." This is misguided. Although Decision 2005-28 will certainly encourage customers to transfer from the ILECs to VoIP competitors, it will also result in higher prices for VoIP than would exist without this decision. In addition, the spread of VoIP service throughout Canada is likely to be slower and less extensive with regulation of ILECs' VoIP services than it would otherwise be. By failing to consider the wider competitive environment, the CRTC maintains extensive regulatory control over ILEC retail wireline services at a time when technological advances--either by cellular or VoIP--are undermining the case for regulation of retail prices and for universal retail wireline service obligations. (1)
We begin by outlining the economic theory used to determine substitutes and the extent of competition in defined markets. We then consider the economic implications of regulatory policy that mandates low retail prices for basic services provided by an old technology, but by doing so inhibits the adoption of competing technologies. We then discuss cellular telephony services, pricing and uptake in Canada; and the empirical evidence on competition between cellular and wireline telephony in Canada and in other countries. Finally, we offer some suggestions for improvements in Canadian regulatory policy.
Competition and Market Definition
Competition may be thought of as the process generated by rivalry between firms. Rivalry occurs through the introduction of new and improved products and services over time, and through the setting of prices at a particular point in time. Economists assess the intensity of competition by examining the ability of each firm to exercise market power by setting prices above the competitive level. (2) The exercise of market power by a firm offering a particular good is constrained by the availability of close substitutes from other firms. These are the products or services that can be said to "compete" with the good in question. The process of identifying those competing products or services is known as market definition. Market definition is usually the first task of competition authorities trying to foresee the likely competitive effects of a merger or a particular business practice.
Telecommunications regulators also define relevant markets as a preliminary step in assessing the extent of competition in order to determine whether regulation is needed and, if so, how much is needed. For example, section 34 of the Telecommunications Act requires the CRTC to "forbear" from regulation if it finds that "a telecommunications service or class of services provided by a Canadian carrier is or will be subject to competition sufficient to protect the interests of users." The CRTC has indicated that the interests of users are protected when markets are workably competitive but that workable competition does not exist if a dominant firm has substantial market power as demonstrated by its ability to set prices above competitive levels for a sustained period of time. (3)
Because it is difficult to measure directly whether a firm has market power, (4) regulators and competition authorities normally define the relevant product and geographic markets and then consider the extent of competition within those markets. Competition is assessed by considering the individual participants' market shares, demand and supply conditions, behaviour of customers, effectiveness of rivals against the incumbent firm and the prospects for future entry or expansion of rival firms. (5) In telecommunications, the pace and direction of technical change will be relevant to any assessment of the potential for existing firms to expand and for other firms to enter the market. It may also be relevant to consider other factors, such as regulation and those bearing on the ability to raise prices significantly above competitive levels.
When products are homogeneous, the market definition exercise is relatively straightforward, but usually they are not. The existence of differentiated products complicates the market definition exercise because the characteristics that distinguish one product from another may vary continuously as existing products are improved upon and new ones introduced.
In the case of differentiated products, simple comparisons of price are not an adequate basis for market definition or analysis of competitive constraints on firms. For example, cellular is differentiated from local wireline service by the fact that each service has unique features, but in particular by the fact that cellular service has features that consumers consider so valuable that it is priced higher as a result. A simplistic interpretation might suggest that the seller of local wireline could raise its price without inducing consumers to switch to cellular. But when the mobility of cellular makes the service more valuable to consumers, the fact that it has a higher price says nothing about the willingness of consumers to switch to it in response to monopoly pricing of the less valuable service.
Another complication can arise when different customers consider services to be competing or complementary to varying degrees. For instance, suppose that many consumers regard two services as complementary, in the sense that an increase in the price of one decreases the demand for the other, and vice versa. If the proportion of such consumers is very large, then the price of one service is not constrained by the availability of the other. However, if a significant number of people view the services as substitutes and, as a result, are willing to switch in response to a price increase in the other, the two goods would then be said to be competing, despite the existence of a number of people that regard them as complementary. It is not necessary for everyone to view the goods as substitutes in order to find that they are competing. So, the fact that some people resist using cellular phones or use them only for special purposes (such as emergency use) is not inconsistent with competition between cellular and wireless service so long as a substantial group of consumers does regard them as substitutes.
In the extreme case, product differentiation can result in regulators or competition authorities refusing to recognize the true breadth of the market until one of the products is viewed by consumers as virtually obsolete. In our view it is unreasonable to wait to recognize cellular telephony as a substitute for wireline telephony until the prices and services offered by cellular networks result in mass extinction of fixed-line telephone subscriptions. It Should be recognized that, for many consumers, the common local service provided by both networks, the potential for cellular service to make wireline local service redundant, and the pricing of both services on a per minute basis put them in the same market.
The difficulty of defining the market in the case of differentiated products is one of the reasons why competition law in New Zealand and Australia calls for the adoption of market boundaries that are consistent with "commercial common sense" as well as those that can easily be demonstrated with the quantitative tools of economists. (6) Here the application of common sense suggests that regulators should consider the extent to which wireless and wireline networks offer competing services rather than allow the differences in functionality and prices to hide the obvious substitutability of their core local and long distance calling capability.
In contrast to its position on wireless, the CRTC focused on functional substitution when it found that because VoIP telephone numbers conform to the North American Numbering Plan and the service connects with the Public Switched Telephone Network (PSTN), local VoIP services are in the same market as circuit-switched local services. (7) But wireless also conforms to the North American Numbering Plan, and it too connects with the PSTN, just as VoIP service does, yet the CRTC does not regard wireless as a substitute for local wireline service. But if functional substitution is paramount, the CRTC's logic suggests that VoIP is in competition with all forms of circuit-switched telephony--both local and long-distance--as well as with wireless service, since all of these services allow for calls to and from the PSTN. This disconnect in logic was pointed out by Andrde Wylie, dissenting Commissioner and Vice-Chair (CRTC 2005a). The CRTC did not consider wireless to be a close substitute for wireline telephone service because fewer than 2 percent of Canadian households were wireless-only as of 2003 (CRTC 2005a, 128). But by December 2004, the number of wireless-only households...
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