Telecommunications mandatory unbundling

Mandatory unbundling in telecommunications markets has been a hot topic in a number of countries around the world, including New Zealand, for sometime now. One obvious issue is What are the effects of such a policy? Did it achieve what it was designed to achieve? There is a new working paper out, entitled Did Mandatory Unbundling Achieve Its Purpose? Empirical Evidence from Five Countries by Jerry Hausman and Greg Sidak, that addresses these issues. In this article, Hausman and Sidak evaluate the rationales offered by telecommunications regulators around the world for pursuing mandatory unbundling.

First, mandatory unbundling is defined, with brief descriptions of different wholesale forms and different retail products. Hausman and Sidak note that

The term ‘mandatory unbundling’ describes an involuntary exchange between an incumbent network operator and a rival at a regulated rate where the scope of unbundling is determined by regulators. Determination of the access rate thus becomes the major bone of contention between incumbent and entrant, as a regulatory access rate that is equal to the voluntarily agreed-upon access rate cannot really be said to constitute ‘mandatory’ unbundling. When formulating that access rate, regulators have generally opted in favor of a measure of total element long-run incremental cost (TELRIC) or total service long-run incremental cost (TSLRIC) and against a measure of opportunity cost or option value.

Then the four major rationales for regulation of this kind are looked at: (1) competition in the form of lower prices and greater innovation in retail markets is desirable, (2) competition in retail markets cannot be achieved with mandatory unbundling, (3) mandatory unbundling enables future facilities-based investment (stepping-stone or ladder of investment hypothesis), and (4) competition in wholesale access markets is desirable.

Next Hausman and Sidak proceed by testing empirically the major rationales in the United States, the United Kingdom, New Zealand, Canada, and Germany. For each case study, they review the mandatory unbundling experience with respect to retail pricing, investment, entry barriers, and wholesale competition.

The lessons learned from unbundling are then reviewed by Hausman and Sidak. There are two possible explanations for why a rationale for mandatory unbundling at total element long-run incremental cost (TELRIC) was not substantiated in practice. First, the rationale was never supported in theory. Second, the rationale was supported in theory but those theories could not be transported from textbook into practice. For example, an exogenous shock, unforeseen by the regulators, may have occurred and the regulatory framework was not sufficiently flexible or robust to cope adequately with it.

Rationales (2) and (4) are not supported in theory, which implies it was unlikely for regulatory intervention to serve its purpose. Rationale (2) fails in theory since rationale cannot account for the significant facilities-based competition that has emerged independent of mandatory unbundling. Rationale (4) fails in theory as well. This is the idea that mandatory unbundling would stimulate competition in the wholesale market for network elements. If wholesale supply of network elements were a viable business strategy, then one would expect several firms to pursue and succeed at such a strategy. But the experience suggests that the most valuable ‘component’ of the network is the carrier's relationship with the customer. It therefore makes little sense to cede this valuable asset to an intermediary for the sake of avoiding the retail costs of providing the service to the end user. Moreover, the idea of divorcing the wholesale activities from the retail activities ignores the significant economies of scope that can be realized in their joint production. For these reasons, it was not reasonable to expect that mandatory unbundling would induce new carriers to enter and limit their business plans to wholesale activities only.

By contrast, the stepping stone hypothesis and lower retail prices were theoretically plausible under certain assumptions yet were not satisfied in practice. The stepping stone hypothesis may have failed due to selection bias created by the unbundling program—that is, the very firms that were attracted to compete with the aid of government support were not interested in developing long-term rival networks. Retail prices may not have declined as quickly as regulators had hoped due to the divergence of interests between managers and shareholders of telecommunications firms or because regulated telecommunications prices are not subject to market power by their incumbent providers in the first place.