Opinion

Fixing of price floor for telcos is not viable

Errol D Souza/Astha Agarwalla | Updated on June 18, 2020

The regulator will open itself to lobbying and rent-seeking. It is best to let market competition weed out the weak players

Fiscal targeting by the government is a big part of the telecom story. It started with fixed licence fees in 1994, which was raised over the years, and resulted in operators defaulting on licence fee payments. In 1999, TRAI came out with a revenue sharing model, and by 2003 the Department of Telecom (DoT) raised a demand to base the levies on adjusted gross revenue (AGR) earned by telcos, including revenue from activities beyond utilisation of licences.

The Telecom Disputes Settlement and Appellate Tribunal (TDSAT) granted a stay on DoT’s definition, but before any final verdict, the Supreme Court ruled in DoT’s favour. In 2012, the Supreme Court cancelled 122 telecom licences in the 2G scam case and spectrum began to be allocated through auctions. In 2016, Reliance launched Jio with free services and consolidations, and exits hit the sector. From 12 companies in 2016, the market further reduced to eight in 2019, and the average revenue per user per month (according to TRAI) reduced from ₹121 in 2016 to ₹74 in 2019.

The Supreme Court’s verdict asking telcos to pay dues could result in a reduction in investment in operational infrastructure, affect the quality of services, and further decrease the number of players in the sector. In response, the regulator is considering a price floor to alleviate the impact of falling prices in the sector and the debt burden of telcos.

Estimating costs

A price floor may appear to be a benign policy instrument that is beneficial in protecting the competitive process. We must, however, be mindful of the prospective harm it may incur. Inefficient firms with higher costs will engage in rent-seeking to peg the price floor at high levels. This opens the regulator up to the charge of preferential treatment.

In calculating the price floor, the regulator will have to take into account the long-run incremental cost. That is not easy to estimate. Service providers incur sunk costs of excess capacity creation and bear the risks of demand materialising in a manner consistent with their forecasts, with significant uncertainty.

Accordingly, the cost of the service at the time of sale may be considerably less than its long-run incremental cost.

These firms, with excess capacity, would charge low rates initially to attract additional transactions to achieve better utilisation, and may raise the rates later. Hence, the configuration of the sales transaction — long term versus what is available at the time, determines the appropriate measure of cost for the price floor.

A price floor will result in allocative inefficiencies as the firm is prohibited from pricing below long-run cost, which otherwise is a natural response to demand uncertainty.

For firms that are engaged in learning by doing — accumulating the experiences enabling the firm to lower its costs in future — it is more relevant to add the present discounted value of change in future cost arising from the increased production today, to the current costs. Large forecasts of demand will be accompanied by sizeable increases in capacity and low initial prices. Such capacity decisions are ex ante efficient.

It is when the competitive process results in strategic behaviour by firms to invest in capacity to deter others from doing the same and from gaining market share, that firms will enter into price reduction behaviour.

Sooner or later, this begins to hurt their bottomline. However, any attempt by the state to protect the industry from going down the slippery slope towards high concentration is ex-post inefficient, as it provides firms with the incentive that engaging in cut-throat competition will not be punishable.

Competitive behaviour

If the government wants to ensure that there are few players in the market via a price floor, then it opens itself to lobbying and rent-seeking as each firm will negotiate for a price to cover its costs. This is dynamically inefficient, and it is best for the government to keep itself at arm’s length and allow competition to weed out a firm that is inefficient and unable to continue business with low prices. This might impact the consumer welfare adversely, when the few surviving firms eventually raise prices. But the anti-competitive policy tools should come into play in time to keep such outcomes in check.

Expected low demand due to the price floor might require firms to resort to non-price competition to attract customers, given that they have spare capacities.

Again, those with deeper pockets and access to patient capital will have an advantage in this form of competition. In any case, the state does not know the cost structure of the various entities who provide the service, and given the information disadvantage it is best if output decisions are made by firms. It would be a travesty if firms who know their costs and capacities cannot coordinate on price (as that is seen to be anti-competitive) but if the state or the regulator does so on their behalf, it is suddenly socially acceptable.

D’Souza is a professor at IIM-Ahmedabad. Agarwalla is associate professor at Adani Institute of Infrastructure Management

Published on March 26, 2020

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