Telecommunications services in France

Tel ecom m u n ications services in France The regulated monopoly and the challenge of competition

Jean Pierre Coustel

Classical microeconomic modelling cannot alone explain the present trend of telecommunications deregulation. Based upon an examination of the French situation, the author argues that the current phenomenon should be viewed more as a game between three main players whose behaviour can be analysed using principles of industrial organization. The traditional telecommunicationa monopoly is bound to react defensively in response to increasingly powerful demand, atlmulated by technical Innovations, while at the same time the public policy maker searches for modem regulatory principlea. Demand, as represented by large corporate customers, will probably trigger the next step in the game between the three players. Jean Pierre Coustel is in charge of the Sales and Marketing and International Policy Department of the Direction des T(~l~communications des Reseaux Ext~rieurs (DTRE). DTRE is the branch of the French Telecommunications System (DGT) for international and overseas operations. He can be reached at DTRE, 246 Rue de Bercy, 75012 Paris, France. The views expressed in this article are those of the author and do not necessarily reflect the views of DTRE, or the views of DGT. This article was originally presented in French at a conference on industrial Organization, held in Paris at the end of 1985 by the Direction de la Pr(~vision, Ministere de I'Economie, des Finances, et du Budget. Direction de la Pr6vision is the continued on p 230

The telecommunications industry is entering an exceptional period which will come to be seen as a major turning point in its history. In many industrialized countries, along with the extraordinary development of telecommunications markets, this decade will mark the end of the regulated monopoly of supply and give birth to a new system of economic regulation based on market mechanisms. Recent transformations in countries which are comparable to France in economic and cultural development attest the change and the magnitude of the challenge to the dominant or sole supplier of telecommunications. In some countries these transformations have been carried out through planned reform; in others they have occurred through a smooth evolution. They demonstrate, locally, and under considerably different circumstances, the degree of acceptability of other models of control in a sector traditionally subject to heavy governmental regulation. They naturally also give rise to certain fears which, along with ideological considerations, occasionally result in defensive behaviour or even avoidance of the problem. Such is likely to be the case in France. The current situation offers an opportunity to analyse an unusual case of rapidly changing industrial structures, and to assess in real time the behaviour of the traditional regulated monopoly when confronted by especially aggressive competition and signs of diminishing captive demand. Pure microeconomic considerations cannot, by themselves, satisfactorily explain the principal phenomenon of the regulated monopoly gradually giving way to supply-side competition. Rather, this farreaching economic process can be described more as a game within industrial organization patterns involving three important players. A thorough examination of their complex interplay might provide a foundation for predicting the evolution of telecommunications regulation in highly industrialized nations.

0308-5961/86/030229-1553.00 © 1986 Butterworth & Co (Publishers) Ltd

229

Telecommunications services in France

Based on the French situation, this article highlights specific elements which may later be submitted to a theoretical analysis, the pursuit of which is beyond the scope of the present study. In addition, questions will be raised that are too often stifled by the power of the dominant or sole telecommunications services supplier because of the monopoly's fear of criticism. The effect of this examination will be to encourage and inspire discussion of a subject which has to date been relatively closed for debate in France.

Change in the control structure and organization of supply Dynamics of a world-wide trend

continued from p 229 research centre for economic policy of the French Treasury Department. The article does not take account of events since February 1986. The author is indebted to all the people who made this study possible and especially to J. Le Foil, R. Poinsard and T. Loper. ~Extensive literature describes the movement of telecommunications deregulation, For the purposes of this article, a useful reference is R. Eward, The Deregulation of International Telecommunications, Artech House, 1985. Further references focusing on the relevant French environment are J.P. Coustel, 'La dereglementation des t(~16communications. Le poids du demembrement d'A'l-I" dans la dynamique de diffusion du mouvement', Revue d'6conomie industrielle, No 30, 1984; and B. Aurelle, 'Les t61ecommunications', La Decouverte, 1986.

230

The 1970s ushered in an era of rapid and dramatic deregulation of the telecommunications industry throughout the industrialized countries. In 1970, the US government authorized Microwave Communications lnc (MCI) to offer long-distance telecommunications service in direct competition with AT&T. This decision was expected, following previous diminutions of AT&T's monopoly power, and its economic impact was minimal. But for the first time since the stabilization of telephone service systems at the beginning of this century, the traditionally regulated monopoly was facing open competition. After almost 15 years of litigation, the Bell System was broken up in the USA. British Telecom is now a private company which since 1982 has had to deal with direct authorized competition from Mercury. NTT in Japan was made a public company and new competitors have been allowed to provide a large part of the range of services offered. In 1985, legalized competition first appeared on major international telephone service routes. In many other industrialized countries administrative reforms have been carried out fairly recently which, although maintaining a regulated monopoly over the supply of telecommunications services, have often introduced something akin to ex post economic and financial control, and have helped to soften some of the characteristic features of a publicly administered sector. This has been the case in Italy, Spain, Canada, Israel, Sweden, Finland, Belgium and Australia, and will soon be the case in Holland. In all, there is clear evidence that there has been a 'no return' evolution in the structure of the supply and control of telecommunications services, which has been fast, recent and often spectacular. This evolution has affected all of the industrialized countries, with the exception of two: West Germany and France. It should be noted, however, that a public debate led by the West German government began in the spring of 1985, raising the question of the adaptation of the structures of supply and control of services to the German market. Certain developing countries, particularly Senegal and Nigeria in 1985, are also undertaking similar reforms. However, at this stage the measures taken have most often been aimed at merely decentralizing the telecommunications monopoly - for example by loosening the ties with the postal service - while generally maintaining a monopoly. The drift of these developments, perhaps incorrectly referred to as the deregulation of telecommunications, tends towards the substitution of the traditional tightly controlled government monopoly by a form of economic regulation based on market mechanisms. Events in the USA, the UK and Japan since the beginning of the 1980s illustrate this historic change, although the methods used were very different in each of the

TELECOMMUNICATIONS POLICY September 1986

Telecommunications services in France

three countries and were guided by differing policy considerations. For the French observer, interested in gaining a better understanding of the interaction between the state and the national economy, the analysis may focus along two main lines. On the one hand, it would be useful for a complete understanding of the phenomenon to undertake systematic research of the causes of telecommunications deregulation, including identification of the mechanisms at play, forecasting the economic effects as a whole, and assessing the consequences of these changes. Indeed, it seems worthwhile to devote serious study to these issues in France. On the other hand, the impact of the drive for change on French telecommunications should be measured, as well as the timeliness of recommending some kind of deregulation in the unique French situation. To do so, the dynamics of the evolution of this trend must be studied, together with the factors that might impart a universal nature to these new structures. The focus of the present analysis is not to propose a different organization or control for the French telecommunications system; such an approach would face a double trap. It would either fall into an excess of normative construction when creativity is required instead, or else not appear credible in the light of the present political tensions in France.2 Instead, the author's main goal is to clarify the interplay of mechanisms which result in an imbalance between supply and demand in the market for telecommunications services. An examination of the French situation will demonstrate the strength of the challenge to the monopoly, as well as reveal unmistakable tensions. A tangible illustration will thus be made of defensive behaviour engaged in by the regulated monopoly faced with competition - a phenomenon which is unfortunately recognized belatedly, both by the monopoly itself and by the regulating governmental authorities.

A game for three players

2Such tension was surprisingly revealed with the publication of Le grande derangement at the end of 1985 by J.C. Lattes. One could argue that the straightforward pleading of J. Darmon, its author, for deregulation, with little background analysis and much mass media support, was not the best way of introducing this important question of industrial organization to the French public. 3Development and discussion of these short conclusions can be found in J. Langlade, 'Competition in telecommunications', Telecommunications Policy, December 1982; or in J.P. Coustel, Le Demembrement d'ATT et la dereglementation des tdlf~communications, Documents de travail de la Direction de la Pr~vision, No 2, 1984. Many other references maintain a similar view, for example, L. Gilles, Les communications par satellite: perspectives et enjeux, Report to the OECD, 1985.

The logic behind the transformations occurring in the countries most committed to telecommunications deregulation may be simply summarized as follows) The process of incorporating rapid technological change in the communications sector continues both to transform profoundly the supply side of the economy and to stimulate demand in the markets concerned. One is then forced to question the advantages of economies of scale and of scope made possible by the integration of telecommunications services within one system. What is valid for a given static technological environment no longer seems to be the driving force for the development of supply, either in quantity or in quality, when production techniques are constantly changing. When public authorities face a situation in which demand may not be adequately satisfied, the tendency seems to be to introduce market mechanisms, based more on considerations of economic policy than on microeconomics. This choice may be based on the prospects for the expansion of telecommunications and on the ripple effects anticipated in the economic, industrial and cultural spheres. Although a review of the causes of telecommunications deregulation will not be repeated here, the following brief outline makes it possible to

TELECOMMUNICATIONS POLICY September 1986

231

Telecommunications services in France

recognize the protagonists involved within this complex market relationship, and to cast some light upon the factors determining the behaviour of each one. Demand is clearly aware of its new strength on the market, and exerts it by influencing the direction of the supply of services and also by seeking greater advantages from the rapid integration of technological innovations. On the supply side, the dominant operating company, entrenched behind regulations protecting its monopoly, appears to be in a quandry when faced with decreasingly captive demand, the belatedly acknowledged need for determined strategic options, and the appearance of particularly aggressive supply competitors (although their current economic impact is still weak). Above all, the dominant operating company is building a defense for its vulnerable points, at least for the short term. Finally, the public policy maker must solve the problem of the structure of control in a market in which state-controlled industries have played an important part since the inception of telecommunications. The belated recognition of the imbalance between supply and demand and the genuine difficulties faced in defining a suitable long-term control model explain why there are some signs of indecision.

Secondary actors Clearly, describing an unquestionably complex interplay between a number of actors as a simpler game between only three players is a stark reduction of reality. Indeed, to gain an understanding of the dynamics of deregulation and to assess the present French situation would undoubtedly require consideration of the motives of some other important social groups. Household consumer demand should have a role in the process too, at least because the group is at the core of what is understood by the term, 'the public interest'. Equipment manufacturers are an industry extremely sensitive to the sometimes violent short-term shocks created by the international trend towards deregulation; their position is far from neutral, and their ability to act against the policy maker cannot be ignored. The trade unions are very sensitive to the issue of job security of communication industry workers. Their position has to be differentiated, though, as job security considerations differ between the equipment industry and telecommunications services industry. This analysis assumes that the social and economic power of the above actors is far less than the power which business demand, the dominant operating company, and the public policy maker have to effect immediate and medium-term change in telecommunications services. Based on this view, the focus here will be on the interplay among the three main players. The considerations developed below strive, first, to identify more precisely the main factors which steer the evolutionary process towards the basic desires of the three protagonists; and, second, to illustrate interactions among them. Issues relating to the attitude and strategy of the policy maker will be given special attention. It is useful in the first instance to point out some aspects of the current situation in France which demonstrate the increase in competitive pressure on the regulated telecommunications services monopoly. 232

TELECOMMUNICATIONS POLICY September 1986

Telecommunications services in France

Competitive pressure on the regulated monopoly The regulated monopoly in France 4

As far as network operation is concerned, the Direction G6n6rale des T616communications (DGT) is the sole authorized provider of public telecommunications services in France (apart from T616diffusion de France (TDF), which since 1958 has handled specialized national services for domestic television transmission). The policies of the two bodies are harmonized by the post office and telecommunications ministry (PTT), which exerts governmental control over both entities, acting de facto as the main regulatory body. Although certain basic services are performed by third parties, with the permission of the DGT, the general principle of the monopoly is not affected. The services performed by third parties - for instance, private networks of DDEs, SNCF, and EDF, 5 citizen band radiocommunications, and so on - are destined for limited groups of private consumers and therefore do not belong to the category of products marketed as public services. Certain segments of the market are nevertheless open to legalized competition, for example the installation of customer premises and terminal-related equipment (CPE) (answering devices, modems, sophisticated telephone terminals, telex terminals, etc). The marketing of these special services is closer to pure distribution than to what is usually understood by telecommunications services supply. Other open markets relate to business communication needs, such as local networks, or private branch exchanges (PBXs and PABXs) linked to the public network. The latter case is the best example of authorized competition. But, a most promising segment of the market has been abandoned by DGT, that of medium- and large-capacity PBXs and PABXs. However, the significance of this particular case can be considered as negligible with respect to the general relationship between the supply and demand for telecommunications services. These exceptions do not limit the conclusion that the supply of telecommunications services in France is a regulated monopoly, the government administration and regulation of which is exercised ex ante pursuant to broad statutory authority, non-existent in the case of the private sector. 4It is not the purpose here to study the legal issues which a methodical assessment of the status of the supply of telecommunications services would eventually bring to light. The author will limit himself to recalling in the simplest way for the foreign observer the reasons which attest the legal existence of a regulated telecommunications services monopoly in France. A useful presentation of the historical and jurisdictional evolution of the French telecommunications system appears in L.J. Libois, Genese et croissance des tdldcornmunications, Masson, 1983. 5DDEs are local or regional authorities for road and public infrastructure management; SCNF is the government-owned national railway system; and EDF is the government-owned national electric public utility.

TELECOMMUNICATIONS

POLICY

De facto competition

A more detailed observation of the market situation leads to the identification of three major groups of telecommunications services. The logic of their classical separation has been demonstrated by recent structural changes in most modern telecommunications systems. Competitive pressure is now virtually non-existent in local telephone services. This is not unique to France. Instead it results mainly from the strong barriers to entry created by the very high and indivisible costs of the initial capital spending required to provide local telephone service. Thus for these services one can admittedly refer to the 'natural monopoly' situation. The threat of competition is nevertheless serious in two main areas: in the short term, through the possible bypass of the local loop by means of new radioelectric systems, with low-cost direct access to higher-level networks. Large customers are increasingly likely to gain economic

September

1986

233

Telecommunications services in France

benefits from this. In the long term - that is for an expected technological generation which will profoundly change the present technical and economic balance - competition is likely to come from radiotelephone mobile systems. Such systems will make it possible to bypass the present entry barriers for the construction of local loop networks. For long-distance services, the possibility of being exposed to non-authorized competition is quite real. It is well known that communications are priced at about four times more than production costs on high-density lines such as Paris-Lyons. It is less well known that the major customers have their own networks, made available by DGT, which siphon off a considerable portion of long-distance telephone revenues. Finally, as demonstrated by Mercury in the UK, the economic feasibility of large independent networks seems to be confirmed. The volume of Mercury's investments amounted only to about 2 billion French francs by mid-1985, thus appearing within reach of a number of European industrial or institutional investors. International telecommunications services, on the contrary, are clearly and unavoidably exposed to competition. The most powerful competitors to DGT in international telecommunications are the.authorized suppliers of public telecommunications services in Europe, and most notably British Telecom. Such competition was revealed only recently; the transformation of British Telecom in the early 1980s seems to be significant in this development, to the detriment of the traditional balance maintained over a very long period based on the absence of pressure from the demand side. In the first stage, such competition appeared only with regard to prices, resulting from the progressive introduction of Mercury. The second stage began by 1984, with increasing non-price competition. Most European telecommunications systems were forced to look for positive service differentiation when the pressure mounted. The next stage will be when European systems have in turn overcome initial delays and internal policy hesitations and achieve the shift towards open competition in international telecommunications. It is of prime importance to ensure that such competition arises from fair business practices. Perhaps British Telecom is spurred on by Mercury, or by a new management ethic; other European telecommunications systems are perhaps more entrepreneurial than DGT. None of these reasons override the fact that this new competition emanates from international telecommunications customers across the Atlantic Ocean. Such customers are accustomed to the supply organization and diversity as it exists in the USA, and indeed are poorly receptive to any national differentiation between European countries with close economic ties and small size by present telecommunications distance standards. Furthermore, apart from such clear and primarily natural competition, a number of independent organizations operate on the same market, and unfortunately their legitimacy is generally not recognized by most national telecommunications bodies. The clearest examples are the cases of telex 'pirates', and international carriers not committed to international standards and product definition, performing bypasses of international public packet networks. Finally, DGT is exposed to direct threats of competition from customers themselves who set up their own networks and resell unused

234

TELECOMMUNICATIONS POLICY September 1986

Telecommunications services in France

capacity to third parties, irrespective of domestic rules or international recommendations which forbid such resale. Daily experience shows that the traditional mechanism of contractual protection is an illusion. The obsolete procedure of usage limitation cannot cope in any realistic way with the requirements of customers such as TYMSHARE, SITA, SWIFT, IBM, EDS, GEISCO, and many others, whose economic and industrial power can be measured on the same scale as that of the government regulators.

Unequivocal causes of competition

6Evidence of this in the USA before the divestiture of AT&T is readily available. An estimation of such distortions in Germany may be found in K.H. Neumann, 'Regulatory policy in telecommunications and media activities in the FRG', Bulletin de /'/DATE, No 17, 1984; and for Japan in T. Ozawa, 'The study of access charge', Bulletin de/'/DATE, No 17, 1984. 7Basic estimations of the amount of such transfers are detailed in governmental reports such as La ratification publique. Quelques r~flexions pour le IXeme Plan, Commissariat General du Plan, 1983, but also in N. Curien and J. Labruneti~re, 'Les transferts de revenu induits par la tarification tel~phonique entre cat(~gories d'abonnes et entre types de prestations', Annales des t~l~communications, Vol 39, No 1112, 1984. A discussion of probable economic and social harm induced by those transfers and recommendations for a new pricing policy are covered in J. Le Foil, La tarification du tdlephone. Une reforme de grande ampleur, Documents de travail de la Direction de la Pr(~vision, No 7, October 1985.

The causes of such competitive pressures are clearly visible at the microeconomic level. They can be classified into three categories which illustrate the most common situations encountered in countries with comparable levels of economic development. On the whole, telecommunication services in France are at present overpriced. The overpricing is roughly 20% of the published price. The reasons behind such overpricing have to do with the volume of expenditure borne by DGT unrelated to its main occupation as a supplier of telecommunications services. To assess the significance of overpricing, some figures from the DGT operating account for 1985 are given in Table 1. 'Debt financing' and 'Operating profits' appear excessively high. Although it is dangerous to draw normative conclusions from the amounts shown without making a more detailed inquiry into the overall position of DGT within the French economy, by usual standards their total (at present 26 billion French francs) could be reduced to 10 billion French francs. This amount is still considerable and takes into account the highly capital-intensive nature of the production concerned, and DGT's financing needs. There are also indirect reasons for overpricing. Under current tax rules value-added taxes (VAT) are not applied to DGT's services. Consequently corporate customers who typically recover VAT on most production costs do not enjoy their usual advantage over household consumers. Another well known cause of competitive pressure is crosssubsidization and resulting price distortions. Correction of price distortion is one of the determining reasons behind deregulation and justifies the segmentation between local, domestic and international long-distance services. Price margins for long-distance services are considerably higher than those for local services, which operate at a deficit by standard accounting principles. The situation is common to telecommunications services throughout the industrialized countries; 6 in France it leads to annual accounting transfers between classes of services of more than 10 billion French francs. 7 The effects of technological change are the direct cause of such distortions. The rigid rules for determining and authorizing prices have not kept pace with the rate at which technological change has been Table 1. DGT operating account, 1985 (billions of French francs).

Source: Approximationbased on DGT's interim accounts.

Production costs (spending, depreciation) Personnel Debt financing Operatingprofits Total

TELECOMMUNICATIONS POLICY September 1986

31 25 15 11 82

Revenue

82

Total

82

235

Telecommunications services in France

integrated into the services offered. The process is much more rapid in concentrated long-distance networks than in more dispersed local networks in which technical standards have barely evolved since the inception of telephone service, s A final factor explaining the growth of competitive pressure is an increasing awareness that demand is not being adequately satisfied. This is discernible in several ways, and the triumphant statements made by DGT at the end of the 15-year period during which France established a modern telecommunications network will have to be placed in their proper perspective. This situation is illustrated by the artificially high costs, by the obsolescence of certain kinds of equipment (radiotelephones, videocommunication networks), and by the inflexibility and somewhat authoritarian behaviour of DGT in the authorization of CPE equipment, restrictions on the use of services, and so on - as well as by its relative unresponsiveness to certain market requirements. Signs of unresponsiveness include the delays in reaction to basic issues and the occasional low standard of professional commitment and responsibility of DGT's employees. On the whole, the situation in France combines a series of conditions which elsewhere have led to the implementation of extensive reforms, made possible by previously established national economic policy. ~ Although no comparable project is under study in France, the interaction of the protagonists involved demonstrates the existence of very real tensions. The strength of the forces at play and the trends influencing the determination of new policy options will now be reviewed in more detail.

The new p o w e r o f d e m a n d The profound transformation of the telecommunications marketplace leads to the observation that supply operated and controlled under the traditional monopoly model is poorly adapted to demand for telecommunications services. An assessment of the role of demand in the transformations flowing from telecommunications deregulation requires an examination of two major issues: • 8Although a great deal of research is still required for a proper understanding of such mechanisms, the initial effects on prices induced by increasing competition in the market may be found from data of the US Department of Labor. Price variations for local and long-distance services have been on average three and four percentage points below the inflation rate during the period 1977-82. During the period 1982-85 the same variations were five percentage points over and four percentage points below the inflation rate. 9An illustration of wider deregulation trends within the US economy is presented in M. Derthick and P. Quirk, The Politics of Deregulation, The Brookings Institution, 1985. Signs of the extension of such industrial policy within Europe are reviewed in J. Pelkmans and M. van Nie, Privatization and Deregulation: The European Debate, Institut Europeen d'Administration Publique, 1985.

236

•

What is the real extent of the power of demand with respect to the regulated monopoly.'? Why did unquestionable evidence of instability in the relationship between supply and demand appear at such a late date?

Study of the first question reveals several noteworthy facts. First, the failure to take household consumers into account in the deregulation process is significant. Economic and industrial policy considerations weighed more heavily in the policy-making process, although household consumers represent the largest share of installed capacity in local networks, and in the short and medium term suffer most from the negative effects of deregulation. Significant increases in local charges, a more complicated system leading to higher information costs, difficulties in acceding to the variety of services offered, and a possible weakening of the concept of 'public service' are some of the better known of the expected negative effects. In addition, the most active examples of customers eager to maintain their distance with respect to regulated monopoly principles and regulations are not an indistinct group of consumers but instead are

TELECOMMUNICATIONS POLICY September 1986

Telecommunications services in France

1°International groups of users have long been backing telecommunications deregulation; the frequent reports of the TUAC or INTUG leave no room for doubt. A subtle outline of that position appears in E. Weiss, 'The user today: the INTUG initiative', USERCOM85, 1985, as a presentation by the chairman of INTUG at the first joint conference between ITU and INTUG. In IBM, 'Commentaires d'IBM sur le programme d'action de la communaute europeene en mati~re de t(~l~communications', Communication to the EEC, 1984, the company demonstrated its determination for less regulation, both as a powerful customer and as a potential alternate supplier for telecommunications services.

TELECOMMUNICATIONS

POLICY

distinct corporations engaged in fair business practices. They are very often multinationals and are therefore in direct contact with alternative experiences in telecommunications supply in other countries. They are familiar with information technology and are closer to the technological side of supply than the average business customer. They operate private networks for their communication needs and, due to the constant drive for improved efficiency, use the best technology available. They are therefore very active and creative in directing the supply of communication equipment. These customers, which are electronics and information technology industries, or the financial and insurance businesses, appear more as an opposing force than as a group of captive customers. Whereas the monopoly could have taken advantage of the signs of decreasing captive demand by anticipating reforms, it seems that the need for change in the organization and control of telecommunications services was understood more clearly by the policy maker. This is partly the reason for the studies undertaken beginning in the late 1960s which eventually led to the reforms of the early 1980s. In fact, deregulation projects were headed more often by individuals from outside the telecommunications sector (jurists, economists or politicians). The policy makers' difficulty in obtaining technical information did not prevent them from perceiving clearly that the main explanation for the belated signs of instability in the telecommunications sector lay with the acceleration of technological change beginning in the 1970s. One of the effects of the specialization of telecommunications techniques and equipment has been to encourage a wider dissemination of information, and consequently to hasten the conclusion that supply is in part poorly adapted to its market. The effects of incomplete information are likely to be reduced, and knowledge about the specific results of reforms undertaken since 1982 in the USA, UK and Japan will broaden this long-term trend. Consequently, the most powerful representatives of demand will be likely to need much less support from the outside to strengthen their dissenting position. Generally, the regulated monopoly is confronted with powerful opponents with sophisticated needs, and such needs are less and less frequently met by the range of products available. Demand tends to move away from the least advantageous supply of services in terms of price levels and price distortions. In the short term such consumer decisions and resulting subtitutions among services do not dramatically threaten the monopoly's revenues. In the medium term, however, there is a real possibility that such consumers will turn into competing suppliers.l° They will eventually do so by reselling to third parties the unused capacity in their private networks, generated by services such as leased circuits, which have a very advantageous, decreasing, cost to performance ratio.

Building a defence on the supply side The relationship between the regulated monopoly of telecommunications services and its market has been shaped for several years by new forces, whose effects on DGT are capable of producing confusion. Indications of the confusion are set out below, followed by a review of the grounds on which the monopoly's defence strategy might be based.

September 1986

237

Telecommunications services in France

A new situation

The novelty of the situation in which the supply monopoly for telecommunications services finds itself forced to consider defensive strategies stems from two main elements. Telecommunications systems were built on the basis of captive demand, which, after a period of uncertainty at the beginning of the telephone era, seems generally to have been met in the most satisfactory way by the monopoly organization. It would be useful, however, to examine why in certain cases the demand was met according to expectations (USA, Sweden), whereas in other cases the development of telecommunications systems suffered very considerable delays (France, Spain). An examination of this differentiation might point out long-term biases in the regulators' decisions. But over the last 20 years, demand has become increasingly exigent. The monopoly is now aware that conditions are ripe for an exodus of its most valuable customers, or at least for a profound transformation of the monopoly's relationship to the market. On the other hand, in France, the monopoly is in the process of completing a re-equipment programme. The marketing of telecommunications services has been characterized over the last twenty years by a rationing of demand, as a direct and straightforward result of the insufficiency of the network infrastructure. The establishment of an efficient production capability was made possible by a policy aimed almost exclusively at increasing capacity. The next period will be one of a search for demand. The satisfaction of demand will not be as easy, production will grow at much lower rates, and result in reduced investment programmes. Despite the growing consciousness of a more hostile environment, all the decisions necessary for the redirection of the production effort have not yet been made. At this point, it is useful to refer to the recent history of the Bell System in the USA to measure the importance of a company redirecting its development strategy when required, and early enough to prevent any critical external reform. At first glance, the present French situation is very much the same as that of the Bell System in the late 1960s, when A T & T requested the consulting assistance of A. Toffier. A T & T then clearly needed a firm redirection of policy; in its absence, the situation eventually led to the divestiture process (which Toffier nearly suggested as a possible solution in his 1972 report to the company"). The Consent Decree of 1982 is another example of AT&T gaining some control of its foreseeable future over the policy maker.t2 S o m e hesitations

11This report was fortunately made available to the public in 1985 in A. Toffler, The Adaptive Corporation, McGraw-Hill, 1985. '2Evidence of the above is illustrated in C. Brown, 'AT&T and the Consent Decree', Telecommunications Policy, June 1983.

238

A monopoly is hesitant to state its strategy. D G T appears to be attracted by major, new equipment programmes, because it needs, at least internally, the same conditions for development which existed in the late 1970s. It is probable that the strong commitment in favour of broad-band cable network projects emanates from this policy. The same determination is demonstrated by major programmes with questionable economic justification, such as videotex development and active replacement of switching equipment. Recently, however, conflicts have arisen with the governmental controlling authority, concerning both development priorities and the allocation of profits. The new role of the D G T as a tool of public spending conflicts with its goal of meeting the needs of its market.

TELECOMMUNICATIONS POLICY September 1986

Telecommunications services in France

DGT's 1986 budget foresees expenditures of 15 billion French francs not directly related to DGT's role as a supplier of telecommunications services, an amount equal to roughly half of DGT's total capital spending. Such expenditures are equivalent to an income tax on DGT's revenues but are much higher than one would expect to pay under normal tax rules, and are highly unpredictable. In addition, DGT is facing difficulties in operating modern and fully adapted internal control mechanisms (and providing audited data on true costs, along with customer and management information), and in improving its ability to respond flexibly to the changing market. An important example of the far reaching efforts to introduce change in long established traditions is the reform of the sales force of DGT. Launched in the late 1970s, this ambitious project is still not fully operational, although many positive results have been achieved. Many examples could be given of the defensive behaviour of the monopoly and of hesitations over strategy issues. Two clear examples are the relatively late embracing of the concept of deregulation by management, and the introduction of competition in transatlantic telephone services roughly one year later than in some other major European telecommunications systems.

What strategy? It is no doubt easy to undertake a negative critical analysis of the problems faced by the single operating company. What is difficult is to state with any certainty what would be the monopoly's best strategy to defend its traditional position and to protect itself from growing competition. The following discussion focuses on the main options available to DGT, as a basis for opening a debate. Any practical recommendations can only come from a wider analysis. Following a period in which it was sufficient merely to count the number of new telephone connections each year, DGT will sooner or later be forced to redefine its objectives. The DGT may find that it must set priorities for each market segment, taking into account the differing levels of competition in each market. Furthermore, DGT must clarify its main role either as an operator of telecommunications services responsive to market forces, or as an instrument of macroeconomic regulation in large part determined by government policy. The definition of DGT's role will come from the policy maker; however, DGT needs to free itself in some measure from ideological and national policy considerations. Although the operation of DGT as a government administration does not make that task easy, providing clearer external means of ex post control might help the process. In addition, DGT is facing an increasingly important question: what are the regulated monopoly's means of defence? Attempts to answer this question immediately give an idea of the extent of the difficulties faced. The problem of pricing distortions may be solved by cancelling cross-subsidization. However no suitable reform project has been proposed, and recent opportunities to increase considerably the price of local communications and reduce that of long-distance communications have been missed. In light of the disagreement over this issue between DGT and P T r (which acts as the first level of government control), the hesitancy may be due to an overestimation by DGT of the political risk of attempting to buck the short-term objectives of the controlling

TELECOMMUNICATIONS POLICY September 1986

239

Telecommunications services in France

governmental authority. A political danger is also perceived in the possible reaction of the French public to telephone price reform. Another possibility would be to establish more generally barriers to entry. But this natural way for a monopoly to defend its position ~3 does not appear to be an obvious solution applicable to the telecommunications market. Protection against cream-skimming over high-density routes appears illusory, due to the very low marginal costs of production. Predatory pricing destined to protect DGT's position over the whole market can only be contemplated after correction of pricing distortions. Finally, non-price predatory behaviour does not seem to be attainable by the monopoly. Although an attempt could be made to modify product range and diversity, it has been shown that DGT deals defensively with this issue, perceiving the threat from potential competing suppliers and the powerful requirements of demand. A final possibility is to meet the least captive demand at every opportunity. However, once again the question arises whether DGT is able to discern rapidly enough the specific requirements of such demand and change and adapt flexibly. In the end, DGT may be certain about the ways of avoiding the harm of a profound deregulation of telecommunications. The organization must correct pricing distortions, satisfy the demand in all situations and, finally, react at every moment as quickly and as efficiently as its surrounding environment. Yet the question remains the same: how to get closer to these ambitious goals? It is clear that all the answers are not available.

The doubts of the policy maker

13A useful introduction to this general question is S. Globerman, 'Predatory pricing and foreclosure in telecommunications', Telecommunications Policy, December 1985. It leads to wider theoretical developments referred to in D. Encaoua, Rdglementation et concurrence. Quelques dlements de theorie economique, Direction de la Prevision, March 1986. ~4Development of this question and the present status of economic theories may be found in D. Encaoua, op cit, Ref 13.

240

It is appropriate here to clarify the concept of 'policy maker'. Ideally the policy maker is an abstract authority, lying within the realm of government, which ultimately echoes public recommendations regarding telecommunications. The policy maker is simultaneously the planner, the arbitrator, and the decision maker on various issues. Such a role includes some coordination and supervision of the controlling, regulating, legislative and jurisdictional authorities. The policy maker is not unified. The balance between the authorities involved may change with circumstances, and ambiguity is usually the rule. It is generally very rare to observe the existence of any long-term policy, and short-term preferences are most common. This situation is clear in France, in Germany, and in Japan, where the authority of the Minister of the Pq-'T is actually limited by other government departments. The case is even clearer in the USA, where one cannot unequivocally ascertain who is the final government authority, given the sharing of regulatory powers among so many governmental agencies and offices. Which aims f o r the policy maker?

For the policy maker, the telecommunications industry plays a primary role in the academic question of the interaction between the public and private sectors.~4 Apart from the advantages specific to a market and a technology which represent a large share of the current economic and industrial promise, the regulated supply of telecommunications services provides a preferred short-term mechanism for macroeconomic regulation. In France, since the beginning of the 1970s, use of the mechanism

TELECOMMUNICATIONS POLICY September 1986

Telecommunications services in France

has made it possible to respond positively and predictably to the objectives of the policy maker, often reaching beyond the communication sector. These objectives have been of considerable diversity. D G T has been asked, for example, to participate in countercyclical economic revival policy, gain national control over the telecommunications equipment industry, maintain a strong research centre, promote employment in the public sector, participate in price control, contribute in a tailor-made way to public spending, perform social redistribution, and borrow on foreign markets. Although these actions are very far from the primary business of DGT, they have generally not created unacceptable levels of tension between DGT and its controlling authority, except for the measures concerning the contribution to the budget, which were decided in 1983. It is no longer certain that it will continue to be as easy to use DGT for purposes other than the production of telecommunications services. Outside concern is growing against such a policy and, led by the most profitable and least captive demand, is jeopardizing DGT's position. Therefore any medium-term change in the position of the policy maker will depend on answers to several major questions: • •

What are the criteria for the policy-maker's decisions? How do telecommunications services contribute to the public interest? Is it appropriate to refer to the supply of these services as a 'public service'? Do the de facto advantages resulting from the use of DGT as a mechanism for macroeconomic regulation outweigh the obstacles to the expansion of telecommunications services and depressed demand, resulting from the higher prices caused by unrelated expenditure? More generally, can one refer to a normative choice of industrial structure or policy ~5 in such markets (level of concentration, integration of services and industry, etc)? Which segments of the market may be actually opened up to competition? How can authorized competitors and a dominant operating company be made to coexist? How does one deal with the political pressure which might come from foreign governments, ]6 exerted either directly and sometimes officially, or indirectly through such international bodies as OECD, GATI', ICC, EEC and CCITT?

15Comparing public policies for telecommunications in the UK, Germany and • France clearly shows the effects of political forces on the process of change. Extensive development of this point can be • found in K. Morgan and D. Webber, 'Divergent paths: political strategies for telecommunications in Britain, France and the Federal Republic of Germany', in K. Dyson, ed, The Politics of the Communication Revolution in Western Europe, Frank • Cass, forthcoming. leThis issue opens a very wide area for research, especially in understanding the process of deregulation diffusion. An uncommon approach to this question • appears in D. Schiller, 'L'espace, nouveau tremplin de la puissance americaine: comment perp~tuer la domination sur les t~le- • communications?', Le Monde Diplomatique, February 1985. Schiller is a professor • at Temple University in Philadelphia. ~TDevelopments are detailed in J.P. Coustel, 'L'evolution des structures dans les services de telecommunications. La France est-elle expos(~eau mouvement de d(~r~glementaUon?', Bulletin de I'IDA TE, In search of principles for regulation No 17, 1984; and in H. Ergas, 'Regulation, monopoly and competition in the telecom- Extensive discussion of the questions raised above is beyond the scope munications infrastructure', Special Session on Telecommunications Policy, of this article, ~7 and would require expertise and current academic OECD, 1985. Although proceeding from a research in modern economics theory. somewhat normative position, Ergas's reSuch open issues make it clear that industrial organization analysis is port discusses in detail the inefficiency of relevant to telecommunications deregulation, and that in no case can traditional regulation and gives the policy maker extensive guidance for regulatory public recommendations result from straightforward modelling alone. reforms. This conclusion arises not only from observing the aforementioned ~SThebasic works include S. C. Littlechild, Elements of Telecommunications Econo- weight of considerations of policy and market structure, but also from mics, Peter Peregrinus, 1979; L. Courville the inability of microeconomics properly to address all relevant issues. et al, eds, Economic Analysis of Telecom- For instance, evidence for or against the so called natural monopoly munications, North-Holland, 1983; and D. Evans, ed, Breaking up Bell, North- situation is unavailable, although a great deal of econometric and modelling work of high quality has been do.ne. ~8 Holland, 1983.

TELECOMMUNICATIONS POLICY September 1986

241

Telecommunications services in France

19Dramatic evidence is presented in N. Cornell and D. Webbink, 'The present direction of the FCC: an appraisal', American Economic Review, Vol 73, No 2, 1984. The authors give convincing examples of the FCC being biased against competition in TV frequency allotment, cellular radiocommunications licensing, and AM radio extensions. The up-to-date status of the discrepancies between FCC and Congressional policy is outlined in H. Geller, 'Telecommunications policy today: against technology', Issues on Science and Technology, US National Academy of Sciences, Vol 2, No 2, 1986. 2°'l'he deregulation of telecommunications in the UK supports this statement. The public announcement of the sale of British Telecom said: 'It [the government] does not intend to use its rights as an ordinary shareholder to intervene in the commercial decisions of BT and does not expect to vote its shareholding on resolutions at general meetings, although it retains the power to do so.'

242

Reference to the US situation is useful for characterizing the determination of the policy maker. It especially demonstrates the effects of lack of unity in the policy maker's position, often viewed as inconsistencies. The trouble over defining value-added services is one example. The attempt to clarify the boundaries between basic and value-added services, and thus between regulated supply and free competition in telecommunications services, has demonstrated both the short-term danger of creating bias in the market structure, and (as can be seen from other foreign experiences) the abuses when the dominant operating company seeks to protect its monopoly position by developing artificial concepts. Moreover, the recent history of regulation is rich with events which demonstrate that the regulatory authorities embrace sometimes policies other than the mere search for fair competition. 19 Wider reference to US, UK, and Japanese projects for reform illustrates the various motives of the policy maker. The three basic motivations for telecommunications regulation in these three countries can briefly be described as legalistic (USA), political (UK) and economic (Japan). However, whatever the national policy, the government remains an active (on a daily basis) and powerful regulator. 2° It seems that the involvement of the government in the supply of telecommunications services can be taken for granted at least over the medium term. In the end, the elements described herein as proof of the poor adaptation between supply and demand have at the present only a limited impact on the output of the French telecommunications system. An alternate way for the policy maker to tackle the question of adapting the supply of telecommunications services to its market, while meeting its short-term commitments, should therefore be considered. Rather than dogmatically building up a new model for controlling the supply, why not keep the dominant operating company under the constant threat of competition and the consequent diminution of its market position, and encourage the medium-term effects on creativity caused by the present instabilities? But, whatever the national economic policy adopted, there are surely other strong incentives for maintaining the present monopoly and an intermixing of DGT and government administration. With yearly unrelated public spending of more than 15 billion French francs, DGT is at the moment supplying about 1.5% of state revenues. Unquestionably this situation causes inertia and acts powerfully against any move towards deregulation, especially when the government may contemplate income tax reductions. Ultimately, the commitment of DGT to macroeconomic regulation demonstrates the extent of outside constraints, and the resulting lack of any satisfying pattern of organization for the medium-term development of the telecommunications system.

Conclusion On the whole the interplay of the three main protagonists appears to be very complex. The parties on the defensive, in particular the monopoly but also to some extent the policy maker, do not appear to possess any economical means to prevent the profound transformations which are imminent in the French telecommunications system. The concerns which focused on microeconomic analysis, and fuelled some ten years of public discussion in the USA, seem in the end rather

TELECOMMUNICATIONS

POLICY

September

1986

deregulalm of telecommunications in the US* is discus& withSOmenovelty in P. Drucker. ‘Beyondthe Bell breakup’, The Public Interest, No 77, 1995, where this positionis developed. “The

TELECOMMUNICATIONS

POLICY

artificial. Technological and economic logic do not appear to be the motives for maintaining or breaking the supply monopoly. In fact, the whole day-to-day decision process of the policy maker accords little importance to justifications such as the achievement of economies of scale, increasing returns to scale, or economies of scope. As pointed out by P. Drucker, *’ the appropriate question is whether an alternative exists to the supply monopoly for efficient nationwide telecommunications services. Should no alternative exist, then is the determined action of the government against- the monopoly, through legislation to ensure fair competition, caused rather by the whims of ‘antitrust cynics’ who see this kind of attack (such as the break up of AT&T or the denationalization of British Telecom) as an efficient way to stir up the sleeping giants? The sleeping giants that AT&T and British Telecom used to be have reacted somewhat violently to the resolve of the regulatory authorities. Everything seems to confirm the existence of all the conditions for a return to a monopoly less regulated by the government. But in the event competition should weaken too much, should not new action be contemplated by the regulatory authorities against the monopoly, to ‘reregulate’ or reduce its power? This process would then lead to a series of cycles of regulation, repeating with each new technological generation. The situation in France is still a long way from this prospect. Thus, before embarking on new developments, it is essential to go back to the question which stands out as a conclusion: fully aware of the hesitations of the parties on the defensive, will the most powerful representatives of demand exploit their present strength over the short term?

September 1986

243