The Finnish telecommunications market

¹elecommunications Policy, Vol. 22, No. 9, pp. 757—773, 1998 ( 1998 Elsevier Science Ltd. All rights reserved Printed in Great Britain 0308-5961/98 $19.00#0.00

PII: S0308-5961(98)00054-8

The Finnish telecommunications market Advantage of local access incumbency

P M Nattermann and D D Murphy The introduction of long distance and local competition in the sophisticated Finnish market in 1994 has resulted in unparalleled growth of the Finnet group of companies. Finnet is the incumbent in local markets and the entrant in the long distance market. The former long distance monopolist, Telecom Finland, has gained little market share in local markets. Finnet’s success was due to its hold on the local access bottleneck, the initial lack of number portability when switching carriers and its right to refuse resale of its access lines to Telecom Finland (both until June 1997). The Finnish case illustrates the importance of ownership of the local loop, even in the face of numerous independent local-only operators. Q 1998 Elsevier Science Ltd. All rights reserved. Philipp M. Nattermann is with the Economics Department, Georgetown University, 37 th & O Street, NW, Washington, DC 20057, USA. Tel: #1 202 338 7709; fax: #1 202 338 6041 Dale D Murphy is with the Chaols of reign Service & Business, Georgetown University, 37th & O Street, NW, Washington, DC 20057, USA. Tel: #1 202 687 7082; fax: #1 202 687 6033. 1 Blackman, C. Caves, M. and David, P., The new international telecommunications environment. Telecommunications Policy, 1996, 20 (10), 721–724. continued on page 758

In accordance with 1997 WTO agreements and the binding EU White Papers on Telecommunications Liberalization of 1994 and 1995, most European nations have opened their telecommunications markets to varying degrees of competition. For these countries, introducing competition implied allowing new operators to enter the market. These developments have been discussed in detail by Blackman et al.,1 Drake and Noam,2 and Sterling,3 who examined the prospects for deregulation in the EU.4 So far, only a handful of countries have gained sufficient experiences in liberalizing their telecommunications markets to predict how fast entrants will gain sizeable market shares. The highly sophisticated Finnish telecommunications market, providing a home base to companies such as Nokia, is a market in which the main entrant, the Finnet group of companies (Finnet Group), was able to corner approximately 50 per cent of the long-distance market within days. However, the companies comprising Finnet, which were the local access monopolists, have been able to largely retain their former monopolies in most local access markets, causing the Finnish experience to be a warning to regulators worldwide. This paper examines the asymmetric growth of entrants in the Finnish long-distance and local exchange markets. We show that the rapid acquisition of market share by the entrant in the long-distance market, the Finnet Group, was due to its continued monopoly in the local access market, combined with an initial lack of regulations enforcing resale of its fixed wireline local access network to its competitors. Although the topic of the paper is the Finnish telecommunications market, the lessons are applicable elsewhere, particularly the U.S. market. In particular, the Finish experience illustrates the possibility of monopoly leveraging by the local access owners in a reintegrated telecommunications environment, due to customer preferences for combined service provision of local and

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long-distance services by a single firm.5 This view of the Finnish experience holds despite the fact that in the Finnish market, cellular and wireline telecommunications services are, for all practical purposes, one market, since seven percent of all Finnish households have only cellular telephones,6 and Finland has a cellular penetration rate in excess of 40 per cent. This has resulted in 35 per cent of all telephone connections to be mobile in the Finnish market in 1996. However, according to the French telecommunications regulatory agency, even in Finland the markup of wireless prices over fixed wireline services has been approximately 100 percent between 1994 and 1997, causing wireless service to be only a limited substitute for wireline services.7 Many of the shortcomings of the original legislation that introduced competition in the Finnish market might have been costly for both consumers and entrants, despite the low overall tariff levels in the Finnish market. In addition, questions concerning interconnection and resale agreements transcend the telecommunications sector and are, with slight modifications, applicable to all network industries, such as electricity distributions. Thus, the Finnish telecommunications market (and therefore this paper) offers a valuable lesson for regulators, competitors and customers in network industries as to the most important rules of introducing effective competition.

The Finnish market The Finnish domestic telecommunications market was opened to full competition on 1 January 1994, while the international sector followed on 1 July 1994. Until that point the telecommunications market had been divided into two areas of operation: local services in urban southern areas on the one hand and long distance as well as local service in rural areas on the other. The reasons for and history of this separation will be examined in the next section. Historical developments continued from page 757 2 Drake, W. and Noam, E., The WTO deal on basic telecommunications: big bang or little whimper? Telecommunications Policy, 1997, 21 (9), 799–819. 3 Sterling, C., Assessing European policies in transition. Telecommunications Policy, 1996, 20(8), 633–365. 4 For a comprehensive treatment of international regulation of multinational telecommunications carriers see Noam, E. and Singhal, A., Supra-national regulation for Supra-national Telecommunications Carriers? Telecommunications Policy, 1996, 20 (10), 769–788. 5 See Beard, T., Kaserman, D. and Mayo, J., Monopoly leveraging, Path dependence, and the case for a local competition threshold for RBOC Entry into Interlata Toll. In Regulation Under Increasing Competition, ed. M. Crew. Kluwer Academic Publishers, Dordecht 1998. 6 Source: Finnish Bureau of Statistics, Helsinki, 1997. 7 Source: Internet page of the L’Autorite de Regulation des Telecommunication.

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Until the Telecommunications Act of 1987 (and its amendments of 1988, 1990 and 1992) the Finish market was characterized by statutory monopoly rights of numerous local operators that were run as cooperatives owned by their respective customers. The aim of these local operators was not to maximize profits but rather to minimize prices in accordance with customers’ (who were also the shareholders) interests. The practice of minimizing overall prices might, however, have resulted in cross-subsidization in small cities and rural areas, and thus have raised prices for certain customers. The long distance market (i.e. the trunk network) and local access services in the less-densely populated regions of northern Finland were the statutory monopoly of the governmental Administration of Posts and Telegraphs (P&T). In 1990 the P&T was transformed from a state agency that offered telecommunications services into an independent business enterprise and has remained a fully state-owned enterprise to this day. In the first half of the century, the majority of telephone services were provided by small local operators, which numbered 815 in the 1930s. However, due to the small market size and inability to construct a uniform nationwide network, most of these firms failed or were purchased by P&T, which was able to gain a dominant position in the trunk line sector by 1935. Until that point there had been several carriers competing directly

The Finnish telecommunications market: P M Nattermann and D D Murphy

Figure 1. Finnish telecommunications market volume (1995).

with P&T in the long-distance market. In order to resist the expansion of P&T and threats of nationalization of the national telecom networks the local companies had founded the Association of Telephone Companies in 1921. This association actively lobbied against further expansion of P&T’s network and was able to prevent planned nationalization of the networks in both 1931 and 1948. Despite these efforts, by 1965 the number of cooperatives had fallen to only 88. By 1994 this number had again roughly halved. This trend of consolidation and mergers is expected to continue for the foreseeable future.8 One of the survival strategies of the cooperatives was the early implementation of new technologies and furthering their development. By 1965, for example, 98 per cent of the private cooperatives’ networks were automated, while it took the state owned operator until 1981 to fully automate its network. The path to complete deregulation

8

Ministry of Transport and Communications, The Effects of Competition on Employment in the Telecommunications Industry. Case Finland, 1995. 9 For the costs of delaying deregulation in telecommunications markets see Baer, W., Telecommunications infrastructure competition: the cost delay. Telecommunications Policy, 1995, 19 (5), 351–364. 10 For different models of liberalization of telecommunications markets formerly solely supplied by a governmental carrier see Gillick, D., Telecommunications policies and regulatory structure: new issues and trends. Telecommunications Policy, 1992, 16 (9), 726–732. 11 Kohtala Antti from the Finish Ministry of Transport and Communications, 17 April 1997.

Due to the introduction of new services, some of the private operators, in cooperation with major Finnish companies, set up Datatie Ltd., a data transmission service, and in 1985 were granted the first new operating license since the 1920s. With this network the private operators stood, for the first time, in direct competition to P&T in at least one sector of the market. Given the increasing demand for new services, it became obvious that the Imperial Telephone Decree of 1886, which still governed the Finish telecommunications sector, was utterly out of date.9 Therefore, in 1987, the new Telecommunications Act was passed, which for the first time separated the administrative and operational activities of the P&T. The regulatory powers were transferred to the Ministry of Transport and Communications under which a new regulatory body, the Telecommunications Administration Centre, was established in 1988. At the same time, parts of the business customers’ telecommunications services and the data transmission sectors were liberalized. In 1990 then P&T was transformed into an independent state-owned enterprise (ISOE) and founded Yritysverkot (Business Network) Ltd. to exclusively provide telco services to large corporate customers. By changing the operating status of P&T to an ISOE, P&T was for the first time no longer part of the Finnish government budget.10 During the monopoly period, the government had repeatedly raised long-distance rates to raise government revenues, which went so far that: ‘‘[The] Government accepted all customer prices of P&T. Actually, many times it happened that if the state needed more money, one good way was to set long distance tariffs a little bit higher.’’11

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With its new status P&T was freed from having to act as government revenue generating entity and could act as a profit-maximizing (yet still state-owned) corporation. Also, with the transformation its right to supply telecommunications services was no longer written in law but due to licenses granted. In this respect, P&T slowly moved towards the operating status of the privately owned operators. As a last step before total liberalization of the market, all business telecommunications services were liberalized in 1991, while previously only data transmission and facsimile services had been provided competitively. In 1992 the last legislative step towards full liberalization was undertaken by the decision of the Ministry to free all forms of national telecommunications services as of 1 January 1994, through the Telecommunications Act of 1992. In preparation for the total liberalization of the market, the two activities of P&T, postal services and telecommunications services, were separated in 1994 and organized under the PT Finland holding. Its subsidiary, Telecom Finland Ltd. (TF), became a stock-holding company fully owned by the government.12 The private operators on the other hand joined forces to found the Finnet group of companies, or Finnet Group, consisting of the remaining 46 independent private telephone companies. While originally formed for the creation of Datatie Ltd., the Finnet Group now also offers mobile telecommunications services through its subsidiary Radiolinja Ltd. The Finnet Group’s domestic and international longdistance services are provided through its subsidiaries Kaukoverkko Ysi Ltd., and Finnet International Ltd., respectively. Developments since deregulation

12

For problems, such as regulatory capture, associated with liberalizing markets formerly supplied by a governmental or government licensed firm, see Melody, W., On the meaning and Importance of Independence in Telecom Reform, Telecommunications Policy, 1997, 21 (3), 195–200.

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After the opening of both the local and the domestic long-distance markets on 1 January 1994 the Finnet Group (FG) experienced an unprecedented growth of market share, and was able to gain roughly 50 per cent of the long distance market share based on revenue within a week. At the end of 1995 the group’s long distance market share stood at approximately 56 percent, and had slightly decreased to 51 per cent by the end of 1997. The explosive growth of FG’s long-distance market share in the first week of competition was partly due to vague governmental pressure on TF to allow the entrant to quickly gain a foothold in the long-distance market. In addition, FG was able to directly target customers via the local cooperatives, which had the advantage of being owned by the customers and therefore had close customer relations. Subscribers were able to preselect FG as their LD carrier by simply checking a box on their local phone bill, were actively targeted by direct mail and through courtesy calls. In the urban local markets the roles between Telecom Finland (TF) and the Finnet Group were reversed, but the results of opening the market were very different. Here TF was the entrant in the more densely populated southern region, while the Finnet Group was the incumbent. Prior to January 1994 the Finnet Group had held 73 per cent of all local customers, with Telecom Finland providing local access to the remaining 27 per cent of the population distributed over the rural northern two-thirds of the country. At the end of 1996 TF had only been able to gain a 2.8 per cent market share in the fixed wireline local access sector previously served by local cooperatives. However, Sonara Ltd., the successor to Telecom Finland Ltd., holds a 71 per cent market share in the mobile telecommunications market via its NMT 450, NMT 900, GSM 900 and GSM 1800 operations. Given the high percentage of mobile phones used as fixed line

The Finnish telecommunications market: P M Nattermann and D D Murphy

substitutes in the Finnish market, the actual local access market share of Sonara Ltd., or Telecom Finland, in the former monopoly areas of the local cooperatives is undoubtedly higher by three percent. However, as pointed out before, the fact that the markup of cellular prices over those of fixed wireline services has continued to be approximately 100 per cent in the Finnish market make cellular services only imperfect substitutes of wireline access. Among the some 70 telecommunications operators active in Finland today13 there are also several completely new entrants, foremost among them is Telia, formerly known as Telivo, when it was a subsidiary of the electric utilities holding company Imatran Voima Ltd. (IVO), and now part of Telia of Sweden. It started operations in mid-1993 in the data transmission sector and commenced full operations in January 1994. Before 1994 IVO already had a fiber optic trunk line network in place along its power grid that had been used for internal communications. Telivo’s main operations are therefore in the data and long-distance voice transmission sector. With a market share of roughly 25 per cent in the data transmission and international Internet traffic market cornered, Telivo is third to the Finnet Group (36%) and TF (32%) in this sector. In the long distance sector it was able to capture a 4.6 per cent market share by the end of 1996. Unlike its main competitors, Telivo started operations without its own voice transmission customers and without any local access lines. This has clearly hampered Telivo’s growth in the local access market, which is illustrated by its meager 0.09 per cent market share in this market at the end of 1996. Telivo’s growth rate is substantially lower than the OECD average for entrants in the telecommunications market.14 The large divergence in the increase in market share in the liberalized telecommunications sector between the success of the Finnet Group on the one hand and Telivo as well as Telecom Finland on the other, raise the question of the cause for Finnet’s phenomenal success. This question will be addressed in the next section.

Developments

13

The 70 operators consist of the 48 Finnet members, Finnet’s nationwide operating subsidiaries, Telecom Finland and its subsidiaries and a handful of new entrants. 14 See OECD, Local telecommunication competition: development and policy issues, OCDEıGD (96) 179, 1996. 15 Bundesministerium fuer Wirtschaft, Info 2000: Deutschlands Weg in die Informationsgesellschaft, 1996, Bonn, Germany.

Within a week of the liberalization of the domestic long distance and local market segments the Finnet Group had gained a 50 per cent market share in the long-distance market. Telecom Finland, on the other hand, has only been able to gain marginal market share in the local access market, while Telivo has so far largely remained a niche player. In this section we detail the developments in the local, long-distance and international market segments. In the local market the Finnet Group is the incumbent with its 46 former regional monopolies. These cooperatives had more than a century to build up a dense local network effectively connecting each household to the network. The high density of the Finnish local networks is illustrated by the fact that there are 55 access lines per 100 inhabitants, compared to 46 in Germany, 58 in the US and 48 in Japan.15 Secondly, although the Finnet Group holds an unlimited license enabling it to operate throughout the countries, cooperatives themselves have so far not entered the markets of each other. This illustrates the collusive conduct of the cooperatives in the local market due to cross-ownership of their subsidiaries.

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The Finnish telecommunications market: P M Nattermann and D D Murphy

Figure shares.

2. Local

access

market

Local markets The entrants into the cooperatives’ local markets in the southern third of the country were Telecom Finland and Telivo. TF’s former local monopolies in the rural northern two-thirds of the country have not attracted much attention from other operators due to the low population density in these regions. Therefore, the local access markets in which competition is expected to take place are the former monopoly regions of the cooperatives. However, compared to the 27 per cent market share of TF before 1994, the current market share of roughly 30 per cent indicates that entry into the local markets has been slow at best, with Telia’s entry having been even slower (see Figure 2). Most (if not all) of Telecom Finland’s and Telivo’s market share gains in the local access market have been in the business customer sector. Telivo’s growth in this sector is largely due to its data transmission network with which it originally commenced operations. Since Telivo did not need to construct a new trunk line system it has been able to offer competitive tariffs for long distance operations. In the local market however, Telivo is virtually absent. The cooperatives have therefore so far been able to stabilize their local market share and keep their virtual monopoly in this sector. The development in the local sector is therefore very much in line with the experiences in other fully deregulated countries. Domestic long distance In the long-distance market the Finnet Group and Telivo were the entrants. Here, the incumbent TF was unable to prevent rapid erosion of its market share with 50 per cent of it having been lost within the first week of competition. The main benefactor of this development was the Finnet Group, while Telivo has only gained a small percentage of the business user voice transmission market (see Figure 3). International long distance In the international long-distance markets, until 1 July 1994 exclusively served by Telecom Finland, the change in market shares developed

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Figure 3. National long-distance market shares.

substantially slower than in the domestic long-distance market. By the end of 1996 the Finnet Group, through its affiliate Finnet International Ltd., had gained a 22.7 per cent market share in terms of revenue, up from 18.5 percent in 1995. At the same time, total outgoing international traffic rose by almost 70 per cent to 365 million minutes between 1993 and 1997.

New regulatory environment The opening of the Finish telecommunications market was not accompanied by the removal of all regulatory rules. Under the new regulatory framework that was gradually implemented following the Telecommunications Act of 1987 and its amendments, two main points govern the market: resale agreements and interconnection rules. We will discuss and evaluate these points in turn. Resale

16

For a treatment of access and access control, see Mansell, R., Davis, A. and Hulsink, W., Strategies for maintaining market power in the face of rapidly changing technologies. Journal of Economic Issues 1997, 34 (4), 969–990.

The resale rules set forth in the Telecommunications Act demonstrate the regulatory authority’s desire to foster facility-based competition. The operators were not obliged to provide leased lines to other operators that hold a license for self-provision for the same kind of network (i.e. fixed wireline). However, entrants can also apply for licenses that do not include self-provision clauses. These operators then are entitled to lease lines from the networks of other operators and act as resellers or ‘phone companies without a network’. The ability of a self-provision operator to refuse resale of its network capacity was of greatest significance in the local access market.16 The three largest self-provision operators, Finnet, TF and Telivo, have a nationwide trunk line network in place and would not desire to lease such lines from one another. However, only the Finnet Group has a widespread local access network in place through its member cooperatives in the urban southern parts of Finland. As of June 1997, however, all operators are obliged to lease their local access lines to all full license carriers. The regulatory agency had determined that the ability of the cooperatives to refuse resale of their subscriber lines was one of the main reasons for the slow development of full-blown competition in the local access market. The ruling has drastically reduced the cost for entrants in the local markets to acquire

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Figure 4. International long-distance market share.

customers since instead of building a local access network, now only an existing local access line has to be leased. However, even the remodeled resale requirement of 1997 has so far not been sufficient to break open the stronghold of the cooperatives over the urban local markets. Interconnection and carrier selection While the Finnet Group, as any other (local) network, could, until June 1997, refuse access of its network to other operators, customers had since 1994 been able to access any operator through their access line. For this all operators are required to provide full network interconnection. Any longdistance call is routed through the local company’s network to the next switch at which point the selected long-distance carrier continues the call. The distinct characteristic of the Finnish system is that the cost of the local access call as part of a long-distance call is billed directly to the customer by its local cooperative. This removes any financial interaction between the local network operator and the selected long-distance carrier. The Telecommunications Act also regulates the permissible price range for routing a call to the long-distance carrier’s switch. The access fee may be no more than the price of a local call and must be at least half of it. Furthermore, the same access price has to be charged for reaching all operators’ long-distance networks. The rationale for billing the access charges separately is twofold. First, it avoids claims of subsidization by the long-distance carrier against the local access bottleneck owner. The long-distance carrier is no longer directly effected by the tariff charged by the bottleneck owner and any rate changes are passed on directly to the consumer. Secondly, since consumers get billed explicitly for the access call by their cooperative, their incentive to press for lower access fees increases dramatically. Given that customers own the cooperatives it is highly likely that they will successfully press for lower access fees to the long distance carrier. The upper and lower bound for the price of interconnection have also been chosen with the intent to foster competition. By setting the lower limit equal to half the cost of a local call the access price covers at least its incremental cost. Consider the cost of a completed local call. The call has to be channeled from consumer A to the switch of the local network and from there to consumer B. An access call on the other hand only has to be channeled from the consumer to the local switch from which point on the selected long-distance carrier carries the call. Therefore, the local carrier incurs only half the cost of a local call. The upper limit of the access call

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charge ensures that local access providers cannot leverage their bottleneck position to incur monopoly profits on long-distance connections. These interconnection rules illustrate the Ministry’s aim to implement equal and cost-based access prices. Universal service

17

Vogelsang, J, Kosten des Ortsnetzes, VTM, 1996. For a more detailed discussion of universal service provision and cross subsidies, see Nattermann, P., Telecommunications reform in Germany: the Rocky Road towards competition. PolisConsulting Working Paper, 1997, pp. 97–103. 19 For a comprehensive treatment of universal service reforms and its welfare effects, see Mueller, M., Telecommunications access in the age of electronic commerce: towards a third-generation Universal Service Policy. Federal Communications Law Journal, 1997, 49 (3), 655–673, (1997); or Tyler, M., Letwin, W. and Roe, C., Universal service and innovation in Telecommunications Services: fostering linked goals through regulatory policy. Telecommunications Policy, 1995, 19 (1), 3–21. 18

One of the most contested issues of deregulation in telecommunications markets is the political will to ensure universal service provision. Universal service mandates that every household is offered basic telecommunications access at reasonable rates. The two main groups targeted to receive universal services are low-income groups and consumers living in scarcely populated rural areas. In most countries, universal service is implemented by subsidizing local access and subscription services through excessive long-distance charges, resulting in local access charges that are not cost based but rather uniform across heterogeneous population densities. As shown by Vogelsang17 for selected US and British markets, it is less cost-intensive to provide local access in densely populated urban than in scarcely populated rural areas since the distance between customer premises and the local switch will be larger in rural areas. Vogelsang’s data yields a simple Pearson correlation coefficient between monthly costs per access line and average population density of !0.559, illustrating the relation between population density and wireline connection costs. Such subsidies involve inefficiencies since all rural customers will be subsidized regardless of their income and the costs incurred by the service provider.18 These subsidies will burden urban customers and cause distortions in consumers’ consumption decisions.19 The Finnish regulatory authority decided not to engage in such distortive practices. Given the vast landmass of Finland and the low population density in the northern part of the country, homogeneous pricing of local access would have placed an unduly high burden on urban customers. Therefore, the Telecommunications Act states that operators are not required to serve all customers at the same price not related to costs. This implies that only as long as costs for providing services to two customers are identical, prices have to equal as well. If on the other hand fundamentally different costs are incurred (e.g. local call in downtown Helsinki or in the northernmost region of Finland) then prices are to reflect these differences in costs. Despite heterogeneous pricing of telecommunications services and the absence of direct cross subsidies, lower income groups are not excluded from telecommunications services. The method employed in Finland to ensure universal access to telecommunications services is direct assistance to the customers in question from the Ministry of Social Affairs. This approach entails using tax revenues to directly support bill payments of citizens meeting support eligibility requirements, based on the recipients’ income. Such financing of universal service causes the least amount of distortions on the collection side and also funnels funds only to truly needy consumers.

Reasons for the developments While competition in the Finnish long-distance sector has been remarkable in the last years, competition in the local access sector still falls short

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of the goal of affective competition. As of 31 December 1996 Telecom Finland only had acquired 55 802 local access lines in the regions formerly supplied by Finnet Group members.20 This implies that for a market consisting of approximately 73 per cent of all customers, the Finnet members still hold a 97.2 per cent market share. The gain of 2.8 per cent market share for the entrant in the southern local markets, Telecom Finland, after three years of competition falls well below the benchmark of many other liberalized nations, notably Chile, New Zealand and even the UK. The divergence of developments in the local and long-distance markets is even more surprising if one considers that the incumbent long-distance operator had offered reliable local access service to 27 per cent of the population for several decades before 1994 and thus had considerable experience in this sector. This raises the questions of the origin for the different growth of market shares for the respective entrants. A possible explanation for these developments is the fact that the Finnet Group is distinct from other telecommunication firms through two characteristics: it consists of customer-owned cooperatives and it had a dense local network in place. Local cooperatives

20

Ministry of Transportation and Communications: Telecommunications Statistics 1996. 21 The 5-year bond market rate has been 9.7 per cent between 1991 and 1997.

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The cooperative nature of the local operators, and therefore of the Finnet Group, has always functioned as a price regulation mechanism for its services. Due to the limited area of coverage of any given cooperative, consumers were able to compare prices between their cooperative and others. Since the consumers were also shareholders of the company they were able to vote for lower prices if the own cooperative’s tariffs moved significantly above those of the surrounding operators. It is therefore unlikely that the cooperatives were able to undertake vast investments during their monopoly period in preparation of their entry in the longdistance market. The implicit price caps (enforced by the shareholders) therefore suggest that the cooperatives were not explicitly predestined to rapidly grow in the long distance sector. One of the great particularities of the Finnish fixed wireline telecommunications market has been the cooperative ownership of most local telecommunications companies. Most of these companies were owned by their customers while a small number were entirely municipally owned. We will first examine the ownership structure of these cooperatives and then test for tying abilities of the cooperatives. Until recently each customer was able to purchase a share in the cooperative for each subscription line purchased from the cooperative. The average price range for these shares was 4000—6000 FIM (approximately US $ 800 to 1200), depending on the cooperative that issued them. These shares not only gave the customer partial ownership of ‘his or her’ company but also reduced the customers monthly phone bill by a flat rate of 50 FIM per month. The return provided by the cooperatives’ shares (10—15 per cent annually) has been equal to market rates21 and in some cases even above market level. This is noteworthy since it runs contrary to most cooperatives, which generate returns substantially below market levels. However, the cooperatives’ shares did have one major drawback, they could not be returned to the cooperative without total loss of the initial investment. Due to the buy-back refusal of the cooperatives a private market for these shares developed. Consumers could buy and sell shares of their respective cooperatives in these markets, but were still

The Finnish telecommunications market: P M Nattermann and D D Murphy

22

Huther, J., Evidence of Baumol’s cost disease in OECD countries. Ph.D. Dissertation, Georgetown University, 1997.

limited to the 50 FIM per month per subscriber line and share income. Therefore, a consumer could not increase his income from the shares by purchasing more than one share as long as he only had one subscriber line. The practice of issuing company bound annuities combined with above market rate return on these investments made the stocks a formidable tool for the cooperatives to tie customers to their networks. Furthermore, as shown by Huther,22 productivity in the telecommunications sector has been higher in all OECD countries than for general manufacturing, a commonly used benchmark industry. Since prices did not fall for the Finnet Group’s services, despite the growth in productivity, the group was able to distribute the gains from productivity increases in the form of above market level returns. The practice of distributing productivity gains (or profits) through annuities rather than reduced prices holds two advantages for the cooperatives. First, by reducing list prices, cooperatives would have run the danger of initiating price wars in which its profits could actually decrease compared to the annuity case. Secondly, due to the similar pricing structure of TF and the Finnet group of companies, the only way for a customer to lower her monthly charges is to become a member in the cooperative. As shown above, this will tie customers to the network, unless they were willing to incur substantial switching costs, and therefore functions as the ultimate loyal customers reward program. While local cooperatives no longer issue new shares due to ongoing restructuring, the large number of existing stocks still ties current customers to the cooperatives. Particularly under the currently low long-term market interest rates of only 6 per cent for 5 year notes, the 50 FIM monthly income provided by the cooperatives is certainly a sound investment. Combined with the almost identical tariffs charged by the Finnet Group’s members and Telecom Finland switching from the cooperatives to TF will only be profitable for a small group of consumers. The tying of the consumers to their original local operator combined with the right to refuse leasing of lines to competitors has most likely slowed Telecom Finland’s move into the local access market. This has caused the degree of competition in the market to be less than would have been possible otherwise. While a basket price comparison of local telephone service charges among EU member states as published by the Finnish Ministry of Transportation and Communication indicates that the charges in Finland are the second lowest behind Luxembourg, service charges and quality could have been improved if multiparty competition had been stronger. The local telecommunications companies are still, more than three years after the introduction of full-scale competition, virtual monopolies in the fixed wireline local markets of southern Finland while having taken a market-dominating position in the long-distance sector. The next question therefore has to be if these developments are due to superior service (better quality or lower prices) by the local telecommunications companies or for other reasons. However, the cooperative nature of the local networks also tied their customers’ to its long-distance operations. Being shareholders in the cooperatives, and therefore in Finnet, the customers had a vested interest in seeing the Finnet Group succeed in the long-distance market. This greatly raised the customers’ incentives to switch their long-distance services to the Finnet Group. The incumbent long-distance monopolist on the other hand was (and still is) a state-owned stock-holding company. It therefore was unable to tie customers to its services. In addition to

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increasing their cooperative’s revenue there was a second reason for its shareholders to switch their long-distance services to Finnet. Given the ownership of the local bottleneck by the cooperatives, these were able to offer one-stop service since the same operator would provide long distance and local services. Due to the limited size of Telecom Finland’s local access network this did not hold for the long-distance incumbent. The unparalleled cooperative nature of the Finnet Group therefore appears to be among the foremost reasons for the Finnet Group’s phenomenal success. Network issues Given the huge costs of building a second local access network any entrant will be reluctant to engage in large-scale construction of such a network if required to rely on infrastructure competition. This would clearly hamper competition particularly for low-volume private consumers since the revenue generated by a private customer access line would recover the fixed costs of construction of a second access network only over a prolonged period of time. The Finnish Telecommunications Act of 1987 did not require operators to lease their networks (or parts thereof ) to other operators licensed to construct their own networks. The only leasing requirements were towards so-called service providers, i.e. telecommunications companies without their own network, or resellers. Telecom Finland does hold a comprehensive license, which allows it to construct its own networks throughout the country. Therefore, the local telecommunications companies were not required to lease their access lines to Telecom Finland. This in turn required TF to construct its own local access networks in the more densely populated southern parts of Finland. The tremendously high costs of such a network explain why the 55 802 new local customers of TF have largely been high-volume business customers. Number portability One of the most important features effecting customers’ willingness to switch carriers is the ability to keep the same telephone number regardless of the carrier chosen. If switching telecommunications carriers requires customers to change their number, this obviously reduces the willingness of customers to leave their current carrier. Changing one’s phone number implies that consumers have to incur substantial switching costs associated with receiving a new number, such as changing stationary, informing business partners, families, and friends. These costs also incur when customers use cellular telecommunication services as their primary or even only telephone system. While cellular telephones allow for number portability when consumers physically relocate, they do not allow the consumer to keep her phone number when switching carriers. The same also holds true for personal 800 numbers, which again are location independent, but still carrier-specific. In Finland, number portability was only introduced with the Telecommunications Market Act on 1 June 1997. Until then customers were required to change their phone number each time they switched carriers. As stated above, the switching costs associated with changing ones number requires substantially lower tariffs of the new provider. As shown below, prices between Telecom Finland and the Finnet group of companies were largely identical. In addition to the switching costs associated with lacking number portability, switching from a cooperative to TF also

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Figure 5. Long-distance calling costs.

included the sale of the customer’s share in the cooperative, as shown above. Therefore, Finnish customers had to incur substantial switching costs to leave their cooperative and select Telecom Finland or Telivo as their carrier. These switching costs further help to explain the continued dominance of the Finnet Group’s cooperatives in the local markets. Tariff and quality issues Accurate measures of quality in the telecommunications sector are inherently difficult to define. However, all Finnish telecommunications networks have been completely digitized since mid-1996. Secondly, given the active competition in the long-distance sector, services along the trunk line can reasonable be assumed to be of equal quality for all operators. Thirdly, all new local access customers of TF have so far been connected via newly built access lines. This indicates that Telecom Finland’s access lines are at least up to par if not superior to the local telecommunications companies’ standards. Despite the above-voiced caution, it seems therefore safe to claim equal quality of service provision by Telecom Finland and the members of the Finnet Group. If service provision is not differentiated by quality, the only other factor is pricing of services. Given the vast gain in market share of the Finnet Group in the long-distance sector (and the equality of service of all operators) the next question concerns prices in the long-distance market. Has the Finnet Group’s success in the long-distance market been due to lower prices in comparison to TF? Finland is partitioned into 12 local telecommunications regions within which any call is billed as a local call, hile a call between any two regions is billed as a long-distance calls, irrespective of the distance covered. As discussed previously, besides actual long-distance charges, local access charges to the trunk line switch are added to each long-distance call. Figure 5 indicates that cost differences for a daytime long-distance call are only marginal between the three longdistance operators. According to Finnet, the price differential for a daytime long-distance call between TF and the Finnet Group was, with approximately 8 per cent, the largest in 1994. Starting in 1995 and up to April 1998 the prices for a call via Telecom Finland’s and the Finnet Group’s networks have been identical. This implies that since 1995 price differentials can no longer be the cause for the Finnet Group’s phenomenal growth in market share in the long-distance sector. It is interesting to note that the Finnet Group’s market share has not increased since the end of 1994. However, Telivo’s (Telia) long-distance tariffs have been consistently below those of either

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TF or the Finnet Group, while it has been unable to gain a sizeable market share in the LD sector. Therefore, tariffs cannot be taken as sole explanatory variable in the Finnish long-distance market. Carrier interaction: collusive duopoly? It is interesting to note that in the long-distance market the Finnet Group and Telecom Finland have similar equal market share with 53.7 and 42 per cent, respectively. Therefore, the two certainly dominate the long-distance market with their combined market share of 95.7 per cent. Furthermore, since 1995 the two have had identical long-distance rates and have been able to prevent substantial gains in market share by Telivo, despite Telivo’s lower per minute price. These circumstances raise the question of a tacitly collusive duopoly in the long-distance market. Under pure competition, identical prices would only be expected to occur under identical cost structures of the firms, an assumption that appears improbable. Cross-market collusion does not seem to take place in Finland, since the two operators compete quite strongly against each other in the local market. This competition has gone so far that Telecom Finland has accused the Finnet Group of anti-competitive behavior. Therefore, the two must strongly differentiate between their activities in the local and longdistance markets. One explanation for this differentiated behavior in the markets is the minor role Telecom Finland plays in the local markets. Carrier prefixes The explanation for Finnet’s slower growth in the international market is based on market specific international call prefixes. Before the international sector was open to competition, Telecom Finland used the prefix ‘990’ for all international calls. After deregulation TF was granted the future use of this prefix for its international calls, while the prefix ‘999’ was assigned to the Finnet Group, and ‘994’ to Telivo. Many customers therefore still dial the ‘old’ prefix when placing an international call, regardless of their local and national long-distance carrier. In addition, the new international prefix 00 was introduced as recommended by the European Commission. 00-calls are routed to different international networks according to the market shares of the carriers for prefix dialed calls (as in the domestic long-distance network). Preselection agreements to route 00-calls in public networks will only be mandatory by 30 September 1998. A similar situation presents itself in the domestic long-distance market. Before the introduction of domestic long-distance competition, all carriers were given new long-distance prefixes to be dialed before the area code. However, an undisclosed but sizeable percentage of customers normally do not dial the operator code before the area code when placing a longdistance call. These calls are routed according to two possibilities: preselection agreements or market share depending distribution. Customers are able to preselect their domestic long-distance carrier in which case no carrier code is required and the designated provider carries all LD calls. If no designated provider has been pre-selected, then calls are allocated on a call by call basis to the three LD carriers according to the portion of prefix dialed calls to that particular network. Therefore, all long-distance market share figures above are for both prefix-dialed LD calls and prefix-free calls, since the two distributions equal. The rapid development of the Finnet Group in the domestic longdistance sector and the issuing of new domestic long-distance prefixes are

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therefore not independent of each other. Only the completely new organization of prefixes in the domestic LD market avoided the (unintended) bias of callers when placing a long-distance call. The developments in the international market indicate that if Telecom Finland had been able to keep its pre-competition long-distance prefix, then the Finnet Group’s gain of market share would have been substantially slower and comparable to the scenario in the international market. This clearly demonstrates that in order to allow all carriers equal chances of gaining market share, it is necessary to remove any dialing related advantages previously held by the incumbent. Conclusion Given the above discussion we see that neither prices nor quality of service provision in both the local access and long-distance markets can explain the success of the Finnet Group in the LD market, particularly if compared to Telivo’s development. At the same time it is difficult to account for Telecom Finland’s slow growth in the local access and subscription market based on its prices and quality of service. This leaves two explanations for the recent developments. First, the tying of customers to the local cooperatives through their share holdings, and secondly the fact that local telecommunications companies could refuse leasing their access lines to other full license competitors. However, as of June 1997, carriers are no longer able to refuse resale of their access lines to any competitor, including Telecom Finland. Having examined possible reasons for the divergent developments in the local and long-distance markets, it has become clear that the ownership structure of the local operators as cooperatives owned by the customers is the most significant one. Based on information supplied by the regulatory agency, the Finnet Group and Telecom Finland, we are able to exclude pricing or quality of service differences as significant explanatory variables. In addition, operators have been able to lease (local access) lines since June 1997 from local incumbents, which diminishes the possible role of the cost of setting up a new local access network as explanatory variable for the slow growth of TF in the urban local access and subscription markets. This leaves only the cooperatives’ ownership structures and number portability as possible explanations. The importance of the ownership structure and the lack of number portability for recent market developments has also been noticed by the regulatory authority, which is demanding that local cooperatives revamp their ownership and profit distribution system. The expectation of the regulatory authority and Parliament that a changed ownership structure of the local cooperatives will increase competition in the local market further supports our conclusion. We can therefore state that the success of the Finnet Group in the LD market without substantial loss of market share in the local sector are due to market idiosyncrasies rather than well-formulated regulatory guidelines. Number portability is expected to facilitate switching from cooperatives to one of the entrants in the local access markets.

A new approach The slow development of competition in the local market caught the attention of both the regulatory authority and the Finnish legislature. On

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30 April 1997 the Finnish parliament passed the New Telecommunications Market Act (TMA) which went into effect on 1 June 1997. One of the attempts undertaken to reduce the advantage enjoyed by the cooperatives in the Finnish market has been to separate network operations and service provision in these entities. While ‘internal divestiture’ between network and service provision is not an airtight approach to prevent the incurring of monopoly rents by the bottleneck (local access) owner, it represents the strongest attempt to curtail possible discrimination undertaken by any nation so far. Internal divestiture in combination with abolishing intra-firm cross-subsidies forces each carrier to offer its network at the same conditions to its own service affiliate as it does to its competitors. In addition, each operator contributes to the national average price for leased line prices. By raising their own prices the operator will entice other operators to follow suit. This will result in higher revenue (from leasing lines to competitors) but will also increase costs for leasing lines from other operators. Since operators have little influence on competitors’ prices other than keeping their own prices low as a benchmark, the main incentive will be to keep their own (and thus competitors’) prices low. As a result, Finland has the lowest leased line tariffs in Europe.23

Summary and conclusion

23

We thank an anonymous referee for pointing out this fact and others to us.

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This paper has laid out some of the events following the deregulation of the Finnish telecommunication market in 1994, when the main entrant into the long-distance market and former local access monopolist, the Finnet Group, gained 50 per cent of the market within the first week of competition. In contrast, the entrant into the local access market and former long-distance monopolist, Telecom Finland, has been able to gain only 3 per cent market share in the local access market. We have shown that the continued monopoly of the local cooperatives over the fixed wireline local exchange networks in urban southern Finland, as well as the lack of number portability caused the recent developments in the Finnish (domestic) telecommunications market. We have also been able to exclude pricing and quality of service as determining factors for the Finnish experience. This strongly supports the argument by Beard et al. (1998) that reintegrated telecommunications environments yield the likelihood of monopoly leveraging by the owners of the local exchange networks. The Finnish long-distance market therefore provides not as much a positive example of the introduction of competition in the telecommunications sector but rather illustrates the inherent power of entrenched monopolies in the local access markets. The slow growth of market share by entrants in the local markets, namely TF and Telivo, are a further illustration of the importance of the ownership of the local bottleneck. The Finnish market, despite its awing developments in the long-distance sector, is therefore a warning example to regulatory authorities worldwide not to underestimate the importance of ownership of the local loop. While the local cooperatives have undoubtedly competed with each other by comparison over the last one hundred years, the degree of competition in the local access markets has been lower than would have been possible under equal footing multiparty competition. As the non-success of competition most likely reduced price and quality of service competition, it has likely reduced consumer welfare.

The Finnish telecommunications market: P M Nattermann and D D Murphy

The developments in the international long distance sector illustrate the importance of ensuring that all pre-competition network access advantages of the incumbent are removed to enable effective competition to take place. Since settlement rates are equal for both Telecom Finland and the Finnet Group, the fact that TF was able to keep its pre-competition international long distance access code has to be taken as the main factor in limiting the Finnet Group’s slow growth in the international sector if compared to domestic long distance. Countries aiming at deregulating their telecommunications markets do well to account for both market idiosyncrasies and the importance of the local access loop in their regulatory frameworks. Access to the local loop is of universal importance as illustrated by the sometimes-frustrating attempts of entrants to gain customer access in the United Kingdom and the United States. Furthermore, the importance in selecting carrier access codes and terms of interconnection as well as resale agreements have been clearly illustrated by the events in the Finnish market.

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