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Some Economic Conclusions

Im Dokument UNIVERSITÄT POTSDAM - Prof. Welfens (Seite 33-47)

In the interest of increased growth and employment, flat rate Internet pricing is useful to the extent that Internet providers welcome it. Above all, it provides tremendous advantages to the economy as a whole, resulting from the intensified Internet use associated with a flat rate.

In the middle term, we expect that intensified Internet will lead to considerable employment and growth gains in Germany. Positive employment effects will emerge not only in the regions in which leading Internet providers have settled. Rather, all regions and sectors will benefit, that are relatively communications-intensive or for which the Internet makes possible a significant reduction in transaction costs. Regions and/or cities with colleges and universities will profit especially, the Internet opens up new expansion opportunities for knowledge-based providers.

Specifically, the following conclusions can be reached based on the analysis at hand:

Fears that a flat rate will lead to lasting network shortages are unfounded. Flat rate pricing –at off-peak times initially – corresponds to the principles of cost- oriented price-setting, used by the European Commission and most federal regulation authorities as a practical orientation aid in price regulation (marginal costs of using the network are near zero).

Flat rate price options would considerably stimulate Internet use in Germany, making both economic and ecological sense (traffic reduction effects), and would open up new points of departure for public participation at various levels of politics. In the face of nearly four million unemployed, the positive employment and growth gains resulting from low-cost flat rates should be considered, which incidentally are especially important for eastern Germany in its process of catching-up to the rest of the German economy – while the improved options for corporate start-ups in general, for corporate networking (in the research sector as well) and for sectoral structural transition should be deliberately exploited.

There is no factual reason why the action parameter of price strategy, so important to competition, should be artificially restricted by regulation

authorities. Only in the context of undue, trade-distorting cross-subsidisation by the ex-monopolist is there a reason for regulation authorities to intervene in price-setting autonomy.

The regulators should request that the dominant telecom provider, the Deutsche Telekom AG, provide special interconnection terms for Internet or data traffic - on the basis of the internet protocol. Because data traffic is much cheaper to handle than voice telephony, network usage prices could be expected to drop sharply given cost-oriented pricing.

As a joint owner of the DTAG, the German government should do its share to ensure that the company's Cable TV network - so important to growth and Internet policies - is sold in its entirety at least in some regions. Otherwise, it will remain unclear what economic or communications potential is contained in Cable TV, as private providers such as the DTAG develop the Cable TV platform without considering internal conflicts of interest (Cable TV telecom use as competition to their own fixed network business); it is conspicuous that in the Netherlands, the dominant fixed network operator KPN holds only one large regional Cable TV company, and even here, the Ministry has been pressing for a shift from a majority to a minority share, for reasons of competition policy.

Partial Internet flat rate prices – with a limited number of free Internet use hours - should only be permitted when flat rate prices have been authorised in general.

Meanwhile, differentiated flat rate concepts are certainly conceivable, such as a flat rate allowing unmetered access within a given time window (e.g. in low- traffic times, calling for a lower flat rate than an equivalent arrangement for peak times or for the total 24-hours cycle).

When the regulator deviates from the price setting practices of leading OECD countries, the public should be given detailed reasons for this. Both the public and the economic sector have a vested interest in reasonable, transparent and appropriate regulation.

It can be expected that the intensified use of the Internet resulting from the introduction of monthly flat rate pricing will lead to a more widespread use of the Internet. This will result in economic benefits to the entire economy and an increase in use value for private households. Alongside private PC leasing, which will probably increase in the long term and create new options for Internet use especially for lower-income households, the introduction of flat rate price strategies would be a large step towards „democratising the Internet," i.e. opening up the Internet to as many households as possible.

In the long term, the triad will be the site of intensified competitive battles because of the increased price transparency associated with the Internet. For Germany, a lasting shortfall in Internet use – vs. the US, Scandinavia, and other OECD countries – would be a serious obstacle to development, or growth and employment.

From a regulatory standpoint, there are no reasons whatsoever to oppose a flat rate for Internet use. On the contrary, non-dominant Internet and/or telecom providers should be given the greatest possible freedom in choosing their price- setting strategies. This corresponds to the basic principles of Germany's social market economy, and also to the Fundamentals of economic freedom as determined in the EG Contract. Meanwhile, the regulators or the government should undertake the necessary measures to prevent the abusive exploitation of a dominant market position on the part of the ex-telecom monopolist.

In a series of programs, Germany's federal and state governments and countries have granted subsidies for first-time Internet use to small and medium- sized businesses, so that this group of companies, so important for employment and innovation, can keep pace with the global Internet Age. So it cannot be in the government's interests if a restriction of price-setting strategies – and excessive local network prices and/or interconnection fees – on the user side reduce the societal dividends of this corporate Internet sponsorship. So, it is in the interest of both the government and citizens to permit flat rate pricing, which experience has shown will lower the cost of Internet use possibilities. In all political decisions relating to flat rate authorisation, the considerable advantages of lower-cost Internet use to the economy as a whole should be acknowledged in full. After all, considering the social market economy's regulative model, one should not overlook the fact that increased Internet use will serve to intensify competition, and that lower-cost Internet use will expand the potential user circle in favour of low-income classes as well.

Flat rate pricing could be introduced in steps, which should, however, lead relatively rapidly to a comprehensive liberalisation in price-setting:

Unmetered Internet use for schools, colleges and universities, so that knowledge building and Internet use are strongly encouraged, which would benefit society and create new impulses on the content side for the Internet.

Unmetered Internet use on the weekends and on holidays, which ought to motivate households in particular to intensify their use of the Internet.

Unmetered Internet use for the low-traffic evening hours (beginning in the late afternoon hours where applicable).

Unmetered Internet use as a general price-setting option in the Internet sector.

In the middle term, it appears possible to achieve 100,000 to 400,000 new jobs and increased growth by driving Internet use– an opportunity that the German economy should seize, especially in the face of its relatively poor past growth and employment figures in European comparisons; especially the businesses and households in East Germany should be encouraged to use the Internet– if necessary, using special demonstration and pilot projects, because expansion possibilities exist in the service sector above all, given the relatively low industrial density in the

"new German states." (In turn, modern, low-cost, company-oriented services would improve the chances of expanding industry). Meanwhile, it would be problematic if

Germany were to fall behind the US, Great Britain and other OECD countries with regard to Internet regulation. In closing, one should note that a delay in deregulating or liberalising Internet price-setting would engender considerable disadvantages for Germany – the employment potential calculated above would not nearly be reached.

Meanwhile, further empirical studies, including a modelling of telecom and Internet use in input-output models and macro models, would be most welcome. Naturally, the present analysis can only be a first step in a systematic investigation of the Internet industry in Germany and Europe.


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A.1 Descriptive Statistics

Fig. A.1: AOL Customers Worldwide, August 1994 – December 1999

0 5 10 15 20 25

Aug 94 Feb 95 Aug 95 Feb 96 Aug 96 Feb 97 Aug 97 Feb 98 Aug 98 Feb 99 Aug 99

AOL Customers Worldwide (in Millions)

Table A.1: International Comparison of Telephone Flat Rates

Country Flat Rate

Brazil 29 US$ + Provider

Canada 8.40 ... 10.40 DM

Great Britain 15 US$

Hull (Great Britain) 25 US$ p. month + 9 Cents p. call

New Zealand 20 US$

NTT (Japan) 76...81 US$ (planned)

Austria 20 US$

Spain 29 US$

USA 17.90 ... 249.00 US$

A.2 Internet Flat Rates and Deregulation Requirements

If Internet service providers offered a flat rate to customers the demand for network capacity would increase as the number of Internet users and the degree of capacity utilization would increase. As regards prospects for a level playing field and fair competition, respectively, it is crucial that there should be no cross-subsidization on the side of the dominanent fixed network operator – which itself is active in the Internet business – and that there is capacity-oriented “digital pricing“ and a flat rate, respectively, in network levels 1-2-3, too.

As regards Germany one has to take into account that the former telecom monopolist Deutsche Telekom AG still has a monopoly on level 1. Moreover, the former monopolist has first mover advantages with respect to mobilizing new customers for the Internet – e.g. via special government programs (with a focus on bringing schools into the net) – and it also has developed various bundled offers (e.g. ISDN plus subsidized Internet access).

In the UK the former monopolist, yielding to pressure from the regulator OFTEL, has introduced a flat rate in the backbone network as of end of 1999;

moreover, at level 2 (regional exchange) there will be also a quasi flat rate. It would be desirable to have capacity-oriented prices, based on long term marginal costs, at all levels of the telcommunications network. If a flat rate – under the heading flat rate offer – were introduced only on one level, this would be quite problematic and would create distortions.

Cross-subsidization and Dominance of Fixed Network Operator

A serious distortion will emerge if the local exchange (market j) is characterized by a de facto monopoly while the Internet market (market i) is competitive. Assuming for simplicity constant marginal costs k´0M in local exchange on the side of the monopolist, we will observe under profit maximization and a given demand curve DDj that the equilibrium is characterized by a monopoly price pM and the quantity q0M. Note that this quantity is much lower than supply under competition (q1),.and this already is to the disadvantage of Internet service providers which need broad access to customers in the local exchange market. The monopolist will obtain in the j-market monopoly profits equivalent to the rectangle ABCpM which can be used for cross-subsidizing its Internet business in market i. On the left hand side of the following graph we have shown the Internet market where we assume that the subsidiary of the former telecom monopolist is facing an initial Internet demand (dd0M) from the pool of fixed network customers; we assume that the subsidiary of the former monopoly has marginal costs k´i0 while that of the Internet competitor is lower, namely k´*i.

Fig. A.2: Cross-subsidization – Monopoly in the Telecommunications Network and Competition in the Internet Provider Market

Unbiased competition would result in sales of the Internet subsidiary of qi2, while the overall demand is qi3. Marketing activities of the newcomer have contributed to overall demand DD0 where sales of newcomers will be equivalent to qi3 minus qi2 which is equivalent to the distance EG. In this setting the market share of the newcomers is larger than that of the subsidiary of the former telecommunication monopolist. If, however, monopoly profits from the telecommunication business – e.g. from the local exchange – were used for cross- subsidization so that the marginal cost curve of the Internet subsidiary is shifted into the position k´i1, the subsidiary would realize a higher sales volume of qi1 which raises its market share (equivalent to the distance FG) at the expense of newcomers.

Here the Internet subsidiary has become a dominant Internet provider due to the cross-subsidization financed from monopoly profits in telecommunications.

Such a biased cross-subsidization can be avoided only if the former telecommunication monopoly is forced to introduce not only accounting separation for the Internet business but that the Internet activities become a separate business so that cross-subsidization on the side of the former monopolist can be avoided.

This points to specific requirements for the privatization of the former telecommunication monopoly and the challenges for the regulatory authorities.

Since Internet providers will get access to customers via the fixed telecommunications network (alternatives are the following: satellites as an expensive substitute; city carriers in a few cities; and in most cities cable TV which, however, in Germany also is controlled by Deutsche Telekom AG – having thus a double monopoly) it is most crucial that unbundled local access at adequate

pi pj

qi qj

DDj DDi0



Z R‘

0 pM


q0M q1 dd0M

qi1qi0 qi2 k‘i0



Market i: Market j: Telecom





H Internet


marginal costs – possibly using efficient marginal component pricing rules – be imposed. The local access which is in the hand of a monopolist indeed is an essential facility for all Internet providers.

Discriminatory Pricing of Intermediate Products of the Former Monopolist Another problem of distortions in the Internet market stems from overcharging of intermediate inputs where the use of the former monopoly´s fixed network is a typical problem for all Internet providers; potential distortions concern conveyance as well as other services of the fixed link operator. A particular problem is the case where the fixed network operator has an Internet subsidiary and is overcharing other network operators with prices above long run marginal costs. In the following figure we have assumed constant marginal costs in the first three layers of the network, while there are rising marginal costs at level 4 (we disregard the case of falling marginal costs).

An implicit overcharging of conveyance services is relevant whenever the former monopoly operator is not offering unbundled and differentiated services in a way which would have to be expected under functional competition – e.g. if the network operator offers only metered pricing for data conveyance while the Internet subsidiary of the network operator explicitly or implicitly obtains lower prices within a capacity oriented approach (according to Sprint the use of capacity oriented digital pricing could lead to a fall of telecommunication prices of up to 90 %).

Such a situation can be described by the following figure which shows two indentical regional markets with demand schedules DD0 and DD0* (Fig. A.3), respectively, where the newcomer in the Internet market is facing excessive prices for using the fixed network. The situation is known to the subsidiary of the dominant network operator which apparently is accepting price leadership of other Internet providers. By imposing an excessive price in its own market segment the subsidiary of the Internet provider nevertheless contributes to higher profits of the fixed network operator; the dominent network operator will raise profits by the equivalent of the triangle A*B*C*D* which reflects overcharging of intermediate inputs – here on level 4 (see 4b* instead of 4a*). Moreover, there will be an additional extra profit in the subsidiary´s market, namely the area E1p1*poF minus the triangle FGEo. However, society is facing welfare losses and reduced growth prospects as the use of the Internet is lower than under competition. Note that the subsidiary of the network operator might transitorily assume the role of price leadership and thus lower prices in order to crowd out Internet competitors (from a theoretical point of view the price leadership uncertainty faced by these competitors raises their marginal costs schedules upwards).

Im Dokument UNIVERSITÄT POTSDAM - Prof. Welfens (Seite 33-47)