Transcript A Methodology for Measuring Universal Service Costs

Interactions between Regulatory and Antitrust
Policies in a Liberalized Postal Sector
John C. Panzar
Northwestern U. and the U. of Auckland
CCP Conference: Balancing Regulation and Competition
University of East Anglia, July 7-8, 2008
Introduction and summary
• As with telecommunications, the introduction of
competition into the postal sector will create
problems for both regulatory and competition
authorities.
• Areas in which the two policies may be in conflict
include:
–
–
–
–
Downstream Access Policy
Anticompetitive Behavior of State Owned Enterprises
Exclusionary Effects of USO Funding
Two-sided market issues:
• PO Box access
Components of Postal Value Chain
(Scale econ. in collection and delivery)
• Collection
– Mail brought to Local PO from
various collection points
• Short haul transport
– Mail transported from Local
PO to Mail Processing Center
• Outward Sortation
– Mail routed to other MPCs
using sorting machines
• Long haul transport
– Mail transported to destination
MPC
• Inward Sortation
– Mail directed to destination
Local PO
• Short haul transport
– Mail transported to destination
Local PO
• Delivery
– Carriers pick up mail for their
routes; sort in route walk order
Stylized postal network
Sorting
Center
Long Haul Transport:
Air, Rail, Truck
Sorting
Center
Outward
Inward
Truck
transport
Local PO
Carrier
routes
Outward
Volumes
Inward
Truck
transport
Local PO
Carrier
routes
Postal Access Issues
• Is mandated access required for successful liberalization?
• Are there “monopoly bottlenecks” and essential facilities
in postal networks?
• Pros of mandating access (by analogy to
telecommunications):
– Reduce sunk costs of entry
– Allow entry at small scale
– Improve network efficiency
• Cons
– Little sunk costs in postal networks
– May undermine Universal Service Obligation
• In any event, how should access be priced?
Sunk Costs and Essential Facilities
• Relative lack of sunk costs makes it difficult to view postal
delivery networks as “essential facilities”
– Postal costs over 80% labor costs
– Even if Incumbent’s labor costs may be sunk, entrants’ probably
are not
• Competition Authorities unlikely to compel unbundled
access, except for
– Address system
– Mail forwarding
– PO Boxes
Regulatory Access Policy
• Regulatory authorities may view compelled access
as useful policy tool in order to:
– Better exploit economies of scale
– Allow entrants to provide ubiquitous service quickly
• BUT, access pricing may result in exclusion of
more efficient upstream competitors
– Anticompetitive, even if “refusal to deal” is not?
Example: shift from “cost plus” to “global
price cap” regulation
• Incumbent offers two
products:
– End-to-end service
– Work-shared mail
• Incumbent regulated to
break-even with ECPR
pricing of work-sharing
– I.e., work-share discount
equal to the incumbent’s
unit cost savings
• Stamp price = p
• Work-sharing discount 
– Access price: a = p - 
•
•
•
•
•
End-to-end demand = D(p)
Fringe supply = S()
I’s upstream unit cost = t
I’s unit delivery cost = c
I’s fixed costs = F
Example: shift from “cost plus” to “global
price cap” regulation
• Freed from “cost plus” regulation, the Incumbent seeks to maximize:
(p,) = (p-t-c)[D(p)-S()] + (p--c)S() – F
subject to:
p(D0- S0) + (p-)S0 < p0(D0- S0)+(p0-0)S0
• (Price cap index weights based upon last period quantities)
• Assuming the constraint holds with equality, solving yields:
dp* S 0 S ( 0 )
p ( ) with
 0 
d D
D( p 0 )
*
Shift from “cost plus” and ECPR to “global
price cap” regulation: discount decreases
d [ p* ( ), ]  dp* 


d
p d 
( p  t  c) D( p) S ( 0 ) D( p) S ( 0 )


 (t   ) S ( )  S ( )
0
0
D( p )
D( p )
Evaluatingat    0  t and p  p * (t )  p 0 yields
d [ p 0 , t ] ( p 0  t  c) D( p 0 ) S (t )

0
0
d
D( p )
Exclusion of equally efficient
competitors
• Thus the shift to global price cap regulation gives
the Incumbent the incentive to reduce the worksharing discount below its unit cost savings.
• The result is the “exclusion of equally efficient
competitors” in the fringe.
– Note: this may be socially efficient
• Would this be of concern to competition
authorities?
– Even if they were not concerned about “essential
facilities”?
“Unfair” Competition by SOEs?
• Likely that most Incumbent Posts will not be privatized
during the Liberalization process.
• Are Regulatory and Competition authorities able to
adequately police their behavior with respect to
competitors?
• Sappington and Sidak analyze revenue maximizing
behavior of SOEs:
– Regulatory cross-subsidy constraints and Antitrust predatory
pricing rules may not be adequate to prevent predation.
Revenue max by SOEs leads to pricing
below cost in competitive markets
• Incumbent is dominant in market 1 and a price-taking
competitor in market 2.
–
–
–
–
Revenues given by:
“Joint and common costs:”
Attributable costs of service 1:
Attributable costs of service 2:
R1(Q1) + p2Q2
K
c1(Q1,K)
c2(Q2,K)
• Example 1: Incumbent assumed to maximize revenues
subject to break-even constraint:
L = (1+)[R1(Q1)+p2Q2] - [c1(Q1,K)+c2(Q2,K)-K]
L2 = 0  p2 =  mc2/(1+) < mc2
Inefficient Investment can allow SOE to
“pass” the Incremental Cost Test
• Example 2: Suppose the regulator imposes the additional
constraint that revenues cover “attributable costs”
L = (1+)[R1(Q1) + p2Q2] - [c1(Q1,K) + c2(Q2,K) - K]
+ [p2Q2 - c2(Q2,K)]
L1 = (1+)MR1- mc1 = 0.
L2 = (1+)p2 - mc2 -  [p2 - mc2(Q2,K)] = 0
LK = -[c1K + c2K - 1] -  c2K = 0  K > Kcost efficient
• Incumbent over invests in common costs to satisfy
constraint.
Universal Service: Burdensome Obligation or
Unfair Competitive Advantage?
• Incumbent Posts differ on the profitability of Universal
Service (at a uniform price).
• Some feel that their ubiquitous coverage is a competitive
advantage or necessity
• Others argue that the USO makes them vulnerable to
cream-skimming and the “Death Spiral”
• However, Incumbents typically also provide potentially
competitive products in High Cost areas, as well as Letters.
What to do about Economies of Scope?
• If Universal Service is (somehow) subsidized, whoever
receives the USO franchise will likely benefit from
economies of scope between services.
– Is this an “unfair” advantage?
– Is it an “abuse of dominance”?
– Is it inefficient?
• Economies of Scope between USO services and
competitive service has the potential to cause conflict
between Regulatory and Competition authorities
An Illustrative USO Example:
(1) Initial situation
• High Cost area potentially
served by three delivery
networks:
– Incumbent Post’s network
delivers 1000 Letters and 1000
pieces of X-Mail.
– NewsCo delivers newspapers
and “ready to” deliver X-Mail
at any price greater than or
equal to 4, its AIC of X-Mail
– Competitive Carriers “ready
to” deliver X-Mail at any price
above their unit costs of 5.
• Before Liberalization:
– Post delivers 1000 Letters and
1000 X-Mail pieces at
marginal costs of 1 and 2.
– Postal network fixed costs of
6000 for HC area.
– Revenues less upstream costs:
Letters = 4; X-Mail = 4.
• Area Postal losses are 1000 =
1000(4-1) Letter contribution
+ 1000(4-2) X-Mail contribution
- 6000 HC area fixed costs.
• No X-Mail competition
An Illustrative USO Example:
(2) “Free Exit,” no USO
• Letter delivery not provided in HC area
– Assume recipients pick up in town, and
• X-Mail market profitably captured by NewsCo
– X- Mail price = 5, the unit cost of competitive suppliers.
• (Eg., Assume Incumbents Stand Alone Cost for X-Mail is 6/unit)
– NewsCo earns an incremental profit of 1000 = 1000(5-4) due to
economies of scope with its existing network
• Local Residents complain to the Regulatory Body about
the loss of “free” delivery.
An Illustrative USO Example:
(3) USO payments fund Letter delivery
• Regulator provides Incumbent a USO payment of
at least 1000 to resume Letter delivery.
• Incumbent resumes Letter delivery service and XMail delivery, as initially.
– If it did not resume X-Mail delivery, the USF payment
would have to be increased by 2000 to replace the XMail contribution
• NewsCo loses its X-Mail delivery business (and
1000)
An Illustrative USO Example:
(4) The “Antitrust” Complaint
• NewsCo files a complaint with the Competition Authority.
– Against whom?
– On what grounds?
• Nonetheless, several things are clear:
– Without the USO payment and Obligation, the Incumbent would
not deliver X-Mail.
• NewsCo has been damaged by the Regulator’s USO policy
– Given, that the Incumbent is induced to deliver Letter mail, it is
socially efficient that it deliver X-mail as well.
• The Incumbent seems to be guilty of economies of scope!
An Illustrative USO Example:
(5) “Tendering” the USO?
• Give NewsCo a chance to exploit scope economies by
tendering the USO.
• Assume NewsCo could also obtain Letter and X-Mail
delivery costs of 1 and 3 if it upgraded its delivery network
at a cost of 7000
– The least it would accept to assume the USO would be:
2000 = 7000 – [1000(4-1) + 1000(5-3)]
• NewsCo would deservedly lose the USO tender
• But, suppose the Incumbent’s network costs are 6000
because of economies of scope with neighboring profitable
areas; on a Stand Alone basis they would be 8000.
Two-Sided Market Issues: Can Rowland Hill
survive Liberalization?
• Network externalities are readily internalized under
regulated monopoly provision.
• Competition brings “two-sided market” anomalies to the
fore, as seen in:
– Telecommunications interconnection
– Payment systems
• Regulatory and competition authorities have been
perplexed by sustained “cross subsidies” and below cost
pricing
• Emerging postal example is PO Box Access
Post Office Boxes
• PO Boxes are facilities rented out to subscribers for the secure
reception of mail.
– Usually on the premises of the incumbent postal provider.
– Mail Boxes, Etc. is a competitive provider of PO Box services in US.
• The share of PO Box addresses varies greatly by country, but accounts
for a significant proportion of both businesses and individuals.
• Delivery entrants in any region find a significant volume of mail
addressed to PO Boxes.
– Delivering this mail may be their only contact with the incumbent.
– Entrants offer to “do it themselves,” but incumbents reluctant to “let them
in.”
Access to PO Boxes must be mandated
• Even those (like me) skeptical of “essential facilities”
arguments in postal networks agree that competitors should
be granted to incumbent’s PO Box addresses.
• But, again, how to price to ensure that there is no
leveraging of “dominant position” in PO Box market to
delivery market.
– Incumbent’s advocate ECPR
• retains the incumbent’s full contribution, even though entrant does
nearly all of the work!
– Entrants (and Postal Regulators) favor cost-based rates
• which can be very low.
– Notice that this comes up in the presence of delivery competition
(bypass), so this is actually an interconnection issue.
• suggests “Bill and Keep” as an option
But, at what rate?
• Natural choices are “cost based” methodologies such as
ECPR or Average Incremental Cost.
• But, those approaches treat PO Boxes as a fully integrated
part of the incumbent’s network.
• What if we treat PO Boxes and postal service as interrelated, potentially competitive markets?
• 2-sided market effects may make cost based rules
inadequate.
PO Boxes as a 2-Sided Market
• PO Box operator provides services to:
– Recipients of mail, who value secure, perhaps anonymous,
delivery
– Postal operators, who are obligated to deliver mail addressed to PO
Box subscribers.
• Postal operators “pass through” the demand of senders of mail, who,
since Rolland Hill, pay for the volumes sent.
• PO Box operator can charge:
– Recipients a monthly fee and/or a per piece charge
– Postal operators an access fee per piece delivered.
Access pricing in “competitive” PO Box
markets
• Competitive PO Box markets would presumably operate
similarly to competitive mobile phone markets:
– PO Box providers compete for subscribers, attempting to make
money on postal access charges
• I.e., by creating “competitive bottlenecks”
– Unlikely to subsidize subscription
• Receivers cannot guarantee access revenues
– Reception subsidies likely
• Assume that free entry and exit of PO Box providers
ensures zero profit
• Following Armstrong and Vickers (2001), assume that this
outcome maximizes receivers’ utility
– But, this means the access charge is set at the “monopoly” level!
What’s the appropriate benchmark for PO Box
access policy?
• If benchmark is unconstrained welfare max
– “Bill and Keep” looks pretty good
• If benchmark is outcome in competitive,
disintegrated PO Box and postal markets
– Access price might even exceed ECPR!
• Because of 2-sided market effects, cost based rules
don’t seem adequate.
Conclusions
• Competition and Regulatory authorities will have
overlapping responsibilities in liberalized postal
markets.
• While “optimal policy is optimal policy,” it does
not necessarily result from a “level playing field.”