Pricing Principles & Practices in Competitive Circumstances by 76E00Gn8

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									Pricing Principles & Practices in
  Competitive Circumstances

            By Patrick Xavier
           School of Business
     Swinburne University, Melbourne

              ITUWorkshop(1)




                                       1
        Traditional pricing
Cross-subsidisation for political, social etc.,
reasons resulting in high prices for
international and long-distance service
subsidising low (below cost) prices for
connection and local service




                                                  2
        Traditional pricing
Cross-subsidisation not sustainable under
competition since services with high profit
margins will be vulnerable to competitive
entry.




                                              3
           Profit margin
PRICE__________________________




COST___________________________

                                  4
Pressure to re-structure prices
To reduce scope for competitors to under
cut TOT’s price, there will be pressure on
TOT to cut international and long distance
prices.




                                             5
     Falls in prices in Australia
• Telstra’s national long distance call prices
  fell by about 30% in real (inflation-
  adjusted) terms between 1995 and 1999.
• Telstra’s international call prices fell by
  about 60% in real (inflation-adjusted) terms
  between 1995 and 1999.
• Calls from fixed to cellular mobile fell by
  about 30% (largely in 1999) although a
  flagfall of 15 cents per call was introduced. 6
  Pressure to re-structure prices
• In order to maintain revenue, there will be
  pressure to increase the prices of currently
  cross-subsidised prices.




                                                 7
          Re-structuring prices
    Other areas of price restructuring towards
    prices becoming “cost-based” or cost-
    oriented” can include:
•   urban/rural
•   upfront (flagfall) component/useage
•   peak/off-peak
•   wholesale/retail
•   price discounts                              8
Appropriate costs upon which to
base prices not easy to identify
• Identification of appropriate costs is not
  easy.
• Until the cost systems are in place, TOT can
  benchmark the price restructuring that is
  occurring in other markets that are
  becoming increasingly competitive.
• Even when cost information is available,
  benchmarking will provide a “reality
  check”.                                     9
Pressure on TOT to reduce costs
• It is not enough simply to base prices on
  current costs.
• This is because prices based on costs that
  are inefficiently high will also provide
  opportunity for competitive entry by more
  cost-efficient rivals.
• So in competitive circumstances it will be
  necessary to keep costs as low as possible.
                                                10
Pressure on TOT to reduce costs
• Another reason to cut costs is that with
  prices falling, cutting costs will be a means
  of helping to maintain profit margins and
  overall rate of return on assets.




                                                  11
    Maintaining profit margin
PRICE__________________________




COST___________________________



                                  12
              Profit levels
• The level of profit becomes increasingly
  important with commercialisation,
  privatisation and competition.
• Benchmarking can help establish
  appropriate profit targets for TOT



                                             13
Cutting costs to maintain margins
        and overall profit
• This is one reason for the considerable cost
  cutting many telecommunications operators
  have been (and are) engaging in.




                                             14
     The “floor level” of prices
• In fact, the “floor level” below which prices
  should not be set are in principle not current
  costs but efficient costs, including the use of
  best technology.




                                               15
     Long run incremental cost
             (LRIC)
• This concept of efficient costs is the
  rationale of “forward-looking” LRIC.




                                           16
     Long run incremental cost
            (LRAIC)
• Important to understand this concept of
  costs because the regulatory agency will
  probably follow what is happening overseas
  and require TOT to apply LRIC in pricing
  decisions, especially regarding
  Interconnection and also “unbundling” of
  network elements.
• But more on this in a later presentation.
                                           17
    Wholesale/retail pricing
New entrants have frequently complained of
being “price squeezed” by incumbent
telecommunications operators that supply
end-user service as well as
access/interconnection service.




                                         18
           Price squeeze
Retail__________________________




Wholesale______________________
                                   19
           Price squeeze
So for competitive reasons, TOT might
consider such competitive tactics.




                                        20
  Price reductions that increase
          total revenue
• To limit revenue loss, the price reductions
  can be selective and restricted to only some
  services.
• However, price reductions can result in an
  increase in total revenue where demand is
  “price elastic” ie. responsive to a price
  change. So there is need for TOT to better
  understand demand elasticities for various
  types of services.                          21
   Price reductions that increase
           total revenue
• Price reductions to boost “loyalty” can also
  increase revenue.
• One common approach that has been
  accelerated by competitive pressure is price
  discount schemes.



                                             22
       Price discount schemes
• Price discount schemes can be used to boost
  loyalty and to target selected market niches.
• They can be used to retain/attract high-
  value customers.




                                              23
       Price discount schemes
  The range of price discount schemes for
  PSTN services includes discounts on:
• connection charges
• rental payments
• ‘non-traditional’ time of day/week discount
  schemes, such as ‘every third minute free’
  for off-peak calls

                                            24
       Price discount schemes
• local calls
• national long distance
• international




                                25
       Price discount schemes
• call duration
• for a fixed charge, talk ‘for as long as you
  like’ on national & international calls
• ‘friends & family’ calling-circle discounts
  on calls to a number of pre-specified
  frequently called numbers


                                                 26
       Price discount schemes
• discounts that vary with the size of the
  customers bill
• discounts based on customer loyalty,
  including the customer’s willingness to use
  the supplier exclusively
• discounts that vary with the term of the
  contract signed.

                                                27
    Price discount schemes
Customer response to discount schemes can
generate important information about
demand sensitivities that can assist the
development of pricing strategies.




                                        28
       Price discount schemes
• Discount schemes may also generate useful
  information for acquisition of customers
  rather than simply traffic.
• This will be important as competitive
  strategies turn to the development of core
  markets for high-value and data-based
  products that go well beyond the simplest
  forms of price competition.
                                           29
     Price discount schemes
In common use are price discounts that vary
with the size of subscription charges
required for participation in the discount
scheme.
Such discount schemes can significantly
increase revenue while encouraging loyalty,
since customers want to maximise the
benefits from their subscription.
                                          30
Benchmarking discount schemes
• TOT could find it valuable to benchmark
  and analyse price discount schemes used
  overseas, including the results of such
  schemes on revenue and competitive
  objectives.




                                            31
      Price discount schemes
      complicate international
      benchmarking of prices
• Note that because the nature, scope, number
  of beneficiaries and depth of price discount
  schemes vary among countries this
  complicates international benchmarking of
  telecommunications prices.



                                            32
     Cross-subsidisation for
      competitive reasons
In some countries, price competition has
tempted the incumbent former monopoly to
cross-subsidise the prices of services for
which there is strong competition.
Revenue from high prices for services for
which there is no (or relatively less)
competition is used.

                                         33
Regulation & Cross-subsidisation
  This would seem an attractive competitive
  strategy but will almost certainly be
  prohibited by regulation which is likely to
  prescribe:
• a “floor” level based on LRIC (below which
  prices are not permitted to fall)
• a “ceiling” level based on “stand-alone
  costs” (above which prices cannot go)
                                            34
Regulation & Cross-subsidisation
• TOT should prepare itself for the expected
  “negotiations” with the regulator by arming
  itself with information relating to cost-based
  price ‘floors’ and ‘ceilings’.




                                              35
Regulation & Cross-subsidisation
• Benchmarking movements in price levels
  and structures of incumbent operators in
  markets experiencing increasing
  competition will provide valuable
  information for pricing strategy as well as
  for negotiations with the regulator.


                                                36
    Interconnection charges in
    competitive circumstances
• As noted earlier, for competitive reasons
  TOT might wish to adopt a ‘price-squeeze’
  strategy with price reductions on the one
  hand and ‘high’ interconnection charges on
  the other.
• The high interconnection charges could also
  serve to compensate for reduction in
  revenue from falling retail prices.
                                            37
LRIC and Interconnection Prices
• However, a regulator-imposed obligation to
  apply LRIC or price cap regulation could
  restrict efforts to increase wholesale
  interconnection price.
• Another constraint on high interconnection
  prices is that this would provide more
  incentive for new entrants to quickly install
  their own infrastructure.
                                              38
    LRAIC and Interconnection
            Prices
• TOT should equip itself for the expected
  “negotiations” with competitors and with
  the regulator by installing cost accounting
  systems that would enable it to obtain the
  required cost information.




                                                39
      Benchmarking can help
• Benchmarking interconnection prices in
  other countries could also generate useful
  information both for developing competitive
  strategy and for use during ‘negotiations”.




                                           40
  Price of “unbundled” network
             elements
• Another potential major issue TOT might
  face relates to the price of “unbundled”
  network elements, including ADSL
  enhanced segments of the network.




                                             41
      LRIC and “unbundling”
• It now seems increasingly widely accepted
  that the price of “unbundled network
  elements” of the local loop should also be
  based on LRIC.
• In Canada, the obligation to allow access
  will be only for five years.
• In the Netherlands, the price is to be
  initially LRIC but then be raised over five
  years to a commercial rate.                 42
             Other areas...
• Other areas where benchmarking will be
  useful are leased lines, and pricing of
  Internet use.




                                            43
              Reference
Patrick Xavier, “Price setting and regulation
for telecommunications in the absence of
reliable and detailed cost information”,
Telecommunications Policy , 1997. Volume
21, No.3, pp.213-233.




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