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How telecom firms reap profits

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December 06, 2005 09:59 IST

This article invokes the simple principle of economics that entry barriers raise profits of incumbents, and that they are willing to expend resources to maintain those entry barriers as long as they result in net positive pay-offs.

While entry barriers created by business during the process of competing in the market - such a brand loyalty, quality of service, acquisitions, vertical integration, and so on – are observable, a strategy that often goes unnoticed is recourse to the legal process to delay and often subvert competition from developing to its fullest potential.

In order to hit the growing mobile phone business, for instance, one of the things the Department of Telecommunications did in 1997 was to unilaterally increase the tariff paid by fixed-line users each time they called a mobile phone from the existing Rs 1.4 per minute to Rs 24 a minute during peak hours!

The Telecom Regulatory Authority of India, naturally, reversed this unilateral decision by DoT. Although the DoT eventually withdrew the tariff, it subsequently challenged Trai's authority both before the Trai (at that time, Trai also had appellate powers) and the Delhi High Court. Among the main grievances of the DoT was the loss of revenue and market to new entrants in the telecom sector.

However, its arguments in the courts were centered around the role of Trai and its jurisdiction. Recourse to courts became commonplace as DoT sought to establish its role as a service provider and licensor in the new "competitive" environment - its regulatory role had been surrendered to Trai.

By mid-1998, Trai had over 20 cases pending before it on the question of its jurisdiction in licensing. And since interconnection and tariffs were also license issues, by implication these also became the subject of litigation.

While the statute establishing Trai itself was not clear on the subject, the situation was confounded by the dual role executed by DoT, as license administrator and dominant service provider.

The response of DoT to the threat of declining revenue was predictable, although somewhat surprising. An aggressive and competitive DoT (now BSNL) would have been a handful for the new private entrants, but it chose litigation as the instrument to delay reform and continue to earn monopoly rent.

Nowhere is this strategy better illustrated than the reaction of DoT (and MTNL) to the proposed introduction of the Calling Party Regime in November 1999 by Trai. The regime involved a revenue share to be paid for calls terminating on mobile to compensate the mobile operator for loss in revenue from incoming calls.

Estimates of revenue loss to DoT as a result of introduction of the CPP regime ranged between Rs 150-200 crore (Rs billion). However, the grounds on which DoT challenged Trai's order in the high court and won the case was that the regulator did not have the power to "specify revenue share between operators" (an integral part of the CPP regime) since this was a part of the license condition. For the record, it should be noted that CPP was eventually introduced in India in October 2003, more than four years after it was first intended.

The original idea in setting up Trai was that it would be the sole, independent arbitrator in settling disputes. However, the high court also emerged as a settlement body, thus providing an incentive for operators to knock on its doors, if necessary.

Recognising that telecom liberalisation and reform was getting frustrated by the institutional mechanism available for legal remedy, the government restructured Trai and created another body, the Telecom Disputes Settlement Appellate Tribunal that replaced the high court.

The creation of TDSAT, however, did not change the incentive of operators to "use the judicial process" if they were aggrieved by a Trai order. If anything, litigation has now increased since there are many more service providers and the chances that a decision of Trai or the government adversely affects at least one entity is, therefore, higher.

Add to this the empirical evidence in disposal of appeals in TDSAT against Trai's orders. The higher the chances that the verdict of TDSAT is "against" Trai, the greater the likelihood of appeals.

The telecom industry is highly capital-intensive and its returns vastly sensitive to regulation. If the costs of litigation are small compared to the gains that can be had from perpetrating the status quo, litigation can be used effectively as a short-term entry barrier. Both private and public sector operators have successfully used this process.

Thus, Hexacom appealed a refund order of Trai, perhaps, to delay the payment of "excess" amount collected from subscribers when the industry moved from high fixed license fees to revenue-share (the move helped delay the refund for around two years). Ditto for Bharti. Consider the most recent order of Trai reducing international private leased circuit (IPLC is also known as submarine cables) prices by about 70 per cent.

IPLCs are used by the ITeS as well as other service providers such as ISPs and international long distance operators. Trai first announced its intention of lowering these prices two years ago since it felt that competition in this segment was inadequate. After protracted litigation, based on an appeal by Tata/VSNL, the reduction finally materialized with effect from November 29, 2005.

Adam Smith had famously remarked that a competitive market is a kind of social machine whose laws of operation allocate resources efficiently without anyone striving consciously for that goal. One hopes the extensive and intensive litigation that we are witnessing in the telecom sector at present can make the judge-made law more efficient, obviating the need for litigation in the long term. But consumers are likely to continue to pay the price in the short run.

The author is a professor at IMI and a consultant with the Telecom Regulatory Authority of India.

Rajat Kathuria