University of Economics, Prague
Faculty of Business Administration
Diploma Thesis
2012 Matúš Strážnický
University of Economics, Prague
Faculty of Business Administration
Major: International Management
Title of Diploma Thesis:
Application of Game Theory Principles in the
Oligopoly-characterized Industry
Author: Bc. Matúš Strážnický
Supervisor: doc. Ing. Bronislava Hořejší CSc.
Declaration
I hereby declare that I am the sole author of the thesis entitled:
“Application of Game Theory Principles in the Oligopoly-characterized
Industry”
I duly marked out all quotations. The used literature and sources are stated
in the attached list of references.
In Prague on May 7, 2012
I would like to thank doc. Ing. Bronislava Hořejší CSc.
for introducing me into the economics of game theory and for all valuable comments
while writing this thesis.
Title of Diploma Thesis:
Application of Game Theory Principles in the Oligopoly-characterized Industry
Abstract:
The goals of the diploma thesis are describing the strategic oligopoly environment of
chosen industry of Czech telecommunications, together with introducing basic game
theory principles with their possible real case application. It mentions historical shifts in
Czech telecommunications sector which influence the actual industry conditions. The
thesis briefly describes the individual players in the market and turns its attention
towards the industry characterization through standard oligopoly models. Following, it
introduces theoretical insight on possible market entry strategies into oligopoly
industries. The application part focuses on game-theory in pricing strategies, market
entry and entry deterring scenarios with examples. Final part summarizes the objectives
in detail and provides final comments on the thesis.
Key words:
Game Theory, Oligopoly, Strategy, Market Entry
1
Table of Contents
Table of Contents..........................................................................................................................................1
Abbreviations................................................................................................................................................2
List of Tables & Figures ...............................................................................................................................3
1 Introduction.........................................................................................................................................4
1.1 From Monopolies to Oligopolies with Strategic Behaviour....................................................... 4
1.2 Choosing the Topic .................................................................................................................... 5
1.3 Objectives of the Thesis ........................................................................................................... 11
2 History of Czech Telecommunications Industry...............................................................................13
2.1 Fixed Telephony....................................................................................................................... 13
2.2 Mobile Telephony .................................................................................................................... 16
2.3 Incumbent Český Telekom going Private ................................................................................ 17
3 Market Structure................................................................................................................................19
3.1 Fixed Telephony....................................................................................................................... 19
3.2 Mobile Telephony .................................................................................................................... 20
3.3 Telefónica CZ........................................................................................................................... 23
3.4 T-Mobile Czech Republic ........................................................................................................ 24
3.5 Vodafone Czech Republic........................................................................................................ 25
3.6 CTU – The Doubtful Regulator................................................................................................ 26
3.7 Safeguarding the Competition.................................................................................................. 29
4 Characterizing a Telecommunications Oligopoly .............................................................................31
4.1 Basic Assumptions ................................................................................................................... 31
4.2 Market Structure Circumstances .............................................................................................. 32
4.3 Oligopoly Models..................................................................................................................... 38
4.4 New Market Entrants................................................................................................................ 46
5 Application........................................................................................................................................53
5.1 Concentration of Czech Telecommunications.......................................................................... 53
5.2 Pricing in Czech telecommunications ...................................................................................... 56
5.3 Behaviour in an Oligopoly ....................................................................................................... 58
5.4 Entering Czech Telecommunications....................................................................................... 61
6 Conclusion.........................................................................................................................................65
6.1 On the objectives...................................................................................................................... 65
6.2 First Objective.......................................................................................................................... 66
6.3 Second Objective...................................................................................................................... 67
6.4 How Professionals see the market structure ............................................................................. 68
6.5 Final remarks............................................................................................................................ 70
7 Appendix...........................................................................................................................................71
8 References.........................................................................................................................................72
2
Abbreviations
ARPU - Average Revenue per User
APMS - Association of Mobile Network Operators
ARCEP - Autorité de Régulation des Communications Électroniques des Postes
CC - The Conseil de la Concurrence
CDMA - Code Division Multiple Access
CTU - Czech Telecommunication Office
DD - Digital Dividend
ERF - European Regulatory Framework
EU - European Union
GATS - Global Agreement on Trade in Services
GDP - Gross Domestic Product
GSM - Global System for Mobile Communication
ISP - Internet Service Provider
ITU - International Telecommunication Union
LTE - Long Term Evolution
MC - Marginal Costs
MPSTP - Main Principles of State Telecommunication Policy
MR - Marginal Revenue
MTR - Mobile Termination Rates
MVNO - Mobile Virtual Network Operator
NMT - Next Mobile Telephony
NTP - National Telecommunication Policy
OECD - Organisation for Economic Cooperation and Development
RM - Relevant Market
UOHS - Office for the Protection of Competition
SMB - Small Medium Business
SMRA - Simultaneous Multiple Round Auction
telco - telecommunications
UMTS - Universal Mobile Telecommunications System
UOHS - Office for the Protection of Competition
WTO - World Trade Organisation
y-o-y - Year on year change
3
List of Tables & Figures
Figure 1 Telecommunication revenue as a percentage of GDP [as of 2009] ................... 6
Figure 2 Telecommunication expenditures as a percentage of GDP [as of 2009] ........... 6
Figure 3 How dailies and weeklies inform about Czech telecommunications? [hits].... 11
Figure 4 Profit development in Czech telecommunications [CZK mil.]........................ 13
Figure 5 Mobile and Fixed network usage [in thousands].............................................. 17
Figure 6 Industry revenues [CZK bil.]............................................................................ 19
Figure 7 Market shares in mobile industry for 2Q 2011 [in %] ..................................... 21
Figure 8 Household expenditures on telecommunication services................................. 22
Figure 9 ARPU fall in the last 9 years [in CZK] ............................................................ 26
Figure 10 Mark-up pricing.............................................................................................. 34
Figure 11 Price line......................................................................................................... 35
Figure 12 Mobile penetration, subscription per 100 inhabitants .................................... 36
Figure 13 Demand for uniform calling patter – Demand for telco services................... 37
Figure 14 Oligopoly matching prices ............................................................................. 44
Figure 15 Firm undercutting the prices........................................................................... 45
Figure 16 Bertrand-Nash equilibrium similar to Perfect Competition ........................... 46
Figure 17 Market share for the new entrant.................................................................... 48
Figure 18 Sunk cost commitment as effective................................................................ 48
Figure 19 An entry game of incomplete information ..................................................... 51
Figure 20 Czech telco concentration using the Herfindahl Hirschman Index................ 54
Figure 21 HHI index comparison according to APMS................................................... 55
Figure 22 Medium consumption basket price development [in CZK] ........................... 58
Figure 23 Keeping prices low strategy ........................................................................... 59
Figure 24 From undertaking the customer to higher prices............................................ 60
Figure 25 Digital Dividend auction and what is played for?.......................................... 61
Figure 26 Prices in LTE spectrum auctions.................................................................... 62
Figure 27 High consumption basket [in CZK] ............................................................... 71
Figure 28 Low consumption basket [in CZK]................................................................ 71
4
1 Introduction
1.1 From Monopolies to Oligopolies with Strategic Behaviour
A government cannot reinstate or secure competitiveness. Government is a monopoly
itself. If a government goes so far, that it requires individuals to have permissions to be
economically active and all it can do is to issue orders, it will only lead to monopoly
situation.
Isabel Paterson (1993)
A well developed, performing and nation/international wide competitive industry is
recognized as of significant importance for any country. Many countries intended to
undertake a shift from state monopoly structures towards oligopolies and further
towards free market structures erected on economic competition principles. The
monopoly structures had considerate economic power and therefore carried implications
for national infrastructure and regulatory affairs. New model structures erected on more
liberal principles of free supply and demand carry intrinsic ambition of continuous
strategic development and prospective self-realisation. It is important to keep in mind
that with more freedom comes more responsibility, where exactly the state monopoly
market elements lack responsibility which is present in a market where private
ownership and decision making dominate.1
With the rise of freedom and responsibility
the importance of strategic behaviour emerges, as an opposite to state managed,
irresponsible and many times un-strategic behaviour of monopolies. Not forgetting
about mutual interdependence, in an oligopoly a properly chosen balance between
governance and regulatory affairs has to be maintained. This thesis elaborates on
strategic behaviour in oligopolistic structures in a chosen industry using game theory
approaches and their application.
Industry the thesis focuses on, are the Czech telecommunications. Telecommunications
as presented by Sarkar, Cabusgi and Aulakh (1999) show behaviour of natural
monopolies. Further research by Valletti shows that the telecommunications industry
evolved into Natural Oligopoly structure. 2
In the observed oligopoly of Czech
1
“With Freedom comes Responsibility,” slogan is often used by liberal movement. First time used by
(Roosevelt, 2012).
2
Natural Oligopoly (other natural structure) – the industry is most efficient in its present state; other state
would not be natural and therefore inefficient.
5
telecommunications industry the aim of the thesis is to implement chosen approaches of
game theory as their origin lays in the economic theory of oligopolistic structures and
competitive behaviour. In the final stage the paper compares different game theory
models on the telecommunication market‟s size to characterize best measurement
approach. With the dynamism in the industry a possible shift in the strategic aligning of
the Czech telecommunications is proposed with its outlook in industry near future.
This paper is organized as follows. The introductory Chapter 1 states the reasoning
behind the motivation for writing the thesis and develops hypotheses. Chapters 2 and 3
are dedicated to introduction the history of Czech telecommunication industry and
actual market structure. Chapter 4 proposes a description of theoretical foundations of a
telecommunications oligopoly. Chapter 5 focuses on practical aspects and tries to apply
the theoretical approaches. Last Chapter 6 comments on the objectives of the thesis and
elaborates on the industry‟s close future.
1.2 Choosing the Topic
1.2.1 Telecommunications are Strategic
Telecommunications industry (telco) shows proof of being an attractive research subject,
because of its size and importance for any national economy. Organisation for
Economic Cooperation and Development (OECD) in its recent publication,
Communication Outlook 2011 postulates a constant annual growth rate of its
cumulative telecommunication market of 3.9% since 2000 (OECD, 2011). The
importance of telecommunication‟s size is illustrated by revenues comparison to annual
national Gross Domestic Product (GDP). Czech industry stood in 2009 with a 3.68%
share of the national GDP. This share belongs to the top five of all OECD members (see
Figure 1) outperforming most of the mature markets. On the other hand the OECD
statistics justifies the trend of diminishing share of telecommunications on national
GDP. In case of Czech Republic the share fell from its maximum of 4.38% in 2003 to
3.68% share in 2009.
6
Figure 1 Telecommunication revenue as a percentage of GDP [as of 2009]
Source: (OECD, 2011)
An alternative view is provided by European Union (EU). The OECD argumentation is
supported by its observations showing a similar trend to the previously mentioned one.3
In 2009 the Czech telecommunications accounted for 3.2% meanwhile in 2010 it was
3.0% share on national GDP, positioned approximately in the midpoint among observed
countries (see Figure 2). Interesting observation is that the countries joining the EU in
2004 and 2007 show higher shares than older EU member countries. Because of nonexistence
of older statistical data, Eurostat reports a 1% fall of telco revenues in the
period of 2006 - 2010.
Even with the downward trend identified, telecommunications industry must be still
considered of important size and of high importance for any national economy. This
claim supports the reason for choosing telecommunications industry as thesis subject.
Figure 2 Telecommunication expenditures as a percentage of GDP [as of 2009]
Source: (Eurostat Database, 2012)
3
Differences in methodology apply. OECD works with revenues/GDP ratio, Eurostat with
expenditures/GDP ratio.
3.2%
0.0
1.0
2.0
3.0
4.0
5.0
6.0
3.68%
0.00
1.00
2.00
3.00
4.00
5.00
6.00
Estonia
Korea
Portugal
Spain
Hungary
CzechRep.
Greece
Poland
Slovenia
Israel
Switzerland
Australia
Japan
U.K.
Belgium
Iceland
Mexico
OECD
France
U.S.
SlovakRep.
NewZealand
Germany
Canada
Netherlands
Denmark
Finland
Ireland
Turkey
Italy
Austria
Sweden
Chile
Norway
Luxembourg
7
1.2.2 Deregulation and Internationalization of Telecoms
Any industry is under the influence of global shifts. As stated by Waverman and Sirel
(1997) in pre-1980s the political and regulatory importance of telecommunications was
not on governments‟ high priority list. In these times it was usual that state owned
monopolies were used as cash cows for the state budget. The inefficiencies and rising
prices plagued the markets and were of major problem because monopolization case
simply failed to benefit customers as the remedies did turn out to have negligible
practical impact for the end in the final stage. Inefficiencies and prices pressures
together with the internationalization of telecommunications players started at end of
the 80‟s and beginning of the 90‟s an inevitable strong horizontal and vertical
deregulation processes. Countries were literally pushed into introducing changes in the
telco industry. These processes started first in United States (early 1980s) in and United
Kingdom (1981) followed by North (Denmark 1990) and West European countries
(France 1988, Germany 1989) accompanied by Asian ones (Japan 1986). After that in
the late 90‟s and beginning of the new millennia a good example of liberalization and
deregulation practise transfer to East-European economies took place (CESifo Group,
2010).4
The internationalization of telecommunication operators was the reason behind
deregulation. Not just telecommunications but many other industries were in the period
of the 80‟s and 90‟s “riding on a horseback”. Bill Clinton‟s rhetoric about, “each nation
is like a big corporation competing in the global marketplace,” claimed by Krugman
(1994) as being dangerous, showed the necessity of having high ambitions for every
individual, for businesses twice as much. As further researched by Sarkar, Cabusgi and
Aulakh (1999) a set of environmental forces of privatization, liberalization and
institutional changes together with firm-level strategic and scale related drivers led
towards globalization of telecoms. Kramer believes that it was eminent that telecoms
were undergoing a fundamental shift from an engineering-dominated sector to one that
was commercially oriented with high resilience towards business cycle (1993).
However the competition does not arrive overnight. Even state monopolies have had the
option of a pro-competitive behaviour or anti-competitive behaviour. Their strategy was
based on the government intentions and management capabilities. Push after
4
The deregulation process might be in many countries not finished yet, possible liberalization as well as
deregulation steps might continue.
8
deregulation was going against the cash cow paradox. Lower prices from deregulation
and new competitors worsened the profit generation capabilities if the company could
not adjust to these new conditions. According to Crandall and Winston (2003) antitrust
laws deter price fixing i.e. in an oligopoly even more than they should deter monopoly
behaviour. 5
The German think-tank CESifo which continuously researches mostly
OECD member countries still identifies minor weak points of state involvement in some
telecommunication structures, proving that further deregulation and demonopolization
opportunities might still lie further ahead. Situation in Czech telecommunications
provide prospects of introducing additional competition into the market together with
changes in the regulatory environment. More detailed concepts as opening new market
and new market entrant will be considered later in Chapter 4.4.
1.2.3 Regulatory Presence for Maintaining the Game
Each government has to take into account several important decisions as: the
technological standard, the timing and number of licences necessary for a network and
procedures by which the licences are granted. With the deregulation and liberalization
processes mentioned, the presence of governance bodies in charge for setting the rules
of the game is important. In the Czech Republic this role is undertaken by Český
telekomunikační úřad (Czech Telecommunication Office, CTU) and Úřad pro ochranu
hospodářské soutěže (Office for the Protection of competition, UOHS). The official
mission statement of CTU is;
“the Czech Telecommunication Office exercises state administration in the area of
electronic communications and postal services, including market regulation and the
determination of business conditions to substitute for the missing effects of economic
competition and to provide conditions for appropriate functioning of economic
competition and for the protection of users and other market actors until a fully
competitive environment is achieved.”6
UOHS focuses on creation of conditions favouring and protecting competition,
supervision, consultations and monitoring. In the process of liberalizing a market,
competition and sectorial regulatory bodies are closely related and often interact. The
market, meaning effective economic competition should be the sole determinant of the
5
Price fixing – see Figure 11 and Figure 11
6
It might appear entertaining when a governmental body declares its intentions of substituting missing
effects of economic competition…
9
market conditions. However Bovet and Gugler (2000) argument, that
telecommunications as parts of public services are essential elements of today‟s
economies and their determination exclusively by competition is hard to achieve and as
a consequence active regulation is necessary.
Apart from the Czech authorities the European Union (EU) plays a vital role. European
policy documents emphasise the role of technology and regulatory decisions as key
determinants of diffusion and development of telecommunications services. With its
European Regulatory Framework (ERF) for electronic communication it represents a
harmonised set of rules regulating electronic communications and services. Whereas the
European Parliament and the Council constituted the groundwork of ERF it is upon
European Commission the review the functioning of the directives, implements new
revision processes, conduct regulatory supervision and manage disputes. This complex
regulatory body stands in focus point, setting the main framework for European
telecommunications industries. Next, the guidelines and recommendations by
International Telecommunication Union‟s (ITU) are of high importance. As it is the
ultimate body for global allocation of radio spectrum, satellite orbits, technical
standards and others close cooperation has to be maintained. World Trade Organization
(WTO) guidelines under Global Agreement on Trade in Services (GATS) supervise
trade and market opening commitments in telecommunication services. Czech
telecommunications WTO commitments are subject of the GATS/SC/26 and
GATS/SC/26/Suppl.2 Schedule of Specific Commitments document. Highlighting
OECD, still there are other international and national bodies having eminent interest in
best practise telecommunications services.7
1.2.4 Public Pressure on the Situation in Telco Industry
Public debate and journalist interest are in many cases the evidence of that there is
something going on in a chosen industry. This assumption was used on Czech
telecommunications as well. The most significant indication of public concern about the
situation in telecommunications is a public from blog ongoing since 2009 Nechceme
předražené volání (We don‟t want expensive calls). This blog started a public awareness
campaign about the unsustainability and high price policy of telecommunication
services in Czech Republic. The campaign was called Napiš ČTÚ (Write CTU) and its
7
Detailed and case concrete regulatory overview is provided in Chapter 3.6
10
goal was to exercise pressure on the regulatory authority (and operators as well) because
of unsatisfactory governance of price competition among operators. With approximately
150 suggestions arriving to CTU offices it was an interesting manifest of public concern
(Peterka, 2011). CTU together with many experts and the general public expect the
problem of high prices to be solved with a new mobile operator market entry as well as
opening of wholesale mobile origination market services (opened as of April the 4th
2012).8
However, this process as it concerns a strategic industry takes some time. A
more detailed analysis of the market entry strategy is provided in Chapter 4.4 and 5.4
of the thesis.
The trend showing, how chosen daily papers and weekly business magazines reflect the
key development of public discontent with the high prices together with the media buzz
around the potential new operator in Czech Republic is provided Figure 3. First news
about possible structural market regulatory changes appeared approximately in October
2010 when CTU announced the procedures, requirements and actions necessary for the
new operator taking place in 2011. Through time it was clear that new entrant will not
be allowed into the market during that year. The actual date for new market entrant was
set 3Q 2012, unless new requirement alternations from Czech regulatory authorities
appear. The experts are despite that sceptical because the new entrant requirements are
too challenging and cost/benefit ratio analysis does not need to pay off for new as well
as present market player (ihned.cz, 2012). Finalizing the reasoning, it is very likely that
with continuous underdevelopment of services and regulatory unwillingness to
introduce changes to the market, the public dissatisfaction will rise. Apart from public
interest, businesses interested in entering Czech telecommunications in any way are
beginning to create pressure on the regulator. It is as well in their interest that changes
occur as they follow their company objectives in searching for any growth potential or
position securing tactics.9
8
Please see http://www.ctu.cz/aktuality/tiskove-zpravy.html?action=detail&ArticleId=9070 (Czech only)
9
Operators from West European are optimizing their operations in domestic markets because of new
alternative market entrants in their relevant telecommunication markets. They see Central and Eastern
European markets as yet not so highly competitive as their domestic ones.
11
Figure 3 How dailies and weeklies inform about Czech telecommunications? [hits]
Source: Draft by author, data from (ANOPRESS IT, 2012).10
1.3 Objectives of the Thesis
The thesis has 2 main objectives which have been chosen because of their importance
and relevance to the industry development in 2012and benefit which they can bring in
understanding specific conditions of a telecommunications market influencing the
strategic behaviour of industry competitors.
1.3.1 First Objective
Czech telecommunication industry is facing significant headwinds (as illustrated mainly
in Introduction and Market structure part). Introducing the industry‟s historical
prospects and actual conditions it‟s assumed of an oligopoly market. With the
introduction of theory of oligopoly and continuous methodology the first objective is;
To outline a theoretical framework for a telecommunications industry under three
member oligopoly. Proposing most important market typical circumstances under
which the market is working in its most common form together with outlying the
foundation of three most commonly used oligopoly equilibrium models.
10
The research was conducted on the time period of 27 months, from January 2010 to March 2012.
Reason for not choosing a longer period is technical restraint of maximum 3 year search query in the
ANOPRESS IT database. Research was undertaken by using a combination of key words: “oligopoly
AND telekomunikace”, “český telekomunikační úřad AND oligopoly” and “český telekomunikační úřad
AND trh”. In the category Daily paper were 8 newspapers. Category Weekly magazines consisted of 23
titles.
0
10
20
30
40
50
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q
2010 2011 2012
Daily paper Weekly magazines Total
12
1.3.2 Second Objective
This objective continues in the findings of the first objective. With the actual structural
changes in the telco industry, it stands in front of a complicated situation multiplied by
public pressure on prices, introducing regulatory changes in the industry and the entry
of a new market player.
With theoretical foundations provided in the first objective the second objective tries to
illustrate behaviour and strategy patterns among industry members using various
approaches, mainly game theoretic ones. The illustration should provide the reader
with possible understanding of present industry conditions with a possible short-term
outlook.
13
2 History of Czech Telecommunications Industry
For understanding key issues in an industry it is important to know its history and
development. Czech telecommunications industry consists of three present players;
Telefónica, T-Mobile and Vodafone forming a market structure of an oligopoly industry.
This chapter provides an historical overview through Czech telecommunications. It is
divided into three logical parts focusing on fixed telephony, mobile telephony and
privatization of state monopoly Český Telekom. The chapter focuses separately on
mobile and fixed voice services as they create the industry‟s dominant and historical
core feature (see Figure 4).11
Figure 4 Profit development in Czech telecommunications [CZK mil.]
Source: Author, Annual Reports, (Magnusweb Database, 2012)
2.1 Fixed Telephony
Few years after the end of II World War Czechoslovakia underwent major political and
structural changes which influenced its development for many decades. During the few
days of February 1948 the communist movement seized power and linked the country‟s
fate with Soviet Block. The soviet state planned economy model was chosen as
exemplary one to be readapted in Czechoslovak conditions. On the 1st of May 1952
with Governmental Resolution 13/1952 Ministerstvo spojů a pověřenectva spojů was
established as the central authority responsible for the administration of
telecommunications, post and telegraph network. Full centralization was achieved
during 1960 when the Ministerstvo spojů a pověřenectva spojů was merged with
11
Division into fixed and mobile services is very usual. Data services (internet, VOIP and others) then
belong under fixed and mobile as corresponding data subcategories.
12280
1,918
8,533
-4000
0
4000
8000
12000
16000
201020092008200720062005
Telefónica Vodafone T-Mobile
14
Ministerstvo dopravy (Ministry of Transportation). Yet this merger of ministries was
not a successful gamble and in 1963 they split again under the guidance of Centrální
Správa Spojů. With a Law no. 110/1964 the state monopoly on post and
telecommunication services under state owned Československé spoje was officially
founded.
Since the 1960‟s changes in ministry names and of the governance levels were regularly
occurring. First signals of structural faults in the telecommunications industry are
emerging at the end of the 1980‟s. This corresponds with the global trends presented in
Chapter 1.2.2 followed by deregulation and liberalization tendencies, as well as with
structural political turbulences occurring in the Eastern Block. In 1989 was founded the
Správa pošt a telekomunikací Praha, státní podnik. This company, again, responsible for
strategic sectors, was later of strategic market creation importance. On the 1st
of January
1993 with the dissolving of Czechoslovakia into two separate countries Czech and
Slovak Republic, two new companies had been created from dividing the one state
monopoly. In Czech Republic for telecommunications was responsible SPT Telekom
meanwhile Česká Pošta s.p. took over postal services.12
In 1994 was SPT Telekom
transformed into SPT Telekom a. with 100% ownership held by Czech National Fund
(Fond národního majetku) falling under the government.
On the 10th of August 1994 the Czech government proposed a strategic plan for its
telecommunications policy in next five years. Document was called Hlavní zásady
státní telekomunikační politiky (Main Principles of the State Telecommunication Policy,
MPSTP). Ten objectives of this document should have provided an exemplary method
of introducing liberal values into a former strictly monopolized industry.
Main Principles of State Telecommunication Policy (MPSTP)
1. Till 2000 the supply of telephone stations should be doubled and network
quality should be improved. Rise in supply shall be reached equally, cheaply and
with the highest possible involvement of Czech industry.
12
With separate but mirrored governance structures similar demonopolization and liberalization processes
occurred in both new countries.
15
Main Principles of State Telecommunication Policy (MPSTP)
2. Objective 1 should is to be achieved with securing SPT Telekom‟s monopoly
market position in the international, nationwide and local call markets.13
3. Objective 2 should be valid till 2000.
4. The entry of strategic investor into SPT Telekom should be facilitated.
5. Ministry of Economy was responsible for the Objective 3 processing. The new
investor should have opted for 27% stake in the company and competences this
share.
6. State‟s ownership will not fall under 51% share. The government will consider
another round of privatization.
7. State regulatory framework to be established till June 30th of 1995. Regulation
of tariff policy, market entry, customer–provider and frequency spectrum rules
to be put into practice.
8. The entry of new players should be allowed in some local networks as they were
intended to co-develop the network with SPT Telekom.
9. The interconnection fees between the new market entrants and SPK Telekom are
to be decided by them. If they cannot come to a conclusion Ministry of Finance
decides.
10. Two licences for GSM mobile network should be offered.
Even with proclaiming liberalization intentions by the government, the new
telecommunication strategy was erected on mixed and contradictory rules still
guaranteeing a single monopoly nationwide market participant SPT Telekom. Local
network entrants could not compete with the state monopoly. The monopoly was used
as a cash cow to mitigate the faults in state budget (Markoš, et al., 2002).
In 1999 Czech government valorised the MPSTP and introduced a new strategy Národní
telekomunikační politika (National Telecommunication Policy, NTP) as of
14th April 1999. The scepticism about the 1994 strategy as rather being a restructuring
13
Exemptions applied.
16
than liberalization process was eminent, yet the authorities declared it as successful in
many ways. Practical implementation of new NTP was enforced by new
telecommunication Law no. 151/2000. The goal of the NTP was obligatory high
importance of telecommunications playing a vital role in Czech economic growth. Its
aim was to meet the needs of private and business customer base with quality tailored
services corresponding with the EU‟s requirements. NTP consisted of many
counterbalancing acts, on one hand it presented deregulatory measures in government‟s
involvement on the other hand it introduced the role of established regulatory authority
CTU (Peterka, 2011). The patronage over SPT Telekom‟s monopoly was ended in 2001
whereas only with telephone number transferability and distant calls operator selection
procedures coming into action in 2003 it is possible to talk about most significant
liberalization steps (Peltrám, 1999).
2.2 Mobile Telephony
First subject with its business focus on mobile network coverage was Eurotel Praha
founded by Správa pošt a telekomunikací (51% stake) and Atlantic West (49% stake) on
16th November 1990. The company‟s strategic goal was to develop mobile and data
communication networks. Meeting this objective the company was backed by the
government‟s generosity and received a guarantee of monopoly position in network
operations matters (similar with Fixed Telephony). Its analogous Next Mobile
Technology (NMT) network was launched on September the 12th 1991 facing problems
as the need of customer education and extremely high prices of mobile telephones.14
Significant shift in mobile telephony occurred in 1996. Corresponding with 1994
MTSTP, GSM licences were to be granted. (Not) surprisingly one was awarded to,
logically in that time already former monopolist Eurotel, launching the new network on
the 1st
July 1996. Second license was awarded to České Radiokomunikace in a
partnership with foreign consortium Cmobil B.V. (Deutsche Telekom holding). The
company started its GSM mobile telecommunications network called Paegas on the 1st
September 1996. This duopoly environment provided outlooks for a fall in prices and
more rapid spread of mobile telecommunication services. Illustrated by Markoš (2002)
Eurotel„s yearly Average Revenue per User (ARPU) fell in 1996 CZK 4000 to CZK
14
NMT technology is often referred to as 2 Generation (2G) technology
17
2500 on 1999. 15
Paegas experienced an ARPU fall in the same period from CZK 2500
of CZK 1000. With expectations the most vibrant development was to be expected with
the entry of 3rd operator.
In March 2000 Český Mobil launched its Oskar GSM network further pushing on price
competition, but already experiencing first problems with market saturation and that the
most attractive customers were already split among former duopoly members – Eurotel
and Paegas. In its first year in business Oskar performed with CZK 400 ARPU with
pushing Eurotel towards CZK 1500 and Paegas to CZK 1100 ARPU. State agreed to
three member oligopoly in telecommunications, but there was always room for
improvement. However, tougher price competition than in a monopoly or duopoly
market was eminent for some time horizon. Mobile telephony underwent a boom period
with fixed telephony significantly lacking behind Mobile because of customer
attractiveness, modern technology and remaining state monopoly of SPT Telekom (see
Figure 5). Further market development is characterized by Paegas‟s rebranding to TMobile
in 2002 and of Oskar„s transformation to Vodafone in 2004.
Figure 5 Mobile and Fixed network usage [in thousands]
Source (Czech Statistical Office, 2012)
2.3 Incumbent Český Telekom going Private
Fulfilling Objective 5 of MPSTP (entry of a new investor into SPT Telekom), during
1995 consortium TelSource acquired a 27% 5 year stake in the company. As TelSource
expressed no continuous interest of taking over the company accompanied by its final
retreat from all investor positions later on in 2003, the search for new strategic investor
15
ARPU/month – Average Revenue per User is a standard financial measure tool in telecommunications.
0
4,000
8,000
12,000
16,000
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Fixed Lines (total) Active SIM cards (total)
18
began.16
During 4Q 1999 Czech government declared intentions of SPT Telekom‟s
privatization as it was nearing the end of its state guaranteed monopoly market position
(Objective 2 MPTSP). The process of introducing a new strategic investor into SPT
Telekom was set to motion, however it was a complicated and long one. Conforming to
this process at the beginning of 2000 SPT Telekom changed its name to Český Telekom
(Czech Telecom) to more clearly express the nature of its operations.
With a similar development as in Figure 5, all operators were facing during the first
years of new millennia headwinds from the need of significant investments into new 3rd
generation UMTS networks as the market conditions demanded faster and more reliable
mobile services. Simultaneously with liberalization processes of telephone number
transferability and distant calls operator selection procedures (Law no. 151/2000), the
attractiveness of SPT Telekom and whole Czech market was facing a fall in
attractiveness in the eyes of foreign investors. The government‟s priority was to create a
compact operator to be offered to potential investors. For this reason the remaining
stake of 47% in Eurotel was bought back from Atlantic West. After paying out the
investor with USD 1.05 bil. the government succeeded to gain 100% control over the
company. Consequently it was merged with Czech Telecom forming an incumbent
operator focusing on fixed, mobile voice and data services (Anderson, 2004). During
2004/2005 the process of Czech Telecom going private still continued. From former
five parties interested, only three remained with Spanish Telefónica S.A. taking over the
initiative. With Government Resolution 407/2005 Telefónica was announced as the
winning party of the long privatization process lasting from 1999 for almost five years.
With this the privatization process of Czech Telecom was fully completed.
With no government ownership stakes in any of the subjects a three participant
oligopoly environment is identified since 2005. Yet the reader should not forget that all
three players have been present on the market since 1999, one of them was the
described Czech Telecom undergoing privatization. Next chapter is focusing on the
description of the thesis most recent 2010-2011 Czech market conditions.
16
More on TelSource‟s decision: http://www.earchiv.cz/b00/b0831002.php3
19
3 Market Structure
After the insight into history of Czech telecommunications industry the following
chapter focuses on describing the most update market situation as a whole (as of spring
2012), describes the market players and provides overview of the regulatory and legal
framework valid in the industry. The market is dominated by three main players
introduced in the previous chapter (Telefónica, T-Mobile and Vodafone) taking
approximately 80% share of the industry sales. Telefónica thanks to its historical
monopoly heritage still holds the largest share (44%) thanks to the wider service
spectrum offering than the competitors.
3.1 Fixed Telephony
The growth expectations in telecommunications for Czech Republic might be biased.
The overall revenues in the Czech telecommunication industry accounted approximately
CZK 126.5 bil. for 2010 with annual 4.8% fall (see Figure 6). The industry accounts for
3.68% of Czech GDP, one of the biggest figures in the OECD comparison (see Chapter
1.2.1). Yet the downward trend is likely to continue in the years to come.
Source: Company ARs, author’s calculation
Fixed telephony trend has been declining since 2000/01. This was caused by the fixedto-mobile
substitution trend. Fixed network penetration was 38%, down from 80%
penetration at the beginning of the century. This is reflected in industry revenues, which
accounted for CZK 45.9 bn. with annual fall around 3% in 2010. Although further
decline is to be expected, the downward move, which was mainly due to decline in
5660656361
1920212019
29
30
333229
130
137
145145
138
20102009200820072006
Telefónica Vodafone T-Mobile CZ Telco
Figure 6 Industry revenues [CZK bil.]
20
voice services, is slowing down as market finds some support points, aided by the
development in fixed data access services (Český telekomunikační úřad, 2011).
Fixed broadband connection revenues partially substitute the outage from voice services.
Number of connections more than doubled from 2006, reaching 2.8 mil. in 2010.
Telefónica holds a leader position on this market taking 36% share with its DSL based
technology – taking advantage of existing fixed line network (Český telekomunikační
úřad, 2011). The only biggest competitor is UPC with fibre technology, aggressively
attacking not only households but Small Medium Businesses (SMB). Wireless
broadband technologies in the Czech market are a phenomenon.17
They grew vividly in
the past due to the very low quality of internet service quality provided by Telefónica
via fixed lines. This also promoted the exodus of Telefónica customers and the result is
second largest number of Internet Service Providers (ISP) in whole EU - 1800 providers
(Český telekomunikační úřad, 2011). The market is therefore as a consequence still
fragmented between small local operators, but there have been some consolidation
moves both within operators themselves and in the form of horizontal acquisitions by
the major players. Both Telefónica and T-Mobile declared intentions of horizontal
integration.
In 2009, T-Mobile acquired share in České Radiokomunikace. By this move it entered
the fixed broadband DSL market where it currently claims second position. It reported
100 000 customers at the end of 4Q2011 creating with this step dynamism in the
segment (T-Mobile, 2012). Telefónica answered by continuous deployment of advanced
Digital Subscriber Line xDSL technology with intention to retain customers with most
favourable ARPU.18
The market trend forecast by the Czech regulator, however, routes
towards the falling shares in xDSL technologies with fibre and mobile gaining on
momentum in the period of 3/4Q 2012.
3.2 Mobile Telephony
Mobile market experienced significant growth in previous years but the penetration
reached high level and the market indicates saturation. There were 14.4 mil. active SIM
cards in 2010, with only 0.9% y-o-y change. The players therefore increase the
17
Wireless broadband services belong under fixed voice. This information was obtained by interviewing
Telefónica staff.
18
The prefix x in xDSL, is used as there are more yet very similar technologies of DSL connections.
21
competition for customers. This is to be identified corporate and SMB segment, where
the market participants possess higher bargaining power. The industry trend is
continuously declining sales in mobile telephony. Overall revenues fell by 3.1% onto
CZK 45.9 bil. With growing customers base a fall in annual ARPU, from CZK 5764 in
2009 to CZK 5229 in 2010, -9.3% change. This was for example driven by special tariff
offers with unlimited calls by all operators (Český telekomunikační úřad, 2011).
Figure 7 Market shares in mobile industry for 2Q 2011 [in %]
Source Company ARs, author’s calculation
Telefónica competes with T-Mobile for the first position in the mobile market, both
having around 38% market share. Vodafone continuously improved its position since
2000, mainly by taking the share from former hegemony Telefónica. The situation
stabilized and the shares have been almost flat in last 4 years. The main concern
regarding the future is the possible development in case of new major competitor entry.
Telefónica has to be prepared to defend its position and not allow repeating the story
with similar script as happened in the Vodafone one. Although there have been some
pressures on prices on the mobile market, the expenditures of the Czech customers on
communications take a not negligible share of their overall consumption expenditures
(see Figure 8).
Internet mobile market is growing rapidly. According to Analysis Mason, this is
expected to account for almost half of all non-voice revenues of telco operators (Kende,
2011). The current trend is led by continuous expansion of 3 Generation (3G) mobile
broadband networks among all operators. Telefónica and T-Mobile are leaders in this
37%
37%
26% 38%
38%
23%
Telefónica
T-Mobile
Vodafone
Customers
Revenue
22
field as well.19
Telefónica covered more than 65% of population with 3G network in
3Q2011. T-Mobile recently announced even more comprehensive coverage of 80%, a
great step from only 37% in 4Q 2010. This can be explained by the infrastructure
sharing agreement signed between Telefónica and T-Mobile.20
The cooperation is based
on complementary 3G stations development with aim of faster network deployment and
investment cost reduction. When announced, Telefónica coverage figures at least
matched T-Mobile ones. Vodafone slightly differs in its mobile broadband strategy. It is
based on its own 3G network and CDMA sharing service with MobilKom (owner of
U:fon network). This company has recently filed for insolvency thus further cooperation
is uncertain.21
Growing mobile internet is certainly promising trend but requires significant
investments which will increase with advanced technologies such as 4G, which are
supposed to be introduced by a new market entrant in 2012. These investments are not
yet fully reflected in the revenues, as operators focus on customer acquisition through
special discount offers. The negative trend observed in traditional voice services is
therefore prevailing.
Figure 8 Household expenditures on telecommunication services
Source (Český statistický úřad, 2012)
19
3G network has many subtypes. The one primarily used in Czech Republic is Universal Mobile
Telecommunications System (UMTS)
20
The case of infrastructure sharing belongs to the competence of UOHS. See Chapter 3.7
21
As company claims on its site. Problems occurred mainly due to CTU bad regulatory policy and
competitor hostile behaviour.
1542
1823
2156
2507
2779
3123
3222
1.82
2.09
2.37
2.58 2.67
2.78 2.79
0
0.5
1
1.5
2
2.5
3
0
1000
2000
3000
4000
2003 2004 2005 2006 2007 2008 2009
Average yearly fees [CZK/1 mobile] % from total consumer expenditures
23
3.3 Telefónica CZ
Telefónica Czech Republic is an incumbent operator providing telecommunication
services under O2 brand. As the integrated provider, the company offers full range of
Convergent Telecommunication Services – operating both in fixed and mobile networks.
Its business activities are primarily concentrated in the Czech Republic; mobile
operations are also run through a subsidiary in Slovakia. Spanish mother Telefónica,
S.A. gained control in 2006.22
Its shares are quoted on the Prague Stock Exchange and
traded in form of GDR on the London Stock Exchange as well. The parent company is
the major shareholder keeping 69,41% stake.
The company operates more than 2.8 mil. fixed lines. Mobile services are delivered to
approximately 4.9 mil. customers in Czech Republic and over 1 mil. in Slovakia. Its
revenues are almost equally split between the fixed and mobile segments, with mobile
accounting for 56%. The backbone of the company operations are voice services which
therefore represent the dominant revenue source (50% in fixed, 70% in mobile). Voice
is experiencing decline in line with the market development. On the other hand, data
services are getting a larger part of the revenue pie.
In fixed telephony, company as the sole provider on the Czech market fights the
declining trend by providing internet connection which now accounts for 25% of fixed
revenues. Its 2011 launch of VDSL brings better connection for customers. This moves
help to mitigate the churn of the most profitable customers. Company also started
buying local WiFi providers to extend the customer base. This will have positive impact
on revenues as well. Other services, IT and ITC solutions for public bodies and
companies, generate solid revenues but this business is at best stagnant in the uncertain
economic environment. Company is also venturing in modern services such as IPTV or
Voice-Over-IP to keep pace with the development on the markets.
Mobile segment is hit by downturn market (-10%). Customers cut the expenses on
traditional services during crisis and further optimized their behaviour by subscribing in
large for tariffs with premium flat rate offers. The company is focusing to migrate its
customers from prepaid to post-paid contracts, where it records higher ARPU. However,
the newly acquired customers diluted the ARPU. The revenues drop of CZK 10 bil.
22
Convergent telecommunication services represent the migration of various services under one umbrella
– into a single network. One can imagine it as an integration and unification of branding, policies,
technologies within one company.
24
(44% y-o-y) of outgoing traffic charge was only partially covered by CZK 6.9 bil.
growth in the monthly fees. The regulation in terms of Mobile Termination Rate (MTR)
cuts and EU roaming limited prices also has negative impact on revenues.23
The company is stressing importance of smart phone sales (over 50% of device sales in
2011, penetration reached 17,4% in 3Q2011). The 3G network deployment is in the
final phase. These activities will strongly support revenues from mobile internet, which
is the main market trend.
3.4 T-Mobile Czech Republic
Corresponding with the 1994 Czech government‟s intentions of introducing competition
into the telco market a consortium led by CMobil B.V. won the licence for a GSM
network in 1996. With the licence in hand in the same year the company RadioMobil
was founded. On the 30th of September it began operating its mobile network Paegas.
In 2002 was Paegas renamed to T-Mobile and the consecutive year of 2003 the legal
name of the company was changed to T-Mobile as well. The actual ownership structure
in the company is CMobil B.V. with a 60.77% and TMCZ HOLDCO with 39.23%
stake belonging into the sphere of German T-Mobile group.
The acquisition of České Radiokomunikace mentioned before did not led to simple
broadening of service and product portfolio. As Vodafone became a company capable
of delivering convergent services by its acquisition of BroadNet Czech, T-Mobile
followed the same goal when acquiring České Radiokomunikace. With this act the
company became the last of three operators delivering convergent services. T-Mobile
owns three licenses, GSM since 1996 in ownership till 2015 and two UMTS licences till
2024.
The company is facing contradicting trends from its predecessors. In 2011 it suffered a -
1.7% y-o-y fall in customers taking in est. 5.3 mil. This customer outflow started in
2010 when the company customer growth was on verge with only 0.2% y-o-y change.
Fall in customers is accompanied by a significant fall in revenues of -8.2%. The change
was from CZK 29.3 bil. in 2010 to CZK 26.8 bil. in 2011. As a consequence of price
competition the company experienced an ARPU fall of CZK 37 y-o-y basis.
23
The regulation is described separately.
25
3.5 Vodafone Czech Republic
The company entered Czech market as Český Mobil acquiring a GSM 900/1800 licence
in 1999 and starting commercial operations in 2000 under commercial brand Oskar. The
company entered duopoly market conditions of former Český Telekom and Paegas and
was betting on price competition with focus on customer migration. Because of its
ferociousness and innovation potential the company was numerous times nominated for
World Communication Awards. During 2004 the company underwent legal change of
name from Český Mobil to Oskar Mobil. With significant changes on the horizon in
2005 was the company acquired by international carrier Vodafone. In 2006 was the
company name changed to Vodafone Czech Republic which is still in its official name.
With its historical focus only on mobile telephony and internet the company decided to
broaden its portfolio horizon. In 2008 with the acquisition of BroadNet Czech became
the company capable of offering as fixed services for business customers. With this was
the company nearing Telefónica„s portfolio offer becoming capable of delivering
convergent services (all-in-one) and becoming a complex telecommunications operator.
The company falls under the globally active Vodafone International group.
Beside the 2nd generation (2G) GSM 900/1800 licence valid for 20 years, the company
expanded its services by acquiring a second 20 years license for a 3rd generation (3G)
UMTS network licence (est. CZK 2 bil.). With this strategic move was the company
capable of deploying higher quality internet services for its customers, although with
comments from the company that 3G benefits according to 2G ones‟ might be
exaggerated (Peterka, 2008). On the other hand the company stated that 3G investment
is a logical in future expansion potential into 4G Long Term Evolution (LTE) network
capacities.
Although facing revenue decline as illustrated in Figure 6 the number of clients is
continuously rising over this period. Reaching est. 2.9 mil. customers in 2008 the
company acquired in next 2 years 270 000 new customers reaching about a 3.17 mil.
customer base. The trend of falling revenues and rising customer base is due to more
fierce price and service competition on the customer side. The company as 3rd operator
facing obligatory challenges of market saturation had to cope as well will points of sale
strategy issues. With pioneer internet in services putting high importance is put on
26
developing store chain. In 2011 the company had 5500 points of sale with 133 own
branded stores and 56 franchise stores.
Figure 9 ARPU fall in the last 9 years [in CZK]
Source Annual Reports, company websites
3.6 CTU – The Doubtful Regulator
Telecommunications is a highly regulated industry. It provided a certain amount of
comfort for operators in Czech Republic, but recently it started showing significant
threats for them. Czech regulator created till now comfort by preventing entry of 4th
proper competitor and not enforcing opening of the wholesale mobile market for Mobile
Virtual Network Operators (MVNO) so far. The oligopoly market structure with
favourable margins is sustained for now. The question is, for how long. The recent
development, however, indicates worsening regulatory conditions. The EU cap on
roaming prices applicable since July 2011 causes decreasing revenues with direct
impact on earnings industry wide with possible outlook on further decrease.
The regulator does not exert governance on the telecommunications market as a unified
entity. CTU divides the telco market into so called Relevant Markets (RM). In effect are
two methodologies for RM categorization. The OOP/1/07/2005-2 divides the telco
market into eighteen RMs meanwhile the newer OOP/1/02/2008-2 into twelve RM.24
Yet the division of the markets is in general not important for the means of the thesis as
they provide particular insights. What is more important is the authority of CTU the
24
The distinction between the two approaches follows the regulatory steps of the EU. Both of them
interlap and complement each other and most importantly are still used in telco praxis.
423.7
380
350
450
550
650
2003 2004 2005 2006 2007 2008 2009 2010 2011
Telefónica T-Mobile Vodafone
27
identify market subjects with significant market power and in some particular markets
induce price regulation (2005). To be identified as significant market power can have
several implications from operation and technological aspect towards amendments
because of sovereign position misuse. Based on identifying a subject as significant CTU
can but does not need to exert price regulation. Only Telefónica accounts for est. three
price regulations, the other operators are without price regulating ordinances. An
exeption is the MTR market. no. 16 in the OOP/1/07/2005-2 and no. 7 in the
OOP/1/02/2008-2 methodology. This price setting influences all three major operators
on regular, est. half yearly basis. Regular price cuts in the Mobile Termination Rates
(MTR) have negative impact on the revenues, but this item also enters the cost side, so
this change can be interpreted almost profit neutral (mentioned before in influencing
Telefónica Chapter 3.3.).25
The variation comes in only from technicalities as operators
charge per second rates among themselves, but the customer is charged for each started
minute. The overall regulatory expectations are determined by two cross-linked major
events.
3.6.1 Mobile Virtual Network Operator
A MVNO is an alternative on the market whereas the operator does not own a licence
for a frequency and so does not own any infrastructure. The MVNO leases a whole part
of a network from an already established network operator. The case of MVNO is
accompanied by media buzz, as illustrated in Chapter 1.2.4. The regulator had to react.
For a long period of 2010 and even before, CTU was aligned behind its standpoint that
the telecommunication market provides the space for an entry. The entry should have
been negotiated out between the potential new MVNO entrant and a host network
operator (one of the three operators).26
Office states this in official replies to the letters
of the Napíš ČTÚ initiative (Český telekomunikační úřad, 2011). Logically, no operator
wants a new competitor, but that was not CTU‟s concern. Following the RM division,
the office investigates the RM‟s for any evidence of breaching the industry rules. The
mobile origination service RM no.15 was considered as fully competitive and so it was
closed with no possibility of entering it. This was the problem for MVNO‟s, they
25
Mobile Termination Rate is a fee mobile phone operators charge their industry peers to terminate calls
on their networks and are a significant input cost when providing the retail service of fixed-to-mobile and
mobile to mobile calls.
26
The host operator provides the contracted capacity of its network based on the contract details.
28
needed this market open. The CTU‟s statement that MVNO had to bargain with one of
the three operators was not correct and caused confusion (Peterka, 2011).
Change occurred on the 30th November 2011 when CTU announced by measure
OOP/1/XX.2011-Y that RM no.15 is no longer competitive and its opening is being
reconsidered after further revision will be undertaken. Office anticipates in case of
definite changes to RM no.15 are to occur, the best would be to connect them with the
digital dividend auction. Yet, with the process of auction in 2012 gaining on momentum
the CTU‟s MVNO proposed roadmap is according to experts unsatisfactory. New
MVNO can be set up only on a new or prolonged licence. This process can take up to 6-
7 years. According to Peterka (2012) the real reason can be that the current operators
rather than being afraid of new full market entrant are afraid of a MVNO entrant.
Possible MVNO price wars can be more destructible in the eyes of the old three than a
market entrant who maybe won‟t even come.
3.6.2 Digital Dividend - New Operator Entry
The second determinant of regulatory expectations is the frequency spectrum auction
often called Digital Dividend (DD). This auction is focused on introducing Long Term
Evolution (LTE) network services into the national telecommunications market. The
LTE networks are so called 4 Generation (4G) networks focused on high-speed data for
mobile phones and data terminals.27
It is important to not forget that frequency package
capable of running LTE network is just a part of the DD. Some remaining frequencies
are in the DD process introduced as wee. High importance is paid on the LTE network
because of its attractivity and future potential, meanwhile remaining free 3G
frequencies might be considered as less attractive because of market saturation. DD is a
complex process of transformation analogous parts of the frequency spectrum to digital
ones, frequency auction itself and improvement of other services related.28
The purpose
of this process is the maximization of DD‟s economic value. This economic value is
described by Kramosil (2009) in three dimensions: socio-economic dimension, the
frequency spectrum efficiency/technological development and telco market benefits.
27
The most widely used technology is 3G.
28
Frequency Spectrum is a list of radio frequencies with their stated purpose. The owner and maintainer
of the frequency spectrum is the state. The operators own licences for some of these part and have their
networks set upon them.
29
With the DD‟s procurement processes, legal actions and expert discussions starting
already in 2008, nothing significant was happening till spring 2012. Similarly as with
the MVNO, the CTU was facing the critique of the Napíš ČTÚ initiative for not acting
promptly in these matters and so not following the interests of end customers.29
Ground
breaking shift in the DD process happened on 22nd
March 2012 when CTU informed
about the start of the selection procedure on the 22nd
June 2012. With a series of
procedural steps, with no circumstances influencing the timetable of the auction, the
results of the DD auction should be known in December 2012. This process might lead
to introduction of a fourth operator on the Czech market (Český telekomunikační úřad,
2012).
The solution is though, not so easy and straight forward. The auction faces several
issues as; technicalities of setting up the network, the price of this licence (whole
spectrum offered costs est. CZK 9.2 bil.), time of 5-6 years for the process of set-up.30
Important fact is that also all three operators have the intentions to take part in the
auction, so maybe there will not be even a new entrant (Peterka, 2012). Most recent
news, as of May 2012 is that CTU has to literally look for a party interested (ihned.cz,
2012).
As it seems the road towards Digital Dividend and changes in oligopoly member has a
still long way to go. The remaining three operators will pursue various means for
lobbying against any changes in the market structure as the actual status-quo is for them
suitable. The one who will still be left in “change expectations” will be the end
customer, as the changes are promised to arrive but no one knows when (Peterka, 2012).
3.7 Safeguarding the Competition
Doing business on a free market is like a competition. The companies are in some cases
tempted to bypass the mutual competition and set their own rules.
UOHS
All the changes in the regulatory environment are heading towards final phase where all
sector specific regulation is being substituted by purely competition based regulation.
29
One should not forget that higher competition would create pressure on price level.
30
The frequency spectrum is not put into the auction as a whole. It is divided into several small parts, and
more combinations of these parts are possible.
30
The ex-ante regulatory efforts of CTU and UOHS‟s ex post ones‟ converge. In fact,
regulation disintegrates on its own. However both organs are not to lose their positions
as the UOHS competition decisions are case specific meanwhile CTU sets the
framework so that the question of minimizing transaction costs is still not answered
(Modernizace soutěžního práva se dotýká i telekomunikací, 2004).
The first predecessor of UOHS was founded in 1991. UOHS‟s modus operandi is set up
by laws no. 272/1996 and 187/1999.31
The office has 3 main areas of focus: ensure that
the market behaviour is in compliance with competition rules and benefits the customer,
supervising public procurements and check-up on state aid provision policy. In telco the
competition rules play the priority, usually with ex post cases of punitive findings
against market distorting behaviour. The competition rules are maintained by law no.
143/2001, particularly interesting part of this law is co called Leniency programme
where specific cases of cartel behaviour are tolerated!32
3.7.1 Cases in Czech Telecommunications Industry
Without going into details of legal steps of procedural actions and punishments
enforced by UOHS, the office informed that former state monopoly Český Telekom was
in its past existence back from 2005 the most often punished company overall (UOHS,
2005). With this the former state monopoly not only lacked management competence
but basically breached the rules set by its major shareholder.
From approximately eighty five cases where a punishment fee was to be paid, which
were classified as maximal ones in the office‟s history, eleven cases involved the three
biggest actual market players. The violations ranged from the misuse of dominant
market position to cartel behaviour. The most evident cartelization was identified in
2000/2001 where Eurotel, T-Mobile and Český Mobil came to a mutual agreement on
common business conditions. UOHS found out about this situation and bestowed a fee
of CZK 44 mil.33
Part of this procedure fell under the Leniency programme and some
amercements were lowered.
With the competition rules numbers infringement falling down in recent years (most of
them in 1/2 of 2010s), man can anticipate improvement in corporate behaviour or only
31
First legislative acts in Czech lands treating competition rules (cartel practises) was during the Austrian
monarchy in 1870.
32
Toleration in this case means that a punitive amercement might be forgiven or significantly lowered.
33
This price is far from big. Český Telekom received a CZK 210 mil. amercement in 2004.
31
more sophisticated rules breaching. Sure is that, the legislative is becoming more
forcible and companies need to take into account the rising interests of their
stakeholders. The challenge for UOHS in the near future is the entry of a new player
into the market.
4 Characterizing a Telecommunications Oligopoly
4.1 Basic Assumptions
The previous chapters illustrated a process of a shift from state owned monopoly
structure towards introducing free market principles based on competition, liberalization
and privatization. As showed, this process usually gets stuck somewhere in between
these two extremes. The presence of a small number of competitors on the market
which act strategically, but they are aware of their market peers is called an oligopoly.
Each oligopoly is built upon strategic interactions arising among its members. With
taking each other‟s actions into account the firms collectively realize that the actions of
one firm affect firm-specific demand curves of all members of the oligopoly industry. It
is acknowledge that price and output choice strategies made by one, affect the benefit
formation performance (profit generation) of others and lead to mutual interdependence.
For that reason oligopoly belongs to imperfectly competitive market structures.
For fully understanding the oligopoly structure fundamental assumptions have to be
valid for the structure for being considered as an oligopoly. Katz & Rosen (1994) derive
from monopoly and perfect competition four assumptions valid in an oligopoly.
Four fundamental assumptions:
1. Oligopoly members are price makers. Firms decide on price policy on their
own, but they recognize that their actions have impact on their competitors‟
behaviour and so have clear impact on whole industry‟s strategic pattern.
2. Members behave strategically. Strategic behaviour in this situation is a logical
consequence as both monopoly and perfect competition do not provide the
opportunity for alignment of strategic behaviour. The single monopoly power
does not need to think strategically. The perfect competition on the other side
32
does not provide space for strategy development as the high number of
participants makes it hardly possible.
3. New entry into the market might be completely blocked or perfectly free.
Meanwhile perfect competition allows and monopoly blocks market entry, the
oligopoly provides different results under different conditions.
4. Buyers are price takers. In the market is no space for shifts in influencing the
market price. Even with the customers publicly discontent with the actual
situation they have to accept the oligopoly‟s price conditions with no or
insignificant room for bargaining.
4.2 Market Structure Circumstances
4.2.1 Seller Concentration – Size and Number
The number of firms in an industry affects the degree of strategic behaviour and the
extent of price making/taking bargaining process on the seller-buyer side. With many
firms in the market, an action taken by any of them has insignificant impact on the
others. In contrast with relatively few market participants, each player is a significant
part of the market and firms carefully follow all the mutual interdependencies in place
(Soukupová, a další, 2004).
For the degree of concentration is commonly used the Herfindahl-Hirschman Index
(HHI) as a measure of the size of firms in relation to the industry. This index is used by
for ex. the U.S. Department of Justice, the Federal Trade Commission (DOJ-FTC
(2010)) to measure market concentration for antitrust purposes. Corresponding with the
DOJ-FTC methodologies, market below 1500 is “un-concentrated” (perfect
competition), between 1500 and 2500 “moderately concentrated” and above 2500
“highly concentrated” (monopoly). Another way of measuring seller concentration is
Concentration Ratio, but for further requirements of the thesis is not used.34
Further
evidence will be provided in Chapter 5.4.
34
UOHS does not provide any methodical tools for measurement of concentration on any market. In 2010
the office conducted some concentration of measurement in agricultural sector with no further
measurements. Into some extent the concentration is followed by CTU with the HHI index but it does not
provide any information regarding methodology.
33
4.2.2 Costs and Pricing
Fixed and common costs35
are substantial as the telecommunication industry requires
constant research & development, telecommunications network maintenance and
amplification. With this, each market participant shows out high sunk costs because of
licence purchase at the beginning of its market operations. The relatively low marginal
cost (MC) and Long Run Incremental Costs (LRIC)36
do not allow covering total costs
incurred to the company. The practise of low marginal costs is due to the fact that it
does not matter how many subscribers use the network.37
Cost based pricing tools are common for oligopoly market structures. With falling
average variable costs from operations a price mark-up strategy is of best application
(Haucap, 2003), so that the prices actually exceed the marginal costs. The firm needs to
identify the absolute minimum price it must obtain from its customers. To this
minimum price it adds a margin usually consisting of two components (see Figure 10).
The first component covers typical operation maintenance cost necessary for keeping
the network running into extent the customers do not experiences any network outage.
The second one creates the profits the company wants to reap. This second component
is on the operator to decide. As Fergusson (1993) claims most usual is to set a
percentage which should reflect the general practise in the industry, with other options
as analyzing the demand size or the behaviour of competitors. This pricing methodology
leads to price aligning among the operators. From indirect price aligning is just a step to
managed price aligning and so towards a possible cartel situation in the industry.
35
Costs not assigned directly to any particular business unit or sector.
36
LRIC models are used in telecommunications regulation to determine the price paid by competitors for
services provided by an operator with significant market power. Some literature can understand under
LRIC - Long Run Investment Costs. For more information see (Courcoubetis, et al., 2003)
37
Based on an interview with telecommunications expert it does matter, as a “full” network has quality
issues.
34
Figure 10 Mark-up pricing
Source (Ferguson, et al., 1993), Author
The other approach is very similar, where (Price Policies and Theory, 1954) identifies
similarities with price mark-up approach. With telecommunications being a sector
where the end products/services are close substitutes, instead of allowing the price to be
determined by costs plus an allowance for profit (mark-up), the firm might decide on
the price first and hold it constant for a longer time period. In the second step the
company develops a strategy for profit generation according to the price level set and
quantity of its output.38
With this the operator can have several price lines set up for
different parts of its network serving different customers (see Figure 11). The price line
method is effectively used when the firm wants to hold the prices for a longer time
period. This is many times characteristic for telecom firms as they offer post-paid
customer packages, usually lasting 1-2 years.
Regarding the industry specifics, it is important mentioning switching costs. Switching
costs occur when customers want to step over from one operator to another one. Each
operator faces them and has to have own processes strategies dealing and minimizing
them. The switching costs react according to the flow of customers among the operators,
high .numbers of leaving/new customers directly influence the switching costs.
Switching costs are an important factor when considering market entry. If switching
costs are low, the new market entrant can effectively lure away old operator‟s customers,
high switching costs imply a less attractive motivation in switching operators.
38
For telecommunications the quantity is hardly measurable, good approach is quality. As with lower
quality in product/products services the customer leaves, so as the quantity falls down.
35
Figure 11 Price line
Source (Price Policies and Theory, 1954), Author
4.2.3 Telecommunications Market Size and Demand
With the assumption that the demanders are price takers, a telecommunication operator
faces the market represented by a whole or wide part of the population. No one is
excluded and no demand side participant is large enough to exert any influence on the
price.39
The strategy of setting price first has to be maintained. Market penetration is a
measure of the amount of sales or amount of product or service compared to the total
theoretical market for that product or service. There is no direct evidence of a maximum
product/service penetration (see Figure 12). The ease of consuming more in
telecommunications or switching to another or more operators gives the potential for
penetration rise. 40
The ceiling of market saturation is when the market has been
maximized in the current state of the marketplace. At the point of saturation, further
growth can only be achieved through product/service improvement, market expansion
(facing specific part of the market) or rise in overall consumer demand.
Kim (2005) provides another view on the market which operators are facing. He takes
on the approach of network externalities as they exist when the amount that the
customer is willing to pay for access to network depends on how many other customers
are connected to the network. The utility the customer gets rises with the number of
users. The value of a network is a function similar to - the number of users‟ increases,
39
One market price is taken into account. Price deals with large businesses that are capable of bargaining
on price are not taken into account.
40
Buying a SIM card/ fixed line (into some extent)/mobile internet became easy. The only trade-off is the
monetary price of purchasing it.
36
the value of network increases exponentially.41
Further extension and a more precise
one is a decomposition of network externalities to the ability to communicate on-net
(inside one network) and the ability to communicate off-net (customers of other
networks).
Figure 12 Mobile penetration, subscription per 100 inhabitants
Source (OECD, 2011)
The origin of n2
theory was provided by Rohlfs (1974) as he alleges that people
typically belong to groups, each of which has a strong community of interest within
itself. In this group are few significant contacts (clients) who are responsible for a
substantial part of the whole communication inside the group. The author defines User
Set as the number of participants in the network who maximize their utility by joining
the network, whereas multiple equilibria at a given price can exist. As he further
explains if the User Set is moving towards the entire population the continuous
adjustment process in the industry can only remove individuals from the User Set –
meaning the number of users begins to fall at some point in time. The population User
Set will have to readjust itself to equilibrium User Set. Rohlfs takes it further and
proposes a demand curve for a uniform calling pattern.42
The demand curve abstracts
fractions of User Sets which are similar to group approach and defines a Critical Mass with
corresponding price level , the network has to achieve. Corresponding the
critical mass is the price growth, which when reaching the maximum of the parabola
falls down (see Figure 13). A very small equilibrium user set might be consistent with
utility maximization, since the smallness of the User Set itself makes the service
unattractive to potential customers ( & . The operator needs to exert activities to
41
This can be adapted for the whole industry, the more customers; the higher is the value of industry.
42
Uniform Calling Pattern is a theoretical example similar to its real world prototype Universal
Telecommunication Service (UTS). UTS are a baseline level of basic services provided to the customers.
It is most commonly put in force by regulatory supervision.
0.0
50.0
100.0
150.0
200.0
37
grow its user set, by reflecting the price strategy. A much higher User Set might be as
well possible for the same population at the same price level ( & . Reader should
see the paradox. Any disequilibrium along the curve is accompanied by User
Set adoption with constant growth/fall due to the necessity of price increase/reduction.43
Figure 13 Demand for uniform calling patter – Demand for telco services
Source (Rohlfs, 1974), Author
43
Reaching parabola maximum resembles economies of scope; meanwhile the fall in prices resembles
economies of scope approach.
38
4.3 Oligopoly Models
A satisfied customer is the best business strategy of all.
LeBoeuf (2012)
An oligopoly is a market form in which a market or industry is dominated by a small
number of competitors – oligopolists. Oligopoly is the study of market interactions with
a small number of firms - competitors. The competitors, so called oligopolists, dominate
the market, act independently on their own, but on the other hand strategically align
their behaviour with their industry peers. With oligopolist‟s self-interest behaviour
defined, the general notion of equilibrium can be applied to the specific case of the
oligopoly. When each firm is satisfied and does not want to alter its behaviour
unilaterally, man recognizes the Nash Equilibrium.44
The theory of oligopoly is related with game theory, where both theories complete each
other. According to Myerson (1997) game theory is “the study of mathematical models
of conflict and cooperation between intelligent rational decision-makers.” Based on the
conflict and cooperation behaviour it is possible to use game theory in the environment
of oligopolies.
There are numerous approaches for describing the strategic behaviour among
oligopolists. All of them are subjects of game theory. First and the most instructive is
the variable approach. In the real environment firms are interested in two variables price
and quantity. These two variables influence how the oligopolists‟ compare and
evaluate their positions with their peers. Second approach tries to answer the question
how many times the interaction among the players (the game) is played? Based on this
it is possible to distinguish static (played once) and dynamic games (played several
times). Third approach is elaborating on the information present in the industry. Acting
on your own meanwhile understanding your competitors is a situation where a
collection of information is necessary. Whether the player has a complex knowledge
about the industry situation or a constrained one, the theory distinguishes Complete and
Non-compete Information games. The last remark concerns the product in first
44
Nash Equilibrium – a market is at a Nash Equilibrium when each firm is choosing the strategy that
maximizes its profit, given the strategies of other firms in the market
39
approach. Whether the product is homogenous or heterogeneous plays an important role
and more complex and advanced game theory applications.45
As described in Chapter 3 there are three dominant players in the Czech
telecommunications industry.46
Game theory usually for simplicity deals with duopoly
market situations; this chapter tries to propose a model description for Czech
telecommunications three company market - triopoly. The models further described will
be the Cournot model, Bertrand model and model of Collusive behaviour.
4.3.1 Telecommunications Model Assumptions
 Output in telecommunications is a homogenous product/service offered by the
operator. Models stake these two as one. The price is considered as general price
level.
 Inverse market demand function ( , where and for
express demand behaviour by describing prices as function of quantities. More
on the topic of demand for telecommunication services was illustrated in
Chapter 4.2.3
 Total output of the industry ∑
 As in a triopoly, number of firms N, N=3
 one period
 Marginal costs are assumed to be identical among all three players.
4.3.2 Cournot Equilibrium
Cournot-Nah equilibrium of output level choice is a non-cooperative simultaneous
model where each firm faces the whole market demand. The firm assumes the other
firm‟s output will not change if it changes its own output level; it is so called
simultaneous quantity setting. The final chosen output maximizes oligopolist‟s output
and so its utility (profit).
The general profit maximization problem for i-th firm is:
45
The typology was derived from Gibbons (1992). More advanced Game Theory elaborates on various
combination of approaches mentioned.
46
The description omits U:fon as its market share was marginal. See Chapter 3
40
( (
So that profit for i-th firm, where is:
( (
Firm 1‟s profits depend on the amount of output chosen by firm 2 and 3. In order to
make a strategic decision firm 1 must forecast firm 2‟s output decision – each player
must forecast the choices of other players.
The first order condition for i-th firm with full industry output is as:
( (
According to Varian (1992) with three firms the marginal revenue equals marginal costs.
Therefore it is possible to derive:
( (
This equation can be taken further:
( [
(
] (
Where the fraction stand‟s for firm i‟s industry output the (
, whew stands
for elasticity of market demand. Knowing this the next step is:
( [
⁄
] (
As Varian further postulates, the Cournot model is a very good example of a situation
where the actual monopoly is somewhere in the middle, between a monopoly and
perfect competition. 47
If , man would reach the monopoly condition, as
the Cournot model approaches a competition based market.
47
This idea was presented already in Chapter 1.1
41
For any linear demand function with an inverse demand equation ( , the
marginal revenue has the function and so that the first order condition
for i-th firm is (Samuelson, et al., 2003):
∑
With this one derives the Reaction functions for triopoly:48
(
(
(
(
(
(
From this it is possible to derive firm 1 provided supply as:
Considering the assumption of all the triopoly players operating under same conditions,
the equilibrium for Cournot model equilibrium is:
Then the total Cournot industry output is:
With the price in the triopoly model as:
48
Reaction function is a graphical tool for showing a decision maker‟s best course of action for each set
of choices made by other decision makers.
42
4.3.3 Collusive Behaviour
In the Cournot model was the assumption of each operator‟s objective as maximizing its
own profit and coming to a decision independently of the other firms. A change might
occur when this assumption is relaxed and possibility of coordinated actions among the
firms emerges. Collusion situation might occur in unstable markets or in case of risk
avoidance. An industry where the operators collude to some degree in setting their
prices and outputs is called cartel. With empirical examples of allowed and punished
telecommunication cartels in Chapter 3.7.1 the next steps describe triopoly cartel model.
The objective of a cartel is profit maximization of the entire industry. This situation is
reached when the industry wide revenues are subtracted by costs of individual operator.
The general profit maximization problem for i-th firm where is:
( (
This leads to optimality conditions:
( (
( (
( (
When the operator considers expanding its output , it will generate more profit from
selling more output and the reduction in profits from forcing the price down. But in the
second effect, it takes into account the effect of lower price on the own output as well as
the whole industry output. The cartel‟s intentions are maximizing the total industry
profits, not only individual firm ones‟. Therefore:
∑ ( ∑ ∑ (
The optimal conditions imply that marginal revenues of a homogenous product must be
the same no matter which triopoly firm produces it. This goes hand in hand in with the
( ( ( rule as it is a condition for maintaining the general
43
equilibrium. If one firm has a cost advantage, with its marginal cost curve being below
the other ones, it will produce more output in the cartel equilibrium.
4.3.3.1 Cheating in a Three Member Cartel
Establishing and maintaining a cartel might be not so easy and it is connected with a
number of difficulties. The biggest challenge is to find a universal agreement to which
all the future participants would agree because each cartel member wants to maximize
its own bargaining position, taking for itself the most operator-attractive markets
share.49
As a consequence, there is always a temptation to cheat
Continuing with the triopoly model introduced in Chapter 4.3.3, the operators are
maximizing industry profit by choosing( . What happens when one firms
diverts from this optimal industry setting and decides to produce more output ? The
marginal profit for this firm 1 will change and so it will breach cartel‟s industry profit
maximizing intentions (Varian, 2006):
( (
Expanding and rearranging the optimality condition from 4.3.3 for firm 1:
( (
Gives:
( ( ( )
As a consequence:
For this, firm 1 believes that the remaining two firms will keep their output fixed. In
that case it can increase its own profits by increasing its own production. Firms acting
49
Market can be divided through the Quota Rule. Maximizing the combined profits of the cartel members,
the cartel has to decide how to divide the profits among its members. The Quota Rule is simple as it just
assigns each member a share in the production of Q (Ferguson, et al., 1993). In telecommunications this
can be transformed in dividing the market into segments of interest.
44
together in a cartel maintain a kind of status quo so that the market does not get spoiled
from special offers of one particular firm.
4.3.4 Bertrand Equilibrium
Equilibrium among firms choosing prices is known as Bertrand-Nash equilibrium.
Firms which choose prices are known as Bertrand rivals, therefore in the triopoly model
the equilibrium consists of for .
Continuing onwards with a standard form market demand function ( to
determine what the firms intend to do, an idea about the firm specific demand patterns
should be known. 50
All the three firms are interdependent as in the cases mentioned
before – the demand for one firm‟s output depends on the other firm‟s strategic
behaviour (Hořejší, 2011).
Figure 14 illustrates the market demand curve and the common level of MC.51
Firms
are operating in a situation with great comfort, dividing the market with no price
competition but with other differentiation means, far above their MC. This situation is
valid only when all three firms on presented price and incline towards profit
maximization. For any of the firms‟ price above would mean losing to their
competitors, but charging below firm takes whole industry sales for its own.
Figure 14 Oligopoly matching prices
Source: Author
50
For the illustration the Figure 14 & Figure 15 are depicted with elastic demand curve.
51
In the Bertrand-Nash equilibrium the market demand curve is not of inverse character as in the
Cournot-Nash equilibrium case as here the quantity is a function of price.
45
Following this the firms have three behaviour options:
1. Firm 1 charges higher prices than the remaining two. As a consequence customers
leave firm 1 and go to competitors. Firm 1 sells no output and firm 2 and 3 face the
whole market demand.
2. Firm 1 undercuts the other firms with a lower price and the previous case is
reversed. Firm 1 faces whole market demand and the remaining two firms take
nothing.
3. All three firms charge the same price. When the three firms set equal prices,
consumers are indifferent between the three. Yet for the general assumption the
customers have to be evenly divided between the three firms. With this each firm
sells ⁄ of the market quantity demanded.
Charging below has significant implications for the industry. Firm 1 by undercutting
competitors‟ prizes with almost triples its product output as the prices are attractive
in the customers‟ eyes and they migrate to firm 1 with cheaper portfolio (see Figure
15).This move also generates higher industry production belonging to firm 1 This
behaviour is hardly tolerated by remaining two competitors. Firm 2 and 3 begin
undercutting their prices as well, starting a price war. Industry comes to a conclusion
that as each firm is capable of additional cost cutting.
Figure 15 Firm undercutting the prices
Source: Author
46
Following the price cutting trend all three firms direct their price strategies towards their
marginal costs, which are industry wide approximately equal for all players. The game
stabilizes on for .52
On this equilibrium level, no firm is motivated to
cut prices lower as the price cutting firm would sell its portfolio below its costs. In the
same logic, diverting from this price upward makes no sense as the remaining
competitors would reap all the industry benefits by staying. With this the Bertrand-Nash
Equilibrium is the similar to the equilibrium in Perfect Competition (see Figure 16).
That is why the self-enforcing mutual interdependence of all triopoly participants entails
them setting their prices equal to marginal costs.
Figure 16 Bertrand-Nash equilibrium similar to Perfect Competition
Source Author
4.4 New Market Entrants
As Shy (1995) states, “why it is so that firms do not enter an industry despite the fact
that the existing firms in the industry make above normal profits,” the process got stuck
somewhere in the middle between monopoly and perfect competition. In an ideal case
there should be inflow of additional competitors into oligopolistic structures, but as one
knows, this does not always happen. As Katz (1994) states, entering a perfectly
competitive market is easy as the price before entering and after entering is easily
estimable as the high number of competitors does not allow great price modifications.
Entering the market with few competitors with aligned and mutual interdependent price
policies is not an easy case. When deciding about entering a market, the subject has to
question itself about its post-entry equilibrium (status quo) in the relevant market. The
52
Being more in detail, in reality all firms choose price level slightly above this level reaping the benefits
of higher price.
47
desired outcome of a market entry should be delivering positive economic profit to the
company. Each entry is connected with barriers to entry which are an important
structural characteristics pattern of any industry and methods of entering the relevant
market.
4.4.1 Barriers to Entry
Barriers to entry have significant impact on competitiveness and performance of the
industry. A classical definition of an entry barrier is provided by Bain (1956): “A barrier
to entry is an advantage of established sellers in an industry over potential entrant
sellers, which is reflected in the extent to which established sellers can persistently raise
their prices above competitive levels without attracting new firms to enter the industry.”
Case attractive and a simple definition presented by Fisher (1979): “A barrier to entry is
anything that prevents entry when entry is socially beneficial.”53
To the most widely acknowledged entry-deterring barriers belong, economies of scale
and sunk cost economies. Beginning with the economies of scale, the incumbent
environment usually owns plants and equipment of firm specific scale and usually
covers the whole market.54
Assuming a saturated market the added output of both the
incumbent and new entrant will exercise pressure on prices, whereas rather than going
into a possible price war the incumbent might offer some part of its output to the new
entrant (combination ). This situation is observed in Figure 17.55
On the other
hand customers might be loyal to the existing incumbent environment and might reject
the new entrant. So far customer loyalty is highly unlikely in the telco industry analysed
as the major industry changes come as pressure from the customer base. The mutual
revenue maximization between the new entrant and incumbent cloud is reached only
with letting the entrant into the market without any deterrence actions. So far the
introduced idea of price war should not be neglected if the incumbent cloud has space
for undercutting the prices.56
53
Definition by Fisher is elegant when taking into account public discontent presented in Chapter 1.2.4
54
Economies of scale are in the case of telecommunications the number of users. The more users the
network has the more difficult it is for the new entrant to steal them. The user prefers to stay with his/hers
group (as mentioned in Chapter 4.2.3) and not to start a new group from the beginning.
55
Figure 17 and Figure 18 consider games with perfect and complete information. Under perfect
information game conditions players have the same information for strategical decision making.
Complete information states the information is available to all participants and no one can be left out.
56
Application will be presented in Chapter 5.4
48
Key to the pay-off matrixes:
 – industry maximum (incumbent) revenues with no entrant
 – incumbent revenues
 – entrant revenues
 – incumbent behaviour patterns
Figure 17 Market share for the new entrant
Entrant
In Out
Market cloud
Let in
Price war
Source: Author
Continuing with sunk costs, the incumbent has to react to the new market entrant and
alter its behaviour to the situation. In Figure 18 with additional investments into the
business the incumbent can enjoy lower marginal costs and high quality portfolio
appealing to customers. The sunk cost lead to higher revenue gains in later periods
which the new entrant cannot face effectively. Wits the cushion created by the initial
investment the incumbent cloud will be more comfortable to engage in a price war,
knowing that new entrant has no cushion for price bargaining. The investment into sunk
costs might be considered in this case optimal as the entrant will have to face negative
payoff and will consider whether to enter or leave out the market. As Ferguson (1993)
claims this threat is credible and should be deterred (combination
).
Figure 18 Sunk cost commitment as effective
Entrant
In Out
Market cloud
Let in
Price war
Source: Author
The presence of sunk costs is of high importance for the situation in the Czech
telecommunications industry. With the Digital Dividend launching in 2012 the
49
regulatory CTU has listed several commitments and obligation which the subject
interested in the DD has to oblige with. More on the specifics of the DD and the auction
process will be provided in Chapter 5.4.
4.4.2 Industry Entry Practise – Auction Process
Entering a market which is considered by the state of great importance is usually
undertaken with an auction process. Auctions are commonly used in selling natural
resources, various public procurement proceedings rights to use certain geostationary
positions and others. A frequency auction (in the thesis many times mentioned Digital
Dividend) belongs to the group as well. The mentioned objects of an auction have one
in common, they are scarce. Their scarcity implies a limited number of potential auction
participants and so a limited number of users, here operators. The auction process has
advantage in that the auction is conducted publicly with no space for bribing or any
insider dealing. Firms usual choose between non-equity and equity entry. With firms
many times feeling unsecure about a pure non-equity or equity a licence creates a
synergy between both methods as the auction combines both non-equity criteria of
establishing the network itself, with equity criteria of the license itself (The Impact of
Corruption on Entry Strategy: Evidence from Telecommunication Projects in Emerging
Economies, 2006). It is possible to view an auction as a partial information game in
which the valuations of auction objects presented by each participant are hidden among
each other. Logically the player should know its own valuation. The valuation has to be
based on present value of the future strategy of undertaking with the frequencies.
However in an industry specific conditions the way how to deal with the auction
objective can be quite known, there some level of common valuation can be present. If
one would see the auction as a game, its equilibrium would be a function of auction
rules, information bidders have, system how the winner is determined and finally the
price. An auction is economically efficient when it manages to maximize Social
Welfare – the object will be allocated to the bidder who offers the highest price.57
Nevertheless as Courcoubetis (2003) states; “designing an auction for a particular
situation is an art”. There is no standardized auction process which can be used in all
auctions.
Switching the attention to a frequency auction as a mean for entering a
telecommunications market, it is important to remember that it is very likely the only
57
A definition of Social Welfare is provided in Chapter 5.2
50
way, how to enter a telco market.58
The only other options of entering a telco market
would be direct rights granted to one chosen operator or establishment of a Mobile
Virtual Network Operator.59
Frequency auctions are complicated as most usually they
do not consist of an auction of one particular frequency spectrum licence, but a number
of them with possible combinations among them. Combinatorial bidding leads towards
two synergy effects. The first can be achieved by a market player already present in the
market, which considers extending its network and introduce in it the new frequency
providing so an additional or wider range of services. According to Courcoubetis (2003)
combinatorial bidding belong to the most complicated ones, nevertheless it has the best
preconditions for delivering true valuations of the auction‟s object and so reach
maximization of Social Welfare.
4.4.3 Oligopoly with an Entry
A monopoly or perfect competition industries which are not facing a potential entry are
not engaged in a strategic process. Monopolist because of lack of competition and
perfect competition because of high number of competitors causing alignment of
strategies rather irrelevant as the ambiguity of diverting from the industry trend is high.
Potential market entrant behaviour was described already in Figure 17 where the entrant
managed to gain some share of the market pie. However the market entry was
conducted under perfect and complete information condition assumptions. The real
process might be similar to games with incomplete information.
Figure 19 is describing such an entry. New entrant is considering an entry into an
oligopoly market. Yet the entrant is unsure about the industry members marginal costs;
are they high or are they low? This decision is of crucial importance as the new entrant
bases on it its entry price decision and might predict the incumbent cloud‟s payoffs and
so the its reactions.. However in real situation any new entrant would at least
approximately know the cost structure of its market peers. 60
Again, the basic
assumption of an oligopoly has to be maintained, see Chapter 4.1.
The first decision is made by the oligopoly members. The participants decide about
their cost structure. Yet this decision is not available for the potential entrant. The
58
This assumption is under the assumption that the new market entrant considers launching a wide
portfolio of services and not only just a small one.
59
The basics of a MVNO have been outlined in Chapter 3.6.1
60
Even the type of market entrant does matter. Is it an industry skilled entrant or a pure new comer
without industry relevant knowledge? Theoretical applications can hardly filter such an assumption.
51
Source Author, (Katz, et al., 1994)
Entrant payoff is first (above) in each box. The entrant has to estimate the first move of the oligopoly.
Enter?
strategy outlined only represents the beliefs which the entrant can have about the cost
strategy in the oligopoly. The desirability of potential entry has to be formed based on
the oligopoly behaviour observations.
The decision whether to enter the market or not is so based on the cost based
assumption, where the entrant tries to foresee the post entry equilibrium, meaning
industry conditions. The oligopoly has low costs, the new entrant moves in. Following,
oligopoly chooses High Output and the entrant suffers a loss of -3. If the incumbent has
high costs and the entry occurs, the proper response will be to opt for Low Output and
the entrant will earn 4.6162
The new entrant can use probability for trying to form understanding of oligopoly cost
structure and reaction pattern. Let stand for probability that the oligopoly sticks to
61
The values have been taken over from (Katz, et al., 1994). They have been estimated with backward
induction. Real-time application would require forecasting and estimating – playing the game.
62
This game can be considered of sequential character, the entrant reacts after it witnesses the strategic
move of the oligopoly.
Entrant makes cost assumptions?
No
Oligopoly
Entrant Entrant
Oligopoly Oligopoly OligopolyOligopoly
0
10
0
12
4
5
-3
6
0
9
0
8
4
4
-3
3
Entrant‟s Probability beliefs… P (High costs)1-P (Low costs)
YesYes No
Output… HighHighHighHigh LowLowLowLow
Figure 19 An entry game of incomplete information
52
High Costs and designate entrant‟s belief about Low Costs trend in the oligopoly.
With this it is possible to calculate the expected payoff from entering the industry as:
( ( (
Not entering the market yields for the entrant payoff of 0. Hence the potential market
entrant will come to the market if:
⁄
With this condition not fulfilled the new entrant will rather choose to stay out the
industry. As Katz (1994) states the potential entrant will come in only if it is sufficiently
optimistic about the high costs and its competing behaviour will be limited. Yet such a
one sided estimation on the entrant‟s side can have several setbacks. The most
appropriate tool for supporting the above mentioned entry condition is to observe the
behaviour of the oligopoly members for a longer time so that a behaviour pattern can be
deduced.
53
5 Application
If you don’t change your game to gain advantage, one of your competitors will, and
there is not much value in being the best chess player when everyone is playing
checkers.
Hugh Courtney (2000)
5.1 Concentration of Czech Telecommunications
For measuring the concentration of the Czech telecommunications industry with using
the Herfindahl-Hirschman Index two key conditions have to be fulfilled.
1. The market has to be geographically determined.
Meeting the criteria of the first condition is easy, as the market borders are clearly set by
the national borders. This definition corresponds with the official CTU policy.63
2. The services/products used for calculating the HHI have to be clearly defined.
The calculation should consist of well-defined services. The number of substitutes
should be as low as possible. The analysis provided by Informační Institut (2012)
measures the industry concentration on mobile calling Relevant Market as this type of
calling can hardly have any other substitute (Over the Top operators, OTT).6465
The
thesis deviates from these conditions and proposes telco market consisting of revenues
of three main and only operators. There are no alternatives to three operators, so
imagining an end customer wanting to choose any telecommunication service (mobile
or fixed, telephony or internet) the customer has to approach one of the three operators
to satisfy demand. For reaching the HHI based on revenue based relevant market,
following steps have to be fulfilled.
Under the paper understand Relevant Market Revenues. In this case these revenues
consist of Operator Revenues - .
63
For more on the market definition see CTU: Analýza trhu č. A/7/09.2009-11
64
The topic of Relevant Market (RM) was first mentioned in Chapter 3.6 CTU does not consider telco
market as a whole; instead it divides it to so called RMs, which serves as more precise and accountable
measurement subjects.
65
Under OTT operator man understands Google, Skype and other ‘operators’ providing telephony
services (globaltelecomsbusiness.com, 2011).
54
∑
Where:
Following telecommunications operator Market share has to be deduced from
as:
⁄
Next it comes to calculating the 3 player HHI index itself:
∑
With the methodology defined the calculations delivers the following results:
Figure 20 Czech telco concentration using the Herfindahl Hirschman Index
Source: Author
Regarding the HHI index, it is of common understanding that industries with low
concentration HHI stand for high competitiveness leading to higher quality and cheaper
services provided to end customers. The average HHI index for the last five years 2006-
2010 stands for 4071. Both the yearly concentration numbers as well the average
calculated stand for a highly concentrated industry. Industries with high concentration
usually represent contradictory observations to low concentration ones‟, leading to
lower competitiveness among market players and sturdy price competition conditions.
402240554056409041344081
44874404
4871
5276
2010200920082007200620052004200320022001
55
The already mentioned research conducted by Informační Institut (2012) states
somewhat lower concentration of 3474 for 2010 in the mobile calling Relevant Market.
This number still supports the thesis findings of highly concentrated market.66
Other
considerably lower HHI index observations are provided by Asociace provozovatelů
mobilních sítí (APMS, 2012). This clear lobby group provides considerable lower HHI
index values (see Figure 21). With different methodology approach APMS shows
relatively good standing point of the Czech telco industry in comparison with
international peers.
Although different methodologies for measuring the market concentration the
conducted measurement as well as third party opinions support the general idea of
disrupted market conditions and price discriminatory approach to end customer.
Introducing more competition into the market would lead to softening the concentration
numbers so that the industry and market benefits from the changes eminent in the telco
industry.
Figure 21 HHI index comparison according to APMS
Source (APMS, 2012)
66
A simultaneous calculation conducted by Informační Institut provides HHI of 3559 in 2010.
3409
3497
2000
3000
4000
56
5.2 Pricing in Czech telecommunications
Telecommunications are a highly regulated industry. Among traditional pricing
strategies as mentioned in Chapter 4.2.2, the regulatory authority has power to identify
subjects in the telecommunications market which hold significant market power and can
undertake coercive actions against market participants (Chapter 3.6).
With the basic and most commonly used principles of pricing in telecommunications
industry a third possible option emerges – Ramsey Pricing.67
Real time marginal costs
are difficult to compute and they can be low or close to zero as a telecommunication
service operators have typically fixed costs. These fixed costs have to be recovered.
With price mark-up and price lining strategies giving the operator space for almost free
price determination, raising the prices arbitrarily might significantly reduce Social
Welfare.68
Exact marginal cost pricing does not allow recovering operator‟s costs. If the
operator is very large and operates with economies of scale (costs which increase less
than proportionately with output level) marginal costs are low (Courcoubetis, et al.,
2003). Revenue under marginal costs would not satisfy fixed costs of operations
(property loans, investment projects and interest on loans and maintenance).
The issue of maximizing Social Welfare is tightly connected with the
telecommunications demand function presented by Rohlfs (1974). The approach of
Ramsey Pricing is about maximizing weighted objectives of the operator. Weighted
objectives are considered because of the fragmentation of the market under separate
business lines and different characteristics patterns in customer demand. As a
consequence more attention can be prioritized to an objective with higher weight. The
issue with Ramsey Pricing is that the operator intending to use its price policy according
to them has to face equally competitive market players. Weighted objective allows the
operator to put different importance on the parts of portfolio offered and so maximize
its revenue generation. Even Ramsey Pricing cannot be considered as a standard pricing
tool for the telecommunications industry as a whole. This methodology is widely used,
but the major condition for its use is market fragmentation. Therefore, this condition is
67
There are other additional pricing strategies, yet Ramsey Pricing is attractive as used by regulators.
68
Considering the public disappointment one can postulate that Social Welfare is disrupted. Social
Welfare of the society can be defined as the sum of all users‟ net benefits, i.e. the sum of all consumer
and producer surpluses.
57
fulfilled in the telecommunications market only when it is applied on Relevant Market
fragmentation done for example by CTU.
Following in the steps outlined in the paragraph above, pricing according to Relevant
Markets would seem as the most through one. Yet the end customer is not facing prices
aligned according to 18 or 12 relevant markets. These prices are rather set for the
regulatory authority to oversee the competition behaviour among industry players. It is
more common practise that the end customer faces prices which are subordinated to
basic pricing strategies as their creation is related to empirical observations of market
conditions and competitor behaviour rather than complex numerical model based price
determination. The observation of real price development is difficult because of time
constraints as the operator regularly changes its service portfolio and price policies.
Yes using available market sources provided by CTU, it is possible to identify vague
trends in the price policies of Czech telco members. Hardly speaking about any price
strategy, Figure 22 provides a rather stagnating development in Medium Consumption
Basket price development with changes occurring only at operator T-Mobile. It is of
utmost importance to mention that these observations are under continuous change as
CTU cannot maintain yearly conformity among observations. For this reason, when not
applicable, the most similar basket is used to the previous year basket. Additional
baskets are in the Appendix but as well even in case of a trend among them the
development does not need to justify that the shifts in price levels occurred due to price
competition among three oligopolists. Information on methodology provided in the
publication focused on price development by CTU (2011).
With the two additional baskets provided by CTU (in Appendix), the reader obtains
mixed price developments among the operators for various products, hardly speaking of
any strategies among them. As a consequence considering a general trend in price
development can be justified; the stable development pattern can be a proof of price
aligning among market players without any price wars occurring in the industry. With
rather than price competition the oligopoly members focused to customer promotions,
active marketing and other promotion activities.
58
Figure 22 Medium consumption basket price development [in CZK]
Source: (Český telekomunikační úřad, 2011)
5.3 Behaviour in an Oligopoly
All transactions between a buyer and a seller are undertaken unilaterally and the actions
affect only the counterparty. A buyer is an agent or player who enjoys a certain service
or goods which are produced or delivered by the seller. The seller carries the costs and
wants to be compensated by the transfers paid by the buyer. Game theory provides
space for strategic bargaining approach can determine price paid for certain goods and
services because of the difference between production costs and the utility held by the
end customer. The difference between the two is bargaining gain. In situations where
the bargaining power is concentrated mainly on the buyer‟s side, the buyer has a good
outside options and the price will cover only little more the production costs. In contrary,
if the bargaining power is concentrated mainly on the seller‟s side, the price will be
little less than the buyer is maximum willing to pay for the service or goods (Stähler,
1998).
The application of bargaining theory in oligopoly is hard to achieve if not impossible.
As the reader knows from Chapter 4.1 producers are price makers and customers price
takers. Yet it is possible to identify some potential for bargaining approach. The
customer can be offered different price than standard, or special price tariffs apply in
various customer segments. With the bargaining strategy‟s limited or no presence in an
oligopoly, the industry players have the opportunity of undertaking to customers.69
Under undertaking one would understand bringing better services to customers with the
69
A more suitable synonym for undertaking to customers would be engaging them.
899 899
870 870
897
823
708 708 707 710
943
833 833
750 750
700
750
800
850
900
950
2006 2007 2008 2009 2010
Telefónica Vodafone T-Mobile
59
possibility of price negotiation, meaning a fall in prices. Yet undertaking to customers
can have profit-increasing function.
As Ferguson (1993) presents, the gesture of undertaking to customers might be
considered as a device for retaining operator‟s goodwill among the customers, but the
reason behind it is rather more utility self-serving on the side of operator than on the
customer‟s side. Taking into account the price development patterns mentioned in
Chapter 5.2 together with the collusive behaviour for industry wide profit maximization,
the operators can have rather incongruity outcomes as will be illustrated in the
following paragraphs.
Imagining a situation where operators set their prices.70
In presented Figure 23 each
operator has the incentive to set a low price (dominant strategy). Maintaining a high
price with a competitor choosing low price leads automatically to lower prices.
Consequently the low price strategy delivers higher pay-off as customers flock to the
operator due to ease of switching among operators. Both operators playing high price
does not pay off as they will migrate to low prices. Low price strategy for both
operators prevails.71
Figure 23 Keeping prices low strategy
Player
High price Low price
Remaining
operators
High price 800:800 790:840
Low price 840:790 795:795
Source: Author
Yet the operator can come up with the idea that it will pay the customers the price
difference between its high price and the low price offered by the remaining competitors.
On the other hand, this approach does not have to be applied only as a price cut when
customers identify a better offer. The price cut can come up as special discount without
mentioning the ambition of catching up the competitors. Naturally the operator follows
its competitors and reacts for it to survive whereas the competitors might follow the
same price adjustment strategy.72
70
The price level will be similar to the on presented in Figure 22
71
The payoff matrix is designed as; the price which is being set reaps the whole benefit. There are no
costs involved.
72
For illustration prices similar to the medium consumption basket are chosen.
60
With firms now undercutting their high price levels to match the prices of the
competitors, the overall equilibrium will stabilize with all operators playing high prices
(see Figure 24). The price matching strategy is represented as (
nevertheless the high price strategy delivers higher pay-off for the operator. Therefore
aligning their price levels together and after that choosing high price appears as more
attractive for the market players as fighting in a low price game. Although the gains are
not as significant as in the industry with great price difference, for an operator facing
the whole market is this strategy of high attractiveness. This apparently precompetitive
gesture of lowering the prices can be viewed as a strategy to ensure that industry wide
higher prices will prevail with the end customer thinking about consuming at low prices.
The supportive argument for the strategy described in this part is that it allows a kind of
collusive behaviour among the oligopoly members, which is hidden from the eyes of the
customer.
Figure 24 From undertaking the customer to higher prices
Player
High price Low price
Remaining
operators
High price 800:800 790:790
Low price 790:790 795:795
Source: Author
This strategy gains on importance when it is clear which strategy do the operators
follow. Do they want to keep the market share or maximize profitability? For the Czech
telco the idea of maximizing profitability is of high probability whereas the importance
of market share is not marginalised (Courtney, 2000). The operators are being used by
their foreign mothers as cash cows. Best example is the behaviour of Czech Telefónica,
as the company‟s objectives are pressed to profit maximization with a minimum of
reinvestment as the dividend is consequently harvested by Telefónica Spain.73
In case a
potential new entrant would hold information and knowledge about the strategic
objectives of the Czech oligopoly cloud a price war strategy would seem as very
attractive if not the only possible way.
73
The Czech subsidiary‟s strategy is to maintain the most stable and dividend yield as the Spanish mother
milks the company through the dividend.
61
5.4 Entering Czech Telecommunications
5.4.1 Auction is the only way
Regulator CTU officially presented the form of the Digital Dividend auction as
Simultaneous Multiple-Round Auction (SMRA) type with being bid ascending and the
opportunity of withdrawal of the bid is at place. The choice of an ascending auction
rather than a sealed-bid (envelope) auction is that bidders reveal information as the bid
process progresses and so the occurrence of Bidder‟s Curse will be limited.74
An SMRA
auction is considered efficient, fair and transparent, so maximizing the utility condition.
The issues of complementarity and substitution also affect bidding strategies in the
auction process. Hence the DD is bringing maximum utility only with a relatively high
number of participants taking part in it. Raising interest about the DD auction was one
of the concerns of CTU as it, the operator had to approach potential subjects interested.
Regulator promoting the auction and trying to lock in participants is definitely a unique
Czech reality. On the other hand, the higher number of participants the better. If CTU
exercises effort to bring in auction competition, it will end up in only more competitive
and so benefit bringing process (ihned.cz, 2012). Bidding occurs in rounds. It continues
as long as there is bidding on at least one of the objects (hence the name simultaneous).
In each round, the bidders make sealed-bids for all the objects in which they are
interested (for the Auction object see Figure 25).
Figure 25 Digital Dividend auction and what is played for?
Source: Compiled by (Peterka, 2012), based on CTU provided DD auction materials.
The most attractive as already mentioned in Chapter 3.6.2 is the LTE compatible
Kategorie A 800 MHz (Category A) frequency band. Limiting factor for the auctioneers
is the Spektrální limit (Spectrum Cap) rule limiting the maximum ownership.
74
Bidder‟s (Winner‟s) Curse is a situation when the winning bidder overpays the auction. There are two
ways in doing this. First the winner‟s bid exceeds the value of the auctioned object making the bidder
actually worse off. The value of the object is less than the bidder anticipated, net gain is still possible, but
it might be smaller than the bidder first anticipated.
62
The auctioneer reads the bids and posts the results for the round. For each object, he
states the identity of the highest bidder and his bid. As the auction progresses, the new
highest bid for each object is computed, as the maximum of the previous highest bid
and any new bids that occur during the round (Courcoubetis, et al., 2003). A more
detailed overview of the auction rules is provided in the Auction Rules Methodology
Appendix (Český telekomunikační úřad, 2012).
Regarding the auction, the previous paragraphs mentioned that the SMRA auction is
considered as bringing higher utility – Social Welfare maximization, if the number of
participants is rather higher than low. As the number of participants for Czech auction is
not known in the time of writing the thesis, whereas the final prices are known only
during the auction process. Research conducted by Arthur D. Little provides
justification of higher number of participants bringing in more benefit (see Figure 26).
Figure 26 Prices in LTE spectrum auctions
Source (Arthur D. Little, 2012)
5.4.2 The French Example
A good example of a market entry into an oligopoly telco market took place during
2011/2012 in France. The new entrant Free Mobile aspired to challenge the industry
rules of the French mobile telecommunications sector. The situation around the French
entrant carries many similarities with the Czech case of a new market entrant.
French mobile telecommunications market was before 2012 divided among three
market players; Orange (brand of France Telecom) taking ext. 40% of the mobile
market, followed by SFR with est. 30% of the market and Bouygues Télécom with est.
20% of the mobile market. Around October 2006 the regulator Autorité de Régulation
des Communications Électroniques des Postes (ARCEP) declared intentions and public
0.81
0.73
0.68
0.47
0.42
0
0.2
0.4
0.6
0.8
1
Italy 2011 Germany 2010 France 2011 Spain 2011 Sweden 2011
€ per MHz
per Capita
High bid competition Low bid competition
63
consultations about issuing a fourth licence. With numerous parties interested in the
bidding process for the new license the remaining three operators began a strong lobby
campaign against the entrant of a fourth operator approaching the governmental bodies
holding decisive power and starting an awareness campaign for general public (Reuters,
2009).75
It might appear as not surprising that ARCEP and The Conseil de la Concurrence (CC)
fined a EUR 534 mil. amercement payment to the three operators in 2005 for breaking
competition rules. Every month between 1997 and 2003 the mobile operators
exchanged detailed and confidential information on the numbers of new and leaving
customers. With a market difficult to penetrate such an agreement led to reducing
uncertainties over competitors‟ strategies and aligning a common market approach. The
three oligopoly structure‟s intentions were to stabilize and divide the market shares
amongst each other (The Conseil de la Concurrence, 2006).76
With this, no wonder that
the expectations from a new competitor have been high. The auction for the fourth
frequency took place in 2009 with the already mentioned Free Mobile as a winner (the
action was for 3G network, LTE auction underway in 2011/2012). The price for the new
licence was est. EUR 240 mil and the operator signed a covenant to launch its network
service in January 2012. 77
The French customer was greatly disappointed by the
approach of the old three member oligopoly and was waiting for the new arrival
restlessly (Pospíšil, 2012).
Free Mobile launched operations on the 10th of January 2012 and in one week
accounted for 500.000 new customers! The operator started a devastating price
competition offering a 50% price cut of their contract with the former operators. The old
operators were accused of cash-milking their customers, bringing no value for them and
intentionally providing confusing information about the services they were offering.78
New entrant officially announced that its presence is because the customers deserve real
benefits. The old operators had to face anger of their customers illustrated by their
massive outflow and even demonstration of dissatisfaction. Following the market
75
It is a very similar case as in Czech Republic. However the French market consists of 6 MVNO
operators as well. As the reader knows, they are not present on the Czech market.
76
Document had been recovered with hand written notes as “pacification of the market” or “Yalta of the
market,” with further documented evidence of communication among the market players.
77
Free Mobile does not own its own network yet. Its services are undertaken as national roaming
provided by Orange.
78
Free Mobile used the example of a one page Terms of Contract document on its side, in comparison
with a 70 page Term of Contract manual of the old operators.
64
conditions they had to react and “unexpectedly” were capable of cutting their prices by
30 to 50% to match Free Mobile‟s aggressive pricing strategy (Pospíšil, 2012).79
With this development the objectives of an auction – Social Welfare maximization, had
to be fulfilled. Taking the licence‟s price as agreed between Free Mobile and ARCEP,
the value it did bring in into the French market of higher customer satisfaction,
aggressive pricing and service competition is clearly the greatest benefit of the whole
process of new market entry. The evidence of tougher French telco market is France
Telecom‟s (owner of Orange) 2012 Q1 results where it lost 615.000 clients and the
group‟s overall revenues fell 1.8% to EUR 10.92 bil. France Telecom stated that it was
due to the market being shaken by competition from an “ultra-low-cost” mobile
operator (Reuters, 2012).
The evidence of this development shows that the three member oligopoly market failed
to react to the market entry of the fourth operator. Their strategy was to keep with the
old prices till the very whereas the newcomer proved that the industry could work even
with lower price levels. Market entry deterring practices were not effective as the
operators have no other option as the entry strongly encouraged by the regulatory
authority and other institutions. One interesting strategy of an old operator was to
excuse the old price levels with high number of staffing. The customer switching to the
new operator would endanger work placements in the old operator‟s employees...
79
Whereas the thesis is focusing on the Czech telecommunications market considers all three players as
convergent services, Free Mobile providing only mobile telephony services has this ambition as well. It is
owned by Iliad which offers services of fixed telephony and internet. Further integration is very likely.
65
6 Conclusion
6.1 On the objectives
The reader would agree that it is not something new that the rules of the game of any
industry are complex and many times difficult to track down and understand. It is very
common that ex-ante conclusions about trends and strategy might be misleading and
only ex-post description of actions are possible. The complexity of the
telecommunications industry is far more extensive than the example provided in this
thesis. 80
Nevertheless this work tries to provide a brief insight into the topic of
telecommunications which are many times represented as oligopoly market structures,
where each competitor tries to design its own strategy not forgetting about the high
interdependence among the players. In thesis not involved the importance of other
horizontal and vertical business partners. Possible games for the best supplier or
contractor on the side of the operators are very likely to occur as well.
The level of difficulty of the chosen industry was multiplied by many parties interested
in its actual condition and future development. Regulator, the state, customers, domestic
and international organizations, all these groups want to have their say about how it will
look like in telecommunications. Theoretical approach of normative economics about
describing telecommunications oligopoly how it should look like is an extremely
challenging task. Providing strategic models and trying to reach a final conclusion about
the industry might prove many times as impossible and even contra productive. The
author during the process of writing this thesis found numerous justifications in
literature that real industries practise is many times different. Looking at the industry
from the opposite approach of positive economics; the numbers of variables which enter
the industry and have an influence on it are extensive. The complex reality of
telecommunications is highly demanding on industry specific knowledge base. As a
consequence any formation of real application models describing the genuine industry
processes and patterns would exceed the goals of the thesis. 81
80
One of the best resources on the topic Economics of Telecommunications is for sure from Courcobetis
(2003) Pricing Communication Networks
81
A good example of the complexity, importance and attractiveness of telecommunications are
investment banks which usually hold specific departments which focus on analysis of only
telecommunications players.
66
This thesis tries to transcend these difficulties and yet provide or rather propose facts on
the Czech telecommunications oligopoly status quo. In the beginning the thesis outlined
two objectives; the next paragraph summarizes and comments on them.
6.2 First Objective
The first objective was focused on proposing details on theoretical foundations of
telecommunications industry. What is of the utmost importance is that the value of any
telecommunications operator can be determined by its customers.82
Important parts in a
lifetime of any operator are its start, when the operator needs to lock in customers.
Second are the situations when the market is nearing its saturation point and finally a
new market entrant arrives as the customer decides to leave. The significant aspects is
that the customer usually does not leave alone, but takes his/hers social circle with
him/her.83
Switching the attention towards pricing, the approaches of price mark-up and price
lining seem as prevalent in the Czech telecommunications. However, price lining might
be more widely used. The operators conduct their business in a very comfortable
environment, till now (spring 2012); there are no pressures with real power, enforcing
any level of price competition. This way the operators can decide on prices almost as
they want. In any case, if necessary the operators could easily switch to mark-up pricing
to act more strategically in their decision making. As further in the analysis mentioned
there are other, more complicated pricing strategies in telecommunications (Ramsey
Pricing) yet their justification because of unified telco market and not segment
separated is hard to prove.
Commenting on the model is a challenging task. First the author opts for Bernard-Nash
equilibrium model as the operators clearly focus on the variable of price and align their
strategies according to it. However better theoretical understanding foundations are
provided when using a Cournot-Nash equilibrium model. Last, the case of a Collusive
behaviour and so maximizing the output of an industry would seem valid as well. All
three operators try to maximize their revenue generation with no signs of stealing
market shares or customer base among each other.
82
The thesis does not cover the financial valuation and final value of a company.
83
Other option is that the customer was already carried away in other customer‟s social circle.
67
6.3 Second Objective
The concentration of the Czech telecommunications market was proven as high. Yet
taking the methodological approach of heterogeneous revenues for the basis of
calculation might be criticised, the calculation supported the concentration calculations
provided by other studies. It is interesting to note that the issue of industry concentration
is complicated in the telecommunications industry as it is always complicated to set-up
industry borders as the industry is many times divided into smaller segmented markets.
On the other hand the technical segmentation according to Relevant Markets can have
many times no relevant value.
It is impossible to determine a pattern in the price level development during any time
period. The fragmentation of telecommunication services means fragmentation of
pricing policies as well. Empirical observation justifies the fact that the prices are high,
however the operators are still free to follow pricing strategic presented in the
theoretical part and so opt for their strategies of maximum revenue generation (see
Figure 6) and profit maximization (see Figure 4).
Behaviour in an oligopoly is outlined by the industry‟s power to set even a higher price
level without going into any price competition, making all the oligopolists better off.
Various customer attractive special discounts and offers can actually lead to price
increase in case they are launched by all the industry members. With a limited, almost
no bargaining power, the customer has no other option of price adaptation. Only a new
market entrant could introduce change in the industry.
Entering Czech telecommunications can have two general strategies. The first is that
significant sunk costs are necessary at the beginning. These sunk costs are represented
by the frequency auction. If the subject wants to enter, it must pay. The second reality is
price war; the oligopolists can enter a price war with the new entrant and so actually
scare him off. However the strategy of Czech operators is rather profit maximization at
all costs, therefore rather an agreement about leaving a new operator some part of the
market is very likely to occur. The other aspect of an entry or even any other action is
its value. The entry is a game; therefore every market entrant has to calculate the value
the entry will bring into the company.
68
6.4 How Professionals see the market structure
Global consultancy Boston Consulting Group (BCG) claims that a stable competitive
market has never more than three significant competitors, where the largest has no more
than four times the market share of the smallest one. With telecommunications industry
the costs are a function of market share. With rising market share implying therefore the
deployment of higher quality networks, providing better services and getting to the
customer. With changing market share the costs and the chained factor of revenues and
profits need to react. Large number of competitors is in the long-term unsustainable and
will eventually shift to market structures with lower players, whereas the opposite
extreme – monopoly is destined to be unable to compete with any challenger
immediately its sovereign position is cancelled. Therefore the logical consequence of an
industry structure of something in the middle is a very usually market form. The
consultancy conceives the most probable and perhaps the optimal relationship exists
with three competitors, where the largest account for 60% of the market and the
smallest for no less than 15% of the market (Henderson, 1976).
This hypothesis fairly corresponds with the mobile market shares presented in Figure 7.
The fourth operator might face challenging environment as its market share generation
capabilities might be strongly constrained by the oligopoly. Going against the BCG
proposal, the presence of regulatory is here to mitigate such a situation. With three
members market considered as saturated, the regulator can create comfort for a new
market entrant, almost enforcing its market entry.84
With unreasonably high price levels,
the new entrant might challenge the old oligopoly members and with its new strategy
can catch a significant market share to sustain its future growth as witnessed in case of
France. The best case scenario for Czech Republic is that there will be a new entrant so
that a similar development pattern than in France would occur. Though as of May 2012
nothing is decided, as all current players declared intentions of taking part in the
frequency auction. From this point of view everything can be open, being sure that a
potential entry of a fourth operator will be warmly welcomed by general public and
considered as a challenge by the remaining market players.
Introducing additional industry professional views on the number of players and
competition, the ITU obviously strongly encourages additional, new subjects. In a
84
Good example on number of market participants was provided by Katz (1994). In his textbook he
identified seven oligopoly market structures with five of them consisting of three or four players.
69
similar way the organization does not explicitly specify any optimal number of market
participants as the consultancy does, yet it identified three steps how to nurture
competition in the industry. All of them, first provided by former ITU former SecretaryGeneral
Tarjanne (1999), are highly attractive and relevant, not only for the Czech
telecommunications market, but other similar markets as well.
First step is reducing entry barriers into the industry and facilitating investment and
divestment. All markets are prone to cartelization and price fixing. Additional
competition will mitigate these trends, whereas the best possible solution is when the
new entrants are a foreign/outside subject. Foreign subject is better as it can bring in
new innovative business models (as the French example) and might be more inclining
towards fierce price competition than a domestic 4th operator which can be under the
influence of the old industry members. As far as it is known to the time of finalizing the
thesis, there are both domestic and foreign subjects interested in the frequency auction.
Deciding which of the two types is better would be rather short-sighted as the criteria
for all of them are the same; however the idea that foreign might be better sounds very
attractive.
Second step is promoting free flow of information, especially price and service quality.
Witnessed in Chapter5.2, any price comparison is very hard to put together. Many times
the price policies and their various combinations are too complicated and confusing.
Better comparability among the prices and services offered would greatly benefit the
Czech telecommunications markets.
Third step is connected with the already mentioned globalization of telecoms.
Telecommunications are globalizing, so should as well the regulatory authorities and
competition policy makers. Telecommunications industry shows similar development
patterns all over the world; coordination of actions, policy recommendations and even
frequency spectrum auctions are a field where convergence is possible.
70
6.5 Final remarks
Strategic behaviour whether game-theory based or not, is a very sound justification for
any series of actions where players intend to maximize their payoffs meanwhile not
neglecting their competitors. The best examples and application for game-theory appear
to be pricing strategies and market entry strategies, as were illustrated in Chapter 4.4
and 5.4. Trying to propose a type of final model for telecommunications industry is a
thesis exceeding task, however some strong points of decision making in
telecommunications industry have been presented.
Any strategic decision making process is usually connected with a wide range of
uncertainty in any future prediction (Courtney, et al., 2000). The thesis provided some
general examples of real case applications of basic game-theory models and approaches.
More complex and precise models might be considerably difficult if impossible and
often of disputable practical application. Yet some basic and simple models developed
for practical approach on the Time Value of Money might be an attractive decision
making tools in further game-theory simulations.85
85
Attractive approaches might be strategic simulations of Future Cash Flows, Net Present Values and
others.
71
7 Appendix
Figure 27 High consumption basket [in CZK]
Source (Český telekomunikační úřad, 2011)
Figure 28 Low consumption basket [in CZK]
Source (Český telekomunikační úřad, 2011)
1178
914
1000
900
1000
1100
1200
1300
1400
1500
2006 2007 2008 2009 2010
Telefónica Vodafone T-Mobile
340
301
312
200
220
240
260
280
300
320
340
360
380
400
2006 2007 2008 2009 2010
Telefónica Vodafone T-Mobile
72
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