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Pricing Strategies in the Context of Price Regulation by Patrick Xavier School of Business Swinburne

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1. Pricing Strategies in the Context of Price Regulation. by. Patrick Xavier. School of Business. Swinburne University. Melbourne Australia. ITUWorkshop(2) ... – PowerPoint PPT presentation

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Title: Pricing Strategies in the Context of Price Regulation by Patrick Xavier School of Business Swinburne


1
Pricing Strategies in the Context of Price
RegulationbyPatrick XavierSchool of
BusinessSwinburne UniversityMelbourne Australia
  • ITUWorkshop(2)

2
Pricing strategies under price regulation
  • The objective of this presentation is
  • to explain the characteristics of price cap
    regulation since this is a scheme in
    increasingly use and may be used in Thailand to
    regulate TOT (indeed that TOT might argue should
    be used rather than direct government approvals
    or profit regulation)

3
Pricing strategies under price regulation
  • to indicate strategies for use under price
    regulation.

4
1. Direct price control
  • Approval of price changes (increases decreases)
    by government or by the regulator.
  • Since price increases are usually politically
  • unpopular, approval tends to be usually given
    with reluctance and delays.
  • This is increasingly seen to be inappropriate in
    competitive circumstances.

5
2. Rate of Return Regulation (RRR)
  • Essentially the limitation of profits to a
    reasonable level
  • Experience (eg. in the US) indicate that the use
    of RRR can involve long arguments about what a
    reasonable rate of return is.
  • Can also involve detailed and long argument over
    what costs were necessarily (and efficiently)
    incurred.

6
Rate of return regulation (cont)
  • This could lead to detailed involvement of the
    regulator in the investment and commercial
    decisions of the service provider
  • The recognition of such disadvantages of RRR (and
    many others) has led to an increasing use of an
    alternative price control approach, so-called
    Price-cap regulation.

7
3. Price-cap regulation
  • Under the price-cap scheme, a service providers
    price increases would be limited to the rate of
    inflation less an agreed X factor (based in
    principle on expected productivity improvement).
  • In principle, there would be no restriction on
    the level of profits.

8
Price-cap regulation (cont)
  • Regulators favoured the price-cap scheme because
    it focused directly on price increases -- a
    variable that is more transparent -- than
    necessary cost expenditure.
  • Operators have favoured the scheme because it
    should allow less intrusive price regulation than
    RRR.

9
Price-cap regulation (cont)
  • Also, it promises to permit unrestricted profits.
  • In fact, in many cases, operator profits have
    shown increases under price-cap regulation.

10
Price-cap regulation (cont)
  • It is not unlikely that the price-cap scheme will
    be considered for use in Thailand to regulate
    TOTs prices.
  • The focus of this presentation is to indicate
    strategies for TOT to consider if it is required
    to operate under the scheme.

11
Price-cap regulation (cont)
  • Essentially the price cap scheme restricts price
    increases to CPI - X where
  • CPI (Consumer Price Index) is the inflation rate
  • the X factor is (in principle at any rate)
    based mainly on the productivity improvement
    potential of the regulated company.

12
Price-cap regulation (cont)
  • Thus if inflation is 8 and the X factor is
    set at 3 making the formula
  • 8 - 3.
  • This means price increases will be restricted
    to no more than 5 per year for the duration of
    the formula.

13
Price-cap regulation (cont)
  • In principle, there would be no restrictions on
    the level of profits that accrue (thus sustaining
    incentives for the company to beat the expected
    productivity improvement reflected in the X
    factor).
  • The formula is usually set for between 3 to 5
    years and reviewed at the end of this period.

14
Price-cap regulation (cont)
  • Probably the most effective way to further
    explain the operation of the price cap scheme is
    to examine its characteristics when applied in
    various countries.

15
Price-cap regulation in the UK
  • 1984 CPI-3. Line rentals, local long distance
    calls individual cap of CPI 2 on line rentals
    until 1997.
  • 1989 CPI - 4.5. Line rentals, local
    long-distance.
  • 1991 CPI - 6.25. Basket extended to include
    international calls.

16
Price-cap regulation in the UK
  • 1992 CPI - 7.5. Line rentals, local, long
    distance, international. Some individual price
    caps placed on certain services.
  • 1997-2001 CPI - 4.5. Single basket of line
    rental, connection, and call (local, long
    distance, and international) charges for small to
    medium usage households (light user scheme).

17
Price-cap regulation in the UK
  • 1997-2001 CPI - 0. Line rentals for small
    business. Low usage small business service
    packages must be as good as for residential
    segment.

18
Price-cap regulation in Canada
  • 1994 Direct price control. Three regulated
    increases for 1996, 1997 and 1998 to bring
    residential service rates into line with costs.
  • 1995 Rate of return. Utility segment (the
    non-competitive part of the industry).
  • 1998-2002 CPI - 4.5. Utility segment.

19
Price-cap regulation in France
  • 1995 CPI - 4.5. Basic voice telephony services
    without discount schemes, comprising access, line
    rentals, calls (local, national, international
    and payphones).
  • 1996 CPI - 5.5. Basic voice telephony services,
    as defined above.
  • 1997 CPI - 9. Basic voice telephony services,
    as defined above.

20
Price-cap regulation in France
  • 1999 CPI - 4.5. Basic voice telephony
    services, as defined above.

21
Price-cap regulation in Sweden
  • 1993 CPI - 1. Basket of telephony services
    supplied to households and smaller companies
    Light user schemes providing users with low
    consumption reduced subscription fees.
  • 1997 CPI - 0. Customer access charges-customer
    line connection and rental.

22
Price-cap regulation in Australia
  • 1989 CPI - 4 Line rentals, local, long distance
    international.
  • Sub-caps. CPI - 0. local calls and residential
    rentals.
  • Notifiable and disallowable Connection fees,
    payphone calls, calls to directory assistance.

23
Price-cap regulation in Australia
  • 1991 Notifiable and disallowable 008 services,
    leased line charges, mobile services.
  • 1992. CPI - 5.5. Connections, line rentals,
    local calls, long distance, international,
    domestic leased lines, international leased
    lines, mobile services

24
Price-cap regulation in Australia
  • Sub-cap CPI - 2 connections, rentals and local
    calls.
  • Sub-caps CPI - 5 Long distance international
    calls.
  • Capped at CPI -0. Increases in prices for
    connections, rentals, local calls and long
    distance calls.

25
Price cap regulation in Australia
  • Notifiable and disallowable. Payphone calls,
    calls to directory assistance, connections for
    resellers.
  • 1996 to 1998 CPI - 7.5. Connections, line
    rentals, local, long-distance and international
    calls, leased lines, mobile telephone services.

26
Price cap regulation in Australia
  • Sub caps. CPI - 1. Residential connections,
    line rentals, long distance calls and
    international calls.
  • Before increasing any charge subject to these
    price control arrangements by more than the CPI
    increase during a calendar year, Telstra is
    required to obtain the prior consent of the
    regulator.

27
Price cap regulation in Australia
  • There is a direct price control of 25 cents on
    local calls from fixed phones and 40 cents on
    local calls from payphones.
  • Notifiable and disallowable Directory
    assistance.

28
Price cap regulation in Australia
  • 1999 to 2001 CPI - 5.5. Connections, line
    rentals, local, long distance, international
    calls, domestic and international leased lines
    and digital cellular mobile telephone services.
  • CPI -0. Line rentals and local call services
    (sub-basket).
  • CPI - 0. Connection services (sub-basket)

29
Price cap regulation in Australia
  • CPI - 1. Connections, line rentals, local,
    trunk and international call services consumed by
    the average of the bottom 50 of Telstras
    pre-selected residential customers by bill size.

30
Price cap regulation in Australia
  • The regulators consent is required for an
    increase in line rentals applicable to the bottom
    10 of Telstras pre-selected residential
    customers by bill size, such consent to be based
    on ensuring that such bills will not increase in
    real terms.

31
Price cap regulation in Australia
  • Revenue-weighted untimed local calls for
    non-metropolitan Australia for 1999/2000 and
    2000/2001, not t exceed that in metropolitan
    Australia for the previous year, in each case.
  • Cap of 25 cents Untimed local calls
  • Cap of 40 cents Directory assistance.

32
Strategy for a regulated service provider
  • As overseas experience indicates, price
    regulation is almost certain to be applied to an
    incumbent former monopoly with market
    dominance.
  • If so, it is TOTs interests to consider what
    sort of price regulation system would be in its
    best interests and begin trying to influence
    decisions in this direction.

33
Strategy for a regulated service provider
  • Price-cap regulation is more arms length than
    other forms of price regulation likely to be
    applied to TOT and likely to provide more price
    re-structuring flexibility (TOT will want) but
    armed with appropriate information, TOT can also
    influence the setting of a price-cap formula that
    is to its advantage.

34
Strategy for a regulated service provider
  • Seek
  • the lowest level of X.
  • none or as few restrictions on price
    re-structuring as possible (in other words no
    sub-caps on individual services).
  • inclusion of services whose prices are likely to
    be significantly reduced, such as long distance
    and international.

35
Strategy for a regulated service provider
  • At least in the first formula -- when the price
    cap formula is likely to be relatively generous
    to the company -- seek a longer term (5 years
    rather than three) so that any higher than
    expected profit achieved can be enjoyed for a
    longer period.

36
Strategy (i) seek lowest level of X
  • It is the level of X in the CPI - X formula
    that determines the size of the fall in real
    prices. A lower X would require a lower real
    price fall (and allow higher revenue/profits).

37
Strategy (i) seek lowest level of X
  • Since the size of X set will be influenced by
    the size of productivity improvement attainable,
    TOT should arm itself with information
    concerning its past and potential labour and
    total factor productivity.
  • TOT should also benchmark productivity
    performance for telecommunications operators in
    other countries.

38
Strategy (iii) seek minimum sub-caps
  • Sub-caps on individual services restrict price
    re-structuring (which TOT will find necessary to
    undertake for commercial reasons)
  • Thus TOT should seek minimum sub-caps arguing
    that a promised benefit of price-cap regulation
    is that it would permit greater price
    flexibility, including restructuring.

39
Strategy (ii) seek inclusion of services with
significantly falling prices
  • Where the price of a service falls sharply, it
    will decrease the average price of the basket of
    services in a price-cap basket. This means that
    the price of other services in the basket do not
    need to decrease as much, or indeed, may
    increase, with the basket still satisfying
    price-cap requirements.

40
Strategy (ii)seek inclusion of services with
significantly falling prices
  • TOT could point to the fact that in the UK,
    France Australia, the price of international
    calls was included in the price-cap basket in
    1991. Some countries do not include
    international calls in the price cap basket so
    that the formula is more demanding.

41
Strategy (ii)seek inclusion of services with
significantly falling prices
  • TOT should also seek to have discounts and
    one-off special prices included in the price-cap
    basket.
  • It may also be possible to re-construct pricing
    to be part of the price-cap regime.
  • Then of course there is creative accounting.

42
Conclusion
  • This presentation has indicated that if price
    regulation is to be applied to TOT (which is
    almost certain), price cap regulation may be
    preferable to other alternative approaches such
    as direct approval or rate-of -return regulation.

43
Conclusion
  • TOT should be prepared -- not least through the
    collection of benchmarking information
  • on the characteristics of price-cap schemes
    applied in other countries and the effects of
    such schemes
  • productivity trends and levels achieved
  • services with rapidly falling prices, etc.

44
Conclusion
  • Armed with such information, TOT will
  • not only better understand the potential impacts
    of price regulation but
  • can significantly improve the outcome of
    negotiations with the government/regulator and,
    indeed, its ability to compete successfully in
    the new competitive environment.
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