Margit Vanberg, Assessment of telecommunications regulation in Europe in:

Margit Vanberg

Competition and Cooperation Among Internet Service Providers, page 158 - 161

A Network Economic Analysis

1. Edition 2009, ISBN print: 978-3-8329-4163-5, ISBN online: 978-3-8452-1290-6

Series: Freiburger Studien zur Netzökonomie, vol. 14

Bibliographic information
158 The European Regulators Group (ERG) published a draft consultation on regulatory principles for next generation access (NGA) in May 2007. In this document, it states that …the inclusion of the fibre loop into market 11 is compatible with the definition of the Access Directive, but would require a change of the Recommendation to include fiber into the relevant market…Market 12 does not require a change of the Recommendation as, by definition, it already comprises all kinds of wholesale broadband access products that can be delivered higher in the network (ERG, 2007: VII). The ERG therefore does not view NGA as a new market. The group discusses as possible remedies: “Unbundling the shortened local loop ending at the street cabinet implies the need for co-location at the street cabinet and backhaul service from the cabinet to the operator’s node” (ERG, 2007: 8).156 9.2.5 Assessment of telecommunications regulation in Europe The overview of telecommunications regulation in the U.S. showed that convergence there had the effect of curtailing regulations in the telecommunications sector. In Europe, in contrast, network convergence was answered by extending the scope of the regulatory framework to other platforms for electronic communication. The experience with the 2002 regulatory framework is still relatively short, considering that many countries took several years to complete the market analysis of the markets on the Commission’s list of recommended markets. The subsequent implementation of remedies took a long time and the effects of these remedies are often only now becoming apparent. Therefore, similar to the assessment of the current U.S. regulatory framework, the assessment of the European framework remains theoretical in many points. An essential positive aspect of the framework is that, in many respects, its provisions are based on economic theory. The Commission recognizes the importance of potential competition (EC, 2002: §74) and the control of bottlenecks (EC, 2002: §78) as criteria to establish whether a firm has SMP. The framework focuses on incentives for innovation and investment (Art. 8 (2c) of the Framework Directive). Furthermore, it includes a mechanism for eliminating regulatory obligations once these are made obsolete by market developments. A regular review process guaran- 156 The German national regulator, the Bundesnetzagentur (BNetzA), published a draft consultation in April 2007 for its market definition and market analysis for Market 11 and Market 12. The BNetzA comes to the same conclusion as the ERG. See:,0/Archive/2__7 _-_April-June_45p.html#10534 ; site last visited on Feb. 15, 2008. The ERG recommendation for regulation in next generation access networks largely corresponds to the conclusion drawn from the disaggregated regulatory framework in chapter 8. Co-location at the street cabinet and duct sharing between the street cabinet and the end-user premises would allow competitors equal chances in FTTC markets. 159 tees that market changes and technological developments can influence the assessment of SMP in a market and lead to the withdrawal of regulatory burdens. The proposed reforms of the regulatory framework which concern spectrum management (EC, 2006: 11ff.) address some of the most pressing issues in furthering infrastructure-platform competition in the market for broadband access. Wireless access technologies will become especially important in European countries, such as Italy, Spain, and Greece, in which the cable network is not widely deployed and where infrastructure-platform competition in broadband access would be strengthened significantly by a wireless access product.157 The proposed reduction in ex-ante regulation is an important signal that deregulation of electronic communications markets remains an ultimate policy objective. The most important drawback of the European regulatory framework is its tendency to overregulation. Overregulation is, in part, addressed by the reform proposals of the EC. The suggested reforms are, however, not far-reaching enough. The European framework continues to lack a clearly defined limiting criterion for the application of ex-ante regulatory measures. The three-criteria test underlying the regulatory framework is, in essence, in accordance with the theory of monopolistic bottlenecks and could successfully be used to limit regulation to instances in which monopolistic bottlenecks hinder competitive market outcomes (Blankart et al., 2007: 11). The “presence of high and non-transitory entry barriers” (first criterion) in economic terms could be rewritten as a market with natural monopoly characteristics requiring sunk investments. Such a monopoly can be considered to pass criterion two, which requires the market to not tend towards effective competition within the relevant time horizon. In current practice, however, the three-criteria test is not being applied in this economically sound manner. The Commission has added markets to the list of relevant markets, which cannot be considered natural monopolies (this holds especially true for all of the retail markets on the list). Oldale and Padilla (2004) even speculate that the list of relevant wholesale markets is artificially inflated in order to facilitate short-term successes in market performance by increasing the number of firms active in the retail markets. They criticize the fact that the framework relies on competition law instruments for market analysis, but does not use the “limiting principles embedded in the competition law rules […] when specifying the remedies to be used” (ibid., 52). Besides the fact that the three-criteria test is not used to limit regulatory intervention to instances in which network-specific market power can be identified, the framework introduces a second step in which SMP status needs to be determined for the imposition of regulatory remedies. The SMP criteria of the Commission are open to much wider interpretation of market power than the criteria the theory of monopolistic bottlenecks applies for the identification of network-specific market power. The criterion “control of infrastructure not easily duplicated” is open to interpretation because of the unspecified nature of the term “not easily.” The required economies of scale and scope are common in network industries. The theory of monopo- 157 See OECD (2005: 219, Table 7.3). 160 listic bottlenecks requires these to be relevant over the entire market output, thus substantiating a natural monopoly. Yet, the SMP criteria of the Commission are not clear on this point. Especially the focus on market shares does not seem appropriate if one recalls the fact that network industries often have only few large market players even when they are competitive. The notifications of the NRAs so far show that, in practice, their determination of SMP is in large measure based on market shares. Even if the threshold for assuming market power has moved from 25 percent market share to 50 percent, there is a danger that the value attached to the other criteria mentioned by the Commission pales in comparison to the easily grasped and readily available market-share figures. Finally, sunk costs are missing from the catalogue of SMP criteria, which also shows that the European Commission defines SMP wider than the theory of monopolistic bottlenecks defines network-specific market power.158 Consider the Internet-related markets on the Commissions’ list of relevant markets. It was shown above that all European countries that have notified these markets have found at least one operator to have SMP and subsequently imposed most of the possible remedies suggested by the Commission (Kiesewetter, 2007). The finding of SMP was always also substantiated by high market shares of the incumbent carrier. Using the disaggregated regulatory approach it is, however, highly questionable whether the regulation of markets 8 and 12, which respectively provide for dial-up Internet access and bitstream wholesale access, is necessary once market 11 is effectively regulated, by which access to the unbundled local loop is guaranteed. The theory of monopolistic bottlenecks sees justification for unbundled access to the local loop whenever no competing access services from cable or wireless carriers are available or are likely to become available should the incumbent make above competitive profits in the market. From the perspective of the disaggregated approach competition by new entrants renting the local loop in order to provide alternative broadband access services suffices to hinder the incumbent from abusing its market power in the access market. It has been demonstrated by entrants into many local markets that the additional services provided by wholesale bitstream access, such as access to the DSLAM and backhaul transportation of traffic, can be competitively supplied. In conclusion, since the Commission’s guidelines are less restrictive in their definition of SMP than the theory of monopolistic bottlenecks is in its definition of sector-specific market power, the framework leads to a broader regulatory basis than the disaggregated approach would. The Commission even explicitly states that a network owner, which is not found to have power over essential facilities, can nevertheless be found to have a dominant position in the market for that access facility. While the owner of an essential facility also has SMP on the market for this facility, the Commission finds that the converse is not necessarily true: “the fact that a given facility is not ‘essential’ or ‘indispensable’ for an economic activity on some distinct 158 The SMP criteria of the Commission are also more comprehensive when compared to the definition of structural entry barriers applied by the FCC (see section 9.1.2 above). 161 market, within the meaning of the existing case law does not mean that the owner of this facility might not be in a dominant position” (EC, 2002: §81). 9.3 Network neutrality regulation The above overview of telecommunications regulation in the U.S. and in the EU focuses on market power regulation in the physical network layer. There is currently no market power regulation in the logical or the applications layer of the Internet.159 There is, however, a very concrete debate over the possibility of market power regulation of Internet transport services in the near future. This debate over so-called “network neutrality regulation” is being carried out mostly in the United States. Advocates of network neutrality regulation want the U.S. government to pass legislation that would guarantee that Internet service providers transport all content and services of independent applications and content providers without blocking, impairing, degrading, or discriminating these services in favor of own services and content (Litan and Singer, 2007, Sec. I. A).160 Concrete demands call for a codification into law of the traditional “best-effort principle,” a practice by which IP packets are delivered regardless of their source and destination (Ganley and Allgrove, 2006: 456). Historically, the “best-effort principle,” by which all IP packets receive the same priority, resulted from the endto-end conception of the Internet. The intelligence of the network design was generally located at the edges of the network (in attached hosts), whereas the routers which connect networks and transmit data packages within networks were designed as “dumb” terminals. An undifferentiated forwarding of packets according to a simple algorithm was fitting to this network design. More recently technologies have become available that allow routers to use information included in IP packets to discriminate in the forwarding of these packets. Peha (2007) provides an overview of the new technical means available for Quality of Service (QoS) differentiation. There are many benefits to customers from traffic discrimination, including improved security, improved quality of transmission, efficient resource allocation, and decreased infrastructure costs (Peha, 2007: 13). According to Marcus these technologies are already widely implemented within networks and there are no technological constraints to implementing QoS differentia- 159 This does not imply that these layers are entirely free from regulation. In the logical layer there are, for instance, technical regulations regarding the assignment of IP address blocks. In the applications layer regulations which concern in particular the content market play a role. These are part of media law and policy, such as for instance must-carry rules by which cable television providers are obligated to carry specific broadcasts. 160 The discussion over network neutrality is in truth more encompassing, as many demands by network neutrality activists target policy goals closer to media-policy objectives. Hogendorn (2007), for instance, differentiates between open-access regulation on the physical network layer and “openness to content” on the applications layer, which he views as the central aspect of network neutrality.

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Die Konvergenz der Netztechnologien, die dem Internet, der Telekommunikation und dem Kabelfernsehen zu Grunde liegen, wird die Regulierung dieser Märkte grundlegend verändern. In den sogenannten Next Generation Networks werden auch Sprache und Fernsehinhalte über die IP-Technologie des Internets transportiert. Mit den Methoden der angewandten Mikroökonomie untersucht die vorliegende Arbeit, ob eine ex-ante sektorspezifische Regulierung auf den Märkten für Internetdienste wettbewerbsökonomisch begründet ist. Im Mittelpunkt der Analyse stehen die Größen- und Verbundvorteile, die beim Aufbau von Netzinfrastrukturen entstehen, sowie die Netzexternalitäten, die im Internet eine bedeutende Rolle spielen. Die Autorin kommt zu dem Ergebnis, dass in den Kernmärkten der Internet Service Provider keine monopolistischen Engpassbereiche vorliegen, welche eine sektor-spezifische Regulierung notwendig machen würden. Der funktionsfähige Wettbewerb zwischen den ISP setzt jedoch regulierten, diskriminierungsfreien Zugang zu den verbleibenden monopolistischen Engpassbereichen im vorgelagerten Markt für lokale Netzinfrastruktur voraus. Die Untersuchung zeigt den notwendigen Regulierungsumfang in der Internet-Peripherie auf und vergleicht diesen mit der aktuellen Regulierungspraxis auf den Telekommunikationsmärkten in den Vereinigten Staaten und in Europa. Sie richtet sich sowohl an die Praxis (Netzbetreiber, Regulierer und Kartellämter) als auch an die Wissenschaft.