Speaking Notes for George N. Addy, Director of Investigation and Research

The 4th Annual Industry Canadian Resale Congress
Toronto, Ontario

February 27, 1996

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Note: Remarks were presented by Val Traversy, Director General, Economics and International Affairs Branch, for the Director of Investigation and Research.

Introduction

I would like to thank the Canadian Institute and the Competitive Telecommunications Association for inviting me to participate in this important conference. I have no doubt that you are in for two days of interesting and vigorous discussion of the important economic, regulatory and competition issues facing the long distance sector of the Canadian telecommunications industry.

In my remarks this morning, "Taking the wraps Off Competition" I hope to provide you with an overview of how the Competition Bureau views its role past, present and future in the transition of the Canadian telecommunications industry from monopoly and regulation to competition and deregulation. In particular, I want to address the evolving relationship of the Competition Bureau and the Competition Act to the CRTC and the Telecommunications Act.

The Competition Bureau, Its Role and Mandate

As Director of Investigation and Research I have broad responsibility for competition policy in Canada through the administration and enforcement of the Competition Act. The purpose of the Competition Act is to promote competitive markets and enhance the benefits to the economy which flow from the operation of competitive markets. On the enforcement side, I have statutory responsibilities and powers to carry out investigations under the Act and, where grounds exist, to bring criminal matters forward to the Attorney General for prosecution before the courts or, in the case of the civil provisions, to apply to the Competition Tribunal for remedial orders. In addition to enforcement, I am empowered under the Act to intervene before regulatory commissions and boards to make representations with respect to competition. Beyond this, the Director's office is also frequently called upon to provide policy advice within government on matters related to comp etition.

Competition Policy 'The Message'

Competition policy is premised on the recognition that competition should act as the driving force of a free market economy. Sectors of the economy in which competition is not the driver should be the exception not the norm. In a mixed economy such as Canada's, where an number of important industries and sectors have been, or continue to be, subject to extensive economic regulation, I believe that it is essential to constantly reexamine and assess the continuing need for, and the costs of, regulation.

It will come as no surprise to you that the Competition Bureau strongly favours the elimination of regulation in favour of competition wherever possible. Why? First, competition is superior to regulation in providing incentives for innovation, to develop new products or services and to minimize costs. This is particularly true in industries such as telecommunications and computing where technological innovation is creating a virtual explosion of new products and services at lower and lower prices. Second, competition creates market forces to drive prices of goods and services toward their relative costs of production, enhancing the efficiency and overall benefits derived from the economy.

In keeping with its mandate to promote competition throughout the economy, the Competition Bureau has a long record of advocating increased reliance on market forces for the provision of goods and services. While you are dealing with the telecommunications sector, other sectors of the economy are also undergoing significant change. The Bureau has consistently advocated the benefits of competition in the telecommunications sector and that effort must continue. However, regulatory reform and increased competition in the transportation sector, energy, financial services, the agricultural sector and the professions are also important priorities for the Bureau.

In our experience we have tended to observe a similar pattern or cycle in the transition of industries from regulation to competition. In the first phase,technological change or some other factor intervenes to challenge the social policy objectives or undermine the 'natural monopoly' assumptions which gave rise to regulation in the first instance. When this happens, in phase two, incumbents invariably attempt to defend their monopoly position against potential new competitors with warnings of dire consequences of competition for employment, public safety and security, universal service or cultural sovereignty.

In the third phase of this cycle, having unsuccessfully defended their monopoly position, incumbents invariably "get religion" and demand to be relieved from regulation and "freed to compete." This is frequently met with resistance from new entrants who turn to the government for some form of regulatory protection from competition amid allegations of predatory pricing and other anti-competitive activity on behalf of the former monopolists. When the Bureau opposes proposals for "competitive handicapping" or a "managed transition to fair and sustainable competition" at least some competitors will find it tempting to lay a portion of blame on the Bureau for their own commercial difficulties. The success of phase four, the implementation of regulatory reforms necessary to facilitate the transition to competition, is to a very great extent contingent on changes to the regulator's mandate and even more importantly the willingness of the regulator to cede its authority and control in allowing competition to determine market outcomes.

I should make it clear that I am not in these remarks attempting to minimize or ignore the very real competition issues that continue to exist in the Canadian telecommunications industry. Clearly in a network industry such as telecommunications, where competitors rely upon access to essential facilities controlled by the dominant firms with whom they compete, there are important competition issues to be resolved. Indeed, there is ample room for differences of opinion as to how such issues should be addressed in the complex and difficult balance between regulation and competition.

What I do want to stress is that you have to recognize the cycle and not lose sight of the objective: the benefits of lower prices, increased choice and innovation that arise from competition and the elimination of the burden of regulation. Our perspective of the conditions and prospects for market competition in the longer term is likely to be much more influenced by technological innovation, changing barriers to entry and trends in prices and costs, than by the quarterly financial results of particular industry participants.

Moreover, it should be evident from the Bureau's record that we don't play favourites and we don't pick "winners." In recent years, the Bureau has managed to come out on different sides of various issues with the telephone and cable companies,the cultural community, consumer groups, as well as the Commission itself. I am well aware, for example, of the sharp criticism of the Bureau which has come from the cable television industry over the past year in regard to the Bureau's strong advocacy for opening cable television markets to competition from the telephone companies, direct to home satellite services and other potential competitors. Recent speeches by cable industry executives are reminiscent of remarks by the chief executives of the telephone companies ten years ago regarding the Bureau's blind faith in the market and its lack of understanding of the consequences of competition for, among a number of things, the "integrity" of the telephone network and the m aintenance of universal service.

The Importance of Telecommunications Competition

Beyond its own significance as an $18 billion industry, telecommunications is the key instrument that will mould Canada's economic and social future. Today, all economic sectors, from services to manufacturing and even governments, rely more and more on an information base built around telecommunications. In manufacturing, telecommunications is contributing to the creation of new industrial processes able to achieve more efficient use of scare material and human resources. Similarly, in retailing telecommunications-based shopping is causing fundamental changes in how we make purchases, how inventories are controlled and how quickly sellers can respond to changing customer tastes. In an era of shrinking budgets, Governments are searching for ways to deliver services more efficiently and effectively through telecommunication.

A remarkable degree of consensus has been achieved that competition must be at the heart telecommunications policy if the industry is to attract new investments, encourage innovation, speed the deployment of new technologies and make new services and applications available to consumers. However, the performance of the telecommunications sector is profoundly influenced by the regulatory framework under which it operates. While there may be general agreement on a broad policy outline for competition, the devil is in the details of the regulatory reform necessary to implement competitive policies.

In Canada substantial progress in introducing competition in the provision of telecommunications services has been made beginning with private line and data services in 1979, terminal attachment in 1982, resale of long distance service in 1984, cellular service in 1985 and facilities based interexchange service in 1992. The CRTC has now embarked on a process to introduce competition into local telecommunications markets, with cable television companies, new PCS licensees and others manoeuvring to challenge the position of the regulated local monopolies.

In the long distance sector, equal access has been achieved and competition has resulted in significant reductions in rates and improved services. In terms of competitive entry, declining prices and market share lost by the incumbent telephone companies, long distance competition has emerged in Canada at a rate much faster than anyone was predicting at the time of the long distance decision in 1992. While this has been of enormous benefit to users, a number of competitors, particularly resellers, have left the market or have been acquired by other firms, and virtually all of the new entrants are experiencing financial difficulties. This has left a number of industry participants and some analysts to question whether long distance competition is "sustainable" in the long run.

Such concerns can easily be misplaced or exaggerated. Moreover, calls for "managed competition" sometimes have more to do with protecting competitors and regulatory entitlements than competition itself. When you have free and open markets there will be winners and losers as individual participants come and go. If someone becomes complacent, fails to innovate, fails to continually earn a place in the marketplace they simply will not survive, nor should they. By rewarding the best, we ensure that Canadian consumers, Canadian businesses and the Canadian economy are the ultimate winners.

Technological change is going to continue to enhance the opportunity for competitive entry into telecommunications. Accelerating technological change is also going to make regulation of telecommunications markets even more difficult. The long term prospects for telecommunications competition are very positive, but they will only be optimized if regulatory reform allows market forces to operate freely. Even with the progress which has been made, substantial regulatory reform remains to be completed before the full benefits of competition in Canadian telecommunications markets are to be realized.

Two things which must be addressed in the transition to competition are the fundamental incompatibility of rate base rate of return regulation for dominant firms in a competitive environment, and regulatory rate distortions which have developed over many years of cross-subsidizing the price of local service. In my view, dealing with these issues and opening local service markets to competition are the major hurdles which must be overcome in order to maximize the role of competition and market forces in Canadian telecommunications markets.

Present pricing schemes -- whereby business long distance and urban subscribers pay a large share of fixed and common costs while residential and rural customers pay a small share -- will become increasingly difficult to maintain as local competition emerges in metropolitan areas. Rate of return regulation provides both the incentive and the opportunity for the telephone companies to cross-subsidize their competitive services from monopoly local revenues. The other major failing of rate of return regulation is that it does not provide the telephone companies with incentives to reduce costs and improve efficiency.

Competitive market pricing for telecommunications services offers two related advantages. First, it produces a price structure which is more conducive to entry and competition in all local markets throughout Canada. This will introduce dynamic efficiency into local markets, a very important element in economic growth. Second, market-based pricing will reduce the large deadweight loss to the economy due to the misallocation of resources attributable to regulatory rate distortions.

There are several reasons why the Commission can and should act promptly to move all telephone rates closer to the costs of providing service. First, universal service has been achieved in Canada with 98+% of households connected to the public switched telephone network. Given the very low price elasticity of demand for local/access service, even a significant increase in local rates will result in, at most, a tiny percentage of households dropping-off the network. Secondly, rate rebalancing will deter or eliminate uneconomic bypass and uneconomic entry. Finally, raising local/access rates is necessary if entry is to occur m most segments of the local/access market. Not only must local rates be increased on average, but they also need to be restructured to reduce the large differences in the markup above variable cost, given demand.

The Commission has now initiated some limited rate rebalancing. It would appear from its Split Rate Base decision and its call for the telephone companies to develop local service pricing options to address concerns over affordability, that the Commission is prepared to take further action to address the problem of regulatory rate distortions. Following on its Regulatory Framework decision, the Commission will also soon be initiating a proceeding to implement price cap regulation for the telephone companies by January, 1998. Replacing rate of return regulation with price caps will reduce the incentive and opportunity for the telephone companies to cross-subsidize their competitive activities with revenues from monopoly services.

The future of telecommunications competition in Canada would be further enhanced by the reduction or elimination of foreign ownership restrictions. In an increasingly global capital and telecommunications environment, I think that there is a need to reconsider the issue of foreign ownership limits in telecommunications. At this critical time in the evolution of this sector and its regulatory framework, these questions need to be considered. For example, what was the public policy objective which led to the introduction of foreign ownership restrictions? Are the reasons for doing so valid today? What is it about telecommunications, compared to other important sectors of our economy, that it requires protection from foreign investment? What is more important from a public policy perspective, the source of capital or its behaviour? Is there any evidence that the public in British Columbia or in the territory served by Quebec Tel are in anyway disadvantaged or receiving inferior telephone service than elsewhere in Canada as a result of their ownership structure?

There are at least two reasons favouring the relaxation of foreign ownership restrictions. First, some have suggested that it may require as much as $30 billion to construct the Canadian information infrastructure. Foreign ownership restrictions impose significant costs on the domestic communications industry in terms of limiting access to financial capital resources by both incumbents and potential competitors. Second, barring foreign enterprises leads to reduced competition in this sector relative to other areas of the economy where these restrictions do not apply. By reducing the pool of capital available and the number of potential competitors in the domestic market, we limit the choices, quality and prices available to Canada's residential, business and institutional customers.

Access to increased foreign financial and intellectual capital at this time would be of great benefit to Canada's long-distance telecommunications firms, cable companies, wireless companies, content providers, and others who are contemplating entering into local telecommunications markets, as well as wireless, cable and telephone companies wishing to upgrade existing networks or to construct new networks in order to offer interactive broadband services and telephony. Foreign investment can hasten the introduction of new products and services by allowing financial and intellectual capital to flow into Canada. In addition to these direct benefits, competition from foreign-owned firms can stimulate efficiency improvements among Canadian firms.

The overall effect of relaxing foreign ownership restrictions would be to facilitate the growth of Canada's entire communications industry, hasten the development of information networks, and enhance our international competitiveness at a time when other countries are liberalizing as fast or faster than Canada. It may also prevent further concentration in this sector, which I know is of concern to many of you and to many users. If foreign ownership restrictions are still considered necessary to ensure Canadian control of some aspects of the communications sector, the benefits of additional investment capital can be obtained if the foreign equity limit is raised to a level short of control, such as 49%.

No one should be under any illusion that something magic happens when you reach a 50% ownership threshold. One's ability to influence the behaviour of a corporation can arise at ownership levels significantly lower than 49% and lower than the foreign ownership constraints already in place. The merger prenotification requirements of the Competition Act pertaining to private and public corporations are triggered at ownership levels 35% and 20% respectively. The Bureau's Merger Enforcement Guidelines make it clear that for the purposes of assessing the issue of what constitutes a "significant interest" ownership of as low as 10% of voting shares could warrant enforcement.

The basic point here that one has to consider is the issue of continued foreign ownership limits in the context of the fundamental policy objective that we are trying to achieve.

Evolving Roles of the Competition Bureau and the CRTC

Increasingly the question is being asked as to what conditions must exist, and at what point should regulation of telecommunications by the CRTC give way to the application of the Competition Act. This is a complex question. In responding, I will make some observations on what I believe are the important considerations.

At the outset, it is useful to reflect on the overall scheme of regulation set out in the Telecommunications Act. The Telecommunications Act provides to the CRTC broad powers of regulation over telecommunications. The Act has, however, as one of its principle objectives, the reliance to the maximum extent possible on market forces for the provision of telecommunications services. In keeping with this objective, the Commission is required to forbear from regulation where sufficient competition exists to protect the interests of users.

Obviously, a determination as to the sufficiency of competition to warrant forbearance is subject to judgement. In the Regulatory Framework proceeding, I recommended to the Commission that the appropriate test was not what economists would define as 'perfect competition', but rather a condition where the market power of incumbent firms was reduced to the point where it was outweighed by the cost of continued regulation. In its Regulatory Framework decision, the Commission agreed that a determination of "sufficient competition" should be based on the principles of competition policy analysis, having regard not only to market share information, but other competition criteria such as barriers to entry and the role of technological innovation.

In considering the question of forbearance, it important to remember that regulation by the CRTC will be replaced by competition in the marketplace, not by further regulation administered by the Competition Bureau. This point is often lost on those who suggest that the Competition Bureau will in some fashion pick up the torch of telecommunications regulation from the CRTC. This is simply not the case, for telecommunications or, for that matter, any industry or sector of the economy. The Competition Bureau has no mandate under the Competition Act to regulate entry conditions, prices or service quality. All of these things, as in any other industry, are best left to the dictates of competitive market forces. The role of the Competition Bureau is to intervene in the market only when restraints of trade as prescribed in the Competition Act are breached and enforcement action is warranted.

The present scope for application of the Competition Act to telecommunications is subject to a number of potential considerations. There are jurisdictional issues surrounding what has become known as the regulated conduct defence. This defence has been developed by the courts over the years in the jurisprudence relating to the criminal provisions of the Competition Act. The courts have generally held that where a specific activity is being carried out pursuant to regulation authorized by valid legislation, such activity is deemed to be in the public interest, and parties engaged in the conduct are absolved of criminal liability. The issue of the regulated conduct defence and whether it would be extended by the Competition Tribunal or the courts to the civil provisions of the Act has been the topic of considerable discussion in the context of the telecommunications industry. It was most recently raised in the proceedings before the Competition Tribunal wi th respect to my challenge to certain practices of TeleDirect.

In addition to the jurisdictional issues, you know that the CRTC has itself implemented a number of competition safeguards. These range from the broad terms and conditions for access to the public switched telephone network established under Long Distance Decision 92-12, to the price imputation test which is intended by the Commission to safeguard against predatory pricing. While I recognize the need for some competitive safeguards during the period of transition, in my view, the Commission should move as quickly as possible to eliminate detailed day-to-day regulation of the activities of the telephone companies. In a rapidly changing industry like telecommunications, regulation cannot possibly be as effective as the market in responding to the diverse demands of business and residential customers for lower prices, increased choice and access to new and innovative products.

Competition in long distance services appears to be fast reaching the point where the Commission should forbear from regulation. Rate rebalancing and the elimination of the contribution scheme from long distance competitors would go a long way to reducing the burden of regulatory oversight of the telephone companies. By taking these steps the Commission could better concentrate its resources on the long run priority of facilitating competition by assuring access to essential facilities.

The transition away from regulation to competition should be accomplished as quickly as possible. An unnecessarily cautious approach to reform runs the risk of prolonging the problems associated with a state of "managed competition" and denying the full benefits to the public of competition.

Marketing Practices

The Competition Act contains a number of provisions dealing with misleading advertising and other deceptive marketing practices. With the introduction of competition in long distance telecommunications the Bureau has received a substantial number of complaints regarding the marketing practices of new entrant competitors and the telephone companies. These complaints most frequently involve allegations of misrepresentations relating to solicitations to provide primary interexchange service, the identity of the company, or other misrepresentations leading to a switch of carrier without proper authority, or as it is better known, "slamming." In addition, there have been a number of complaints involving alleged misleading impressions concerning the basis for discounts promised or the level of savings which consumers may realize from subscribing to various discount plans. Other complaints have dealt with misrepresentations involving the selection of a preferred interexchang e carrier.

In order for consumers to make informed choices in a competitive market, it is essential that the information which they receive does not mislead in a manner which may be material to their choice of primary long-distance service provider. The Bureau has received some thousands of complaints over the past three years regarding marketing practices in the long distance sector, particularly leading up to and following the introduction of equal access. We attempted unsuccessfully to persuade the Commission that an insert in local telephone subscriber billing envelopes could address these issues surrounding long distance competition. We sought to inform consumers of the benefits of competition and to encourage consumers to feel at ease in shopping for long-distance services like other products, by providing them with tips to avoid undesired changes in their long-distance service provider.

While it is now declining somewhat in volume, I am concerned at the level of complaints which the Bureau is continuing to receive regarding marketing practices in the long distance sector. For this reason, I am pleased with the initiative which is being taken by the Competitive Telecommunications Association to develop an industry code of conduct in respect to marketing and other business practices, supported by innovative suggestions to encourage and promote industry compliance and resolve consumer disputes. Industry codes of conduct can be particularly valuable in protecting the public from deceptive marketing practices. However, they must be developed, and should be applied, in a manner which respects and promotes all of the provisions of the Competition Act. In this regard, the Bureau has had preliminary meetings with the CTA and will continue to work in a co-operative and positive fashion with the industry, and others, as this initiative unfolds.

Examination of Stentor

As most of you will be aware, the Bureau recently concluded an examination of the structure and conduct of the Stentor Alliance under the merger and abuse of dominant market position provisions of the Competition Act.

The main focus of the Stentor examination was on local and long distance services and, to a limited extent, equipment markets. In addition to the market and technological factors relevant to Stentor, our examination also took into account the changing regulatory environment in which the Stentor companies operate. While the CRTC has exercised its powers of regulatory forbearance in respect to wireless services, resale and non-dominant carriers, the Stentor companies remain subject to considerable regulatory oversight, including the safeguards which the CRTC has established as part of the transition to competitive markets.

The threshold question under both the abuse of dominant market position and the merger provisions of the Competition Act was whether the formation or operation of Stentor has resulted or is likely to result in a "substantial prevention or lessening of competition." As a result of the geographic monopolies that the member companies of Stentor have historically held and because of the regulatory environment in which these monopolies have evolved, it was concluded that the members have never competed against each other in any of these markets. Consequently, it could not be shown that the formation of Stentor would result in a substantial "lessening" of competition. The Bureau, therefore, focused on the question of whether the formation of Stentor was likely to result in a substantial "prevention" of competition. A substantial prevention would result if the formation of Stentor and its activities substantially impeded the erosion, or substantially entrenched , the market power of the Stentor companies.

The facts that emerged from the examination did not support the conclusion that the Stentor companies have substantially more market power than they would have in the absence of the creation of the alliance. In reaching this conclusion, the Bureau considered a number of developments in respect to competition in Canadian telecommunications markets in the period since Stentor was first announced in January, 1992. These developments included:

In addition to these factors, customers, particularly large business customers who require advanced telecommunications services on a regional or national basis, indicated very clearly that they have realized substantial benefits in terms of service quality, innovation and price as a result of the facilities-based competition in long distance services that was introduced in 1992. In a number of cases, these customers indicated that they had benefited from the co-ordination of the telcos in providing telecommunications services through the Stentor Alliance. These customers also confirmed that substantial competition from new entrant carriers has developed over a period of two or three years.

Having examined all of the issues surrounding the formation and conduct of Stentor, I concluded that grounds do not exist at this time to make an application to the Competition Tribunal. I do, however, have a continuing concern about the market power of the Alliance, particularly in light of the vertically integrated nature of its members. The Alliance does place a constraint on the incentive and ability of the telephone companies to enter into competition with one another in both product and geographic markets.

In light of these concerns, I intend to maintain a proactive approach to fostering competition in this industry. More particularly, the Bureau will continue to closely assess the effectiveness of the evolving regulatory environment in facilitating the introduction of competition in the local service markets. Should it become apparent that the measures that have been adopted or those that are to be adopted are not sufficient to achieve an open and competitive market, I will not hesitate to take whatever action is warranted under the Competition Act . The Bureau will also be continuing its role as an intervenor before the CRTC, encouraging further liberalization of competition in telecommunications markets.

Review of Teleglobe's Mandate

The Government is currently in the midst of reviewing the statutory monopoly of Teleglobe Canada in respect of the carriage of international telecommunications traffic. My submission on this issue, as you might expect, advocated that Teleglobe's monopoly not be renewed when it expires on March 31, 1997.

Teleglobe can no longer be looked at in isolation from the changes that are taking place in Canadian and international telecommunications markets. Teleglobe is not a natural monopoly. This is clear from the fact that its position in the market is being eroded by illegal bypass of its facilities. Teleglobe has estimated that bypass currently results in approximately 10% loss of revenues. Ultimately bypass will increase as these users hunt out lower prices. The ability of the CRTC to detect and stop illegal bypass will likely become increasingly difficult.

The market for international telecommunications services is becoming increasingly global. Denying users the benefits of growing international competition involves significant risks. If users are not able to obtain the lowest rates from domestic carriers, they will be at a competitive disadvantage vis-a-vis their international rivals.

Conclusion

This is an exciting time for all of us as we try to meet the challenge of introducing competition into our communication markets. Four years ago, the CRTC held its long distance proceeding in which the threshold issue was whether facilities-based competition in long distance telephone service was in the public interest. Since then, we have come a long way in a short period of time. No one can predict with certainty where the forces of technology and competition will take the industry over the next few years. The challenge, however, is to ensure that this progress toward privatization, deregulation and expanding the role of competition will accelerate during this time.

It is clear from the direction in which the rest of the world is moving that Canada must proceed quickly to develop competitive and efficient communications markets if it is to compete effectively in international markets. I strongly support the need to further open up all telecommunications markets to competition, and meaningful action on rate rebalancing and restructuring to make these markets as efficient as possible. In addition, I believe that consideration should be given to relaxing foreign ownership restrictions for all communications companies. By doing so Canada will be able to attract the necessary financial and intellectual capital our communications infrastructures require.

In this era of rapid and fundamental transformation, it is especially important for the Bureau to understand the changes which are taking place in telecommunications and their consequences for competition. In this regard, I am committed to maintaining an open dialogue and to working with industry participants and users. I want to ensure that application of the Competition Act to this important sector of our economy is informed, responsible and, above all else, effective in protecting the public interest in competitive markets.

Judging from the diverse list of panel participants and, in particular, the title of tomorrow afternoon's session "The Role of Government in Supporting Telecom Competition", I would expect that my remarks this morning will be the subject of some analysis and commentary before this conference is ended. I would like to thank the Competitive Telecommunications Association for the opportunity of speaking to you this morning.