Local Competition: What Does It Mean In Canada?

Luncheon Address by George N. Addy
Director of Investigation and Research
Competition Bureau

To the Canadian Institute
Local Telecommunication Services Conference

April 1, 1996

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Introduction

I would like to thank the Canadian Institute for inviting me to participate in this very timely conference.

I have no doubt that you are in for two days of stimulating and vigorous discussion of the economic, regulatory and policy issues as Canada embarks on the road of opening local telecommunications services to competition.

In my remarks today I'll offer the Competition Bureau's perspective on the fundamental challenges to be addressed as Canada prepares for the transition from monopoly and regulation to competition and deregulation in the delivery of local telecommunication services.

In addition I will say a few words on how the Competition Bureau sees its role as this transformation unfolds.

Let me first add one caveat: the term "transition" implies a beginning point and an end point. I think it is wrong to think of transition in this sector in those terms. The transition will be on-going, at the very least from a technological standpoint.

The Competition Policy Message

Competition policy is founded on the recognition that competitive market forces should act as the fundamental driving force in our 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 ours it is essential to constantly re-examine and re-assess the continuing need for, and the costs associated with sector-specific regulation.

It will come as no surprise to you that I strongly favour the elimination of regulation in favour of competition wherever possible. Why?

First, competition is better than regulation at creating incentives for innovation, in encouraging the development of new products, services, and methods of doing business. Competition is also a better driver to minimize the costs of bringing products and services to consumers.

This is particularly true in telecommunications where rapid technological innovation in computing and bandwidth use is creating an explosion of new products and services offered at increasingly lower prices.

Second, competitive market forces drive the prices of goods and services toward their relative costs of production and minimizes the misallocation of scarce resources. This in turn enhances economic efficiency, generating overall benefits for the Canadian economy.

Again telecommunications is an excellent example. Being an important input into almost every part of the economy, lower telecommunications costs feed into virtually all other sectors.

The Competition Bureau has a long record of advocating increased reliance on market forces for the provision of goods and services. We have done so not only in the telecommunications sector but also in other sectors of the economy which have undergone, or are undergoing, significant changes as a result of globalization and the information revolution.

The Bureau has consistently advocated the benefits of competition in regulated industries such as transportation, energy, financial services, agriculture and the professions.

From our vantage point, many of the issues associated with opening up local telecommunication markets in Canada to competition are not unique. We have observed a similar pattern or cycle in the transition of other industries from regulation to competition.

In the first phase, technological change or some other factor undermines the "natural monopoly" assumptions which gave rise to economic regulation in the first instance. At the same time public policy objectives are often challenged.

When this happens, in phase two, incumbents invariably attempt to defend their monopoly position against potential new competitors with warnings of the dire consequences competition will portend for employment, public safety and security, universal service, cultural sovereignty, or some other public policy goal.

In the third phase, having unsuccessfully defended their monopoly position, incumbents invariably "get religion" and demand to be relieved from regulation immediately demanding full "freedom to compete". This is frequently met with resistance from new entrants who ask the government or the regulator for some form of asymmetrical regulatory protection from the incumbents. Or they will argue: Now that we're in, close the door because the market can't support any more players. Also, new entrants often allege predatory pricing and other anti-competitive activity on behalf of the former monopolists.

New entrants frequently have difficulty accepting Bureau opposition to proposals for "competitive handicapping" or a "managed transition to fair and sustainable competition."

In my view, the sooner the puck is dropped and the game begins, the better for the fans.

Phase four invariably brings the necessary regulatory reforms to facilitate the transition to competition. The success of this phase is contingent on changes to the regulator's mandate and, even more importantly, the willingness of governments and regulators to allow competition to determine market outcomes.

Ultimately the economic and technological forces pushing for change can't be stopped. But they can be hastened or impeded, channeled or diverted by the choices we all make as we are going through the cycle.

It is my view that when confronting dramatic economic and technological change, the regulator's role is better directed at looking for ways of hastening the benefits and opportunities flowing from this change and minimizing dislocations. It must avoid throwing up roadblocks because ultimately these transformations are inevitable .

I should make it clear that in bringing this pattern to your attention, I am not attempting to minimize or ignore the very real competition issues that face the Canadian telecommunications industry as a result of the chips and bit revolution.

In fact, the corporate behaviour I have described is quite rational. It is designed to optimize shareholder value. The challenge is for those forming and implementing public policy to understand this process.

A cycle involving a network industry such as telecommunications, where competitors must interconnect, and some may rely upon access to essential facilities controlled by the dominant firms with whom they compete, clearly raises important issues which must be addressed.

Right now the CRTC is grappling with the numerous technical and economic matters involved in opening up local telephone markets to competition, including co-location, number portability, price caps, local service pricing options, rate rebalancing and restructuring, and access to the essential components of the Stentor networks.

There is ample room for differences of opinion as to how such issues might be resolved in the complex and difficult balance between regulation and competition.

What I want to stress today is that the pattern I just described exists and we must not lose sight of the ultimate objective facing all of us: how we can hasten the introduction of competition into local telecommunications markets for the benefit of all Canadians.

Competition will not simply bring about lower prices. It will also bring more price dispersion, increased consumer choice, more rapid innovation, new services and new competitors. It will also free competitors from the shackles of a very costly regulatory regime.

I also want to underscore that the Competition Bureau does not play favourites. We don't pick "winners" and "losers". When confronting the issues arising from the transition from regulation to competition, we are obligated to transcend the particular perspectives of industry participants, interest groups, and other constituencies.

We try, and I believe for the most part succeed, in bringing the best analysis and policy advice possible to the table to ensure Canadians as a whole benefit from the emergence and operation of competitive markets.

With free and open local markets there will inevitably be winners and losers as individual participants come and go. That is what the competitive process is all about.

Those who become complacent, fail to innovate, offer poor service or higher prices for similar products, or fail to continually earn their place in the marketplace, will simply not survive. Nor should they.

By rewarding the best, we ensure that Canadian consumers, Canadian businesses, and the Canadian economy are the ultimate winners. This must be the central focus of Canadian telecommunications policy as we enter into a new era for local telecommunications.

Local Telecommunications Competition and the Choice of Regulatory Framework

For most of this century regulation of local telecommunications has been based on the premise that the public switched telephone network was a natural monopoly. It is now clear that this premise may no longer be true.

Recent technological advances in fibre optic technology, in the use of the electro-magnetic spectrum, and in microelectronics are bringing about a proliferation of alternative communications technologies and networks or, in short, competitors.

Four short years after opening the long distance telephone market to competition, Canadians now face the potential of receiving telephony, data and video services from a number of wireline and wireless networks. This prospect has been fostered in part by several policy initiatives. For example:

• Last December the Government awarded four personal communication services licenses.
• This past February it invited license applications for local multipoint communications systems. (LMCS)
• The Government will soon be announcing its policy for convergence which will allow cable companies and telephone companies to compete head-to-head.

And as I speak, the CRTC is embarking on a process of creating an environment for open competition in the provision of local telephone services.

Yet, in my view the performance of the local telecommunications sector itself will be most profoundly influenced by the choice of regulatory framework under which it operates. While there may be general agreement on a broad policy outline for local competition, the devil is in the details of the regulatory oversight necessary to implement competitive policies.

With emerging local competition in sight, I would urge that we move as quickly as possible to create an environment that promotes the formation of competitive local markets and economically efficient pricing.

A competitive environment will ensure that the correct market signals are sent to firms and individuals so that they may each make their optimal pricing, purchase, market entry, investment, and research and development decisions. The operation of market forces will ensure that the Canadian telecommunications industry becomes as efficient as possible thereby best serving the public interest.

The extent to which each Canadian benefits from this evolution will either be enhanced or impeded by the regulatory structure put in place.

Failure to adopt a pro-competitive regulatory regime at the outset will perpetuate the costly regulatory burden and ultimately cause Canada to fall behind our international competitors in the race to embrace the information economy.

Some argue that the United States, in passing its new telecommunications legislation earlier this year, now leads that race. Europe is in the process of deregulating its markets and Asian nations are busy building modern communication infrastructures.

Canadian businesses will soon face even stiffer competition from foreign firms who benefit from the innovations outside our borders. You can be sure that they will demand that telecommunication providers in Canada keep pace. They will be even more insistent in demanding that Canadian regulatory policy also keep pace.

I believe Canada can be at the forefront of international communications if we act now to introduce a pro-competitive regulatory environment. We need to eliminate entry barriers into local telecommunications markets and adopt a competition policy framework for regulating the industry.

One significant competitive barrier is the present telephone rate structure which deters entry into some local markets.

The single most important step the CRTC can take to ensure the success of new entrants would be to immediately introduce efficient pricing by rebalancing and restructuring telephone rates. To attempt to introduce competition into local markets while preventing prices from moving closer to costs may prove to be a very difficult task, if not altogether impossible.

Absent an economically efficient pricing structure, the CRTC is likely to be at the centre of lengthy, costly and continuous disputes between long distance companies, new entrants into the local market, and the incumbent telephone companies over contribution payments, bypass and price squeezes.

Such disputes are costly and time consuming. They impede price and service competition as well as hinder the rapid spread of new and more efficient technologies. While individual firms in the industry might occasionally benefit from the outcome of such battles, the real losers will be the Canadian public.

An economically efficient pricing structure is clearly more conducive to competitive entry into local markets. The regulatory burden is removed and market forces are free to determine the most efficient delivery of local telecommunications services.

During the transition period, competitive solutions should be relied upon wherever feasible rather than regulation.

Technological change has fundamentally altered the benefits and costs of regulating the telephone companies . There should be no predisposition to regulation and any tendency to impose or perpetuate costly and complex regulation must be resisted or at the very least thoroughly scrutinized to ensure that the benefits outweigh the costs.

For instance why should new entrants who have no market power be regulated at all?

Regulation, where it remains, should apply only to essential telecommunications services not subject to effective competition. By essential I mean services that exhibit natural monopoly characteristics. All other services do not need to be regulated, as is the case with goods and services in other sectors of our economy.

To assist those in our society who could be adversely affected by rebalanced or restructured rates, I favour a competitively neutral mechanism of assistance -- one that is targeted directly at subscribers who need assistance and which provides them with the freedom to choose their communication providers. In this way we assure access to essential telecommunications services for all Canadians, reduce the costly regulatory burden, and provide consumers with freedom of choice of service offerings which best meet their needs.

To protect against the telephone companies from abusing their market power, I support the introduction of a price cap regime. However, these caps should only be for essential services and they should only be in place for the period of the transition away from regulation to competition.

Furthermore, price caps should be designed in such a way as to provide the telephone companies with the maximum freedom and flexibility to offer consumers the full benefits of their economies of scale and scope.

Ultimately it is entry and competition in local markets that will place a ceiling on the rates which the incumbents will be able to charge for their services.

Another important aspect of the transition will be to ensure access by new entrants to essential facilities owned or controlled by dominant firms. This will increasingly be a time-consuming area of focus by the CRTC given the complex economic and technical issues involved. In this regard I have recommended that the Commission adopt an alternative dispute resolution procedure that will deal with access disputes in a timely and binding fashion. This will ensure that the benefits of the competitive process for Canadians are not impeded by the behaviour of incumbents or new entrants who play the regulatory game.

The transition from regulation to competitive markets should be accomplished as quickly as possible.

An unnecessarily cautious approach to telecommunications reform runs the risk of prolonging the problems associated with a state of "managed competition" and of denying the full benefits of competition to users who require competitively priced services to compete in a global economy.

The Relaxation of Foreign Ownership Rules

The future of telecommunications competition in Canada would benefit from a further relaxation of foreign ownership restrictions. In an increasingly global capital environment, it is necessary for Canadians to reconsider the issue of foreign ownership limits in telecommunications.

At this critical juncture in the evolution of this sector, and largely as a result of the pressures brought on in a competitive environment, questions are increasingly being asked as we consider this issue.

What were the public policy objectives which led to the introduction of foreign ownership restrictions in the first place? Are these objectives still valid today?

Are the means of attaining these objectives still valid today?

What is it about telecommunications, compared to other equally important sectors of our economy, that requires limits on foreign investment?

What is so different about the pipes that carry telecommunications signals from those that carry other vital commodities, such as crude oil and natural gas, where no foreign ownership restrictions apply?

What is more important from a policy perspective, the source of capital or its behaviour and use?

Is there any evidence that the public in British Columbia or in the territory served by Quebec Tel are in anyway disadvantaged or receive inferior telephone service as a result of their foreign ownership structure?

More and more these questions are coming to the forefront of the policy debate in this sector.

While I recognize that there may be non-competition policy reasons to retain some foreign ownership restrictions, let me focus on at least two competition-related reasons favouring their relaxation.

First, some have suggested that it may cost about $30 billion to construct the Canadian information infrastructure. Some of the companies represented here have told me that foreign ownership restrictions impose significant costs on the domestic communications industry by limiting access to cheaper foreign capital.

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.

Increased access to foreign financial and intellectual capital would be of benefit to cable companies, long-distance telecommunications firms, wireless companies, content providers, and others contemplating entry into local telecommunications markets. It would also benefit wireless, cable and incumbent telephone companies wishing to upgrade existing networks or to construct advanced high speed networks capable of providing interactive broadband and narrowband services .

The overall effect of relaxing foreign ownership restrictions would be to facilitate the growth of Canada's 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.

If foreign ownership restrictions are 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 de jure control, such as 49%.

Evolving Roles of the Competition Bureau and the CRTC

Increasingly I am asked at what point should the regulation of telecommunications services by the CRTC give way to the application of the Competition Act. This is a complex question with no easy answer.

Let me share some observations on what I believe are the important considerations.

At the outset, it is useful to reflect on the overall scheme of relevant legislation governing the mandate of both organizations.

The Telecommunications Act provides to the CRTC broad powers of regulation over telecommunications. The Act has numeral objectives, one of its principle objectives is to foster reliance to the maximum extent possible on market forces for the provision of telecommunications services. In keeping with this objective, the CRTC 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 judgment.

In the Regulatory Framework proceeding, I recommended to the CRTC, 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 CRTC agreed that a determination of "sufficient competition" should be based on the principles of competition policy analysis, having regard not only to an analysis of market shares, but to other competition criteria such as the height of entry barriers and the role of technological innovation.

In the Bureau we consider the contestability of markets: are entry barriers low enough that potential entrants could come into the industry and compete monopoly profits away. This is particularly true in an industry like communications where rapid technological change makes markets increasingly contestable.

Concepts like "commercially viable", "profitable", and "sustainable" or ensuring that a specific number of firms are earning positive profits are not necessarily determinative as to whether a market is competitive.

An industry in which two firms have entered into a profitable market sharing agreement may be sustainable, profitable and exhibit market stability; but it is not competitive.

In considering the question of deregulation, it is 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.

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 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 set out in the Competition Act are present and enforcement action is warranted.

The present scope for application of the Competition Act to telecommunications is subject to a number of additional 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 it's extension to the civil provisions of the Act has been the topic of considerable discussion in the context of the telecommunications industry.

In addition to the jurisdictional issues, you know that the CRTC has itself implemented a number of competitive safeguards. These range from the broad terms and conditions for access to the public switched telephone network established under the CRTC's Long Distance Decision 92-12, to the price imputation test for toll services which is intended by the Commission to safeguard against predatory pricing. Similar safeguards are under consideration for local markets.

While I recognize the need for some competitive safeguards during the period of transition, the CRTC should move as quickly as possible to eliminate detailed day-to-day regulation of the activities of all telephone companies.

In this rapidly changing industry subject to immense technological change, regulation cannot possibly be as effective as the market in responding to the diverse demands of business and residential customers .

Conclusion

There is a remarkable degree of consensus that competition must be at the heart of our nation's local telecommunications policy if our industries are to attract new investment, become more innovative, speed the deployment of new technologies, and make new services and applications available to consumers.

As the information infrastructure evolves, open markets and private investment will work together to provide the levels and kinds of access to the services that Canadians want in their homes, at work, and in their communities.

The message I want to leave with you today is that opening up local telecommunications markets to competition, requires us to focus our attention on fundamental policy objectives and how best to achieve them.

In doing so we must seriously rethink our policies to determine if they still have merit as we embrace the information age. Outmoded regulatory models should not be used to hinder this transition. We all need to be more creative and innovative in meeting public policy objectives in ways that are least restrictive of competition.

Today we stand on the verge of vigourous competition between a whole host of wire and wireless providers of local communication services offering packages of video, videoconferencing, data and telephone services to our offices and our neighbourhoods.

No one can predict with certainty where technology will take us over the next few years or which new ones will arrive on the scene.

What is clear however, from both the speed and direction in which some of our trading partners are moving, is that we must act quickly to develop competitive and efficient communications markets at home if we are to compete effectively in global markets.

To achieve this goal, I strongly support policies that open domestic telecommunications markets to competition, that remove barriers to entry by domestic and foreign firms, and that encourage our markets to operate as efficiently and competitively as possible. If we do it right, Canada will attract the financial and intellectual capital required to build the communications infrastructures of the future.

Lastly, it is extremely important for us at the Competition Bureau to fully understand the immense changes which are taking place in communications and their consequences for competitive markets. We welcome an on-going dialogue with everyone of you associated with this sector - whether user, service provider, or interested observer.

We, in the Bureau, have an obligation to ensure that the application of the Competition Act to this critical sector of our economy is informed, responsible and, above all else, effective in protecting the public's interest in competitive markets. And we count on your assistance. Thank you.