Taking the Wraps Off Competition

Speaking Notes for an Address by Robert G. Lancop
Chief, Civil Matters
Competition Bureau

1996 Carrier Services Group
Annual Conference and Workshop
Toronto, Ontario

May 10, 1996

---

Note: Remarks presented by Mr. R. G. Lancop for the Director of Investigation and Research, Competition Bureau.

Introduction

I would like to thank Stentor and the Carrier Services Group for inviting me to participate in this important conference.

In my remarks this afternoon, "Taking the Wraps Off Competition," I hope to provide you with an overview of how the Competition Bureau views its role 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

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

The Competition Policy Message

Competition policy is founded on the belief that competitive market forces should act as the engine of growth for 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 the Competition Bureau strongly favours the elimination of regulation in favour of competition wherever possible. First, competition is better than regulation at creating incentives for innovation, the development of new products, services, and methods of doing business. Competition is more effective in minimizing the costs at which products and services are brought to consumers. This is particularly true in telecommunications where rapid technological innovation is creating an explosion of new products and services at increasingly lower prices. Second, market forces drive the prices of goods and services toward their relative costs of production and minimize the misallocation of resources. This in turn enhances economic efficiency, increasing overall benefit to the Canadian economy.

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 such as transportation, energy, postal services, financial services, agricultural and the professions.

From our vantage point, many of the issues associated with opening up telecommunications markets in Canada to competition are not unique. We have observed a similar pattern 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 regulation in the first place and, accordingly, public policy objectives are challenged.

In phase two, incumbents invariably attempt to defend their monopoly position against potential new competitors with warnings of the dire consequences competition will hold for employment, public safety and security, universal service, cultural sovereignty, or some other public policy goal. Most recently we have heard these dire warnings from Canada Post Corporation during the Mandate Review exercise.

In the third phase, 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 ask 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, these new entrants often allege predatory pricing and other anti-competitive activity on the part 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." At least some competitors will find it tempting to lay a portion of blame on the Bureau for their commercial difficulties.

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 the willingness of governments and regulators to cede their authority and 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 made as we are going through the cycle.

It should be clear that we are not attempting to minimize or ignore the very real competition issues that face the Canadian telecommunications industry. A network industry such as telecommunications, where competitors must interconnect, and may rely upon access to essential facilities controlled by the dominant firms with whom they compete, clearly has important issues to address. 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.

Nonetheless, the pattern I just described is real and the objective of competition and eliminating the burden of regulation is worth the effort because it will deliver the benefits of lower prices, increased choice, innovation, greater efficiency and increased competitiveness.

It should be clear from the Bureau's record that we don't play favourites. In recent years, we have managed to come out on different sides of various issues with a number of groups, as well as the CRTC itself.

What we are striving to do is to provide the best analysis and policy advice possible to ensure Canadians as a whole benefit from the emergence and operation of competitive markets.

The Importance of Telecommunications Competition

Beyond its significance as an $18 billion industry, telecommunications is key to Canada's future prosperity. Today, all economic sectors rely increasingly on an information base built around telecommunications.

There is a remarkable degree of consensus that competition must be at the heart of telecommunications policy if the industry is to attract new investment, encourage innovation, deploy new technologies and make new services available to consumers. However, the performance of this 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.

In the long distance sector, equal access has been achieved and competition has resulted in significant reductions in rates and improved services. From competitive entry, declining prices and market share lost by the incumbent telephone companies, it is clear that long distance competition has emerged in Canada at a rate much faster than anyone would have predicted in 1992. Despite the enormous benefits 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 led a number of industry participants and analysts to question whether long distance competition is "sustainable" in the long run.

However, the resultant calls for "managed competition" sometimes have more to do with protecting competitors and regulatory entitlements than competition itself. With free and open markets there will be winners and losers as individual participants come and go. 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 not survive. Nor should they. By rewarding the best, we ensure that consumers, efficient businesses and the Canadian economy are the ultimate winners.

Accelerating technological change is going to continue to enhance the opportunity for competitive entry into telecommunications and make regulation 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 are 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 our 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 benefits of competition.

Presently, business long distance and urban subscribers pay a large share of fixed and common costs while residential and rural customers pay a small share. This 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. Moreover, it also fails to 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. 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 costs. 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 in most segments of the local/access market.

The Commission has now initiated 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 its Regulatory Framework decision, the Commission has also initiated a proceeding to implement price cap regulation for the telephone companies by January, 1998.

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.

While there may be other policy reasons for retaining some foreign ownership restrictions, let me focus on two competition-related reasons favouring their relaxation. First, 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. 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.

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 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 de jure control, such as 49%.

Evolving Roles of the Competition Bureau and the CRTC

Increasingly the question is being asked at what point should regulation of telecommunications by the CRTC give way to the application of the Competition Act. This is a complex question. It is useful to reflect on the overall scheme of relevant legislation in order to answer it.

The Telecommunications Act provides to the CRTC broad powers of regulation over telecommunications. The Act has as one of its principle objectives, the reliance to the maximum extent possible on market forces for the provision of telecommunications services.

Forbearance

In keeping with this objective, the CRTC is required to forbear from regulation where sufficient competition exists to protect the interests of users.

In the Regulatory Framework proceeding, the Director 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 market shares, but also other criteria such as entry barriers and the role of technological innovation.

In the Bureau we consider the issue to be one of contestability of markets. In other words, are entry barriers low enough that potential entrants could come into the industry and compete monopoly profits away.

Concepts like "commercially viable", "profitable", and "sustainable" or ensuring that a specific number of firms are earning positive profits are not necessarily indicative of 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 forbearance, 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. These are determined by 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 committed and enforcement action is warranted.

Competitive Safeguards

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 the CRTC's Long Distance Decision 92-12, to the price imputation test which is intended by the Commission to safeguard against predatory pricing.

While the Bureau recognizes 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 the 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.

Competition in long distance services appears to be fast reaching the point where the CRTC 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 CRTC could better concentrate its resources on assuring access to essential facilities. This will increasingly be a focus of the Commission's activity given the complex economic and technical issues involved. In this regard, the Director has recommended that the Commission adopt alternative dispute resolution procedures that will deal with access disputes in a timely and binding fashion. This will ensure that the benefits of the competitive process are not impeded by the behaviour of companies engaging in regulatory gamesmanship.

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 of denying the full benefits of competition to users who require competitively priced services to compete globally.

Regulated Conduct Defence

The present scope for applying the Competition Act to telecommunications is limited by what has become known as the regulated conduct defence. This defence has been articulated by the courts 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 its extension to the civil provisions of the Act has been the topic of considerable discussion in the context of the telecommunications industry. This issue recently arose in the proceedings before the Competition Tribunal with respect to the Director's challenge to certain practices of Tele-Direct.

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 many complaints regarding the marketing practices of long distance providers. The majority of these complaints involve allegations of misrepresentations relating to solicitations to provide interexchange service, the identity of the company, or a switch of carrier without proper authority, better known as, "slamming". In addition, there have been a number of complaints involving discounts or savings promised for subscribing to various plans.

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 long-distance service provider. The Bureau has received 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. In order to address these concerns, we attempted unsuccessfully to persuade the Commission to order that an insert be placed in local telephone subscriber billing envelopes.

While it is now declining somewhat in volume, we remain concerned at the level of complaints which the Bureau is continuing to receive regarding marketing practices in the long distance sector.

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 forbearance with 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."

The facts that emerged from the examination did not support the conclusion that the formation or conduct of the Stentor alliance had the effect of substantially preventing or lessening competition. In reaching this conclusion, the Bureau considered a number of developments in Canadian telecommunications markets in the period since Stentor was first announced in January, 1992. These developments included:

• The opening of the market for long distance service to facilities-based competition in June, 1992, and equal access in mid-1994;
• The entry into the long distance sector by facilities-based carriers, including large foreign carriers such as Sprint and AT&T;
• Significant reductions in long distance rates;
• The introduction of new and innovative services;
• Market share declines by Stentor member companies in the order of 20-30%;
• The growing potential for competition from wireless networks and the cable industry;
• A more pro-competitive regulatory environment.

Having examined all of the issues surrounding the formation and conduct of Stentor, the Director concluded that grounds do not exist at this time to make an application to the Competition Tribunal. The Director does, 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, the Director intends to maintain a proactive approach to fostering competition in this industry.

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. The Director's 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 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 which Teleglobe conservatively estimates results in a 10% loss of revenues. Ultimately, bypass will increase as 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. If users are not able to obtain the lowest rates from domestic carriers, they will be at a competitive disadvantage vis-à-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 communications markets. 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 the momentum toward deregulation and expanding the role of competition is maintained 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. The Competition Bureau strongly supports the further opening of telecommunications markets to competition, and meaningful action on rate rebalancing and restructuring to make these markets as efficient as possible. In addition, we believe that foreign ownership restrictions should be relaxed 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, we are committed to maintaining an open dialogue and to working with industry participants and users. We 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. Thank you.