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Real Consumers

and Telco Choice:

The Road to
Professor Joshua Gans
Melbourne Business School
University of Melbourne

Presentation to the Australian

Telecommunications Summit,
Sydney, 21st November 2005
Is Competition
●Can competition enable consumer
●It is a necessary condition
●Consumers need options
●But is it sufficient?
●Can consumers make the necessary
●Will competition reduce exploitation of
consumer irrationality?
●Scott Adams: “a group of companies with
similar products who intentionally confuse
customers instead of competing on price.”
●Examples: energy retailing, insurance,
mortgages, credit cards, etc.
●But what about telecommunications?
Search Model
● Consider an industry with several
producers of an homogenous product
● A consumer considering switching
suppliers will switch if:
Pold > Pnew + D
● where D are switching costs including any
disconnection fees
● A consumer will only search for a new
supplier if:
Expected Savings > S
● where S are search costs
Diamond Paradox
●With many suppliers, why would you
expect to get a better deal?
●If all highly competitive, then can’t do better
●Only if you think firms will offer you a customer
specific deal; but will they?
●According to Diamond (1971): each firm
won’t lose many customers by charging a
slightly higher price than other firms
●In equilibrium: all charge the monopoly price
and no search occurs.
‘Sleepy Incumbent’
● Customers may expect to get a better
deal if switching from an incumbent
● Implication: entrants should advertise pricing
deals (high marketing spend relative to their
market share)
● Incumbent may accommodate this by
charging higher prices (Guilietti, Waddams-
Price, Waterson, 2005)
● Should see incumbent retailers charging
a higher price than entrants in an area
Energy Retailing
● In July, 2005, I considered energy retailing in
● Utilising the Essential Services Commission
calculator I found that the complex pricing schemes
of AGL, Origin and TRU were identical and equal to
the regulated cap
● Evidence for the Diamond Paradox
● Would telecommunications be better given
that it is based on an incumbent/entrant model
rather than a divided incumbent model?
Which Model for
●Which model applies in telecommunications?
Diamond Paradox or Sleepy Incumbent
●With this in mind, examined choice between
fixed line versus mobiles for long distance
●Are these substitutes for consumers?
●(Thanks to Nera for data gathering and analysis)
Plans (calls to
Telstra Telstra Optus Vodafone Hutchison
Complete Plus 1.49 Mobile

Per 23c (peak), 24c (peak), 60c 60c 70c

15c (off 12c (off
minute peak) peak)
Surcharge 35c 35c 20c 20c 30c

Cap <20 min ($2) <20 min $49 cap ($230)$79 cap ($500) $49 cap ($230)
off peak only ($1.49) $79 cap ($500)$149 cap $69 cap ($400)
($1200) $129 cap
$149 cap
● Calls modelled are long distance within Australia, and to
mobiles within Australia;
● Distributions of call durations as below, with means of 5 and 10
minutes respectively;
● Ownership of a mobile on a base plan (the lowest cost) is
assumed for each mobile network;
● Calls switched to mobiles have the same distribution as the
distribution they were drawn from. That is, consumers do not
only switch calls of a particular duration from fixed to mobiles -
this is a future line of analysis;
● 50% of calls are in the peak period;
● 70% of calls are to fixed lines, 30% to mobiles. The phone of
choice is independent of whether the call is made in peak
period or not – this assumption can easily be relaxed with
appropriate data; and
● 45% of calls to mobiles are to Telstra mobiles (reflecting
Telstra’s share of the mobile market).
Call Patterns (5 min


Switching from Telstra
Complete to Mobile


350 Vodafone


5 min
Nera analysis
Switching from Telstra
Plus 1.49 to Mobile

350 Vodafone


5 min
Nera analysis
Switching from Telstra
Complete to Mobile

350 Vodafone


10 min
Nera analysis
Switching from Telstra
Plus 1.49 to Mobile

350 Hutchison


10 min
Nera analysis
● Difficult to compare price offers
● Depends on a consumer’s specific calling pattern.
● Networks differentiate on call duration
● Mobiles are a potential substitute for fixed line calls
● Imperfect analysis but substantial savings possible
● ‘Sleepy Incumbent’ (rather than ‘Diamond Paradox’
model) alive and well in telcos

Despite competition regulated Telstra prices still

Reform Option?
● Portuguese Competition Authority analysis
● Conclusion:
● Wide number of mobile plans difficult for consumer to assess
● This impeded price competition
● Reform:
● Require all networks (and agents) to provide a web-based
program to allow consumers to identify the cheapest plan
● Supply information to allow regulator to host a program to
allow consumers to compare competing plans between
mobile networks.
Can competition protect
Re-considering bundling
The contention
●If consumers can be exploited (i.e., pay for
goods they don’t value enough), won’t
market forces fix this?
●If there is competition, there will be at least
some suppliers who will find it profitable to
actually supply consumers with products
they value.
●So competition protects consumers
The issue …
●In May, David gets asked to give a
talk on regulation on the 21st
November and happily accepts.
●On the 17th November, David wishes
he could defer giving the talk even
though nothing has changed.

●This lack of self control is common.

… it’s even worse …
●In May, David does not anticipate
that he will regret, in November,
his decision to give the talk.

●This is a common failure to

anticipate your future position – it
is a naïve approach.
The point …
From The Onion …

LOMPOC, CA—The Bally Total Fitness membership

purchased Monday by Alex Scarbe already appears
destined for failure. "I really should go buy some new
shoes, so I can come back tomorrow and work out,"
Scarbe said, moments after completing the
membership paperwork. "Just getting in here and
signing up is enough for today. I think I'll reward
myself with a smoothie." Scarbe will return to Bally's
twice in April, then once in May to use the whirlpool,
and ultimately cancel his membership in 2007, when
he notices Bally listed on his credit-card statement.
Supplying what they
●If consumers lack self-control but are
otherwise sophisticated, firms will offer
products to help them commit
●E.g., low unit price for gym visits
●If consumers lack self-control but are
naïve, firms will exploit this
●E.g., extract payments for automatic
renewal fees
●New economic approaches for dealing with
consumer irrationality
●Basic idea:
●When faced with an upfront cost and future
options, consumers with over-weight option
value and spend too much upfront
●When faced with an upfront benefits and future
avoidable costs, consumers will under-weight
ability avoid costs and spend too little upfront
Implications for
● Consumers will under-weight importance of
disconnection fees
● Consumers will under-weight ability to opt out of
automated payments to switch in the future
● Consumers will under-weight future switching costs
● Consumers will fail to invest in information to make
choices transparent
● And firms will not have an incentive to provide transparency
as consumers will demand more upfront to compensate for
switching costs later on.
● Demand in a market is based on actual consumer
● For time-based consumption, naïve consumers will place
too little weight on future costs and anticipate getting
more value than they actually receive
● Consumers will purchase today more than they would if
they anticipated their wants in a sophisticated manner
● Over-consumption for any given price
● Competition works to ensure consumers are
supplied with what they demand at a lower price
not with what they want.
Welfare Impact

Loss Supply



Naïve Demand


Q* Qn
Impact of reduced
$ Supply without competition

Supply with

Overall welfare is
P* Consumer welfare
may not be improved.
Naïve Demand


Q* Qm Qn
Bundling and add-on
●Buy one product (hotel, groceries) and
then buy another (phone calls, petrol)
●Consumer reaction
●Sophisticated consumers anticipate add-on
prices and substitute away (benefit of lower
price for initial good)
●Naïve consumers do not anticipate prices and
●Firms price first good low and naives cross-
subsidise sophisticates
●Suspicious of bundling without any
efficiency or value rationale.
Educating consumers
●Under monopoly,
●May have incentive to educate naives if
don’t want to price discriminate against
●Under competition,
●If educate a naïve, then they learn to
substitute away – go to another firm and
receive cross subsidy
●No incentive for a firm to educate
●Education is a public good
● Implication of behavioural economics: cannot rely on
competition to protect naïve consumers
● Difficult to exercise consumer choice
● Competition generates more supply of things they don’t want
● Education and information are public goods (under-
provision in market place)
● Regulators should focus attention on undesirable
● E.g., disconnection fees, automatic renewal fees, unbundling
● Critical for future issues such as cross-media ownership