Pricing Strategies in the Context of Price

Regulation

by
Patrick Xavier
School of Business
Swinburne University
Melbourne Australia
ITUWorkshop(2)

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 Pricing strategies under price
regulation
The objective of this presentation is:
• to explain the characteristics of price cap
regulation since this is a scheme in
increasingly use and may be used in
Thailand to regulate TOT (indeed that TOT
might argue should be used rather than
direct government approvals or profit
regulation)
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 Pricing strategies under price
regulation
• to indicate strategies for use under price
regulation.

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 1. Direct price control

• Approval of price changes (increases &

decreases) by government or by the
regulator.
• Since price increases are usually politically
unpopular, approval tends to be usually
given with reluctance and delays.
• This is increasingly seen to be inappropriate
in competitive circumstances.
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 2. Rate of Return Regulation (RRR)

• Essentially the limitation of profits to a

“reasonable” level
• Experience (eg. in the US) indicate that the
use of RRR can involve long arguments
about what a “reasonable” rate of return is.
• Can also involve detailed and long
argument over what costs were necessarily
(and efficiently) incurred.
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 Rate of return regulation (con’t)

• This could lead to detailed involvement of

the regulator in the investment and
commercial decisions of the service
provider
• The recognition of such disadvantages of
RRR (and many others) has led to an
increasing use of an alternative price control
approach, so-called “Price-cap regulation”.
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 3. Price-cap regulation

• Under the price-cap scheme, a service

provider’s price increases would be limited
to the rate of inflation less an agreed “X”
factor (based in principle on expected
productivity improvement).
• In principle, there would be no restriction
on the level of profits.

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 Price-cap regulation (con’t)

• Regulators favoured the price-cap scheme

because it focused directly on price
increases -- a variable that is more
transparent -- than “necessary” cost
expenditure.
• Operators have favoured the scheme
because it should allow less intrusive price
regulation than RRR.
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 Price-cap regulation (con’t)

• Also, it promises to permit unrestricted

profits.
• In fact, in many cases, operator profits have
shown increases under price-cap regulation.

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 Price-cap regulation (con’t)
• It is not unlikely that the price-cap scheme
will be considered for use in Thailand to
regulate TOT’s prices.
• The focus of this presentation is to indicate
strategies for TOT to consider if it is
required to operate under the scheme.

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 Price-cap regulation (con’t)
• Essentially the price cap scheme restricts
price increases to “CPI - X” where:
• CPI (Consumer Price Index) is the inflation
rate
• the “X” factor is (in principle at any rate)
based mainly on the productivity
improvement potential of the regulated
company.
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 Price-cap regulation (con’t)
Thus if inflation is 8% and the “X” factor is
set at 3% making the formula
“8% - 3%”.
This means price increases will be restricted
to no more than 5% per year for the
duration of the formula.

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 Price-cap regulation (con’t)
In principle, there would be no restrictions
on the level of profits that accrue (thus
sustaining incentives for the company to
‘beat’ the expected productivity
improvement reflected in the ‘X’ factor).
The formula is usually set for between 3 to
5 years and reviewed at the end of this
period.
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 Price-cap regulation (con’t)
Probably the most effective way to further
explain the operation of the price cap
scheme is to examine its characteristics
when applied in various countries.

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 Price-cap regulation in the UK

• 1984: CPI-3%. Line rentals, local & long

distance calls; individual cap of CPI + 2%
on line rentals until 1997.
• 1989: CPI - 4.5%. Line rentals, local &
long-distance.
• 1991: CPI - 6.25%. Basket extended to
include international calls.

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 Price-cap regulation in the UK
• 1992: CPI - 7.5%. Line rentals, local, long
distance, international. Some individual
price caps placed on certain services.
• 1997-2001: CPI - 4.5%. Single basket of
line rental, connection, and call (local, long
distance, and international) charges for
small to medium usage households (light
user scheme).
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 Price-cap regulation in the UK
• 1997-2001: CPI - 0%. Line rentals for
small business. Low usage small business
service packages must be as good as for
residential segment.

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 Price-cap regulation in Canada
• 1994: Direct price control. Three regulated
increases for 1996, 1997 and 1998 to bring
residential service rates into line with costs.
• 1995: Rate of return. Utility segment (the
non-competitive part of the industry).
• 1998-2002: CPI - 4.5%. Utility segment.

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 Price-cap regulation in France
• 1995: CPI - 4.5%. Basic voice telephony
services without discount schemes,
comprising access, line rentals, calls (local,
national, international and payphones).
• 1996: CPI - 5.5%. Basic voice telephony
services, as defined above.
• 1997: CPI - 9%. Basic voice telephony
services, as defined above.
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 Price-cap regulation in France
• 1999: CPI - 4.5%. Basic voice telephony
services, as defined above.

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 Price-cap regulation in Sweden
• 1993: CPI - 1%. Basket of telephony
services supplied to households and smaller
companies; Light user schemes providing
users with low consumption reduced
subscription fees.
• 1997: CPI - 0%. Customer access charges-
customer line connection and rental.

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 Price-cap regulation in Australia
• 1989 CPI - 4% Line rentals, local, long
distance & international.
Sub-caps. CPI - 0%. local calls and
residential rentals.
Notifiable and disallowable: Connection
fees, payphone calls, calls to directory
assistance.

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 Price-cap regulation in Australia
• 1991: Notifiable and disallowable 008
services, leased line charges, mobile
services.
• 1992. CPI - 5.5%. Connections, line rentals,
local calls, long distance, international,
domestic leased lines, international leased
lines, mobile services

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Price-cap regulation in Australia
Sub-cap: CPI - 2% connections, rentals and
local calls.
Sub-caps: CPI - 5% Long distance;
international calls.
Capped at CPI -0%. Increases in prices for
connections, rentals, local calls and long
distance calls.

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 Price cap regulation in Australia
Notifiable and disallowable. Payphone
calls, calls to directory assistance,
connections for resellers.
• 1996 to 1998: CPI - 7.5%. Connections, line
rentals, local, long-distance and
international calls, leased lines, mobile
telephone services.

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Price cap regulation in Australia
Sub caps. CPI - 1%. Residential
connections, line rentals, long distance calls
and international calls.
Before increasing any charge subject to
these price control arrangements by more
than the CPI increase during a calendar
year, Telstra is required to obtain the prior
consent of the regulator.
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Price cap regulation in Australia
There is a direct price control of 25 cents on
local calls from fixed phones and 40 cents
on local calls from payphones.
Notifiable and disallowable: Directory
assistance.

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 Price cap regulation in Australia
• 1999 to 2001: CPI - 5.5%. Connections, line
rentals, local, long distance, international
calls, domestic and international leased
lines and digital cellular mobile telephone
services.
CPI -0%. Line rentals and local call services
(sub-basket).
CPI - 0%. Connection services (sub-basket)
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Price cap regulation in Australia
CPI - 1%. Connections, line rentals, local,
trunk and international call services
consumed by the average of the bottom
50% of Telstra’s pre-selected residential
customers by bill size.

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Price cap regulation in Australia
The regulator’s consent is required for an
increase in line rentals applicable to the
bottom 10% of Telstra’s pre-selected
residential customers by bill size, such
consent to be based on ensuring that such
bills will not increase in real terms.

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Price cap regulation in Australia
Revenue-weighted untimed local calls for
non-metropolitan Australia for 1999/2000
and 2000/2001, not t exceed that in
metropolitan Australia for the previous year,
in each case.
Cap of 25 cents: Untimed local calls
Cap of 40 cents: Directory assistance.

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Strategy for a regulated service provider

• As overseas experience indicates, price

regulation is almost certain to be applied to
an incumbent former monopoly with
“market dominance”.
• If so, it is TOT’s interests to consider what
sort of price regulation system would be in
its best interests and begin trying to
influence decisions in this direction.
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Strategy for a regulated service provider

• Price-cap regulation is more “arm’s length”

than other forms of price regulation likely to
be applied to TOT and likely to provide
more price re-structuring flexibility (TOT
will want) but armed with appropriate
information, TOT can also influence the
setting of a price-cap formula that is to its
advantage.
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Strategy for a regulated service provider

Seek:
• the lowest level of “X”.
• none or as few restrictions on price re-
structuring as possible (in other words no
sub-caps on individual services).
• inclusion of services whose prices are likely
to be significantly reduced, such as long
distance and international.
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Strategy for a regulated service provider

• At least in the first formula -- when the

price cap formula is likely to be relatively
generous to the company -- seek a longer
term (5 years rather than three) so that any
higher than expected profit achieved can be
enjoyed for a longer period.

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 Strategy (i): seek lowest level of “X”

• It is the level of “X” in the CPI - X formula

that determines the size of the fall in real
prices. A lower “X” would require a lower
real price fall (and allow higher
revenue/profits).

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 Strategy (i): seek lowest level of “X”

• Since the size of “X” set will be influenced

by the size of productivity improvement
attainable, TOT should arm itself with
information concerning its past and
potential labour and total factor
productivity.
• TOT should also benchmark productivity
performance for telecommunications
operators in other countries. 37
 Strategy (iii): seek minimum sub-caps

• Sub-caps on individual services restrict

price re-structuring (which TOT will find
necessary to undertake for commercial
reasons)
• Thus TOT should seek minimum sub-caps
arguing that a promised benefit of price-cap
regulation is that it would permit greater
price flexibility, including restructuring.
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 Strategy (ii): seek inclusion of services
with significantly falling prices

• Where the price of a service falls sharply, it

will decrease the average price of the basket
of services in a price-cap basket. This
means that the price of other services in the
basket do not need to decrease as much, or
indeed, may increase, with the basket still
satisfying price-cap requirements.

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 Strategy (ii):seek inclusion of services
with significantly falling prices

• TOT could point to the fact that in the UK,

France & Australia, the price of
international calls was included in the price-
cap basket in 1991. [Some countries do not
include international calls in the price cap
“basket” so that the formula is more
demanding.]
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 Strategy (ii):seek inclusion of services
with significantly falling prices
• TOT should also seek to have discounts and
one-off special prices included in the price-
cap basket.
• [It may also be possible to re-construct
pricing to be part of the price-cap regime.]
• Then of course there is “creative
accounting”….

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 Conclusion
• This presentation has indicated that if price
regulation is to be applied to TOT (which is
almost certain), price cap regulation may be
preferable to other alternative approaches
such as direct approval or rate-of -return
regulation.

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 Conclusion
TOT should be prepared -- not least
through the collection of benchmarking
information:
• on the characteristics of price-cap schemes
applied in other countries and the effects of
such schemes
• productivity trends and levels achieved
• services with rapidly falling prices, etc.
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 Conclusion
Armed with such information, TOT will:
• not only better understand the potential
impacts of price regulation but
• can significantly improve the outcome of
negotiations with the government/regulator
and, indeed, its ability to compete
successfully in the new competitive
environment.
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