Real Consumers and Telco Choice: The Road to Confusopoly

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Real Consumers and Telco ChoiceThe Road to
Confusopoly

• Professor Joshua Gans
• Melbourne Business School
• University of Melbourne

Presentation to the Australian Telecommunications
Summit, Sydney, 21st November 2005
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Is Competition Enough?

• Can competition enable consumer choice?
• It is a necessary condition
• Consumers need options
• But is it sufficient?
• Can consumers make the necessary comparisons?
• Will competition reduce exploitation of consumer
  irrationality?

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Confusopoly

• 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?

4
Search Model

• Consider an industry with several producers of an
  homogenous product
• A consumer considering switching suppliers will
  switch if
• Pold gt Pnew D
• where D are switching costs including any
  disconnection fees
• A consumer will only search for a new supplier
  if
• Expected Savings gt S
• where S are search costs

5
Diamond Paradox

• With many suppliers, why would you expect to get
  a better deal?
• If all highly competitive, then cant do better
• Only if you think firms will offer you a customer
  specific deal but will they?
• According to Diamond (1971) each firm wont lose
  many customers by charging a slightly higher
  price than other firms
• In equilibrium all charge the monopoly price and
  no search occurs.

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Sleepy Incumbent Model

• 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

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Energy Retailing

• In July, 2005, I considered energy retailing in
  Victoria
• 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?

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Which Model for Telcos?

• 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)

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Plans (calls to landlines)
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Assumptions

• 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 Telstras share of the mobile market).

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Call Patterns (5 min average)
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Switching from Telstra Complete to Mobile
Hutchison
Vodafone
Optus
5 min average
Nera analysis
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Switching from Telstra Plus 1.49 to Mobile
Hutchison
Vodafone
Optus
5 min average
Nera analysis
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Switching from Telstra Complete to Mobile
Hutchison
Vodafone
Optus
10 min average
Nera analysis
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Switching from Telstra Plus 1.49 to Mobile
Hutchison
Vodafone
Optus
10 min average
Nera analysis
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Summary

• Difficult to compare price offers
• Depends on a consumers 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 important.

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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.

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Can competition protect consumers?

• Re-considering bundling

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The contention

• If consumers can be exploited (i.e., pay for
  goods they dont value enough), wont 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

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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.

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its 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.

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The point
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From The Onion
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Supplying what they demand

• 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

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Behavioural Economics

• 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

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Implications for Switching

• 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.

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Themes

• Demand in a market is based on actual consumer
  behaviour.
• 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.

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Welfare Impact
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Impact of reduced competition
Overall welfare is increased! Consumer welfare
may not be improved.
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Bundling and add-on pricing

• 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
  over-consume
• Firms price first good low and naives
  cross-subsidise sophisticates
• Suspicious of bundling without any efficiency or
  value rationale.

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Educating consumers

• Under monopoly,
• May have incentive to educate naives if dont
  want to price discriminate against them
• 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

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Conclusions

• Implication of behavioural economics cannot rely
  on competition to protect naïve consumers
• Difficult to exercise consumer choice
• Competition generates more supply of things they
  dont want
• Education and information are public goods
  (under-provision in market place)
• Regulators should focus attention on undesirable
  practices
• E.g., disconnection fees, automatic renewal fees,
  unbundling
• Critical for future issues such as cross-media
  ownership