Pricing Principles

1
Pricing Principles Practices in Competitive
CircumstancesBy Patrick XavierSchool of
BusinessSwinburne University, Melbourne

• ITUWorkshop(1)

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Traditional pricing

• Cross-subsidisation for political, social etc.,
  reasons resulting in high prices for
  international and long-distance service
  subsidising low (below cost) prices for
  connection and local service

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Traditional pricing

• Cross-subsidisation not sustainable under
  competition since services with high profit
  margins will be vulnerable to competitive entry.

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Profit margin

• PRICE__________________________
• COST___________________________

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Pressure to re-structure prices

• To reduce scope for competitors to under cut
  TOTs price, there will be pressure on TOT to
  cut international and long distance prices.

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Falls in prices in Australia

• Telstras national long distance call prices fell
  by about 30 in real (inflation-adjusted) terms
  between 1995 and 1999.
• Telstras international call prices fell by about
  60 in real (inflation-adjusted) terms between
  1995 and 1999.
• Calls from fixed to cellular mobile fell by about
  30 (largely in 1999) although a flagfall of 15
  cents per call was introduced.

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Pressure to re-structure prices

• In order to maintain revenue, there will be
  pressure to increase the prices of currently
  cross-subsidised prices.

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Re-structuring prices

• Other areas of price restructuring towards
  prices becoming cost-based or cost-oriented
  can include
• urban/rural
• upfront (flagfall) component/useage
• peak/off-peak
• wholesale/retail
• price discounts

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Appropriate costs upon which to base prices not
easy to identify

• Identification of appropriate costs is not easy.
• Until the cost systems are in place, TOT can
  benchmark the price restructuring that is
  occurring in other markets that are becoming
  increasingly competitive.
• Even when cost information is available,
  benchmarking will provide a reality check.

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Pressure on TOT to reduce costs

• It is not enough simply to base prices on current
  costs.
• This is because prices based on costs that are
  inefficiently high will also provide opportunity
  for competitive entry by more cost-efficient
  rivals.
• So in competitive circumstances it will be
  necessary to keep costs as low as possible.

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Pressure on TOT to reduce costs

• Another reason to cut costs is that with prices
  falling, cutting costs will be a means of helping
  to maintain profit margins and overall rate of
  return on assets.

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Maintaining profit margin

• PRICE__________________________
• COST___________________________

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Profit levels

• The level of profit becomes increasingly
  important with commercialisation, privatisation
  and competition.
• Benchmarking can help establish appropriate
  profit targets for TOT

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Cutting costs to maintain margins and overall
profit

• This is one reason for the considerable cost
  cutting many telecommunications operators have
  been (and are) engaging in.

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The floor level of prices

• In fact, the floor level below which prices
  should not be set are in principle not current
  costs but efficient costs, including the use of
  best technology.

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Long run incremental cost (LRIC)

• This concept of efficient costs is the rationale
  of forward-looking LRIC.

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Long run incremental cost (LRAIC)

• Important to understand this concept of costs
  because the regulatory agency will probably
  follow what is happening overseas and require TOT
  to apply LRIC in pricing decisions, especially
  regarding Interconnection and also unbundling
  of network elements.
• But more on this in a later presentation.

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Wholesale/retail pricing

• New entrants have frequently complained of being
  price squeezed by incumbent telecommunications
  operators that supply end-user service as well as
  access/interconnection service.

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Price squeeze

• Retail__________________________
• Wholesale______________________

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Price squeeze

• So for competitive reasons, TOT might consider
  such competitive tactics.

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Price reductions that increase total revenue

• To limit revenue loss, the price reductions can
  be selective and restricted to only some
  services.
• However, price reductions can result in an
  increase in total revenue where demand is price
  elastic ie. responsive to a price change. So
  there is need for TOT to better understand demand
  elasticities for various types of services.

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Price reductions that increase total revenue

• Price reductions to boost loyalty can also
  increase revenue.
• One common approach that has been accelerated by
  competitive pressure is price discount schemes.

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Price discount schemes

• Price discount schemes can be used to boost
  loyalty and to target selected market niches.
• They can be used to retain/attract high-value
  customers.

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Price discount schemes

• The range of price discount schemes for PSTN
  services includes discounts on
• connection charges
• rental payments
• non-traditional time of day/week discount
  schemes, such as every third minute free for
  off-peak calls

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Price discount schemes

• local calls
• national long distance
• international

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Price discount schemes

• call duration
• for a fixed charge, talk for as long as you
  like on national international calls
• friends family calling-circle discounts on
  calls to a number of pre-specified frequently
  called numbers

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Price discount schemes

• discounts that vary with the size of the
  customers bill
• discounts based on customer loyalty, including
  the customers willingness to use the supplier
  exclusively
• discounts that vary with the term of the contract
  signed.

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Price discount schemes

• Customer response to discount schemes can
  generate important information about demand
  sensitivities that can assist the development of
  pricing strategies.

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Price discount schemes

• Discount schemes may also generate useful
  information for acquisition of customers rather
  than simply traffic.
• This will be important as competitive strategies
  turn to the development of core markets for
  high-value and data-based products that go well
  beyond the simplest forms of price competition.

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Price discount schemes

• In common use are price discounts that vary with
  the size of subscription charges required for
  participation in the discount scheme.
• Such discount schemes can significantly increase
  revenue while encouraging loyalty, since
  customers want to maximise the benefits from
  their subscription.

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Benchmarking discount schemes

• TOT could find it valuable to benchmark and
  analyse price discount schemes used overseas,
  including the results of such schemes on revenue
  and competitive objectives.

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Price discount schemes complicate international
benchmarking of prices

• Note that because the nature, scope, number of
  beneficiaries and depth of price discount schemes
  vary among countries this complicates
  international benchmarking of telecommunications
  prices.

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Cross-subsidisation for competitive reasons

• In some countries, price competition has tempted
  the incumbent former monopoly to cross-subsidise
  the prices of services for which there is strong
  competition.
• Revenue from high prices for services for which
  there is no (or relatively less) competition is
  used.

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Regulation Cross-subsidisation

• This would seem an attractive competitive
  strategy but will almost certainly be prohibited
  by regulation which is likely to prescribe
• a floor level based on LRIC (below which prices
  are not permitted to fall)
• a ceiling level based on stand-alone costs
  (above which prices cannot go)

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Regulation Cross-subsidisation

• TOT should prepare itself for the expected
  negotiations with the regulator by arming
  itself with information relating to cost-based
  price floors and ceilings.

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Regulation Cross-subsidisation

• Benchmarking movements in price levels and
  structures of incumbent operators in markets
  experiencing increasing competition will provide
  valuable information for pricing strategy as well
  as for negotiations with the regulator.

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Interconnection charges in competitive
circumstances

• As noted earlier, for competitive reasons TOT
  might wish to adopt a price-squeeze strategy
  with price reductions on the one hand and high
  interconnection charges on the other.
• The high interconnection charges could also serve
  to compensate for reduction in revenue from
  falling retail prices.

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LRIC and Interconnection Prices

• However, a regulator-imposed obligation to apply
  LRIC or price cap regulation could restrict
  efforts to increase wholesale interconnection
  price.
• Another constraint on high interconnection prices
  is that this would provide more incentive for new
  entrants to quickly install their own
  infrastructure.

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LRAIC and Interconnection Prices

• TOT should equip itself for the expected
  negotiations with competitors and with the
  regulator by installing cost accounting systems
  that would enable it to obtain the required cost
  information.

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Benchmarking can help

• Benchmarking interconnection prices in other
  countries could also generate useful information
  both for developing competitive strategy and for
  use during negotiations.

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Price of unbundled network elements

• Another potential major issue TOT might face
  relates to the price of unbundled network
  elements, including ADSL enhanced segments of the
  network.

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LRIC and unbundling

• It now seems increasingly widely accepted that
  the price of unbundled network elements of the
  local loop should also be based on LRIC.
• In Canada, the obligation to allow access will be
  only for five years.
• In the Netherlands, the price is to be initially
  LRIC but then be raised over five years to a
  commercial rate.

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Other areas...

• Other areas where benchmarking will be useful are
  leased lines, and pricing of Internet use.

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Reference

• Patrick Xavier, Price setting and regulation
  for telecommunications in the absence of reliable
  and detailed cost information,
  Telecommunications Policy , 1997. Volume 21,
  No.3, pp.213-233.