Fixed and Mobile Competition in Transition Economies

Transcription

1 Fixed and Mobile Competition in Transition Economies Chris Taubman * and Maria Vagliasindi ** Abstract The main aim of this paper is to explore the substitution effects between traditional fixed line and mobile services across Eastern Europe and Former Soviet Union. Whereas there have been some pioneer studies for the US empirical evidence for other regions is very limited. Transition countries witnessed important trends in the mobile segment of the market. First, mobile penetration rates have been growing at exponential rates, whereas fixed line penetration rates have at best stagnated. Our analysis is based on empirical evidence based on country level data, case studies, as well as enterprise level data based on major surveys that the EBRD and the World Bank undertook in 2002 across all transition economies. Our econometric analysis at the enterprise level shows some interesting results, including evidence of some substitution effects in place at the country level. However, complementary effects dominate at the enterprise level, likely due to the fact that wireless solutions can be considered as a good alternative to voice services, but not for other services (accessible via Internet through fixed line). We are very grateful to Izzet Guney for his extensive comments and for sharing with us his extensive knowledge of the issues discussed in this paper. We would also like to thank our colleagues in the EBRD Telecom, Informatics and Media Team and Office of the Chief Economist for sharing with us documents and information on the topic. This research does not necessarily reflect the views and policies of the EBRD. * Senior Banker, Telecommunication, Informatics and Media Team, European Bank for Reconstruction and Development, One Exchange Square, London EC2A 2JN, UK; Tel: , Fax: , taubmanc@ebrd.com ** Senior Economist, Office of the Chief Economist, European Bank for Reconstruction and Development, One Exchange Square, London EC2A 2JN, UK; Tel: , Fax: , vagliasm@ebrd.com 1

2 1. Introduction The economic literature defines fixed-to-mobile substitution as the use of mobile instead of fixed phone for calls or access to telecom services. This phenomenon represents in principle a considerable threat to fixed line telecom operators and needs to be carefully considered by policy makers. From the perspective of mobile operators, the decision to devise services to attract substitution at least in some areas or for some segments of the population depends on careful calculation of the associated revenues and costs. From the perspective of fixed line telecom operators, fixed-to-mobile substitution might imply losing a substantial base of subscribers if users decide to go wireless or to make an increasing proportion of their calls over their mobile handsets. From their perspective, call substitution is certainly the most worrisome phenomenon. Not only does this trend deprive fixed operators of call revenue, but it could lead to subscribers cancelling the fixed line subscription, and a total loss of the subscriber and the associated line rental revenues as well. Fixed operators defensive strategies include attempts at neutralising the drivers that push users to mobile while reinforcing the barriers. Price is an important factor, but not the only one. Fixed line incumbent can exploit the fact that Internet use is closely tied to the fixed line, a particularly important factor for business users. Finally, from the policy makers perspective, continued price regulation introduces many rigidities including inflexibility to respond to competitive markets, embedded subsidies to special groups and government entities. In some markets, such inflexibility was reflected in the impossibility to respond to growing mobile and Internet-related traffic. Hence, this topic deserves a more careful analysis. In developed telecom markets, voice is mature on the fixed network and maturing on mobile. Few users decided to disconnect from fixed line services, evidenced by the relatively stable number of lines in the Western European economies. Users will pay the price premium for traffic, but will not quickly give up their fixed line, although in some countries (e.g. Finland) they already started to do so. However, many new users decide to subscribe only to mobile services. According to a recent EU-commissioned survey, about 12% of EU households are using only mobile services and do not subscribe to fixed line services. This 2

3 figure ranges from 4% in Germany and Sweden to 16% and 29% respectively in France and in Finland. For developing and transition countries, recent analyst reports predict that mobile will take most of the voice growth, and Voice over Internet Protocol (VoIP) will take the rest, gradually becoming the dominant medium. Fixed-to-mobile substitution is generally considered to take place but to occur gradually. However, official data indicate fixed line penetration rates in Central and Eastern Europe are declining. The main aim of this paper is to explore the substitution effects between traditional fixed line and mobile services across Eastern Europe and Former Soviet Union. Whereas there have been some pioneer studies for the UK (coming from the OFTEL 2003 survey on residential consumers), US (e.g. Hausman, 1999 and 2000, Rodini, Ward and Woroch, 2003) and Korea (Ahn and Lee, 1999, Sung, Kim and Lee, 2000), empirical evidence for developing countries is very limited. The evidence on the existence of strong substitution effect is not yet fully conclusive. Hausman (1999, 2000) estimates the elasticity of aggregate subscription to cellular service in the 30 largest U.S. markets over the period Ahn and Lee (1999) estimate demand for mobile access in Korea using wireless subscription data for 64 countries. Sung, Kim and Lee (2000) find that the number of Korean mobile subscribers is positively correlated with the number of fixed-line disconnects, but negatively related to the number of new fixed-line connections, suggesting net substitution between the two services. However, this pattern occurs even while the stock of fixed lines is positively correlated with the number of mobile subscribers, offering evidence that the two services are complementary. Rodini, Ward and Woroch (2003) found only modest substitution between mobile subscriptions and the demand for second lines. The focus of this paper is on the specific challenges that characterise countries that are in the process of moving from command to market economies ( transition economies ). The initial conditions were completely different from the ones characterising the introduction of mobile services in developed countries for many factors, ranging from historical to socio- 3

4 economic ones. Historically, the legacy of central planning left transition countries with underdeveloped fixed line network, due to lack of investment. This historical legacy has important implications on the extent of fixed-to-mobile substitution, as both intuition and empirical studies suggest that it is easier to create a mobile substitute for a hitherto nonexistent fixed line service than to persuade users to abandon fixed line services. Transition countries witnessed important trends in the mobile segment of the market. First, mobile penetration rates have been growing at exponential rates, whereas fixed line penetration rates have at best stagnated. Second, in many countries, mobile penetration rates have overturned (?) fixed line penetration rates. This is the case not only for most of the EU accession countries but also for countries of South Eastern Europe (notably Albania and Serbia and Montenegro) and is expected to come soon for some Former Soviet Union countries (notably Russia). The novelty of our paper is twofold. First, there is still limited empirical evidence on transition economies, partly due both limited availability of adequate or reliable data. Second, the majority of the studies are based on cross-country analysis. This paper considers new microeconomic evidence from survey data from a major enterprise level survey (implemented by EBRD and the World Bank in the summer of 2002). Although serious constraints in the database limit the econometric analysis that can be undertaken, these are balanced by the richness of the database. The analysis is complemented by case studies that will focus also on the extensive experience that EBRD had in supporting competition through financing network and capital expansion in telecom operators. Our econometric analysis at the enterprise level shows some interesting results, including evidence of some substitution effects in place at the country level. However, complementary effects dominate at the enterprise level, likely due to the fact that wireless solutions can be considered as a good alternative to voice services, but not for other services (accessible via Internet through fixed line). 4

5 The remainder of this paper is organised as follows. Section 2 describes the fixed-tomobile substitution across transition economies from aggregated country data and reports case study evidence. Section 3 generalises the evidence from Section 2 and introduces the key hypotheses on the expected links between the use of mobile services at the enterprise level and the relevant country and enterprise level explanatory variables. Section 4 reports the results of the empirical analysis, complemented by case studies and anecdotal evidence. Section 5 concludes and draws some policy implications. 2. Fixed-to-mobile substitution in transition countries In the context of transition countries, official data shows in the most recent years, an exponential growth of mobile penetration rates versus stagnation in fixed line rates. The mobile segment of the market is very different from the fixed services industry in many regards both in developed and transition countries. While the fixed incumbents still provides well over 95% of fixed connections for most of the EU-25 Member States, the largest mobile operator typically has a market share of between 40% and 60%. In 22 of the EU-25 member states, the leading mobile operator is a subsidiary of the fixed incumbent. In transition countries, the mobile arms of the fixed line incumbent operators are not always the most successful operators, despite the clear potential for comparative advantage (to the extent that this is not or cannot be effectively regulated) in areas of customer information, domestic brand recognition and network build-out. In cases of late acquisition of a GSM licence, such as in Bulgaria and Romania, the mobile arms of the dominant incumbents are the smallest and least successful operators. Large foreign players such as Orange in Romania hold the largest market shares through a combination of low-cost, prepaid offers, backed by extensive marketing and branding activity as well as by national distribution networks. In what follows, we will describe the trends in fixed and mobile penetration rates (that is the number of subscribers per 100 inhabitants) distinguishing Central Eastern European (CEE) countries from South Eastern European (SEE) countries and Commonwealth of Independent States (CIS). 5

6 In the context of CEE countries, official data shows in the most recent years an exponential growth of mobile penetration rates versus decline in fixed line penetration rates. Notably fixed line penetration rates started declining from 2001 from an average of just above 30% to an average slightly above 28%. In the absence of mobile possibilities, the number of fixed line subscribers would probably have been increased significantly more, albeit subject to the limits of capital expenditure constraints that contributed to the growth of mobile telephony in the first place. 70 Fig. 1 Fixed and mobile penetration rates in CEE ( ) 60 cee-fixed cee-mobile Source: ITU Another important feature emerging from Fig 1 is that the mobile penetration rates are very high. Indeed, some of the CEE countries mobile penetration rates are close to Western European penetration levels. Top of the league is Czech Republic, with a 96.5% mobile penetration rate as of the end of 2003, closely followed by the Slovenia, Hungary and Estonia, which all have penetration rates of well over 70%. Poland is still lagging behind with mobile penetration rates just above 45% suggesting potential for significant subscriber growth. 6

7 Another notable feature emerging from Fig. 1 is that from 2001, mobile penetration rates exceeded fixed line penetration rates for CEE countries, a clear evidence of fixed mobile substitution effects. Notably, in 2003, mobile penetration rates stood at an average of 63%, more than twice the average of fixed line penetration rates (just above 28%). Furthermore, notwithstanding premium mobile tariff, total minutes by use of mobile subscribers is forecast to exceed that from the fixed network in Czech Republic and Poland by 2005 and by 2006 for CEE as a whole. For SEE, fixed line penetration rates are approaching CEE fixed line penetration rates, reaching an average of 26%. Even though we still do not yet see on average a decline in fixed line penetration rates, the rate of growth in recent years has been very low (just 3.5% and 2.5% respectively in 2002 and 2003 Fig. 2 Fixed and mobile penetration rates in SEE ( ) see-fixed see-mobile Source: ITU In terms of mobile markets in a number of countries including Croatia, and Bulgaria - mobile penetration rates are above 50% (higher than Poland) and are still increasing, as there is still potential for subscriber growth. For another set of countries - including Serbia and 7

8 Montenegro, Albania, Macedonia and Bosnia and Herzegovina - mobile markets are growing extremely fast from a low subscriber base. In Albania mobile penetration rates in 2003 reached a level above 35% from only 13% in Fig 2 provides also strong evidence of fixed mobile substitution. Indeed, starting from just one year after the more advanced CEE, in 2002 mobile penetration rates exceeded fixed line penetration rates for SEE countries. Fig. 3 shows a very different picture for CIS countries. Fixed line penetration rates are still very low, reaching an average of 14.6% in 2003, which is half of the value of the CEE average. Mobile penetration rates are still below fixed line penetration rates, with the exception of Azerbajian where mobile penetration rates have already overtaken fixed line penetration rates. Mobile penetration in Russia has been relatively low, with the exception of Moscow and St Petersburg, but accelerated dramatically after 2002 to approach fixed line penetration rates. Fig. 3 Fixed and mobile penetration rates in CIS ( ) cis-fixed cis-mobile Source: ITU 8

9 In what follows, we report some more detailed evidence from some case studies of the most striking evidence of fixed-to-mobile substitution effects in action. Albania The entry of an additional mobile operator can bring significant benefits. Crandall and Hausman (2000) showed that, in regional US mobile telephone markets, one additional operator has been sufficient to bring significantly lower prices when compared to a monopoly, while further market entry did not have significant effects on mobile telephone prices. We find even stronger results for transition countries. In Albania, the arrival of Vodafone in the market alongside Albanian Mobile Communications has provided a significant boost to subscriber numbers. Mobile telephony was only introduced in Albania in The sector was dominated by a single company, Albanian Mobile Communications (AMC), 85%-owned by CosmOTE, the mobile arm of Greek telecommunications group OTE, until August 2001 when Vodafone Group entered the market through its subsidiary, Vodafone Albania. Despite launching services in the third quarter of 2001, by the end of 2001, Vodafone's pre-paid services had proved so popular that it had gained 118,567 subscribers in just three months, helping to increase penetration from 13% in 2001 to over 25% at the end of 2002 and 35.8% at the end of Cellular penetration has far outstripped that of fixed-line, which stood at 7.4% at the end of The ease of acquiring a mobile phone, as well as the availability of pre-paid offers, has contributed to the popularity of mobile services. This is a great achievement, particularly in a country whose per-capita GDP is among the lowest in the SEE. Subscriber bases are comprised almost entirely of pre-paid subscriptions - 99% and 97% of Vodafone Albania's at the end of 2002 and 2003 subscriber base was pre-paid - and are attracted by an increasing number of cheap pre-paid offers, particularly as mobile can be bought and utilised immediately, whilst fixed-line operators are still battling to overcome long waiting lists. Some Albanian enterprises report that fixed telecom lines are stolen or someone would illegally connect to the lines to get access to 9

10 telecom services. One of the interviewed Albanian enterprises had filed an application for 40 telephone lines in one of its buildings and has not received an answer from over a year. 1 Fig. 4 Market shares by Albanian mobile operators ( ) AMC Vodafone Albania As of 2003, AMC has, however, retained its leadership of the sector. However as shown in Fig. 4, the market shares of the two companies are converging. By the end of 2003, AMC's subscriber base stood at 592,804, a year-on-year increase of 18.3%. 97.6% of AMC's subscribers at the end of 2003 were pre-paid. At the end of 2003, the company had a total subscriber base of 507,000, a year-on-year increase of 45.3%. Lithuania An extreme example of fixed-to-mobile substitution is offered by Lituevos Telekomas (LT), the Lithuanian incumbent fixed operator, which suffered from a decline in fixed lines market penetration from 33% in 2001 to 24% in Most other Eastern European incumbents saw a decline in their fixed lines of between 2-3% and strong growth in mobile penetration in the same period. Shrinking mobile premium was the key: mobile tariffs declined under competition while fixed prices remained stable due to the late onset of liberalisation. LT was established in 1992 and had a monopoly over fixed-line voice 1 For a more detailed discussion of the case studies conducted by the EBRD and the World Bank on South and Eastern Europe see Vagliasindi (2004). 10

11 communications until the end of It was re-organised into a public company in 1997 and, in 1998, a 60% stake was sold to Amber Teleholdings, which is a fully-owned subsidiary of TeliaSonera. In 2000, a 30% stake in the company was privatised in an initial public offering (IPO), tradable as shares on the Lithuanian Stock Exchange and as Global Depository Receipts (GDRs) on the London Stock Exchange. As well as being the fixed-line incumbent, the company, its subsidiaries and stake-holdings are leading players in the data communications and Internet markets. Lithuanian Telecom provides local, long-distance and international telephony, as well as VoIP services via its subsidiary UAB Voicecom. The revenues of LT by segment of the market are reported in Table 1. Table 1 shows the declining trend in revenues coming from fixed line telephony services, in contrast with positive trends from Internet and data communication services. LT is one of the few incumbent in CEE with no mobile subsidiary. Table 1 Revenues of LT by telecom services Thousands (Ltl) Q Q Q Q Fixed-line telephony 164, , , ,532 services % Quarterly Change Internet and data communication 29,124 29,908 29,862 31,056 services % Quarterly Change Other services 10,477 16,193 13,368 22,415 % Quarterly Change Source: Lithuanian Telecom 11

12 Some incumbents, like BT in the UK and Eircom in Ireland, have voluntarily divested themselves of their mobile subsidiaries. But is there a case for mandating such divestiture? We will look at this question in the concluding section. 3. Explanatory Variables of the Model This section describes the key hypotheses regarding the expected links between the business use of mobile services versus more traditional fixed line services. The demand for each telecom services will in general depend on the prevailing price structure of various services, users income, and network sizes of both fixed and mobile lines among others. Historically, mobile services did not represent an alternative to fixed line service. Given its high relative price, cellular service was truly a luxury, not a substitute for fixed line. Cellular technology also lagged significantly in quality and geographic coverage. These differences resulted in limited mobile penetration rates in Western European countries when first introduced in the 1980s. Since those early days, mobile service adoption has grown at astonishing rates in parallel with steady improvements in quality of the service and the performance of mobile providers and existence of European standard (GSM). The enterprise-level variables are based on the Business Environment and Enterprise Performance Survey (BEEPS), a microeconomic survey implemented by EBRD and the World Bank in the summer of The main aim of the survey was to shed light on enterprise behaviour and performance and their relation to competitive pressures, the business environment and the relationship between enterprises and the State. The full sample included over 6,000 enterprises in 26 countries of the region. The survey sample was designed to be broadly representative of the population of the firms according to their economic significance, sector, size and geographical location within each country, subject to minimum quotas for the total sample in each country. 2 Although serious constraints in the database limit the econometric analysis that can be undertaken (e.g. we cannot run panel data regressions), these 2 See Appendix 1 for more details on the survey sample. 12

13 are balanced by the richness of the database. In particular, the survey includes a number of questions from which we are able to capture the extent of fixed-to-mobile substitution. In theory, we expect growth of mobile to lead to an initial increase in fixed network traffic (due to complementarities) and then a decline in the fixed network (due to the dominance of substitution effects). Network externality seemed to have played an important role at the beginning stage of mobile development across all countries. Moreover, we would expect complementarities between fixed and mobile use, if business users are relying on fixed line to get access to other services (e.g. Internet). The dependent variable that we use in our empirical model is the use of mobile services by enterprises in their interactions with clients and suppliers. The list of explanatory variables is reported in Table 2. It consists of both country-level variables as well as enterprise-level. Let first describe the country level variables. In particular, we use different indicators associated to increased investment, fixed and mobile penetration rates (that is, the number of business and residential subscribers per 100 inhabitants). In the presence of fixed line and mobile substitution effects we expected to find a negative association between the dependent variable and fixed line penetration rates. On the other hand in the case of complementarity between fixed line and mobile services we expect a positive sign. We use an indicator of lagged annual investment in the sector (as a percentage of GDP). Investments are expected to result in the upgrade and or development of network leading in turn to better service provision of telecom services, particularly in the presence of complementary effect between fixed and mobile services. We also expect the enterprises use of mobile services to be more likely in countries characterised by higher mobile penetration rates (that is higher subscribers among residential and business consumers), due to externality effects and by the presence of more than one GSM operator in the market (captured by a dummy variable). 13

14 Table 2 Explanatory Variables Influencing Mobile Use (Expected Relationship) Variables Definition Exp. Sign COUNTRY-LEVEL VARIABLES Investment = telecom investment (capital expenditure + Fixed line Penetration rates Mobile Penetration rates Mobile Competition Fixed line Business use Internet Business use Private De Novo Privatized SOE SOE Small Medium Large Population Density in telecom infrastructure, in % of GDP) = Fixed line subscribers per 100 inhabitants = Mobile subscribers per 100 inhabitants + = 1 if there is more than one GSM operator in the country = 0 otherwise ENTERPRISE-LEVEL VARIABLES = 1 if the firm regularly use fixed line in its interactions with clients and suppliers = 0 otherwise = 1 if the firm regularly use fixed line Internet services in its interactions with clients and suppliers = 0 otherwise BASIC CONTROLS = 1 if private since established = 0 otherwise = 1 if privatized = 0 otherwise = 1 if state-owned = 0 otherwise = 1 if small enterprise (below 50 employees) = 0 otherwise = 1 if medium enterprise (between 50 and 250 employees) = 0 otherwise = 1 if large enterprise (between 250 and 10,000 employees) = 0 otherwise = 1, 2, 3, 4, 5 if the enterprise is respectively located in the capital, in an other city with density over 1 million, between 250,000 and 1,000,000 50, ,000, under 50,

15 Let us first describe the country level variables. In particular, we use different indicators associated to increased investment, fixed and mobile penetration rates (that is, the number of business and residential subscribers per 100 inhabitants). In the presence of fixed line and mobile substitution effects, we expected to find a negative association between the dependent variable and fixed line penetration rates. On the other hand, in the case of complementarity between fixed line and mobile services, we expect a positive sign. In addition, we use an indicator of lagged annual investment in the sector (as a percentage of GDP). Investments are expected to result in the upgrade and or development of network leading in turn to better service provision of telecom services, particularly in the presence of complementary effect between fixed and mobile services. We also expect the enterprises use of mobile services to be more likely in countries characterised by higher mobile penetration rates (that is higher subscribers among residential and business consumers), due to externality effects. Let us now turn to the enterprise level variables. We are able to identify the intensive users of fixed and Internet services for communication with partners. That is, we are also able to identify at the enterprise level the presence of fixed mobile substitution effect. Namely, we would expect a negative correlation between the dependent variable and the use of fixed line services. On the other hand, in the presence of complementarities between fixed and mobile, we would expect a positive sign. This effect can be reinforced by the use of fixed lines to get access to enhanced services, such as Internet. Notably, we expect more intensive users of mobile to be also more intensive users of Internet. We control for several enterprise-level variables. The first of these control variables is represented by ownership. Our prediction is that private de novo enterprises are more likely to use mobile services, because - where they have the financial means - they try to resort to more reliable service providers (using mobile versus fixed line services in the case of telecom). Regarding the relationship of the with firm size, we expect larger firms to be more 15

16 intensive users of value added services, such as mobile as to be characterised by a much higher bargaining power versus the mobile telecom providers, as they represent their biggest source of revenues. More intensive users of infrastructure services can in addition find it profitable to resort to innovative solutions as described earlier. Enterprises located in highly densely populated towns are less likely to use intensively mobile services than the ones located in less densely populated towns. This can be explained by the network externality effects. Moreover, in many rural areas serious problems can be also due to lack of choice in providers that artificially keeps prices. 4. Regression Results at the Enterprise Level In this section, we test the hypotheses that we put forward in section 3. Equations (1)- (4) in Table 3 report the marginal effects of probit regressions, where the dependent variable is an indicator of use of mobile services, as captured by a binary variable equal to 1 if the firm regularly use fixed line services in its interactions with clients and suppliers and 0 otherwise. Equation (1) represents the basic model, where we introduce as explanatory variables country level variables, including the fixed line and mobile penetration rates (that is, the number of business and residential subscribers per 100 inhabitants) and the telecommunication investment (in percentage of GDP). All variables are positively and significantly (at 1% level) associated to the intensive use of mobile services by enterprises to communicate with partners. Equation (2) adds as explanatory variables the interacted variables given by the product between fixed and mobile penetration rates. The interacted variable is negatively and significantly (at 1% confidence level) associated to the intensive use of mobile services by enterprises. That is, when overall the joint availability of fixed and mobile services is low, enterprises are more likely to make use of mobile rather than fixed line services in their interaction with business partners. This can be interpreted as evidence of substitution effects, motivated also by attempts by business users to overcome the poor quality of fixed line services. 16

17 Table 3 Determinants of Mobile usage (1) (2) (3) (4) Fixed line use 0.029*** 0.* (0.018) (0.020) Internet use 0.145*** (0.010) (0.010) BASIC CONTROLS De novo 0.081*** 0.066*** (1.011) (0.011) Small *** *** (0.011) (0.011) Medium *** *** (0.019) (0.020) Pop Dens Dummies Yes (+)*** Yes(+)*** COUNTRY LEVEL VARIABLES Investment 1.536*** 2.025*** 1.689*** 2.087*** (0.572) (0.589) (0.506) (0.528) Fixed line penetration rates 0.438*** (0.070) 0.742*** (0.079) 0.171*** (0.062) 0.409*** (0.070) Mobile penetration rates 0.416*** (0.033) 1.772*** (0.101) 0.340*** (0.031) 1.361*** (0.094) Fixed*Mobile penetration rates *** (0.003) *** (0.003) Mob Comp 0.022*** (0.012) N Χ *** *** *** *** Adj R Notes: *** indicates significance at 1% level, ** at 5%, * at 10%. All regressions are based on enterprise-level variables for Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, FYR Macedonia, Moldova, Poland, Romania, Russia, Serbia and Montenegro, Slovak Republic, Slovenia, Tajikistan, Ukraine and Uzbekistan. Equation (3) introduces the enterprise level variables, including the intensive use of fixed line and internet services by enterprises. Both of them are positively and significantly (at 1% confidence level) associated with the use of mobile services. Equation (3) also control for ownership, size and geographical effects. In terms of ownership effects, as expected, private de novo enterprises are more intensive users of mobile services. In terms of size dummies, larger enterprises are characterised by more intensive use of mobile services, most likely due to the strong bargaining position they enjoy. 17

18 The positive and highly significant (at 1% confidence level) coefficient on the geographic location confirms the divide between urban and rural areas, as we expected. This confirms our predicted hypothesis; that is, the disadvantages of rural areas in terms of lack of choice in the provision of infrastructure services. Equation (4) includes an additional variable capturing competition in the mobile market. This variable is positively and significantly associated to mobile use, confirming our hypothesis on the relevance of competition. 5. Conclusions and Policy Recommendations The main aim of this paper is to assess whether there is evidence of fixed-to-mobile substitution effects in transition countries. In particular, we use probit analysis to derive the key explanatory variables underlying the business use of mobile versus fixed line for facilitating interactions with key business partners (e.g. suppliers and clients). Our results provide some evidence of some substitution effects in place at the country level. Despite the fact that business use of mobile services is positively associated to fixed line penetration rates, it is negatively and significantly (at 1% confidence level) associated to the interacted variable given by the joint fixed and mobile penetration rates. This can be interpreted as clear evidence of substitution effects at country level. However, complementary effects dominate at the enterprise level, likely due to the fact that wireless solutions can be considered as a good alternative of voice services, but not for other services (accessible via Internet through fixed line). In sum, we can conclude that whilst the very rapid adoption of mobile telephony in transition countries has led to significant advantages in terms of increasing coverage and connectivity of the population, enhanced competition there remain important concerns. These relate to the challenges for fixed line operators, already constrained by unbalanced tariffs, which face reduced or even declining customer subscription, with consequent negative impact on capacity for capital expenditure and the overall development of data and Internet services. This has been identified as a factor in the observed reluctance of incumbent fixed line 18

19 operator to facilitate access to their network by competitors (e.g. through cost based interconnection rates). Policy makers need to appropriately address such issues. This might imply focusing on investment-oriented regulatory policies and on better flow of information between regulators and investors, revisiting traditional approach to retail price regulation of fixed line services and more attention to the implications of mobile-fixed substitution with respect to ongoing retail price regulation. Let us now review policy recommendations appropriately tailored for transition economies, analysing the type of regulatory barriers that could be removed to facilitate entry in the mobile segment of the market. Spectrum allocation has represented a major barrier to entry across transition economies, particularly in FSU. For example, private property rights in frequency spectrum could be broadened so as to allow spectrum use for different purposes and spectrum trade, as already suggested by Coase (1959). Furthermore, measures such as spectrum caps and the general competition law could also be applied in order to prevent operators acquiring a dominant position in a market or significantly lessening competition. Other candidates for such barriers to market entry are the price and terms of interconnection. Interconnection is critical in providing efficient investment and effective competition in the transition region. Indeed, there is extensive evidence that even in advanced countries (such as Poland) that the regulator has faced considerable challenges to enforce effective interconnection rules, based on constraints related to lack of expertise, resources and political independence. If the regulator fails to understand interconnection, distorted market-entry signals, invalidated investments, and the abuse of dominant positions will result, to the detriment of consumers. Hence, those operators with the ability to abuse their market power should be subject to special rules (ex ante regulation) to ensure that they do not abuse their dominance. These rules should include a requirement for the operator to meet all reasonable demands for interconnection services from other network operators (for example, transparent and costbased interconnection, unbundling of interconnection charges, non-discrimination, and 19

20 publication of interconnection offers, including terms and conditions of contracts and prices). From a public policy viewpoint, the resulting interconnection price needs to be economically efficient, to guarantee fair recovery of costs for all operators, and to provide the right entry signals. Customer switching costs can also represent a source of barrier to entry. In this context, switching costs consist not only of the direct monetary expenses when changing providers such as a contract penalty when cancelling a mobile telephone contract prior to expiry, but also include indirect costs such as the costs associated with giving up one's mobile telephone number. In this context, the introduction of mobile number portability (MNP) that is still lagging behind in our region can reduce consumers' switching costs and thereby not only make market entry easier for new operators, but also strengthen the competition for customers between already established operators. The question is also whether introducing MNP is efficient, given that the system costs of introducing and implementing it can be quite substantial (see Aoki and Small, 1999). Finally, some economists put forward some arguments in favour of such divestiture. Divestiture would lead to greater competition in retail mobile service markets. Divestiture would increase the prospects for infrastructure competition between fixed and mobile operators for voice traffic. Currently, there is relatively little competition between fixed and mobile networks for voice traffic in the EU. In contrast, there is much stronger competition between fixed and mobile operators in the USA, where the number of fixed network long distance minutes is falling at 6% p.a. largely as a result of mobile substitution. This was also due to the fact that mobile penetration there has been very low, due to technology issues such as no calling party pays principle. An obvious barrier to such competition in the EU is the fact that the fixed incumbent owns one of the main mobile operators in many Member States. In contrast, in the USA, where the main competition is for long distance minutes, five of the six largest mobile operators were independent of long distance carriers or are owned by ILECs. Recent trends shows that the most profitable business in the US is bundling mobile and fixed line services. This explains why SBC bought ATT Wireless through and the 20

21 attempts of Verizon to get into the long distance business. Divestiture would increase the level of competition in the provision of public WLAN services and the incentives for innovation in the development of integrated fixed and mobile services. Without a substantial mobile subsidiary, a fixed operator concerned about loss of traffic and revenues to mobile operators, is more likely to launch such services in an attempt to reverse or stem this trend. 3 Finally, divestiture makes regulation of deals between the fixed incumbent and mobile operators more transparent and easier to regulate. The fixed incumbent would no longer have any incentive to discriminate between mobile operators in the supply of service bundles or of network infrastructure e.g., for next generation and 3G networks. Opponents argue that the benefits of divestiture are not proportionate to the disruption which it would cause. In particular, they argue that the mobile subsidiaries of the fixed incumbents cannot control the degree of competition between fixed and mobile operators in a Member State. The impact of divestiture on competition in the public WLAN market will be limited. The need for divestiture to ensure that the fixed incumbent does not discriminate between mobile operators is not conclusive. The impact of divestiture on innovation by the fixed incumbent is also speculative. Based on this consideration, we conclude that there is currently no case to require incumbents to divest themselves of their mobile subsidiaries. The case for or against legal separation (as opposed to divestiture) is less clear-cut. Some incumbents, such as and Telecom Italia, run their mobile businesses as separate entities. Also France Telecom used to run its mobile subsidiary as a separate entity until recently, where major management changes took place and France Telecom now runs Orange as well more directly. There is a case to require legal separation on the grounds that it increases the transparency of deals done between the fixed incumbent and its mobile subsidiary. This case may strengthen if demand for integrated fixed and mobile service packages grows rapidly. However, many argue that such problems can be dealt with through accounting separation as easily as through legal separation. 3 BT is one of the few fixed incumbents in the EU without a mobile subsidiary. It was the first to announce firm plans for a service which provides, through a single subscription, integrated fixed voice telephony, private WLAN and public WLAN service in hotspots and mobile phone service elsewhere 21

22 In sum, regulators should monitor closely the extent to which fixed incumbents and their mobile subsidiaries favour each other to the exclusion of mobile rivals and consider legal separation as a remedy in response to such behaviour. 22

23 Appendix 1 Sample structure The minimum quotas of the samples for each country were: 1) At least 10 per cent of the total sample should be small in size (2 to 49 employees), 10 per cent medium-sized (50 to 249 employees) and 10 per cent large (250 to 9,999 employees) Firms with only one employee and 10,000 or more employees were excluded from the sample. 2) At least 10 per cent of the firms should have foreign control and 10 per cent state control, where control is defined as an ownership share of more than 50 per cent. 3) At least 10 per cent of the firms should be exporters, meaning that at least 20 per cent of their total sales are from exports. 4) At least 10 per cent of the firms should be located in a small city (population under 50,000) or countryside. In addition, enterprises established after 1999 were excluded from the sample because the questions on business performance covered the period 1999 to The quotas were fulfilled in the final sample in all but the following cases: state-owned enterprises in FRY Macedonia, Hungary and Slovenia and foreign-owned firms in Tajikistan. 23

24 Basic firm characteristics of the sample Characteristic Sample share (in per cent) Sector Industry 38.7% Services 61.3% Size Small 67.6% Medium 18.5% Large 13.9% Ownership Private De Novo 68.0% Privatised 17.7% SOE 14.3% Location Capital 31.9% Large cities (above 1 million) Large cities (above 250,000) Small cities (between 50,000 and 250,000) 4.8% 14.8% 23.4% Rural (below 50,000) 25.1% 24

25 References Ahn, H. and M. Lee (1999) An Econometric Analysis of the Demand for Access to Mobile Telephone Networks, Information Economics and Policy, 11, Aoki, R. and J. Small (1999), The Economics of Number Portability: Switching Costs and Two-Part Tariffs, Working Paper, University of Auckland, November Boylaud, O. and Nicoletti G. (2000), Regulation, market structure and performance in telecommunications, Economics Department working paper, 237, OECD. Crandall, R. and J. Hausman (2000), Competition in U.S. Telecommunications Services: Effects of the 1996 Legislation, in: S. Peltzman und C. Winston (eds.), Deregulation of Network Industries: What s next?, Washington, DC: AEI-Brookings Joint Center for Regulatory Studies, pp Guitérrez, L. F. (2003) The Effect of Endogenous Regulation on Telecommunications Expansion and Efficiency in Latin America, Journal of Regulatory Economics, 23, Hausman, J. (1999) Cellular Telephone, New Products and the CPI, Journal of Business and Economic Statistics. Hausman, Jerry (2000) Efficiency Effects on the U.S. Economy from Wireless Taxation, National Tax Journal. Navas-Sabater, J., Dymond, A. and Juntunen, N. (2002), Telecommunications and Information Services for the Poor, World Bank Discussion Paper, 432. OFTEL (2003) Consumers' use of mobile telephony: Summary of Oftel residential survey, 27 October Rodini, M., Ward, M. and G. Woroch (2003) Going Mobile: Substitutability between fixed and mobile access, Telecommunication Policy, Volume 27, Ros, A. (1999), Does ownership or competition matter? The effect of telecommunications reform on network expansion and efficiency, Journal of Regulatory Economics, 15,

26 Sung, Nakil, Chang-Gun Kim, and Yong-Hun Lee (2000) Is POTS Dispensable? Substitution Effects Between Mobile and Fixed Telephones in Korea, paper presented at International Telecommunications Society biennial conference, Buenos Aires, July Vagliasindi, M. in Broadman, H. et al (2004) Access to Regulated Infrastructure Services in Building Market Institutions in South Eastern Europe, Word Bank and EBRD. Wallsten, S. (2002), Does sequencing matter? Regulation and privatization in telecommunications reforms, Mimeo, Stanford University. 26

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