Structural Separation and Prospects for Welfare-Enhancing Price Discrimination in a New 'Natural Monopoly' Network: comparing fibre broadband proposals in Australia and New Zealand

David Heatley and Bronwyn Howell

No 19159, Working Paper Series from Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation

Abstract: The Australian and New Zealand governments have both decided that substantial government investment is required to accelerate the deployment of new nationwide fibre-to-the-home (FTTH) networks. This paper examines the two proposals in light of the crucial role of price discrimination in enabling rapid and early uptake of a new technology with a natural monopoly cost structure given the assumptions that both networks will be subject to provisions that separate elements of network ownership from retail operations and both will face competition from other (vertically integrated) network technologies. Whilst price discrimination enables a monopolist to maximise profits by extracting surplus from consumers when the firm has a natural monopoly cost structure it also enables the firm to increase welfare by accessing scale economies (static efficiency gains) and to introduce the technology earlier than under the counterfactual of a single price (dynamic efficiency gains). However vertical separation of network and retail functions and regulated 'open access' and 'equivalence' requirements used as regulatory tools to increase retail competition and constrain price and non-price discrimination by monopoly network operators restricts the ability of a new network operator to use its price structure to introduce the technology in a timely manner and to gain access to welfare-enhancing scale economies. In a competitive environment when the new (frontier) network must build its customer base principally from the substitution of customers from the existing (legacy) natural monopoly networks (which may be vertically integrated and engaging in price discrimination themselves) the non-discriminatory provisions of structural separation impose substantial limitations upon the regulated firm's business case. Both the Australian and New Zealand FTTH proposal impose separation and non-discrimination requirements as a precondition for government financing although they differ in their approaches in respect of both the point at which the separation must be enforced and the extent of competition anticipated from existing network operators. Whilst neither proposal enables the full efficiency gains available from producing at maximum efficient scale to be realised the Australian proposal with integration of layer 1 and 2 operators and acquisition of the competing copper access networks appears to offer efficiency and substitution advantages over the New Zealand proposal which requires separation between layer 1 and 2 operators and provides no clear view of the competitive positioning of the FTTH network relative to the legacy copper access rival.

Date: 2010
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