ITS Introducing Competition and its Welfare Implications in Korean Mobile Telecommunications Services Duk Hee Lee & Dong Hee Lee School of IT Business, Information and Communications University, Daejeon, South Korea August 24, 2003

ITS Donghee Lee Content I. Introduction II. Korean MTS and Social Welfare III. Estimating Consumer Surplus IV. Estimating Producer Surplus V. Total Social Welfare VI. Conclusions

ITS Donghee Lee Introduction Industrial change in telecommunications services Rapid growth in the Mobile Telecommunications Industry How has the change affected the social welfare? How much benefits has been achieved from the services? Natural Monopoly Competition Technological advance in switching and transmission Developed new services diversified and individualized demand Service Convergence

ITS Donghee Lee Korean MTS and Social Welfare Korean MTS market situation Monopoly SKT Duopoly SKT, STI Competition SKT, STI KTF, KTM, LGT

ITS Donghee Lee Korean MTS and Social Welfare Introducing competition How much benefits from MTS have been achieved owing to introducing competition? What are the structural patterns of benefits btw consumers and service operators over the time? Competition Operator profits↑ subscribers↑ Price↓ Quality↑ Consumer benefits↑ calls ↑ Source: KISDI (2001)

ITS Donghee Lee Korean MTS and Social Welfare Empirical estimation of the benefits Social Welfare in economic concept  Consumer Surplus : price elasticity, operator revenue  Producer Surplus : operators’ annual report Price Equilibrium price 0Quantity Equilibrium quantity A Supply C B Demand D E Producer surplus Consumer surplus

ITS Donghee Lee Korean MTS and Social Welfare Empirical evidence in some countries Researcher Time Periods Consumer Surplus Producer Surplus CS/GDP U.S. Hausman (1997) 1989~1993B$31 ~ B$50 per year-0.71% UKRA (2001)2001B$ in 2000B$ % AustraliaACA (2002)1995~2001 B$2.002 ~ B$4.307 in % ~0.65%

ITS Donghee Lee Estimating Consumer Surplus Alexander, Kern, and Neil(2000) Critical assumptions: Demand function for MTS is only affected by the service price (for subscription and call) Model: : consumer surplus : subscription price or call price at time t : the number of new subscribers or the volume of calls at time t : elasticity of demand

ITS Donghee Lee Estimating Consumer Surplus Estimating elasticity (η) of demand for the subscription  factors: subscription fee, handset price, handset subsidy, income level, call price, other consumer product price : Price elasticity of demand for subscription : Cross elasticity of demand for subscription : Income elasticity of demand for subscription : Subscription price (= subscription fee +handset price – handset subsidy) at time t : call price (= basic fee + usage fee) at time t

ITS Donghee Lee Estimating Consumer Surplus Estimating elasticity (η) of demand for the call  Factors: call price, income level, subscription price, the number of subscribers, and other consumer product price : Cross elasticity of demand for call : Price elasticity of demand for call : Income elasticity of demand for call : Subscription price (= subscription fee +handset price – handset subsidy) at time t : call price (= basic fee + usage fee) at time t

ITS Donghee Lee Estimating Consumer Surplus Estimated elasticity of demand and consumer surplus Before competition ( ~ ) After Competition ( ~ ) Elasticity of demand for subscription Elasticity of demand for call YearSubscription CSCall CSTotal CS , ,2681, ,0402,4013, ,0703, ,2103,949 Total3,50611,63415,140 (Unit: USD Mil)

ITS Donghee Lee Estimating Consumer Surplus Year CS/GDP(%)

ITS Donghee Lee Estimating Producer Surplus Producer surplus Economic concept  The dollar amount by which a firm benefits by producing a profit-maximizing level of output.  If ∏ E (economic profit) = TR - TC and TC = VC + FC, then PS = TR – VC = TR – TC + FC = ∏ E + FC (in the short-run)  In the long run, PS = ∏ E  TC already includes opportunity cost of capital that a firm requires to do business. (Frank, 1999)

ITS Donghee Lee Estimating Producer Surplus Total cost of MTS (TC) Accounting Principle for telecommunications services  introduced in 1994 to provide: useful accounting information for a fair competition among operators; proper telecommunication policy-making; reasonable and efficient decision-making of operator;  and then has been revised (KISDI, 2003). Business cost + Return on invested capital (ROIC)  Business cost = Operating expense + Non-operating expense (license fee, NUSC, loss from disposal tangible assets, tax)  ROIC = Rate base × Cost of capital (Required rate of return)  Rate base = (average tangible/intangible assets per year) + (average inventory assets per year) + (relevant working capital)

ITS Donghee Lee Estimating Producer Surplus Cost of capital estimated in other countries ResearcherMethod Results (real price, pre-tax WACC) Hong KongNERA (2000) WACC CAPM Incumbent: 9.78% ~ 15.33% Entrant: 10.84% ~ 16.20% UKOftel (2001) WACC CAPM Low gearing: 13.55% ~ 16.95% High gearing: 13.01% ~ 16.61% AustraliaACG (2000) WACC CAPM Pilot area: 10.0% ~ 10.2% Extended zone & rest: 7.6% ~ 7.7% for NUSC in Korea Referring to the several cases, we assume that CoC of Korean MTS ranges from 10%~15% (12%~17%)

ITS Donghee Lee Total Social Welfare Results of estimation PS is negative value until 2000 Cumulative total PS generated by MTS is amount to -$2,448 ~ -$794 million. Thus, total social welfare is less than consumer surplus. Year Total PS (Low ROIC) PS (High ROIC) ,448 CS9791,0401,8873,4413,8443,94915,140 Social Welfare (Low ROIC) ,4452,8353,6384,71714,346 Social Welfare (Low ROIC) ,1832,4843,2594,36312,692 (Unit: USD Mil)

ITS Donghee Lee Total Social Welfare Structural change of social welfare

ITS Donghee Lee Total Social Welfare The social welfare has been rapidly increased after introducing competition in Korean MTS Consumer surplus is much larger than producer surplus. Mobile operators inputted a huge amount of money for establishing network facilities and promoting marketing activities such as handset subsidy. Consumers largely benefited from the service competition on equipment, price, and quality among operators. From 1998 to 2000, the amount of handset subsidy provided by five mobile operators was about $5.7 billion

ITS Donghee Lee Conclusion The Korean mobile telecommunications market has rapidly grown since 1997 when competition was introduced. Measuring the effect on welfare, consumer surplus estimated by using price-elasticity of demand reached $15.1 billion during 1996~2001 Producer surplus estimated by using operators’ annual reports was ranged from –$0.8 ~ -2.4 billion during the time period. Due to the competition, consumer has benefited much more from the MTS than the mobile operators in Korea. Thank you !