Regulating Competition in Oligopoly:

The Case of Telecommunications in

Brazil

Mario Possas

Institute of Economics, Federal University of Rio de Janeiro, Brazil

Av. Pasteur, 250 – Urca, Rio de Janeiro- RJ, CEP 22.290- 240, Brazil

Tel 55-21-295- 1447

e-mail: possas@ie.ufrj.br

Jorge Fagundes

Cândido Mendes University, Rio de Janeiro, Brazil

Av. Rui Barbosa, 532/1201 – Flamengo, Rio de Janeiro- RJ, CEP 22.290- 240, Brazil

Tel 55-21-552- 7860

e-mail: fagundes@ie.ufrj.br

João Luiz Pondé

Institute of Economics, Federal University of Rio de Janeiro, Brazil

Av. Pasteur, 250 – Urca, Rio de Janeiro- RJ, CEP 22.290- 240, Brazil

Tel 55-21-295- 1447

e-mail: ponde@ie.ufrj.br

Regulating Competition in Oligopoly: The Case of Telecommunications in Brazil

Abstract

The paper discusses the transition from active regulation in natural

monopolies to the “reactive” regulation required by oligopolistic market structures.

The typical anticompetitive risks that characterize the transition period in Brazilian

telecommunications sector are analyzed and some preventive measures indicated,

which should be implemented both by regulators and antitrust authorities.

I. INTRODUCTION

Public utility sectors, including telecommunications services, were

traditionally organized in natural monopolies, capable of operating with lower

production costs than a competitive market structure. In order to protect

consumers from their market power, however, prices have been regulated through

either the nationalization of the companies or conventional regulation by

specialized agencies.

Changes in technological and market conditions in the telecommunications

services, usually organized in private or public monopolistic structures, have

produced a structural change, whereby competition through newcomers coexists

with the need for market regulation in segments still monopolized. As a result, this

sector has been simultaneously caught under regulatory regimes and competition

policy rules, determined by the antitrust legislation of each country. It has been a

difficult task to harmonically integrate these two dimensions, although both of

them are necessary to limit the monopolistic market power as well as to strengthen

competition.

In this context, the role of competition policy is essential to avoid strategic

use of dominant position from incumbent firms –by restricting competition in

their markets or by improving such position through mergers or strategic alliances

with competitors. On the other hand, since public utility sectors are still partially

regulated, it is important that regulation criteria be consistent with the objective of

promoting competition.

This article intends to provide a first assessment of the consequences of the

implementation of a transitional regulatory structure for stimulating competition

and/or economic efficiency of the telecommunication services sector in Brazil, a

country where little if any regulation in the economic sphere has been experienced

besides direct state intervention . In other words, to promote a change, as brief and

effective as possible, from a natural monopolistic structure (also under

government control in Brazilian case) to a situation where some competition

exists, in the limited sense of a non- monopolistic market structure (and almost

always an oligopolistic one). Generally, the new challenge does not consists of

regulating (only) monopolistic structures anymore, but also oligopolistic ones,

either in the previously monopolistic sectors now open to competition, or in the

sectors that still have a monopolistic structure but are now vertically related to

others, and are therefore oligopolistically interdependent (in a strategic way) with

the open ones, as is the case in telecommunications.

The following section provides a general theoretical approach to the nature

and importance of the regulation of such “transition” towards a competitive

structure, or more precisely, towards deregulation in public utilities. The third

section points out the importance of competition policies aiming at improving

competitive conditions in telecommunications services markets. The Brazilian case

is presented in the fourth section, summing up the present institutional

competition policy criteria along with the privatization and regulatory processes in

Brazilian telecommunications services, followed by a discussion of the structural

conditions in different markets that could originate competition problems. Some

such problems are briefly discussed, where preventive or repressive actions from

the regulatory agency are deemed necessary. This involves a special concern in

continuous monitoring of structural conditions as well as potential anticompetitive

actions and requires, at the institutional level, an integrated action with

competition policy agencies.

II. FROM NATURAL MONOPOLY TO COMPETITION: RATIONALE AND

CONSEQUENCES TO REGULATION

(a) Theoretical references

Reasons usually put forward by the literature to support public regulation of

economic activities are related to the so-called “market failures”, of which natural

monopoly is the most easily recognized as a candidate to active regulation. In spite

of having its economic analytical support now widely spread and accepted, such

kind of state intervention paradoxically no longer has its empirical preconditions

as often found as before.

Economic literature traditionally considers natural monopoly to be the only

kind of market structure that allows for a theoretically supported public regulation,

assuming that unit cost reduction due to operation of a single production unit

(plant or firm) offset the costs and risks of its regulation. Regulatory policy is

usually centered on price setting at minimum average costs for a given demand;

and on blocking entry in the market(s) so as to allow either expected gains from

efficiency increases or, in some cases, the adoption of cross subsidies.

The presence of a natural monopoly is presumed in face of significant scale

or scope (in case of multi- product) economies relative to market size, at a

minimum average cost pricing level (corresponding to minimum efficient scale);

or, more technically, whenever long run cost is significantly subadditive at that

quantity (single or multi- product).

In such cases, regulation is often regarded as the only solution to avoid three

lower welfare alternatives 1: free operation of a private monopoly; free operation of

several private firms at sub- optimal scales and higher costs, although at lower

margins; and state- owned production at an efficient scale but subject to

inefficiencies resulting from a politically biased and/or a low incentive

management as for productivity and quality improvement.

Basically, regulation consists of maintaining capitalist production - thus

keeping at least part of the incentives which private property and market system

are supposed to entail - while at the same time restricting the autonomy of

decisions, replacing profit seeking behavior by administrative rules in the decision

making of the regulated company. In general, such rules may be classified in three

categories 2: limitations to entry in and exit from a market; specifications

concerning quality of output; and criteria for price determination.

Once accepted that the main motivation for regulatory intervention comes

from the structural features of the industry and/or market that significantly

hamper the competition process, public utilities could at first be able to exhibit an

endogenous drive capable of rendering unnecessary any regulation 3. By definition,

one can immediately conclude that a movement away from the natural monopoly

situation will take place whenever the settlement of another efficient plant

becomes feasible through market growth, fixed costs reduction and/or variable

1 VISCUSI et alii (1995), ch. 15.

2 WEYMAN-JONES (1994).

3 We do not intend to give a complete account of possible reasons for regulation policies: for

example, such social dimensions of regulation as universal access to public utility services are left

aside.

costs increase. 4

(b) From natural monopoly to oligopoly

The change of a natural monopoly into a competitive structure, from the

demand side, is mainly due to a high rate of growth of demand, leading to a market

size that is large enough to make sustainable (in the contestable markets jargon) a

structure with more than one efficient size operating unit. From the supply side,

technical progress is no doubt the most relevant variable, although input price

decreases may also have important effects. The deterioration of a natural

monopolistic position may result from three kinds of technological change:

(i) a decrease in scale economies and/or in fixed costs in proportion to variable

costs due to technical innovations, within the existing stock of technologies;

(ii) a radical process innovation, allowing the same output to be produced with

a completely new technology, involving lower minimum scales and sunk

costs;

(iii) the emergence of new substitute products and resulting changes in market

boundaries, so that a natural monopoly eventually becomes a monopoly of

a specific product variety within a larger market, composed of a greater

product mix and many rival producers.

As a consequence, the evolution of the parameters which rule the operation

of a regulated sector should be subject to frequent monitoring by regulatory

agencies and policy makers. As discussed in VISCUSI et alii (1995, ch. 15), changes

in conditions determining the existence of a natural monopoly, that may

eventually lead to open it to competition, put difficult challenges to regulation.

Foremost decisions are those concerning the amount and scope of

regulation to be pursued. In an “orderly” scenario this takes place whenever

demand and/or supply changes bring about the feasibility of one more efficient

supplier, within a reasonably delimited market. In this case, the main challenge for

the regulator is, when analyzing these changes, to find the appropriate timing for

removing regulation, so as to:

(i) take advantage of the increasing competitive pressures to replace

administrative controls by market mechanisms, leading producers to

4 VISCUSI et alii (1995), p. 482.

spontaneously adopt welfare promoting behavior;

(ii) discourage monopolists to adopt entry- deterring strategies towards

newcomers;

(iii) adapt to the new context, or else eliminate, cross subsidy mechanisms

directed to groups of consumers.

Regulation becomes even more difficult in a “disorderly” scenario, in which

transition from a natural monopoly proceeds amidst the emergence of new

products/services or a change in important features of existing products. The

introduction of competitive pressures in this case goes along with less sharp

boundaries between markets and with firm diversification strategies, which turns

the regulation more complex.

Not only the timing for regulation weakening or even removal must be

decided, but also the definition as to which products should be under the scope of

regulation; what controls should be set on entry into new markets - e.g. as to

permission or prohibition for a regulated monopolist to enter into a market under

deregulation -; and how to avoid the so- called “cream- skimming” that takes place

once a possibly inefficient newcomer enter a more profitable market, leaving the

less profitable one to the incumbent.

(c) Implications for regulation

In any of these conditions for a public utility sector in transition from a

natural monopoly, three possibilities for policy arise: to keep regulation

unchanged; to fully “deregulate” it, allowing free entry; or some partial

“deregulation”. In the latter case, short run anticompetitive risks associated with

immediate “deregulation” would be avoided through elimination or reduction of

restrictions to entry, along with holding a strong control on prices. One possible

policy would be to set minimum and maximum price limits, while letting them free

to fluctuate within this band; another is to allow price changes except when under

suspicion of anticompetitive conducts 5. On the other hand, minimization of long

run risks require a gradual removal of controls on firms strategies concerning

growth, investment and diversification and to direct regulatory policy towards the

5 When the problem amounts to the dominant position of the former monopolist, its prices may be

put under control while the new entrants’ may be left free.

shaping of the new market structures.

Such partial deregulation policy is desirable when: (i) the change in market

structure is a gradual process instead of a one- shot event; and (ii) there is

uncertainty as to the future evolution of cost and demand conditions, so that any

forecast of future competitive conditions in this market is difficult and not much

reliable. It seems sensible to assume, from now on, that this is the most frequent

case, and as such to take it as a reference for the following discussion. This is the

usual choice in actual situations, where for whatever political or economic reason a

gradual - sometimes very long - transition to competition, or to deregulation , is

preferred 6. This situation may in general be expected to stabilize (if at all) not in a

competitive market structure, but in an oligopolistic one.

It is worth noting that to regulate such oligopolistic structures - no longer

natural monopolies, it should be stressed - is in general not desirable in itself from

an economic efficiency standpoint, but a requirement imposed by institutional

preconditions; i e., by the fact that the sector has already been under some kind of

regulation. Given the regulation, it may (in principle) increase the level of social

efficiency of the market either setting the price or rate (as well as quality

parameters), or controlling entry. It is easy to conclude, in particular, that price

regulation usually implies some entry control, since any price above average cost

may attract inefficient (with cost above minimum level) entrants.

In the first place, partial regulation on prices will usually keep some

relatively flexible controls - for instance, upper and lower price limits - so as to

prevent respectively, after entry took place, collusion and consequent abuse of

market power through monopolistic prices, and predatory prices against

competitors. The latter depends on possible financial advantages for the

incumbent (former monopolist), and/or its dominant position in some market

allowing to finance predatory prices elsewhere.

Partial price regulation may in some cases be rightly asymmetric in face of

newcomers and incumbent, keeping control solely on the latter in order to avoid

market power abuses against the former. However, this policy option may cause

distortions - such as when regulatory policy intends to preserve a cross

6 For example, when a soft transition is intended toward deregulation so as to minimize lobbies or

to face a political stalemate, or when the regulatory agency feels very uncertain as to the actual

conditions of demand and cost in the regulated market(s).

subsidization by the incumbent from a market open to competition toward

another in which it holds a monopoly. In the presence of scope economies this

may entail an inefficient entry from a hypothetical single- product firm trying to

profit from the higher price set by the incumbent in that market to subsidize a

price lower than cost in the other (monopolized) market7.

Secondly , partial regulation may also involve entry restrictions on some

markets; for example, when transition regulatory policy still preserves a

monopolistic position in a market, from which the regulated incumbent could be

able to perform a predatory control on other non- regulated markets, so that to

forbid its entry in these other markets is justifiable. In the literature this subject is

called the separation problem of markets in which the former monopolist

incumbent might possibly operate, forbidding its permanence or entry in some or

all of the non- regulated ones.

Possible competitive gains from preventing abuses of market power from a

monopolist in a regulated market toward non- regulated ones - whatever the

discriminatory practice involved (predatory pricing, vertical foreclosure, etc.) -

should be weighed against the disadvantage of excluding from the latter an

important potential competitor.

(d) Regulatory problems during transition

Two basic groups of problems may be faced by the regulation of

oligopolistic industries with some competitive potential, according to the

literature: those emerging in situations where regulated prices are set above costs

(more often) and those associated with prices below costs. In both cases entry and

exit are supposed to be forbidden by the regulators.

In the first case, typical problems are:

(i) productive inefficiency , where costs are higher and quality of products or

services lower than the expected outcome of free entry, due even to extra-

price collusion;

7 This is the “cream- skimming” practice mentioned above. It can theoretically be prevented if

regulators impose Ramsey pricing (whereby margins over unit costs in each market are inversely

proportional to respective demand price- elasticities), which entail sustainable market shares for the

incumbent but at the same time may cause the politically desired (for regulatory policy) low prices

to become unfeasible in the subsidized market.

(ii) excessive product differentiation , advertising included (not necessarily

through quality), induced by the impossibility of price competition.

In the second case (prices below costs), a cross- subsidization policy is

typically employed to make such activity economically feasible. This policy usually

entails welfare losses in the diverse markets involved, which may in principle be

justified by other policy objectives (such as distributive equity). Low profits that

normally result may create difficulty to investments needed to increase efficiency

in such activities and may even rise capital costs to the point that the firm’s

productive capacity as well as its productive, technical and innovative performance

deteriorate, to the eventual long run damage of product quality, variety and prices,

and therefore to the consumer’s detriment

(e) The importance of transition

A point deserving to be stressed is that, in a good number of cases,

regulators of a sector in which a former natural monopoly is being dismantled

should concentrate their attention in a careful management of the transition

toward new market structures. During this period, public intervention may not only

affect the pace or the smoothness of the transition, but the point of arrival itself. In

other words, such transition cannot be reduced to a shift between two equilibrium

structures, whose actual trajectory does not affect the final or “long run” result.

Partial regulation features not only follow a transition; but they are one of the main

factors conditioning the market structures that will eventually emerge in such

sectors.

Strategies adopted by regulated firms during the transition phase have in

consequence a decisive role. Under sunk costs, increasing returns accruing from

technological learning and network externalities, as is usually the case in

telecommunications services, the making of competitive positions by the agents

follow irreversible paths. Although various market structures could initially be

possible, the evolution of the real one consists of a sequential elimination of

alternative paths, part of which is effected by entrepreneurial decisions that do not

necessarily lead to a satisfactory result from the standpoint of social welfare.

Once assuming the role of establishing restrictive parameters to strategic

behavior of firms during the transition, regulatory agents enter a twilight zone

between conventional regulation and antitrust policy. The main issue ceases to be

the speed in which the former natural monopoly is divested, and shifts to such

ambiguous problems as which kind of oligopoly will eventually emerge and how its

configuration may - and should - be conditioned. As we shall see below, this brings

forward some original normative problems, in the sense that while traditional

regulation intends to substitute for (non- existing) competition, while competition

(antitrust) policy intends to look after its preservation, the management of

transition involves the construction of competitive environments.

(f) Strategy

The preceding discussion emphasized that, among the determinants of the

dynamics of sectors that are leaving the position of natural monopolies, the

strategies adopted by incumbent firms that are already established or in the

process of becoming established form the basis for the market structures that will

be shaped - and also, the type of regulation that will prove most efficient during the

transition into the eventual oligopolistic structure. Technological trends, changes

in market boundaries and the different capabilities and assets accumulated by

firms in the past interact and generate opportunities and stimulate that make them

redimension the scope of their activities.

Business strategies can be part of defensive movements towards a raise - real

or expected –in competitive pressures, especially the entry of new competitors in a

market where monopoly was institutionalized. The variety of actions that can be an

instrument of what is generally called strategies of entry deterrence is very wide, as

illustrated by the proliferation of models based on game theory to study the

conditions of many of their modalities.

An important aspect stressed by the authors is the capacity of an established

firm’s behavior of having a permanent effect on the market structure. In this

context, such behaviors may have an anticompetitive character, for they represent

an obstacle to the construction of a competitive environment in which greater

pressures may threaten the dominant firms. This seems to justify an effort, to be

taken by the regulatory agencies, to discourage their proliferation.

On the other hand, strategies of diversification and vertical integration -

whether or not involving strategic alliances -, as well as mergers and acquisitions,

are sure to have causes other than the prospect of rising future profit by means of

creating difficulties to real or potential competitors. At least three motivations can

be imputed to these strategies in order to change them into instruments for

efficiency improvement:

(i) the use of opportunities created by technological learning inside the firms,

that lead to accumulation of different capabilities potentially used for the

expansion in new markets. Initially propose by PENROSE (1959), this subject

has been retaken by neoschumpeterian authors such as DOSI, TEECE and

WINTER (1992) - in an approach that relates the growth path of firms with a

greater schumpeterian efficiency in the competitive process;

(ii) the minimization of coordination problems, expressed in transactions costs

(WILLIAMSON,1985), to the extent that the presence of asset specificity

makes the market interfaces between production chain links a source of

contract conflicts and dissentions;

(iii) the necessity of exploring synergies or opportunities for interactive learning

for the development of technologies that present any degree of systemic

complexity, so that the vertical integration or the diversification may

constitute a means of building the indispensable channels for the exchange

of information and tacit knowledge.

In all three cases, we have business strategies that can be called pro-

competitive, meaning that they are an essential part in the process of innovation or

discovering new forms of organization provided by competitive dynamics. One of

the challenges in the regulation of the transition from natural monopoly into

competition within an oligopoly structure is to distinguish between possible

anticompetitive elements and the search for rising efficiency in the actions

undertaken by the dominant firms. The experience accumulated by the institutions

responsible for the application of antitrust policies can be useful in the discussion

of this topic.

III. COMPETITION POLICY IN REGULATED SECTORS IN TRANSITION

The increasing liberalization in sectors of public utilities, including

privatization of public monopolistic firms, by removing institutional barriers to

entry in some of its segments and by the constitution of regulatory agencies,

determines the emergence of several competition problems. The presence of sunk

costs, market power and the possibility of strategic behavior on part of incumbents

implies that such market structures are not contestable, and so liberalization alone

is not sufficient to ensure a greater level of competition.

Several anticompetitive risks can arise, as referred to before, from the

occurrence of vertical restrictive practices along the productive chain to possible

movements of concentration of market structures through alliances, joint ventures,

acquisitions and mergers among groups that are competitors - or potential

competitors - in the industry, in their various segments.

(a) Control Over Vertical Conducts

A large part of the antitrust problems concerning vertical conducts in

regulated sectors are conditioned by the vertical structure of these sectors. There

are four possible industrial structures in these sectors (ARMSTRONG AND DOYLE,

1995):

(i) integrated monopoly, in which a single firm is responsible for the supply of

all services;

(ii) structural separation with liberalization, where there is competition in some

markets and the monopolist does not operate in the competitive markets;

(iii) vertical integration with liberalization, where the natural monopolist is

allowed to operate in the markets subject to competition. The account

separation, in which the monopolist must keep distinct account structures

for monopolist and competitive services, may or may not be required; and

(iv) joint ownership, in which the supply of services characterized as monopolist

is accomplished by a firm whose property is shared by the firms which

operate in the competitive sectors.

In all cases, the existence of monopoly power in the providing key inputs for

the service supplied in markets open to competition demands the presence of

permanent monitoring of the behavior of the monopolist firm. However, the

importance of the regulating mechanisms and towards protecting competition

differ depending on the kind of vertical structure of the sector.

In the case of integrated monopoly, the problem derived from vertical

anticompetitive practices is obviously irrelevant, since the concern of the regulator

is only related to the prices of final services. In the case of structural separation

with liberalization, all the competitors in the liberalized market are in equal

conditions regarding the provision of basic input. The problem is basic regulation,

involving the determination of access price - the prices of services under monopoly

- to promote efficiency in sectors open to competition. The last alternative (joint

ownership) is not a problem from the antitrust view, if the control of the monopoly

firm is equally shared among the firms that operate in the competitive segments,

except for the existence of asymmetric power related to the process of decisions

making regarding prices, quantities and quality of services provided by monopolist

- this can determine the necessity of monitoring by regulatory and antitrust

agencies.

It is the third alternative which shows the greater risk from the viewpoint of

competition: in this case the monopolist provide vital inputs for its rivals in the

markets of final services, so that the emergence of practices directed to the deter

entry in these markets and/or for rising rival’s costs becomes highly likely. Under

these circumstances, the operating firm is interested, by taking restrictive actions,

in preventing the entry of new firms, or reducing the competitiveness of

newcomers in downstream markets, whether or not these markets are subject price

regulation.

Specifically, vertically integrated incumbents with dominant position or

monopoly of the basic network are able to adopt vertical anticompetitive behavior,

such as:

�i) predatory prices in downstream markets; and

�ii) discriminatory actions which raise costs of real or potential competitors -,

such as access price discrimination and/or raise entry barriers in the market

of final services, tied selling and exclusive dealing.

These strategies prevent uniform conditions of competition between the

dominant firm and its new - or potential- competitors (level plying field) in

downstream markets, making it difficult for competitors to have the same access

costs as those faced by the monopolist firm in these markets8.

(b) Concentration Ventures

Although the so- called vertical anticompetitive conducts or practices ( and

so, in a smaller degree, the horizontal, connected to several types of collusion)

represent by far the greater risk of market efficiency losses resulting from opening

the public utilities regulated sectors to competition, they do not exhaust the

reasons for pro- competitive concerns for regulators during the transition process.

It is usual in antitrust law and practice to evaluate the potential risks of mergers

and acquisitions or other contracts that may limit competition, either directly

affecting the structure or not.

In the first place, as in any other economic activity subject to private

strategies and, in particular, to the present conditions of strong competitive

pressure over most markets, there may be incentives to acquisitions, mergers or

joint ventures in regulated markets or those vertically related to regulated markets,

increasing concentration and consequently the risk of collusive actions.

In these cases, besides the particularities of a legal complex regulatory

regime that would necessarily involve at the same time general aspects of

competition policy and specific aspects of regulation, they pose at first problems

similar to those that are already dealt with by the regulatory institutions and by the

technical and legal experience of antitrust policy. The specific aspects are due to

the oligopolistic competition.

In the second place, and even more important, we must consider the

possibility of loosening the competitive pressure over regulated markets due to

collusive conducts that are always possible, but become more likely in the

segments of higher concentration and/or smaller dynamism of demand and

technology, and that are particularly made easier by setting criteria and rules or

even rates by the regulatory agency. In these cases, there is a strong tendency to

“managed competition” to evolve, expressed in three most important risk factors9:

�i) a tendency as to regulators to feel “ responsible “ for maintaining the

8 For example, in the case of telecommunication, an integrated operator could rise the costs of its

opponents in the markets of final services - such as access to Internet - through the offer of low

quality inter- connective services.

9 Cf. STANBURY (1996), referring to regulation of telecommunications services in Canada.

existing market structure, trying to assure, as much as possible, the

profitability of the newcomers - this can involve a certain degree of division

in the market by approximate shares;

�ii) a sometimes excessive concern with the financial/economical destiny of the

newcomers, who tend to be over protected, on similar grounds to those of

“infant industries” - obviously paid by the users of the services - against the

pre- existing advantages in the late monopoly, under the pretext that if one

or more of them should fail, this would cause a greater evil in the

interruption of these services;

�iii) creation of opportunities for the strategic use of regulation by the firms.

There are often situations which favor typical behavior of rent seeking by the

regulated firms, both incumbents and new comers, even when they are

aggressive, in order to reap economic rents from the regulatory system by

using strategies of eliminating rivalry in the search for regulating criteria

which are mutually more advantageous.

One typical form of regulatory action that can bring benefits to the regulated

firms and induce horizontal anticompetitive strategies (price and extra- price

collusion) is to allow for exceptions, under certain circumstances, in the regulation

law of the sector or even in the competition law for segments and especially for

certain firms. Aiming to make changes easier and to flexibilize the regulatory

pressure, this device can also create competitive asymmetries among firms and,

more than precipitate a predatory competition, can generate incentives to the

strategic use of regulation, toward making tacit collusion viable.

IV. THE BRAZILIAN CASE

IV.1. Competition Policy In Brazil

�a) Concentration Ventures

Article 54 of The Antitrust Brazilian Law No. 8884/94 aims to avoid excessive

market concentration that might strongly reinforce market power and induce

overpricing and/or hamper static and dynamic economic efficiency gains creation

and/or diffusion. Its main section states that any action that may limit or otherwise

restrain free competition, or result in the control of relevant markets (20% or more

of a relevant market) for specific products or services or in which at least one of the

firms engaged has a turnover equal to or over US$ 400 million, must be submitted

to CADE - Administrative Economic Protection Council (Brazil’s antitrust agency) -

for approval 10.

CADE is the agency which effectively decides whether a requirement

concerning a concentration venture (e.g. a merger) shall or shall not be approved.

It is an independent office and its members are either lawyers or economists. The

FTC’s Horizontal Merger Guidelines is used as an important analytical frame, which

means that CADE’s procedures consist of balancing the potential adverse

competitive effects of a merger or acquisition against its potential static and

dynamic efficiencies .

Article 54 also states that CADE may authorize any transactions referred to

in its main section - those limit or restrain competition -, provided they meet the

following requisites: (i) they shall be intended to increase productivity; improve the

quality of a product or service; or cause an increased efficiency, as well as foster

technological or economic development; (ii) the resulting benefits shall be fairly

allocated among participants, on one part, and consumers or end- users, on the

other; (iii) they shall not drive competition out of a substantial portion of the

relevant market for a product or service; and (iv) only the action strictly required to

attain the envisaged objective shall be performed.

One should note that, according to Brazilian antitrust law, CADE could, as

far as mergers and acquisitions are concerned, approve operations with

performance commitments. The imposition of performance commitments upon a

party presupposes that the transaction has been approved, for they function as a

necessary condition for its the approval. In these cases, CADE Board will define the

performance commitments to be assumed by any interested parties that have

submitted transactions for review pursuant to Article 54, so as to ensure

compliance with the conditions above mentioned.

(b) Anticompetitive Conducts

10 It should be noticed that, as opposite to other legislation, Brazilian Law does not demand

previous notification of planned transactions, though not accomplished yet, even though nothing

prevents firms from doing it.

Articles 20 and 21 of Law 8884/94 deal with procedures related to presumed

anticompetitive conduct. Article 20 sets forth the types of conducts which shall be

deemed, in accordance with the Brazilian legislation, violations of the economic

order: (i) to limit, restrain or in any way injure free competition or free enterprise;

(ii) to dominate a relevant market of a certain product or service; (iii) to increase

profits on a discretionary basis; and (iv) to abuse of one’s dominant position 11.

Two remark’s related to this article are important: (i) infractions to the economic

order are any conducts which, even though do not generate the anticompetitive

effects foreseen in the article, are able to produce them; and (ii) article 20 introduce

the notion of dominant position, present in European tradition. As to article 21, it

should be noted that: (i) the conducts referred to do not constitute an exhaustive

list of anticompetitive actions described in article 20; (ii) they only typify situations

that may violate the economic order, in case they are described in the premises of

article 20.

Thus, in accordance to this antitrust law, no conduct shall be deemed illegal

per se (with only a few exceptions). The system adopted in Brazil concerning

antitrust violations rests upon the “rule of reason”. The judgment of most actions

pursuant to Articles 20 and 21 of Law No. 8884/94 requires a careful analysis of the

structural characteristics of relevant markets in which they occur. Depending on

such characteristics, a conduct may or may not be deemed a violation of the

economic order. Additionally, the language itself used in the statute indicates that

the authorities shall be focusing their attention primarily on the effects of a

conduct not on a single competitor, but on the relevant market structure.

IV.2. Structural and Institutional Changes in Telecommunications Services

With only a few exceptions, telecommunications services in Brazil have been

rendered by public companies from Telebrás System, consisting of 27 local carriers

and one long distance - national and international – carrier (Embratel), each of

them a monopoly in its market area. The sector is being restructured at present,

and this involves two basic processes:

11 The dominant position referred to in (iv) is presumed when a company or group of companiescontrol 20% of a relevant market, this percentage being subject to alteration by CADE for specificsectors of the economy.

�i) privatizing the public operators and liberalizing markets, through the

removal of institutional entry barriers; and

�ii) building a regulatory structure, able to manage the transition from state

monopoly into more competitive market structures, as well as establishing

the rules of the game in which telecommunications services firms will

operate in the future.

In this section, we will discuss mainly the following up presented by the

conduction of the transition, in terms of market structures which shall emerge in

the segments of traditional and cellular telecommunications markets12.

Privatization of the Telebras System will be preceded by its deep reform, and

this will have a decisive impact on market structures to be formed. Basically, the

General Law of Telecommunications (Law number 9.472/97), from now on called

LGT, determines:

�i) the creation, from the old Telebrás system, of three regional operators,

(“Teles”) operating local and long distance wired traditional services within

specific region, with no competition among them;

�ii) that Embratel will continue to provide long distance services all over the

country and also international services;

�iii) the creation, from Telebras existing subsidiaries, of ten wireless (cellular)

operators, operating in specific areas and under the so- called A frequency

band; and

�iv) the creation of a Regulatory Agency: ANATEL (National

Telecommunications Agency).

Until privatization is completed, these services provided by Embratel and

the other local public carriers will be submitted to a new legal status - called public

regime - through franchise granted by the government, containing obligations

related to the continuity and the quality of the services. This regime determines

well distinctly conditions and a very strict regulation. The difference between

public juridical regime, in general for (former state- owned) incumbents, and

private juridical regime, for newcomers, constitutes one of the major institutional

innovations of the new regulatory system, which is being set in

telecommunications services in Brazil, with important consequences in the level of

12 For a more detailed description of the regulatory mark being developed, see IOOTY (1998).

competition and in public policies 13.

After the privatization of “Teles” (regional operators) and of Embratel as well

as the ten cellular regional operators (A Band), the competition will be gradually

introduced through the following measures:

�i) expedition of authorization for the entry of a new competitor in each of the

three regions, to exploit the services of traditional telephony under private

regime;

�ii) expedition of authorization - also in private regime - for the entry of a new

competitor in long distance services provided by the privatized Embratel;

�iii) concession, through bidding, of one license for operating cellular services

in each of the ten areas defined at the time of privatization. The newcomers

will operate under the frequency range called B band; and

�iv) from December 31, 2001, total liberalization for entry of new competitors in

the markets of wired telephony.

Thus, one can conclude that in traditional telecommunication services

(wired), the market structures after privatization will be, initially, a duopoly , in both

segments - national (international and inter- regional long distance) and regional

(intra- regional and local). With new authorizations after Dec. 31, 2001, when the

beginning of “effective competition” in the various segments is foreseen, there will

be the possibility of new entries - and then a lower market concentration - resulting

from the competitive dynamics of each market.

In the case of cellular services, there will be no difference between the

13 Basically, the differences between both regimes are: a) Conditions of entry: in the public regime,

through franchise bidding; in the private regime, through authorization from the Agency, which

cannot be denied except in special cases; b) Regulation of prices and tariffs: in the public regime, the

contract for concession set tariffs and mechanisms for readjustment and revision; while in the

private regime, there is price freedom; c) Obligations of continuity and universalization : the

contracts of franchise in public regime will impose obligations of continuity and universatization of

services provided by privatized carriers, as opposed to what happens under private regime; d)

Degree of regulation and controlling: the contracts of franchise of services in public regime will

define the conditions of provision of telecommunications services, the obligations of

universatization and continuity, and the tariffs and criteria for readjustment and revision; while in

private regime the freedom foreseen in the Constitution will be the rule, except for restrictions

imposed by government; and e) deadlines : the maximum deadline for any franchise is twenty years,

which may be extended only once, for an equal time period. On the other hand, the authorization is

only extinguished by annulment or similar event(more details in IOOTY, 1998).

regulation of newcomers and that of incumbents. This option seems to be justified

by the fact that such a service is not considered as essential, as well as by its

technical characteristics - especially smaller sunk costs - which make it easier for

new competitors to enter (IOOTY, 1998, p. 10).

IV.3. Competition and Regulation in Emergent Market Structures

As explained above, telecommunications restructuring in Brazil, in

particular in the local wired telephone markets - national and regional -, are

producing a transition from state monopolies to private duopolies, with the

possibility of less concentration in the near future. However, such a progressive

introduction of competition, as largely acknowledged in the literature based on the

experience of other countries, is not enough to prevent the emergence of

anticompetitive conducts and of inefficient market structures.

An important source of concern is the presence of asymmetric market

power among two kinds of firms: (i) incumbent firms (former state- owned in most

cases - the ones that will purchase the old Telebrás system, including Embratel),

with high market power, originated from their dominant or even monopolistic

positions in the traditional wired local and long distance networks; and (ii)

newcomers to the new markets - e.g. value- added services (VASs) and Cable TV - or

to the traditional markets, but using new technologies, such as wireless

telecommunications and optical fiber.

These differences in market power can generate some antitrust and

regulatory concerns. Firstly, it is necessary to design mechanisms to prevent

incumbent firms to adopt strategies of entry deterrence in any markets. However,

since these asymmetric positions are associated with huge sunk costs incurred by

the incumbent firms - which now operate under a public franchise regime

(including targets for universalization of services, for example) -, these

mechanisms should ensure the achievement of public policy objectives. As seen

above, such mechanisms are in part already present in the different franchise

regimes (public and private) created by Brazilian law (LGT).

It is important to note that price regulation of an operator with market

power do not prevent anticompetitive conducts. For example, price cap rules

restrain only the aggregate level of prices, leaving the operator with a significant

margin of freedom to set the prices of specific services. In this case, the operator

will be able to set prices in order to deter entry or to raise rivals’ costs in

downstream markets. The permanence of discriminatory price practices and of

cross subsidies among different segments of the telecommunications services

market under the new regulatory frame would allow inefficient market structures

to be settled in the more profitable segments, where prices are above average costs.

Secondly, even in face of new technologies, high rates of diffusion of the

traditional networks would lead newcomers to require access to them, opening the

stage for anticompetitive conducts by the incumbents. As a result, in addition to

the final telecommunication service market, there is also an interconnection

service market whose supply is the access to the traditional network: network

services. From the competition policy viewpoint, there are therefore two basic

relevant markets: (i) final services markets; and (ii) network services 14.

Possible vertical discriminatory practices and concentration ventures in the

telecommunications services markets, resulting from incumbent strategies of

market power maintenance or enhancement - as well as by newcomers –, may

involve a wide range of anticompetitve actions 15. The restructuring of Brazilian

telecommunications services has avoided legal monopolies, implementing

duopoly as an initial market structure, but certainly can avoid neither the

emergence of market power asymmetries, nor the vertical and horizontal

anticompetitive practices related to such asymmetries. Since the general features

of these practices have already been discussed in section III, in what follows only a

few examples will be raised of telecommunications services markets where such

problems have been studied, as well as some very preliminary implications for the

Brazilian case. Typical cases are as follows:

• Refuse to Deal

The conflicts among companies related with interconnection problems -

access rules toward bottleneck (monopolized) segments - are one of the major

forms of refuse to deal in telecommunications services markets16. The refuse to

14 Cf. EC, General Directorate of Competition , 1996.

15 See, for example, NOLL (1995); BAKER & BAKER (1983); and BESEN & WOODBURY (1983).

16 U.S. antitrust policy, as the Brazilian one, approaches the refuse to deal on the basis of the rule of

deal may be explicit, when interconnection is denied, but may also involve more

subtle forms, associated with low quality or high costs; these constitute a refuse to

deal as long as the vertically integrated firm has exclusive access to optimal

interconnection conditions 17. Another important related issue is the quality of the

information about network characteristics delivered to competitors18. Certainly the

dominant operator has an incentive to use its own systems and products vis à vis

the competitor’s.

Such practices can be exercised, for example, when an carrier retains a

monopoly in the local network but is also operating, together with other

competitors, in long distance markets. More generally, the access to local network

is crucial to the long distance carriers as well as VAS´s providers.

The (future) absence of legal monopolies in the Brazilian case reduces, but

cannot eliminate, these problems, as long as dominant positions are and will be

present in the network operation. Given the difficulties in detecting and controlling

every possible competition problem directly through the law, in particular through

LGT, most devices preventing the abuse of dominant positions will have to be

established in the specific franchise contracts. As much important an instrument

of prevention and repression of anticompetitive conducts will be the surveillance

of ANATEL.

In the case of wireless network in Brazil, there has been an explicit concern

about interconnection. The norms of cellular mobile services have established the

principle of equal access in a non discriminatory basis, in defining that “traditional

wired services operators should provide interconnection to mobile services

providers; and the conditions of interconnection will be subject to free negotiation

among involved parties; their rates should be fair and isonomic (the agency will

decide on the conditions for interconnection in the case of disagreement among

the parties). It is also established that the interconnection (...) should be subject to

integrated planning among the parties” (IOOTY, 1998, p.12 ).

reason principle: the conduct is not condemned per se, being considered illegal only when it is

possible to prove the relation between the practice and the aim of creating or maintaining a

monopoly position.

17 There is a relatively large jurisprudence on this subject in U.S. See, for example, Eastman Kodak

Co. v. Southern Photo Materials Co., 273, US. 359, 375 (1927) and Otter Tail Power Co. v. United

States, 410 U.S. 366 (1973).

18 BAKER & BAKER (1983), p. 24.

• Discriminatory Practices

These practices are in most cases associated with price structure. It happens

when prices of a dominant firm in one market impose some competitive

disadvantage to competitors in a vertically related market. There are three main

possibilities: (i) predatory pricing; (ii) raising rivals’ costs; and (iii) tying.

In the first case, existing cross subsidies could be used to hold vertical

foreclosure strategies, in which prices of a dominant position carrier are set below

costs aiming at entry deterrence 19. For example, a carrier with dominant position in

local network might use part of its profits generated in regulated activities to

subsidize predatory prices in the VAS´s markets, or even to forestall entry in such

markets.

In the second case, also called “price squeeze”, a dominant carrier could set

discriminatory prices for its rivals in another market segment. For example, a long

distance carrier could sell services for VAS providers at prices higher than those

charged to their own subsidiaries in the same market, producing cost

disadvantages for its competitors.

A third possibility is the so- called tying20. It is considered a discriminatory

practice when an integrated firm sells bundles of services or products without an

economic or technical justification for not selling the components separately. In

this way, non- integrated competitors are potentially damaged since they cannot

sell the hole range of products/services or are forced to pay for something they are

nor interested in.

Although almost all such problems could be solved by a structural

separation of the monopolistic incumbent from other segments, there are some

economic efficiencies related to integration that should be taken into account.21. In

19 In mainstream economic analysis, predatory pricing is found when a supplier sets prices below

costs with an intent to eliminate competition (HOVENKAMP, 1994, p. 298). This label is applied to

strategies implying the expectation of recouping present losses by means of future monopoly pricing

(ROSS, 1993, p. 56).

20 A tying is defined as the selling of a product or service being conditioned to the acquisition of

another product/service by the buyer. Brazilian law considers such arrangement illegal only if it

results in domination of a relevant market, in restraining competition or if it represents an abusive

exercise of a dominant position.

21 See NOLL (1995) for the main benefits of integration, such as: (i) transaction costs reduction; (ii)

the Brazilian case, the design of the emerging market structures contains some

degree of vertical integration, especially between local and long distance wired

telephone services, and also between wired and wireless (cellular) services, but

with explicit concerns to possible anticompetitive conducts. In fact, the LGT

confers Anatel powers in this field, very similar to CADE’s ones.

• Horizontal Concentration

As noted by SHEPHERD (1997) in his analysis of the structural perspectives

for introducing competition in telecommunications services markets, deregulation

should be managed carefully, because dominant positions can be easily built in

markets where regulatory mechanisms are untimely removed and/or where

mergers and acquisitions allowed without further analysis. Competitive pressures

on dominant firms could thus be reduced, giving them freedom to implement

anticompetitive strategies.

The detection, and eventually the repression, of such strategies are not easy

tasks, as shown by the ambiguous effects emerging from technical progress. In fact,

technological change was pointed before, as it is usually, as the main cause for the

transition from natural monopolies towards more competitive markets structures,

since it creates opportunities for profitable entries and change the degree of

product substitutability. However, even if the general direction of technical

progress is pro- competitive, the practical implementation of new technological

solutions will be essential to the degree of competitive threat effectively added by

newcomers, in face of the incentives incumbents have to adopt strategies allowing

them a greater control over the evolution of these technologies.

As a result, one can hold that if incumbents are active in pursuing the

reinforcement of their market power in the context of fast technological change,

the capacity of deregulation and competition policies to sustain or increase

competitive pressures will depend on the degree of tolerance of the regulatory and

antitrust authorities facing mergers and acquisitions of the kind mentioned above.

It goes without saying that the analytical issues involved in assessing the potential

protection of proprietary information; and (iii) improve investment safety in specific assets. But the

author recognizes that the relevance of these points for telecommunication services far from clear

(p. 514).

anticompetitive effects of concentration increasing ventures could benefit from the

antitrust expertise and case experience on the subject.

In the Brazilian case, the presence of an institutional concern in preventing

eventual trends toward horizontal or vertical market concentration, through

mergers and acquisitions, is expressed in the prohibition, in the LGT, for the same

group of investors to get franchises in different regions during the privatization

phase, as well as in further restrictions to mergers.

• Franchise Bidding

As to services franchising, there are basically three relevant issues from the

competition policy viewpoint 22. Firstly, there is the risk of coercive use of the

bidding process against the bidders, i.e. the possibility that an operator with

dominant position in one market employs its market power to reduce competition

in the bidding process or even to force the winner to give up its franchise under the

threat of retaliation. For example, an carrier having market power in a local wired

network could try to force the winner of a cellular service bidding process in some

other region to sell its franchise in the case of the latter being dependent on the

former for the provision of network services in the first region.

Secondly, dominant firms can cause trouble to a bidding process by abusing

of legal suits to government agencies or to the courts, with a view to deter

newcomers entry (“Sham litigation ”). In these cases, a major entry barrier is

related both to the time length needed for the administrative and legal conflicts to

be solved and to litigation costs23.

The third question is related to a possible conflict between the objectives of

the regulation authorities and those of the antitrust law and agencies. Although, in

general, regulatory agencies take into account possible antitrust effects of their

actions - in the Brazilian case, particularly in telecommunications, they are

mandatory through law itself -, some situations may arise in which public interest,

as interpreted by regulatory policies, conflict with antitrust rules, raising severe

22 BAKER & BAKER (1983).

23 This procedure, for example, has been used in different situations by ATT in U.S. in terminal

equipment markets. The strategy was to provoke litigation on the basis of network damages

allegedly caused by competitors equipment using different technical standards.

bureaucratic and legal mismatching between regulatory and antitrust agencies.

V. CONCLUSIONS

This paper indicates that an important policy challenge is how to manage

the transition from active regulation in natural monopolies to the “reactive”

regulation required by oligopolistic market structures. Since this transition is

gradual, it will often require a step- by-step approach by the public agencies, whose

actions and procedures, given the market and technological dynamism of

telecommunications sector, are always partially uncertain.

Among the features of Brazilian telecommunications sector transition

discussed above, three points can be emphasized:

(i) The policy main goal should be the introduction of competition (as free

entry and exit as possible) in the markets. If structural factors turn it

unrealistic in some market segments, a second best goal can be to

continuously improve its allocative, productive and selective efficiencies;

(ii) Incumbent firms in most markets can – and possibly will – use their market

power to increase prices, forestall entry or predate against competitors. It is

therefore necessary to monitor their strategies and to prevent and punish

anticompetitive behavior;

(iii) Market structures are still emerging in markets created by privatization and

restructuring, and their evolution should be oriented, whenever possible,

toward more competitive configurations.

Both tasks – to check anticompetitive practices and to direct the evolution of

market structures – require a large amount of capabilities and flexibility from

regulatory agencies. This means that a satisfactory regulatory policy cannot be a

once- and- for-all state decision of setting up an institutional structure with

predefined rules of the game before it really begins. In order to develop the

required capabilities, the agencies will have to learn and to respond creatively to

the events of the transition phase.

During this learning process it seems sensible to look for a broad variety of

sources of information and experiences. Not only the experience of other countries

in privatization and deregulation should be studied, but also the tradition of

competition policies enforcing a kind of “reactive” regulation (antitrust) on

oligopolies provides very useful insights. Despite telecommunications services

sector’s many specific features, an interaction between its regulatory agency

(Anatel) and the Brazilian antitrust authorities (CADE) can be very positive, since it

will make it possible to coordinate both institutions and to use CADE´s legal

authority and expertise to get a prompt prevention and repression of

anticompetitive practices.

The institutional learning of public agencies will be essential for the success

of privatization and deregulation process in Brazil, particularly in

telecommunications. In the transition from state- owned monopolistic companies

to private- owned oligopolistic ones, the opportunities to influence market

structures and firm behaviors provide a very efficient way to assure a good social

performance of telecommunication markets, but at the same time the risks and

costs of missing the target are very high.

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