High sunk costs and economies of scale are reasons for some of the mega deals and consolidation in the telecom industry. By acquiring Spice recently, Idea has been able to enter into the lucrative Karnataka and Punjab circles, thus synergizing its pan-India operations. Recollect that Idea acquired Escotel in a similar vein in 2004. The same holds true for Verizon, AT&T Wireless and Sprint-Nextel in the US, which were born out of mergers and acquisitions (M&As).
Illustration: Malay Karmakar / Mint
It is thanks to the liberal telecom policy that the mobile market in India is one of the most competitive in the world with six-seven operators providing service in each licensed service area. With the recent issuance of numerous unified access service licences, it is expected that the market will witness more fragmentation. While competition has brought down prices of mobile services (one of the lowest in the world), it is time for the industry to reap the benefits of economies of scale and further bring down the cost of servicing subscribers. Hence the need for friendlier M&A guidelines.
Our estimation of the production technology of mobile services based on seven years of data on mobile subscribers and their minutes of usage clearly indicates the existence of economies of scale and scope in the mobile industry. This implies that per unit costs decline with an increase in subscribers (up to a certain point) and, given our market size, there are a limited number of operators who can service the market while operating at an efficient scale of production. For the consumer, the existing and expected fragmentation in the market may imply higher prices on account of inefficient scales of production, or else poor quality.
An ideal market structure will be a limited number of operators who operate at efficient scales and whose competition with each other restricts the markups over unit cost. Our research indicates that even with a vastly expanded market in 2010 (of about 500 million subscribers), efficient production requires an average of five operators, with only two-three operators in some circles. This reality will naturally be reflected in an increase in M&A appetite, which should be allowed without unduly restrictions by policymakers. However, a closer look at the intra-service merger guidelines announced by the department of telecommunications in April reveals an overly cautious M&A environment.
First, the minimum number of access providers required in each licence area is set at four. This will prevent M&As from happening in several circles where efficient scales are achieved with two-three operators. To have a minimum level of competition as well as industry efficiency, Jagdish Seth’s classic “rule of three” should be applied, and the floor on the number of operators set at three. Alternatively, different floors could apply to different categories of circles with a minimum of three.
Second, the maximum market share of the merged entity has been set at 40%. Notice that if we accept the upper bound on the market share, the minimum number of firms in the market will be three. Therefore, we do not need to specify any lower bound on the number of operators. However, in some circles, the efficient scales may be achieved at 50% of the market share and, therefore, we recommend increasing the upper bound on market share to 50% and retaining the rule on the minimum number of operators.
Third, the maximum cross-holding of 10% (reduced from 20% as recommended by the Telecom Regulatory Authority of India) is justified only in the case where the combined market share of the cross-held entities is greater than the stipulated upper bound on market share. In the case when the combined market share of the cross-held entities is less than the stipulated cap, the law is unnecessarily restrictive.
A holding of 10%, or less in most cases, is in the nature of a financial investment, and therefore, need not be regulated unless the market share cap is violated by the merged entity. In many countries, the cap on the market share is the primary instrument used to control market power and, where possible, we need to adopt the same approach. EU regulation even says that higher market share does not necessarily lead to higher market power and sustainable price increases.
M&As represent the new frontier of telecom policy. A plethora of restrictions are unnecessary. Fewer restrictions, wisely chosen, would be sufficient for the industry to grow. The government should adopt “sparse regulation” that uses the minimum number of instruments to achieve its objective in a manner similar to the EU’s competition regulation that relies on significant market power assessment, only when needed.
A reasoned approach that recognizes the techno-economics of the market structure will give the necessary fillip towards industry efficiencies and their associated benefits.
Rohit Prasad is professor at Management Development Institute (MDI), Gurgaon, and V. Sridhar, visiting research fellow at Sasken Communication Technologies, is on lien from MDI. These are their personal views. Comments are welcome at firstname.lastname@example.org