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| H.S. Shirideh P.O. Box 15388 AMMAN - 11134 JORDAN |
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| Price Cap: | Methods of Price Regulation. |
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| Introduction: |
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| Why is price regulation needed: |
There are many economic and ideological arguments in favour of removing activities such as the provision of telecommunications services away from the direct control of the state to commercial and/or private sector organization. However, it has to be recognized that in some parts of the telecommunications industry, such as the provision of basic PSTN services to rural areas, there is little prospect for competition. In such circumstances specific controls are required to mimic the effects of competition and ensure that prices are minimized through the dual objectives of : a) Removal of abnormal profits. b) Maximizing efficiency improvements. Internationally two different forms of price regulation have been used, each focusing mainly on one of these two objectives: Rate of Return methods focus on limiting abnormal profits, while Price Cap regime aim to maximize incentives for efficiency gains. Despite their names, both methods aim to provide the regulated business with an adequate rate of return. Where the differ is their responsiveness to ex-post changes in cost and the resulting risk/reward profile faced by the business. There have been many attempts at combining the best elements of the two approaches. As a result the distinction between the two approaches have been increasingly eroded. As an aside, it is important to note that a price control mechanism is only effective when coupled with obligations on quality of service; otherwise profits can be increased purely through reduction in quality. |
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| Details of price cap regulation: |
A price cap control limits the year on year increase in prices to inflation plus or minus a predetermined X factor, applicable for a period of several years ( the capping period ). The X factor is initial set with the view of allowing the business to finance its activities, taking into account initial price level and expectations about cost of capital, operating and capital expenditure, cash flow requirements, and possible efficiency improvements over the capping period. With this general structure many variations are possible relating to area such as: a) Tariff Rebalancing. The ability of the operators to rebalance tariffs (ie. Bring them more in line with costs) is dependent on the manner in which the price cap is applied. The X factor may apply uniformly to all categories of customers and services. This removes the possibility of any rebalancing of tariffs for economic or social reasons. Different X factors are set for different customers or services categories. However this requires a prior decision on the requirement for rebalancing. The X factor is applied to an average price, or basket of prices. This is an even more flexible approach which could be modified further through the introduction of subcaps. b) Tariff Profiling The X factor(s) may be fixed at the same level for the entire capping period, or may be profiled. The choice depends on the starting level of prices, the public relations benefits of a regime of falling price rises, and the company's return and cash requirements. c) Inflation Indexation The objective of including an inflation factor in the price cap is to protect the company against general movements in prices and costs over which it has no control. This suggest that the inflation index used should be one that mimic the company's underlying costs as closely as possible. An example might be a composite index that is a weighted average of indices for salaries, power, construction prices and other costs. On the other hand a more well-known index such as the consumer price index (CPI) may be used because of it is familiar to customers, it cannot be influenced by operators, it is unlikely to be revised retrospectively and it is professionally complied. Another issue is whether prices in each year should be set on the basis of an estimate of the rate of inflation for the year, or on the basis of historical inflation rates. The former is in theory better at matching the company's costs and revenues. However, given forecasting difficulties, large errors can do occur, requiring a correction factor to be built into the price cap formula. This can produce large corrective swings in prices and can in some occasions be open to abuse.
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