Introducing Competition and its Welfare Implications in Korean Mobile Telecommunications Services

1. 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

2. Content • Introduction • Korean MTS and Social Welfare • Estimating Consumer Surplus • Estimating Producer Surplus • Total Social Welfare • Conclusions Donghee Lee

3. 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 Donghee Lee

4. Korean MTS and Social Welfare • Korean MTS market situation Monopoly SKT Duopoly SKT, STI Competition SKT, STI KTF, KTM, LGT 1984.4 1996.4 1997.10 2001.12 Donghee Lee

5. Consumerbenefits↑ Quality↑ subscribers↑ Competition Operatorprofits↑ Price↓ calls ↑ Source: KISDI (2001) 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? Donghee Lee

6. Price A D Supply Consumer surplus Equilibrium price E Producer surplus Demand B C 0 Quantity Equilibrium quantity 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 Donghee Lee

7. Korean MTS and Social Welfare • Empirical evidence in some countries Donghee Lee

8. : consumer surplus 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: : subscription price or call price at time t : the number of new subscribers or the volume of calls at time t : elasticity of demand Donghee Lee

9. 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 Donghee Lee

10. 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 Donghee Lee

11. Estimating Consumer Surplus • Estimated elasticity of demand and consumer surplus (Unit: USD Mil) Donghee Lee

12. Estimating Consumer Surplus < Yearly Trend of Consumer Surplus > < The Ratio of Consumer Surplus to GDP > Donghee Lee

13. 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) Donghee Lee

14. 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) Donghee Lee

15. Estimating Producer Surplus • Cost of capital estimated in other countries Donghee Lee

16. 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. (Unit: USD Mil) Donghee Lee

17. Total Social Welfare • Structural change of social welfare Donghee Lee

18. 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 Donghee Lee

19. 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 ! Donghee Lee