32526 W O R L D B A N K W O R K I N G P A P E R N O . 4 2 Competition in International Voice Communications Carlo Maria Rossotto Björn Wellenius Anat Lewin Carlos R. Gomez THE WORLD BANK W O R L D B A N K W O R K I N G P A P E R N O . 4 2 Competition in International Voice Communication Carlo Maria Rossotto Björn Wellenius Anat Lewin Carlos R. Gomez THE WORLD BANK Washington, D.C. Copyright © 2004 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First Printing: October 2004 printed on recycled paper 1 2 3 4 5 06 05 04 World Bank Working Papers are published to communicate the results of the Bank's work to the development community with the least possible delay. The manuscript of this paper therefore has not been prepared in accordance with the procedures appropriate to formally- edited texts. 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Rossotto, Carlo Maria, 1970. II. World Bank. III. Series. HE8635.C66 2004 384.6'4­dc22 2004053427 Contents Foreword v Acknowledgments vii Acronyms and Abbreviations ix Executive Summary xi 1. International Voice Communications: The Industry Moves towards Full Competition 1 Market Trends 1 The Dynamics and Benefits of Full Competition 4 Regional Differences in Implementing Reform 8 2. The Driving Forces Behind Competition 15 Globalization of Economic Activity 15 Technological Change 17 International Trade System 18 3. Understanding the Resistance to Competition 21 Sector-specific Factors 21 Systemic Factors 25 4. Conclusions and Requirements for Success 31 Bibliography 39 LIST OF BOXES 1. BT and Telekom Malaysia: The Effect of Competition on Financial Results 23 2. Telekom Malaysia: Adapting to a Competitive Environment 24 LIST OF FIGURES 1. Growth of International Service Revenues 2 2. Forecasted Decline of International Telecommunications Revenues 3 3. Partial Competition Offers Partial Results in Price Drop 7 4. Introduction of Competition in Major Markets Coincides with Rapid Growth 8 5. Latin America is Leader in Competition Among Developing Regions, Africa and the Middle East Lag Behind 9 iii iv Contents 6. Competition Means Substantially Lower Prices 11 7. Chile: Incoming and Outgoing Traffic Booms with the Introduction of Competition 11 8. Driving Forces and Sector Change 16 9. Higher Transmission Capacity at Lower Cost 17 10. Growth of International Traffic Through IP 18 11. Reasons for Resistance to Competition 22 12 Countries with Limited Economic Freedom Face More Obstacles to the Introduction of Competition 28 13. Controlling Corruption and Reforming International Long-distance 29 LIST OF TABLES 1. International Communications Draws Closer to a Perfectly Competitive Market 5 2. Degree of Concentration in the International Communications Market 7 3. Main Regulatory Features of Full Competition, Partial Competition, Monopoly 13 4. Pro-reform Actors Need a Stronger Political Voice 26 5. Imbalanced Telephone Tariffs Before Competition 36 6. Net Cost of Universal Telephone Service in Selected Countries 37 Foreword C ompetition in international voice communications is a global phenomenon. Vir- tually all high-income countries and selected developing countries have adopted a model based on low barriers to entry, multiple technological options, and competition. As a result, prices dropped dramatically and volumes increased, to the full benefit of the consumer. Moreover, low cost international communications proved to be a key en- abler of economic competitiveness. International communications has been regarded increasingly as a key determinant of industrial location, job creation, trade facilitation, and trade integration. Some developing countries, for example, Chile and El Salvador have introduced and sustained full competition in international communications,which has resulted in notable successes. Despite these encouraging examples, about 74 percent of developing countries have retained barriers to entry in the international communications business, and about 85 countries still maintain monopolies. If the benefits of competition are so evident, and there is great success from selected developing countries, then what are the reasons for resisting competition? This paper, pre- pared by a team from the Policy Division of the Global Information and Communications Technologies Department of the World Bank, explores possible reasons. It draws on the team's experience in covering an active policy dialogue on telecommunications reform in some 60 countries. The paper investigates the emergence of full competition in international communi- cations as a global phenomenon; assesses arguments and reasons commonly brought by governments to resist the introduction of competition; and illustrates some regulatory requirements to implement full competition. While part of the world makes international calls at a price of a few cents a minute, other very poor countries pay exorbitant prices for international calls. The paper looks at some of the reasons for this divide; and the findings are interesting and relevant to eco- nomic development. Pierre Guislain Manager Policy Division Global Information and Communication Technologies Department v Acknowledgments T his report was written by a team composed of: Carlo Maria Rossotto (Regulatory Economist, Task Team Leader), Bjorn Wellenius (consultant), Anat Lewin (Knowl- edge Sharing Analyst) and Carlos R. Gomez (Junior Professional Associate), from the Policy Division of the Global Information and Communications Technology Depart- ment of the World Bank. The editorial assistance of Andrea M. Ruiz-Esparza is much appreciated. The team expresses gratitude for the input provided by the reviewers: Agostino Appendino, Mark Jamison, Charles Kenny, Gareth Locksley, Massimo Mastruzzi, Christine Zhen-Wei Qiang, and Roberto Saracco. The team thanks an additional reviewer, who has asked to remain anonymous, and who has provided outstanding contributions to the paper. The responsibility for mistakes and omissions remains solely with the authors. vii Acronyms and Abbreviations $ United States dollar unless otherwise noted BT British Telecom ECA Eastern and Central Europe EU European Union FCC (United States) Federal Communications Commission FDI Foreign direct investment GATS General Agreement on Trade in Services GBP Great Britain Pounds Sterling GDP Gross domestic product HHI Herfindahl-Hirschman index IP Internet protocol ITU International Telecommunications Union LAC Latin America and Caribbean MYR Malaysian Ringgits MNA Middle East and North Africa OECD Organization of Economic Cooperation and Development PAT Profit after tax PSTN Public switched telephone network VoIP Voice over Internet protocol WTO World Trade Organization YC Year that competition was completed ix CHAPTER 1 International Voice Communications The Industry Moves Towards Full Competition Market Trends Over the last 20 years, the international voice communications market experienced substantial changes. International call volumes increased and prices dropped dramatically. International call revenues declined both relative to revenues from other communications services, and in absolute terms. This transformation in the industry was due to the adoption of new technologies1 in a competitive environment. Technology change and regulatory reform led to a new market structure based on lower entry barriers and competition, affected the business model of firms in the telecommunications industry, and created pres- sures to modify the settlements system--a century-old set of bilateral agreements that ruled international communications. International call volume increased from less than 20 billion minutes in 1984 to over 144 billion minutes in 2001, a 13 percent annual growth rate.2 International outgoing traf- fic per subscriber also increased from less than 60 minutes in 1990, to about 120 minutes in 2001, a 6 percent annual growth rate--a higher pace than the global economy's annual growth rate during the same period (2.7 percent). The price of international retail calls fell. TeleGeography estimates that the average retail price per minute of an international call dropped from $1.57 in 1983, to $0.42 in 2001. The impact of price in competitive routes, such as New York/London, was even more dramatic, dropping from $0.30 in 1997 to $0.04 in 2003. Another competitive route is 1. Key technological improvements occurred in the international voice communications market since 1980. Progress in fiber optic technology and the emergence of Internet protocol (IP) personal computer- based distributed telephone technology lowered entry barriers. 2. TeleGeography. 1 2 World Bank Working Paper Figure 1. Growth of International Service Revenues: International Service Revenues Increase by 10.9 percent from 1983­1992, and 2.8 percent from 1992­2001 80 70 Revenue 60 50 40 Service billion) ($ 30 20 10 Global International 0 Revenues 1983 1986 1989 1992 1995 1998 2000 2001 Source: TeleGeography Global Traffic Statistics and Commentary 2003, ITU, pp. 12, 33. Missing years are estimated. Santiago/Miami, which in 1997, was priced at $1.60 per minute,3 while in 2003 the price was closer to $0.15 per minute.4 International wholesale prices have fallen even more sharply. For example, the wholesale price of a call from the United States to Chile or to the United Kingdom is around $0.015 per minute. Industry revenues experienced modest growth, and recently, a decline. Competition has stimulated volume and reduced prices. But the price reduction had a substantial impact on revenues, causing stagnation and decline. During 1992 to 2001, revenues from international communications grew at a rate of 2.8 percent annually, close to global gross domestic prod- uct (GDP) growth. The global international communications industry generated $70 billion in 2000, its peak year, decreasing to just over $60 billion in 2001 (decreasing by 14 percent; see Figure 1). This decline can probably be attributed to the worsening global economic con- ditions in 2001 and 2002. Good economic conditions may have contributed to the superior growth experienced in the 1990s. The radical transformation in the international telecommunications market has effected the overall telecommunications industry revenue mix. Revenue growth from international communications has been lower than the growth in two other market segments: mobile and datacommunications.5Therelativedeclineofinternationalrevenuesisexpectedtocontinue. Other sources (IDC 2002, IntelSat) have forecasted that international revenues will decrease in the near future by 1.6 percent per year. In contrast, IP/Packet data has been forecasted to grow by 21.1 percent per year, and mobile voice revenues by 9.3 percent per year. As a con- sequence, long distance and international voice services, accounting for 18 percent in 2001 of overall sector revenues, are expected to decline to 12 percent in 2005. 3. Published ENTEL retail tariff. Source: SUBTEL 4. The price $0.15 is probably the lowest available in the Chilean market. The incumbent price is $0.97. 5. Siemens research presents global revenue growth by market segment. Growth rates show that inter- national communications grew by only 12 percent in 1996­2000. In the same period, mobile communi- cations revenues boomed by 127 percent. Over the same five years, data communications revenues doubled. Competition in International Voice Communication 3 Figure 2. Forecasted Decline of International Telecommunications Revenues CAGR Telecom Revenues, 2001-2005 2001 1,456 8.1% LD/Intl Voice 1,354 31.6% 96 Wireless 18% 1,256 77 31% 1,158 56 1,068 42 425 9.3% 32% Mobile Data 398 32 19% 376 Voice Access 338 Data Mobile Voice 298 251 21.1% .1 211 174 143 IP/Packet Data 117 5.8% 100 106 2005 90 95 Private Line Data 84 LD/Intl Voice Wireless 343 354 367 382 397 12% Local voice 3.7% 36% 27% Voice Access Intl/LD Voice 194 191 188 186 181 -1.6% 25% 2001 2002 2003 2004 2005 Data Source: IDC 2002, Intelsat The decline of international revenues had an impact on the business model of market players. Incumbent operators were affected by these changes. For example, in Hong Kong the incumbent operator witnessed a decline in international service revenues over total cor- porate revenues from 53 percent to 21 percent in five years. Similarly, SingTel's international wholesale revenues went from 40 percent of total revenues in 1997, to 15 percent of total revenues in 2001. Telmex international revenues (originating revenues only) over total rev- enues dropped from 19 percent to 8 percent in the same period (TeleGeography 2003). Other changes in the business model and practices involved the need for frequent (monthly or fewer) updates of international call prices, and the need to enhance the billing system. As a consequence of the relative decline in international revenues, some incumbents have diversified their business activities, entering into new lines of business. For example, a large number of incumbent operators have focused on the development of mobile oper- ations and data (such as, Telecom Italia Mobile and Telekom Malaysia). Other operators have changed their business model, and have expanded their operations abroad (such as BT). A common change in the business model consisted of changes to the tariff structure (tariff rebalancing). Incumbent operators implemented tariff rebalancing to reduce their dependence on revenues from international communications. In some cases, rebalancing was the choice of the operator. In other cases, rebalancing was mandated by regulation, to prepare the incumbent operator for competition. There has been a positive impact of rates rebalancing on network development. In Latin America (and elsewhere) rebalancing gen- erated new revenues which allowed for an expansion of the local network, as shown by Ros and Banerjee (2000), Gutierrez and Berg (2000), and Wallsten (1999). Changes in international communications affected the business model of nonincum- bent operators as well. New mobile operators (for example, MediTelecom in Morocco, and Tunisiana in Tunisia) profited from the introduction of competition in the international communications market by developing their own competitive gateways. Competition in the mobile sector is important to the development of competition in international communica- tions. It is a powerful force, in addition to being in many cases the only legal competition. In 4 World Bank Working Paper many developing countries the number of mobile subscribers is surpassing that of fixed-line subscribers (Wellenius and Rossotto 1999). This rapid transformation of the industry created pressures to modify the "settlement system," the set of bilateral agreements, established initially in the late nineteenth century to administer payments between national monopoly providers of international telegraph and telephone services (Kelly 1997). An increasingly high quota of the global traffic moved away from these bilateral administrative agreements, and was settled using market-based systems. In particular, the factors that contributed to the changes of the settlements system were: (a) the growth of alternative ways to bypass the system, such as callback, refile and voice over Internet protocol (VoIP) termination;6 (b) the growth in the number of fully competi- tive markets, with several players negotiating termination charges; and (c) the pressures from regulatory agencies such as the United States Federal Communications Commission (FCC) and international organizations such as the International Telecommunications Union (Kelly 1997). In addition to these forces, global corporate data networks were increasingly used to carry voice transmissions, and contributed to attracting traffic away from incumbent oper- ators. The incumbents also contributed to undermining the settlement system, as they received termination income from new global competitive carriers with whom they had agreements outside of the system.7 Two changes were brought about as a result of these pres- sures: accounting rates became more cost-oriented, and a higher percentage of traffic was carried outside the settlement system. The Dynamics and Benefits of Full Competition When regulatory barriers to entry are removed, the market structure for international voice communications shows most of the features of a competitive market: multiple suppliers, low barriers to entry, and stiff price competition. This market segment contrasts with other parts of the telecommunications industry, such as mobile or fixed local loop access, in which the market structure resulting from competition tends to be, respectively, an oligopoly, or a market characterized by a dominant firm with fringe competition (Rossotto, Kerf, and Rohlfs 1999). This difference is due to the lower initial capital requirement to be a com- petitor in the international communications market. Table 1 presents the market share of selected countries' incumbent operators three, five, and ten years after competition is introduced. The year in which competition is intro- duced is shown as YC, while YC+3, YC+5 and YC+10 refer, respectively, to three, five and ten years after competition is introduced. Table 1 also shows an index of market concen- tration, the Herfindahl-Hirschman index (HHI), three and five years after competition is 6. Artificially high termination rates created and strengthened the gray market through incentives for entrepreneurs to make quick and substantial gains. Most of the gray marketers were local companies, offi- cials of ministries in developing countries, or employees within the incumbent's own structure. 7. Incumbents also rerouted calls using new competitive carriers to remove excess traffic for which they would otherwise have to pay high rates to their settlement partner. In other cases, incumbents with insufficient traffic to fulfill their side of the settlement agreement received traffic destined for the settle- ment partner's hub that originated in a different part of the world. Competition in International Voice Communication 5 of 5 2002 34 32 16 21 11 120 500 minutes) Number suppliers in 5+ YC outgoing at of 2394.1 5604 3920 4177 4836.7 6238 4984 4039 4524 HHI 3+ YC percentage at a 3008.2 6176 5019 6112 4974.8 5295 6226 5291 5262 as HHI shares (%) share Incumbent 10+CYt 32.5 n.a. n.a. n.a. n.a. 49.9 43.4 33.3 39.77 (market market of Market 5a+ 9 4 8 YC 10 21 12 60 215 at Number competitors Competitive (%) share 5+CYt 37.3 72.2 54.7 61.1 66.6 79 66 54.9 61.4 Perfectly Incumbent market a data. to of 3a+ 7 3 8 5 9 2003 YC 16 13 Closer 100 at Number competitors Draws (%) TeleGeography share 3+ on YC 40 77 66 77 68 69 76 67.7 67.6 Incumbent at market based Communications Malaysia) calculations, (CODETEL) (BT) Chile) Bank Rep. (PLDT) International (Sonera) (Telekom 1. (Telmex) (Telia) Kingdom (ENTEL World Table Country (incumbent) Chile Dominican Finland Malaysia Mexico Philippines Sweden United Average Source: 6 World Bank Working Paper introduced, and the number of suppliers in 2002. HHI is the sum of the squared market shares of different competitors. An HHI of 10,000 indicates a perfect monopoly; HHI val- ues between 2,000 and 5,000 are an indication of an oligopoly. Values close to or lower than 2,000 indicate features closer to a competitive market. The data indicate that when full competition is introduced in international com- munications, the resulting market structure resembles a tight oligopoly with increased competition. When full liberalization occurs, the incumbent operator may retain a dominant position for a few years, but the erosion of its dominant position is inevitable. In all four cases (Chile, the Philippines, Sweden, and the United Kingdom) for which data are available, the mar- ket share of the incumbent decreases to less than 50 percent, 10 years after full competi- tion is introduced. Other more recent liberalization experiences (for example, Germany and Israel), for which 10 years of data are not yet available, suggest that the erosion of mar- ket shares of the incumbent might happen in a shorter period of time. The market share of Deutsche Telekom in the German international market went from 100 percent in 1998, to 48.7 percent in 2001. Bezeq's market share in the Israeli international communications market fell from 100 percent in 1996, to 41.1 percent in 2001 (TeleGeography 2003). Competition in the international communications market is sustainable over time. In seven out of the eight cases there was a drop in HHI from YC+3 to YC+5, indicating a decrease of market concentration.8 New entrants established at the time of liberalization were able to retain and increase market shares. New entrants, possibly exploiting techno- logical advancements, entered the market and contributed to its fragmentation. In mar- kets for which data are available there is evidence that the drop in industry concentration continues after YC+5. For example, in the United Kingdom, the HHI for 2003 (YC+10) is 2026, a drop of over 2,000 points with respect to YC+5. Where full competition is introduced, a high number of firms will operate in the market seg- ment. The Dominican Republic's small market sustains five competitors; Chile's sustains 34; and the United Kingdom's sustains 500. In addition to the data presented in Table 1, it is interesting to note that the trend has continued, even during the sector's financial crisis in 2000 to 2001. The number of suppliers in the United Kingdom's market grew from 306 in July 2000, to 500 in July 2002. In the same period, the number of suppliers in Malaysia grew from five to 12, and in Argentina from four to 66 (TeleGeography 2003). The market structure of a liberalized international communications market is closer to a competitive services industry, or goods industry, than it is to a network utility. Looking at measures of concentration alone, the international communications market has values closer to a large, competitive distribution market--like the chocolate market--than to the local fixed-line access market (Table 2). Developing countries can opt for partial or full competition in international voice communications. Compared with gradual liberalization, full competition results in lower prices and higher welfare gains. Figure 3 shows that international call charges in fully com- petitive markets can be as low as one-third of the prices in partially competitive markets, resulting in substantial benefit to consumers. 8. The exception is the Philippines where carriers conduct extensive price fixing among themselves so as to prevent new operators from entry and to retain higher price levels. Competition in International Voice Communication 7 In Chile, following full opening Table 2. Degree of Concentration in the of international services to competi- International Communications Market tion in 1994, the weighted average call charges to major destinations by Market Segment HHI (2003) 1998 had declined by 50 percent, United Kingdom compared with a similar basket in international voice 2,026 1991, under limited competition. United Kingdom cellular 2,600 Traffic also increased fourfold to 215 United Kingdom fixed-line Over 7,000 million minutes. This resulted in an domestic voice estimated consumer surplus of about Chile international voice 2,386 125,000 million pesos ($275 million) Sweden international voice 2,523 from 1994 to 1998. This is approxi- United States international 2,218 mately 2.7 percent of total revenues United States chocolate (2000) 2,149 from the major operators during the Mexico international voice 4,886 same period. Mexico chocolate9 1,875­2,220 In addition, full competition Sources: TeleGeography; Mexico FCC; Business Rankings requires less regulatory intervention Annual 2003. thanpartialcompetition,reducingthe administrative burden and cost for the government and operators. In the partial competition model, administration is based on regulatory barriers to entry. Examples of these barriers to entry are the presence of numeric restrictionsontheoperatorsinthemarketandtheasymmetrictreatmentbetweentheincum- bentoperatorandcompetitors.Forexample,inapartiallycompetitiveenvironment,thegov- ernment needs to spend time and resources to decide when to allow new entrants into the market, and when to allow carrier preselection. Operators need to lobby the government to Figure 3. Partial Competition Offers Partial Results in Price Drop Average price of 3 minute call to US by market structure (in $), 2001 $6 $5.15 $5 $4 $3 $2.33 $1.78 $2 $1 $0 Partially competitive Fully competitive Fully competitive markets markets (developing markets (all available countries) countries) Source: ITU 9. Mexico Federal Competition Commission, Annual Report 1994­1995. Http://www.natlaw.com/ pubs/spmxat3a.htm. The Mexico FCC assessed the impact of certain mergers in the Mexico chocolate mar- ket, concluding that the HI value emerging from those mergers--2220--would not hinder competition. 8 World Bank Working Paper maintain or remove regulatory entry barriers. In contrast, in a fully competitive environment all operators meeting standard, objective criteria are free to compete. The fully competitive model not only reduces costs considerably, but also decreases opportunities for corruption, especially in environments with weak governance. Regional Differences in the Implementation of Reform Manymajornationalmarkets,accountingforabout75percentofglobaltraffic,arenowopen to competition (ITU 2002). However, most developing countries did not follow this trend, and retained entry restrictions. This "policy divide" has implications on sector performance. Measured by volume, competition has become a global phenomenon. In 1998, 74 per- cent of global outgoing traffic originated from markets open to competition, compared to 35 percent in 1990 (ITU 2002). After the liberalization of international communications was introduced from the 1980s to the mid-1990s in Australia, the European Union (EU), Japan, theUnitedKingdom,andintheUnitedStatesallmajorinternationalcommunicationsroutes were open to competition. In addition, competition has been established in several emerg- ing markets, including Argentina, Bolivia, Brazil, Chile, Dominican Republic, El Salvador, Guatemala, India, Mexico, Malaysia, and the Philippines. However, the 25 percent of global outgoing traffic that is not open to competition originates almost exclusively from developing countries. The introduction of competition in major markets coincided with rapid growth of vol- umes. In 1990 to 1998, the size of the market open to competition doubled, and the volume of the outgoing traffic grew by 450 percent (ITU 2002). Figure 4 shows rapid traffic growth originating in countries that are open to competition. Globally 88 countries have a monopoly, 33 have introduced "partial competition," and 65 have full competition in international voice communications. The Organization of Eco- nomic Cooperation and Development's (OECD) high-income countries have full compe- Figure 4. Introduction of Competition in Major Markets Coincides with Rapid Growth Introduction of Competition in Major Markets Coincides with Rapid Growth in Volume 160 140 ffic 120 Tra nutes)i 100 Global outgoing m traffic generated in of 80 noncompetitive markets Outgoing 60 (billions 40 Global outgoing Global traffic open to 20 competition 0 1990 1995 1998 2001 2005 (forecast) Source: ITU 2004 32874 Behind IBRD SEPTEMBER Lag East dle Mid the and LD Africa TIONAL Regions, elopingv INTERNA De IN 2002., Among LEVELS Database Competition y Competition tial Full Par Monopoly N/A Regulator Competition in unications COMPETITION elecommT Leader a orld is W , ITU to America updates Latin by Bank The and on the or of shown Bank on such 5. imply, territory, Unit of orld produced boundaries, not World e any The W was do The judgment of Design information Bank. denominations of map nya endorsement map Map other this part status any Figur This the World colors, any on the Group, legal or acceptance boundaries. Source: 10 World Bank Working Paper tition. Non-OECD high-income countries (such as Andorra and Malta), and high-income countries in the Middle East (such as Bahrain and Kuwait), retain a monopoly. As of 2003, about 26 percent of developing countries (37 out of 156) have adopted full competition. Most of the countries that now offer competition were monopolies five to 10 years ago. Figure 5 shows that 37 of the 156 developing countries (as classified by the World Bank) have adopted full competition. And 33 developing countries are classified as having "partial competition" in international communications. These countries have intro- duced some degree of competition, but have also retained certain restrictions.10 Outside the OECD region, where full competition is the norm, the majority of coun- tries in the Latin America and Caribbean (LAC) region introduced full competition (among them, Argentina, Bolivia, Chile, Colombia, El Salvador, Guatemala, Peru, and Venezuela). A few countries in the Europe and Central Asia (ECA) region have introduced competition (among them, Estonia, Hungary, and Ukraine). A majority of African countries retain a monopoly. The Asia-Pacific region presents a mixed picture, with fully competitive coun- tries such as Malaysia, and the Philippines; countries with partial competition such as Cam- bodia, and China; and countries with a monopoly such as Myanmar, Vietnam, and Pacific Island states. The Middle East and North Africa (MNA) region's predominant market struc- ture is the monopoly, with partial competition emerging in North Africa. No country in MNA has adopted full competition. Three-quarters of developing countries still maintain restrictions on market access. What are the implications of this policy divide? Developing countries that restrict entry to the international communications market face: higher prices, lower outgoing volume, and reduced network investments. The prices for international communications are higher, with negative consequences for consumers and domestic enterprises. Figure 6 shows the price of a three-minute phone call to the United States from different regions. Africa has the highest price at over $5.00-- where only 17 percent of the countries have full competition. The two regions with the low- est international communications prices are LAC and ECA where 45 percent and 29 percent of the countries have, respectively, full competition. There are no comprehensive and comparable data for MNA, the only region where no country has adopted full competition. Four out of 16 countries have adopted partial com- petition, while the remaining countries maintain monopolies. As an indication, an average tariff calculated on a sample of 12 MNA countries indicates a price of $5.42 for a three- minute call to the United States.11 This price is higher than the average for Africa--the region with the next highest price, which also maintains a high number of monopolies.12 Call volumes will be lower. Consumers will make fewer calls, and they will try to bypass the system. The impact of competition on volume in selected fully competitive developing countries coincided with a rapid growth of incoming and outgoing traffic. Several examples, including Chile (Figure 7), support this evidence. 10. "Partial competition" occurs where there is a numeric restriction on the number of international carriers, or where competition is limited to resale, or is otherwise constrained. 11. World Bank, World Development Indicators, citing ITU data, 2003. Data are from 2000. 12. The price reduction experienced in fully competitive markets not only means significant increases in competitiveness for businesses, but also the possibility for disadvantaged groups in the society to call relatives living abroad. The international long-distance prices in developing countries with fully compet- itive markets, like El Salvador, match the price of a local call. Competition in International Voice Communication 11 Figure 6. Competition Means Substantially Lower Prices ECA and LAC Offer Lowest Prices, AFR the Highest 6 50% 45% 45% 5 40% ($) 38% 35% US 4 Cost of 3 min to 29%30% Call to US ($) Call (2000) 3 25% Min 3 20% % countries with of 2 17% 15% full competition 13% Cost 10% 1 5% 0 0% Sub-Saharan East Asia & South Asia Latin America Europe & Africa Pacific & Caribbean* Central Asia Source: World Development Indicators 2003, World Bank, citing International Telecommunications Union data. *LAC data are for 1999. MNA data were unavailable. There are no countries in the MNA region with full competition. Countries that retain a monopoly will attract less investment to the network and be excluded from the development of international backbone networks. The share of new investment from competitors over total investment in telecommunications is increasing. Countries that are opening their markets to competition are attracting more investment (Hausman, Leonard, and Sidak 2003). Introducing competition is a better way to integrate the country with the Figure 7. Chile: Incoming and Outgoing Traffic Booms with the Introduction of Competition Chile: Increase in international traffic Total minutes (in millions) 40 0 400 35 0 350 Incoming Incoming 30 00 300 25 0 250 20 0 200 Outgoing Outgoing 15 0 150 10 0 100 Multicarrier system 50 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002* * Estimate Source: Subtel 12 World Bank Working Paper development of regional high bandwidth networks. This has been the case in the EU, where a common liberalized framework allowed the development of pan-European networks. Thanks to a common, pro-competitive regulatory framework, high-bandwidth, pan- European networks have reached peripheral and lower income regions of Europe, such as in Estonia, Hungary, and Poland. Liberalization led to higher transparency and better governance. This is due to the fact that when other carriers or investors buy into an incum- bent at privatization, they demand increased accountability and transparency. The imple- mentation of a common regulatory framework, allowing for full competition for the accession countries in Eastern Europe, let operators of pan-European networks extend their presence in Estonia, Hungary, and Poland and to reach these countries with high bandwidth networks. Liberalization also contributed also to the growth of local operators.13 The push for competition has led policymakers in Europe, the United States, and in selected developing countries to establish principles and rules of an open and competitive market for international voice communications. The United States, as a precursor of sector regulatory reform, and one of the biggest markets for international communications, is one of the most influential proponents of sector reform. The EU has also played a key role by fully liberalizing its international voice communications market in 1998, and requiring new acces- sion countries to open their markets as a prerequisite to gaining membership. One notable case among developing countries is Chile--now considered one of the best examples of how full competition can be introduced effectively and reap the full benefits of reform. Following these early liberalization efforts, many countries have introduced competi- tion. But in the process to open the market, some countries have retained regulatory restric- tions to market entry. As a result, with respect to international communications, regulatory frameworks can be included in three categories: full competition, partial competition, and protection of the monopoly. Table 3 shows the main regulatory features of full competition, partial competition, and monopoly. 13. An important example of this development is the growth of the operator Tiscali, now one of the strongest Internet service providers and alternative network operator in Europe, which originated from a peripheral region of Europe (the island of Sardinia), and developed as a Pan-European operator, includ- ing network points of presence in the Czech Republic and Hungary. Another example is the operator Telia International Carrier, which has a 22,000 km network linking 25 cities in Western Europe, with PoPs in the Baltic countries, Czech Republic, Hungary, Poland, and Russia. GTS has a network of over 22,000 km covering all major Western European cities, with PoPs in the Czech Republic, Hungary, Poland, Roma- nia, Russia, and Ukraine (IDATE, 2001). Competition in International Voice Communication 13 Table 3. Main Regulatory Features of Full Competition, Partial Competition, Monopoly in International Voice Communications Protection of Full Competition Partial Competition the Monopoly Restrictions on the No restriction The government Only one operator number of operators determines the num- in the market ber of operators allowed in the market Nature of the Class license or Individual license License protecting the license(s) authorization incumbent operator Competition at Competition at both Competition limited No competition at network operator levels, network to resale (service either level or service provision operator and service provision level) or to level provision "own customers"14 Investment None Investment obliga- Not applicable requirements tions in addition to the international gateway Fair competition Regulatory asymmetry Regulatory asymmetry Not applicable thresholds in favor of new in favor of the entrants incumbent Carrier selection Yes No Not applicable Technological Technologically Technology specific VoIP prohibited; neutrality and VoIP neutral licenses; VoIP licenses; VoIP often government efforts in allowed or not prohibited enforcing prohibition regulated Limits on foreign None Yes Not applicable ownership of international communications operators Interconnection Clearly defined in Flaws in the inter- Not applicable the regulatory frame- connection regime work, transparent, non-discriminatory, cost-oriented 14. For example, in Morocco, the second global system mobile for communications operator has the right to offer international services to its own final clients. It cannot terminate international traffic origi- nated in other networks. CHAPTER 2 The Driving Forces Behind Competition C ompetition in international communications has been driven by globalization of economic activity, technological change, and international trade (Figure 8). Growth in the movement of goods, people, and capital across national borders has increased the demand for low-cost, high-quality international communications. Key tech- nological progress occurred at the same time in the telecommunications industry, notably the emergence of IP telephony, which enabled the provision of international communica- tions at a much lower cost. Also, reducing barriers to trade in goods and services increased integration of economic activity. In this context telecommunications services became fun- damental enablers of trade and a crucial input for export oriented companies. They became more prominent in the overall global trade agenda. International institutions such as the World Trade Organization (WTO) and the World Bank, and other relevant players like the EU and the FCC have promoted market-based reform to the provision of telecommuni- cation services. Globalization of Economic Activity Globalization of economic activity increased the demand for international telecommuni- cations services. Trade in goods increased from 33 percent to 40 percent of world GDP from 1990 to 2001 (World Bank 2003b). Mobility of people increased as well. From 1995 to 2000, about 11.6 million people migrated from developing to developed countries (United Nations Development Programme 2002). Foreign labor in the United States increased from 19.7 million people in 1990, to 28.4 million people in 2001 (World Bank 15 16 World Bank Working Paper Figure 8. Driving Forces and Sector Change Driving Forces and Sector Change International Globalisation Technological trade system of economic progress activity Sector policy reform Many more players Development of worldwide market Less distinction between users and providers Increased Aggressive search competition for new business Source: Adapted from Wellenius and others (1989) 2003b); and the movement of labor increased demand for international calls, including by poorer migrants from developing countries. The last decade also saw an increase in cross- country financial transactions. On a global scale, foreign direct investment (FDI) grew from $203 billion in 1990, to $746 billion in 2001, with FDI of middle-income countries increasing from $21 billion to $162 billion gross, as the percentage of GDP increased from 2.7 percent to 5.1 percent (World Bank 2003b). Globalization requires high-quality and low-cost communications to promote better access to markets and to increase economic integration and global competitiveness. For example, in Lithuania, the high international charges are identified as a bottleneck to the development of a knowledge economy, and as a constraint for regional and international integration (World Bank 2003a). Tunisia's high charges are also identified as a disadvantage todevelopingexport-ledtelecommunicationsintensiveservices,suchascallcentersandelec- tronic delivery of software (World Bank 2002). Low-cost, high-quality international com- munications networks are a prerequisite for the development of high-growth value-added services;whileinformationcommunicationtechnologies-relatedservices(WorldBank2002) are considered key to the success of national trade facilitation policies, and for the develop- ment of electronic commerce (Schware and Kimberly 1995; 2000). High-quality, low-cost communications can be effectively provided only in competi- tive markets. Several studies (Dökmeci and Berköz 1996; Rossotto, Sekkat, and Varoudakis 2003) found that the introduction of competition in international communications low- ers the input costs for firms (lower cost of international calls, access to global data net- works), and spurs productivity gains (better integration in the client-supplier chain). These two factors improve the competitiveness of export-oriented firms and stimulate economic growth. Therefore, firms searching to expand globally have pushed for competition in international communications around the world. Competition in International Voice Communication 17 Figure 9. Higher Transmission Capacity at Lower Cost Source: Saracco and others (2003) Technological Change Technological change reduced network costs and increased their capacity. Until the begin- ning of the 1980s, the cost of transmitting a telephone call was particularly sensitive to dis- tance and traffic volume. With the advent of digital technology, the capacity of existing wire networks has increased substantially. By 2005 capacity is expected to increase by a factor of 1,000. From 1955 to 1985 the introduction of optical fiber enabled transmission capacity to increase 100-fold (Figure 9). During this same period, major intercontinental submarine cables reduced the cost of a single circuit by a factor of 10,000 (Saracco, Harrow, and Weih- mayer 2000). Progress on the transmission side was coupled with switching improvements, a multiplicity of technological options for reaching end customers, and the emergence of IP-based networks. The development of IP-based services over increasingly broadband wireless connection to customers is expected to further revolutionize cost structures and business models. Telephony through IP-based networks15 contributes to competition, through lower investment and operating costs, and by opening alternatives to traditional technical and 15. The development of Internet technologies and the increase in bandwidth capacity permits the transport voice communications in a more effective and reliable manner. Voice traffic is converted into coded small data packets that travel through the Internet network to a specific destination, where it is converted into voice stream. Although it is usually difficult to notice if a call is being carried by IP or by traditional switched-networks, some countries have allowed IP-based international traffic with the condition that it does not miss a quality threshold of a circuit-switched voice call. 18 World Bank Working Paper commercial solutions, often outside Figure 10. Growth of International Traffic of the traditional accounting rate sys- Through IP tem.16 Prices for wholesale interna- tional long-distance calls through IP International traffic through IP is growing International minutes(in millions) networks cost 30 to 50 percent less 350,000 than traditional networks and com- mercial arrangements. Most of the 300,000 major international carriers have 250,000 IP announced plans to increase their 200,000 international voice traffic through 150,000 IP networks. If the current IP traffic PSTN 100,000 growth trend continues, by 2005, 50,000 about 45 percent of the total traffic 0 could be carried through IP-based 1997 1998 1999 2000 2001 2002* 2003F 2004F 2005F networks (Figure 10). Source: Forecast using Telegeography data * estimate F forecast The largest share of IP voice traf- Source: TeleGeography ficterminatesindevelopingcountries, where the cost of switched-networks is relatively higher. For example, from the total traffic originating in the United States, only four of the top-10 traffic destinations are developing countries; whereas nine from the top-10 IP voice traffic destinations are developing countries. In 2001, East Asia, Eastern Europe, and Latin America were the primary destinations of global IP voice termination (TeleGeography). International Trade System The establishment of an international trade system promoting increased economic inte- gration was a major driver for the introduction of competition in international commu- nications. The WTO framework has played a key role in pushing for competition in international long-distance as a way to increase trade in services (Sherman 1998; Blouin 2000). This has unfolded in three directions. First, through negotiations under the WTO, countries that have liberalized--such as the UnitedStatesandtheUnitedKingdom--soughtthederegulationofthetelecommunications sector of their commercial partners.17 Second, once countries commit to open their markets under the WTO framework, they have a legally binding obligation that has precedence over national law, strengthen- 16. Despite successive modernization attempts, the accounting rate regime still results in user prices that are well in excess of cost. Carriers using IP telephony do not usually follow the accounting rate regime, thereby substantially reducing cost. 17. The United States also promoted the inclusion of services in the Uruguay Round under the Gen- eral Agreement on Trade in Services (GATS), which contains a special annex dedicated to telecommuni- cation services. Competition in International Voice Communication 19 ing the credibility of their commitment (Sherman 1998; Schwarz and Satola 2000; Blouin 2000; Intven 2000).18 Third, in the process of accession to the WTO in telecommunications, countries com- mit to adhere to the GATS fundamental principles (nondiscrimination, transparency, and reasonable regulation and competition safeguards) and, often also adopt the Reference Paper of the Negotiating Group on Basic Telecommunications (April 24, 1996). These principles introduce regulatory requirements that are important to implement full com- petition, as indicated in Chapter 4 (Schwarz and Satola 2000; Intven 2000; Rossotto 2003). 18. Countries that commit to introducing competition in telecommunications services within the WTO framework commit to introducing competition both at the service provision and network operat- ing levels, unless otherwise specified in their schedule of commitments. CHAPTER 3 Understanding The Resistance to Competition D espite the benefits and the track record of developing countries that have suc- cessfully implemented full competition in international voice communications, policymakers in some developing countries resist introducing competition. Policy- makers who oppose full competition present the following sector-specific arguments: their lack of institutional capacity to implement reform, their fear of undermining the sustain- ability of the incumbent operator, and their fear of losing fiscal revenues and control. Addi- tionally, liberalization is sometimes constrained by corruption and nepotism. Sector-specific Factors Lack of institutional capacity. Developing countries maintain, and private sector investors confirm that developing countries often lack the technical, legal, business practice, and reg- ulatory capacity to enable reform. However, there is ample evidence, including from some of the poorest developing countries, that these minimum requirements needed in a fully competitive environment can be met at an early stage. Some of the regulatory rules and decisions, for example, can be embedded in operating licenses and contracts (Smith and Wellenius 1999). Fear of undermining the sustainability of the incumbent operator. The desire to protect the incumbent operator is commonly cited as a reason for governments' reluctance to intro- duce competition in international voice communications, competition is usually supported by officials of the ministry in charge of telecommunications and managers of the incumbent operator. There is concern among staff about possible threats to continuity of employment and level of remuneration. The argument is that a rapid shift to a fully competitive market would reduce drastically the revenues and profits of the incumbent operator, thereby, com- 21 22 World Bank Working Paper Figure 11. Reasons for Resistance to Competition Reasons for Resistance to Competition Sectoral Systemic Lack in Fear of Fear of Political Corruption technical, bankrupt- losing Economy and legal, ing the fiscal reasons: Nepotism business incumbent revenues e.g., weak practice and operator and organized regulatory control consumer capacity groups promising its financial viability. A related concern is that, in this event, subsequent privati- zation would be more difficult. However, international experience shows that incumbent operators can adapt, suc- cessfully, to the changing conditions in the telecommunications market following the introduction of competition in international voice communications. Of the 65 countries where full competition has been introduced, none has experienced bankruptcy. Competition in international voice communications, through the radical changes it provokes, does change the revenue structure of the industry. It forces the incumbent oper- ator to operate at levels of higher efficiency and transparency, and implement a new pric- ing structure that is aligned to real costs. Furthermore, competition induces major changes in the business model of telecommunications operators. Boxes 1 and 2 show how BT and Telekom Malaysia--both successful incumbent oper- ators in a liberalized environment--have implemented changes to adapt to the new market environments. Competition in international voice communications stimulated change in the incum- bent operator in both examples. The key to this change was flexibility and diversification. Competitive pressures in international voice communications created incentives for the incumbent operators to launch new services. This benefited the consumer as well as the financial health of the companies and countries. Both operators were able to safely main- tain financial profitability, and the states were able to collect additional revenue. There are also examples of incumbent operators that rely solely on revenues from inter- national termination services for stable revenues. For UTEL in Ukraine and FINTEL in Fiji the immediate impact of competition in international voice communications will be stronger. When full competition is introduced, a steep decline in turnover and profitability is to be expected as rates fall to the level of the global competitive market. A decrease in rev- enues from international call termination is already taking place, even if the monopoly is de jure maintained. Refile, "country direct services," reorigination, call-back, and other means of bypass are gradually eroding revenues. Competition in International Voice Communication 23 Box 1. BT: Effect of Competition on Financial Results A good example of the effect of competition on the financials of an incumbent voice services operator is the case of BT. Until the mid-1980s, BT was a monopoly. Revenues from international voice services accounted for 40 percent of total BT revenues. When limited competition was intro- duced, revenues from international voice services declined to represent 14 percent of BT revenues. In the same period, the market share of BT fell to 67 percent. When full competition was intro- duced in 1996, the international revenues fell to represent 8 percent of BT's revenues, and BT's market share fell further to about 40 percent. This forced BT to change. While BT's international revenues were declining in relative and absolute terms, BT was able to increase its turnover in higher growth activities, such as mobile communica- tions, which grew from 5 percent to 8 percent of overall turnover, and business services, such as data and corporate solutions. BT also increased its foreign presence. Business services and revenues from foreign acquisitions represented around 20 percent of BT's revenues in 1999. Interconnection revenues from competitors grew to 4 percent of turnover. As a result of the success of BT in changing its revenue structure and business model to face compe- tition, overall revenues grew by 31 percent, and the profit after tax (PAT) went from GBP 1,736 mil- lion to GBP 3,002 million, a 73 percent increase. The ratio PAT/sales improved from 12.5 percent to 16.5 percent. Far from provoking the incumbent operator into bankruptcy, competition in international voice communications stimulated change and forced the enterprise to react to the new market forces. Pre-competition Post-competition Revenue Revenue Pounds m. 1995 Share (%) 1999 Share (%) Inland calls 4,941 36 5,178 28 International calls 1,935 14 1,501 8 Subscription 2,534 18 3,337 18 Private circuits 1,024 7 1,165 6 Interconnection 0 645 4 CPE supply 1,041 7 870 5 Mobile 657 5 1,400 8 Directories 371 3 491 3 Other (business services 1,390 10 3,636 20 + foreign) Total 13,893 18,223 Markets share in 67.7 39.7 international (%) Stock price (pence) 352 1,459 Profit after tax 1,736 3,002 Profit after tax/sales (%) 12.5 16.5 Source: Analysis of data adapted from www.bt.co.uk. In the case of diversified incumbent operators, and of incumbent operators that spe- cialize in international voice communications, the fear of financial upset is not a reason to hold on to outdated business models and pricing structures. It is good practice, how- ever, to ensure that incumbent operators have the tools to react, if change is the key to adapting to the introduction of competition. Both BT and Telekom Malaysia had the 24 World Bank Working Paper Box 2. Telekom Malaysia: Adapting to a Competitive Environment A good example from a developing country is the introduction of competition by Telekom Malaysia in 1996. In 1997, the market share of Telekom Malaysia on Malaysia's international voice communi- cations market was 80 percent. In five years it decreased to 54.7 percent. In 1997, Telekom Malaysia was enjoying monopoly profits. In that year, it realized MYR 1,786.4 of PAT, on a turnover of MYR 796, a 26 percent profit/sales ratio. Also in this case, competition in international voice communications forced the operators to change. Telekom Malaysia successfully diversified its revenue sources. In particular, the development of data and Internet services, a high growth segment, contributed to sustained revenues. In 2001, five years after introduction of competition in the international voice communications market, Telekom Malaysia's turnover increased to MYR 7,909. Also in this case, the incumbent operator was far from bankrupt, achieving MYR 858.6 PAT, in a difficult year for telecommunications and technology com- panies worldwide. Its PAT/sales ratio decreased to 11 percent, a value more in line with telecommu- nications companies operating in a competitive environment. Pre-reform Post-reform RM 1997 2001 Turnover 6796 7909 *Of which Internet and data 208.5 1152 PAT 1786.4 858.6 PAT/sales 26% 11% Market share in international 67.7% 54.7% Source: Telekom Malaysia annual reports. Available at: http://www.telekom.com.my/corporate/intro.php chance to diversify and adapt their businesses. It is crucial that incumbent operators in developing countries use their opportunity for capacity building in revenue diversification, setting and adapting to changes in the pricing structure, and training in competitive and open business practices to facilitate the transition to an open and competitive market. In countries with a state-owned incumbent operator, competition reduces government control over a major source of fiscal revenues. Under a monopoly the incumbent operator bills customers for international calls; the revenues go to the state budget through either a dividend policy agreement (if the incumbent is corporatized), or directly to the state (if telecommunications operations are run through a government department). In cases where the country is a net recipient of international accounting rate settlements, the operator col- lects settlements revenues--and this is, often, a substantial source of foreign currency. The introduction of competition brings changes to both channels of revenue collection. First, competition brings new private operators into the market. The state has only indirect control over the revenue collected by the new operators, typically through sales taxes. Sec- ond, the new operators (both in the originating and in the destination country) bypass the traditional settlement rates system, thereby reducing the amount of revenue received directly from the state. The net effect of these changes depends on a series of parameters, including: the divi- dend policy before competition, the rate of value-added tax, the market share of the incum- bent in a liberalized market, the settlement rate, the fees from the award of new licenses, and the elasticity of demand. Competition in International Voice Communication 25 If competition in international voice communications is isolated from other sector reforms, there are some cases where, in the short-term, revenue collection may decrease. The introduction of competition, however, does not necessarily lead to the loss of revenue. As shown in the examples of BT and Malaysia Telecom, when reform is undertaken appro- priately and with flexibility, revenue channels are redistributed and total revenue remains comparable or may increase. It is unlikely that the government could, in any case, continue to collect monopoly rents since bypass, even where illegal, erodes the revenue base. High charges for interna- tional voice communications provide an incentive to bypass the system, through call-back, refile or "directs" using VoIP and public switched telephone network (PSTN) technology. The revenues originating from these operators are difficult to tax, therefore, this causes a natural erosion of the tax base. High international voice communications charges provide incentives to originate the call outside the country. The use of settlement rates as a fiscal instrument is constrained by the FCC's decision to apply lower benchmarks on settlement rates. This has driven down the settlement prices, and will harm countries that still rely on settlement revenues as a source of hard currency. For example, in Myanmar settlement revenues are estimated to constitute between 7 and 13 percent of government budget revenues. The introduction of competition opens the market to all players, and generates transparent revenue for taxa- tion. In most cases, the reluctance to lose control is not justified and originates from a short-term view of fiscal contributions. Countries with a state-owned monopoly operator have high international charges and low telecommunications investment per capita. The monopoly rent, therefore, is used mainly to satisfy fiscal needs. For example, in Myanmar, a three-minute call to the United States costs more than $23.00, and the investment per capita is $0.10. In contrast, coun- tries with full competition in international communications have cheaper international charges, and a high investment per capita. For example, in El Salvador, under full compe- tition, the cost of a three-minute call to the United States is $1.23, and the investment per capita is in excess of $25.00. Systemic Factors Political economy. In some countries, powerful political forces are opposed to reform. Table 4 provides examples of the beneficiaries of reform and those of the status quo. The beneficiaries of the status quo are few and often a well-organized political con- stituency, capable of influencing the ministry responsible for telecommunications and the ministry of finance (Smith 1995). On the other hand, the beneficiaries of reform are many; they comprise a large consumer and enterprises base and do not usually find an adequate way to voice their interests. As studies indicate, where benefits of reform are diffused among many beneficiaries, those beneficiaries find it difficult to organize themselves into pressure groups (Olson 1971). Therefore, in monopoly situations, there is often no organized con- stituency working to introduce competition in international voice communications --or if one exists, it is a weak one.19 19. In some cases, the independent telecommunications regulator and the trade ministry can act as catalysts for reform, and counterbalance the power of the incumbent telecommunications operator. 26 World Bank Working Paper Table 4. Pro-reform Actors Need a Stronger Political Voice Pro-reform Actors (demand side of reform) Status Quo Actors I Consumers, often underrepresented I Incumbent operators I Urban consumers who may cross-subsidize I Risk or change-averse staff in fear of losing rural access employment and remuneration I Rural consumers who may benefit from I Political leadership post-competitive rural rollout I Enterprises, often not organized in I Trade unions pressure groups I Small operators, without lobbying means, I Major global carriers that enjoy exclusivity in private sector competitors e.g., VoIP and international voice communications in the call-back operators market I Independent regulators, often with I Sector ministries, in fear of losing political inadequate means power I Ministries of trade, to comply with WTO I Ministries of finance, for fear of harming fis- commitments and facilitate trade and cal revenues, especially in countries where exports there are difficulties in raising sufficient taxes from other sources I Politicians facing a debt crisis and looking I Low income consumers who may lose subsi- for benefit of ownership shares and licenses dies after tariff rebalancing I World Bank, WTO, EU, US FCC, IMF, to foster I Politicians able to extract rents in status quo economic development and reduce poverty regime The resistance to competition in international communications is higher than the resis- tance to reform in other segments of the telecommunications market. This can be ascribed, partly, to international voice communications licenses not being associated with large "price tags," unlike, for example, licenses in the cellular segment. In the case of privatization and sale of cellular licenses, the expectation of large proceeds provides incentive to respond to beneficiaries of the reform process, such as potential competitive operators, officials in the ministry of finance. In turn the prospect of privatization and sale of licenses is also a cata- lyst for international investors--a group with the ability to add pressure to implement reform--to enter the arena. Small- and medium-sized operators who benefit from the introduction of competition in international communications, do not usually have the means to exert political pressure.20 An exception to this is India, where competition in the international voice communications market was introduced under the pressures of software and information technology export- oriented companies. The companies' management complained about the high cost of inter- national voice communications which they argued were hindering the capability to provide real-time information technology assistance and electronic delivery of software. Reform was linked to local groups who lobbied against the high cost and inadequate quality of interna- tional voice communications as a constraint to growth and development. 20. Competition in international communications is usually introduced after the general sector reform process has started. For example, competition in international voice communications in Africa and the Maghreb followed the introduction of cellular market competition. Newly established cellular operators exercised political pressure to obtain a separate international gateway. Competition in International Voice Communication 27 In the absence of strong, politically organized local advocates of competition, the advo- cates are often organizations outside of the domestic political system.21 Unless the stakes extend beyond telecommunications (for example, when reform is needed for accession to the EU or to the WTO), it is unlikely that external political pressure groups alone can bring reform. Because sector reform is a political process, good regulatory governance and economic freedom are increasingly identified as key factors for its success (Gutierrez and Berg 2000; Varoudakis and Rossotto 2003). In the paper and database "Governance Matters: Gover- nance Indicators for 1996­2002," Kaufmann, Kraay, and Mastruzzi (2003) rank countries on the basis of several governance indicators.22 One such indicator is "voice and account- ability," offering a composite governance index showing how, in different countries, local enterprises publicly express concerns in the political process. The voice of the enterprise is one of the indicators considered; others include an assessment of civil liberties and freedom of the press. Figure 12 shows that out of a sample of 20 countries (10 with a monopoly in international voice communications and 10 with competition) the countries that ranked high in terms of voice and accountability offer competition in international voice commu- nications. The eight countries that ranked low retain a monopoly in international voice communications. Of the index's 10 best-performing countries in terms of voice and accountability, nine have competition in international voice communication.23 Corruption and nepotism. The rent paid to a monopoly in international communica- tions results in the concentration of large sums of cash, often in foreign currency, in few hands. Li and Xu explain that, if ruling politicians face less political competition, they enjoy more discretion in choosing policies that maximize rents or corruption proceeds, or fur- ther their private interests. However, their ability to extract rents may be limited if there are conflicts of interest among different groups of politicians. The configuration of politi- cians' interest groups may affect telecommunications policies in ways that are similar to the interest-group politics in more democratic societies (Li and Xu 2002) and may facili- tate reform. On the other hand, while corruption in the typical sense involves paying a gov- ernment official for personal gain, a form of corruption described as "state capture" involves individuals, groups or firms in the public and private sector illicitly providing pri- vate benefits to public officials, thereby influencing (to their advantage) the formation of 21. For example, the EU exercised positive pressure in introducing competition in the ECA region, especially for accession countries, with the price of international services decreasing dramatically. The US FCC 1997 Benchmarking Order determined a price cap on settlement rates that United States' operators should pay to foreign operators for terminating United States traffic. According to the FCC and several authors, this decision acted as a stimulus for developing countries to reduce their costs of international voice communications and implement reform (Stanley 1997; for a different perspective, see Melody 2000). The reduction of settlement rates forces a change in the recipient country's telecommunications sector, reducing the reliance of the incumbent operator, and of fiscal authorities, on settlement revenues. In other cases, the proponents of reform have been international organizations, such as the World Bank and the WTO. 22. Kaufmann, Kraay, and Mastruzzi recognize that there are margins of errors and therefore the rankings can be subject to a certain variation. Another corruption index, published by Transparency International, is available at http://www.transparency.org/cpi/index.html#cpi, while another index dis- cussing corruption and the voice of the enterprise, the Global Economic Competitiveness Index published by the World Economic Forum/Harvard University, can be found at http://www.weforum.org. 23. Malaysia is the only country outside of the top-10 that has full competition in international voice communications. It is ranked number 12. See also Gutierrez and Berg 2000. 28 World Bank Working Paper Figure 12. Countries with Limited Economic Freedom Face More Obstacles to the Introduction of Competition Voice of Constituencies and Reforming International Long Distance Competition Competition Competition Competition Competition Competition Competition Monopoly Competition Competition Monopoly Competition Monopoly Monopoly Monopoly Monopoly Monopoly Monopoly Monopoly Monopoly Source: D. Kaufmann, A. Kraay and M. Mastruzzi, 2003: Governance Matters III: Governance Indicators for 1996­2002 (http://www.worldbank.org/wbi/governance/data) laws, regulations, decrees, and other government policies. Powerful local interest groups, such as incumbent operators or private sector companies, may offer funds for legislation that benefit their monopoly or oligopoly status (Hellman and others 2000). A second indicator of governance introduced by Kaufmann, Kraay, and Mastruzzi in their governance study addresses governments' efforts to control corruption. Among the 20 countries with the highest anticorruption standards, all 20 offer full competition in inter- national voice communications. Of the 20 countries with the lowest anticorruption stan- dards, only five offer full competition (Figure 13). In the chosen sample of countries, countries with competition in international communications tend to have a higher ranking in terms of anticorruption efforts. While a direct correlation is difficult to certify, private sector operators' war stories provide anecdotal support. In Sri Lanka, for example, petty crime was reduced, arguably since competition caused the incumbent operator to tackle inefficiency, waste and corruption or face losing its customers (Samarajiva 2001). However, competition alone is not sufficient in alleviating corruption. A study by Ibarguen (2003) shows that in Guatemala, good licensing in addition to full competition, were comple- mentary agents for increasing transparency and reducing corruption in the radio spectrum liberalization process. Competition in International Voice Communication 29 Figure 13. Controlling Corruption and Reforming International Long Distance Competition Competition Competition Monopoly Monopoly Competition Competition Competition Monopoly Monopoly Monopoly Competition Competition Competition Monopoly Competition Monopoly Monopoly Monopoly Monopoly Source: D. Kaufmann, A. Kraay and M. Mastruzzi, 2003: Governance Matters III: Governance Indicators for 1996­2002 (http://www.worldbank.org/wbi/governance/pubs/data) CHAPTER 4 Conclusions and Requirements for Success T his paper argued that opening international communications to competition plays a key role in reforming the telecommunications sector; is sustainable in developing countries; and results in major gains to consumers, business users, and the economy. It has made the case for opening these markets quickly rather than gradually. The transition from monopoly to competitive provision of international services, however, needs to be preceded or accompanied by action in related areas: I Establishing the principles and rules for fair competition and a core institutional capacity to monitor, investigate, and take action against anticompetitive behavior. In countries without general competition laws and effective enforcement capabil- ity, these functions must be incorporated in the legal, regulatory, and institutional framework of the telecommunications sector. I Establishing a licensing regime that allows new entry without quantitative limi- tations, and subject only to general requirements applicable to all public tele- communications operators and commercial enterprises. A class license may facilitate, expedite, and enhance transparency in the process of authorizing new entrants. I Implementing a system whereby the user can select the international operating company for each call. I Rebalancingtheincumbent'stariffstobringthemclosertotheindustrycoststruc- ture, establishing the means to regulate prices in areas where there is not enough competition, and developing a strategy and financing mechanism to extend services beyond the market when required for social or other development reasons. 31 32 World Bank Working Paper I Freeing the incumbent to adjust its business strategy and practices along com- mercial lines to face growing competition in an effective manner. This generally requires the incumbent to be established under company law, is enhanced by the participation of private capital and management, and by training staff in new technical and commercial skills (such as contracts, and collection and billing practices). I Putting into place the basic elements of a credible interconnection regime that is consistent with internationally accepted principles. This includes sector legislation; regulations; default terms and conditions of interconnection; and a core institu- tional capacity to monitor, enforce, and adjudicate on interconnection rules and agreements. This is a tall order, and it means that competition in international services is not a panacea. The conditions necessary for successful implementation are no less important than those required for overall sector reform. Below we examine in detail the issues and options involved in creating some of the conditions necessary for effective competition in interna- tional communication. Interconnection and international accounts. Interconnectionisthemostimportantdeter- minant of a successful transition from monopoly to competitive telecommunications mar- kets. Internationally accepted principles for interconnection in competitive markets have been adopted at global and regional levels. Putting in place the basic elements of a credible interconnection regime that is consistent with these principles is a key precondition for effec- tive competition in the provision of international services. The interconnection regime designed for competitive environments is still in use, and coexists, however, with the remains of the accounting rate regime that was developed in the context of national monopolies. Moving decisively to an interconnection regime for international communication is neces- sary for successful development of this market segment, and to enhance its impact on sector reform and overall economic development. Interconnection enables new entrants to reach customers connected initially only to incumbent or dominant operators. Interconnection also gives operators choices between developing their own infrastructures and facilities or paying to use those of others, thus reducing barriers to entry and enhancing overall network efficiency. Technical issues, such as the number and specification of the points where networks interconnect, tend to be resolved more readily than commercial issues, particularly, prices. The trend is for inter- connection to be treated as a commercial matter between the interconnecting parties. It is often necessary, however, for the regulatory authority to provide guidelines for such nego- tiations, intervene when the parties fail to agree, and require operators with market power to publish standard interconnection offers approved by the regulator that apply in the absence of agreement.24 In 1997, the WTO Agreement on Basic Telecommunications was the first widely recog- nized, multilateral treaty to include binding rules for interconnection. Fifty-seven countries, accounting for at least 70 percent of international traffic, committed to the Reference Paper 24. An annotated selection of papers, case studies, and websites dealing with interconnection can be found at http://rru.worldbank.org/. Competition in International Voice Communication 33 where these rules are defined, and more countries have followed.25 Regional organizations in Asia, Europe, and Latin America have established similar directives for interconnection.26 The WTO Reference Paper establishes basic principles for interconnection, with spe- cial attention to operators that control essential infrastructures or have dominant market position. Interconnection to such major suppliers must be ensured at any technically fea- sible point of the network, in a timely manner, on nondiscriminatory and transparent terms, at cost-oriented prices, and sufficiently unbundled to avoid charges for unnecessary components. The procedures for interconnection, as well as interconnection agreements or model interconnection offers of major suppliers, must be made public. Putting in place the basic elements of a credible interconnection regime that is consis- tent with the WTO principles is a key precondition for effective competition in international telecommunications services. Specific initial measures are: I Sector legislation that establishes the right and obligation to interconnect, the basic principles of interconnection (including nondiscrimination, transparency, and cost orientation),theroleoftheregulatorinenforcingtheseprinciples,andtheprocedures for requesting interconnection and handling disputes (Schwarz and Satola 2000). I Interconnection regulations that flesh-out the way that principles and procedures established in the law will operate. I A reference interconnection offer by the incumbent, approved by the regulator, that establishes default technical and financial terms and conditions applicable to other operators that request interconnection. I Acoreinstitutionalcapacityandauthoritytomonitorandenforceinterconnection rules and agreements--including the means to outsource technical expertise-- needed to address specific problems. The interconnection regime's credibility can be enhanced by having the main rules and procedures reflected in contracts and operating licenses, undertaking binding commit- ments with international and regional organizations, vesting regulatory authority in an entity that is separate from the operators and reasonably free of day-to-day interference by the government and the political system, and other measures (Smith and Wellenius 1999). Accounting rates. The interconnection regime, designed for competitive environments and increasingly applied to the provision of international communication, coexists with the accounting rate regime. 25. The Fourth Protocol of the GATS (usually referred to as the Agreement on Basic Telecommuni- cations), negotiated under the auspices of the WTO in February 1997 and signed by 69 countries, became effective on January 1, 1998. The Reference Paper is an informal text containing regulatory principles negotiated among WTO members, contained in an annex to the Fourth Protocol. The Reference Paper became legally binding on 57 WTO members that attached it as part of their "additional commitments" in their GATS Schedule of Commitments on telecommunications market access. Six more committed to parts of the Reference Paper, and several other countries that did not commit formally have since reflected the principles of the Reference Paper in national legislation and regulations. See Intven (2000), module 3, "Interconnection," and the Reference Paper in Annex 1. 26. Some of these regional frameworks are binding on member countries (European Union), while others are of an advisory nature (CITEL and Andean Pact in Latin America, APEC in Asia-Pacific). All point roughly in the same directions as the WTO agreement and Reference Paper. 34 World Bank Working Paper International telecommunications services were traditionally supplied (jointly) by at leasttwooperatingcompaniesindifferentcountries.Underthisarrangement,eachcompany has its own international gateway and a network (half-circuit) extending to a real or fictitious midpoint between both gateways where they connect. The companies jointly own, operate, and maintain facilities to provide international service, such as pairs or fibers in submarine cables and transponder capacity in satellite systems. Other equipment (such as local switches, transmission, and distribution networks) is owned, operated, and maintained in each coun- try by the individual company (Stanley 2000). The corresponding relations between the companies are governed by bilateral operat- ing agreements, including the financial arrangements to compensate each other for the costs incurred by one company to terminate calls originated and billed by the other company. The accounting rate per minute of traffic is negotiated bilaterally (mostly). The settlement rate between or among companies usually apportions the accounting rate equally between them, that is, divided in halves between two companies or in thirds if traffic transits through another company. Occasionally, settlement payments are made between companies for the net traffic exchanged. Accounting rates are meant to compensate for the costs incurred by each company to provide (jointly) the service, but in practice they are bargained between companies with little reference to costs, are influenced by the circumstances of individual negotiations, and thus vary widely among companies. Furthermore, the uniform settlement rate implies that the total costs are evenly divided between the joint providers. Although accounting rates have been declining, they are still generally higher than the cost of handling and terminating minutes of international traffic in domestic networks. The accounting rate regime has, thus, contributed to maintaining the high price of inter- national traffic, despite dramatic cost reductions resulting from technological innovation and global market growth. The international accounting rate system is under mounting pressure to align account- ing rates with costs and--more broadly, their phase-out--in favor of interconnection arrangements better suited to competitive markets.27 The pressure for change has come from international organizations (ITU, OECD) and some national regulators (FCC), but above all from changing market conditions worldwide. The opportunity for arbitrage between the accounting rates and the much lower underlying costs has led to an increased proportion of international traffic being carried by competitive providers bypassing the accounting rate regime. New modes of service provision have the potential to determine the termination charges for international traffic by market forces rather than bilateral negotiation.28 The direction of change is clear, but in many developing countries it is held back by delays in opening international services to full competition. High accounting rates, besides resulting in high prices, also contribute to large and growing settlement payments by some major operators (especially in the United States) to some other countries. Large settlements discourage the receiving operators from negotiating lower accounting rates, and their gov- 27. The international accounting rate regime was established initially about 100 years ago for tele- graph and then telephone services provided by a single monopoly operator in each country. Today it is used extensively despite the advent of widespread competition and massive traffic growth. 28. These new modes include leased-line resale, refile, and related modes, international alliances, international points of presence, and Internet telephony. See chapter 6 of Tyler and Joy (1997), and also Stanley (2000). Competition in International Voice Communication 35 ernments from increasing competition. The dependence of some developing countries on international settlements as a source of foreign exchange and fiscal revenue factors into keeping the accounting rate regime alive (Braga, Forestier, and Stern 1999). Fear of abuse of market power also keeps some governments from making the transition from account- ing rates to interconnection for international services. Tariff rebalancing and universal service. A critical step towards competition in interna- tional services is to rebalance the incumbent's retail tariffs to reflect (roughly) industry cost structures. This is necessary for reasons of economic efficiency as well as for the financial via- bilityofincumbentsandnewentrants.Tariffrebalancing,however,requiresregulatoryinter- vention, as the incumbent is likely to remain the sole or largest provider of connections to the end customers. Tariff rebalancing also raises concerns about maintaining or extending service beyond those that operators are prepared to provide on a commercial basis alone, especially in order to reach high-cost rural areas and low-income urban population groups. Thus tariff rebalancing, preceding or undertaken concurrently with the advent of interna- tional competition, must be coupled to a strategy to deal with universal service. Enough progresscanbeachievedfairlyquicklyonallthesefrontstoenableearlyintroductionofinter- national competition. At the beginning of the transition to competitive supply, retail prices are often dis- torted relative to costs. Under monopoly supply, telephone connections, monthly sub- scriptions, and local calls were typically priced below costs, resulting in deficits that were cross-subsidized by above-cost international and domestic long-distance call charges. While distorted tariffs have adverse economic effects on efficiency (by sending the wrong signals to users to consume and operators to invest), the operator's overall financial via- bility can be achieved by setting aggregate tariff levels high enough, so that there is little pressure to rebalance tariffs towards costs. Highlydistortedtariffsarenotsustainableundercompetition.Thehighmarginsofinter- national service are quickly competed away and the incumbent is increasingly left with loss- making services. The case for tariff rebalancing thus becomes urgent not only for economic efficiency, but, primarily, for the incumbent's financial survival; and to give the new entrants incentives to invest in a broad spec- trum of networks and services, not Table 5. Imbalanced Telephone Tariffs Before only in the overpriced international Competition, Latvia 1996 segment. Table 5 shows distorted tele- US$ phone tariffs prevailing in Latvia in 1996, compared to those in a basket of Average of Five Competitive markets where prices were close to Tariff Element Markets Latvia costs through a combination of effec- Rental/month tive competition and some regula- Business 22 7 tion. The table illustrates the need for Residential 14 1 major increases in monthly telephone Local call/min 0.03 0.03 charges as the incumbent faced fierce Long-distance call/min competition from international call- Near 0.38 0.36 back operators, as it also prepared to liberalize all market segments towards Far 0.71 1.91 accession to the EU. Source: Author's compilation. 36 World Bank Working Paper Although it is a key element in moving from monopoly to competition, tariff rebalanc- ing cannot be left entirely to the market. In the early years of reform, and probably for a long timethereafter,theincumbentwillbethesoleormainproviderofconnectionstotheendcus- tomers.Tariffrebalancinginvolvesamixoffreeingcompetitiveinternationalcallpriceswhile regulating fixed and local call charges (and as discussed later, interconnection prices between international and domestic operators). In the early stages of development, the regulatory authority,mustequipitselftoaddressthesematterstoprepareforinternationalcompetition. Tariff rebalancing has a political cost. Although rebalancing typically decreases the over- all cost of communication for all users and for almost each category among these, business users benefit the most. Rebalancing may increase the cost to low-income households for whichfixedcharges(forexample,monthlyrentalofphonelines)accountformostofthebill.29 Thus, rebalancing must be coupled with dealing with universal service, that is, maintaining or extending service to localities and customers that are not commercially viable by them- selves, or that are deemed by the government to deserve services below actual cost. Tariff rebalancing, therefore, requires addressing the consequences of ending cross- subsidies (among services, categories of users, or locations) that were implicit in the monop- oly regime, or of replacing them by explicit subsidies that are sustainable in an increasingly competitive environment. Where a considerable number of low-income households have under-priced telephone service (for example, the former Soviet Union and Eastern Bloc countries, at the time of transition from centrally planned to market economies) the ques- tion is, what can be done with households that are already connected, and that cannot afford the higher cost-based prices. In Bulgaria and Latvia in the mid-1990s, it was estimated that about one-third of residential customers could not pay the market price for telephone ser- vice, and were likely to be disconnected unless given support.30 In most developing countries, however, with fewer pervasive networks, and where most customers are middle-income or business users, the traditional argument against rebalancing is rather that cross-subsidies from international service are necessary to rollout networks and reach high-cost localities especially in rural areas. Since, in practice, most companies operating under monopoly sta- tus were unable to meet demand even in prime urban markets, let alone in less profitable ones,thisargumentcarrieslittleweight,butthechallengeremainsofreachingunservedhigh- cost areas and low-income users. What will universal service cost? Who will pay for it? How will the revenue be collected and distributed? These are the questions that lie at the heart of all contemporary approaches to universal service (Wellenius 2000). The market can be used to determine if, and how much, of a subsidy is needed to reach a specific set of universal service targets, and who can provide them at minimal cost. The subsidies can be funded from the government's budget (as done in Chile) or, as is more common, though less economically efficient, from con- tributions by all or the largest telecommunications operators passed on to end customers through tariffs (as done in Peru) or from other sources (for example, proceeds of radio licenses in Guatemala). Sri Lanka recently adopted an unusual arrangement, whereby a tem- 29. Fixed and local call charges are sometimes included in the retail price index, so raising them may increase the measure of inflation, which in turn can lead through indexing to other price increases (for example, public sector wages). 30. One solution is to offer residential customers an optional package of minimal service at a low (sub- sidized) price, and let customers self-select the quality of service they can afford. Competition in International Voice Communication 37 porary tax on incoming international calls (on foreign callers, many of them expatriate Sri Lankans) captures part of the price reduction following international competition, and channels it to rolling out networks (including broadband) in provincial towns and rural areas. Despite the complexity of pricing, regulation, and universal service provision, rebal- ancing tariffs to the extent needed to introduce international competition can be done fairly quickly--typically in less than one year--once, politically, the decision is made. In the absence of reliable cost accounts, approximately appropriate levels for regulated prices can be prescribed readily from benchmarks derived from competitive markets, adjusted to reflect major country differences in factor costs (for example, labor, capital, land), or through simple network engineering models. Following tariff rebalancing and other mea- sures to allow markets to work well, reasonable targets can be reached at a modest cost, relative to total sector Table 6. Net Cost of Universal Telephone revenue, to extend service beyond the Service in Selected Countries32 market (Table 6) and new services Net Cost as a Percent help reach the least privileged popu- Country of Sector Revenue lation groups.31 Argentina 0.6­1.0 Developingcountriesshouldcon- Australia 2.0 sider,withoutdelay,introducingcom- Chile 0.2 petition in international communica- Colombia 4.3 tions. Maintaining the status quo in France 3.0 a monopoly market structure only Norway 2.0­2.4 results in protecting the interests of Peru 1.0 the incumbent operator; it constrains Sweden 0.8­1.2 volumes, has an adverse affect on Switzerland 1.7­2.2 network development, imposes high UK 0.2­0.3 charges on domestic consumers and enterprises, and stifles economic US 5.0 competitiveness. Source: Wellenius, 2000. 31. Prepaid mobile phone service, typically available to 90 percent of the population only one or two years after competitive entry, further reduces the cost of universal service and shifts the issue from net- work extension to affordability of use. 32. The data are estimates or projections covering various periods from 1995 to 2004, collected in 1999. Net cost of universal phone service has further declined since then. Some countries, however, now aim at universal provision of Internet and other advanced communication and information services that cost more. 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This study presents the case that opening international voice communication to competition is key to reform of the telecom- munication sector, is sustainable in developing countries, and results in major gains to consumers, businesses, and the econo- my. Over the last 20 years full competition became a dominant attrib- ute in virtually all high-income countries and in selected develop- ing countries, especially in Latin America. Three forces were behind competition: globalization, technological change, and the emergence of international telecommunications as an enabler for integration and trade. Now over 80 percent of voice traffic originates in fully competitive markets. Resistance to competition remains strong in several developing countries (only 26 percent of them have competition), even though countries such as Chile and El Salvador have demonstrated spectacular success in introducing and sustaining competition. Among the reasons for resistance to competition, some are telecommunications-specific, such as, lack of technical, regulatory, and business skills, and fear of bankrupting the incum- bent operator; while others are systemic, for instance, the concern over fiscal losses, the lack of political influence by pressure groups favoring competition, the existing corruption, and the restrictions over information flows. Competition in inter- national communications is also a matter of economic freedom. This paper makes the case for quickly opening developing-coun- try markets, and identifies regulatory matters that need to be tackled. World Bank Working Papers are available individually or by subscription, both in print and online. ISBN 0-8213-5951-7 TMxHSKIMBy359518zv,:&:*:&:, THE WORLD BANK 1818 H Street, NW Washington, DC 20433 USA Telephone: 202 473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org