Subir Gokarn: Regulatory convergence -II

Broadband may well emerge as an effective competitor to cable

To recap briefly, in the first part of this two-part column (January 19), I had explored some issues arising from the decision to regulate the cable television industry.

The article began by classifying the issues raised by the consultation paper prepared by the Telecom Regulatory Authority of India (Trai), which now has the regulatory responsibility.

It then characterised the structure of the industry, which is critical to the regulatory approach. Addressing the first set of issues raised by Trai, that of product definition and pricing, it argued that, while the principle of regulation was relatively clear, the fragmentation of ownership of the "last mile" "" the link to the subscriber "" would pose a challenge for implementation.

Essentially, the principle is to look at the entire link between the broadcasters and the subscribers "" which comprises the large, multi-service operators and the small and numerous local operators "" as though it was an integrated structure and cost it accordingly.

After that, it is a matter of sharing the costs between the two components. For this, one possible approach is to draw on the information that Trai is likely to have about the relative magnitudes of the "wholesale" and "retail" components of the network.

The relative costs in the cable television industry are unlikely to be very different from those of telecom.

If the businesses concerned have any violent objections to this formula, they would have to provide credible information about their cost structures to justify a departure from the telecom benchmark.

As was argued in the first part, getting credible information from a highly fragmented last mile ownership is going to be Trai's key challenge and using the telecom industry as a working standard offers one way around this problem.

The second concern within the product definition and pricing set is whether channel "bouquets" can be priced at steep discounts relative to the prices charged for individual components of each bouquet, which is the current practice in areas in which CAS has been implemented.

From a regulatory perspective, this is price discrimination, because the bouquet pricing is not based on any cost differential.

There has to be a reasonable tariff for individual channels, which operators are mandated to offer. Once this in place, their discounting practices for bouquets should be left to them.

The other three sets of issues are service quality, technological development and limits to advertising time. The service quality issue is again closely related to the fragmentation of ownership and the disincentive this creates for investment in high-quality equipment and manpower.

From a long-term perspective, the regulator has the option of setting the prices of the wholesale and retail margins in a way which induces integration between the two.

Large, integrated providers are more likely to satisfy higher quality standards. However, there is a dilemma here, in terms of whether the pricing regime should have an overt bias towards a particular industry structure.

In the short term, the most practical instrument is a consumer redressal process, in which local operators are called up after a certain number of complaints and penalised if they don't have a satisfactory explanation.

The question of limits to advertising time on paid channels is a difficult one. In the US system, premium channels do not typically sell advertising time, but they do spend a lot of time promoting their own programmes.

In the Indian context, an advertising-free channel is likely to be expensive enough to shut out everybody but the most die-hard viewers, which probably threatens the survival of the channel.

Perhaps, given the fact that many of the channels that have positioned themselves in the premium category appear to be pretty close substitutes for each other, the regulator should just let this issue be for the moment and let the forces of competition create a self-regulating upper limit.

Basically, other than a ban on advertising on pay channels, which, as was argued, may be self-defeating, it is difficult to visualise a rational, information-based time limit.

The last issue, that of technological development, is certainly the most complex. Flawed regulatory decisions could hurt consumer interests in the longer term.

As things stand, there are two apparently viable alternatives to the conventional cable system "" Direct-to-Home (DTH) and broadband. There are varying international experiences with each. In the US, the early experience with DTH revealed the shortcomings of fragmentation in this business.

A large number of providers went into business, each requiring dedicated equipment purchased by the subscriber. Many of them went bankrupt because they couldn't achieve the minimum level of subscribers needed for viability, leaving their customers with useless equipment. This is similar to the CAS story in India.

However, large, monopolistic DTH providers, like BskyB in the UK, appear to have crossed the minimum subscriber threshold successfully. As of now, two large providers are in the business (or poised to enter) in India.

Licensing will keep the number low, but even then, their business model requires a relatively large upfront investment by subscribers.

There is, therefore, a great deal of uncertainty about their ability to attract customers, even with any deferred payment schemes that they might devise.

From the regulatory perspective, perhaps the best approach would be to let this alternative evolve under the pricing umbrella set up for the conventional cable operators.

Ultimately, it is for the consumer to decide his optimal pattern of upfront vs monthly payments and the other advantages and disadvantages of cable vs DTH.

Broadband is the true convergence channel, with voice, data and video being transmitted through the same pipeline.

It appears to have been successful in Korea, for instance, but not as much in Europe.

Regulatory and pricing regimes undoubtedly have something to do with this, but from an Indian perspective, there are some structural constraints to the growth of this medium as a television provider. The economics of broadband are sensible when the penetration of telephones, computers and television are broadly on par, as they are likely to be in the more affluent countries (Korea's per capita GDP is above $10,000 now).

But, when there is a large disparity between them, loading the entire cost of reaching the household exclusively on television will reduce its competitiveness relative to cable. WLL and cybercafes effectively reduce the penetration disparities somewhat, but probably not enough.

The appropriate regulatory position would have two aspects. First, in India, this is an incipient technology, like DTH, so letting it develop under the cable pricing umbrella is practical.

Second, its competitiveness will increase as telephone and computer penetration, particularly amongst households, increases. As long as this process is not impeded in any way, it may well emerge as an effective competitor to cable and render formal price regulation redundant.

The writer is Chief Economist, CRISIL. The views expressed are personal.