The following section describes select attributes of some of the more dramatic events in the transition of a centralized to a market-based competitive telecommunications sector in Latin America. Due to time and space, the anecdotes are presented for only three countries; Chile, Mexico and Peru, though they exist equally in all of the countries in Latin America.
A. Chile
In 1978, then President Pinochet, commenced the opening of the telecommunications sector in Chile with new laws and the introduction of private investment and competition in non-basic, value added services in Chile. Almost simultaneously, he withdrew Chile from the Andean Pact, citing as his reason the Pact’s inclination against a decentralized, market-based economy.
The commencement of continuous updates on the new telecommunications laws, and the appearance of new service providers propelled the telecommunications sector in Chile to a level of private investment, which exceeded virtually all of its neighbors in the 1980’s. Then, in 1988, the Government of Chile, through the Secretariat of Communications, undertook to sell all of its shares in the dual telecoms monopoly. Entel Chile had been the monopoly for long distance and international service and Compania de Telefonos de Chile ("CTC") had been the monopoly for local exchange service.
Alan Bond’s Bond Group of Australia bought CTC, the larger and more profitable of the two companies. Telefonica of Spain bought a minority share, but controlling stake, in Entel Chile. Within two years of the sales, the Bond Group encountered financial and legal problems, which landed its leader in jail in Australia and forced the need to sell of its telecommunications properties, including CTC.
As the Government of Chile had not maintained control over the transfer contractually, the transaction of sale was privately conducted between Telefonica of Spain (the obviously interested and most motivated purchaser) and the Bond Group in Australia. The result was that Chile; having spent twelve years introducing competition in its telecommunications sector was again faced with the potential of monopoly control of its two major carriers.
The Antimonopoly Commission and then the Chilean Courts reviewed the matter, received extensive legal briefs, read all material written on the break-up of AT&T in the U.S. as a comparison, and after four years of litigation, reach a conclusion. The Court up-held CTC’s right to enter the long distance and international market to compete with Entel and others, once CTC completed certain digitalization and other acts designed to eliminate its bottleneck capabilities. Also, it granted Entel the right to provide local exchange service. Finally, and most resoundingly, it required the divestiture by Telefonica of its interests in one or the other of the companies within 18 months of the decision. Telefonica logically elected to dispose of its interests in Entel, and maintained control of CTC, the larger of the companies.
CTC went on to do a very successful capital markets offering in the U.S. and the Chilean market opened to a multi-carrier long distance, and local exchange service in the mid-1990’s. In long distance service, eight operators immediately rushed in to compete upon the opening of the market. The small size of the population coupled with the steep in international service made Chile the least expensive international dial tone in the Western Hemisphere. It also caused the eventual merger of competitors and elimination of others.
Nevertheless, Chile’s commitment to enforcement of its rules and regulations, and the robust growth of its economy fueled investment in its telecommunications sector throughout the decade. Recently, however, a decree by the Government concerning regulation of tariffs, specifically related to the monthly recurring charge, has caused a moratorium on investment in local exchange service in the country. This phenomenon is a manifestation of the changing nature of the economics of the sector examined in the last Part IV of this paper.
B. Mexico.
Mexico has had an interesting history with the U.S. Being a contiguous neighbor, greatly impacted by all actions by the U.S. regulator and the corresponding positioning of U.S. carriers, Mexico has had an unique position in U.S. international telecommunications policy and statistics; and conversely, a great impact positively and negatively on the development of the Mexican telecommunications sector. In the 1970’s and the 1980’s the government-owned Mexican PTT corresponded with AT&T, the U.S. long distance carrier that accounted for over 90% of the international traffic to its southern neighbor.
When AT&T’s competitor, the then GTE-Sprint, tried to gain market entry in the 1980’s, AT&T had made Mexico a deal it could not refuse and Mexico resisted competitive entry even at the strong encouragement of the U.S. Government. In an international settlements environment where most international carriers "settled" their accounts with each other on a 50-50 basis (each carrier paying the other 50% of the accounting rate agreed to between them to complete the call on either end), AT&T had agreed to pay Mexico 70%, while AT&T would accept 30%. Since international traffic was then and for some time thereafter over 40% of the Mexican company’s total revenue and over 90% of its international traffic was with the U.S., the AT&T deal quickly became literally the lifeline of the Mexican telephone company. This was true to the point that when in the late 1980’s the U.S. Federal Communications Commission ("FCC") set out vigorously to impose its International Settlements Policy on U.S. carriers exchanging traffic with TELMEX, which would require the brisk shift to 50-50 from 70-30, the officers of TELMEX flew to Washington to impress upon the FCC the severe threat of bankruptcy of the company if such a program were instituted "cold turkey". The FCC recanted and allowed a "phase in" to then U.S. "normalcy". In the meantime, as part of the FCC’s campaign to expand competition in the U.S. international traffic market, it seized the opportunity to "encourage" Mexico to share at least 5% of its traffic with the new lead U.S. international competitor, MCI.
The irony of this piece of Mexican telecommunications history as we will see below, is that it is now MCI-WorldCom’s and AT&T’s Mexican long distance subsidiaries suffering most from Mexican regulation and enforcement policies which they believe are designed to "control" the level at which they compete with TELMEX today in an open telecommunications sector; to the point that the two had declared a "moratorium" on their further investment in the Mexican telecommunications sector and urged the FCC to intervene on their behalf. Not surprisingly, a considerably more mature Mexican commercial government than the one the U.S. dealt with in the 1980’s has reminded the FCC of Mexico’s sovereignty and has sought to resolve the conflict completely free of U.S. intervention.
In the late 1980’s the Mexican telephone company was an under-performing monopoly that, typically for its era, and bureaucratic ownership, used sharp cross-subsidies of its services to mask severe inefficiencies. The result was a national monopoly provider to telecommunications services, with strong governmental protection, that almost literally gouged its international customers, with rates at hundreds of multiples above cost, while barely covering one third of its costs to provide the limited local exchange service it provided.
Following two in-depth corporate restructuring studies conducted by U.S. consultants, TELMEX reorganized itself into five divisions, designed to allow the company to identify its costs, subsidies and revenue streams and rationalize them. The "corporatization" took about 18 months, after which 20.4% of TELMEX’s shares were sold to private strategic investors for nearly U.S.$2 billion. This sobered those who laughed at TELMEX’s pre-restructuring estimate of its corporate worth at U.S.$10 billion. The international 1990-91 IPO was a raving success with overseas markets clamoring for a larger share and a share value that went from U.S.$0.10 just prior to privatization, to U.S.$65 at its peak! The rest, as they say, is history.
The TELMEX privatization was structured to serve Government’s priorities, which included Mexican blood voting the last vote in TELMEX’s management, and a foreign ownership not to exceed 10% of the company’s equity, at least in the area of voting stock. For reasons related to the pre-privatization rising of capital by the company, and the need to cede management and operational control to the strategic investors, the restructured company ended up with three classes of stock for privatization. Class AA represents 20.4% of the company, but most of its voting shares. It controls the company. Of that class, Grupo Carso purchased 10.4% (being the "Mexican blood") and France Telecom and South Western Bell evenly shared the "foreign strategic 10%. SBC also made a passive investment in options on 5% of the non-voting shares, which resulted to be very successful for it.
The privatization brought with it, a New Mexican telecommunications law of October 1990 and a six-year exclusivity period for TELMEX over long distance service, in exchange for a very vigorous (perhaps overly so in hind-sight) build-out and service obligation, and a mandatory reversing of the cross-subsidies. Having personally worked on the TELMEX privatization, I can relate that it was truly the turning point in the explosion of the Mexican telecommunications sector.
Within one year of the expiration of the exclusivity period, the Government and regulator, now COFETEL, accepted suggestions from interested parties and from TELMEX as to how to go about how to introduce Mexico’s multi-carrier system. While long distance and private line service had been the lucrative pursuits for most, local exchange also was given attention and carriers encouraged to enter.
More than a dozen new operators were licensed in long distance from the expiry of the exclusivity period in 1996 through present. While levels of investment are high, the road has been rocky for some. Also, since 1996, other services have been opened and new technologies are being deployed with private operators in almost regular pace with the industrialized world.
Mexico’s economy has recovered from its fall in the late 1980’s, and its telecommunications sector is increasingly robust and supportive of and supported by its economy. Nevertheless, like investment anywhere, and certainly in emerging economies, risk factors must be carefully assessed.
C. Peru
Basic telephony was characterized by two monopolies in Peru prior to its privatization in 1995, similarly to the Chilean structure. One was for local exchange and domestic service and the other for international service. The companies were combined and 45% of each was sold to Telefonica Internacional S.A., the international investment subsidiary of Telefonica of Spain for over U.S. $2 billion. While the price paid substantially exceeded the next bid, the deal had in it a management contract for Telefonica, which allowed it recoup some of its investment, as it caused the company to grow and succeed economically. Again, typically of Latin American privatizations, the Telefonica del Peru concession contained a series of build-out obligations, which were both rigorous and costly, particularly in the rural areas.
While Telefonica complied with its contractual obligations tensions grew between it and the regulator, OSIPTEL, and eventually reached the point of Government’s wanted to terminate the exclusivity period in advance of its 5th year anniversary. Telefonica, on the other hand, objected to Government’s proposal to license competitors upon the conclusion of the exclusivity period, under terms and conditions, which Telefonica believed were more favorable to the new entrants than to Telefonica. Citing a provision of its Concession Agreement which allows it all the benefits of any concession granted after its own, with terms and conditions more advantageous than its own, Telefonica threatened to challenge OSIPTEL’s granting of any more favorable license following the expiry of the exclusivity period.
The parties resolved the matter by a balanced compromise. Telefonica agreed to give up a year of its exclusivity period, in exchange for the elimination of its continuing obligation, after the opening of the sector to competition, to build out in costly, low-return rural and other areas.
In this fashion, the sector opened a year ahead of schedule and investment has been robust in Peru.
Similarly to Chile and Mexico, and Argentina as well, Telefonica had virtually completed the rebalancing of its tariffs, a Concession obligation, by the time of the opening of the sector. The implications of this are explained below in Part IV, which introduces the new economics of the sector on the near horizon.
THE CHANGING ECONOMICS OF TELECOMMUNICATIONS
As noted above, Latin America is and has been ahead of many countries with emerging economies in the development of its telecommunications sectors and the attraction of private investment. Similarly, it has been substantially advanced in its promulgation of rules and regulations, changing as required to keep up with constant change in technology and services. All of the above drives or suppresses competition and growth depending on how the change is effected and how effective enforcement is executed.
In Mexico, we have seen investment moratoria declared by MCI WorldCom and AT&T based on alleged failure of the Government to enforce the telecommunications regulations against TELMEX, which most affect the economics of service-provision by the competitors. While resolution has commenced of these issues in Mexico, full resolution is not yet a reality, and the sector has suffered a slow-down in investment at a time when investment should have been the most robust in Mexico’s history.
On the other hand, one sees in Mexico, a reversal of the cross subsidies which previously characterized the service of TELMEX. For example, before privatization, TELMEX’s local exchange service failed to cover one third of its costs and was permanently subsidized by TELMEX’s dramatically high international tariffs. That has reversed, forced, in part, by the requirements of its Concession and the introduction of competition in long distance and international service. As new international operators can compete on price, without regard to local exchange service, if the incumbent does not lower international prices and remain competitive, it will lose a large portion of its revenue and its best and most lucrative customers. In fact, some of the most vigorous of the complaints of TELMEX’s interconnection and access charge practices demonstrated a policy of avoidance of competition in this lucrative market.
Currently, ITU reports show dramatically higher local exchange charges than those, which characterized the pre-privatization company. Indeed, TELMEX’ monthly recurring charge is on par with other countries of Latin America which have rebalanced their tariffs to eliminate the cross subsidies. Thus, it is significantly higher than monthly recurring residential charges of companies in other countries that have not been obligated to rebalance. The latter means that those countries remain largely without formal or effective competition. This is because competition forces rebalancing of tariffs in order for the incumbent to maintain market share in the price-competitive and lucrative markets like long distance, international and commercial.
Similarly, Argentina and Peru have monthly recurring charges, which reflect a rebalancing of tariffs and elimination of much of the cross-subsidies that previously characterized the company’s finances. This means necessarily, a higher monthly recurring residential charge than countries such as Paraguay, Surinam and others that have not yet eliminated their cross subsidies (again typically revealing a lack of competition which threatens the market share of lucrative and over-charged markets).
As noted earlier, the law and the vigorous competition in Chile contributed to the elimination of cross subsidies and the balancing of tariffs with cost of providing the service. Thus, like Argentina, Peru and Mexico, Chile had monthly recurring residential charges, which reflected its cost of providing the service, and operators competed vigorously in long distance and international pricing for market share.
At the end of 1999, however, the Government forced a lowering of monthly recurring charges, which substantially impacted the revenue balance of local exchange carriers. That is, with long distance and international tariffs subject to severe competition and thus as marginally low as possible, the monthly recurring charge is one of the few revenue sources available to generate margin. While it cannot create wide margins as monopoly international services once did due to the economy of the market of residential users, it at least covered its costs and generated profit in a rebalanced tariffing environment. Now Chilean local exchange carriers are saying that the new rules no longer allow that. Thus, they have declared a moratorium on the construction of local exchange infrastructure. Perhaps by the time of the PTC conference, we shall have a resolution of the dispute.
What all of the above, and current marketing of services in other countries, like the U.S., cause us to think about is how networks will be paid for in the future. In a technological environment where long distance is virtually the same as local exchange service (eg. AT&T advertises its "one service" which encompasses the entire of the U.S., local and long distance; Venezuela has reduced its domestic long distance to two regions, all else within them is local exchange; Sprint sells its "ten cent" minute anywhere in the country, etc); wire line virtually the same as wireless (Uganda’s second national operator uses exclusively a GSM cellular network with software distinctions for price-capped services; Canada and U.S. move toward wireless local loop being interchangeable with cellular and fixed line telephony); data equals voice services (GPRS and UMTS provide telephony services with internet access, interactive email and other mixed services features), etc.
Thus, technological convergence; global seamless mergers of services and service operators and new means of delivery, like the INTERNET, point toward different measures of financing infrastructure build-out. For example, whereas operators used long distance and international revenues predominantly in the past as a primary revenue stream, which supported financing of build-out, those streams have shrunk substantially in a competitive environment. The same is true for international settlements. Now, as we are seeing in Chile, the same could be true in the future for the monthly recurring charge on local exchange service. Prepaid services and cellular or other wireless substitutes for local exchange service, already threaten this revenue stream. As voice over the Internet is refined to basic telephony quality, monthly recurring charges and per minute rates will be vestiges of the past. In the new economy, then, what will operators look to in order to finance network build-out. Will it be retail advertising on the INTERNET??
