COMPETITION IN BRAZILIAN TELECOM MARKET: AN EMERGING MARKET EXPERIENCE Paulo Roberto Gião M.Sc. in Electrical Engineering at University of Brasilia and MBA in Corporate Strategy at Fundação Getúlio Vargas – FGV – Brasília, DF, Brazil. Address: SQS 102 Bloco C Apto.508, 70330-030, Brasília, DF, Brazil. Tel: (55) (11) 8286-0994 / 2245371 Email: [email protected]. José Rogério Vargens Filho PhD student of Economics at Federal University of Rio de Janeiro and regulation consultant at Brasil Telecom. Address: SQSW 302, Bl D, Apto 115, 70673-204, Brasília, DF, Brazil. Tel: (55) (61) 84011538 / 4151538 Email: [email protected] or [email protected] JEL-Code: L10 Keywords: Telecommunications, Competition, Regulation, Emerging countries Abstract This paper explores what is happening in Brazilian telecom market six years after privatization. The regulatory agency, market (users) and companies expectations are presented and an analysis will be made about the status of privatization process in Brazil. The telecom privatization process has begun in 1997 when new telecom licenses were sold. In addition, wireline and wireless companies from former Telebras, the public monopoly, were sold in 1998. At the end of this first phase, at least two different companies could compete in the same market. The second phase was represented by a new PCS (Personal Communications Service) licenses when three new frequency bands were sold for three geographic areas but some of them were not sold. Nowadays, in many regions there are two wireline operators and four wireless operators. For users, some successfully goals were achieved. The amount of fixed and mobile lines has increased greatly and became available to everybody. Competition increased in cellular and long distance segments, but not in the fixed local one. The new fixed local entrants could not develop their networks and their market share reached about 3%. Regulatory agency ANATEL expectation is mainly related to increase competition in all markets to reduce service tariffs and prices but it did not happen in every segment. Some of new entrants have problems in their operations and in most companies financial results were below expectation. So, what is wrong with the model? The paper analyzes the evolution and the results got in Brazilian telecom industry. Some examples will also be used as reference to help the understanding of this complex process. Finally, some proposes will be remembered to improve the telecom model and a way to be satisfied for all players, users, investors and government. 1. Introduction

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The Brazilian telecom market structure has been consolidating since the privatization in 1997 and 1998. By that time, several national and international groups got into the country to provide telecom services. The telecom model established in Brazil achieved good results for regulator and users, but companies faced strong difficulties. As a result, many companies that entered in the market have already finished their operation. Nevertheless, some of them purchased those that decided to go away and restructured themselves. This process generated a more concentrated industry with five big players, among other small ones. However, there are some obstacles to overcome and regulator has the opportunity to do it now by the time of regulatory review. This paper deals about the evolution of Brazilian telecom industry from 1998 to 2005. It shows how the market structure evolved and presents the results gotten by three principal economic agents in the process: regulator, users and companies. To achieve its aim, this paper was divided in more four sections, in addition to this introduction. Section 2 presents the players that got into Brazilian telecom by the time of privatization. Section 3 brings some details of the telecom regulatory model established in Brazil. Section 4 shows the players that emerged from a wave of mergers and acquisitions that generated a new market structure. Section 5 discusses the results gotten by regulator, users and companies ant points some problems and tendencies. Finally, Section 6 concludes this work, rescuing the fundamental questions discussed. 2. New players in telecom market. The main event in Brazilian telecom reform was the privatization of the public vertical integrated monopoly, Telebras and its subsidiaries, at 07/29/1998. Brazilian government, the principal player in telecom industry until this date, became the regulator of telecom services, which are now supplied by private companies. To reorganize Brazilian telecom industry, the National Congress approved the Law nº 9.472 in 07/16/1997, called General Telecommunications Law, which established a new juridical and regulatory infra-structure and created the National Telecommunications Agency (ANATEL) to regulate the sector with administrative autonomy and budget independency. Because of the Brazilian market telecom size, which was the eighth in the world by 19971, Telebras public monopoly could be divided into 4 PSTN2 companies: 3 local incumbents and 1 long distance incumbent. The local PSTN incumbents were established in 3 different geographic regions, shown in Figure 1. It was also gave permission for 4 firms to enter in the market: 1 long distance carrier to compete with the long distance incumbent, and 3 local telephone companies to compete with the local PSTN incumbents. Other small telephone companies also were and still are present in Brazilian telecom industry. Figure 1 – Brazilian PSTN map after privatization.

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According to Dores (1999; p. 3), Brazil had 2.15% and 2.05% of world fixed and mobile lines in 1997, respectively. 2 PSTN – Public Switched Telephone Network.

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Region I Region II

Region IV: Long distance in all territory Region III

Source: Own elaboration.

Following are the companies that started to offer PSTN services after privatization: Region I (local and LD intra-region): the incumbent TELEMAR (Brazilian joint venture) and the entrant VESPER (Qualcomm; Velecom). Region II (local and LD intra-region): the incumbent BRASIL TELECOM (National and international investment funds, managed by Opportunity Brazilian Investment Bank; Telecom Italia) and the entrant GVT (Bell Canada; WLL; Qualcomm; SLI Wireless). Region III (local and LD intra-region): the incumbent TELEFONICA (Telefonica Spain) and the entrant VESPER (Qualcomm; Velecom). Region IV (international, national and intra-region LD): the incumbent EMBRATEL (MCI/WorldCom) and the entrant INTELIG (National Grid; France Telecom; Sprint). The initial mobile market structure in Brazil was established by the Ministry of Communications in 1996, which divided the country in 10 areas and determined 2 cellular companies to play in each area with different radio frequency band, commonly called “A band” and “B band”. These areas are showed in Figure 2 and the companies that play in them are following described. Figure 2 – Brazilian cellular map after privatization.

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Region 8

Region 10

Region 9 Region 7 Region 4 Region 2 Region 3 Region 5 Region 1

Region 6

Source: Own elaboration.

Area 1 – A band: TELESP CELULAR (Telefonica Spain; Portugal Telecom) and B band: BCP (Safra Brazilian Bank; Bell South). Area 2 - A band: TELESP CELULAR (Telefonica Spain; Portugal Telecom) and B band: TESS (Telia; Algar Telecom Eriline). Area 3 – A band: TELEFONICA CELULAR (Telefonica Spain) and B band: ATL (Algar Telecom). Area 4 - A band: TELEMIG CELULAR (TIW; Opportunitty Brazilian Investment Bank; pool of Brazilian pension funds) and B band: MAXITEL (Telecom Italia; Vicunha). Area 5 - A band: TIM SUL (Telecom Italia) and B band: GLOBAL TELECOM (Inepar; DDI; Motorola; Suzano). Area 6 - A band: TELEFONICA CELULAR (Telefonica Spain; Portugal Telecom) and B band: TELET (Bell Canada; TIW). Area 7 - A band: TCO CELULAR (Splice) and B band: AMERICEL (Bell Canada; TIW). Area 8 - A band: TELEMIG CELULAR (TIW; Opportunitty Brazilian Investment Bank; pool of Brazilian pension funds) and B band: NBT (Inepar; Splice). Area 9 - A band: TELEFONICA CELULAR (Telefonica Spain) and B band: MAXITEL (Telecom Italia; Vicunha). Area 10 - A band: TIM NORDESTE (Telecom Italia) and B band: BSE (Safra Brazilian Bank; Bell South). 3. Telecom policy after privatization. Since the General Telecommunication Law was published, the main important goals established by Brazilian telecom policy have been the development of competition in industry and the universal access of population to telecom services. In the privatization process, ANATEL established some universal obligations to the new companies that bought Telebras. Beside other obligations, the PSTN local incumbents had to install individual lines in all cities with more than 300 inhabitants and to install public telephones in all cities with more than 100 inhabitants until 2005. Local 4

incumbents had to set public telephones at intervals of 300 meters in urban areas and to attend the teledensity of 7,5 public phone per 1000 inhabitants in all of the country until 2005. To accomplish these obligations, the local incumbents would have al least to double PSTN plant between 1998 and 2005. To cellular companies, no universal obligations were established, because the mobile market was been developed by 1996 and 1998, and ANATEL judged that two companies competing in each regional market was enough to expand the service in Brazil. To promote competition in PSTN, ANATEL established asymmetric rules that imposed restrictions to incumbents but not to entrants, as Figure 3 shows. The intention was to provide some temporary artificial competitive advantages for the entrants to give them time to develop their networks. Figure 3 – Asymmetric rules in PSTN market. REGULATORY MARKS

INCUMBENTS

NEWCOMERS

Contract Geographic operation Universal obligations Diversification of services Use of new technologies

Public Restricted to its area until 2002 Yes Since 2002 WLL liberalized since 2001

Private No restriction No Since 2001 No restriction

Source: Own elaboration.

Until 2001, only one incumbent and one entrant could compete in each PSTN region I to IV (duopoly competition). After 2001, the entrants could diversify their services and could to expand them for other regions. The incumbents only could do it after 2002 and if they had accomplished universal their universal obligations. The plan was that PSTN companies could gradually play not only in other market segments but also in other geographic regions. So, the duopoly segmented market structure would be substituted by a national oligopoly market structure in which the firms could compete with all others. In the mobile market, the plan was to reinforce competition by the entry of other firms. In order to get it, ANATEL auctioned PCS licenses for bands C, D and E in Areas 1 to 10 (showed in Figure 2) after 2001. In the total of 9 new licenses, only 4 were sold, three for Telecom Italia and another one to Telemar. So, the success was not the same as in beginning. At the end of 2002, after another attempt to auction the remaining bands and areas, only one was sold to Brasil Telecom in this own PSTN area. After this last trying, no other tentative was done until this time. 4. The consolidation process. Some forces like competition, technical change, regulation and globalization have been doing pressures in the Brazilian telecom market structure. In response, it evolved from its initial design established in the privatization process by an ample concentration process. According to Sherer (1980; p. 81), concentration of market structures happens mostly because of economies of scale and scope, which allow firms decrease costs per unit of product. In reason of these economies, there is a minimum level of efficient production

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that permits firms to stay in the market. The maximum number of competitors in a market is given by the total volume of production demanded by costumers divided by the minimum level of efficient production. The search for economies of scale and scope is one of the factors that induced mergers and acquisitions in Brazilian telecom industry, especially in the mobile segment. In the 1990’s last years, mobile market showed signals that it could not accommodate the amount of cellular companies that got into it. Many mobile players were not able to get back their investments with the revenues they were earning, because of the little average revenue per subscriber. The necessity of an economic feasible mobile operation left a wave of mergers and acquisitions and generates the bigger companies present today in Brazil. These companies got more scale of production and more coverage and so became able to overcome the obstacles faced in Brazilian market. As a result, mobile market is now dominated by a set of big companies, showed in Figure 4. Figure 4 – Mobile companies in 2003 (% of Brazilian subscribers). Vivo (Telefonica) 44% of subscribers

TIM (Telecom Italia) 18% of subscribers

Claro (Telmex) 22% of subscribers

Brasil Telecom GSM (Opportunity) 0% of subscribers

Oi (Telemar) 7% of subscribers

Telemig/Amazônia Celular (Opportunity) 9% of subscribers

Source: own elaboration.

In fixed telephony, the concentration process was not so intense. There were some mergers and acquisitions, but they kept PSTN map, showed in Figure 1, almost intact. EMBRATEL brought VESPER in 2003 and both companies were sold by MCI/WorldCom to TELMEX. The consolidation process may not have yet finished, but it already has created a market structure dominated by five economic groups: 1) TELEFONICA from Spain, with the local PSTN incumbent in Region III (Figure 1) and the first mobile operator, VIVO, present in 8 of the 10 mobile regions (Figure 4). VIVO is a Telefonica Mobile and Portugal Telecom joint venture.

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2) TELEMAR, a joint venture formed by some Brazilian groups, with the largest PSTN incumbent in Region I (Figure 1) and OI PCS Company present in the same geographic area (Figure 4). 3) TELMEX from Mexico, with the first Brazilian long distance carrier EMBRATEL, the second Brazilian mobile operator CLARO, the local PSTN entrant in regions I and III, VESPER, and the first TV per subscription operator, called NET. 4) BRASIL TELECOM owned by some national and international investment funds and controlled by Opportunity Brazilian investment bank. BRASIL TELECOM is the PSTN incumbent in Region II (Figure 1) and will launch in 2004 its PCS subsidiary to operate in the same geographic area (Figure 4). Opportunity also controls TELEMIG and AMAZONIA CELULAR, but the ownership composition is different of BRASIL TELECOM. 5) TELECOM ITALIA from Italy, with the unique mobile operator that covers all Brazil, Telecom Italia Mobile or TIM (Figure 4). 5. Results after 6 year of privatization. 5.1. Regulator point of view. Regulator succeeds in establishing telecom Brazilian model. All telecom indicators improved after privatization, as Figure 5 shows. Figure 5 – Evolution of Brazilian telecom indicators. INDICATOR 1997 2003 Population (1000 inhab.) 163.471 176.876 GDP (US$ 1000) 807.745 508.011 Fixed lines (millions) 18 39 Mobile lines (millions) 4,55 46,37 Public phones (millions) Fixed lines (per 100 inhab) Mobile lines (per 100 inhab) Internet users (% of populations) Broadband access (per 100 inhab)

0,52 11 2,8 1,3 0

1,43 22 26,2 9,5 0,65

Growth 8% -37% more than 2 times more than 10 times almost 3 times about 2 times almost 10 times more than 7 times -

Source: own elaboration based on ANATEL data (www.anatel.gov.br).

Telecom industry experienced significant growth all over the world in the last twenty years. It was caused by three principal factors: technical change, institutional reorganization and globalization. The technical change created new services and permitted the development of new markets, like mobile and Internet. It also created new transmission middleware, like fiber optics that improved transmission capacity, decreased prices per bit transmitted, and allowed new competitors to develop its network. With the institutional reorganization, the State transferred telecom operation to private companies and introduced competition to the sector. Globalization provided market liberalization and expanded the principal operators from developed countries to the developing ones.

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Brazilian regulator permitted the action of these global forces in Brazil and got their positive effects, when it chose a telecom model based on competition, technologically neutral, without restriction to foreign players and oriented to universal services. As a result, indicators of Internet, fixed and mobile telephone increased many times, despite of the slowdown in Brazilian economy in the last 6 years. Competition was intensified in Brazilian telecom industry. However, as in all over the world, it does not increase symmetrically in every telecom segments. It increased faster in the long distance and mobile telephone segments than in the fixed local one. Why did it happen? The technical change acted in industry with a double edge sword. In one hand, it decreased investments required to build wireless network and long distance optics backbones, allowing entrants to develop its cellular and long distance networks. In the other hand, xDSL technologies rejuvenated the copper wires in the PSTN last mile, keeping them as the mostly economic feasible technology to transmit voice and data. The entrants could not build this part of the network, in result of the high investments required, and it was kept dominated by local PSTN incumbents. According to TELETIME (2004; p. 20), local PSTN incumbents have 97% of fixed lines in Brazil. However, competition has been gradually intensified in Brazil. It is already intense in many segments, like mobile, long distance and fixed local to corporative segment. Even in fixed local residential business, competition tends to increase because of the fixed voice substitution by mobile voice and the entry of TV per subscription players in this segment to provide broadband Internet and voice over IP upon their cable TV network. 5.2. Users Benefits (or not) There is no doubt that the privatization was benefic for users. The amount of fixed and mobile lines has increased many times, as can be seen in Figure 5. The number of cellular phones increased more than 10 times. Some Brazilian states in south and southeast have a penetration ratio above 40% and in the Capital, Brasilia, this rate is about 80%, above, for instance, the rate in United States, Australia, France and Germany. Nowadays, there are at least three different mobile companies in each state. There are different kinds of service plans for postpaid and prepaid subscribers. Penetration rate has increased in poorest segments of population because of prepaid cellular, which now represent about 75% of the plant. The two main barriers to users, handset price and per time fee have been decreasing and in some plans they already approximated to fixed telephone levels. Between 1998 and 2002, fixed telephone plant increased more than two times. PSTN reached the entire country and many small villages were connected. The price of connection to PSTN decreased from an extremely high level after privatization and now everybody that can pay monthly fees can be connected. However, as entrants could not develop their network at economic and technical feasible conditions, the desired competition in local PSTN did not happened. In most small cities, only the incumbent provides PSTN local connection. In these cities, users have only one provider for local calls but it can choose among at least three providers of long distance calls.

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Nevertheless, fixed telephony began to face mobile competition. The fixed segment has lost not only voice traffic but also subscribers for the mobile segment. Even so per time fee paid for PSTN subscribers is still lower than the paid for cellular subscribers, some of them have changed fixed lines to mobile ones because of the monthly subscription, which is about US$ 10 for PSTN and zero in cellular prepaid plans. It is possible to access Internet dial-up from every place served by the widespread fixed telephone network. However, broadband is not available in most small cities, where there are not enough costumers to justify investments in this service. Brazil has low Internet penetration rates because there are some obstacles that limit connectivity, specially the insufficient income for most part of population for acquiring computers. For users in general privatization was a good solution for the availability of wire and wireless handsets, decrease of tariffs and possibility of choice among providers. 5.3. Investors point of view (operating companies) The Brazilian privatization process in 1998 occurs in a period that telecom was experienced a boom. According to Fransman (2002; p. 7), it was built in the 1996-2000 period a consensual vision in which the investors expected from companies a very high and unreal financial return. These irrational expectations made enormous pressure on companies for them to reach the desired goals. It created an environment so that everybody in the financial market and in the companies started to behave more riskily and aggressive. This behavior made a speculative buble that exploded with the NASDAQ slowdown in 2000. It left to a strong crisis in ICT sector, in which telecom assets and companies’ shares lost significant part of their value. Many international telecom players came to Brazil for the privatization process. Bell South, MCI/WorldCom, Telecom Italia, Telefonica, Telia, Bell Canada, TIW, Qualcomm, Portugal Telecom and others have participated. They super evaluated Brazilian companies based on a scenario in which there was a boom in international telecoms and Brazilian economics was expected to grow. None of this premises happened. The NASDAQ bubble explosion introduced a crisis in global telecom industry and Brazilian economics did not grow, as can be seen in Figure 5. Facing serious difficulties in their Brazilian and/or in their international operations, some of investor has gone, since they realize it would be impossible to get back their investment done in Brazil. Bell South, Telia, MCI/WorldCom, Bell Canada and others sold their participation in operating companies and left the country. Telefonica, Telmex and others purchased their participations. With them, these players could complement and gain synergy with their previous operations. The process left to emergence of a new market structure dominated by five big telecom groups in which there some small players also remain acting in market niches. The new companies have now more scale of production; big coverage; and can exploit economies of scope by offering almost all telecom services. After five years of operation, almost all B band mobile companies are still at a loss. In addition, many of them started operation in TDMA technology and now are upgrading their networks to GSM, incurring in a new great volume of investments. Some regulatory actions can improve the mobile business, for example the wireless number

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portability. The possibility of changing operator with no change in its own number can provide a migration of unsatisfied users from one operator to another. In spite of that, ANATEL intends to promote 3G auctions in next years with new threats to actual operating companies meaning that a return over investments can be compromised. As already mentioned, 75% of cellular users are prepaid. They do not provide enough revenues to sustain mobile operation costs. The mobile market was so developed based in PSTN revenues transferred through a cross subside scheme in which PSTN users pay a high value to call to mobile phones and PSTN operator transfers part of this value to the mobile operator by a high interconnection fee. Interconnection is one of the greatest source of revenue for cellular operating companies but the major expense for PSTN operators. With the competition between mobile and fixed networks, the scheme is not feasible anymore. Therefore, ANATEL liberalized fixed-mobile interconnection fee to be negotiated among players in july/2004. It is an additional element added in the competition between fixed and mobile operators. It tends to decrease mobile revenues in the short term but can increase traffic and accelerate fixed to mobile voice substitution in the long term. However, some mobile companies can face serious difficulties. PSTN have also faced financial problems since privatization. Long distance carriers were not yet able to get back their investment. Competition in the segment decreased revenues because long distance tariffs diminished and long distance carriers lost market share. This process was intensified after local incumbents were authorized to national and international long distance calls in 2002. In spite of having kept their market share, local PSTN incumbents were not yet able to get their investment back also, because they have to invest in universal goals established by regulator. These goals were heavier than it was necessary to supply the repressed demand that existed in Brazil before privatization. It resulted in high degree of inactivity. According to TELETIME (2004; p. 20), PSTN plant in 2003 had of 50 millions installed lines and only 39 millions of these were in-service (22% of inactivity). ANATEL is now revising PSTN regulatory model and will publish new rules for the period of 2006-2025. These rules will regard about unbundling, interconnection, account segregation, price caps, universal goals, number portability, competition and others. Some of them are not compatible, as unbundling and universal goals. ANATEL adopted a competition model for Brazilian telecommunications and imposed PSTN local loop unbundling in 2004. However, the agency had imposed new heavy universal goals to PSTN incumbents for the period of 2006-2025 in 2003. According to Hayashi (2003; p. 20), universal goals, that are based on cross-subsidy from highincome costumers to the low-income ones, used to work in monopolistic model, but they are not compatible anymore with competition rules and unbundling and became increasingly unsustainable. The author affirms that “we have indicated that competition with transient regulations in the local access facilities may work in the short run to bring in lower usage price and increased choice of services but it gives disincentives for improving already installed facilities and deploying new technologies for the owners of infrastructure. We must pay attention to possibility that this negative effect will outweigh in the long run.” (p. 19).

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Regarding investors and operating companies, it seems that there are some unsolved problems and regulator should give a clear direction to avoid a lack of investments in this strategic sector and fragile companies. 6. Conclusions Government succeeded in privatizing and in establishing a new telecom model. The number of wire line and wireless subscribers has increased and most population now can have a phone. All telecom indicators improved and users were benefited in many ways. It is not a complete success because some discrepancies can be observed. For example, the model allowed that in poorest region of Brazil (north and northeast) there are four cellular concurrent players while in richest one (Sao Paulo) there are only three. The new companies that got into Brazilian market after privatization faced serious difficulties because of the global crisis in the telecom sector and the slowdown in Brazilian economy. As a result, the market structure evolved by an ample consolidation process based in mergers and acquisitions that may have not yet finished. The new market structure emerged is based on five big telecom groups. It is more robust than the previous one and seems to be well adapted to Brazilian market. Three years after privatization, after nine PCS band were auctioned but only four were sold, it was clear that the industry has changed and some adjustments in process should be done. Regulator is now doing some adjustments. It is establishing not only new universal goals but also new rules of unbundling, interconnection, price caps, competition and others. It is important to observe that competition is a tool for achieving an efficient market structure but market forces cannot solve all problems, like the availability of telecom services in poorest regions. Competition policies like unbundling have to be established in such a way not to disincentive investments and technical change. The new rules should take in account that the model has to be sustainable to operating companies. They will be feasible if they can contributed to consolidated an efficient market structure for Brazilian telecom, in which players can compete among themselves, invest in network expansion and new services, reduce prices, keep universal and quality levels but also allow firms to get a sustainable return. 7. References [1] DORES, A. M. B. “Telecomunicações: o novo cenário”. Rio de Janeiro (Brazil): BNDES (in Portuguese), 1999. [2] FRANSMAN, M. “Telecoms in the Internet Age: from Boom to Bust to...?” New York: Oxford University Press Inc, 2002. [3] HAYASHI, T. “Fostering globally accessible and affordable ICTs”. Geneva: International Telecommunication Union. Visions of the Information Society project, 2003 Available from: www.itu.int/visions. Accessed in: 19/jun/2004. [4] SCHERER, F. M. “Industrial market structure and economic performance”. Boston: Houghton Mifflin Company, 2ª ed, 1980.

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[5] TELETIME. “Brazilian Atlas of Telecommunications”. São Paulo, Brazil: Ed. Glasberg, 2004 (in Portuguese).

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