competitor enters the market with a price discount of at least 15%, reflecting partly the lower cost of the competitive operation and partly the need to offer discounts of at least this level to encourage customer migration. (It should be noted that the lower costs faced by the competitor may be due in part to the opportunity which it has for "cream skimming", or the targeting of particularly profitable sections of the market in the first instance.) Entry discounts of at least 15% in all services provided by Mercury have been typical, for example, in the UK. In the longer run the dominant provider responds by cutting its own costs so as to narrow gap between its prices and those of the competitor. This has been the experience in the United States, where initial discounts of 30% or more below the dominant long distance carrier's (AT&T's) price were narrowed to the range of 5% to 10% after a few years.
Bearing in mind this overseas experience, we have used the figure of 15% as illustrative of the magnitude of user benefits in those parts of the telecommunications service market subject to competition (see Exhibit 1.5). We emphasize that this is not presented as a specific prediction of the likely behaviour of telecommunications tariffs in Hong Kong : is put forward as a figure representative of international experience, and possibly indicative of the long run outcome in Hong Kong if competitive services were to be introduced.
1.3.4 Assessment of true economic benefits
it
The preceding discussion was concerned with benefits as perceived by telecommunications users. The relationship between these benefits and the true economic benefits is a complex matter. Very broadly, we expect the former to provide a useful approximation to the latter. The precise relationship between the two is discussed below, and illustrated in Exhibit 1.6. The remainder of this section is written for readers interested in technical economic analysis.
If the 15% (or other) price cut to the user is made by a telecommunications operator entirely at the expense of its profit, it clearly constitutes a gain in consumer surplus directly offset by a loss in producer surplus, resulting in no net first order economic gain. There is a second order benefit, equal to the welfare triangle gain created by growth in demand stimulated by the price cut (see Exhibit 1.6, upper diagram). However we noted earlier that the price drop does in fact correspond, at least partially, to a lower resource cost. In the first instance, the lower costs are experienced only by the new competitor, for example because it uses newer, lower cost, technology and because it has an administratively leaner operation.
In due course, however, the main carrier also tightens its cost discipline as a consequence of the competitive pressure, so that the price reduction is not made at the expense of long run profitability.
Under these circumstances the price cut of 15% can be taken as a measure of the long run cost improvement in the industry. If the service in question is operating on a non-subsidised basis (i.e. returning a fair economic return on capital), then the relationship between user benefits and true economic benefits will be as illustrated in the first case on
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