TNAG-2247-FCO40-3230-Business-interests-in-Hong-Kong-Cable-&-Wireless-1991 — Page 133

CONFIDENTIAL

CLARIFYING OPTIONS FOR

LOCAL TELEPHONY IN HONG KONG

Appendix to Annex C

McKinsey & Company, Inc.

EXECUTIVE SUMMARY

The Hong Kong Government, in its review of Hong Kong's telecommunications

policy, is considering whether to allow the introduction of a second fixed-link local telephone network when the Hong Kong Telephone Company's (Telco's) current exclusive franchise to provide basic local telephony expires in 1995. Hong Kong Telecom has asked McKinsey & Company to provide an independent perspective on the facts and potential issues involved with the creation of a second network.

Our findings show that Hong Kong already has one of the world's most advanced and efficient local telephone services; there is limited opportunity for competition to materially improve the quality or price of these services; and active competition in non- franchised local services (e.g., mobile, value-added and data) exists today, and can be further stimulated by the Government without the creation of a second fixed-link network.

Also, because of the high cost of constructing a second local network, such a network will be viable only with some form of subsidy and/or increased tariffs, raising questions about the economic justification of support to a second local provider.

Furthermore, Hong Kong's approach to a second local network is unique. No country has considered introducing competition in local telephony only. Rather, local competition has been permitted in a few countries as part of broader deregulation. Where a second local network has been allowed, competitive response has been very limited and has focused on serving high-volume users who can provide the revenues needed to offset high installation costs. Similarly, in Hong Kong, a second network would be a very limited one and would benefit large businesses, at the expense of most residential and small business customers who are likely to pay higher tariffs for local services.

Thus, introduction of a second network raises fundamental issues for Hong Kong's policymakers regarding the true benefits of local competition and the costs to different sectors of introducing a second network. Specifically:

CONFIDENTIAL