CONFIDENTIAL
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sustained because Hong Kong Telecom International (HKTI) shares part of its revenues with Telco for the international calls that Telco's customers generate. A second network would likely seek a revenue-sharing arrangement comparable to Telco's and, unhampered by a universal service obligation, would focus on Telco's largest customers, such as hotels and financial institutions, which generate significant volumes of international calls. It would attract these customers by offering them rebates on international calls. Moreover, a second network probably would limit its geographic coverage to portions of major business districts, such as Central, Wan Chai, Causeway Bay, and Tsim Sha Tsui, and would not offer services to residential and small business customers in these areas or elsewhere in Hong Kong. Thus, a second network would in effect offer competition in international calls to a limited number of users, and would not result in much competition in local telephony.
Contrary to expectations, local tariffs are highly likely to rise significantly as a result of competition. Because of high investment costs, a second network would not be viable at today's local tariff levels, even if it received a share of international call revenues similar to Telco. It would therefore seek to offer local services at higher tariffs. At the same time, Telco would be forced to replace international revenues lost to the second network by increasing local rates to bring them more in line with the costs of providing service. Moreover, to retain its largest customers, Telco would have to match any discounts offered by a second,network on international calls. Under this scenario, local rates would have to rise by as much as 51% (see Exhibit 11). If Telco were not allowed to increase local rates, its profitability would decline, putting at risk its commitment to invest substantial shareholders' funds - as it has in the past - in Hong Kong's telecommunications infrastructure.
Furthermore, while large businesses would likely benefit from a second network, they would do so at the expense of residential and small business users. As explained above, the introduction of a second network would necessitate a substantial hike in local rates. While large business customers would be compensated by rebates on international calls, residential and small business users would face big increases in their telephone charges. Given that a second network would not receive a franchise till 1995 and the time required for network construction, most of the tariff increases would need to be implemented after 1997.
McKinsey & Company, Inc.
CONFDENTIAL
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