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Published by Core Research

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Published by: Core Research on Jan 09, 2009
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Dr. Stephen P. King
Competition and Regulatory Policy Program
Center for Economic Policy Research
Research School of Social Sciences
Australian National University


Before discussing appropriate methodologies for pricing access to essential
infrastructure facilities, it is necessary to answer some preliminary questions.
First, why do we care about infrastructure access? Secondly, even if we care
about access, why should we care about the price charged for access services?
Thirdly, what basis should be used to determine whether one set of access
prices are better or worse than another set?

Infrastructure access, through both the new Part IIIA of the Trade Practices
Act 1974, and the Competition Principles Agreement, provides a solution to

the 'essential facilities' problem.1While much of National Competition Policy
involves the removal of barriers to competition, there may be circumstances
where competitive production is inefficient. If production involves
increasing-returns-to-scale technology, or more generally a natural monopoly
technology, then it is always more efficient to have only a single firm or
facility involved in all relevant production. In such circumstances,
competitive production will lead to excessively high costs and a waste of
social resources.2

However, the existence of natural monopoly technology does not immediately
imply that there is a problem with competition. While competitive production

of the relevant good or service (which may itself be an input into further
production) is wasteful, the owner of an unregulated natural monopoly facility
may be constrained by competition from other products. If the good or service
produced by a natural monopoly facility is merely one of a number of products
that are reasonably close substitutes then there may be little or no scope for
monopoly abuse.

As an example, consider residential gas distribution. It is reasonable to
suggest that such distribution involves a natural monopoly technology.
Production costs are likely to be minimised if each house is serviced by only a
single low pressure pipeline controlled by one firm. Efficient production
dictates that gas distribution is controlled by a monopoly service provider. If
gas is simply one product in a larger market for "fuels and energy sources",
then retaining an unregulated monopoly gas distributor may provide little
concern. While gas distribution involves a natural monopoly, the owner of the
gas distribution network will have little or no monopoly power if other fuel
sources, such as electricity and oil, provide ready substitutes.

In contrast, if there exists a separate gas market, where consumers have little
ability to substitute between fuel sources, then the existence of natural
monopoly technology in gas distribution may raise significant concerns.3

A firm with natural monopoly technology only creates regulatory problems if
it either has substantial power in a final product market or if it provides an
essential input to either upstream or downstream production processes. It is
this latter case which leads to the 'essential facility' problem

An essentiality facility involves two distinct characteristics. First, the relevant
product involves a natural monopoly technology, so that it is always socially
efficient to have a single producer. Secondly, the product is essential to final
market production. The product must be essential to the manufacture of
another good or service in that there does not exist an alternative input or
production process that can enable a competitor to produce an equivalent final
good or service at a comparable cost. In addition, the product is only essential
if there does not exist an alternative final good or service that is able to be
supplied at a competitive price without that input.4

Essential facilities provide a problem for policy makers. Allowing
competition in the provision of the natural monopoly product may lead to
socially wasteful facility duplication. At the same time, in the absence of any
effective competition, a firm that controls an essential facility will be able to
exercise considerable monopoly power, to the detriment of consumers and
economic welfare.

The Hilmer Report approached the essential facility problem by
recommending a regulated access regime. If a facility produces a service
which is both characterised by natural monopoly technology and is essential to
competition in another market, then the owner of the facility must allow other
firms access to that service. This recommendation formed the basis of the
access regimes included in the Trade Practices Act and the Competition
Principles Agreement.5


Requiring access, by itself, is insufficient to prevent the owner of an essential
facility from abusing his market power to reap monopoly profits. While
access will aid entry into relevant downstream or upstream markets, the
facility owner will be able to seize all available monopoly profits by choosing
appropriate pricing schemes for access.6

For example, consider the case of an infrastructure owner who controls an
essential input for downstream competition. If the infrastructure owner is
required to provide access to other firms, then he can no longer monopolise
the downstream market. But this does not mean that the owner need forego
any monopoly profits. Rather than reaping monopoly profits directly from the
downstream market, the facility owner can simply seize those profits upstream
by setting appropriate access prices. If he believes that there will be many
firms seeking access, resulting in strong downstream competition, then the
facility owner merely needs to charge a sufficiently high price for access to
garner all available profits. If he believes that there will only be weak
competition downstream, then the facility owner can lower the per unit price
for access to encourage downstream price competition while seizing all
available profits by charging each access seeker an appropriate upfront fee.

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