AmCham arrow Publications arrow Topics Archive arrow Topics Archive 2005 arrow Vol.35- No.4 arrow The Call for Change: Where the Industry is Headed
The Call for Change: Where the Industry is Headed PDF Print E-mail

Telecom specialist C.K. Mao offers his views on the direction of the market and the challenges being faced.

BY DON SHAPIRO

 

C.K. Mao, who previously served as chairman of Chunghua Telecom and as Vice Minister of Transportation and Communications, is now a professor at National Chiao Tung University's Institute of Business and Management. Regarded as one of Taiwan's leading experts in the telecom field, he was interviewed for Taiwan Business TOPICS by Don Shapiro.

TOPICS: How do see the future of the fixed-line business in Taiwan?

MAO: Over the past decade, the fixed-line business worldwide has been challenged by the advent of mobile cellular service. In less-developed countries, fixed-line penetration in the residential market stopped growing. In the more developed countries - including Taiwan, where there are almost two phone lines per household - there was no loss of penetration, but traffic began shifting from fixed to mobile. In both developed and developing countries, in terms of the volume of traffic, growth in the cellular market is much higher than for fixed. So the fixed telecom empire basically started to erode.

And most recently the fixed-line market started to experience another challenge - and to me it's even more severe - and that is the taking off of the Voice Over Internet (VOIP) phone business. Because systems such as Skype apply the so-called P to P [peer to peer] strategy, they don't have to install their own networks or pay anything for their bandwidth to provide their service. Anyone can download the Skype software, and then use it on top of ADSL. Skype users might use your PC as a relay station to reach other Skype users, so in a way it is a "virtual network." And Skype also tries to use the existing instant-message users as their customer base, so its market penetration is very, very fast. In Taiwan alone, we are seeing about 400,000 downloads of Skype software and about 200,000 actual new users every month. Once people start to use VOIP, it means the fixed side is losing business. It's even more of a threat than cellular, which can be looked on as kind of complementary, especially in the developed markets. But once VOIP starts to get popular, it's a real substitution, and the revenue from fixed voice service will evaporate. The real beneficiary is the customer, but to the carriers it will really be a disaster.

And VOIP is just one kind of content service on top of the broadband network. These days, once you have the bandwidth access to the network, then you can have many, many types of content, and in a way voice is becoming just one of those free content services. The carriers, like it or not, have to accept this change in paradigm.

Going forward, there is even a further threat to the survival of the fixed operators, and that's the emergence of wireless technology. Until now the most mature wireless technology, the so-called WiFi or wireless LAN service, has lacked the real power to replace fixed service on a large scale. But the coming wireless technology, the so-called WiMAX - or I would rather call it WiMAX-like - will be far more powerful, with bandwidth to user of as high as 75 mega and base-station coverage of around 50 kilometers. A number of technical barriers still need to be resolved before WiMAX is a truly commercialized technology. But if it becomes mature, then it means that a very high bandwidth but low-cost technology is available in the market. It will pose a direct threat to ADSL.

In Taiwan, ADSL penetration is very high - some 60% to 70% of households. The bandwidth is up to 1 to 2 mega. Before I left Chunghua Telecom, I already reminded my colleagues that ADSL is not for ever - certainly more powerful technologies are on the way - so I encouraged them to spare no effort to convert their ADSL subscribers to fiber subscribers. Fiber can be brought to the households using a technology called "fiber to the building," and once in the building you can use an Ethernet-type of technology through the exchange so that every household can enjoy double-digit mega bandwidth. Once the carrier has this kind of penetration to the market, it's for good. Fixed carriers had better have this kind of deployment before WiMAX-like technology becomes mature and commercially available. The time to the maturity of more powerful wireless technology is not too long - maybe three to four years. If fixed-line operators globally don't take effective measures to meet this challenge, they might be history. The whole landscape of the industry will change.

For the fixed operators, if they are incumbent, fiber is the only solution. I tell the private fixed operators in Taiwan that the day is coming when they should make a choice - whether to take a position like an incumbent to defend the traditional fixed market or rather to take a disruptive innovator's position to challenge the traditional fixed technology with a more powerful wireless technology. By that time, the wireless technology should be already mature. If I were them, I would take the latter position, because their stake as a fixed operator is not that big.

For CHT and maybe a majority of the incumbents around the world in developed countries, fiber deployment already is up to what is called "fiber to curb" - not yet in the building, but close, certainly less than the last mile. They should do everything possible to take the last step forward to get into the building. "Fiber to the desk" is too expensive, but once you get into a high-rise metropolitan apartment building you can use a router to direct it into 50 household units, which can share the cost. This next-generation wireless technology - entailing little capital expenditure, even less operating expenditure, but very high bandwidth - should be good news for the new fixed-line entrants. It may be a disaster to the incumbents [in each market], but to the newcomers, it could be a good opportunity.

TOPICS: Is the regulatory environment conducive for development of Multi-media on Demand?

MAO: The general trend is that bandwidth is getting larger and larger, whether through fixed or wireless technology. The issue for consumers and operators then becomes how to use the bandwidth. At this time, unless we think about transporting cable-TV video programs onto the broadband telecom network, it's hard to think of any other way to use that bandwidth. That raises a related issue, which is the convergence of cable TV service and broadband telecom service. Taiwan's situation may be unique in the world. The number of cable TV channels is one of highest in the world, with more than 100 channels to choose from. But in terms of quality, it's not that great. That can be attributed in part to the regulatory regime, because the cable TV companies are limited to a very, very small area. The average cable-operator subscriber base is only about 50,000 to 100,000, which limits their revenue potential and therefore their capacity to invest to upgrade their system. Until now, the only pricing mechanism they can apply is a flat-rate charge, giving them insufficient incentive to provide high-quality service. If you could charge on a per-view basis on top of the flat rate, then you'd have incentive to improve the content.

TOPICS: Why are the regulators reluctant to allow flexible rates?

MAO: It's political. Because those cable operators are very influential in their local areas, they're a kind of vested interest group. They aren't necessarily satisfied with what they've got at this moment, but comparatively, if any people propose an institutional change - changing the boundaries, allowing people into the market, encouraging M&A activity - they might consider that at as a threat [to their business]. They know the game they're playing now, and don't want to see any change in the rules, so politicians consider this a taboo area. But it's really unfortunate, because the cable situation also creates a barrier for development of the broadband telecom network system, making it very difficult to approach the content providers for cable in Taiwan. The content provider or distributor is easily held hostage by the cable operator, who says "don't do business with [the telecom operators] or I'll boycott you." The content agent will [do the math on the number of viewers and potential revenue and shy away from what looks like] a very uncertain and small market.

Broadband telecom operators trying to provide good programs for their new platform face a very hard time. In the Taiwan market, if we really want to have very prosperous broadband digital content, we have to solve the cable regulation and the broadband telecom platform regulation problems simultaneously. You can't only look at the telecom side and leave the cable side alone. Government needs to carry out extensive cable regulatory reform, to provide a much more modern and healthy regulatory regime. For instance, Taiwan's cable system probably should be merged eventually into two or three big companies, since only that kind of scale will get the investor interested to upgrade the system. Then we can have two different technology platforms - a digitized cable system versus broadband telecom - competing with each other [on a relatively equal footing].

TOPICS: What will be the impact of CHT privatization?

MAO: By definition, privatization means the government's share becomes lower than 50%. From a business point of view, I wish that once the government share is lower than 50%, the government can really leave the company alone and allow it to operate totally on a professional basis. Respect the market, let the management decide how to run the company, and avoid any government intervention in the operation. That's my wish, but in reality it will be very difficult to achieve unless the government is 100% divested -zero ownership. In many countries all government shares were eventually sold out, but in Asian countries the government mentality in most cases is still to consider telecom as something related to national security.

So post-privatization, to what extent and in what way government is still going to intervene is an important consideration. If the government could follow the mentality of institutional investors in the international capital market, that would be a good model. International institutions take a position that as long as you're making money, as long as you're doing a good job, they support the management. This is something we should emulate. no dispute about it."



Mobile Market Enters Maturity

Consolidation has left three roughly equal players in competition, and their focus is now riveted on revenue rather than merely gaining subscribers.

BY TIM CULPAN

There once was a time when the worldwide telecom industry marveled at the miracle of the Taiwan mobile market. Taiwan was known for its fast growth, high penetration rate, and sophisticated consumers. But more recently, something else has appeared in the market. Maturity. Gone are the days when loads of new subscribers were signing up every month, and operators were cutting prices in bitter price wars aimed at stealing market share and inflating subscriber figures. "Service revenue is a more important statistic," says Jan Nilsson, president of Far EasTone.

In the calmer times of 2005, that may seem like an obvious statement, but it wasn't always so. During the heady days of Taiwan's cellphone boom, one operator was giving away a second phone number to new customers, just to inflate subscriber figures. Another was selling phone numbers by the hundreds, for similar reasons.

Today, the market is divided into roughly equal thirds. Chunghwa Telecom remains strong due to its former telecom monopoly position, Far EasTone has caught up in terms of market share thanks to its merger last year with KG Telecom, and Taiwan Cellular has purchased TransAsia and Mobitai. That reduces the market to just three operators - not counting PHS (Personal Handy Phone) operator FITel and 3G (Third Generation)-startup Asia-Pacific Broadband Wireless. This roughly equal division, and overall market maturity, has lead to a detente among operators.

Price wars are no longer the key tool of competition, and marketing managers have all but stopped boasting of subscriber numbers. For Jim Wilson, who led the start-up of southern-based TransAsia before departing and then returning to Taiwan years later, the contrast is stark. "When I left Taiwan, we were fighting for new customers. When I came back, we were fighting for existing customers," says Wilson, who early last year became Chief Business Officer at Taiwan Cellular.

That "fight" recently appears to have become tamer, almost gentlemanly, as each company deals with its own internal problems - two have mergers to digest, one has shares to sell. They're also busy tinkering with strategy. Says Nilsson, another returnee who took over the helm at Far EasTone in September 2002: "What I discovered when I came to Taiwan is that no one had made any claims on brand - subscriber numbers and costs were the claims. So FET embarked on a systematic approach to building brand."

Taiwan Cellular and CHT have done the same, launching sub-brands for their services and call plans aimed at building awareness and loyalty among consumers. Key among the sub-brands has been each company's non-voice offerings. But the Taiwanese penchant for the Internet and mobile phones has failed to translate into spending on mobile Internet. High-tech cellphones now come with built-in cameras, GPRS, multi-media messaging (MMS), Java, and WAP. But all that gee-whiz technology has done little to change the fact that more than 90% of cellphone usage (by value) is to make humble phone calls.

Taiwan Cellular's Wilson says that, in fact, Taiwan is not so different from comparable markets in its failure to tap non-voice revenue. Taiwan Cellular's non-voice revenue stood at 4.8% for 2004. "I agree that Taiwan is not as energetic about this as we would have expected, and we haven't been successful in creating the energy needed," says Wilson.

Moving into branding

"It's our own fault as operators," notes Nilsson, who puts his company's non-voice revenue at around 8%. His point is that the operators had pretty much left the branding arena to the handset makers. Users tend to choose a handset by brand, but they choose a carrier not by brand but only price. The result is that when it comes to status, image or other intangibles, the handset is what matters, not the operator. In general, customers first choose a handset, then they shop around for the best deal from the operators, and only after that might they decide to see what they can actually do with the handset. That decision matrix leaves content low on the list of must-dos for consumers. "The key is changing the order of the decision-making sequence," says Nilsson.

Ironically, it was Nokia that has helped operators to wake up and take matters into their own hands, not just in Taiwan but globally. The launch of Club Nokia, a mobile content business, was an incursion into what operators felt was their turf, and they started to take a more aggressive stance in response.

The current marketing push sets the operators up to tackle two of the biggest changes due to face the industry in the next year. Call-number portability and 3G have both been hyped as revolutionary developments for the telecom market. But in fact, operators are not greatly excited by either, and are even bemused about their implications. "The worldwide experience is that it's a non-event...a huge exercise in musical chairs," says Jim Wilson of call-number portability.

Under new Taiwan government regulations expected to go into effect later this year, operators will have to allow customers to keep their existing phone numbers while shifting to another carrier. The rationale is that the desire to hold onto a phone number may prevent customers from switching carrier. But in most cases the net gain-loss in subscribers for each operator is negligible, while the costs of implementation are heavy.

As for 3G, with the hype of sky-high European license fees now over, the industry is being more cautious about what it will mean. At the height of the bubble, European operators got into fierce bidding wars for 3G licenses, believing that 3G would be a big hit among consumers and that profits would follow. But so far, those dreams have not coincided with reality. In Taiwan, the failure of non-voice revenue on current 2G and 2.5G networks helps put the prospects for 3G into perspective. Just consider this statistic: a mere 55,000 of Taiwan Cellular's 4.8 million subscribers used MMS over the entire month of January. Only 1.5 million used the far more pedestrian SMS text-message service. "The only point to build 3G is for non-voice traffic," notes Far EasTone's Nilsson. But voice remains the bread and butter of the cellphone industry, and history has so far proven that a faster network means little to the consumer. "There are a few 3G services you can't offer on 2G...but we're not expecting a major uptake," says Nilsson.

With this summer as the likely launch period for most 3G networks, the excitement is conspicuous by its absence. The only 3G network to launch so far, Asia-Pacific Broadband Wireless, has struggled to make a splash despite a heavy marketing effort. The launches of 3G networks from CHT, Taiwan Cellular, and Far EasTone are likely to be a boon to ad agencies and equipment vendors, but for the operators and even the customers, not much will change.

No frenzy for the launch of a new technology in tech-savvy Taiwan? Now that's maturity.



Why-fi?

Everyone seems to want to build a WiFi city. But dreams and reality have a habit of colliding.

BY TIM CULPAN

A WiFi conference held in Taichung last December serves as a good illustration of the potential highs and lows of Taiwan's ambitions for building a WiFi island. The conference was sponsored by the Industrial Development Bureau of the Ministry of Economic Affairs, which is spending big bucks to make Taiwan a wireless paradise. It is farming business out to contractors who then get to work on both the hardware and software aspects of wirelessly connecting each specific geographical area. Overall, Taiwan's cabinet has allocated NT$37 billion (US$1.15 billion) to be spent on such projects before the end of 2008, with its eye on big international cities as a benchmark for success. "The wireless project is one of the most important in Taichung," notes one cabinet official.

But exactly how each city deploys and uses a wireless network makes an interesting case study. Speaking at that conference, Chi Chao-yin, research manager at the semi-governmental Industrial Technology Research Institute (ITRI), outlined examples of how and why North American cities are deploying WiFi networks. In New York City, for example, the government is spending up to US$1 billion to roll out a two-phase Mobile Wireless Network. The Phase-1 pilot will get underway this year and take 12 weeks to complete - with the goal, Chi points out, of at least 95% and preferably 99% in-street coverage throughout the city. That scope of coverage is similar to the goal for Taichung, and for Taipei City as well.

Many other municipalities around the globe have similar aspirations. "They all want to build WiFi cities because they want to build a new image by providing WiFi access," says Chi. In New York, a key aim of WiFi deployment is to support police and emergency services personnel, with a wireless "Automatic Vehicle Location" service among the scheduled offerings. Wireless call boxes for emergency services, as well as wireless traffic signals, are part of the aim. Throughout the United States, in fact, the prevailing theme in almost every major city that's looking to build, or has already built, a WiFi network, is crime fighting and disaster recovery.

In Taichung, Taipei, and elsewhere in Taiwan, such police and emergency services barely factor in at all. The reason seems to be the differing cellphone penetration in the two countries, as Taiwan's far outstrips that of almost any U.S. city. A wireless emergency call system is far more compelling when not every citizen is carrying a cellphone. "There's a digital divide, and wireless applications can provide the last mile to bridge that," says Chi.

Instead of the emphasis on police and emergency needs, Taiwan appears firmly focused on the leisure industry, and with giving consumers another outlet with which to connect with their notebooks to get online. In Taichung, for example, the government is aiming largely at tourism and local information services. Local businesses will be invited to join the network, and tourists will be able to borrow PDAs to guide them around the city.

Perspectives on wireless

To many in the industry, a key notion is that WiFi and broadband work well together, and that WiFi is an important part of making broadband compelling. Says Bobby Chen, president of the Cable Broadband Institute in Taiwan: "Broadband network has a bright future, [and] wireless broadband is an especially important part of the infrastructure." But from a wider perspective, WiFi is just one more wireless technology to add to the myriad technologies already in existence today, from infrared to microwave. For all of WiFi's benefits and potential, none of the leading cellphone providers in Taiwan seem particularly perturbed or threatened by the competing technology. Their consistent response to questions about WiFi is that it's merely another technology, and it will have its place alongside current and next-generation networks.

According to IDC, a leading IT and telecom market intelligence and advisory firm headquartered in Framingham, Massachusetts, the worldwide WLAN (WiFi) equipment market will hit US$3.5 billion this year. Despite the growth to date, the forecast globally is still very strong, with IDC predicting 33% average annual growth from 2003 to 2008. "The key here is that the dynamic of the market is changing," says Dominic Grant, telecoms and hardware analyst at Macquarie Securities in Taipei. "The proliferation of laptops and mobile devices is moving WiFi from being hotspot-oriented, to more of a network and integrated service model." The new approach is to combine fixed line and wireless in what is known as a "hybrid" network.

But if the trend is toward larger planned and coordinated networks, what is the plan? Wireless Internet Service Providers or WISPs have already sprung up around the world, and in Taiwan a handful of them, including some owned and/or operated by traditional fixed-line or wireless carriers, are battling it out for market share.

"Using a hybrid network will be the most beneficial approach," says Simon Hsu, research manager at Topology, a Taiwan research company. "In Europe, most hotspots can't attract enough traffic to make money," he notes. "In cafes, it's difficult to make money because there's no immediate need for Internet access." Airports have proven to be the best location, since travelers are by necessity sitting around with time on their hands - and tend to appreciate Internet access for emailing or other purposes.

But for WiFi, "there is no killer app," says Hsu. "It's still basic communications such as email and Web surfing." Perhaps there is no killer app, but how the customer will use a WiFi service must be taken into account. "When considering WiFi, you really need to think about convergence and how the different technologies can fit together," says Eric Lin, a research manager at Taiwan's Market Intelligence Centre (MIC). "The key is to target the customer and their needs."

Adding an add-on

A common model being deployed in Taiwan is WiFi as an add-on to an existing service (though for state-owned Chunghwa Telecom it does not exactly represent an add-on, since subscribers are charged full price whether they are already a CHT customer or not). In Taichung, for example, cable-TV and Internet provider Taiwan Broadband Communications (TBC) is considering adding WISP to its buffet of services. Under the model, broadband ISP customers would automatically get access to the company's WISP hotspots dotted around the city. Eastern Multimedia has also advertised a similar bundle, and most cable and Internet providers are expected to come out with one formulation or another of this model.

One advantage enjoyed by companies such as TBC is an existing network backbone throughout the city, removing the need to access the incumbent operator's network and pay the associated costs that go with it. "If you have to run out and ask Chunghwa for a leased line every 200 meters, then that'll really kill you," says Heinz Knoedlseder, CTO at TBC. While "vanilla" ISP services are one part of TBC's approach, the company is also on the lookout for local partners that could leverage the benefits and characteristics of a WiFi network. "We need partners who have WiFi-specific applications," says Knoedlseder.

One continuing challenge for WiFi is the inherent limitation in coverage. "If you don't have good indoor coverage, which you can't do with current WiFi standards, then users won't take it up," he says. And therein lies the greatest strength and weakness of WiFi to the Taiwan market. For it to be totally widespread and usable, it needs to have the strength of being reliable and robust. Yet its open standards, limited power, and symmetrical transmission power (meaning receiver and transmitter are of similar power) are inevitable curbs on how far it can spread. "The critical issue is pricing," notes Joseph Lin, vice president of GSM operator MobiTai. "The problem is that WiFi coverage is not extensive, so in the end it's too expensive to use."

Those that have gone all the way and built WiFi ISPs are adapting the standards to suit themselves. There's nothing to say, for example, that WISPs must buy standard off-the-shelf products when they can tailor the technology to their own needs. "We developed our own access points in order to run our business- we didn't just use off the shelf APs," says Joy Huang, vice president of Easy-Up, a Taiwan WISP.

For the government's part, the massive budget being thrown at WiFi is not about turning municipal governments into WISPs. In fact, they're merely being used as the guinea pigs. "I would be very grateful if manufacturers could get some leverage from our wireless Taiwan project," says Roger Cheng of ITRI's Computer and Communications Research Laboratory. Put another way, the government is hoping that it can leverage Taiwan's position as a manufacturing leader to turn the entire island into a test bed for technological development.

In the end, all the potentials and pitfalls of WiFi for the Taiwan market can be summed up by that afternoon conference in Taichung. The event was held to promote the virtues of making WiFi accessible to all Taichung residents, and to announce how it would be accomplished. The reality: In a room full of industry leaders, supposedly those who understand and care the most about WiFi, fewer than 10 laptops were in use, and the WiFi network itself was so unreliable as to be rendered useless.

WiFi City? A WiFi room is still a stretch. But at least now everyone's talking about it.



Taiwan Remains Ahead of Many Markets

Taiwan is "probably one of the most dynamic markets we have in the Asia-Pacific and around the world" - and will continue to be at the forefront of new market developments, said Christian Gregoire, Alcatel's senior vice president for the Asia-Pacific region. A leading international supplier of telecom equipment and technology, Alcatel has been active in the Taiwan market for three decades.

Gregoire, based in Shanghai and a frequent visitor to Taiwan, referred to three major trends that will impact telecom business developments worldwide in the coming several years, with Taiwan perhaps "a bit in advance" of many other markets: 

* The development of "triple-play" services, meaning the offering of voice, data, and video services through the same platform. Multi-media on Demand is considered a first step in this direction. One of the challenges now facing Chunghua Telecom (CHT), said Gregoire, is how to best position itself to become a highly competitive triple-play provider.

*The convergence of fixed and mobile services. Mobile devices, for example, could connect to a fixed network (via radio transmission, Wi-Fi, or a technology such as Bluetooth) whenever the user is close to such a network. Interoperability will make it convenient for consumers to access a multitude of networks with a single device.

*The introduction of "managed services,"provided by telecom operators to their enterprise customers, especially among small and medium-sized companies. Instead of the enterprises having to make heavy IT investments, the carriers will host applications and services that they can take advantage of.

Gregoire said the mobile telephony market in Taiwan is "quite unique" in that the three main players have roughly the same market share. "That makes the competition extremely strong" and means that they "have to look for ways to differentiate themselves in the market," he noted. He sees the move toward 3G as progressing strongly. Japan may be a year and a half in advance of Taiwan, but in his view the gap between Japan and most of the rest of Asia is more like three years.

For the fixed-line business, which is under pressure to provide higher bandwidth, Gregoire predicts that Taiwan will be even faster than Japan in bringing fiber connections close to the user over the next several years. He has found that companies in Korea and elsewhere in the region are paying close attention to CHT's plans for fiber deployment.

Taiwan will also be an important market for the emergence of the wireless broadband solution known as WiMax, said Gregoire. He sees it as complementing ADSL on the fixed side and 3G deployment on the mobile side.

For Alcatel, Taiwan has been an excellent market, said Gregoire. Although "there are more opportunities than pitfalls," one negative he cited has been the awarding of some major contracts purely on the basis of low price. Some vendors, after winning the bid with what Gregoire called a "dumping" price, were unable to execute the project properly and exited the market. In contrast, he said, Alcatel is continually investing for the long term.

Currently Alcatel is partnering with Microsoft to carry out a showcase project in the United States for SBC Communications (formerly Southern Bell). Known as Project Lightspeed, the plan aims to deliver triple-play services (integrated IP television, ultra-high-speed broadband, IP voice, and wireless bundles of products) to 18 million households by the end of 2007. Alcatel and Microsoft are worldwide strategic partners, said Gregoire, and will continue to team up on other projects.



The Need for Accounting Separation

Telecommunications regulators need a tool for ensuring transparency, fair competition, and continued liberalization in the market.

By NIGEL MUKHERJEE AND JASON WANG Over the past decade, governments and regulators have achieved tremendous strides in liberalizing the telecommunications market. Once dominated by vertically integrated incumbents, the global telecommunication market has seen the rise of full-service and niche players, allowing consumers to enjoy a range of wireless, PSTN (analog), and IP-based services. With the advent of "triple-play" - the offering of voice, data, and video services through one pipe - convergence has brought an even wider range of services as the line between telecommunications and broadcasting becomes further blurred.

Given all this change, it is tempting but erroneous to assume that merely the introduction of new operators places adequate pressure on the incumbents. In fact, incumbents continue to possess a range of means to frustrate the regulatory objectives and render new entrants ineffective. Incumbents, for example, can use their "Significant Market Power" to engage in such anti-competitive activity as cross-subsidization of services, prices set at unsustainably low levels, and wholesale services priced on a discriminatory basis to prevent the establishment of a market competitor. While provisions against such behavior exist in nearly every regulatory regime, they count for little if a regulator lacks the evidence on which to act. Globally, "Accounting Separation" is the mechanism-of-choice used by regulators to obtain the necessary information to ensure a competitive landscape.

Accounting Separation is the means of analyzing the constituent parts of an integrated business as if they were a set of stand-alone companies, thereby providing transparency. It is a disaggregation of the group financial statements to determine income statements and balance sheets at business-unit level. As a financial overlay, it doesn't require the legal separation that is applied to fixed and mobile service operators.

An incumbent fixed-line operator like Chunghwa Telecom or British Telecom will need to keep clear and separate accounts for its various retail businesses (such as local, national, and international calls) and a range of network services (including call origination, transit, and termination). For mobile operators there is less emphasis on retail services but recognition that termination is a monopoly requiring network costs to be analyzed properly and regularly.

Implementing Separation

Disaggregating financial statements into the constituent business units is a complex but not insurmountable exercise. Cost drivers are identified for all costs, as the allocation differs depending on whether they are direct, indirect, or fixed-asset costs. Operators commonly raise questions as to how network costs are allocated to different services. This process is performed by breaking down the network into its constituent "building blocks" and then understanding the relationship among "building blocks" via their routing factors. Lastly, traffic data is used to allocate building-block costs to different services.

Once the transfer prices have been determined, network business-unit revenues appear as part of the cost of the retail business. Here it is essential to ensure that all services normally appearing in a competitive operator cost base are reflected in the discrete accounts (for example, the mobile division of an integrated operator should be charged for the leased lines used for backhaul and the rental of space for antennae).

It is important to note that all costs must be allocated, with the provision of data showing full reconciliation between separate business accounts and statutory group accounts. While some data may not be available, it is acceptable to use proxies as long as they are explicitly noted. The use of proxies does not undermine the exercise, but merely highlights where further effort is necessary to improve clarity in the near future.

Finally, transfer prices must be established between business units. Since Accounting Separation is a financial overlay, it introduces internal interfaces where none would naturally exist (for example, a network business selling to a retail business). In determining transfer prices, the regulator must try to simulate the competitive outcome of businesses contracting on an arm's length basis. Notably, since the very reason that Accounting Separation is required is the existence of Significant Market Power, it is rarely possible to obtain benchmark data from contract information. Thus, the appropriate solution is to introduce cost-based charges, including allowances for the cost of assets used and a fair return.

Proportionality is the key defining principle - the level of detail requested by a regulator must always be proportionate to the risk that a market position will be abused.

Regulators must respect the fact that compliance imposes a cost on an operator. While Taiwan's current accounting separation requirements are non-mandatory and ill-defined, excessive requirements are just as bad as inadequate ones. The Taiwan government can find a number of well-established models in the European Union.

No need for complexity

Operators frequently argue that Accounting Separation is too difficult, expensive, and time-consuming to implement. That is erroneous. Implementation of an Accounting Separation framework does not require complex IT systems to be effective, nor does it need an army of accountants to execute. In fact, all Accounting Separation exercises around the world start with spreadsheets for speed of implementation, transparency, and flexibility. Through the use of spreadsheets, an operator better understands its requirements from a technical and user-management perspective, resulting in a quicker ROI and lower total cost of ownership for their ERP investments.

Accounting Separation facilitates internal transfer pricing, which is highly useful for telecom operators seeking to control their costs. The operators also benefit from increased internal transparency of operations, as the exercise serves as an impetus to drive clarity and accountability within their organizations, something that all Taiwanese operators can benefit from. The Accounting Separation manual that operators are required to produce not only ensures consistency in interpretation by the regulator but also provides a set of Standard Operating Procedures for the companies' staff.

The regulator, whether it is the current Directorate General of Telecommunications or the future National Communications Commission, must not be deterred from implementing well-defined Accounting Separation requirements. Nor should it be afraid to demand that operators produce a manual audited by an experienced internationally respected accounting firm. Implementing the system is inevitably a learning process for both the regulator and the operators. Concrete progress can be ensured by setting demanding targets while accepting that data will need to be steadily refined.

Accounting Separation provides clarity in the market and the evidence necessary for a regulator to take prompt action. The regulator can ensure that the transfer prices between separate business units of an incumbent are applied equally to third parties, thus eliminating any unfair advantage for in-house retail-service providers.

Accounting Separation also allows the regulator to monitor the rate of return earned by the operator on the capital employed in each of its businesses. By providing the first indication that the operator may be exploiting its position unfairly, this helps prevent operators from exceeding a fair cost of capital.

Fundamentally, Accounting Separation provides the essential data to ensure that steps to a liberalized competitive market continue to be realized. The regulator must not shirk from the political challenges of implementing a framework that promote transparency and a level playing field, the bedrock of sustainability for any growing economy.



Nigel Mukherjee and Jason Wang of PricewaterhouseCoopers are practice leaders in the firm's Greater China Technology, InfoComs & Telecommunication (TICE) Practice.
 
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