Product-Market Competition in the Water Industry: Voluntarily Nondiscriminatory Pricing


Product-Market Competition in the Water Industry: Voluntarily Nondiscriminatory Pricing

Reto Föllmi and Urs Meister

2002

Institute for Empirical Research in Economics
University of Zurich

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Institute for Empirical Research in Economics
University of Zurich
Working Paper Series
ISSN 1424-0459
Working Paper No. 115
!rod%ct()ar+et .o/0etition in the 4ater Ind%str78
9ol%ntaril7 Nondiscri/inator7 !ricing
Reto FGllmi and Urs Meister
May 2002
!
Product-Market Competition in the Water Industry:
Voluntarily Nondiscriminatory Pricing
#eto ‘oe((mi+ ,rs /eister++
/ay !23 4554
67stract
9:is ;a;er ;resents an attem;t to create com;etition in t:e =ater mar>et 7y means o? @irect
com;etitionA Be argue t:at t:e usua( (i7era(isation @evice3 com;etition !”# t:e mar>et 7y
?ranc:ise 7i@@ing3 is ;ro7(ematic @ue to t:e ;articu(ar ?eatures o? t:e =ater in@ustryA Fur
a;;roac: ;ro;oses t:e im;(ementation o? ;ro@uct mar>et com;etition3 iAeA com;etition $%
t:e mar>etA Gn suc: a situation severa( =ater uti(ities using a sing(e set o? ;i;es com;ete ?or
customers in t:e same areaA Hince t:e =ater in@ustry is o?ten c:aracterise@ 7y (oca(
net=or>s3 =e consi@er a sim;(e mo@e(3 =:ere com;etition is intro@uce@ 7et=een vertica((y
integrate@3 neig:7ouring =ater su;;(iers t:at connect t:eir net=or>sA
Iven =it:out any regu(ation3 =e s:o= t:at: KiL 6n ine??icient incum7ent =i(( give u;
its mono;o(y ;osition an@ (o=er t:e access ;rice ?ar enoug: so t:at t:e (o=Mcost com;etitor
can enter :is :ome mar>etA KiiL I??iciency o? ;ro@uction =i(( rise @ue to (i7era(isationA KiiiL
Gn contrary to ;reNu@icia( c(aims3 investment incentives are not @estroye@ 7y t:e
intro@uction o? com;etitionA Gnvestments o? (o=Mcost ?irms may even increaseA
&'()W”#+,: Oro@uctM/ar>et Com;etition3 Bater3 Qon@iscriminatory ;ricing
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++ 6rt:ur 6n@ersen3 Zusiness Consu(ting3 Zinbm[:(estrasse !U3 C\M]5T5 Y[ric:3 9e(: __U!M!MV5] !S TV3 ‘a`:
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t:e I,QGO Con?erence in dienna ?or :e(;?u( commentsA
4
!A Gntro@uction
9ra@itiona((y3 net=or> in@ustries suc: as e(ectricity3 te(ecommunications3 rai(=ays or =ater
su;;(y are regar@e@ as natura( mono;o(iesA 9:e @u;(ication o? t:e net=or>s Krai(roa@
system3 =ater ;i;es etcAL =ou(@ not 7e e??icient an@ t:ere?ore un@esira7(eA 6ccor@ing to t:is
rationa(e3 t:ere is no reason to :ave severa( ?irms engage@ in t:e mar>et3 7ecause tota(
out;ut cou(@ 7e ;ro@uce@ more c:ea;(y =it:in a sing(e ?irmA ‘or a (ong time t:e e`istence
o? natura( mono;o(ies an@ a(so ot:er as;ects suc: as t:e im;ortance o? eua(ity issues :ave
7een a Nusti?ication ?or t:e a7sence o? @irect com;etitionA ‘or t:at reason in many Iuro;ean
countries services as te(ecommunications3 e(ectricity or =ater su;;(y =ere ;rovi@e@ 7y
;u7(ic enter;rises or strong(y regu(ate@ ;rivate ?irmsA
\o=ever3 in t:e course o? ;rivatisation an@ (i7era(isation3 governments an@ regu(ators
trie@ to e`;an@ t:e ro(e o? com;etitionA 9=o main ;ossi7i(ities e`ist in or@er to im;(ement
e??ective riva(ry into net=or> in@ustries: ‘ranc:ise 7i@@ing3 ca((e@ com;etition !”# t:e
mar>et3 an@ ;ro@uctMmar>et com;etition3 >no=n as com;etition $% t:e mar>etA Gn t:e ?ormer
variant3 as ;ro;ose@ 7y \aro(@ Demsetb K!S^]L3 t:e governmenta( aut:orities auction o?? t:e
mono;o(yA Zi@@ers are reeuire@ to s;eci?y t:e tari??s t:ey =ou(@ c:arge ?or t:e su;;(ie@
;ro@uct f ?or a given set o? ;er?ormance ;arametersA 9:e com;any ;romising t:e (o=est
tari??s gets t:e e`c(usive rig:t to serve customers in t:e @e?ine@ areaA Bit: enoug: 7i@@ers it
is e`;ecte@ t:at a 7i@@er revea(s :is minimum costs: \e o??ers t:e ;rice3 =:ic: corres;on@s
to t:e (eve( o? :is e??ective average costsA Gn t:e =ater in@ustry ?ranc:ise 7i@@ing actua((y
too> ;(ace f ?or e`am;(e ?or t:e Zuenos 6ires =ater an@ se=erage system in !SSV an@ a(so
?or @i??erent (oca( systems in ‘ranceA!
9:eory suggests t:at ?ranc:ise 7i@@ing is a reasona7(e =ay to im;(ement com;etition
in t:e =ater mar>etA Gn our vie=3 suc: auctions :ave @i??erent @ra=7ac>s3 ;articu(ar(y in t:e
ca;ita(Mintensive =ater su;;(y in@ustryA Hince ;arameters as tec:no(ogy3 =ater eua(ity3
@eman@ or (ega( as;ects a(ter over time3 t:e setting o? ;rices in a@vance is @ominate@ 7y
uncertaintyA 6verage costs are a??ecte@ 7y mo@i?ie@ circumstances3 un=ante@ gains or
(osses in t:e (ongMterm cou(@ 7e t:e conseeuencesA 9o :an@(e t:is ;ro7(em3 t:e
governmenta( aut:orities cou(@ regu(ate t:e in@ustry or re;eat t:e auction ?reeuent(yA
\o=ever3 carrying out ne= roun@s o? 7i@@ing is very cost(yA ‘urt:ermore 6rmstrong3
Co=an an@ dic>ers K!SSU3 ;A !4SL in@icate t:at a s:orter :o(@ing ;erio@ o? t:e mono;o(y
rig:t un@ermine t:e incentives to invest into t:e net=or> in?rastructureA 9o ;revent
! Hee g(ein K!SS^L ?or ?urt:er @etai(s regar@ing ?ranc:ise 7i@@ing in Zuenos 6ires an@ ‘ranceA
V
un@erinvestment3 t:e incum7ent s:ou(@ 7e com;ensate@ ?or :is e??ort in case o? a @e?eat in
t:e (atest auctionA G? :o=ever3 as Bi((iamson K!S2^L argues3 t:e regu(ator cannot serious(y
@etermine t:e actua( =ort: o? t:e rea(ise@ investments an@ t:ere?ore t:e com;ensation sum3
t:ere is a serious @anger o? ine??ective com;etitionA4 Zecause o? t:e @anger o?
un@erinvestment or ine??ective com;etition3 6rmstrong3 Co=an an@ dic>ers conc(u@e t:at
?ranc:ise 7i@@ing is un(i>e(y to 7e very use?u( ?or ca;ita(Mintensive e(ements o? natura(
mono;o(y in@ustries suc: as =ater su;;(y net=or>s3 =:ere ca;ita( costs are usua((y 25 to S5
;ercent o? tota( costsA
Gn or@er to avoi@ t:ese ;ro7(ems =e suggest t:e im;(ementation o? ;ro@uctMmar>et
com;etition3 =:ere t=o or more riva( com;anies ren@er =ater services in t:e same areaA Be
;resent a mo@e( o? @irect K;ro@uct mar>etL com;etition t:at ta>es t:e =ater sectorhs s;eci?ic
tec:nica( as;ects into consi@erationA Fur ;ro;osa( is t:ere?ore 7ase@ on a sim;(e structure
t:at a((o=s an easy im;(ementation o? @irect com;etitionA Co=an K!SS2L in@icates t:at t:e
regu(atory 7ur@en o? assessing access ;rices ?or a great num7er o? net=or>s =ou(@ 7e (argeA
\e ?o((o=s t:at common carriage is not (i>e(y to 7e a maNor ?eature o? t:e Zritis: =ater
in@ustry in t:e ?utureA 9o avoi@ t:is regu(atory ;ro7(em t:e mo@e( assumes a 7ase(ine case3
=:ere regu(ation @oes not e`ist an@ t:e incum7ents are ?u((y ?ree to set t:eir o=n access
?eesA 9:e mo@e( s:o=s t:at even in suc: a =orst case com;etition arises an@ signi?icant
e??iciency gains can 7e rea(ise@A
Gn ot:er net=or> in@ustries suc: as te(ecommunications3 e(ectricity or rai(=ays3 @irect
com;etition is a(rea@y im;(emente@ or at (east ;(anne@A 9o ;revent ine??icient net=or>
@u;(ication3 o;erators are ?orce@ to give com;etitors access to t:eir net=or>sA 6n@ to secure
nonM@iscriminating access3 government cou(@ eit:er set t:e access ;rices or o;erate t:e
=:o(e net=or> itse(?A 9:e (atter variant reeuires vertica( se;aration o? t:e e`isting
com;aniesAV 6 simi(ar (i7era(isation ;rocess cou(@ a(so 7e im;(emente@ in t:e =ater sectorA
,n?ortunate(y3 t:ere is on(y a ?e= (iterature a7out ;ro@uctMmar>et com;etition in t:e =ater
sectorA 9ec:nica( @i??icu(ties an@ t:e im;(icit assum;tion t:at =ater com;anies are natura(
mono;o(ies f 7ecause t:e net=or> @ominates t:e cost structure f (arge(y ;revente@ suc:
@iscussionA Qevert:e(ess3 t:e ;rivatisation an@ (i7era(isation o? t:e ,g =ater in@ustry in
!S]S inten@e@ a very restricte@ @irect com;etitionAU
4 \arsta@ an@ Cre= K!SSSL ;ro;ose a ?ranc:iseM7i@@ingMmo@e(3 =:ic: a@@resses t:e mentione@ va(uation
;ro7(em o? trans?erre@ assetsA \o=ever3 it is necessary to assume t:at t:e entrants are in?orme@ as goo@ as t:e
incum7ent a7out t:e va(ue o? t:e assets to 7e trans?erre@A
V G? t:ere are signi?icant economies o? sco;e3 :o=ever3 suc: a se;aration =ou(@ not 7e @esira7(eA 6ctua((y3 in
t:e (i7era(isation ;rocess in ,g3 =ater su;;(iers remaine@ vertica((y integrate@ Ksee section V 7e(o= tooLA
U Hee Correia an@ graemer K!SS2L or Co=an K!SSVL an@ Co=an K!SS2L ?or a survey o? t:e re?orm in t:e =ater
in@ustry in Ing(an@ an@ Ba(esA
U
\o=ever3 @ue to tec:nica( issues3 ;ro@uctMmar>et com;etition in t:e =ater sector
@i??ers su7stantia((y ?rom ot:er sectors suc: as te(ecommunicationsA Fur mo@e( ta>es t:ese
as;ects3 =:ic: =i(( 7e @escri7e@ in more @etai( in section 43 into account an@ e`;(ores t:e
e??ects o? @irect com;etition on tari??3 su;;(y an@ investment 7e:aviourA 6s mentione@
a7ove3 =e assume a 7ase(ine case =:ere regu(ation f es;ecia((y t:e regu(ation o? access
;rices f @oes not e`istA ‘urt:ermore3 t:e incum7ents stay vertica((y integrate@3 iAeA t:ey o=n
t:eir Kin:erite@L net=or> 2%+ t:ey se(( =ater to ?ina( customersA dertica( integration is
Nusti?ie@ 7y t:e e`istence o? economies o? sco;e: Zot: @istri7ution systems an@ =ater
treatment ?aci(ities reeuire sanitary >no= :o=A 6(t:oug: t:e ?irms remain vertica((y
integrate@ an@ access ;rice regu(ation is a7sent3 our mo@e( s:o=s t:at f un@er (inear 2%+
nonM(inear access ;ricing f t:e ?ormer mono;o(y situation =i(( not ;ersist an@ t:at ;rices
=i(( @ecrease in t:e :ome mar>et o? t:e :ig:Mcost mono;o(istA
6 secon@ issue o? t:e (i7era(isation @e7ate concerns t:e investment 7e:aviour o? t:e
incum7entsA Due to t:e (ongMterm c:aracter o? investments in t:e =ater ;i;e net=or>T t:ere
is serious @anger o? insu??icient investment e`;ensesA 6ccor@ing to a ?arMreac:ing ;reNu@ice
incum7ents neg(ect (ongMterm net=or> investments in or@er to im;rove mar>et ;osition an@
to ma`imise s:ortMrun ;ro?it i? com;etition =ere intro@uce@A 6s a resu(t o? com;etition3
net=or> eua(ity =ou(@ @eteriorate an@ a consi@era7(e s:are o? t:e ;ro@uce@ @rin>ing =ater
=ou(@ esca;e ?rom t:e (ea>y =ater ;i;esA Qevert:e(ess3 @es;ite o? t:e a7sence o? @irect
com;etition =ater to@ay3 (ea>age in Iuro;ean net=or>s is estimate@ ?rom !T to T5 ;ercenti
Iuro;ean =ater su;;(iers re;(ace on average 53^ ;ercent o? t:eir ;i;e net=or>s year(y3
=:i(e t:e Gnternationa( Bater Hu;;(y 6ssociation KGBH6L recommen@s to re;(ace !3T
;ercent Ksee H>ar@a !SS]3 ;A ]2ULA 9:is un@erinvestment =i(( 7e one o? t:e main ?uture
issues in t:e =ater sector an@ Nusti?ies t:e mo@e(hs ?ocus on t:e investment 7e:aviourA 9:e
mo@e( @oes not su;;ort t:e ;reNu@ice mentione@ a7oveA Bit: on(y =ea> assum;tions3 t:e
mo@e( ;re@icts increase@ investment incentives o? t:e (o=Mcost mono;o(ist cause@ 7y t:e
im;(ementation o? ;ro@uct mar>et com;etitionA^
9:e ?o((o=ing section ;oints out t:e s;eci?ic structura( as;ects o? t:e =ater sector an@
t:e corres;on@ing im;(ications ?or a com;etitive mar>etA Zase@ on t:ese as;ects =e ;resent
in section V a rea(istic mo@e( o? ;ro@uctMmar>et com;etition in t:e =ater in@ustryA 9:e
mo@e( assumes a t=oMstage game3 =:ere ?irms set investments in t:e ?irst ;erio@ an@ 7ot:
out;ut an@ access ;rices in t:e secon@ ;erio@A 6?ter t:e @etermination o? t:e cost an@
T De;en@ing on t:eir materia(3 =ater ;i;es :ave an o;erating (i?e ?rom 45 to 455 yearsA Hee H>ar@a K!SS]L ;A
]2UA
^ #emin@ t:at t:e regu(ator is not a7(e to veri?y t:e incum7entsh actua( investment vo(umeA
T
income structure o? invo(ve@ =ater su;;(iers3 =e so(ve t:e mo@e( in section U 7y
7ac>=ar@sMin@uction an@ ana(yse t:e incum7entsh 7e:aviour regar@ing out;ut3 access ;rices
an@ investmentsA ‘or 7ot: stages =e ana(yse t:e case o? (inear an@ t:e case o? nonM(inear
access ;rices3 since in ;ractice 7ot: tari?? systems are commonA 9:e conc(usions in section T
@iscuss t:e re(evant ;o(icy im;(icationsA
4A Htructura( Gssues in t:e Bater Hector
Gn contrast to rai(=ays or te(ecommunications =ater ;i;e net=or>hs e`tension is rat:er (oca(
or regiona( t:an nationa(A Gn most Iuro;ean countries communa( aut:orities o;erate t:e
=ater su;;(y an@ t:e =ater ;i;e net=or>A Hince neig:7ouring net=or>s are usua((y not
connecte@3 t:e uti(ities act as mono;o(ists in o?ten sma(( (oca( mar>etsA Gn H=itber(an@ ?or
e`am;(e t:ere are 4jSST uti(ities serving Vj54V communitiesA /ore t:an S5 ;ercent o? t:e
H=iss =ater su;;(iers serve an area =it: (ess t:an Tj555 in:a7itants Ksee g(ein an@ /anser
!SS]3 ;A UU]LA 6not:er im;ressive e`am;(e is Gta(y3 =:ere ^j^55 communities are serve@ 7y
!VjT55 uti(itiesA \o=ever3 in Best cermany t:e num7er o? su;;(iers =as ?a((en @ramatica((y
a?ter Bor(@ Bar GGA !ST2 e`iste@ more t:an !Tj555 uti(ities3 !SS5 (ess t:an 2j555 Ksee
Correia an@ graemer !SS23 ;A ]^ M ]2LA
9:e num7er o? su;;(iers in an area an@ t:e net=or>hs e`tension is 7ase@ 7ot: on t:e
;ro@uction ;rocess in t:e =ater sector an@ ;o(itica( issuesA 9:e ?ormer is main(y in?(uence@
7y t:e eua(ity o? use@ ra= =ater resourcesA Drin>ing =ater can 7e ;ro@uce@ in t:ree
@i??erent =ays: I`;(oiting sur?ace =aters suc: as (a>es or rivers3 ;um;ing groun@ =ater to
t:e sur?ace or ta;;ing s;ring =aterA Due to its :ig: eua(ity3 s;ring =ater usua((y @oes not
reeuire any treatment suc: as screening3 ?(occu(ation3 c(ari?ication3 ?i(tration3 t:e a@@ition o?
c:emica(s or t:e use o? u(travio(et (ig:tA croun@ =ater usua((y reeuires a (o=er (eve( o?
treatment t:an sur?ace =ater3 =:ic: most(y consists o? ;oorer eua(ityA Hince treatment is a
signi?icant cost @river in =ater ;ro@uction3 t:e use o? s;ring =ater is very ine`;ensive =:i(e
t:e use o? sur?ace =ater is most cost(y Ksee D=r Cymru Be(s: Bater !SSS3 ;A SLA
De;en@ing on t:e e`istence o? suc: ra= =ater resources t:e =ater su;;(iersh cost an@ tari??
structures are very @i??erentA2 Bater treatment causes 7ot: varia7(e an@ ?i`e@ costsA \ence3
economies o? sca(e cou(@ 7e ac:ieve@ t:roug: t:e centra(isation o? t:e @rin>ing =ater
2 Gn ‘rance eAgA =ater tari??s ;er cu7ic metre vary 7et=een 5AU4 an@ !5AS4 ‘renc: ‘rancs Ksee Correia an@
graemer !SS23 ;A 4]]LA
^
;ro@uction3 es;ecia((y =:en t:e s:are o? use@ sur?ace =ater is e`tensiveA Fn t:e ot:er :an@3
@iseconomies o? sca(e are re(ate@ to t:e customerhs @istance ?rom storage an@ treatment
?aci(itiesA 9:e increasing @istance in@icates :ig:er =ater (osses an@ greater ;um;ing
reeuirements Ksee Yarni>au !SSU3 ;A !S5 M!S!LA 9:e ;um;ing e??ort @e;en@s on @istance an@
to;ogra;:y an@ causes ?i`e@ ca;ita( an@ varia7(e energy costsA 6not:er tec:nica( as;ect t:at
:in@ers t:e centra(isation o? @rin>ing =ater ;ro@uction is t:e (oss o? =ater eua(ity in t:e
;i;e net=or>A 9:e eua(ity (oss is ;ositive(y corre(ate@ =it: trans;ort @istance: 9:e (onger
=ater remains in t:e ;i;es3 t:e (arger gets t:e eua(ity @ecreaseA ‘urt:ermore3 t:e ca;acity o?
severa( groun@=ater or s;ring =ater resources is very (imite@A 9:e use o? suc: re(ative
ine`;ensive ra= =ater resources in@icates a @ecentra(ise@ =ater ;ro@uctionA
Due to t:e e`istence o? 7ot: economies an@ @iseconomies o? sca(e3 @i??erent @egrees
o? centra(isation cou(@ 7e a@vantageousA Gn :i((y or mountainous countries suc: as Gta(y or
H=itber(an@ one e`;ects =ater su;;(y to 7e more @ecentra(ise@ t:an in ot:ers3 since ?arM
reac:ing net=or>s =ou(@ reeuire a :ig: ;um;ing e??ort an@ t:e to;ogra;:y in@icates t:e
e`istence o? s;ring =ater resourcesA] Fn t:e ot:er :an@3 t:e increasing use o? sur?ace =ater
an@ t:e :ig:er =ater contamination raise treatment reeuirements an@ t:ere?ore t:e economic
nee@ ?or a stronger centra(isationA Huc: a conso(i@ation an@ centra(isation ;rocess =as
o7serve@ in countries suc: as cermany3 Qet:er(an@s or Ing(an@ an@ Ba(esA Gn most
Iuro;ean countries a ?urt:er conso(i@ation ;rocess is e`;ecte@A Hma(( uti(ities in (oca(
mar>ets are o?ten una7(e to meet gro=ing @eman@ or to >ee; raise@ eua(ity stan@ar@s3 since
t:e construction o? ne= treatment ?aci(ities causes :ig: ?i`e@ costsAS Fne ;ossi7i(ity to raise
economic e??iciency in =ater mar>ets is to merge neig:7ouring uti(ities an@ to connect t:eir
net=or>sA ,ti(ities ?acing ;oor ra= =ater resources cou(@ overcome ca;acity (ac>s3 =:i(e
ot:er su;;(iers cou(@ raise t:eir treatment ?aci(itiesh rate o? ca;acity uti(isationA \ence3 t:e
merger s:ou(@ im;(ement a cost e??icient ;ro@uction structureA Cost minimum =ou(@ 7e
arrive@ =:en a(( invo(ve@ uti(ities ?ace i@entica( margina( costsA 9:e ;otentia( e??iciency
gains cou(@ 7e su7stantia(3 since to@ay f as mentione@ a7ove f =ater su;;(iersh margina(
costs vary signi?icant(yA
Des;ite suc: ;otentia( e??iciency gains cause@ 7y t:e merger o? neig:7oure@
uti(ities3 it seems not to 7e @esira7(e to create 7igger an@ t:ere?ore more ;o=er?u(
] Gn Gta(y t:e s:are o? use@ s;ring =ater resources in t:e @rin>ing =ater ;ro@uction amounts to VS ;ercent3 in
H=itber(an@ U4 ;ercent an@ in cermany ] ;ercentA 9:e ,nite@ ging@om an@ t:e Qet:er(an@s use Nust groun@
an@ sur?ace =ater3 =:ic: reeuire a :ig:er (eve( o? treatment Ksee HdcB !SSS3 ;A SLA
S 6ccor@ing to Dutc: stu@ies t:e uti(ityhs minima( ;ro@uction vo(ume s:ou(@ vary 7et=een !5 an@ 45 mi((ion
cu7ic metre @rin>ing =ater ;er year in or@er to cover t:e e`tensive s:are o? ?i`e@ costs Ksee g(ein an@ /anser
!SS]3 ;A UU]LA Less t:an one ;ercent o? H=iss uti(ities =ou(@ meet t:is reeuirementA
2
mono;o(ists3 =:ic: may e`ert ;o(itica( ;ressure eAgA to as> ?or e`aggerate@ su7si@iesA
‘urt:er3 t:e e`istence o? suc: 7ig an@ ;o=er?u( mono;o(ies is o?ten im;ossi7(e @ue to
institutiona( or ;o(itica( groun@sA /ore im;ortant(y3 t:e ?act t:at t:ere are many =ater
net=or>s is to 7e (oo>e@ as an e??icient ans=er to tec:no(ogica( constraints3 iAeA t:e
@iseconomies o? sca(e mentione@ a7oveA
VA Direct Com;etition in t:e Bater /ar>et: 6 Him;(e /o@e(
Hevera( H=iss communities near Yuric: :ave c:osen a @i??erent =ayA Iconomica((y an@
(ega((y in@e;en@ent neig:7ouring =ater su;;(iers connecte@ t:eir net=or>s an@ ma@e t:e
commercia( e`c:ange o? @rin>ing =ater ;ossi7(eA ,ti(ities ?acing ;oor resources ;urc:ase
@rin>ing =ater ?rom near7y 7etter su;;(iers in or@er to overcome ca;acity ;ro7(emsA!5 Hince
t:e =aters o? t:e 7uyer an@ t:e su;;(ier mi` =it:in t:e 7uyerhs @istri7ution system3 7ot:
:ave t:e same eua(ity o7(igationsA Zut t:e necessity to coMor@inate t:e =ater eua(ities an@
t:e treatment activities consi@era7(y (imits t:e num7er o? invo(ve@ ;arties an@ t:ere?ore t:e
;ossi7i(ity to connect numerous net=or>s f ;rovi@e@ t:at a(( o? t:e invo(ve@ uti(ities
;ro@uce @rin>ing =ater t:emse(vesA ‘urt:ermore3 @iseconomies o? sca(e cause@ 7y t:e
a7ove mentione@ tec:nica( as;ects ;revent a com;re:ensive connection o? @i??erent
net=or>sA
Fur mo@e( uses an ana(ogous a;;roac: ?or t:e im;(ementation o? ;ro@uct mar>et
com;etitionA Gn t:e mo@e(3 every =ater uti(ity o=ns an in:erite@3 e`ogenous(y given
net=or>3 =:ose =i@t: may @i??erA Zase@ on t:e mentione@ tec:nica( issues in t:e =ater
sector!!3 com;etition 7et=een uti(ities ta>es ;(ace at a regiona( or (oca( (eve( so t:at on(y a
?e= net=or>s can 7e connecte@A 9:e connection means t:at t:e f vertica((y integrate@ M
=ater uti(ities can com;ete ?or customers in t:e same area using a sing(e set o? ;i;esA Hince
?avoura7(e ra= =ater resources suc: as s;ring an@ groun@=ater are (imite@ an@ t:e
construction o? ne= treatment ?aci(ities causes :ig: sun> costs3 t:e entrance o? ne= mar>et
;artici;ants seems to 7e un(i>e(yA ‘or t:is reason t:e mo@e(hs ?ocus on a(rea@y e`isting
!5 Gn !SS2 a7out !V ;ercent o? ;ro@uce@ @rin>ing =ater in H=itber(an@ =as @e(ivere@ to neig:7oure@
@istri7ution systems Ksee HdcB !SSS3 ;A 2LA
!! 9:e e`istence o? @iseconomies o? sca(e3 t:e necessity to coMor@inate t:e incum7entsh =ater eua(ities an@
treatment activities3 t:e use o? @ecentra(ise@ ra= =ater resources suc: as s;ring =ater or groun@=ater an@
eua(ity (osses cause@ 7y t:e trans;ort @istance signi?icant(y restrict net=or>sh e`tension an@ t:e ;ossi7i(ity to
connect @i??erent @istri7ution systemsA
]
=ater su;;(iers3 =:ic: remain vertica((y integrate@ @ue to economies o? sco;e3!4 seems to
7e rea(isticA Gn contrast to t:e te(ecommunication sector3 =:ere t:e ?ormer ;u7(ic uti(ity
o=ns t:e main s:are o? t:e @istri7ution system3 t:e mo@e( im;(ements a @i??erent structure
=:ere t:e su;;(iers a(( o=n a sma(( net=or>A 9o >ee; t:e ana(ysis sim;(e3 =e assume
t:ere?ore t:at on(y t=o ?ormer mono;o(ists K@enote@ 7y 5 an@ 6L connect t:eir
corres;on@ing net=or>s K@escri7e@ as ! an@ 4L an@ enter into @irect com;etitionA!V Hince
@rin>ing =ater mi` in t:e connecte@ net=or>s3 7ot: ?irms su;;(y a :omogenous goo@A!U Gn
t:e ca;ita(Mintensive =ater in@ustry it is natura( to assume t:at uti(ities c:oose t:eir
euantities or ca;acities rat:er t:an ;rices K=it: e`ce;tion o? access ;ricesLA!T
,sing t:e com;etitorhs net=or>3 eac: su;;(ier is a7(e to serve customers in t:e entire
connecte@ areaA 9:e corres;on@ing gri@ o=ners c:arge an access ?eeA Gncum7ents cou(@ no=
@e?en@ t:eir mono;o(y ;osition 7y euoting e`tensive access ;ricesA Gm;ortant(y3 =e assume
t:at a regu(ator 32%%”4 set t:e access ;riceA Hince t:e costs o? using =ater ;i;e net=or>s
@e;en@ on various tec:nica( as;ects Ksuc: as age or materia( o? ;i;es3 ;um;ing
reeuirements3 =ater ;ressure etcAL access ?ees =ou(@ :ave to 7e set in an in@ivi@ua( mannerA
9:us3 :eterogeneous cost structures an@ asymmetric in?ormation ;revent t:e regu(ator ?rom
veri?ying rea( margina( costs an@ t:ere?ore ?rom assessing a@eeuate c:argesA
9:e t=o ?irms 5 an@ 6 ?ace :eterogeneous cost ?unctions =it: varia7(e treatment
costs 078!93 7)” #53)6$3 =it: increasing margina( costs: 05:);)0 an@ 05::)%)0A Gn a@@ition3
t:ey ?ace investment costs K&7L3 =:ic: @o not @e;en@ on out;ut 7ut increase in investmentA!^
Gn or@er to minimise treatment costs3 uti(ities ?irst(y use ra= =ater resources o? :ig: eua(ity
suc: as s;ring =aterA 9o overcome t:e re(evant ca;acity constraints ?irms use ?urt:er
resources =it: ;oorer eua(ity an@ t:ere?ore :ig:er treatment reeuirements suc: as
groun@=ater or sur?ace =aterA Due to t:is reasoning3 margina( costs o? @rin>ing =ater
;ro@uction are o7vious(y increasing in out;utA 9ota( ;ro@uction euantity consists o? so(@
!4 dertica( integration =as a(so a;;(ie@ in t:e ;rivatisation an@ (i7era(isation ;rocess o? t:e =ater mar>ets in
Ing(an@ an@ Ba(esA
!V 9:ere is a :uge (iterature concerning net=or> com;etition =it: kt=oM=ay interconnectionl in
te(ecommunications3 eAgA La??ont et a(A K!SS]L or 6rmstrong K!SS]LA \o=ever3 as Zue:(er K4555L notes3 t:is
(iterature @ea(s main(y =it: t:e ana(ysis o? com;etition 7et=een symmetric ?irms or uses s;eci?ic ?unctiona(
?ormsA Gnstea@3 our mo@e( =or>s =it: genera( @eman@ an@ cost ?unctions an@ :eterogeneous net=or>sA Iven
more im;ortant(y3 t:is (iterature :as to @ea( =it: t:e ;ro7(em t:at t:e t=o mono;o(ists =2>’)4″ give access to
eac: ot:er suc: t:at consumer ! reac:es consumer 4 7y te(e;:one3 t:is ;ro7(em @oes not e`ist in t:e =ater
mar>etA F7vious(y3 customers @o not care =:o e(se is connecte@ at t:e =aterMnet=or>A
!U 9:e mo@e( a7stracts ?rom ;ro@uct @i??erentiation suc: as service or imageA
!T 9:e assum;tion o? ;rice com;etition =it: @i??erentiate@ ;ro@ucts =ou(@ not c:ange t:e mo@e(hs resu(ts
?un@amenta((yA
!^ \ig:er investment re@uces o? course ot:er ?i`e@ costs3 eAgA net=or> maintenance costs t:at are main(y
@riven 7y t:e re;air =or>A \o=ever3 t:e net e??ect o? investment on out;utMin@e;en@ent cost is assume@ to 7e
;ositiveA
S
=ater an@ =ater (ea>age cause@ 7y (ea>y ;i;esA Bater (ea>age /$ in t:e net=or> $3 $ ” #!3
4$3 @ecreases in net=or> investment ?7 7ut @oes not @e;en@ on t:e so(@ euantity since =ater
;ressure :as to 7e :e(@ constant any=ayA 5hs re(evant tota( cost ?unction @05 rea@s t:ere?ore
K K LL K L 5 5 !5 45 ! 5 5 5 @0 ‘ 0 A & A & / ? & & ? K!L3
=:ere AB5 stan@s ?or t:e euantity o? so(@ =ater to customers in 5hs o=n net=or> !3 AC5
@enotes t:e vo(ume o? 5hs @e(ivere@ =ater to customers in net=or> 43 an@ /B8?59 stan@s ?or
=ater (osses in 5hs o=n net=or> !A 6hs re(evant cost ?unction can 7e =ritten simu(taneous(y
7y reversing t:e in@icesA
Gn genera(3 t:e uti(itiesh revenues consist o? t:ree com;onentsA ‘irms @e(iver @rin>ing
=ater to customers connecte@ to t:eir o=n an@ t:eir com;etitorhs net=or>3 an@ t:ey
generate income 7y c:arging an access ?ee3 =:ic: can consist o? a varia7(e ?ee 2 an@ a ?i`e@
?ee D3 to t:eir com;etitorA 5hs earnings can t:ere?ore @etermine@ as ?o((o=s K6hs earnings
are o? course @e?ine@ ana(ogous(yL:
( ) ! ! ! ! 4 4 4 4 4 4 ! ! ! . E KA A LA E KA A L 2 A D 2 A D 5 5 6 5 5 6 5 6 ‘ & & & * * & & K4L3
=:ere EB8AB5FAB69 @enotes t:e inverse @eman@ ?unction in t:e mar>etmnet=or> !A AB5)F)
AB6 is t:e tota( euantity o? so(@ @rin>ing =ater in mar>et !A!2 ‘irm 5hs gross revenues in t:e
mar>et 4 are EC8AC5)F)AC69AC5A \o=ever3 t:ese revenues are re@uce@ 7y t:e varia7(e access
;rice ;ayment 2C)AC5A an@ t:e ?i`e@ access ;ayment DCA ‘ina((y3 ?irm 5 generates earnings
7y c:arging an access ?ee 2BAB6)F)DB to its com;etitor 63 =:ic: uses 5hs net=or> to @e(iver
customers in t:e mar>et !A Outting costs an@ earnings toget:er3 =e @e?ine ?irm 5hs ;ro?it as
5 5 5 + ‘ . *@0 KVL
‘irm 5 ma`imibes its ;ro?it 7y c:oosing AB5 an@ AC53 t:e access ;rice 2B3 =:ic: is
restricte@ to 7e euantityMin@e;en@ent3 DB an@ t:e investment ?5A 9:e eua(ity o? t:e ;ro@uce@
@rin>ing =ater3 :o=ever3 is not a c:oice varia7(e o? t:e uti(itiesA Be rat:er assume t:at a
!2 9:e mo@e( a7stracts ?rom t=o ;art tari??sA \ence3 =ater an@ access ;rices EB3 EC3 an@ 2C are constant ;er unit
o? out;utA 9:is assum;tion is reasona7(e3 7ecause varia7(e ?ees actua((y @ominate tari?? structuresA Gn cermany
eAgA3 more t:an S5 ;ercent o? t:e =ater su;;(iersh earnings are generate@ 7y varia7(e ?eesA KCorreia an@
graemer !SS23 ;A !U^LA
!5
:ea(t: aut:ority sets a minimum eua(ity stan@ar@3 =:ic: can 7e veri?ie@ 7y a (a7oratoryA
Oro?it ma`imibing ?irms =i(( e`act(y meet t:is o7(igationA
9:e mo@e( is structure@ as a t=oMstage gameA LongMterm @ecisions are ma@e in t:e
?irst3 s:ortMterm @ecisions in t:e secon@ ;erio@A Due to t:e (ongMterm c:aracter o? net=or>
investments3 ?irms set ?5 an@ ?6 simu(taneous(y in t:e ?irst stageA Gn t:e secon@ ;erio@ t:e
;(ayers simu(taneous(y set t:e ?(e`i7(e c:oice varia7(es3 iAeA ;ro@uction euantities A$73 access
;rices 2$ an@ D$A Zot: out;ut an@ access ?ees are assume@ to 7e su??icient ?(e`i7(e an@
t:ere?ore set in t:e s:ortMtermA ‘irms set t:e euantities ?or 7ot: mar>ets given t:e euantities
c:osen 7y t:e ot:er uti(ityA 9:is ;roce@ure meets t:e tra@itiona( Cournot ana(ysisA \o=ever3
t:is ana(ysis cannot 7e a;;(ie@ ?or t:e setting o? access ?eesA 9:e @etermination o? access
?ees is a ;rice @ecisionA G? 5 raises access ;rice 2B3 6 re@uces its engagement in t:e ?oreign
mar>et !3 7ecause t:e increase@ varia7(e access ;rice raises 6hs margina( costsA Gn or@er to
ma`imibe ;ro?its3 5 must ta>e 6hs 7e:aviour into consi@erationA!] 9:is suggests AB6 an@
AC5 to 7e a @ecreasing ?unction o? 2B an@ 2C3 res;ective(yA
UA Ho(ving t:e /o@e(
)
!”#$%&’on*$%+,-&$
)
GHBHB)/$%’2#)233’,,)E#$3$%I)
Be ?irst ?ocus t:e case o? ;ure (inear access ;ricing3 =:ere DB) J) DC) J) 0A ‘irms
simu(taneous(y set euantities in t:eir o=n an@ ?oreign mar>et res;ective(y net=or> an@ t:e
access ;ricesA Be assume t:at eac: com;etitor =i(( su;;(y a ;ositive euantity in its :omeM
mar>et 7ut it may 7e un=i((ing to su;;(y on t:e ?oreign mar>etA 9:e ?irst or@er con@itions o?
5hs ;ro?it ?unction KVL rea@ t:ere?ore3 =:ere K L m K L m j 5 !5 5 45 5 -0 . -A ‘ -0 . -A , 0 an@
K L m j ! ! ! E A E 5 – . – , :
j j 5 ! ! !
!
‘ & * ‘

-+
5 5
5
5 E A E 0
A
KUL
!] Gn or@er to sim;(i?y t:e mo@e(hs structure3 =e assume t:at access ;rices an@ euantities are set
simu(taneous(y in t:e same stageA 6(ternative(y one cou(@ assume t:at at a secon@ stage ?irms =ou(@ set access
;rices an@ in a t:ir@ stage t:e euantitiesA Huc: a structure =ou(@ not c:ange t:e mo@e(hs resu(ts ?un@amenta((yA
!!
j j 5 4 4 4 4
4
‘ & * * /

-+
5 5
5
5 E A E 2 0
A
an@ 5
4
4 ‘

-+
5
5
5 A
A KTL
0 j 1 j 5 4 4
!
4
! ! !
!
!
!
!
‘ & & & ‘

-+
5
6
5
6
6
5 E A
+2
+A
E A 2
+2
+A
A
2
K^L
Due to symmetry 6hs ?irstMor@er con@itions can 7e =ritten using t:e ana(ogous notation
j j 5 4 4 4
4
‘ & * ‘

-+
6 6
6
6 E A E 0
A
KUnL
j j 5 ! ! ! !
!
‘ & * * /

-+
6 6
6
6 E A E 2 0
A
an@ 5
!
! ‘

-+
6
6
6 A
A KTnL
0 j 1 j 5 ! !
4
!
4 4 4
4
4
4
4
‘ & & & ‘

-+
6
5
6
5
5
6 E A
+2
+A
E A 2
+2
+A
A
2
K^nL
Be =ant to @etermine :o= 5 =i(( set its access ;rice K?or 6 t:e @iscussion =ou(@ rea@
ana(ogous(yLA Be assume t:at eac: ?irmhs ;ayo?? ?unction an@ rationa(ity Kas re?(ecte@ in t:e
?irst or@er con@itionL is common >no=(e@geA Be ?ocus on t:e case =:ere -+6K-AB6)J)5A!S
Ho(ving eeuation KThL ?or 2! t:en yie(@s j j ! ! !6 ! 6 2 ‘ E A & E * 0 A ,sing t:is e`;ression an@
KUL3 =e re=rite 5hs ?irst or@er con@ition K^L regar@ing t:e access ;rice 2B: 9ota(
@i??erentiation o? KUhL f K^hL s:o=s t:at +AB682B9K+2B)2))5 an@ +AC582C9K+2C)2)5A45
( j 0 j j1) j 5 4 4
!
4
! !
!
!
5o 5 !
! ! !
‘ & & * & ‘

-+


-+


-+ 5
6
6 5 6
6
6
A A
5 E A
+2
E A 0 0 +A
+2
A +A
2
6
6
5
5 K2LA
Due to t:e nonMe`istence o? an access ;rice regu(ation3 eac: ?irm cou(@ easi(y @e?en@ its
mono;o(y ;osition in its origin mar>etA G? ?irm 5 c:arge@ a very :ig: access ?ee 2B3 ?irm 6
!S F7vious(y3 t:e case -+6K-AB6)p)5 is uninteresting3 since t:en +AB682B9K+2B)J)53 iAeA 6 =ou(@ not react =it:
its euantity AB6 i? 5 c:anges its access ;rice in?initesima((yA
45 9ota( @i??erentiation o? KUhL3 KThL3 an@ K^hL yie(@s3 a;;(ying Cramerhs ru(e:
! 5 4
4 4
4
4
4
4
4
4
4
!
! 2
3 3
4
5
6 6
7
8
9 9:
;
< <=
>
– –
– +
*

– +

– +

6
6
6
6 6 6
+2 L 2 A 2 A
+A an@ ! jj 5
4
4
4
!
4 ?

– +

2
0
+2 L
+A 6
6
6 A
Qote t:at t:e term in 7rac>ets :as to 7e ;ositive @ue to t:e 4n@ or@er con@itionsA L stan@s ?or t:e \essian
@eterminant3 =:ic: is negative in t:e o;timumA Gnteresting(y3 t:e euantity in its k:omel mar>et AC6 reacts to
an access ;rice increase o? 5: Hince 6 re@uces its engagement in mar>et !3 margina( ;ro@uction costs @ecrease3
an@ t:is (ea@s 6 to increase t:e euantity in its o=n net=or> 4A
!4
=ou(@ not 7e intereste@ to engage in mar>et !3 since its margina( costs 0:6)F)2B =ou(@ t:en
7e too (arge to serve customers in net=or> !A ‘or t:at reason 6 =ou(@ con?ine its
engagement to t:e o=n net=or> 4 an@ ?irm 5 cou(@ e`c(usive(y serve customers in t:e
mar>et !A G? 5 an@ 6 c:arge@ eac: anot:er e`tensive access ;rices3 com;etition =ou(@ not
ta>e ;(ace at a((3 an@ t=o in@e;en@ent mono;o(ies =ou(@ resu(t3 @es;ite t:e connection o?
t:e net=or>sA \o=ever3 c:arging :ig: access ;rices consi@era7(y restricts t:e t=o ?irmsh
o;;ortunities to overcome ca;acity restraints or to generate a@@itiona( earnings 7y c:arging
access ?eesA Due to t:is tra@eMo??3 incum7ents =i(( set mo@erate access ;rices3 =:ic: ma>e
interconnection an@ @irect com;etition ;ossi7(eA 9o ;rove t:is statement =e ana(yse 5hs
7e:aviour regar@ing t:e setting o? 2B in an autar>y case3 =:ere AB6 q)AC5 q 5A4! Gn t:at case
eeuation K2L ta>es t:e ?o((o=ing va(ue:
0 j j1
!
!
! 5o 5 3 ! 53 4 5
! !
5 6
6
A A
A A
5 0 0
+2
+A
2 6 5
6
6
5
5
‘ *

-+
‘ ‘ ‘

-+


-+ K]LA
Ieuation K]L is t:e centra( resu(t o? our mo@e(A G? t:e (e?t si@e o? t:e eeuation is
negative3 it is ;ro?ita7(e to re@uce t:e access ;rice a! 7e(o= EBM06: an@ t:ere?ore to ;romote
6hs engagement in t:e mar>et !A 9:en3 to ma`imise its o=n ;ro?it3 5 s:ou(@ give u; its
mono;o(y ;osition 7y cutting 2! an@ setting a nonM@iscriminatory access ;riceA Ieuation K]L
s:o=s t:at suc: a scenario :a;;ens3 i? 5 ?aces :ig:er margina( treatment costs t:an 6 K05:)?)
06:LA #e(evant are t:e margina( costs in t:e status euo Kautar>yL3 =:ere 7ot: ?irms o;erate
in se;arate@ mar>etsA Zecause o? t:e ;ro7(emhs symmetry t:is statement is a(so va(i@ ?or
?irm 6A G? 6 ?aces :ig:er margina( treatment costs3 it o;ens its net=or> to com;etitor 5 7y
setting t:e access ;rice 2C 7e(o= ECM05:3 =:ere 5 gets ;ro?it troug: mar>et entryA Be
summarise t:is in t:e ?o((o=ing ;ro;ositionA
P/o0o1i+ion$ 34) 5) >’#4$3211() $%4’I#24’+) N24’#) ,OEE1$’#) “E’%,) $4,) %’4N”#P) 4″) 4=’)
3″QE’4$4″#)4=24)E#”+O3′,)N$4=)1″N’#)Q2#I$%21)3”,4,H)
4! Gn t:e autar>y case3 t:e access ;rice 2B is so :ig: t:at 6 a7an@ons its engagement in t:e mar>et !A Hince
j j ! ! !6 ! 6 2 ‘ E A & E *0 :o(@s3 AB6 is bero =:en 2B)J)EBM06:A
!V
6n ana(ogous resu(t cou(@ 7e ac:ieve@3 using access ;rice regu(ation 7y t:e I??icient
Com;onent Oricing #u(e KICO#LA44 6ccor@ing to t:is ru(e mar>et entry is on(y ;ro?ita7(e
?or ?irms t:at are more e??icient t:an t:e incum7entA 6s in our mo@e(3 mar>et entry on(y
:a;;ens3 i? t:e incum7enths com;etitor ?aces (o=er margina( costsA \o=ever3 t:ere is no
vo(untary motivation to o;en t:e net=or>3 since ICO# in@icates revenue neutra(ity ?or t:e
incum7entA Gn t:is res;ect our mo@e( :as stronger resu(ts: Gncum7ents ?acing :ig: margina(
treatment costs are a7(e to increase ;ro?it 7y o;ening net=or>s to more e??icient
com;etitors3 since access ?ees are not (imite@ 7y any regu(atorA 9:ere?ore incum7ents can
;ro?it ?rom t:eir com;etitorhs :ig:er e??iciency 7y (eaving mar>et s:ares to t:emA
Decreasing sa(es are more t:an com;ensate@ 7y 7ot: access c:arges t:at e`cee@ origina(
contri7ution margin an@ re@uce@ margina( ;ro@uction costsA
Di??erent margina( treatment costs are t:e main con@ition ?or t:e e`istence o?
interconnection an@ t:ere?ore @irect com;etitionA Gn =:at ?o((o=s =e consi@er a situation
=:ere 5 ?aces :ig:er margina( treatment costs t:an 6A Due to ;ro;osition G ?irm 5 a((o=s
com;etitor 6 to serve customers connecte@ to 5hs @istri7ution systemA \ence3 in t:e mar>et
!3 a @uo;o(y com;etition arisesA Fn t:e ot:er :an@ 5 is not engage@ in t:e mar>et 43 since 6
:as (o=er margina( costsA ‘or t:at reason 6 maintains its mono;o(y ;osition in mar>et 4A
Zase@ on t:e a@@itiona( engagement in t:e mar>et ! K@enote@ 7y AB6L3 ?irm 6hs margina(
costs increase Kor at (east @o not @ecreaseLA \o=ever3 t:e :ig:McostM?irm 5 re@uces out;ut
AB5 an@ t:ere?ore its margina( costsA 9:us3 margina( costs o? 7ot: ?irms a;;roac: eac:
ot:erA Gn contrast to t:e actua( situation3 =:ere uti(ities act @e ?acto as mono;o(ists in
se;arate@ mar>ets3 @rin>ing =ater ;ro@uction is no= more e??icient in t:e tota( o? 7ot:
mar>etsA \ig:est e??iciency =ou(@ 7e ac:ieve@3 i? 7ot: ?irms ?ace@ i@entica( margina( costsA
\o=ever3 suc: scenario cannot arise3 since t:e mo@e(hs eeui(i7rium reeuires a @i??erence in
t:e ?irmsh margina( costsA Ieuation K2L im;(ies t:at 05: must e`cee@ 06:3 i? AB6)?)0A
P/o0o1i+ion$ 334) @=’) $%4#”+O34$”%) “!) 3″QE’4$4$”%) $%) 4=’) N24’#) Q2#P’4) $%3#’2,’,)
‘!!$3$’%3() “!) E#”+O34$”%R) $!) O4$1$4$’,:) Q2#I$%21) 3″,4,) +$!!’#) S’!”#’) 1$S’#21$,24$”%H) T2#I$%21)
3″,4)+$!!’#’%3′,)+’3#’2,’)$%)4=’)%’N)’UO$1$S#$OQH)V’>’#4=’1′,,R)4=’)’UO$1$S#$OQ)#’UO$#’,)2)
Q$%$Q21)Q2#I$%21)3″,4)+$!!’#’%4$21H)@=’#’!”#’)=$I=’,4)E”,,$S1′)’!!$3$’%3()$,)%”4)23=$’>’+H))
44 Hee La??ont an@ 9iro(e K!SS^L ?or a @etai(e@ survey o? access ;rice regu(ation an@ critica( assessment o? t:e
ICO# ru(eA
!U
Gt is straig:t?or=ar@ to see t:at t:e intro@uction o? suc: a @uo;o(y com;etition raises
t:e vo(ume o? so(@ =ater in t:e com;etitive mar>et !A 9:ere?ore3 in eeui(i7rium3 ;rice EB is
(o=er as in t:e origina( mono;o(y situationA
P/o0o1i+ion$3334)@=’)$%4#”+O34$”%)”!)3″QE’4$4$”%)#’+O3′,)#’42$1)E#$3′)2%+)#2$,’,),”1+)
N24’#)>”1OQ’)$%)4=’)%’4N”#P)”!)4=’)=$I=M3″,4)$%3OQS’%4H)
6 @i??erent e??ect arises in t:e mar>et 4A 6s mentione@ a7ove3 ?irm 6 may ?ace
increase@ margina( costs @ue to its a@@itiona( engagement in t:e mar>et !A Zut :ig:er
margina( costs in@icate a re@uce@ mono;o(y out;utA \ence3 retai( ;rice EC =ou(@ rise an@
so(@ =ater vo(ume AC6 in t:e mar>et 4 =ou(@ ?a((A \o=ever3 aggregate =e(?are increases
=it: certainty @ue to :ig:er e??iciency o? ;ro@uction3 as state@ in ;ro;osition GGA
GHBHC)V”%M1$%’2#)233′,,)E#$3$%I)
6gain =e consi@er t:e situation3 =:ere t:e (ess e??icient mono;o(ist 5 a((o=s com;etitor)6
to serve customers connecte@ to 5hs @istri7ution systemA Gn t:e a7ove mentione@ case o?
;ure (inear access ;ricing mono;o(ist 5 ten@s to set a ;ositive access ?ee 2B a7ove its o=n
margina( net=or> costs4VA ‘or t:is reason uti(ity 6hs re(evant margina( costs3 =:ic: consist
o? margina( treatment costs an@ access ;rice 2B3 are :ig:er t:an tota( margina( ;ro@uction
costsA \ence 6 =i(( (imit its engagement AB6 in mar>et ! 7e(o= t:e socia((y o;tima( amount3
=:ic: =ou(@ guarantee e??iciency o? ;ro@uctionA 6s state@ in ;ro;osition GG :ig:est ;ossi7(e
e??iciency can not 7e ac:ieve@A \o=ever3 instea@ o? c:arging a ;ure (inear access ;rice 2B3
mono;o(ist 5 can im;(ement a t=o ;art access tari?? 7y com7ining a ?i`e@ ?ee DB =it: a
varia7(e ;rice 2BA
#e@ucing t:e varia7(e tari?? 2B increases 6hs incentives to engage in mar>et !3
=:ereas mono;o(ist 5 @ecreases its o=n ;ro@uction amount AB5A Hince =e assume@ t:at 6
?aces (o=er margina( ;ro@uction costs t:an 53 overa(( e??iciency an@ t:ere?ore aggregate
;ro?it can 7e im;rove@A \o=ever3 accor@ing to eeuations K4L an@ KVL re@ucing AB5 an@ 2B
(o=ers 5hs revenues an@ t:ere?ore earningsA Fn(y 6 =ou(@ ;ro?it ?rom t:e a7ove mentione@
e??iciency gainA Zy c:arging an a@@itiona( ?i`e@ access ?ee DB3 mono;o(ist 5 can
com;ensate suc: a (ossA Hince t:e ?i`e@ ?ee DB @oes not a??ect 6hs ;ro?it ma`imising
4V Be assume margina( net=or> costs eeua( to beroA
!T
7e:aviour at t:e margin4U3 5 can c(aim t:e entire a@@itiona( aggregate@ ;ro?itA C:arging DB
s:i?ts t:e ;ro?it3 =:ic: resu(ts ?rom t:e re@uction o? t:e varia7(e ?ee 2BR ?rom 6 to 5A F?
course mono;o(ist 5 can not c:arge an in?inite ?ee DB3 :e :as to meet 6hs ;artici;ation
constraint3 =:ic: rea@s + *+533’,, % 5
6
5O42#P(
6 A Denoting t:e o;tima( euantities in t:e autar>y
case 7y AW
463 =e can =rite
K L K + L
4
+
4
+
4 46 6 6 6
5O42#P(
6 + ‘ E A A *@0 A KSL an@
5 6 6 5 6 6 6 6 6 6
533’,,
6 E A A A E A A A @0 A A D 2 A4 4 4 4 ! ! ! ! ! 4 ! ! ! + ‘ K & L & K & L * K & L * * K!5L3
=:ere eeuation K!5L @enotes gross ;ro?it minus access ?eesA Be ca(cu(ate t:e o;tima( access
?ees 2B an@ DB c:arge@ 7y 5A 5 ma`imises its ;ro?it ana(ogous to eeuation KVL 7y c:oosing
t:e o=n ;ro@uction amount AB5 an@ t:e access ?ee3 =:ic: consists o? 2B an@ DB3 given t:e
a7ove mentione@ ;artici;ation constraintA Be set u; t:e re(evant Lagrangian:
(0 1 5O42#P( )
5 6 6 5 6 6 6 6 6 6 6
5 6 5 5 5 6
E A A A E A A A @0 A A D 2 A
/ E A A A 0 A D 2 A
& & & & * & * * *+
‘ & * & &
4 4 4 4 ! ! ! ! ! 4 ! ! !
! ! ! ! ! ! ! !
K L K L K L
K L K L
@
K!!L
Gn t:is case t:e ?irstMor@er con@itions ?or t:e ;ro?it ma`imisation ;ro7(em are
j j 5
! ! !
!
‘ & * ‘


5 5
5
E A E 0
A
/ K!4L
! 5
!
‘ * ‘


@
D
/ K!VL
0 1
0 j j 1 0 j j 1 0 j 1 5
j
! ! !
!
!
!
!
!
! ! !
!
4
4 4 4
! ! !
!
!
!
!
‘ 9
9
:
;
< <
=
>
34
5
67
8
* & * & & * * & &
‘ & &


E A 2
+2
+A
A
+2
+A
E E A 0
+2
+A
E E A 0
E A 2
+2
+A
A
2
/
5
6
6
6
6 6
6
6 6
5
6
6
@
K!UL
Ieuation K!VL im;(ies t:at @) q !3 so t:e (ast e`;ression sim;(i?ies @ramatica((yA Be can
re=rite eeuation K!UL as ?o((o=s:
4UZecause t:e ?i`e@ ?ee DB is not e`istent in Zhs ?irst or@er con@itionsA
!^
0 j j 1 0 j j 1 5
!
!
! ! !
!
4
4 4 4
!
‘ 9 9
:
;
< <=
>
‘ * & * & & *


+2
E E A 0 +A
+2
E E A 0 +A
2
/ 6
6 6
6
6 6 K!UnL
Hince =e >no= t:at j j 5 4 4 4
4
‘ & * ‘

-+
6 6
6
6 E A E 0
A
=e can sim;(i?y t:e a7ove e`;ression
againA Gnserting t:ese t=o eeuations into eeuation K!UhL yie(@s
5
!
!
!
!
‘ * ‘


+2
+A
2
2
/ 6 K!TL3
=:ic: im;(ies t:at 2B is eeua( to beroA 9:e outcome is 7y no means sur;risingA Be get t:e
=e(( >no=n resu(t t:at t:e varia7(e ;art o? a nonM(inear ;rice is set eeua( to t:e margina(
costA
Hince 5hs margina( net=or> costs are assume@ to 7e bero3 :e =i(( re@uce t:e varia7(e
access ;rice 2B to an amount =:ic: is as =e(( eeua( to beroA 9:e more e??icient uti(ity 6 gets
incentives to increase its engagement in t:e ?oreign mar>et !3 =:ereas 5 re@uces o=n
se((ingsA \o=ever3 mono;o(ist 5 ma`imise o=n ;ro?it 7y setting t:e ?i`e@ access ?ee DB in
t:e =ay t:at t:e ;artici;ation constraint :o(@s =it: eeua(ityA 9:us :e e`tracts t:e ?u((
a@@itiona( rent o? mono;o(ist 6A 9:en t:e access ?ee DB is t:e @i??erence 7et=een 6hs gross
;ro?it K7e?ore ;aying access ?eesL in case o? access an@ 6hs ;ro?it in case o? autar>yA
P/o0o1i+ion$ 354) W$4=) 2) %”%M1$%’2#) 42#$!!)Q”%”E”1$,4)5) ‘X4#234,) 4=’) !O11) #’%4) “!) 2%)
2++$4$”%21) ‘!!$3$’%3() I2$%H)L’) N$11) ,’4) 4=’) >2#$2S1′) 233′,,) E#$3′) 2B) ‘UO21) 4″) Y’#”) 2%+) 4=’)
!$X’+)233′,,)!”)DB),O3=)4=24)4=’)E2#4$3$E24$”%)3″%,4#2$%4)”!)6)=”1+,)N$4=)’UO21$4(H)@=’#’!”#’)
6)$%3#’2,’,)AB6)N=$1′)5)#’+O3′,)AB5)O%4$1)05:)$,)’UO21)4″)06:H)@=’)’UO21$Y24$”%)”!)Q2#I$%21)
3″,4,)IO2#2%4”,)=$I=’,4)’!!$3$’%3()2%+)4=’#’!”#’)Q2X$QOQ)2II#’I24’+)E#”!$4,H
Gn case o? c:arging nonM(inear access tari??s :ig:est ;ossi7(e ;ro@uction e??iciency =i(( 7e
ac:ieve@A 9:is e??iciency corres;on@s to t:e case3 =:ere on(y one mono;o(ist serves 7ot:
mar>etsA F? course3 t:is is rare(y ;ossi7(e since t:ere are institutiona( restrictions =:ic:
?or7i@ t:atA Zig mono;o(ies may a(so (ea@ to :ig:er `Mine??iciency an@ to more severe
in?ormationa( ;ro7(ems o? t:e ;u7(ic3 =:ic: en:ances3 ?or e`am;(e3 rent see>ing activities
o? t:e merge@ mono;o(yA
$
!2
!”6$7i/1+$%+,-&$
Gn t:e ?irst ;erio@ t:e ?irms ta>e t:eir investment @ecisionsA 9:e centra( euestion to ans=er
is :o= t:e intro@uction o? com;etition c:anges t:e investment incentives3 in com;arison to
t:e case =it: t=o autonomous mono;o(istsA 9a>ing into account t:e o;tima( @ecisions o?
t:e secon@ stage3 =e can so(ve t:e mo@e( 7y 7ac>=ar@ in@uctionA
GHCHB)?%>’,4Q’%4)$%3’%4$>’,)2%+)1$%’2#)233′,,)E#$3$%I)
Be ?irst(y @iscuss t:e case o? ;ure (inear access ;risingA ,sing t:e Inve(o;e t:eorem3 t:e
@erivative o? t:e ;ro?it ?unction KVL =it: res;ect to investment ?5 rea@s
0 1
5
5 5
5
5
5 5
5 5
6
5
6
5
5
5
?
& ?
?
A 0 / ?
?
2
?
E A
?
E A 2 A
+?
+


*


* 9 9
:
;
< <=
>


*


&


‘ &
+ j j j !K L K L
4
4 4
4
!
! ! ! K!^L
BH)’!!’34))))))))))))))))))))))CH)’!!’34) )))))))))))))) ZH)’!!’34)
9:e @erivativehs sign an@ :ence t:e investment @ecision is in?(uence@ 7y t:ree e??ectsA Gn
eeui(i7rium3 t:e ?irst e??ect on(y arises =it:in t:e :ig:Mcost ?irm =:ereas t:e secon@ e??ect
is on(y re(evant in t:e (o=Mcost ?irmA 9:e t:ir@ e??ect can 7e o7serve@ in 7ot: ?irmsA
9:e ?irst e??ect is negativeA \ig:er investment @ecreases =ater (osses3 t:us ?or given
amounts o? so(@ =ater3 t:e margina( costs o? 5 are re@uce@A 9:is in@uces 5 to ;ro@uce more3
an@ t:is ;us:es 6 out o? 5hs mar>etA4T Fn t:e one :an@ revenues o? ! ! K A ? L2 6 5 – – are (ost 7ut
;rices in t:e :ome mar>et increase3 =:ic: gives a gain o? K LK j L !6 5 ! !5 -A -? E A A Ieuation
K^L te((s us t:at3 in eeui(i7rium3 t:e ?ormer e??ect @ominatesA
9:e secon@ e??ect3 =:ic: occurs on(y =:en 5 is t:e (o=Mcost ?irm3 is am7iguousA Be
can i@enti?y t=o ;artia( e??ectsA Zy investing3 ?irm 5 im;roves its ;osition in t:e ?oreign
mar>et an@ in@uces 6 to re@uce its euantity since margina( costs o? 5 :ave @ecrease@A 9:is
argument is re?(ecte@ in term 6 5 5 E A ? A4 4 4 K j- – L 3 =:ic: is ;ositiveA 9:e ot:er ;artia( e??ect3
5 5 2 ? A4 4 K*- – L 3 is negativeA /ono;o(ist 6 >no=s t:at 5 =i(( stay in t:e ?oreign mar>et
even =it: a s(ig:t(y :ig:er access c:arge 7ecause margina( costs o? 5 :ave ?a((enA 9:is
in@uces 6 to get its ;art ?rom t:e increase@ e??iciency o? 5 an@ to increase t:e access ;riceA
4T Be assume reaction curves to 7e ?a((ingA
!]
F7vious(y3 t:is :as a negative in?(uence on 5hs ;ro?itsA B:ic: ;artia( e??ect @ominates in
tota( cannot 7e @etermine@ genera((yA
9:e t:ir@ e??ect is t:e @irect e??ect an@ a;;ears in t:e case =it: se;arate@ net=or>s
tooA Gt re(ates margina( cost o? investment 5 5 5 -& K? L -? to t:eir margina( revenues3 t:e (o=er
cost o? ;ro@uction K K L L j ! 5 5 5 * -/ ? -? 0 A Hince margina( cost o? ;ro@uction is increasing3
t:e ?irm3 =:ic: increases ;ro@uction @ue to (i7era(isation3 =i(( ?ace :ig:er investment
incentives 7ecause =it: :ig:er margina( ;ro@uction costs margina( revenues o? investment
are :ig:erA 9:e o;;osite :o(@s ?or t:e ?irm t:at (o=ers ;ro@uctionA #eca(( t:at in
eeui(i7rium3 t:e (o=Mcost ?irm =i(( increase ;ro@uction =:ereas t:e out;ut o? t:e :ig:Mcost
?irm @ecreasesA Li7era(isation no= @ecreases unam7iguous(y t:eir investment incentives
t:roug: t:e ?irst an@ t:e t:ir@ e??ectA ‘or t:e (o=Mcost ?irm investment incentives increase
@ue to t:e t:ir@ e??ect3 =:ereas t:e secon@ e??ect is am7iguousA Be conc(u@e t:at t:e
intro@uction o? com;etition :as an asymmetric im;act on investment incentives in t:e sense
t:at e??icient ?irms =ant to invest even more com;are@ to :ig:Mcost ?irmsA
GHCHC)?%>’,4Q’%4)$%3’%4$>’,)2%+)%”%M1$%’2#)233′,,)E#$3$%I)
Be turn no= to t:e case o? nonM(inear access ;ricingA 9a>ing t:e @erivatives o? 5hs ;ro?it
?unction4^ =it: res;ect to ?5 an@ using again t:e Inve(o;e 9:eorem3 =e get
5
5 5
5
5
5
5
5
5
6
5 5
6
5
5
5
?
& ?
?
/ ?
0
?
D
A
?
A
E
?
D
?
A
E A
+?
+


*


*


*


&


&



+ K L K L
j j 4 j !
4
4
4
! !
! ! K!2L3
BH)’!!’34))))))))))))))))))))CH)’!!’34) ))))))))))))) ZH)’!!’34)
=:ere
5
5
6
5 ?
A
E A
?
D




– !
! !
! j an@
5
6
5
5 ?
A
E A
?
D




– 4
4 4
4 j A
6gain =e can @istinguis: t:ree e??ectsA 9:e ?irst e??ect ca;tures t:e c:anges in investment
incentives o? t:e :ig:Mcost ?irm @ue to mar>et interactionA Gts sign is am7iguousA 9:e ?irst
;artia( e??ect 6 5 5 E A ? A! ! ! K j- – L is ;ositive 7ecause 6 re@uces AB6 =:en 5 increases
investment ?5 Kremem7er t:at euantities are strategic su7stitutes in Cournot com;etitionLA
4^ 6hs ;ro?it ?unction can 7e @e?ine@ ana(ogous to Zhs ;ro?it ?unction3 =:ic: is @escri7e@ in eeuation K!5LA
#eversing a(( in@ices in eeuation K!5L yie(@s 6hs ;ro?it ?unctionA
!S
Fn t:e ot:er :an@ t:e secon@ ;artia( e??ect -D m -? 5 ! is negativeA Zy investing3 ?irm 5
re@uces its margina( cost an@ im;roves its mar>et ;ositionA 9:is re@uces 6hs ;ro?itA 9:e
;artici;ation constraint @irect(y im;(ies t:at 5 must c:arge a (o=er access ?ee DBA
9:e secon@ e??ect matters on(y =:en 5 is t:e (o=Mcost ?irmA 9:e e??ect is am7iguous
as =e((A 9:e reasons are e`act(y t:e same as in t:e ?irst e??ect: Fn t:e one :an@3
6 5 5 E A ? A4 4 4 K j- – L is ;ositiveA Due to :ig:er investment ?53 6 re@uces its euantity AC63 =:ic:
increases ;rice in mar>et 4 an@ 5hs incentives to engage in mar>et 4A Fn t:e ot:er :an@
5 * -D m -? 4 is negativeA 6 =i(( increase t:e access ?ee =:en 5 increases its investmentA 9:e
t:ir@ e??ect is t:e ;ositive @irect e??ect o? a cost re@uctionA Be conc(u@e t:at t:e same
e??ects occur in 7ot: access ;rice sc:emesA
TA Hummary an@ Conc(usions
9:e nonMe`istence o? a nationa( =ater gri@ restricts geogra;:ica( e`tension o? ;ro@uct
mar>et com;etition in t:e =ater sector to a regiona( or even (oca( (eve(A Hince on(y ?e=
=ater su;;(iers are e`;ecte@ to ;artici;ate in suc: a (oca( com;etitive mar>et3 t:e e`istence
o? ;er?ect com;etition $% t:e mar>et seems not to 7e very rea(isticA Qevert:e(ess3 =e s:o=e@
t:at signi?icant e??iciency an@ =e(?are gains can 7e ac:ieve@A 9:e connection o?
neig:7ouring net=or>s an@ t:e im;(ementation o? @irect com;etition a((o=s some su;;(iers
to overcome t:eir ca;acity constraints =:i(e ot:ers are a7(e to raise t:eir treatment
?aci(itiesh rate o? ca;acity uti(isationA 9o ma`imise ;ro?its3 uti(ities ?acing :ig: margina(
costs vo(untari(y o;en t:eir net=or>s to com;etitors an@ re@uce o=n ;ro@uction vo(ume3
su;;(iers ?acing sma(( margina( costs e`;an@ t:eir ;ro@uctionA Gn contrast to t:e ?ormer
situation3 =:ere uti(ities act @e ?acto as mono;o(ists3 @irect com;etition arises an@ t:e
re(evant retai( ;rice in t:e com;etitive mar>et goes @o=nA G? nonM(inear access tari??s are
a((o=e@3 =e get t:e even stronger resu(t t:at3 7y intro@ucing com;etition $% t:e mar>et3
:ig:est ;ro@uction e??iciency is ac:ieve@A
Gt is im;ortant to note3 t:at t:e im;rovement o? ;ro@uction e??iciency is ac:ieve@ 7y
t:e im;(ementation o? com;etition an@ not 7y co((a7oration 7et=een neig:7ouring uti(itiesA
9:e mo@e( t:ere?ore @oes not assume an e??icient negotiation ;rocess 7et=een t:e mar>et
;(ayersA Com;etition itse(? (ea@s to ;ro@uction e??iciency in t:e mar>etA
Fne may o7Nect t:at t:e =ater su;;(iers sti(( :ave some @egree o? mar>et ;o=er3
@es;ite t:e im;(ementation o? com;etition $% t:e mar>etA \o=ever3 =e s:o= t:at t:e :ig:
45
cost ?irm gives u; its mono;o(y ;osition an@ ;rices @ecrease3 a(t:oug: t:ere is no K;riceL
regu(ationA Gn or@er to a@@ress t:is issue ?urt:er3 com;etition $% t:e mar>et cou(@ 7e
com7ine@ =it: a@@itiona( e(ements o? com;etition or =it: regu(ation f ?or e`am;(e
yar@stic> com;etition3 ;rice ca;s or rate o? return regu(ationA
9:e mo@e( s:o=s ?urt:er t:at t:ere are on(y =ea> reasons ?or re@uce@ investment
incentives cause@ 7y t:e intro@uction o? com;etitionA 9:e e??ects are in 7ot: access ;ricing
systems simi(ar: on t:e one :an@ t:e (ess e??icient ?irm re@uces net=or> investments3 on t:e
ot:er :an@ t:e more e??icient one ten@s to increase investmentsA \o=ever3 it s:ou(@ 7e
note@ t:at t:e mo@e( assumes a =orst case3 =:ere regu(ation @oes not e`ist at a((A Zot:
@egree o? com;etition an@ investment vo(ume are e`;ecte@ to im;rove 7y e??ective
regu(ationA
9:e sim;(e structure o? t:e mo@e( an@ t:e nonMe`istence o? any regu(ation suggest an
easier im;(ementation o? suc: a @irect com;etition t:an ot:er a;;roac:esA Gn ;ractice Nust a
?e= structura( an@ (ega( c:anges an@ o? course t:e ;:ysica( connection o? neig:7ouring
net=or>s =ou(@ 7e nee@e@A Zot: uti(ities an@ consumers cou(@ ;ro?it ?rom ?ast e??iciency
gainsA \o=ever3 to@ay =ater uti(ities costs are @ominate@ 7y ?i`e@ ca;ita( costs3 a7ove a((
7y net=or> investment costsA Ootentia( e??iciency gains in =ater treatment cause@ 7y t:e
intro@uction o? @irect com;etition =ou(@ 7e minorA Zut in t:e (ongMterm increasing @eman@3
ca;acity constraints an@ :ig:er contamination o? ra= =ater resources are e`;ecte@ to raise
treatment reeuirements an@ t:ere?ore varia7(e costs signi?icant(yA Gn t:is sense our mo@e(
:e(;s @iscussing ?uture ;ro7(ems in t:e =ater in@ustryA
4!
#e?erences
6rmstrong3 /ar>o Qet=or> Gnterconnection in 9e(ecommunications3 .3″%”Q$3) -“O#%21)
B0[3 !SS]3 TUTMT^UA
6rmstrong3 /ar>3 Himon Co=an an@ ro:n dic>erso \’IO124″#()\’!”#Q]).3″%”Q$3)5%21(,$,)
2%+)6#$4$,=).XE’#$’%3’3 /G9 Oress3 Lon@on3 !SSUA
Zue:(er3 Hte?ano 5)DO#4=’#)/””P)24)@N”MN2()V’4N”#P)0″QE’4$4$”%)$%)@’1’3″QQO%$324$”%,A
Bor>ing Oa;er3 ,niversity o? Yuric:3 4555A
Correia3 ‘rancisco Qunes an@ 6n@reas graemero ?%,4$4O4$”%’%) +’#) W2,,’#N$#4,3=2!4) $%)
.O#”E2)^)/_%+’#S’#$3=4’3 H;ringer3 Zer(in3 !SS2A
Co=an3 Himono Com;etition in t:e Bater Gn@ustry3 `X!”#+) \’>$’N) “!) .3″%”Q$3) a”1$3(3
do(A !V3 QoA !3 !SS23 ]V M S4A
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