Achieving Price Transparency in Bundles

A Report on behalf of Hutchison Telecommunications

Joshua Gans and Stephen King

The analysis here represents the views of CoRE Research Pty Ltd
(ACN 096 869 760) and should not be construed as those of
Hutchison Telecommunications.

21st October, 2002

Contents Page

1 Background ............................................................................. 2

2 Competitive concerns about bundling .............................. 3

3 Transparency to Competitors and Authorities................. 5

4 Customer-Level Transparency............................................. 9

5 Conclusion............................................................................. 11

6 Appendix ............................................................................... 13

July, 2001 i
Section 1 Background

1 Background

On the 19th July, 2002, Telstra and Telstra Pay TV filed a notice with
the ACCC regarding its intention to use a bundled price when re-
selling the pay television services of Foxtel. That price would offer to
customers who have pre-selected a Telstra fixed line service a further
discount of 5 percent on eligible services if they also subscribed to
one of Telstra internet, mobile or pay TV services and 10 percent if
they subscribed to any two of these.

This report focuses on one aspect of Telstra’s proposed pricing policy

– the issue of transparency. Section 14 of their submission deals with
this issue. Telstra write:
Telstra is aware that one of the primary concerns
with the practice of bundling is that, where a single
price is offered for the package, there is potential for
disguising the prices of individual components of the
package. The economist, Professor Stephen King has
suggested that: “The problem is not that Telstra can
sell a bundle of pay-TV, high-speed internet and
telephony services, but rather that it can set a single
price for the bundle of services.”1
The Telstra Rewards Options programme will not
offer a single price for the bundle of packaged
services. Neither the 5% nor the 10% discount
would operate to disguise the prices of the individual
elements of the package, such as the prices of mobile
telephony services.
The Telstra Rewards Options programme does not,
and will not, allow Telstra to disguise the price of its
telephony services. It will still be possible to compare
Telstra’s telephony prices with those of its
competitors. There is total transparency of pricing
and no potential for Telstra to disguise the pricing of
different elements of the Rewards Options
programme. For this reason, the proposed conduct
will not have the anti-competitive effect feared by
Professor Stephen King. (p.27)

1 Stephen King, “Why this bundle should worry the ACCC,” Australian Financial

Review, 16 April 2002, p.67.

2
Section 2 Competitive concerns about bundling

Hutchison Telecommunications has asked CoRE Research to

comment on the issue of the transparency of Telstra’s proposed
pricing policy. We begin by briefly recapping the potential anti-
competitive problems that can arise with price bundling. We then
consider the Telstra proposed pricing policy. Specifically we consider
whether it is transparent to competitors and regulators and whether
or not it could create competitive concerns. Finally, we comment on
the issue of transparency from the customers’ perspective.

2 Competitive concerns about

bundling

Gans and King briefly reviewed the economics literature on

bundling.2 We noted two broad anti-competitive concerns about
bundling that have been highlighted by economic research. First,
bundling can be used to disguise predatory pricing. The firm selling
the bundle can cross-subsidise one market from another market for
the purpose of driving competition from the subsidised market.
Second, bundling can be used to create a barrier to entry in a
potentially competitive market.

King discusses the first of these concerns in more detail.3 In

particular, he focuses on the relationship between bundling and a
vertical price squeeze. “If the incumbent is the monopoly provider of
access to an essential facility, then anti-competitive bundling can
involve a vertical price squeeze. In this situation, the access provider
bundles retail products involving the essential input together (and
possibly with other products where it also has market power) and
sells the retail bundle at a price that cannot be profitable for a
competitor who buys access. The competitors are ‘squeezed’ between
the access price and the retail price” (p.1).

King also notes that this form of anti-competitive bundling is similar

to predatory pricing. Just as with standard predatory pricing, a vertical
price squeeze instituted through a bundled product can benefit some
customers in the short-term, but is aimed at reducing competition
and raising profits in the longer term.

2 See Gans, J. and King, S. (2002) “Potential anti-competitive effects of bundling: A

report on behalf of Hutchison Telecommunciations”, CoRE Research.

3 See King, S. (2002) “Bundling and imputation rules under accounting separation:

A report on behalf of Hutchison Telecommunciations”, CoRE Research.

3
Section 2 Competitive concerns about bundling

In the quote presented above, Telstra argues that King’s concerns

about anti-competitive bundling are irrelevant for the Telstra
proposed pricing policy because there are individual product prices
and “total transparency of pricing”. This claim is misleading. A
vertical price squeeze and anti-competitive bundling involves the
relationship between retail and wholesale prices and costs. The fact
that various prices are ‘listed’ does not mean that there is no risk of a
vertical price squeeze. Rather, a vertical price squeeze and anti-
competitive bundling can arise when the relationship between prices
is distorted by a firm with market power.

A simple example can illustrate this point. Suppose an essential-

facility access provider has a wholesale access price of $10 per unit
and the efficient retail-level costs of transforming a unit of wholesale
input into a unit of retail output are $5. If the access provider sets a
retail price of $14, then this is ‘transparent’ in the sense that the price
is well known and observable. But it also involves a vertical price
squeeze because, given the (transparent) wholesale access price, the
retail price cannot be matched by an efficient competitor.4

Contrary to the claim made by Telstra, their proposed pricing rules

may be used to hide anti-competitive conduct. This is explained in
more detail in section 3. However, there are two underlying drivers of
any potential anti-competitive conduct. First, the discounts in the
Telstra proposed pricing policy are not explicitly related to any cost
savings. There might be legitimate cost savings realised by Telstra
through bundling, but such savings are not formally presented or
measured by Telstra. Second, the discounts are ad valorem reductions
in a customer’s payments over all relevant services. Such ‘total
bundle’ discounts can lead to individual products being priced below
incremental cost. In fact, as shown below, the Telstra proposed
pricing policy might lead some customers to face negative prices for
some components of the Telstra bundle. Such below cost pricing
could clearly be used to undermine legitimate competition.

4 This is analysed in detail in King, S. and Maddock, R. (2002) “Imputation rules

and a vertical price squeeze”, Australian Business Law Review, 30, 43-60.

4
Section 3 Transparency to Competitors and Authorities

3 Transparency to Competitors and

Authorities

One element of pricing transparency relates to the signals sent by

prices to competitors and the information available for regulatory
authorities. If there is no bundling, then the posted price for say
Telstra’s mobile service is the price competitors know they have to
beat in order to attract customers. Regulatory authorities can easily
cross-check such prices against the relevant competition laws.

Telstra’s bundling does not allow full price transparency to either

competitors or regulatory authorities. From the perspective of
competitors, they do not know the average price customers are
actually paying for a Telstra service. In particular, competitors need to
know what price the greatest proportion of Telstra mobile customers
are paying to know what price to beat. However, without detailed
information regarding Telstra’s subscribers to fixed line, Pay TV and
internet, it cannot easily assess this. In this respect, bundling makes
pricing less transparent.

As noted above, the lack of transparency in bundled prices can make

disguised predation more likely – allowing a dominant firm to set a
price for a particular service below cost under the radar of both
competitors and regulators alike. Telstra’s proposed bundling carries
with it a risk to overall competition as price signals cannot be sent to
competitors to Telstra or to regulatory authorities.

To avoid a firm with market power using bundling to disguise

predatory behaviour, it may be desirable to require the firm that
provides the bundle to also sell the individual products at ‘consistent’
prices. The bundled product can be discounted to reflect legitimate
cost savings. This approach allows both the producer and customers
to enjoy benefits of bundling where they exist while avoiding the anti-
competitive potential of bundling.

The potential for predatory pricing under Telstra’s proposed bundled

product pricing arises because the proposal does not guarantee
consistency between prices of bundled products and the costs faced
by Telstra for serving a customer. Telstra’s current bundling proposal
can easily lead to incremental prices for customers that fall below
incremental cost. Such prices will be prima facie inconsistent with
standard competitive behaviour.

To see this, consider the simple example of the first customer in the
Appendix. The incremental price to the customer of Pay TV is only

5
Section 3 Transparency to Competitors and Authorities

$8.50. This is the extra revenue that Telstra earns from the customer
when they subscribe to Pay TV given that they subscribe to all the
other services listed in the example. To see this, note that the
customer would pay $199.50 to Telstra if they did not subscribe to
Pay TV. This involves a pre-Reward bill of $210 less a 5% discount.
With Pay TV the customer’s bill is $207. Thus the customer only pays
an extra $8.50 for the Pay TV subscription. While we do not have
information on the incremental cost to Telstra of supplying Pay TV
services to a customer, if these exceed $8.50 then Telstra is losing
profits by selling Pay TV services to this customer.

Even if the incremental costs of each of the services from Telstra’s

perspective were close to $0, Telstra’s proposed bundling may lead to
implicit product prices below marginal cost. In fact, a customer might
pay a negative price for an additional product under Telstra’s bundling
proposal. To see this suppose that a customer pays on average $250
per month in fixed line calls (local calls, long distance calls and fixed-
line calls to mobiles) using Telstra. The customer also buys Pay TV
from Telstra, including say movie and sport packages, paying say $70
per month. The customer will pay $304 per month after the 5%
discount. Now suppose that the customer subscribes to Telstra
mobile. The customer has a relatively low mobile bill of only $15 per
month on average before any bundling discount. The customer’s total
bill before the Reward discount is $335 per month. After the 10%
discount the customer pays $301.50. In other words, Telstra is paying
the customer $2.50 per month to have the customer use a Telstra mobile
phone. Telstra is charging a negative incremental price for mobile
services to this customer.

While this example is extreme, it is not impossible or unrealistic.

Further, if pricing under incremental cost is not only feasible but
wide-spread under Telstra’s bundled pricing, then Telstra’s
competitors will face a substantial barrier to effective competition. In
the above example, suppose that the customer was originally with
another mobile carrier. Even if that carrier was significantly more
efficient than Telstra, it would not be able to retain its customer – it
could not compete with the negative price associated with mobile
services under the Telstra bundle. More generally, the Telstra
proposal does not guarantee that there will not be significant pricing
below incremental cost on some products or for some groups of
customers. If this occurs, efficient competitors will be driven from
the market by the Telstra bundled pricing.

Implicit pricing below incremental cost can clearly lead to competitive

concerns. The potential anti-competitive effects of Telstra’s proposed
pricing are exacerbated because they apply to products where
Telstra’s competitors must buy access to wholesale services provided
by Telstra in order to compete with Telstra at the retail level. For

6
Section 3 Transparency to Competitors and Authorities

example, the Telstra bundled products include fixed-line telephone

services. In this situation, Telstra might be able to institute a vertical
price squeeze even if the price to a customer for the retail service is
above the incremental cost to Telstra of that service. If Telstra’s
wholesale access price exceeds incremental cost then Telstra’s retail
competitors will not be able to match Telstra’s pricing.

In summary, Telstra’s proposed bundled pricing does not guarantee

that Telstra will not engage in predatory conduct. In fact, the pricing
proposal, by allowing customers to gain an increased percentage
discount over their entire bill when they subscribe to an incremental
service, will most likely lead to pricing below incremental cost for at
least some customers and some services. It provides an excellent
strategic cover for predation or a vertical price squeeze.

We do not have enough information to predict the extent of either

below-cost pricing or vertical price squeeze under the Telstra
proposal. If such pricing is potentially wide-spread or will apply to
important classes of customers, then Telstra’s proposed bundled
pricing could severely retard efficient competition.

At a minimum, to reduce anti-competitive concerns about disguised

predatory pricing, Telstra’s bundling should proceed only on the basis
that Telstra makes certain commitments to the ACCC regarding
information and bundled prices. Telstra needs to assure the
Commission that the incremental prices set for any customer or
group of customers exceed incremental costs for the relevant
services. Telstra needs to provide any relevant information to the
Commission to allow the Commission to reassure itself that the
bundled pricing will not be used to disguise predatory conduct. This
information will include customer purchasing profiles and
incremental cost information.

For example, Telstra and the ACCC (possibly in consultation with

other interested parties) could identify relevant classes of customers.
Telstra would then provide the Commission with aggregate data
relating to each customer group. This data could include average
customer profiles as well as the profiles of the lowest ten percent (in
terms of expenditure) for each bundled product. Telstra would also
need to provide incremental cost data to the Commission for each
customer class (and relevant subclasses) so that the Commission
would be able to determine if any class or subclass of customers were
receiving implicit product prices that are below incremental cost. The
Commission would need to independently verify the information
provided by Telstra. If the Commission determines that there is or
will be a significant class of customers who receive a service or group
of services under the Telstra bundle at an incremental price that is
below incremental cost, then the Commission should, at a minimum,

7
Section 3 Transparency to Competitors and Authorities

require that Telstra alter its bundled pricing to eliminate this

predatory behaviour.

There are obviously considerable difficulties with this approach. The

choice of relevant customer classes would be contentious. Even if the
Commission were able to gain relevant information from Telstra, it
would be difficult to verify that all relevant classes of customers were
being competitively priced. Experience in telecommunications has
shown the difficulty of determining incremental costs for a fixed-line
telephone system. The relevant cost information, generated by
computer models, is contentious and is sensitive to a variety of
modelling assumptions. As a result, in practice, it is unlikely that the
Commission could ever be certain that the Telstra proposed pricing
policy was not being used as a cover for illegitimately undermining
competition.

Further, the checking of Telstra’s bundled pricing would not be a

once-off exercise. The relevant information and the potential for
predation to emerge needs to be regularly checked by the
Commission. For example, the Commission might need to review
Telstra’s bundled options every eighteen months. Alternatively, firms
that are potentially being harmed by below-cost pricing could apply to
the Commission for a formal investigation if there is a reasonable
possibility that some incremental prices have fallen below incremental
cost. Again, the checking would be information intensive and
contentious.

An alternative approach would involve the Commission requiring that

Telstra justify its bundled discounts. This alternative approach would
require that Telstra can only discount a bundled offering to the extent
that they can show legitimate cost-savings from bundling. For
example, bundling might lower the costs of billing for a customer
relative to the situation where that same customer bought the relevant
individual products. Telstra should be allowed to discount its retail
price to the customer to reflect such cost savings. But Telstra would
not be allowed to discount a bundle in excess of the legitimate cost
savings.

Under this alternative approach, the Commission would require

relatively little information from Telstra. The Commission would only
require the individual prices of each retail product and the relevant
cost savings that Telstra generates through bundling. These cost
savings are likely to be fixed dollar amounts rather than percentage
savings. The Commission could require that Telstra provide any
relevant information about these savings before it approved a
bundled discount. In other words, the onus would be on Telstra to
show the legitimate cost savings before it would be able to include
these discounts in its retail prices.

8
Section 4 Customer-Level Transparency

This alternative approach was summarised in the report by King. 5

The pricing of Telstra’s bundled products “must be consistent with
(1) the individual retail prices set for the relevant bundled products by
Telstra and (2) any cost savings associated with the bundle that can be
explicitly shown to exist to the satisfaction of the ACCC”. The report
by King also noted the information required by the Commission to
ensure that there was no price squeeze occurring on a single product.
In this sense, the Telstra bundled pricing proposal is simply one
example of a general class of pricing concerns that face the
Commission.

4 Customer-Level Transparency

The Telstra proposal is to set its prices for all of its services and then
to offer discounts to customers who select a broader range of their
services. To see what this means from the customer’s perspective,
consider two services, A and B supplied by a single firm. Let pA and
pB be the prices offered to customers for the stand-alone services and
pAB be the price paid by customers subscribing to both services.
Bundling occurs in the pricing of these services if pAB < pA + pB.

In the Telstra case, there is bundling as pAB = α.(pA + pB); where α =

0.95 or 0.9 as the case may be. However, if it is more difficult for
Telstra to change α than to change pA and pB, there is a sense in which
Telstra might be more constrained in its bundling pricing options
than a textbook case of pricing bundles.

In terms of transparency for consumers, for a sophisticated customer,

these prices are relatively transparent. What concerns us more is the
impact of bundling on less sophisticated customers. In particular,
what does bundling do to those customers’ ability to compare price
offerings from Telstra with its rivals; in particular, those rivals who do
not offer the full range of services Telstra does?

In this regard, we believe that Telstra has an opportunity both to

provide customers with greater information regarding their prices as
well as an indication of the benefits customers are receiving by having
their services through Telstra. Our proposal would also give
competitors the opportunity to readily compare their price offerings

5 See King, S. (2002) “Bundling and imputation rules under accounting separation:

A report on behalf of Hutchison Telecommunciations”, CoRE Research.

9
Section 4 Customer-Level Transparency

with Telstra in a way that allows customers to easily compare

competing offers – whether they are bundled or not.

Our proposal is for Telstra to offer on their bill a breakdown of the

Rewards benefits to customers. That would take the form of a table
that described – beyond fixed line pricing – what are the savings the
customer received each month from subscribing to a particular
service.

An example of the information that would be provided is in the

Appendix. The idea would be that a simple reporting of the
contribution of a service to the reduction in the customer’s bill for
other services could be listed at the end of the bill. The Appendix
does this under the heading “Rewards Breakdown.” So, for example,
the first customer who received a total discount of $23 would be told
that their bill was reduced by $10.50 because they subscribed to
Telstra’s mobile service and by $8.50 because they subscribed to
Telstra’s pay TV service.6

These amounts would then allow customers to readily compare any

savings they would receive, in terms of lower prices, by switching to
say another mobile carrier with the increase in their Telstra bill that
this would cause. Thus, by providing this information Telstra would
allow their customers to more easily compare the benefits of being a
Telstra subscriber (in terms of reduction in their overall bill) to those
offered by other carriers who might not have a bundle of services to
offer. Even less sophisticated customers would have the benefits of
increased transparency in terms of comparing the options available
from different providers.

Practically, in calculating this additional information, no further data

is required than amounts already on the Telstra bill – used to calculate
the Rewards discount. Thus, the practicalities of doing this would
appear to be very modest.

6 Note that these do not add up to $23 as they are incremental discounts from each

product.

10
Section 5 Conclusion

5 Conclusion

In this paper we have briefly considered the transparency of Telstra’s

proposed bundled prices. We consider the transparency for
competitors, customers and regulatory authorities.

From the customers’ perspective, Telstra’s bundled discounts should

be made more explicit. This can easily be achieved by a simple
addition to the customer bill. This increased transparency will aid
customers when choosing between Telstra and alternative service
providers for particular products.

From the perspective of competitors and regulatory authorities,

Telstra’s bundled options might be used to hide predatory prices. In
this sense, the prices are non-transparent from a regulatory
perspective. Bundled prices might involve incremental services
supplied to customers below incremental cost or even at a negative
cost. Such pricing is inconsistent with standard competitive behaviour
and may significantly harm competition. Telstra’s bundled pricing
might also be used to disguise a price squeeze for products such as
fixed-line telephone services where Telstra’s retail competitors are
dependent on Telstra for wholesale essential facility access.

We consider two alternative approaches to the bundled pricing that

could be adopted by the Commission. First, given the competitive
concerns, the Telstra bundled pricing might only be given regulatory
approval if the regulator (1) is satisfied, given current customer
purchasing profiles, that no significant group of customers will
receive any incremental services form Telstra under a bundle at a
price that is less than incremental cost; and (2) has on-going
procedures in place to check the Telstra’s bundled pricing to ensure
that no elements of the bundle are priced below incremental cost in
the future. As we noted, however, this approach requires high levels
of information and may be impractical.

Alternatively, the Commission could require that Telstra’s bundled

pricing falls within the bounds of standard imputation rules. In
particular, Telstra would only be able to offer bundled product
discounts to the degree that these discounts reflected legitimate cost
savings. Telstra would be required to verify these savings to the
satisfaction of the regulator before it could offer the relevant retail
discounts to customers. This approach considerably reduces the
information burden on the regulator. It requires that Telstra provide
information on relevant savings. However, this information should be
readily available, as Telstra would need this information internally in
order to determine its own bundled pricing policies. Further, this

11
Section 5 Conclusion

alternative approach ensures that there is alignment between cost

savings and retail customer discounts. Such alignment is consistent
with standard competitive market conduct.

12
Section 6 Appendix

6 Appendix

Consider the following Telstra bill for a customer who subscribes to

two additional services:
Local Call Costs: $20
Long Distance Calls: $100
Fixed-to-Mobile: $30
Mobile Phone: $60
Pay TV: $20

Total $230
Reward Discount: $23

Amount Owing: $207

Rewards Breakdown: this month you saved the following amounts by

subscribing to the following Telstra services.
Mobile Service: $8.507
Pay TV: $10.508
Or, alternatively, consider a customer who only subscribes to one
additional service:
Local Call Costs: $20
Long Distance Calls: $100
Fixed-to-Mobile: $30
Pay TV: $20

Total $170
Reward Discount: $8.50

Amount Owing: $161.50

Rewards Breakdown: this month you saved the following amounts by

subscribing to the following Telstra services.
Pay TV: $8.509

7 This is the total bill without the mobile service = $170 (= $230 - $60) multiplied

by 0.05 (= 0.1 – 0.05).

8 This is the total bill without the Pay TV service = $210 (= $230 - $20) multiplied

by 0.05 (= 0.1 – 0.05).

9 This is the total bill = $170 multiplied by 0.05.

13