Since the telecoms regulator decreed a sharp reduction in the rate network operators charge competitors to direct calls to their networks, there's been a wailing and gnashing of teeth in the halls of companies that offer least-cost routing (LCR) services to customers.
Altech's CEO, Craig Venter, in an article by Candice Jones and Nicola Mawson, went so far as to declare himself pleased that the company's LCR division, AutoPage, "didn't do too good a job and become number one".
That, of course, overstates the truth. Even if the window of opportunity to make a profit from a particular service closes after a time, maximising profit while that window remains open is surely the rational goal of any company. Pretending otherwise is an admission of failure in the company's duty to shareholders.
That the regulator's ruling will close the window of opportunity for LCR, and cost LCR operators a big chunk of both revenue and profit, is not in doubt, however.
This is to be celebrated. It is often thought, not least by government officials with a shallow grasp of economics, that any company that makes a profit is a good company, and is good for the country's economy.
In simplistic terms, it contributes to GDP, and any such contribution is perceived as a net benefit.
However, many a profit is made by circumventing, or ironing out, inefficiencies in business processes. It is the purpose of free-market economics to reduce these inefficiencies to the benefit of consumers.
Many inefficiencies persist as a result of lack of competition in a particular market. This has long been the case in our telecommunications sector, and is what gave rise to the opportunity to route outgoing calls to the destination network before placing it, to avoid the networks' own anti-competitive interconnection charges. A share of the resulting savings would accrue to the companies that provided the equipment to do this. Understandably, companies were more than willing to employ these LCR firms and share in the benefits.
The regulator's ruling will close the window of opportunity for LCR.
Ivo Vegter, ITWeb contributor
The very existence of the opportunity, however, points to a market inefficiency. Just as a buyer of bulk goods might choose to pay a road haulage company when the rail service fails them, the improvement of the rail service, while harming the economic prospects of the truck operator, would benefit the greater economy by making bulk good transport more efficient.
Likewise, while the inefficiency exists, LCR operators provide a valuable service. This is the sense in which economists declare the ensuing profit to be "good".
However, it would be better for their customers - and the economy at large - if the inefficiency didn't exist in the first place, so they didn't have to pay to have it reduced. Ergo, the harm done to LCR companies by the interconnection ruling not only coincides with, but conclusively demonstrates, the economic benefit to everyone else.
On a wider scale, government regulators would do well to grasp this principle. When a company makes a profit, this does indeed demonstrate that it delivers a valuable service, and one could say the company is entitled to its profit. However, in an efficient market, such profit, if greater than the nominal amount justified by the opportunity cost and the risk at which capital is employed, should attract competition and new investment into the sector. These new competitors will hope to gain a share of the profit made by the incumbents, by delivering a comparable service with greater efficiency. The result of this competition is that the profit opportunity is whittled away over time, until it is so low that only the most efficient, large-scale operators survive, and the capital employed by the less efficient losers in this battle is free to be redeployed in more profitable ventures.
This is how competition promotes efficiency in the market.
Regulators all too often believe the companies under their remit are somehow entitled to some arbitrary profit, deemed "fair" in the wisdom of the bureaucrats. There's no such thing as an objectively quantifiable "fair" profit. Given a percentage profit, one could easily find companies for which it is deplorably low, and others for whom it would be wealth unimaginable.
The only "fair" profit is the least the customer can get away with paying. In other words, the profit earned by the most efficient competitor in a particular sector is ipso facto "fair".
If such a profit appears great, this points unerringly to an inefficiency in the market, which the operation of a free market, by encouraging competition, would tend to correct over time.
An example is that of supermarkets. Large supermarkets tend to enjoy very small profit margins - a fact often hidden by the sheer scale of their operations. Despite the small percentage profit on the amount of capital invested, and despite the fact that this drives smaller, less efficient "mom and pop" stores out of the market, the consumer ultimately benefits. The consumer gets to pay less for better quality, higher availability and more convenience, while inefficient capital is freed up for better use elsewhere.
Many competitors are often required in the growth stages of an industry, and competition should for this reason in no way be restricted by regulation. But their numbers will gradually fall as the industry matures and consolidates, until only the most efficient remain in business. As a result of this process, the incomes of consumers go further, and the real prosperity of society is improved. (In fact, this is the distinguishing factor between an unnatural monopoly, established by the state, and a natural monopoly, which earned its power in the free market by proving to be the most efficient among multiple competitors.)
The same holds true for LCR companies. The declining profit opportunity will first become limited to the largest, most efficient few, who can profit even by selling far smaller savings to many customers. Eventually, the opportunity may be whittled away almost entirely.
It is true that the inefficiency in this case was created by artificial regulation restricting competition, and consequently had to be artificially reduced by regulation rather than being left to the natural competition, which a free market begets. This is an unfortunate legacy of our over-regulated past. It does not, however, change the fact that the decline and ultimate demise of LCR companies is right and proper. It demonstrates that the consumer ultimately benefits.
Let us toast the LCR industry upon its imminent demise. Thank you for providing a valuable service over the years. Happily, those services are no longer required, so you will be pleased to be able to redeploy your capital more profitably in serving another, more pressing need of society. Cheers.
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