How to stop predatory tendencies by internet service providers

The popular African saying that frogs croaking at a river does not prevent cows from drinking water may have taken a completely new meaning in the age of ICT for eastern and southern Africa.

The region now has two fibre-optic cables that became operational last year — the East African Marine Systems (TEAMS) and SEACOM. The East Africa Submarine Cable System (EASSY) project funded by multilateral financial institutions and African governments is yet to be realised.

In the meantime, problems and complaints abound on pricing, taxation and regulation in a catalogue of host countries — Kenya, Uganda, Rwanda, Mozambique and Botswana, for example. To the credit of the Kenya government, it leads the official awakening to the market collusion by ISPs in the region to fix Internet connectivity prices coupled with lack of willingness to reduce charges. Kenya’s current four-month deadline (ending March 2010) for ISPs to cut down the charges or face an official price cap has become a regional barometer on how governments will deal with the dithering ISPs. While much is at stake in policy and economic growth of the region, it is a time of reflection on the destructive power of bad policies when married to a predatory private sector.

Pricing jokes

In recent years while undertaking a number of comparative country case studies of ICT for the Economic Commission for Africa, I came face to face with the twin arguments of taxation of ICT services and the pricing strategies of ISPs. Along with lack of depth in government fiscal policies on the industry, and a lack of technology readiness blueprints to deepen content in ICT (a key to ICT benefits) the findings were worrisome. Vast potential is being curtailed unnecessarily.

First, the pricing jokes. Take the example of Kenya’s ISPs. With a straight face they claim that with the fibre optic cable connected, they have to keep their high internet charges until they recoup the fixed costs of their investments in earlier satellite connectivity contracts and the TEAMS cable.

TEAMS was financed to the tune of 85 per cent of public funds while Etisalat, a United Arab Emirates telecoms company held 15 per cent. The government sold its share to private operators, leaving the Kenya government with a 20 per cent stake. A secondary argument is made that if prices are lowered, up-take of internet demand may be too sluggish to make up for the price reduction. If the Communications Commission of Kenya (CCK) has a research department, it should mobilise data to analyse and puncture the fallacies and call the bluff on ISPs.

Each argument is a red herring and an abuse of economic theory. Generations of businesspersons and accountants have argued erroneously that given their rents and fixed costs, lower variable costs (read cheaper bandwidth prices in this case) are an opportunity to keep prices high in the interests of profit maximisation, recouping pre-invested rents and fixed costs (in this case TEAMS investments and satellite connectivity contracts) rather than expanding output.

The Kenya government, as part-investor using taxpayer shillings in the fibre-optic cable, should reject this extortionate myth and defend customers. Were the CCK to call the industry to order, it would save Kenyans billions of shillings, revenues that the firms have tried to corner by colluding to shave off the benefits of the landing of the fibre optic cable since last November. Government action would not just help the push for growth from ICT, but also buttress Kenya’s emerging regional leadership as much in policy as in applications such as M-Pesa.

The only reason why players can contemplate the exploitation of customers and perhaps even succeed in wedging them out of the technology benefits is lack of competition in the industry. More specifically, ISPs seek a windfall in the transition from contracts for provision of internet via satellite connectivity (at $5000-$6500 per megabyte) to fibre optic cable provision at vastly reduced prices — as low as $400 per megabyte.

Globally in digital markets, the underlying costs of supply are falling towards zero — for example digital storage, bandwidth, blogging accounts and services.

Kenyans expected that with Seacom and TEAMS cables going live, internet charges would fall, with dividends on faster connectivity and affordability. Not so, the firms argue falsely. Pay our ex-post facto fixed costs first. Key players like Safaricom have expanded their services to the provision of internet solutions to cyber cafes offering help for growth of services and firms. As a part-investor in fibre optics (with a 22.5 per cent stake in TEAMS whose board it chairs), Safaricom thus competes with traditional mobile service providers and ISPs in Kenya that have no ownership stake in the cable. For Safaricom, the market is a piece of cake, but a setback for governance.

It will shake the sector and perhaps make a large profit. So far, cyber cafe owners claim little in improved prices and no relief from internet connectivity that is still on- and-off.

Dropped its price

On the other hand, providers of optic fibre networks such as Access Kenya and Kenya Data Networks (KDN) have significantly lowered their supply prices to the industry. KDN dropped its price per megabyte to $400 — a reduction of over 90 per cent from the recent industry averages of about $5000.

Access Kenya is operating a double-bandwidth-for-free to corporate clients. Yet the overall wider benefits of the reductions for consumers of internet services remain trapped between the fibre optic cable offer prices and the ISPs who fight the expected price reductions to customers with false arguments in order to keep prices high and make windfall profits.

Under better competition, economists know that fixed costs should never affect the profit-maximising level of internet service provision, especially in the short run period of the transition from satellite to fibre optic cable internet provision. Between what is termed as variable costs and fixed costs that make up total costs of production, fixed costs are irrelevant to the planned profit maximising output of internet service provision in this context. The simple mathematical proposition would help the industry to expand output and long run profits by lowering prices, and focusing the new configuration of marginal costs and output expansion made possible by fibre-optic.

As for fears of lack of demand if prices fall, this is even more intriguing. For ordinary goods and services, economists expect a price reduction will always induce greater demand. The industry underestimates the enthusiasm of Kenyans to leap across the world’s digital divide between developed and developing countries. Already, Kenya leads the world in financial services transactions through the mobile phone money transfer and is among Africa’s leaders in network connectivity. It has expanded its consumption of mobile services rapidly. Little suggests lower prices would cut demand.
A key factor in the price shenanigans and curtailment of services is purely a trap of the government’s own making, missing the forest for the trees.

Its entry into the new area of e-taxation has reined in the beneficial economic uses and demand of ICT. In Africa, mobile phone operators are a rapidly growing sector as taxpayers, to the extent of being branded as the new “Treasury”. They average seven per cent of tax receipts. In some countries, they are the single largest taxpayer.

In Kenya, for example, as of December 2007 tax revenues from mobile phones grew by 30 per cent in the year compared to 2006. Kenyan authorities including CCK have so far been cautious on strategic regulation and taxation. They have smiled away the repeated begging of ISPs for tax reductions. They are right, but for the wrong reasons. Taxes and tax credits never work that directly. In the uncompetitive market of mobile telephony and internet provision, and going by the arguments that ISPs offer on the fibre optic cables, suppliers would easily corner a tax reduction to increase profits without a compensating expansion of supply or lower prices to customers. Hence, although the tax as such restricts supply of services, government should not be lured into accepting tax reductions as a vehicle for ISP super-profits.

Uncompetitive market

A better strategy would be to spur the suppliers to competition to increase ISP services. During a Roundtable that the ECA held in Kenya in February 2007 on the ICT study for Kenya, participants including CCK, Central Bank and industry players like Safaricom made specific recommendations on taxation on mobile telephony, currently at 16 per cent for VAT and 10 per cent excise tax on air time. First, reduce the excise tax by 5 per cent; second, increase the user base; third, use 10% of the remaining excise tax on airtime to pursue two objectives- the Universal Service Fund and rural ICT infrastructure.

Going by its comfort with breakfasts at the high tables of annual performance reviews of ISPs, the Kenya government seems over-impressed with the tax-cheques it receives from them today, perhaps missing its responsibilities to design a fiscal strategy for the future. As a starting point, evidence shows that the effects of mobile phone use on economic growth are twice as strong in developing countries as they are in developed countries.

An increase of 10 mobile phones per 100 people in developing countries propels GDP growth by 0.6 percent per year compared to 0.3 percent in developed economies.

In developing Africa, mobile phones are increasingly recognized as powerful tools in the fight against poverty, since they reduce transaction costs, disseminate information, facilitate entrepreneurship and substitute for slow, unreliable fixed line systems.

In Kenya, they have forever revolutionized the provision of financial services and exported the technology for good measure.

Regressive tax

Yet many economists would classify current mobile taxation as a regressive tax, not a progressive tax. For the same airtime, the poor spend a higher proportion of their income to pay the tax than the rich do. Taxes on mobile phones should be an integral tool of poverty reduction and growth strategy, from both the GDP impacts and potential to reduce inequality. In fact, the increasing share of telephony in household budgets suggests a future role in monetary policy.

Falling prices in the fibre-optic cable would work as follows, for example: in a falling price level, people become wealthier as the real value of the money they hold rises. Their spending of the excess liquidity lowers interest rates and helps growth.

The strategy should thus be to target the potential economic and productivity growth attributable to ICT services, which would earn both higher GDP and tax revenues in the future. The current tax regime is in the comfort zone of collecting licensing fees, and the regressive taxes on mobile telephony. The KRA probably has not even figured that some mobile phone revenues leak through the backdoors of corporate tax returns. Since cost deductions are allowed, companies that increasingly allocate mobiles and airtime to employees may deduct this expense as part of operating costs without this leakage being traced.

Furthermore, the mobile phone taxes in place are in the category of luxury taxes, at par with the so-called “sin-taxes” on alcohol and cigarettes. In a new strategy with greater relevance to economic objectives, the authorities should give incentives for content-oriented ICT services, and build ICT-readiness scenarios that guide the expansion and taxation regimes to be adopted for each of the main sectors of the economy- agriculture, industry and services.

Dr Wagacha consults in Macroeconomics for African Development Bank, ECA, SADC, ACBF and others. mwagacha@gmail.com