When Is Competition Actually Wasteful? One Set of Pipes

The situation arises where the fixed cost of the network is enormous and the cost of serving one more customer over it is small. Laying water mains, building a rail network, running cables to every house or constructing a distribution grid consumes most of the money, after which each additional user adds very little. A second company entering must build its own complete network to reach anybody, doubling the fixed cost while splitting the customers, so both end up with higher costs per customer than one firm serving everybody would have. Competition therefore raises total cost rather than lowering it, which reverses the usual argument and is the whole basis of treating these industries differently.

The condition applies to networks far more than to production:

• •Water supply and sewerage, where duplicate mains are plainly absurd
• •Electricity and gas distribution to premises, as distinct from generation
• •Rail track, as distinct from the trains running on it
• •Local fixed telephone and cable networks, historically
• •Ports, airports and bridges serving a particular place
• •District heating networks

A single supplier facing no competitor will charge more and supply less than a competitive market would, which is the standard objection to monopoly and applies here in full. Customers of a water company cannot go elsewhere, so the usual discipline is absent. The firm also has weak incentives to control costs or to invest in quality, since neither affects whether customers stay. Against that, breaking the firm up to create competition destroys the cost advantage that justified the arrangement, and leaving it alone permits exploitation. Every approach taken has been an attempt to capture the efficiency of a single network while preventing the behaviour a single supplier would otherwise adopt, and none has been fully satisfactory.

Technology changes what counts as a network, and several industries treated this way for a century no longer qualify. Long distance telephone service was a textbook case until microwave links and then satellites allowed competitors to reach customers without laying parallel cable, and the American monopoly was broken up in 1984 on exactly that reasoning. Electricity generation was bundled with the wires for decades and was separated once it became clear that generation is a competitive business connected to a network rather than part of the network. Postal delivery faces the same argument now. The general lesson is that these conditions apply to particular activities rather than to whole industries, so the regulatory question is which part of a business is genuinely the network and which part merely travels over it.

Three broad responses have been used and each has characteristic failures. Public ownership removes the profit motive and with it the incentive to exploit customers, at the cost of political interference in investment decisions and weak pressure to control costs, which was the experience across much of Europe before the 1980s. Regulation of a private firm caps prices or returns while leaving ownership private, which requires the regulator to know the firm's real costs when only the firm knows them, and which produces either excessive profits or underinvestment depending on how the cap is set. Separating the network from the services running over it, so that competing suppliers use one shared infrastructure, has worked reasonably in telecommunications and energy retail and has proved contentious on railways.

Where the network costs almost everything and serving one more customer costs almost nothing, a second entrant doubles the fixed cost and splits the customers, so competition raises total cost. That advantage comes with a supplier facing no discipline on price, cost or quality. Public ownership, price regulation and separating the network from the services over it are the three responses, and each trades one failure for another.