Home > Consultations > Consultation Documents > Business Connectivity Market Review > Summary

Business Connectivity Market Review

Introduction

1.1 This consultation document sets out the preliminary conclusions of our review of the retail and wholesale markets for leased line services in the UK. The present review supersedes the Leased Lines Market Review carried out by Ofcom in 2003/04 (the 2003/04 Review), the findings of which were set out in a statement published in June 2004^(-1-)

1.2 This review has been carried out in accordance with the requirements of the regulatory framework for electronic communications networks and services which came into force on 25 July 2003. The framework is based on five EU Communications Directives and is aimed at reducing entry barriers and fostering effective competition to the benefit of consumers. Ofcom has also taken the utmost account of the EC Recommendation on relevant product and service markets, an updated version of which came into effect in November 2007^(-2-), and the EC Guidelines on market analysis and the assessment of SMP.

Overview of findings

1.3 Leased lines, or private circuits as they are also known, provide dedicated transmission capacity between customer sites, which can be used to carry voice and data traffic. Retail sales of these services in the UK are estimated to be worth approximately £1bn a year.

1.4 Wholesale leased lines are also used by Communications Providers (CPs) as inputs to their retail services. These may take the form of complete circuits connecting two or more end-user sites, or partial private circuits (PPCs) connecting customer sites to points in the purchasing CP’s network. PPCs can in turn be made up of ‘terminating segments’, which are currently defined as running from a customer site to a Tier 1 node in BT’s network, and ‘trunk segments’, which typically run over longer distances between Tier 1 nodes. Terminating segments are also known as Symmetric Broadband Origination services. These wholesale inputs may be used to provide retail leased lines or other retail services such as Virtual Private Networks.

1.5 Leased lines play an important role in business communications in the UK. They are a key building block in the communications networks on which UK businesses depend, and which are central to the effective functioning of the economy. It is therefore of considerable importance that the markets for these services operate effectively, and deliver the services which businesses require in a timely, efficient and cost-effective manner, based where possible on active competition between service providers.

1.6 The 2003/04 Review found that there were separate markets for two broad types of leased line service: ‘Traditional Interface’ (TI) services, which include analogue circuits and digital circuits using SDH and PDH^(-3-) transmission; and ‘Alternative Interface’ (AI) services, which use other methods of transmission, notably Ethernet. Separate markets were also identified for TI circuits with different bandwidths and, at the wholesale level, for terminating and trunk segments.

1.7 This review has focused on the leased lines markets which are currently subject to ex ante regulation, following findings of market dominance in 2004. Those markets include the retail market for low bandwidth TI leased lines, the wholesale markets for low and high bandwidth TI terminating segments and the AI market for terminating segments at all bandwidths. In each of these markets, Kingston Communication (‘KCOM’) was found to have Significant Market Power (SMP) in the Hull area, and BT was found to have SMP in the rest of the UK. BT was also found to have SMP in the UK market for trunk segments. Based on these findings, a range of SMP obligations were imposed on BT and KCOM, including obligations to supply, requirements not to discriminate unduly between customers, requirements to publish prices terms and conditions, and in some cases price controls.

1.8 Our review has been based on a programme of market research^(-4-), the findings of which are summarised in Annex 9, extensive discussions with industry stakeholders and user groups, data supplied by CPs in response to formal information requests and desk research and analysis of publicly available information. We have also taken account of the discussion document on geographic markets published by Ofcom in March 2006 and the stakeholder responses thereto.^(-5-)

Markets outside the Hull area

1.9 In broad terms, we have found that since the 2003/04 Review, the progress made towards more effective competition has varied considerably by market. On the plus side, the evidence indicates that there has been a significant increase in competition in the markets for some higher bandwidth wholesale services. We believe that, outside the Hull area, a separate market now exists for wholesale AI services at bandwidths over 1Gbit/s and that this market is effectively competitive. We also consider that 155Mbit/s TI terminating segments now form part of the wholesale market for ‘very high bandwidth’ TI services, and that this market is effectively competitive outside the Hull area. In view of these findings, we propose that SMP regulation should no longer apply to these services.

1.10 In addition, we believe that a separate wholesale market now exists for high bandwidth (34/45Mbit/s) TI terminating segments in the Central and East London Area (CELA), which is made up broadly of the central London congestion charging zone and Docklands. Our analysis indicates that this market is effectively competitive and that, as a result, BT’s provision of the relevant services should no longer be subject to SMP regulation.

1.11 But while deregulation appears to be warranted in some markets, progress towards greater competition is far less evident elsewhere. BT continues to have a very strong position in the retail market for low bandwidth TI leased lines, its market share having increased from 78% in 2002/03 to 80% in 2006. We believe that BT’s continued dominance in this market is linked to certain deficiencies in the way in which upstream wholesale services are provided to competing CPs, which make it more difficult for them to replicate BT’s retail offerings. These deficiencies were described in Ofcom’s April 2006 statement on replicability (the Replicability Statement)^(-6-), and have not yet been fully remedied by BT. Until those matters have been resolved, our view is that any steps towards deregulation in the low bandwidth retail market would be premature.

1.12 We are nevertheless of the view that, once the existing weaknesses in the wholesale regime have been fully addressed, the retail market for low bandwidth services should be prospectively competitive. In this context, we note that this market has been removed from the EC list of markets in which ex ante regulation is likely to be required^(-7-). With this in mind, we propose that the SMP obligations imposed on BT in the retail market for low bandwidth services should apply for a fixed period of four years. Unless a further market review has been completed within that time, the proposed obligations would fall away at the end of the four year period.

1.13 Some end users and user groups have expressed concern about the possibility that BT may seek to withdraw legacy services – notably analogue and low bandwidth TI circuits – prematurely as it rolls out new services based on its 21st century network. There is also concern that BT may increase the retail price of analogue services, of which it is now effectively the sole supplier.

1.14 In order to address these concerns, we propose to require BT to continue to support existing analogue and low bandwidth TI circuits for the duration of the 4-year review period. In addition, BT has indicated that it is prepared to give a set of voluntary undertakings that it will continue to supply new analogue and sub-2Mbit/s retail circuits until 2011 or earlier if, subject to industry agreement and consent by Ofcom, the underlying platform is closed at an earlier date; that it will not increase its prices for analogue services more quickly than the rate of inflation (RPI-0%) for a period two years following the publication of the LLMR statement i.e. from 2008 to 2010; and that it will commit to a further two-year cap, the level of which would be agreed with Ofcom prior to 2011. We believe that these undertakings should provide a reasonable level of assurance for consumers of legacy services but would welcome stakeholder views on this issue.

1.15 BT also remains dominant in the wholesale market for low bandwidth TI terminating segments, its share of which increased to an estimated 89% in 2006. Our analysis indicates that BT has a position of entrenched dominance in this market, which warrants continued regulation, and we propose to retain broadly the same set of obligations as is currently applied. Amongst other things, this will involve extending the existing PPC charge control, which is due to expire at the end of September 2008, out to 2012. We propose to consult separately on the details of the new control.

1.16 Several industry stakeholders have argued that PPC prices are currently too high, partly because the revenues from PPC sales to BT’s downstream business have been understated in the regulated accounts, and the charge control may therefore be more generous than the reported profits would suggest. These arguments will be examined fully in the consultation on the new charge control.

1.17 Our analysis indicates that BT has SMP in the market for high bandwidth TI terminating segments outside CELA and the Hull area. BT’s share of this market was 45% in 2006 and has changed little since the last market review. We propose to retain broadly the existing set of SMP obligations in this market.

1.18 We have found BT to have SMP in the market (outside Hull) for low bandwidth AI terminating segments at bandwidths up to and including 1Gbit/s, with a market share of 72%. This market has been expanding rapidly in recent years and is expected to continue growing as CPs deploy next generation networks using Ethernet technology. Our analysis indicates that BT has a position of entrenched dominance in this market, which is unlikely to be eroded in the foreseeable future. Effective regulation will therefore be of critical importance, if the potential benefits of technological progress are to flow through to business users.

1.19 Some stakeholders have argued that BT’s wholesale ethernet services have had a number of shortcomings which have impeded the development of fair and effective competition in downstream markets. Their concerns relate to a range of issues, including delays in rolling out more efficient backhaul services based on WDM technology, poor service quality, an inflexible approach to product migrations, high charges and restrictions on the use of space in exchanges, and possible over-pricing of some circuit types.

1.20 To some extent, we believe these concerns are justified. In response, we have pressed BT to give firm commitments for the roll-out of ethernet backhaul products based on a new national backhaul network using WDM technology. We expect to consult on these commitments following the completion of this market review. We have also consulted on a new Service Level Agreement/Service Level Guarantee (SLA/SLG) regime for BT’s wholesale Ethernet services^(-8-), which would be implemented via a Direction issued under the relevant SMP condition.

1.21 Regarding space in exchanges, we propose to define exchange accommodation used primarily for the termination and/or aggregation of wholesale leased line products as technical areas related to the markets for terminating segments in which BT has SMP. As a result, the provision of space will be subject to the same SMP conditions as the associated leased line services, including charge controls where applicable.

1.22 In relation to pricing, the 2003/04 Review decided against the imposition of a charge control for wholesale ethernet services because the market was at that stage nascent, and there was a risk that a charge control woud impede its development. The market is now far more mature, and we believe that a charge control should now be added to the existing SMP conditions. This will help to ensure that the efficiency benefits of technological progress flow through to consumers in the form of lower prices, whilst enabling BT to earn a reasonable return on its investment, allowing for the risks involved. It will also enable us to examine more fully the arguments raised by some stakeholders, that some of BT’s wholesale ethernet services are over-priced.

1.23 Our analysis indicates that BT continues to have SMP in the market for trunk segments, with a market share in excess of 60%. This is perhaps contrary to expectations, as this market was regarded as prospectively competitive in the 2003/04 Review. The market has also been removed from the recently updated EC list of markets considered likely to require ex ante regulation. However, we note that BT continues to earn very high returns in this market (the return on capital employed was 59% in 2006/07) and has not de-averaged its prices by geography or route. In addition, our analysis shows that BT continues to have market shares in excess of 40% on almost all major trunk routes, and suggests that high trunk prices have helped to push retail charges for TI leased lines above the levels found in most European countries. There is little evidence that the profitability of BT’s trunk services has been subject to increased competitive pressure.

1.24 Given these circumstances, we propose to retain the existing SMP remedies in the trunk market, and also to impose a charge control on BT’s trunk services, the details of which will be subject to a separate consultation.

Markets in the Hull area

1.25 The development of competition in the Hull area has also varied by market. We have found that KCOM no longer has SMP in the retail market for low bandwidth TI services, and therefore propose to remove ex ante regulation from that market. On the other hand, our analysis indicates that KCOM has SMP in the wholesale markets for TI and AI terminating segments at all bandwidths. In these markets, we propose to retain broadly the same set of obligations as currently apply in the wholesale markets in which KCOM has SMP.

1.26 The most significant difference is that we believe consideration should be given to a voluntary undertaking on the price of TI terminating segments, as an alternative to the imposition of a cost orientation obligation or a charge control. KCOM has indicated that it would be prepared to give an undertaking that the price of its TI terminating segments would not increase more quickly than the general rate of inflation (RPI-0%) over the next four years. Our preliminary view is that such an undertaking would provide a reasonable safeguard against monopolistic pricing behaviour, but we would welcome stakeholder views on this issue.

1.27 If we conclude that the proposed undertaking is sufficient, we would propose to withdraw the cost orientation obligation which currently applies to KCOM in these markets. The cost orientation condition requires KCOM to maintain a cost accounting system, the costs of which are likely to be passed on in some form to consumers, and the benefits of which appear to have been very limited. In our view, the acceptance of a voluntary undertaking would provide an opportunity to reduce the burden of regulation, in accordance with our statutory duties under the Communications Act.

Dark fibre in the access network

1.28 One of the issues that has arisen in the course of this market review is whether BT should be required to provide dark fibre in the access network (i.e. from a business customer site to the Local Serving Exchange), as a means of promoting more effective competition in the downstream markets for leased lines.

1.29 In our view, this issue merits some consideration, for three reasons. Firstly, as discussed above, in several of the leased lines market under review, the amount of progress made towards a more competitive market has been very limited in the past four years, and that more radical options may therefore be worth considering. Secondly, a dark fibre access remedy would represent an intervention at the deepest layer in the infrastructure at which competition is likely to be feasible, and would therefore be in line with the principles set out in the Telecoms Strategic Review. Thirdly and most importantly, several CPs have argued strongly that such a remedy would enable them to compete more effectively against BT, on quality of service as well as on price, and would allow them to offer service innovations which at present are not possible.

1.30 At this stage we have only given preliminary consideration to this option. Our initial view is that a dark fibre access product would fall under the definition of an Electronic Communciation Network and that Ofcom would therefore have the power to impose a requirement to provide such a product, following a finding of SMP.

1.31 We have also considered whether such a requirement could be imposed as a remedy in the wholesale markets for terminating segments, or whether it would be necessary to carry out a separate market review of the upstream market into which a dark fibre access product would fall. Our preliminary view is that a separate market review is likely to be necessary.

1.32 Ofcom is aware that a market review would be a major exercise, and would raise a number of complex issues, for example, over the definition of the market, the nature of any possible access obligation, compatibility with existing regulations, the impact on investment incentives, the pricing of the access product and consistency with Ofcom’s regulatory principles.

1.33 It is also not clear that BT would have SMP in the relevant market. Even if the market were defined to include only access to business premises, fibre is used to support a wide range of downstream services, many of which are provided into competitive markets. It is possible that no CP would be found to have SMP, or that a CP other than BT would be found dominant.

1.34 Above all, it would be necessary to consider whether the benefits for consumers of mandating the provision of a dark fibre access product, in terms of improved competition and market development, would outweigh the costs of implementation, taking account not only of the impact on the markets for leased lines, but also of possible effects on other downstream markets.

1.35 Notwithstanding these issues, we believe that it is appropriate to initiate the debate over the possibility of regulating the provision of dark fibre in the access network, as a means of stimulating more effective competition in the markets for leased lines. We would welcome stakeholder views on whether this option should be explored further, whether it is likely that BT or any other provider would be found to have SMP in the relevant market and whether the benefits of mandating a dark fibre access product would outweigh the costs.

EC Recommendation

1.36 Ofcom is aware that two of the markets in which we propose to apply ex ante regulation have been removed from the second edition of the EC Recommendation on product and service market susceptible to ex ante regulation. The markets concerned are the retail market for low bandwidth leased lines (outside the Hull area) and the wholesale market for trunk segments.

1.37 The explanatory note accompanying the Recommendation (the Explanatory Note) states, however, that National Regulatory Authorities (NRAs) may be able to regulate markets which differ from those identified in the Recommendation, where this is justified by national circumstances. Ofcom also notes that BT is currently subject to SMP regulation in these markets and that a further market review is required in order to determine whether ex ante regulation is still warranted. As Ofcom’s preliminary conclusion is that BT still has SMP in these markets, we consider the imposition of appropriate ex ante remedies to be consistent with the requirements of the EC framework, and those of the Communications Act 2003.

1.38 The Explanatory Note also refers to three criteria which the Commission considers should be met if ex ante regulation is to be imposed on markets not identified in the Recommendation. The criteria are that a market should be subject to high and non-transitory entry barriers, that it would not tend towards effective competition without ex ante regulatory intervention and that competition law by itself would be insufficient to address the market failure.

1.39 Whilst Ofcom does not believe that the passing of these criteria constitutes a legal requirement for the imposition of regulatory obligations, it considers that these criteria are met in the case of the retail market for low bandwidth leased lines and the wholesale market for trunk segments. In the case of the former, the evidence indicates that BT’s retail services are not yet technically and commercially replicable by its competitors and that its market share is persistently high, having increased marginally to 80% in 2006. In the case of the latter, our SMP finding reflects BT’s persistently high market share and high level of profit in this market, as well as the existence of economies of scale and other factors which impede market entry and expansion. In both cases, Ofcom considers that a reliance on competition law alone would not be sufficient to promote the development of effective competition.

Footnotes:

1.- http://www.ofcom.org.uk/consult/condocs/llmr/statement/

2.- See EC Recommendation on relevant product and service markets in the communications sector susceptible to ex ante regulation at http://ec.europa.eu/information_society/policy/ecomm/doc/library/proposals/rec_markets_en.pdf

3.- Synchronous Digital Hierarchy and Pleisynchronous Digital Hierarchy

4.- The full independent end user market research report is published alongside this document on the Ofcom website.

5.- see Discussion Document of 28 March 2006 and Summary of Responses, published on 14 November 2006, at http://www.ofcom.org.uk/consult/condocs/disagg/.

6.- http://www.ofcom.org.uk/consult/condocs/busretail/statement/

7.- See EC Recommendation on relevant product and service markets, op cit.

8.- http://www.ofcom.org.uk/consult/condocs/slg/

The full document is available below: