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Explanatory Statement and Notification of decisions on BT’s SMP status and charge controls in narrowband wholesale markets

Summary

1.1 This document covers Ofcom’s decisions in two areas:

1.2 Where BT has a dominant position that makes it hard for other companies to compete, Ofcom can make sure that BT lets its competitors use parts of its network, at a controlled price, using ”network charge controls” (“NCC”s). This protects consumers from the effects of BT’s dominance by promoting competition, bringing more choice, better quality and lower prices.

1.3 In this document, Ofcom sets out required cuts in BT wholesale charges on a range of services during the four years to 2009. Over that period, this should save retail customers about £350 to 400 million (relative to letting BT’s prices for these services rise by the rate of inflation), as those cuts get passed on as lower retail prices. The parallel steps that Ofcom is taking in its strategic review of telecommunications should increase retail competition, by causing more of the wholesale savings to be passed on to consumers.

1.4 This document, which completes a process of consultation , also presents Ofcom’s decision to completely deregulate one economic market - inter-tandem conveyance and inter-tandem transit - by removing charge controls and all other regulations. This follows Ofcom’s finding that BT no longer has Significant Market Power status in that market. Furthermore, Ofcom is loosening regulation in another market, by moving BT's charge control on local-tandem conveyance to a ‘safeguard cap’ that will limit charge increases for that service to below inflation. These conclusions are in accordance with the principles set out the in Second Phase of Ofcom’s Telecoms Strategic Review (“TSR”), and recognise growing competition in those markets.

1.5 Wholesale narrowband interconnection services provided over BT’s core network have been one of the key enablers for competition in the UK telecoms market. We are currently approaching the end of the second of two four-year NCC periods that have used the widely acknowledged RPI minus X mechanism to set price limits. These controls have managed to ensure that the UK remains one of the lowest cost interconnect regimes in Europe while at the same time incentivising BT to continue to improve the efficiency of its core network.

1.6 However the new NCCs may be the last ones to regulate BT's the current set of narrowband services using the same broad approach that has applied since 1997. As BT changes to its new 21CN network, new interconnect products will be introduced, and Ofcom will have to consider the impact in terms of how markets are defined and how BT's wholesale services should be regulated.

The new charge controls

1.7 NCCs limit BT’s ability to set charges in wholesale markets in which it has a dominant position, also known as Significant Market Power (“SMP”). The NCCs are a remedy imposed on BT owing to its SMP in the markets covered in this document. BT’s dominance in those markets was last assessed in 2003 by Oftel, in accordance with the requirements of the legal framework of EC Directives.

1.8 Ofcom has decided that the following NCCs should apply to BT for the four years from 1 October 2005.

Service

Current controls 2001-5

Proposed controls 2005-9

Call termination

RPI – 10%

RPI – 5%

Call origination

RPI – 10%

RPI – 3.75%

Single transit

RPI – 13%

for combined basket

RPI – 11.5%

Local-tandem conveyance

Safeguard cap of

RPI – 0%

Interconnection circuits (ISB)

 

RPI – 8.25% for combined basket; RPI + 0% sub-caps for each of

ISB & PPP

RPI – 5.25%

Product management, policy and planning ( PPP )

RPI + 0.75%

DLE FRIACO

RPI – 7.5%

RPI – 8%

Single Tandem FRIACO

RPI – 8.75%

RPI – 8.5%

Inter-tandem conveyance and Inter-tandem transit

Safeguard cap of

RPI – 0%

No control as no SMP

1.9 In the consultation document, Ofcom consulted on a range of values because some relevant issues were still being resolved. This document takes into account Ofcom’s decisions on all of those issues, including the appropriate cost of capital as part of the NCC cost base (which is covered in a separate Ofcom publication today).

1.10 Some of the final values of X are considerably below current levels. This is due to, among other things, lower BT starting ‘super-normal’ profits (those profits in excess of the appropriate return on capital) for these services (which means a lower value for X will be sufficient to eliminate super-normal profits) and forecast falls in traffic volumes on BT’s network (which means a lower value for X because BT’s average unit costs will be higher).

1.11 Ofcom’s decision that the charges will run for a period of four years minimises regulatory risk and promotes an environment in which communications providers can make forward-looking decisions. This is consistent with proposals in the TSR to allow regulated businesses and the wider market to plan against a predictable regulatory environment for the period in question.

1.12 The TSR also proposed Ofcom’s main considerations when regulating the returns BT makes from providing wholesale access to different parts of its network. These are: the incentives to invest; the likelihood of competition; and the need for direct consumer protection where competition is not effective or sustainable. The NCCs described in this document will apply to a period of transition including the migration of BT from its current public switched telephone network (“PSTN”) to its proposed 21st Century Network (“21CN”). Ofcom’s analysis is therefore designed to meet these considerations on a forward looking basis.

1.13 In order to achieve this, Ofcom has adopted a technology neutral model to determine the average unit costs of narrowband PSTN services over the period to 2009. This is a way to cope with the uncertain speed of traffic migration to the 21CN, and to incentivise efficient migration of that traffic. It also has the effect of using hypothetical levels of PSTN capital expenditure during a period when it is expected that BT will move from PSTN to internet Protocol (IP) investment as part of its proposed 21CN deployment. Ofcom has assumed within this hypothetical model that BT will continue to improve its PSTN efficiency levels in line with historical experience and international benchmarks, and has set an achievable efficiency target for BT that is at the high end of the range on which Ofcom consulted.

1.14 As such, Ofcom has attempted neither to forecast actual efficiency gains that BT might reap from its 21CN deployment nor to take into account BT’s forecast parallel running costs of running down its PSTN capability while migrating to 21CN. Ofcom will consider how to take account of BT’s 21CN efficiency if and when Ofcom determines a price for 21CN interconnect services, and in any future NCC in the period from 2009 onwards. Ofcom’s proposed approach to 21CN interconnection pricing was set out in our most recent consultation on Next Generation Networks . In adopting this approach Ofcom has sought to make a forward-looking trade off between incentivising efficient investment, promoting competition and passing on cost savings to consumers.

1.15 For three markets – call origination, call termination and single transit - Ofcom is satisfied that there has been no material change in those markets and that the degree of change is not sufficient to warrant the level of analysis that Ofcom has performed for the two markets set out below. In so doing, Ofcom is using its powers under the Communications Act 2003 (“2003 Act”) to set all the relevant SMP services conditions, and to impose the new NCCs, by publishing its Notification (see Annex 3) of conclusions in the UK as well as at a European level (to the European Commission and other national regulatory authorities).

De-regulation

1.16 In the TSR, Ofcom proposed a number of principles including that Ofcom should withdraw from regulation as soon as competitive conditions allowed. In performing its initial assessment of changes in market conditions, Ofcom observed that in two economic markets (inter-tandem conveyance and transit, and local-tandem conveyance and transit) there was prima facie evidence that BT’s level of market power has been reducing. Ofcom therefore has conducted in-depth analysis on these two markets, using the same processes followed in 2003.

1.17 This document explains where Ofcom’s market definitions for those markets differ from those in the European Commission’s Recommendation on relevant product and service markets. In assessing SMP, Ofcom has also taken due account of the European Commission’s Guidelines on market analysis and the assessment of SMP (“SMP Guidelines”).

1.18 Based on evidence available and having considered the responses to its consultation, Ofcom concludes that:

1.19 As a result of its conclusion that BT does not have SMP in inter-tandem conveyance and inter-tandem transit, Ofcom must revoke all obligations on BT in relation to that market. This is a legal requirement that follows from Ofcom’s conclusion that BT does not have SMP in this market. The current NCCs for this market are ‘safeguard caps’ (i.e. BT is restricted to raising prices for these services by RPI-0%).

1.20 In the market for local-tandem conveyance and local-tandem transit, Ofcom considers at present that there is sufficient potential for competition over the period of the new NCCs due to the demonstrated ability of other operators to interconnect with BT’s local exchanges, either using their own infrastructure, or by leasing dedicated transmission capacity from BT. On this basis Ofcom therefore concludes that regulation should be reduced, by moving to a safeguard cap on BT’s charge increases, to no more than inflation. Also for that market, Ofcom concludes that BT should be able to change its charges at 28 days notice, rather than the current 90 days as this is more in keeping with competitive market conditions.

1.21 As Ofcom concludes that BT still has SMP in local-tandem conveyance and transit, Ofcom has considered all of the other SMP remedies currently imposed on BT that relate to its SMP in that market, such as network access, and is re-setting all those remedies (except for the change to the notification period for charges, terms and conditions, as mentioned above).

1.22 In assessing BT’s competitive position in these two markets, and thereby reducing regulation, Ofcom is following its regulatory principles by operating with a bias against intervention. Ofcom is exercising its discretion to remove BT’s SMP status in the inter-tandem market, based on a steady decline in BT’s share of that market, along with other factors that also suggest that continued regulation of BT would be disproportionate.

Implementation

1.23 Throughout this document, Ofcom explains how it has taken account of the nine consultation responses received (see Annex 1). These responses included one from the European Commission, which raised no objections to Ofcom’s proposals. Having considered representations made within the period to 1 June 2005, Ofcom can give effect to its proposals, with or without modifications, under the 2003 Act. Ofcom has decided to give effect to most of its proposals without modifications. However, for reasons set out in this document, Ofcom has also decided to give effect to certain of its proposals with modifications to take into account consultation responses. In Ofcom’s view, those modifications nevertheless fall within the most basic features of Ofcom’s proposals as set out in the consultation document.

1.24 To implement its decisions, Ofcom is today publishing a further Notification (see Annex 3) to accompany this Explanatory Statement. Ofcom will, however, continue to monitor market developments and, in the future, review at appropriate intervals the identified services markets, market power determinations and the regulatory remedies imposed.

The full document, divided into sections, is available below



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