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SMP assessment in the markets for wholesale mobile voice termination

3.1 This section contains Ofcom's final conclusions on the assessment of SMP in the markets for wholesale mobile voice call termination. In this section, Ofcom responds to the comments made in response to the December consultation. Further details of Ofcom's reasoning for its decision on SMP, and of the analysis performed by Ofcom to arrive at the conclusions presented below, are available in Chapter 3 (paragraphs 3.9-3.45) of the December consultation and Chapter 4 and Annex B of the May consultation.

Criteria used in assessing SMP

3.2 In its assessment of SMP in the markets for voice call termination, Ofcom has focused on single firm dominance and has relied on four of the criteria^(-7-) listed in the SMP Guidelines^(-8-) and in Oftel's Guidelines^(-9-) on the assessment of SMP. These criteria are:

1. market share;
   
   
2. ease of market entry;
   
   
3. excessive prices and profitability; and
   
   
4. countervailing buyer power.

3.3 Ofcom has also considered the CPP arrangements - a key factor in shaping the competitive conditions prevailing in the wholesale mobile voice call termination markets.

3.4 The rest of this section presents separately Ofcom's conclusions on the position in the markets for mobile voice termination of the MNOs Vodafone, Orange, O2 and T-Mobile, the new entrant '3' and Inquam. Even though Ofcom has reached similar conclusions for all six MNOs, these are discussed separately to highlight the differences in the analysis.

Ofcom's conclusions on Vodafone, Orange, O2 and T-Mobile

3.5 Ofcom considers that Vodafone, Orange, O2 and T-Mobile each have SMP in the market for mobile voice termination on their 2G (and, where services are offered, their 3G) networks. This is due to the fact that the CPP arrangement and existing technologies prevent other providers from offering termination services on a specific network. This is an absolute barrier to entry. Hence, each MNO faces no actual or potential competition in the supply of termination services on its own network(s). This means that each MNO is, in effect, a monopolist^(-10-). This is further addressed in paragraphs 3.11-3.16 of the December consultation.

3.6 In addition, Ofcom believes that there is insufficient countervailing buyer power on the part of any originating operator (fixed or mobile) to off-set the ability of these MNOs to act independently of their customers, and to prevent them from setting excessive termination charges. See paragraphs 3.32-3.45 of the December consultation for further detail.

3.7 This SMP finding has been further supported by Ofcom's analysis of 2G voice call termination charges, which appear to have been substantially above a reasonable estimate of each MNO's costs for a number of years, despite both formal and informal regulation. This ability to keep prices persistently and profitably above the competitive level is a further, important, indicator of SMP. In addition, Ofcom considers that, in the absence of any ex-ante regulation (or threat of ex-post regulation), the MNOs would have an incentive and ability to set even higher termination charges (i.e. at the profit-maximising level - which may be at 20 pence per minute or more). See paragraphs 3.17-3.31 of the December consultation for further detail.

3.8 Ofcom has also considered whether there is scope for competition to develop in the provision of termination services in the future. It has concluded that it will depend on how mobile technology and consumers' behaviour develop, and that it is unlikely that the necessary developments will take place before 2006. For further detail refer to Annex D of the December consultation.

Responses to the December consultation

Links between the market for access and origination and the market for termination

3.9 In its response, Vodafone (paragraphs 1.9 to 1.15) argues that, as Ofcom has concluded that the market for mobile access and origination services is effectively competitive^(-11-), no MNO can have SMP in the mobile termination markets. Vodafone claims that, if the retail market is competitive, the MNOs are effectively prevented from keeping any excess profit they may gain in the mobile termination markets and, therefore, are deprived of the independence that characterises dominance.

3.10 Vodafone argues that:

"…there is a clear and undisputed link between the pricing of termination services and access/origination services. The existence of this waterbed effect means that the pricing of Vodafone's and the other MNOs' termination and access/origination rates are subject to the same economic pressures, namely competition for subscribers." (Vodafone, paragraph 1.14)

3.11 Hence, it concludes that the resulting structure of prices - with relatively high termination charges and relatively low retail prices - is the outcome of a competitive process. Vodafone also argues that:

"…one can argue about the welfare effects of such a structure, but it is wrong to characterise this as a situation where one UK MNOs can act independently of the other MNOs in setting any price, whether for termination or access and origination services." (Vodafone, paragraph 1.15)

3.12 Vodafone claims that this dynamic is also recognised by Tommaso Valletti in his study on the telecoms markets prepared for DG Information Society^(-12-), where he states:

"…if there is competition among MNOs, then the termination profits would be passed on to mobile users, for instance via lower rental fees or via cheaper handsets, and the excess profits are competed away." (Valletti, p.18)

3.13 Hence, Vodafone concludes that Ofcom cannot hold that there is effective competition in the UK market for mobile access and origination services while maintaining that all UK MNOs can set termination prices independently of each other, as the two conclusions are contradictory.

Ofcom's response

3.14 Ofcom is aware of the links between the retail access and outgoing calls market and the termination markets and has considered them in its analysis. Indeed, the justification for having an externality surcharge in the termination charge relies on this very link. However, Ofcom does not agree with Vodafone's conclusions. As discussed in Chapter 4 of the May consultation (paragraphs 4.23-4.25 and 4.38-4.44), competition in the retail market merely determines the extent to which the profits earned in the market for termination services are competed away through lower retail prices. It does not take away from an MNO its ability to set excessive termination charges. This ability is derived from its SMP position. The independence of action that characterises an operator with SMP manifests itself, among other things, in its freedom to set charges well above cost.

3.15 In Ofcom's view, the extent to which competition forces an MNO to lower retail prices and competes away most of the excess profits it earns in the termination market is a relevant consideration in the analysis of the detrimental effects of excessive termination charges and in the determination of proportionate remedies. However, it does not affect the assessment of SMP^(-13-).

3.16 Ofcom also considers that, if read in its totality, the paper by Tommaso Valletti supports Ofcom's, rather than Vodafone's, analysis. Valletti does not argue that MNOs cannot have SMP in termination if the retail market is competitive, but simply points out the link between the two markets. In fact he clearly states that:

"…the mobile operator is typically able to set charges at the monopoly (i.e. profit maximising) level independently of the intensity of competition in the market for subscribers." (Valletti, p. 17)

3.17 Hence, Ofcom does not consider that Vodafone's argument weakens its SMP analysis.

SMP and 3G networks

3.18 BT claims that Ofcom's analysis:

"…is based on the assumption that network operators will levy the same charges on 3G termination as they do for 2G termination. The basis of Oftel's resulting proposal is that cost-orientation of 2G call termination would then safeguard consumers by also applying when consumers make a call terminating on a 3G network. This implies to us that Oftel has effectively defined two separate markets (one for 2G and one for 3G), but found the mobile operators not to have SMP in the market for 3G termination on the basis that there will be a spill-over of the regulatory remedies from 2G to 3G." (BT, paragraph B2)

3.19 BT also argues that:

"…the underlying competition problem for voice call termination on 3G networks is exactly the same for such termination on 2G networks and gives rise to the same public interest concerns and Oftel has provided no argument why the type of technology used by the mobile supplier alters the mobile operators' market power". (BT, paragraph B5)

Ofcom's response

3.20 Ofcom does not agree with BT's conclusions. Ofcom has not defined two separate markets for termination on an MNO's 2G and 3G network, nor has it found no SMP in the latter market for each MNO. Ofcom, as identified in paragraph 2.23 above, has defined a single market for mobile voice termination services on both the 2G and the 3G network of each of Vodafone, Orange, O2 and T-Mobile, and this is unchanged from the December consultation. The SMP finding applies to the provision of all the services included in this market. As BT has correctly pointed out, the reasoning behind the SMP finding is independent of the technology used, therefore, Ofcom considers that Vodafone, Orange, T-Mobile and O2 have SMP in the provision of termination on both their networks. The issue of which obligations should be introduced to remedy this SMP is discussed further in Chapter 5 on Remedies.

Ofcom's conclusion on the new entrant: '3'

3.21 Ofcom maintains its view that '3' has SMP in the market in which it supplies wholesale mobile termination services. Ofcom considers that (i) '3''s 100 % market share in the market for wholesale voice call termination on its network; and (ii) the presence of absolute barriers to entry in that market, mean that '3' has SMP.

3.22 In addition, Ofcom believes that purchasers of termination from '3' have insufficient buyer power to off-set '3''s market power, and thus constrain its pricing behaviour.

Response to the consultation

3.23 In its response to the consultation, '3' claims that Ofcom's analysis of whether '3' has a position of SMP in the wholesale mobile voice call termination market is highly generalised and unduly aligned to the analysis for the existing 2G mobile operators. '3' also indicates that it does not believe Ofcom has taken into account all of the relevant evidence and submissions provided by '3'.

3.24 Ofcom considers that the basic analysis of voice call termination on mobile networks is consistent across all MNOs, and believes that it has taken sufficient account of '3''s evidence and submissions. Ofcom now addresses the specific points raised by '3' in response to the December consultation.

BT's countervailing buyer power

3.25 '3' claims that Ofcom's analysis of whether BT has countervailing buyer power in the market for mobile termination on '3''s network is "cursory and inadequate" and highlights a number of weaknesses (paragraphs 2.9 to 2.32 of '3''s response).

3.26 '3' also argues that Ofcom bases its claim that BT has no countervailing buyer power on BT's obligation to purchase call termination. However, '3' states that in the Oftel guidance document End to End Connectivity^(-14-) it is acknowledged that BT has no obligation of this kind.

3.27 In addition, '3' claims that Ofcom focuses solely on whether BT can refuse to purchase termination, and ignores its ability to cause material delays in the negotiation process. According to '3', this is a major shortfall in the analysis, because BT, in agreeing termination charges, has exploited the fact that '3', as a new entrant, could not even commence essential network testing without an interconnection agreement with BT. Hence, '3' argues that, even if BT may not be able to refuse interconnection, it is able to threaten to delay negotiations.

3.28 '3' concludes by suggesting that a further proof of BT's countervailing buyer power is that the terms of the contract between '3' and BT prevent changes to '3''s charges. The contract subjects any change in interconnection charges to BT's approval, and, where no agreement is reached, the matter may be referred to Ofcom. Hence '3' believes that, in any renegotiation of termination charges, BT will refer any attempt by '3' to raise charges excessively to Ofcom.

Ofcom's response

3.29 Ofcom believes it has taken account of all relevant evidence supplied by '3'.

3.30 In relation to the point about BT's countervailing buyer power, Ofcom does not believe that the existing regulatory framework would, in practice, allow BT (as an originating operator) to reject price increases by '3'. While, as '3' has pointed out, there are no formal conditions in place - because they have not previously been required - the May guidance explains that BT is expected to offer end-to-end connectivity in order to meet USO requirements to provide publicly available telephone services. This weakens BT's bargaining position as it removes the threat of BT not providing connectivity if agreement over charges cannot be reached.

3.31 It is possible that during the initial interconnection negotiations between BT and '3', '3''s urgency to launch services was a relevant factor in the relative bargaining positions of each party. However, Ofcom's analysis in this market review must be forward-looking and consider '3''s likely position in the next 18-24 months. Therefore, Ofcom must also consider future negotiations between '3' and BT.

3.32 With such a forward-looking perspective, and with delay not such a critical issue for '3', it would be difficult to argue that '3' could not set excessive charges for the termination services provided to BT. With specific regard to '3''s evidence, Ofcom believes that it refers to the specific circumstances which '3' was in prior to offering services to the public. However, it does not provide a sufficient indication of how future negotiations with BT would run, given the change in '3''s circumstances (i.e. previously it required an interconnection agreement with BT to start operating, but that is no longer the case). It may be that existing contractual arrangements between '3' and BT make it difficult for '3' to raise charges from their current level. However, there is no arrangement in this contract for BT to ensure that charges fall over time from their current level (in line with costs). Some evidence of this is BT's inability to enforce reduced termination payments to '3' at the time of the 15 per cent charge reduction applied to the other MNOs in July 2003.

3.33 Hence, for the reasons set out above Ofcom considers that BT is under an obligation which leads to a position where it does not have countervailing buyer power that off-sets '3''s market power in call termination.

MNOs' countervailing buyer power

3.34 In its response, '3' complains that the Director has not examined in detail the bilateral relationships between '3' and the other MNOs:

"…especially as Ofcom expressly recognises elsewhere in the Notification that there is an imbalance of market power between '3' on the one hand and the four incumbents on the other". ('3', paragraph 2.24)

3.35 '3' claims that because of: (i) its small size;(ii) the competitive threat that it represents for the MNOs; and (iii) the clear urgency for '3' to obtain interconnection from them, Orange, Vodafone, T-Mobile and O2 have countervailing buyer power.

3.36 '3' also holds that the MNOs do not necessarily have to cut off '3' to exert their buyer power, but that they could delay negotiations or make them more resource intensive.

3.37 Furthermore, '3' argues that there is an inconsistency between Ofcom's SMP finding and Ofcom's position (paragraph 5.44 in the December consultation) that

"…whilst (the four) MNOs may have an incentive to weaken '3' 's position in the retail mobile market by charging '3' very high termination rates, Ofcom would not expect '3' to have the same interest as most of its traffic is off-net".

Ofcom's response

3.38 In the December consultation (paragraphs 3.37 and 3.40) Ofcom considered the individual relationship between all six MNOs and concluded that it is unclear whether any of them has a level of buyer power sufficient to off-set each MNO's monopoly in providing termination and constrain their charges to a cost-reflective level. Ofcom expressed the view that it would be the exception rather than the rule that the level of countervailing buyer power in these bilateral negotiations would be of the precise magnitude to ensure that voice call termination charges were constrained to the competitive level, and that it had not been provided with any evidence to show anything to suggest that the position is otherwise. Ofcom currently sees no reason to alter this view.

3.39 The December consultation (paragraph 3.44) noted that there were commercial considerations which limited the countervailing buyer power of MNOs. Aside from these commercial considerations, Ofcom also considers that, in relation to whether an operator has countervailing buyer power, the threat of regulatory intervention is relevant. Any failure by Vodafone, Orange, O2 or T-Mobile to purchase call termination from '3' may trigger a regulatory intervention under section 73 of the Act. Ofcom considers that this implicit regulatory threat curbs any countervailing buyer power the MNOs may have in the market for voice termination services on '3''s network.

3.40 Furthermore, as mentioned above, the analysis performed in this review is forward-looking; hence, Ofcom considers that, having launched its services, '3' is no longer under pressure to enter into new interconnection agreements. The threat to delay is primarily effective when there is no interconnection agreement in place. Therefore, any delaying tactics on the part of another MNO is unlikely to be an effective strategy to exert power in future interconnection negotiations.

3.41 Hence, Ofcom considers that there is no compelling evidence (either from a theoretical point of view, or having considered in detail '3''s submission) that any of these MNOs has a level of buyer power sufficient to off-set '3''s market power in the provision of termination on its network.

3.42 With regard to the comment made by Ofcom in paragraph 5.44 of the December consultation about '3''s position, this was related to the justification for not imposing a non-discrimination obligation. Ofcom believes that Vodafone, Orange, O2 and T-Mobile may have an incentive to raise termination charges to '3', not simply to maximise profits from termination services, but also to reduce its ability to compete with them in the retail market. Each of Vodafone, Orange, O2 and T-Mobile has a large subscriber base and offers low rates for on-net calls between customers on its network. This means that by charging a new entrant a high charge for termination they are able to exploit the size of their customer bases as a competitive weapon in the retail market. By contrast, '3', which presently has a small subscriber base in the retail market, does not have the same opportunity to use discrimination in the termination market to its advantage in the retail market.

Excessive prices

3.43 '3' considers that Ofcom:

"…has manifestly failed to give proper individual consideration to the question of whether Hutchison 3G can set excessive call termination prices." ('3', paragraph 2.4)

3.44 '3' also questions whether Ofcom's analysis of the MNOs' behaviour in setting 2G voice termination charges and its conclusion that these charges have been set above a reasonable estimate of each MNO's costs for a number of years applies also to '3'. '3' argues that the December consultation contains no analysis of its costs that could have led Ofcom to conclude that '3''s charges are excessive. In addition, '3' claims that it has provided Ofcom with evidence that demonstrates that its pricing is not excessive.

3.45 In addition, '3' considers that Ofcom has not given enough consideration to the effects of the current number portability arrangements on '3''s ability to set charges above the competitive level. In particular '3' claims that the effect of the number portability charging arrangements curbs any pricing freedom it may have. [Confidential text redacted]

Ofcom's response

3.46 The analysis of 2G termination charges Ofcom presented in Chapter 4 of the December Consultation was limited to the charges levied by Vodafone, O2, Orange and T-Mobile. Ofcom is aware that '3''s termination charges in practice reflect a combination of its 2G and 3G termination costs, and Ofcom has not performed a detailed analysis of '3''s charges. As Ofcom has noted, 3G networks are new and capable of providing a range of innovative services, and therefore it would be difficult to assess with confidence the relevant voice call termination costs and the appropriate rate of return on capital invested. However, this does not imply that '3' is unable to set excessive termination charges, given the lack of constraints it faces. The constraints facing '3' are similar in nature to those facing the other MNOs, and these are not sufficient to hold charges at the competitive level on a forward-looking basis.

3.47 With regard to the evidence submitted by '3', this did not include any information on '3''s termination costs and, more importantly, it only refers to ported numbers for which '3', like all the other MNOs, receives a different termination charge from its own. This charging arrangement is the result of the current technical routing system agreed between the MNOs. This (imperfect) system has been set up because of the high cost of implementing a system that would permit terminating operators to receive their own termination charge.

3.48 The presence of ported numbers will not preclude MNOs from setting excessive termination charges to those subscribers that have not ported their number. Therefore, Ofcom is of the view that the fact that '3' currently cannot set charges for terminating a share of calls to its network does not justify concluding that '3' (nor any of the other MNOs) has no pricing freedom in setting charges for customers without ported numbers.

3.49 With regard to '3''s roaming agreement with O2, Ofcom considers that, to the extent that it has constrained '3''s termination charges, the effect is likely to be transitory and short-term. This is because, in Ofcom's understanding, the agreement was struck to ensure that '3''s customers had sufficient network coverage in the time before '3''s network is completed. Hence, this feature will be of declining importance over the period to 2005/06.

Regulatory constraints

3.50 '3' claims that it submitted evidence to indicate that the threat or use of dispute resolution processes had constrained its own pricing and would continue to do so for the foreseeable future, but that Ofcom has dismissed this without any consideration.

Ofcom's response

3.51 Ofcom believes it has already addressed this issue in paragraphs 4.3 to 4.9 of the December consultation, where it was explained that the possibility of dispute resolution will not, in practice, constrain a MNO from setting excessive termination charges. Ofcom provides further reasoning on this point in the following chapter (see paragraph 4.14).

Ofcom's conclusions on Inquam

3.52 Ofcom remains of the view that Inquam has SMP in the market for mobile voice termination supplied on its network. Ofcom considers that, because of the presence of absolute barriers to entry (see above) and the lack of countervailing buyer power, Inquam does not face sufficient constraints on its pricing behaviour in the market for voice call termination services.

Response to the consultation

3.53 The European Commission pointed out that Inquam's subscribers are predominantly small and medium enterprises, which may be sensitive to the cost of customers calling them and may therefore limit Inquam's freedom to set excessive termination charges. The European Commission also suggested that Ofcom may wish to take account of Inquam's prior pricing behaviour.

Ofcom's response

3.54 Ofcom is aware that the existence of 'closed user groups', i.e. groups of people whose members care about the cost to the other members of calling their mobile number, could mitigate the effect of the CPP arrangement and act as a constraint on the MNOs' ability to set excessive voice termination charges. However, Ofcom considers that, in general, the presence of closed user groups does not limit an MNO's pricing freedom in the relevant wholesale termination market. This is because the MNO can offer special retail tariffs to these price-sensitive customers, ensuring that these calls remain 'on-net' (i.e. they also originate on Inquam's network), and maintain excessive charges for the supply of wholesale termination services to other fixed and mobile operators.

3.55 Ofcom understands that a very high proportion of calls terminated on Inquam's network are 'on-net', and that the services offered by Inquam primarily consist of private networks that allow those on it to communicate with each other. Inquam effectively enables these customers to bypass the excessive wholesale termination charges that would be paid if calls were terminated 'off-net'. Hence, Inquam's customers rarely receive off-net calls as all the parties they regularly communicate with are already on the network.

3.56 Ofcom therefore accepts that Inquam's customer base is composed largely of closed user groups, who are able to apply competitive pressure on termination charges. Nonetheless, Ofcom concludes that for calls which are originated on other networks (off-net), Inquam faces the same lack of constraints on its wholesale termination charges as do the other MNOs.

3.57 Ofcom also requested and received information from Inquam on its wholesale termination charges. While Ofcom has not undertaken a study of costs, in order to determine whether these charges are excessive, the fact that these charges are above the regulated charges of the other MNOs appears consistent with Ofcom's market analysis and SMP finding.

Conclusions

3.58 After taking into account further responses, Ofcom concludes that each mobile operator has SMP in the market for the supply of wholesale mobile voice call termination on its network(s).

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Footnotes:

7. - These four criteria are only a subset of the criteria listed in the EU Commission and Oftel Guidelines on SMP. Annex B in the May consultation discusses the other criteria and explain why they have been considered to be less relevant in this specific market.

8. - "Commission Guidelines on market analysis and assessment of significant market power under the Community regulatory framework for electronic communications networks and services" which can be found at http://europa.eu.int/information_society/topics/telecoms/regulatory/new_rf/
index_en.htm.

9. - "Oftel's market review guidelines: criteria for the assessment of significant market power " which can found at http://www.ofcom.org.uk/static/archive/oftel/publications/about_oftel/2002/
smpg0802.htm

10. - Each MNO has (since launch of its services) a 100% share of terminating voice calls on its 2G network, both when measured by volume of calls and by revenues. As services on 3G networks are launched (as have been by '3'), each MNO running a 3G network will also have a 100% share of terminating voice calls on that network.

11. - Discontinuing regulation: mobile access and call origination market, Oftel 4 November 2003

12. - "Access Services to Public Mobile Networks", Dr. Tommaso Valletti, September 2003

13. - See Chapter 4 (paragraph 4.38 to 4.44) in the December consultation for more details about the 'waterbed' effect.

14. - Published in May 2003.

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