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	Performance with consumers
	Competition
	Innovation and investment
	Industry financial performance

H.1 This annex provides an assessment of the telecoms industry’s performance in delivering benefits to society. It looks at four areas:

• performance with consumers - how well the telecoms sector is delivering value and choice to consumers, how this is changing over time, and how it compares to other countries;
• competition - the different forms of competition in telecoms, and the existence of alternative networks providing competition in infrastructure. The extent to which the various forms of competition have developed in different UK telecoms markets, how this is changing over time, and how it compares to other countries;
• innovation and investment - how well the UK telecoms sector has made new products available to consumers, and the extent to which it has invested in making these products widely and rapidly available; and
• industry financial performance - the profitability of the UK telecoms sector and the evolution of investor sentiment.

H.2 Throughout this annex, we have provided data to support our assessments. In general we have provided figures going back in time as far as we have the data available. For some data, this a longer period than for others.

Performance with consumers

H.3 This section assesses the benefits that the telecoms sector is delivering to the consumer in terms of the price of services, quality of service and customer satisfaction, service choice, and access to services. We then assess the degree of competition between suppliers.

H.4 These are very conventional measures of performance. One of the conclusions of the Telecoms Review may be that other measures of success of the sector are appropriate. Annex I discusses a number of emerging trends in consumer demand, which we will be researching further as part of Phase 2 of this Review. One aim of this research is to identify other measures of the sector’s performance with consumers.

H.5 Figure 4 summarises our findings. The scores are intended to be illustrative only, and further analysis to support the table’s conclusions is provided later in this annex. The table assesses the sector’s performance based both on comparative measures (for example, is there more competition in the UK than abroad?), and absolute measures (for example, how much competition is there in the supply of mobile voice telephony?).

H.6 In general, it shows that the UK is performing well. It has generally lower prices and higher levels of competition and choice than many other markets. However, there are some important exceptions; in particular, business PSTN prices are higher, and broadband take-up lower than many of the UK’s peers. BT, in common with the incumbent fixed network operator in almost all markets, has a very high market share of access lines and certain call markets.

Exhibit 4. Summary of the benefits to consumers from the UK's telecoms sector

	Price	Quality of service and customer satisfaction	Service choice	Access to services	Competition
Fixed voice telephony	UK residential prices compare well with other countries; business prices above average	Very high levels of SME and residential consumer satisfaction; declining incidence of faults	Wide range of tariff structures and bundling options	Near ubiquitous take-up, only 1% of households do not own either a fixed nor a mobile phone	More competition in calls and access lines than other countries. Much of the call competition is from service providers, using alternative long distance networks. BT still provides most access infrastructure
Internet	Narrowband and entry level broadband prices compare well with comparable markets; higher speed broadband more expensive	High satisfaction with broadband, lower satisfaction with connection speeds of narrowband	Full range of narrowband price structures. Some choice of broadband connection speeds, contention ratios, but flexibility in price structures only just emerging	Ubiquitous availability of narrowband. Broadband only available recently in many areas, other areas need a "trigger" level of demand in an exchange, and some households and exchanges not DSL enabled	Many service providers, none with market shares over 30%. Infrastructure provision largely provided by BT and cable companies, almost all DSL lines use BT's access infrastructure
Mobile	Prices for pre-pay are lower than many other markets, and the UK is also relatively competitive in post-pay pricing	High overall satisfaction, less satisfaction on cost and value for money. Incidence of dropped calls improving	3G services starting to become available, and a full range of 2G and 2.5G tariff packages and devices	Mature networks cover almost all population and all except remote areas. Near-ubiquitous take-up amongst younger consumers; voice and text message usage increasing	High (licensing) barriers to entry at the network level, but least concentrated market in Europe. Some new service provider competition, but many existing service providers now bought by network operators
Corporate network services	Published leased line prices are above European average.	High levels of overall satisfaction with suppliers and reliability of service; less so for value for money and customer service.	These services the key focus of many Altnets. Competition has encouraged development of bespoke and tailored solutions.	Most large corporate businesses are using some form of data network service. May be reliant on BT infrastructure for some services.	At least six players with significant market share although BT still retains around half the market; more for lower capacity leased lines.

Key

Good

Poor

 

H.7 Below, we look at the fixed voice telephony, internet mobile and corporate network services sectors in turn.

Fixed voice telephony

Price

H.8 The rate of decline of both business and residential fixed telephony prices has slowed substantially over the last three years. Figure 5 measures the overall price paid for voice telephony including access and calls. The increased take-up of indirect access offerings has lead to a significant reduction in average call prices. However, in parallel there has been a move by service providers to offer increased fixed fees including line rental in return for a certain amount of call time. Therefore, although call prices are falling, fixed charges are increasing, resulting in an overall flat price basket.

Figure 5: Real Price index of telephony services in the UK ^(-23-)

H.9 Price comparison work carried out by Oftel over the last four years (shown in Figure 6) shows that residential services in the UK are cheaper than in many other countries. This is broadly confirmed by other surveys including the OECD T-Basket and Analysys’s ‘Cutting the Cost’ comparison.

Figure 6: Comparision of residential PSTN prices in the UK with other markets ^(-24-)

H.10 Prices for UK small^(-27-)businesses are slightly more expensive than in the same comparator countries although prices for medium businesses are about average, as shown in Figures 7 and 8. Using published tariff data to compare prices for medium sized and larger businesses may be misleading, as these customers tend to negotiate prices on a bespoke basis, and the terms of those deals are not made public. Larger corporate customers have been excluded from this comparison for this reason.

Figure 7: Comparision of small business PSTN prices in the UK with other markets ^(-25-)

Figure 8: Comparision of medium-sized business PSTN prices in the UK with other markets ^(-26-)

Quality of service and consumer satisfaction

H.11 Consumers have experienced steady improvements in fixed telephony service quality. Research by Oftel in 2003^(-28-) found that 97 per cent of residential customers claim to be very or fairly satisfied with the overall standard of service they receive. There were 0.22 faults per exchange line per year in 1987, but only 0.12 in 2002,^(-29-) as shown in Figure 9.

Figure 9: Faults per exchange line per annum ^(-30-)

H.12 International comparisons of quality of service are difficult to make. However, the OECD reported that in 2001 the UK figure for fault incidence was about average among those countries who reported data, and similar to the US. The UK figure for the percentage of faults repaired within 24 hours (78 per cent in 2001) was below average.^(-31-)

Service choice

H.13 In recent years, UK consumers have had access to a number of innovations in voice telephony. These include the continued evolution of telecoms tariff schemes, allowing consumers to pick options tailored to their own specific requirements, as well as other services such as call-back, calling line identity and voice mail services.

H.14 Choice of supplier in fixed telephony is considered in the analysis of competition below.

Access to services

H.15 Access to fixed voice telephony is ubiquitous in the UK, because it is included in the Universal Service Order, as discussed in Annex G. Take-up is also almost ubiquitous. At the end of 2003, for example, 76 per cent of UK households had access to both a landline and a mobile phone, 14 per cent had access to a landline only, while 9 per cent had access via a mobile phone only. Only 1 per cent of households did not have a phone of any kind, with cost cited as the main reason for not having a phone.^(-32-)

Internet

Price

H.16 The UK is one of the cheapest places in the world for basic dial-up internet services, as evidenced in Oftel’s benchmarking study in August 2003. This has partly been due to a number of innovations in internet access in the UK. For example, these included the development of the ‘Freeserve model’ of free connection and pay-as-you-go internet access in the late 1990s. Unmetered narrowband internet access was pioneered by the cable companies, and later adopted by BT and other service providers following regulatory intervention. Figure 10 compares dial-up internet prices in the UK with other countries.

Figure 10: Comparison of dial-up internet prices ^(-33-)

H.17 Oftel also found that prices in the UK for entry level broadband services also compare well, although prices for higher speed business services were the most expensive of the countries considered. This is shown in Figure 11.

Figure 11: Comparison of broadband prices ^(-35-)

H.18 The conclusion that prices for residential broadband services in the UK are relatively low compared to other countries is not supported by some other studies that have used different methods. For example, Analysys found residential ADSL prices in the UK to be higher than those in Germany and the US^(-34-), Analysys surveyed a wider selection of markets to show that UK broadband prices were very substantially higher than, for example, those in Japan, South Korea and Canada.

H.19 Any price competitiveness in the UK is also relatively recent. For example, in October 2000, Oftel found residential broadband prices in the UK to be the most expensive of these five markets^(-36-).

Quality of service and consumer satisfaction

H.20 Overall satisfaction with internet services in the UK is good, and higher for broadband than for narrowband. Oftel found overall satisfaction with the service to be 94 per cent among broadband customers in November 2003. Overall satisfaction among narrowband customers was slightly lower, at 89 per cent, perhaps on account of the fact that narrowband customers were less satisfied with the speed of their online connection ^(-37-).

Service choice

H.21 The UK compares well with other countries in terms of internet service choice. Metered, unmetered and partially unmetered narrowband packages are widely available, both from the BT and from alternative suppliers. In broadband, choice can be measured in terms of access to different payment structures, bandwidths, contention ratios, levels of IT support and other services (such as virus protection or content blocking) provided by ISPs. The UK provides choice in some of these areas but not others. There is some variety in connection speeds, contention ratios and ISP add-on services. However, there is less variety in terms of payment structures. For example, metered broadband tariffs are not available in the market. BT’s recently announced broadband product which includes 1 Gb of usage per month is the market’s first major foray into volume-based pricing.

Access to services

H.22 The UK’s internet penetration of around 50 per cent of households lags behind the Far East, US and Scandinavia, but is broadly comparable to Germany, and is ahead of France and most of southern Europe ^(-38-). There are substantial age variations in UK internet penetration, with penetration being lower amongst the over-55s, possibly as a result of the costs of PC ownership, and lack of knowledge and interest ^(-39-). Internet penetration among small businesses is around two thirds, but has remained fairly static since mid 2002 ^(-40-).

H.23 The UK lags behind its peers on broadband take-up, both among residential consumers and among SMEs. Residential broadband penetration is now 22 per cent of households with internet^(-41-), and 35 per cent of SMEs with Internet access. Figure 12 compares broadband take-up in the UK with a number of other markets. Comparisons with Korea should bear in mind the impact of its high level of population density, and public financing of roll-out.

Figure 12: Broadband take-up ^(-42-)

H.24 The UK’s lower broadband take-up could be due to a number of factors, including higher prices for broadband services in the UK (until recently), limited availability of ADSL-enabled exchanges (again until quite recently), and the widespread availability of unmetered narrowband packages which some consumers use as a ‘half-way house’ between metered narrowband services and broadband.

Mobile

Price

H.25 Ofcom’s benchmarking in November 2003 found mobile prices in the UK to be very competitive with other markets, as shown in Figure 13. The comparison is different depending upon whether the costs of handsets are included or not. When handsets are excluded, the cheapest packages are typically pre-pay packages, and the UK is very price competitive in this sector of the market. When handsets are included, the cheapest packages are typically contract packages. Though the UK remains price competitive, the various countries are much closer together on prices for these services.

H.26 In spite of the UK’s price competitiveness, the rate of decline of mobile prices has slowed very substantially in the last four years, as shown in Figure 14.

H.27 In contrast, research reports by the OECD and Analysys^(-43-) find prices in the UK to be higher than many of its peers. The differences in results are largely due to methodology. In general, Ofcom’s benchmark includes a wider range of service providers and packages than either Analysys or the OECD.

Figure 13: International comparisons of mobile prices^(-44-)

Figure 14: Index of the real price of mobile services^(-45-)

Quality of service and consumer satisfaction

H.28 With the 2G operators’ networks now mature, network quality is very good. Figure 15 gives the results of Oftel’s call completion survey in May 2003. It shows very high call completion in general, except in certain regions that have large rural areas.

Service choice

H.29 The UK offers a substantial diversity in mobile services. A broad range of handsets and tariff packages, including varying levels of device subsidies, is available. The mobile sector has brought a steady stream of new services to market over the last few years, including WAP, picture messaging, java applications, ringtones and logos.

H.30 Though the UK market is one of the few European markets to have commercial 3G services, the incumbent operators have nonetheless delayed full-scale launches of 3G services to date.

Access to services

H.31 Oftel’s survey in November 2003 found adult mobile penetration to have levelled off at around 75 per cent, as shown in Figure 16. Mobile penetration is significantly lower for older age groups, and over 50 per cent of consumers between 65 and 74, and over 75 per cent of consumers over 75, do not have a mobile phone. The survey also found that mobile penetration amongst SMEs has fallen after a peak in 2002.

H.32 As Figure 17 shows, average mobile voice usage has begun to increase again over the last couple of years. The decline from 1999 to 2002 was the result of a dilution of the user base by lower-usage customers, following the surge in mobile penetration as a result of the introduction of pre-pay. The recent slight increase has been driven entirely by contract customers. There has also been an increase in the average number of text messages sent per subscriber to nearly 40 a month since the widespread take-up of SMS in the late 1990s.^(-46-)

H.33 The combination of growing usage, growing penetration and yet (recently) relatively flat prices has resulted in a steady increase in consumer spend on mobile, which now makes up around a third of consumer spending on telecoms in the UK.

Figure 15: Mobile networks call success rates surveys, May 2003^(-47-)

Region	% of calls completed successfully
East Anglia	98.0%
London	97.2%
Midlands	98.1%
Northern England	98.0%
Northern Ireland	97.4%
Scotland	93.9%
South East England	96.9%
South West England	95.7%
Wales	87.8%
UK	96.9%

Figure 16: SME and residential consumer mobile penetration^(-48-)

Figure 17: Average mobile usage (outgoing minutes per month per user)^(-49-)

Corporate network services

Price

H.34 Leased lines are the product making up the largest proportion of business consumers’ spending on network services (around 30 per cent in 2003).^(-50-) Therefore the relative price of leased lines is a key indicator of the UK’s overall position in terms of price for corporate services. As Figure 18 shows, most types of leased line are substantially more expensive in the UK than the EU average.

Figure 18: Comparison of UK leased line prices with EU average^(-51-)

H.35 However, price comparisons such as these tend to rely on the incumbent operator’s published prices. In reality businesses receive discounts or bespoke bundled solutions which incorporate a range of services, and they often buy from sources other than the incumbent. Though this situation will be the same in all the comparator countries, it means that these data cannot be taken as definitive.

H.36 In addition, leased lines only make up around 30 per cent of business’s spend on corporate network services. Because the remaining services are often highly bespoke, it is hard to make price comparisons between markets. However, because the corporate network services market in the UK is highly contested, being a main focus of many alternative network operators, it is likely that prices in the UK are relatively competitive with other countries.

H.37 Results from Oftel’s Large Business Panel in October 2003 suggested that around one in five corporate customers were not satisfied with the value for money of their overall fixed telecoms service.

Quality of service and customer satisfaction

H.38 Overall, customer satisfaction among corporate consumers is good. Results from the same panel survey showed that overall, around nine in ten large businesses^(-52-) are satisfied with their telecoms suppliers and the reliability of the service provided. The same businesses are, however, less satisfied with the customer service and aftercare provided by their suppliers, with only two-thirds being satisfied with this aspect of service.

Service choice

H.39 Because of the need for bespoke services, and the integration required with existing IT systems, service choice is particularly important for these services. It is also a key driver to innovation in business processes, and hence possibly to economic growth, as discussed in Annex F.

H.40 The UK has more infrastructure-based suppliers offering corporate network services to large businesses than almost any other market in the EU. For example, Cable and Wireless, Energis, MCI, Thus, COLT, Global Crossing as well as other suppliers all have a large UK presence in this segment. In addition, a number of systems integrators compete for some types of services.

H.41 Though Ofcom does not collect data in this area, it is likely that this competition has encouraged easy accessibility of bespoke and tailored solutions to suit individual businesses, using products such as IP managed router services, Frame Relay and ATM, and Ethernet. IP VPNs are becoming increasing common and large businesses are also taking advantage of the increased availability of DSL to encourage home and tele-working.

Access to services

H.42 Ofcom estimates nine in ten corporate businesses are using at least one corporate network service - such as leased lines, VPN, Frame Relay/SMDS, ATM or other high bandwidth data network.^(-53-) While much of this is based on alternative network operators’ infrastructure, it is likely that many businesses are still reliant on BT infrastructure to some extent, particularly outside major business centres.

Competition

H.43 We now assess the level of competition in the various telecoms markets. As in most sectors, competition in telecoms can deliver many benefits to consumers by reducing prices, raising quality, ensuring that services are produced efficiently, and creating incentives for providers to innovate and to increase service choice.

H.44 Measuring competition is difficult for a number of reasons:

• the relationship between market share and market power is not a precise one. A high market share may in some cases be the result of successful competition rather than a sign of its absence - though the latter is a possibility too;
• the implications for the degree of competition of there being more similar or divergent operator sizes are not straightforward. Therefore, comparisons between market structures with different divisions of the market between operators are difficult to draw;
• the availability of a range of service providers may not equate to a competitive market if customers face high barriers to switching between them, or if reliable information about alternative suppliers is difficult to obtain and compare; and
• finally, the ability of firms not currently operating in the market (which may be either new firms, or ones currently operating elsewhere) to enter the market easily and serve customers can be an important constraint on the exercise of market power.

H.45 However, broadly speaking, the existence of a greater number of competitors tends to imply stronger competition, while the existence of a large, dominant supplier tends to imply weaker competition.

H.46 In telecoms, competition can take different forms depending upon whether competitive suppliers use the same, or an alternative infrastructure to the established operator. Figure 19 shows the (very simplified) routing of a typical long-distance telephone call.

H.47 The different forms that competition can take are:

• Access competition: competitors have their own networks reaching all the way to the customer. For example, when a cable operator competes with BT, it does so by having a separate wire into a home or business. This form of competition typically requires the least regulation to maintain, and gives competitors maximum scope to innovate and introduce service choice. In some cases it may also allow further service provider competition to develop without wholesale access to networks being mandated;
• Long-distance network competition: competitors use their own networks for the longdistance portion of the call, but use the established operator’s network for the local access part of the call. This form of competition typically requires regulation to allow the competitor access to the established operator’s network. It allows some scope for innovation, but only where competitors can provide the new product using the local access part of the network that they buy from the established operator; and
• ‘Service provider’ competition: competitors use other networks’ transmission infrastructure. Often, they use the established operator’s network to access the customer, and another operator for the longdistance part of the call. This form of competition can deliver benefits in terms of lower prices if wholesale prices are heavily regulated. However, service providers often have little ability to innovate except in price structures, customer service or other non-network product elements.

Figure 19: Routing of a long-distance call through the telecoms network

H.48 Because access and long-distance network competition can in principle deliver greater benefits than service provider competition, the scope for benefits due to telecoms competition in the UK depends on the extent to which alternative networks are rolled-out. The current roll-out of these networks in the UK is discussed below.

Extent of alternative network roll-out

H.49 The UK has a number of telecoms companies that operate long-distance telecoms networks. These networks vary in their breadth (i.e. how many regions of the UK they pass through), and their depth (i.e. how many points of access and interconnection they have). These companies have varying business models - some long-distance network providers focus purely on carrier services to wholesale customers, while others offer retail services, usually to business customers. The UK networks of two alternative networks providers are shown in Figure 20.

Figure 20: UK long distance networks of Thus and Cable & Wireless^(-54-)
Thus

Cable & Wireless

H.50 The extent of consumer choice in access provision depends on location, and the type of consumer. In general, residential and low- or medium-use business consumers have no choice of fixed access provider other than BT, unless they live in an area which has been passed by a cable network. Cable roll-out extends to around 55 per cent of the UK population. The cable companies have captured over a third market share^(-55-) in their franchise areas, giving them just under 20 per cent of UK lines in total. In addition to this infrastructure competition, the entire population has a choice of a large number of fixed call service providers using other suppliers’ access infrastructure.

H.51 In general, larger volume business customers have a greater choice of infrastructure-based fixed telecoms provider. Many of these providers are long-distance network operators. Whether a long-distance network operator also supplies access infrastructure typically depends on the size of the customer and their location. For large sites, and in densely populated metropolitan centres or business parks, many alternative suppliers provide access infrastructure. For other sites, regulation allows alternative network operators to use BT’s infrastructure to provide access at regulated wholesale prices, and many use this method instead.

H.52 The extent of infrastructure roll-out also has implications for broadband competition. Only BT and the cable companies have mass-market broadband fixed access infrastructure, though not all BT or cable customers can yet access a broadband service. In addition, there are some areas where broadband access via fixed wireless is available, although take-up remains very low.

H.53 At the end of 2003, broadband was available to 85 per cent of the population.^(-57-) Figures 21 and 22 show broadband coverage by percentage of the population, by region.

Figure 21: Broadband availability^(-56-)

Figure 22: Broadband availability by region^(-58-)

H.54 Analysys estimates that 99 per cent of households in ‘ urban centres’ now have access to broadband. This figure falls to 95 per cent in ‘suburban centres’’, 65 per cent in ‘market towns’, 18 per cent in ‘rural villages’ and just 4 per cent of ‘rural’ households.

H.55 In addition to these fixed networks, almost all of the UK population has access to four mobile networks. With the 2G networks of the four established mobile operators now mature, coverage extends to most of the country except certain rural areas. In addition, 70 per cent of the population^(-59-) also has access to 3G services over 3’s network.

Assessment of competition in UK telecoms

H.56 We now discuss the extent of different types of competition in the various UK telecoms market sectors. In summary:

• BT retains a high share of fixed narrowband retail access and related markets. Competitors have a higher share of business narrowband access than residential. Nonetheless, competing suppliers with their own access infrastructure (largely cable television companies) have a much higher market share than in most other developed economies;
• BT’s competitors have a higher share of fixed narrowband retail call markets than they do in access markets, though much of this is service providerbased competition. In many markets, BT still has significant market power. Its competitors have a higher share of international calls, long-distance calls and calls to mobile, than of local calls;
• narrowband internet access is supplied by a number of providers, none with very large market shares. The market is slightly more concentrated now than three years ago;
• fixed broadband access is a rather more concentrated market than narrowband access. Much of the competition for residential and SME consumers is at the service provider level. At the infrastructure level, the market is largely divided between BT and the cable operators; and
• mobile services are provided by four established network operators and a new entrant, and there is also some service provider competition. Oftel found no firm to be dominant in the market for calls from mobiles, though the high barriers to entry are likely to constrain competition.

H.57 Our assessment begins with a summary of the market reviews carried out by Oftel in 2003, then looks in more detail at fixed narrowband access, fixed narrowband calls, internet access, corporate voice and data services, and mobile.

Market reviews

H.58 In accordance with the new EU regulatory framework which came into force in July 2003^(-60-), Oftel carried out market reviews of a broad range of telecoms markets. The narrowband reviews are now closed, while others are still at the draft proposal stage. These reviews will form the basis for telecoms regulation in the UK over the next few years. For each market, Oftel has assessed whether one or more supplier has Significant Market Power (SMP) and, if so, what regulatory remedies are appropriate. A summary of Oftel’s assessment for the UK excluding Hull^(-61-) is shown in Figure 23.

Figure 23: Summary of Oftel Market Reviews for UK excluding Hull

Market	Operators with SMP?	Explanation
Narrowband exchange line services(-62-)	Yes (BT)	Assessment based on static and high market shares, and high entry barriers
Narrowband call markets(-63-)	Yes (BT)	Although market shares are being eroded in call markets, profitability remains very high
Wholesale unmetered narrowband Internet termination(-64-)	No	Revenue figures in this market fluctuate and show strong signs of competition
Wholesale international services markets	BT in 108 markets (routes) C&W in 4 markets (routes) No SMP in 123 markets (routes)	Barriers to entry critical to the assessment of SMP. Certain high volume routes (e.g. to the US) are very competitive, many low volume routes (e.g. to Ascension Island) are not
Fixed geographic call termination(-65-)	Yes (many operators, by definition)	Any operator that terminates fixed geographic traffic has SMP by definition as no other operator can terminate calls to those customers. This applies to 54 telecoms operators
Call origination, transit and conveyance(-66-)	Yes (BT)	BT originates around 79% of UK calls, and provides 62.5% of local-tandem conveyance For inter-tandem conveyance, single transit and inter-tandem transit, operators need to connect with BT in order to send calls to it and to all other providers
Broadcasting terrestrial transmission services* (-67-)	Yes - television (Crown Castle and ntl) No - radio	In television, each area is covered by only one mast owned by one or the other company, and therefore each has 100% market share in a given area Radio was considered a single national market
Wholesale broadband access*	Yes (BT)	BT has a market share approaching 60%, which is expected to grow further
Wholesale leased lines*	Yes (BT), except for very high bandwidth terminating segments of traditional interface circuits	Market shares vary by bandwidth and type of circuit, reflecting the significance of costs of provision of basic infrastructure, and scale effects
Retail low bandwidth leased lines*	Yes (BT)	BT has a very high market share. Effects of upstream regulation expected to be fairly muted in this market
Wholesale mobile access and call origination	No	No operator has a market share exceeding 40%, or have significant advantages on other criteria such as technology or economies of scale
Mobile wholesale call termination*	Yes (Mobile network operators)	Because the calling party pays on calls to mobile, each network operator has a 100% share of the separate markets for voice termination on their own networks

* These market reviews are not yet complete

Fixed narrowband access

H.59 Figure 24 shows the share of analogue exchange lines supplied by BT. It reveals that:

• BT’s overall market share is very high, at over 80 per cent, and is higher in business than in residential lines. Cable companies account for most of the remaining residential lines, although other alternative networks have a higher share of business lines than do the cable companies; and
• the rate of growth of competitive analogue exchange line services is very slow - in the residential market competitors have gained just two percentage points of market share in the last five years.

H.60 At present, almost all the competition in this market is at the infrastructure level; there is very little service provider competition. The obligation on BT to provide wholesale line rental at cost-oriented prices may result in future in an increase of competition from service providers.

H.61 In future, mobile may provide increasingly effective competition to BT in the supply of narrowband access. There is some evidence that this kind of competition is already starting to emerge. In November 2003, 9 per cent of consumers had only a mobile phone for telephony services; in May 2000, this figure was 5 per cent. The proportion of consumers claiming to use a mobile as their main method of telephony has risen from 17 per cent of adults in February 2002 to 22 per cent currently.^(-68-) The issue of substitution between fixed and mobile is discussed further in Section 5 of the Phase 1 consultation document.

H.62 BT’s share of the market for fixed narrowband access is less than the incumbent’s share in many other markets. For example, in France, Italy, Germany, the Netherlands and Sweden the incumbent’s market share of fixed access lines is over 95 per cent.^(-69-)

H.63 Market power in this market is particularly relevant because it creates a potential for leverage into many other markets. BT’s SMP in this market generates the need for many of the regulatory remedies proposed for BT by the market reviews in other markets.

Fixed narrowband call markets

H.64 Figures 25 and 26 show BT’s share of retail call revenues for different types of geographic calls and for calls to mobile. This does not always reflect where the revenues for the call end up. For example, operators that originate calls to mobile typically pay out a large proportion of the call revenues to the mobile operator that terminates the call. The figures reveal four things:

• in general, competitors have a higher market share in providing calls than they do in providing fixed narrowband access. Much of this is service providerbased and/or long-distance network-based competition;
• BT’s share of local fixed calls is significantly higher than its share of national calls and calls to mobiles. Competitors’ share of international calls is highest of all;
• BT’s share of fixed call revenues is continuing to fall in the business market but has recently stabilised in the residential market; and
• BT’s share of the residential fixed call market is significantly higher than its share of the business market.

Figure 24: BT’s market share of analogue exchange lines^(-70-)

Figure 25: BT’s share of narrowband call revenues^(-71-)

Figure 26: BT’s share of business and residential fixed call revenues^(-72-)

H.65 Trends in BT’s market share of call volumes are largely consistent with those in its revenue share. BT’s share of international call volumes and, to a lesser extent, national call volumes are below its respective revenue shares. This reflects both BT’s higher prices for similar types of call, and BT’s greater market share in the less competitive, smaller volume and higher price international routes.

H.66 Despite BT’s continued high market share, nonincumbents have a higher market share in UK call markets than they do in many other European countries. For example, France Telecom and Deutsche Telekom have over 70 per cent shares of call markets in France and Germany respectively.^(-73-)

H.67 Because of BT’s high market share in fixed narrowband access, much of the competition in calls takes place at the service provider or long-distance network level, using BT or another access provider to originate or terminate calls. So, for example, BT originates 78 per cent of UK outgoing calls, and it provides local tandem conveyance for 65 per cent.^(-74-)

H.68 The fixed call market share trends shown do not take account of the fact that mobile may be beginning to provide competition to fixed call services. In 2000, calls from mobiles represented 12 per cent of all outgoing calls in the UK. In 2003, they represented 17 per cent.^(-75-) As the price differential narrows between mobile and fixed services, and consumers’ behaviour alters, consumers may increasingly switch towards using the mobile, rather than the fixed network, for making calls. This is discussed in Section 5 of the Phase 1 consultation document.

H.69 The above trends exclude non-geographic calls such as calls to premium rate services, directory enquiries and dial-up internet. While originating volumes are consistent with access market shares, the market for terminating these calls is much more competitive. For example, BT terminates just around a third of all dial-up calls to the internet. Revenues from these calls are largely retained by the terminating operator. For example, BT retains less than 20 per cent of combined freephone, special local rate and special national rate termination revenues.^(-76-)

Internet access

H.70 A variety of ISPs supply services to both residential and SME customers, with no supplier having more than a 30 per cent share in either market, as Figure 27 shows.

H.71 Competition in broadband can be measured both at the service provider and the infrastructural level. At the service provision level, the market is split between a number of suppliers. Though BT, ntl and Telewest have 70 per cent of broadband subscriptions between them, the remainder of the market is split between other service providers.^(-77-)

H.72 At the infrastructural level, the market is made up of three players; BT, ntl and Telewest. BT, through DSL connections, has a 50 per cent share of broadband infrastructural provision. In addition, a small amount of broadband access is also available in the UK via fixed wireless access, satellite and unbundled local loops.

H.73 As Figure 28 shows, the level of competition in broadband both at the infrastructural and service provision levels is higher in the UK than in some other European countries.

Figure 27: Share of residential and business ISP markets, November 2003^(-78-)

Figure 28: Incumbent operator’s share of broadband connections^(-79-)

Mobile services

H.74 The market for mobile (GSM and 3G) subscription and outgoing call services is much less concentrated than that for fixed services, and much of the mobile competition is at the infrastructural, and not just at the service provision level.Figure 29 shows the proportion of customers connected to each of the mobile networks. Ofcom estimates that roughly 50 per cent of the mobile market by revenue comes from residential customers, around 25 per cent from SMEs and around 25 per cent from corporates.

H.75 There are also competitors operating only at the service provision level. Network operators have recently acquired a number of independent service providers, such as Singlepoint. Offsetting this, other service providers such as Virgin Mobile, Carphone Warehouse’s Fresh, and OneTel have entered the market. Some, such as Tesco, have entered the market quite recently. There are now around three million customers buying access from these service providers.

H.76 Though it is much less concentrated in market share than many fixed markets, the operation of mobile networks has high barriers to entry, and as a result the four firm retail concentration ratio is over 90 per cent. Nonetheless, as shown in Figure 30, the UK’s mobile market is more evenly balanced at the infrastructure level than comparable European markets.

Corporate voice and data services

H.77 In general there is greater competition in the provision of telecoms access and services to large business consumers than in many other telecoms markets, reflecting their high level of spend. Ofcom estimates that this sector spends at least £10bn a year on voice and data services.

H.78 Leased lines services are an important service for large corporate customers, who value a high degree of control over their telecoms infrastructure. However, in many cases these services are sold to customers bundled together with a range of other corporate network services, such as Virtual Private Networks (VPN), Frame Relay, and value-added services like managed firewalls. As a result, data on market shares is hard to gather, and Ofcom collects less detailed data on this market.

H.79 Ofcom estimates that BT’s market share remains high for basic corporate telephony services, but declines to below 40 per cent for circuits of more than 155Mb capacity. Overall, BT is thought to account for around half of the total corporate market. This is shown in Figure 31.

H.80 Oftel’s research^(-80-) also noted that around seven in ten large corporate consumers use multiple suppliers for telecoms services. Though five alternative fixed network operators (Altnet) identified in the survey^(-81-) each had a presence in at least 18 per cent of large corporate businesses, BT had a presence in almost all (98 per cent).

H.81 At the level of access infrastructure, there is rather less competition. As noted above, much of the physical access connection to alternative provider networks is via BT’s infrastructure. BT is required to provide particular forms of private circuits to other telecoms operators at regulated prices. In this way, the access part of the corporate network services supplied by BT’s competitors often uses BT’s infrastructure.

H.82 Nevertheless, in the access elements, there is some competition to BT from telecoms operators who have invested in metropolitan access or other broadband local networks. The extent of competition to BT from other fixed operators varies depending on precise location, and changes over time with the position of individual competitors and the changing nature of business requirements. Few Altnets are continuing to roll out their networks with the exception of building tails to particular customer sites, especially where the required bandwidth is very high.

H.83 There is more infrastructure competition to BT in the core network element of private circuits. However, BT still retains a high share, particularly on the less dense routes.

Figure 29: Mobile network share of subscribers^(-82-)

Figure 30: Comparison of mobile market shares in Europe (subscribers)^(-83-)

Figure 31: Share of large business telecoms revenues^(-84-)

Innovation and investment

H.84 This section discusses how well the UK telecoms sector has made new products available to consumers, and the extent to which it has invested in making these products widely and rapidly available. Ofcom is not aware of any reputable studies currently available which seek to disaggregate investment by platform or type of operator. Our analysis is therefore a discursive review that does not seek to quantify actual levels of investment by category of operator, but looks at broad trends in investment in different parts of the market over time. It also considers what this has meant for innovation in the market - recognising that innovation is a very important output of a competitive market environment. This section is not intended to be a definitive account of investment patterns, nor an attempt to benchmark innovation against other countries.

Overall investment

H.85 Over the period since 1984, the UK has attracted high levels of investment in telecoms markets. At its height in 2000, annual telecoms investment stood at £ 11bn and accounted for over 10 per cent of total UK capital expenditure. Even with the slow-down following the fall in telecom stocks, annual capital expenditure was still almost £8bn in 2002, representing just over 7 per cent of all capital expenditure in the UK. Figure 32 shows annual telecoms investment since 1984. It is important to note that a significant proportion of this investment is made by BT.

Figure 32: Real investment by the UK telecoms industry (2002 prices)^(-85-)

The duopoly period

H.86 During the duopoly period, four major sources of investment can be identified. First, BT was undertaking the process of rolling out a digital network infrastructure, a process which was not fully completed until the mid-1990s. This was a major network investment at the time, and the retail price controls set by Oftel recognised the need for BT to complete these investments. Second, Mercury was required during the duopoly period to roll-out its own physical infrastructure, and this also necessitated significant investment. Third, Cellnet (in which BT had a majority stake) and Vodafone were rolling out their first-generation analogue mobile networks. Finally, there was investment in new equipment and services, such as value-added services and consumer premises equipment.

H.87 In terms of innovation, the introduction and development of mobile services (not just voice but also paging) was a major feature of this period. The liberalisation of the equipment market also led to many new devices, both for corporate and residential consumers, being placed on the market. Partly as a consequence of the investment made by BT in digital networks, a range of new value-added services was developed for the corporate sector, and this rate of development was stimulated by BT/Mercury competition in this sector. For residential consumers, innovation was more limited. Premium rate services were introduced to the market, and Mercury’s indirect access telephony services used its ‘blue button’ phones.

H.88 The principal benefit of competition and regulation in this period was arguably not innovation, but improvements in quality. BT was encouraged to improve its service quality to match that of Mercury’s new network.

Post-duopoly infrastructure-based entry

H.89 The decision to liberalise the market following the Duopoly Review created the conditions for a major increase both in the level of investment and the number and type of companies making this investment. Most significant were the investments made in new access infrastructure by the cable companies and by the two further newly licensed mobile networks.

H.90 Very little cable infrastructure had been built in the UK prior to the Duopoly Review, and it was the prospect of being able to offer voice telephony services alongside television which led to the growth spurt of cable networks between 1992-1997, by which time most of the cable infrastructure in place today had been completed. The investors in this wave of cable investment were predominantly US and Canadian cable or telecoms companies. The UK was considered an attractive investment opportunity. It had liberalised markets well ahead of mainland Europe and at a time when this was rare outside of North America. The regulatory regime was also considered to be conducive to such investments, partly because of the continued restriction on BT providing video entertainment services in its own right.

H.91 Equally remarkable was the investment in the two additional mobile networks, which made the UK almost unique in the existence of four complete national mobile networks. Again, the bulk of this investment was made between 1992 and 1997. The two new mobile networks were initially majorityowned and funded by the Hong Kong telco giant Hutchison Whampoa and by Cable & Wireless. Again, favourable regulation was seen as important to assist entry. One feature of this was the absence of regulation on these two providers to provide third- party access to service providers, which was maintained on the two established networks.

H.92 Other access infrastructure investment at this time included fixed wireless networks (for example, Millicom and Ionica). COLT was established and started investing in metropolitan fibre-based networks for business consumers. These developments marked a departure in that they were largely funded through capital raised on open markets, as opposed to investment from existing telcos in other territories.

H.93 The development of alternative access infrastructure appears to have been a significant stimulus to innovation. In mobile, there was significant product and service differentiation. For example, Orange differentiated itself at launch partly by offering persecond billing. Mercury offered innovative geographic and off-peak tariffs. The mobile market has since followed this initial wave of innovation with other developments such as the launch of pre-pay.

H.94 In the fixed market, cable companies adopted a variety of strategies to gain market share. Some focused on headline discounts to BT, whilst others focused on bundled tariffs combining TV, telephony and eventually internet. Ionica focused on valueadded telephony features (such as call-waiting and call-minder services, and differential ring-tones). This may have acted as a stimulus to BT to launch similar services.

H.95 In the corporate sector, the development of rival access infrastructure of the kind provided by COLT, Worldcom, Cable & Wireless and others had a significant stimulus effect on the development of corporate managed networks and services.

Investment in long-distance, businessto- business and international segments

H.96 As the 1990s progressed, the investment in competing access networks was increasingly complemented by entry at other levels in the market.

H.97 The regulatory regime continued to differentiate between infrastructure and non-infrastructure operators, with only the former being eligible for cost-based interconnection. Therefore, most new entry involved constructing some level of physical infrastructure. However, this took a number of different forms. A number of overseas telcos built ‘ thin’ UK businesses to exploit the partial liberalisation of international calls markets, because so-called International Simple Resale (ISR) operators could qualify for cost-based interconnect even if they only had a single switch in the UK. Only in a handful of cases (most notably Worldcom) did such ISR-based entry constitute a beachhead towards much more extensive business activities and extensive physical infrastructure roll-out.

H.98 An alternative form of entry was the exploitation by other utilities of their extensive private telecoms networks, ducts or rights of way, to build rival long- distance networks to that of BT. Examples of this included British Rail Telecom (BRT, later bought out by Racal and now part of Global Crossing); Scottish Telecom (now Thus, whose initial market entry used Scottish Power’s extensive physical infrastructure); and Energis (which exploited the infrastructure of the National Grid). By exploiting newer transmission technologies, these operators had lower costs than BT on some services. Increasingly, they also exploited market opportunities created by Oftel regulation, notably in premium rate and national/local rate numbers.

H.99 This led to significant innovation in terms of the range and type of services offered to business and residential consumers. The revenue share formula between BT and the terminating operator introduced by Oftel for local and national rate services stimulated not only the development of a range of voice telephony services, but also the introduction of subscription-free dial-up internet access services.

H.100 With less substantial capital requirements than alternative access operators, these operators entering the market on the basis of alternative provision of business-to-business, international and long-distance services were able to make positive returns relatively quickly. As a result, a number of companies in the sector enjoyed high stock market valuations.

The ‘boom and crash’ period

H.101 Throughout the post-duopoly period, the evidence shows that BT continued to make high and stable profits and continued to invest in its UK businesses. In addition, BT invested in overseas markets. During the period when the market was at its peak, BT tried to consummate a global business strategy through a merger with MCI. This strategy was ultimately unsuccessful. Vodafone and Orange, on the other hand, successfully expanded beyond their core markets into other countries.

H.102 By 1997, the UK was experiencing very high levels of investment in the telecoms sector as a whole. The pattern of investment largely shifted from private sources (principally profitable businesses in other countries or sectors transferring capital into telecoms) to funding sourced from financial markets. A number of new entrants went ‘public’ in this phase. In addition, a new wave of consolidation in the cable sector was funded from US and European bond markets and debt financing. Cable also started to invest in digital TV and broadband technologies.

H.103 Increasingly telecoms companies emphasised the growth opportunities inherent in the rise of data services rather than voice, and in particular the predicted rise of the internet and related e-commerce business opportunities. The expected future size of the market led to a further wave of investment in additional fibre infrastructure, in terms of new fibre laid in metropolitan areas as well as further investment in long-distance and international fibre links.

H.104 As is well known, at its zenith this process led to a complete reversal of the normal financial order, with telecoms companies who had never made a profit or returned a dividend entering the FTSE 100. It was also during this period that the 3G auction led to significantly higher bids from the five successful companies than had been anticipated by the Government. With hindsight this reflected some of the same exuberance about future business prospects for data and video services.

H.105 This period resulted in a level of telecoms investment which, with the benefit of hindsight, would appear excessive. Large amounts of capital were ploughed into the sector, based on expectations of future demand that did not materialise in the timescale expected. As a result investment was wasted on surplus capacity and new ventures that failed to thrive.

H.106 The crash in telecoms, media and technology stocks in 2000 has been much discussed, and its causes extensively analysed. For our purpose, it is primarily of interest to understand how the crash affected the rate and type of investment in the market. Clearly, the effects of the crash were dramatic for a number of companies who were precipitated into financial restructuring as a result of the massive write down of asset values across the sector.

H.107 In some areas, the crash had less impact. For example, to date, there has been little exit from the market. This may reflect the fact that the assets are largely sunk, and continue to appear profitable on a forward-looking basis. Though cable companies have stopped building new infrastructure, this predated the crash by some considerable period, as noted above. Mobile companies have continued to roll-out new products, albeit that the advent of 3G services has perhaps been slower than was originally expected.

H.108 One significant victim of the crash appears to have been investment in new fixed wireless networks where they are heavily capital-intensive. For example, there was less interest than the Radiocommunications Agency expected for some of the spectrum it made available for new fixed wireless broadband networks.

New wave of investment in services

H.109 As discussed in Annex G, the period after the introduction of the EU telecoms liberalisation package in 1997 led to a switch in emphasis away from pure infrastructure competition. This in turn led to a significant increase in the range of opportunities for service provider-based competition in the market. The introduction of carrier preselection led to the entry of indirect access telephony suppliers. The introduction of a new wholesale line rental product in 2004 may also stimulate a shift in investment toward service-based rather than infrastructure-based competition. In the last few years, major retail companies or service organisations from other sectors, including Centrica, Carphone Warehouse, Virgin and Tesco, have moved into the telephony business. Service innovations include innovative call plans, bundling of fixed and mobile offerings, and of internet and residential telephony with other household ‘utility’ services. By the nature of service provision using others’ networks, it is less easy to provide innovation in terms of technologybased service characteristics (e.g. bandwidth).

H.110 A similar process in relation to internet offerings has created a very significant ISP market opportunity, first in relation to narrowband services and later broadband services. Innovation in the realm of the internet can take a number of different forms. The market has moved rapidly through dial-up metered access services, to unmetered dial-up through to unmetered broadband services at a range of speeds. Innovation has also taken place at the service level in terms of service quality and the bundling of portal services and content.

H.111 On the other hand, many consider that the market structure has under-delivered certain forms of innovative services, for instance symmetrical as opposed to asymmetrical broadband services, a wider range of access speeds, and some form of metering or variable bandwidth. Noticeably, the forms of innovation which the market is said to be underdelivering tend to be those that rely on control of network elements.

Industry financial performance

H.112 The changes in the levels of prices, choice, innovation and other measures of consumer benefit have been accompanied by a very mixed financial performance by the UK telecoms industry in recent years. Assessing the performance of the telecoms industry is important to the Telecoms Review, because industry performance affects consumers and citizens in a number of ways. First, if regulation is designed on the expectation that competition will deliver certain benefits to consumers, then it is important for Ofcom to be sure that this competition is sustainable in the long run. Second, the profits that telecoms operators hope to make create an incentive for them to innovate and invest. Finally, telecoms regulation may be based on the assumption that where there is an opportunity for operators or new entrants profitably to invest in a new opportunity, they will do so. But this expectation is crucially dependent on the availability of investment capital to the industry.

H.113 In the course of Phase 1 of the Telecoms Review, Ofcom has met with telecoms companies, equity analysts and financiers such as investment banks and venture capital funds, and has reviewed various commentators’ reports on the performance of the sector. This research suggests the following conclusions, which we expand below:

• investment in the sector has been highly volatile;
• capital to the sector has gone from being abundant, to scarce, to selectively available;
• BT is profitable and cash-generative;
• many fixed alternative network operators (‘Altnets’) have performed weakly in recent years; and
• the established mobile operators are generally performing strongly, and the UK is prospectively one of the most competitive mobile markets in Europe.

Investment in the sector has been highly volatile

H.114 In common with telecoms markets worldwide, the UK telecoms sector experienced a period of very rapid expansion in the late 1990s. Both debt and equity capital were readily available to fund infrastructure roll-out, overseas expansion and investment in new ventures such as 3G. The result was high levels of debt among operators and emerging over-supply in many sectors of the market. Investors realised that asset prices had risen to a higher level than could be justified by future expected cash flow, and that a correction was in order. This led to a severe fall in investor confidence in the telecoms sector worldwide between 2001 and 2003. Figure 33 shows how telecoms stocks at first substantially outperformed, then underperformed, the FTSE 100 index between 1999 and 2003.

Figure 33: UK telecoms index compared to FTSE 100 performance^(-86-)

H.115 During this transition, investors changed the emphasis that they placed on the various metrics that they used to value telecoms companies, and most telecoms companies changed their corporate strategies in response. In the expansion phase, investors focused heavily on revenue growth and prospects for future revenue growth. As a result, many telecoms companies rolled out networks aggressively, and pursued strategies designed to deliver market share growth at the expense of shortterm profitability. Following the collapse in stock prices, the focus of many investors changed. The new focus was on short-term profitability and cash generation through cost reduction and organic revenue growth. Citigroup noted in 2003 that, “ with sluggish top-line growth or even decline, operators continued to focus on cost control and cash generation in 2003".^(-87-) Telecoms operators have not been heavily rewarded by the market for the growth potential of new ventures, such as investment in new technologies or expansion into new market segments. Deutsche Bank commented in early 2004 that “pre-mature investment in technology may not pay off ".^(-88-) As a result, many telecoms operators have abandoned loss-making business development activities which were not yet cash positive. For example, Energis abandoned its European expansion plans, and Cable & Wireless has divested its US and certain other overseas operations.

Capital to the sector has gone from being abundant, to scarce, to selectively available

H.116 Rapidly falling share prices meant that equity capital became very expensive for most telecoms operators in 2001and 2002, because of the effect on the dilution of existing shareholders’ equity of raising a given sum of money via equity finance. Many operators had also accumulated high levels of debt in the preceding years, which, combined with higher gearing as equity values fell, resulted in many operators’ credit ratings deteriorating rapidly, as shown in Figure 34. Debt finance therefore became very expensive.

H.117 The sudden unavailability of capital had a number of impacts on telecoms operators in the UK and elsewhere between 2001 and 2003. These included:

• freezes on non-essential capital expenditure. As Morgan Stanley noted in July 2003, “Operators have completed their network roll-out and are focusing on improving network utilisation. Most suggest that over 75 per cent of their capex is incrementally customer or revenue generating."^(-89-)
• divestment of non-essential assets. For example, BT sought to reduce its debt by divesting BT Cellnet, Yell, a number of overseas investments and much of its UK property portfolio.
• debt restructuring. Some UK operators (for example, ntl and Energis) effectively went into the hands of debt holders, leaving equity holders with little or nothing.

H.118 While many operators have reduced or restructured their debts and have stronger balance sheets, the lack of capital availability has remained a feature of much of the market. For example, Credit Suisse First Boston estimates that there was a net outflow of capital of around €5bn from the European telecoms industry last year in the form of dividends and share buy-backs. Telecom Italia’s strategy of investing in DSL in other European markets was received negatively by the market.^(-90-)

H.119 We understand that the current situation can be characterised as a selective availability of capital. There are signs that debt finance, including high yield debt, may now be available for established players, with proven business models, who are rolling over debts or funding organic growth. But debt appears not to be flowing to new entrants or to be funding higher risk new ventures. There appears to be some appetite for such new ventures in equity markets where the ventures’ Fundamentals are strong. For example, Iliad, an ISP and unbundled local loop operator in France, raised € 94.5m in an Initial Public Offering (IPO) in January that valued it at € 871m.^(-91-)

Figure 34: Telecom operator credit ratings ^(-92-)

	1999	2000	2001	2002	2003
BT	AA+/Stable	A/Neg	A-/Neg		A-/Stable
C&W	--/--	A/Stable	A-/Neg	BBB+/Neg (Nov)	BB/Neg
COLT	B/Stable	B+/Stable	B+/Stable	B-/Stable (Nov)
Energis	BB-/Stable	BB-/Stable	BB-/Stable	D (ratings withdrawn in Aug)
mm02			BBB-/Stable		BBB-/Stable
NTL	B/Watch Pos	B+/Pos	B-/Neg	D (from CCC-) in April
Telewest	BB-/Stable	BB-/Stable	BB-/Stable	CC then SD
Vodafone		A/Stable	A/Stable		A/Stable

 

BT is profitable and cash-generative

H.120 Figure 35 summarises BT’s financial performance since 1998. It shows how BT’s group revenues grew rapidly between 1998 and 2001, and then declined between 2001 and 2003. Its Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) remained fairly constant through this period, though as revenues rose the EBITDA margin fell to 21 per cent in 2001 following a margin of over 35 per cent in the late 1990s. Through 2001, BT focused on cash generation and carried out a programme of debt reduction, including a rights issue in May 2001. In June 2003, BT stated^(-93-) that its strategy was focused on defending its core activities and achieving profitable and organic revenue growth. By 2003, its EBITDA margin had recovered somewhat to nearly 29 per cent.

Figure 35: BT group financial performance, 1998-2003^(-95-)

£ Billion	1998	1999	2000	2001	2002	2003
Revenue	16.0	18.2	21.9	29.7	24.6	20.2
EBITDA	6.1	6.4	6.4	6.3	6.0	5.8
EBITDA margin (%)	37.8%	35.1%	29.4%	21.3%	24.3%	28.8%
Net profit	1.7	3.0	2.1	(1.8)	1.0	2.7

 

Many Altnets have performed weakly in recent years

H.121 Many companies in the fixed Altnet sector were particularly affected by the change in investor sentiment. Many had invested heavily in rolling out networks in the late 1990s. As discussed above, heavy debts and high capital constraints led some operators to restructure their debts.

H.122 Where Altnets have restructured their debts, they have emerged with stronger balance sheets and less immediate debt repayment schedules. In July 2003, Morgan Stanley commented that “all of the carriers have now completed their restructuring programmes with a significantly improved balance sheet and cost structure. Several suggested that, with their new financial and operating position, they are closer to efficient scale."^(-94-) Many Altnets have indicated that their focus is on improving operating margins and improving cash generation through a combination of organic revenue growth, cost savings and freezing non-essential capital expenditure.

H.123 Though the operating performance of most Altnets is improving, their ability to return operating profits (even if the historic investment in the network is regarded as sunk) is mixed. Figure 36 shows the financial performance of some of the larger Altnets since 1998.

Figure 36: Fixed Altnet financial performance, 1998 to 2003 (£ million)^(-96-)

THUS
	1998	1999	2000	2001	2002	2003
Revenue	113	166	217	234	268	291
EBITDA	11	27	14	-21	3	27
EBITDA margin (%)	0	0	0	0	0	0
Net profit	n/d	-3	-57	-66	-104	-59

Energis
	1998	1999	2000	2001	2002	2003
Revenue	168	286	494	840	694	770
EBITDA	16	50	92	142	82	103
EBITDA margin (%)	0	0	0	0	0	0
Net profit	-50	-30	-41	-98	n/d	n/d

COLT (Global)
	1998	1999	2000	2001	2002	2003
Revenue	215	402	687	906	1030	1166
EBITDA	-5	-1	27	26	72	163
EBITDA margin (%)	0	0	0	0	0	0
Net profit	-56	-101	-117	-360	-718	-125

MCI (Global)
	1998	1999	2000	2001	2002	2003
Revenue	11333	23794	25057	22234	13451
EBITDA	788	7846	8352	5934	n/d
EBITDA margin (%)	0	0	0	0	n/d
Net profit	-1711	2570	2660	2585	n/d

Global Crossing (Global)
	1998	1999	2000	2001	2002	2003
Revenue	272	955	2429	2313	1966
EBITDA	-12	n/d	-10	n/d	-187
EBITDA margin (%)	0	n/d	0	n/d	0
Net profit	-56	-45	-1070	-14150	412

C & W (Global)
	1998	1999	2000	2001	2002	2003
Revenue	7000	7940	9200	8100	5910	4390
EBITDA	2390	2730	2390	1780	484	334
EBITDA margin (%)	0	0	0	0	0	0
Net profit	1290	910	3720	2630	-5030	-6530

C & W (UK)
						2003
Revenue						1728
EBITDA						110
Operating profit						-303

H.124 As a result, many commentators predicted consolidation in the sector, and exit of some of the weaker players from the market. For example, as Kingston Communications noted in July 2002, in its memorandum to the Joint Committee of the draft Communications Bill,^(-97-)“however, the future for the sector is not as secure as it could be. The overall downturn in market sentiment with respect to telecoms has meant that most ‘altnets’ have been unable to continue investment in their networks. The collapse of many ‘dotcoms’, and a general slackening of demand in the market, has led to a rapid slowing down of growth for many ‘altnets’. This in turn has triggered a continuing wave of consolidation across the industry, with some business failures, as excess capacity has been squeezed out of the market."

H.125 To date, however, this trend has not been as extensive as many predicted. This might be because managements were focused on turning around their own businesses and not on acquisition and subsequent integration, or because owners of potential acquisition targets were reluctant to sell at the bottom of the market.

The established mobile operators are generally performing strongly, and the UK mobile market is prospectively one of the most competitive in Europe

H.126 Despite the high levels of infrastructure-based competition in the mobile sector, the four established network operators are profitable and cash positive. Figure 37 shows an estimate of the performance of the UK businesses of the four established mobile operators.

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Figure 37: Incumbent mobile operators’ financial performance, 1998 to 2003 (£ millions)^(-98-)

Vodafone (UK)
	1998	1999	2000	2001	2002	2003
Revenue	1700	2100	2950	3460	3760	4030
EBITDA	n/d	n/d	934	1070	1290	1540
EBITDA margin (%)	n/d	n/d	32%	31%	34%	38%
Net profit	564	643.2	n/d	n/d