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Contents

	Residential consumers
	SMEs
	Large corporate consumers

I.1 Understanding trends in consumer demand for telecoms services is very important for the Telecoms Review, for two reasons. First, the behaviour of consumers shapes the structure of the telecoms industry. For example, sustainability of competition in voice telephony depends upon consumers' propensity to switch suppliers if a cheaper or better alternative is presented to them. Second, information about what consumers value helps Ofcom to understand what a successful outcome for the telecoms sector might be. For example, if consumers care more about accessing new services than they do about prices, then this helps inform the preferred position on the trade-off between allocative, productive and dynamic efficiency discussed in Section 4 of the Phase 1 consultation document.

I.2 In Phase 1 of the Telecoms Review, Ofcom has drawn from existing Oftel market research and other secondary data sources (including findings from consumer behaviour analysts), and has also commissioned some preliminary research into the behaviour of telecoms consumers. This research has identified a number of trends in consumer demand, which are discussed in this annex. In Phase 2, we will be carrying out more detailed research to investigate these trends further. In the meantime, we are interested to hear the opinions and evidence of stakeholders on these and any other trends in consumer demand.

I.3 By 'consumer' Ofcom means any end user of telecoms. There are many different types of consumer that might be distinguished. For simplicity, we have divided consumers into three groups; residential customers, small and medium sized enterprises (SMEs), and large corporate customers. We have identified a number of trends for each of these categories of consumer. As Figure 39 shows, just under half of consumer spending on telecoms is by residential consumers, around a third of spending is by large corporate consumers, and the rest is by SMEs.

Figure 39: Consumer telecoms spending^(-100-)

I.4 The principal trends that Ofcom's research has identified for each of these three groups of consumers are outlined below.

Residential consumers

I.5 As in other markets or categories, there are different types of residential telecoms consumers, with very different needs and attitudes to telecoms. For example, in research conducted by Oftel in 2001/02, residential consumers were segmented along the dimensions of (1) the degree of sophistication of the telecoms services that they used, and (2) how proactive their attitude was towards telecoms. The results are shown in Figure 40.

Figure 40: Classification of residential telecoms consumers^(-101-)

I.6 The research found that 34 per cent of residential consumers were 'progressive'. They consumed an above average mix of internet, mobile, digital TV and other technological services. Cost and quality were equally important to them, and they tended to want the best, rather than the cheapest deal. They tended to be younger to middle-aged, often families, and typically with slightly higher than average incomes. In contrast, 20 per cent of residential consumers were 'contented'. These consumers were basic and light telecoms users, typically having either a fixed or a mobile phone and had no interest in using anything else. They tended to be middle-aged or older, often living alone, and often living in urban areas with lower than average incomes. These consumers were typically unlikely to contemplate switching telecoms suppliers, either because they were satisfied with their telecoms service, or because they were light spenders and did not consider the savings to be worthwhile. Forty-one per cent of residential consumers were 'passive heavy users', meaning that they were fairly sophisticated in the services that they used, but they were unlikely to go to the effort of switching telecoms provider.

I.7 In recent years residential consumer choice, in terms of both services and suppliers, has increased dramatically. Partly as a consequence of this, the behaviour of residential consumers has become increasingly difficult to predict. Rather than consumers just responding to services marketed to them by operators, take-up of some telecoms services (such as text messaging and peer-to-peer file sharing) has been largely driven by consumers. In contrast, take-up of services such as WAP, which many expected to be popular, has been well below expectations.

I.8 In spite of the variety of residential consumers, and the difficulty in predicting their behaviour, we have identified five trends in residential consumer demand from the research we have available so far. These are:

• time and energy are becoming as important as money;
• increasing requirements for connectivity any time, anywhere;
• increasingly personal use of telecoms;
• increasing demand for customisable, transparent bundles of services; and
• increasing demand for bandwidth.

Time and energy are becoming as important as money

I.9 Residential consumers use multiple 'currencies' in making decisions about what to do. They consider how much effort it will take to do something like choose a different telecoms supplier, as well as how much it will save them. Research conducted by the Henley Centre has shown that many people in their everyday lives balance time and energy against monetary gains.

I.10 This trend towards placing a high value on time and effort is accompanied by consumers experiencing an apparent 'information overload'. For example, the amount of entertainment content, non-solicited communications ('spam') and other information has increased substantially. The Henley Centre found that about half of consumers say they do not have the energy or time to use the information that they already have. This finding is also consistent with research published by Oftel, which showed that while consumers were aware that they could make some savings in telecoms expenditure by switching supplier, they chose not to do so because of the effort involved.^(-102-) In telecoms, the right tariff for any one individual depends upon their pattern of usage, and there are many more tariff permutations than exist with utilities such as electricity and gas, and therefore finding the most suitable tariff takes more effort.

I.11 The trend towards valuing time and energy more highly is particularly important for two reasons:

• consumers might be less likely to switch between telecoms suppliers because of the effort involved in identifying the best offer and making the switch, even if by doing so they will save some money; and
• the cost of time and effort is a criterion in the choice of suppliers, as well as in the decision to switch. Consumers want to use suppliers who will provide a trouble-free service. Ofcom's focus groups found that consumers are increasingly frustrated by the customer service experience, citing queues, cost of calling, call menu systems and overseas centres.^(-103-)

I.12 Research by the National Audit Office (NAO)^(-104-) in summer 2002 supported these findings. It showed that consumers cared more about reliability and service than cost of telecoms, and many were unlikely to switch suppliers due to the effort involved. Figure 41 summarises the findings of this research.

I.13 This trend could imply a need for published, authenticated information about telecoms services, which includes measures of customer service performance, and therefore makes the switching decision easier. Oftel found that although two in three residential consumers were aware of having a choice of telephony suppliers, only a minority were aware of the Comparative Performance Indicators (CPIs) that telecoms companies publish.^(-105-) The NAO^(-106-) research supported this conclusion, and found that four in five consumers could not name any indirect access telephony suppliers.

Increasing requirements for connectivity any time, anywhere

I.14 Increasingly busy lifestyles and the ubiquity that mobile telecoms offers mean that consumers have increasing expectations of being able to access any aspect of their life at any time. For example, they wish to keep in touch with work life while at home, or home life while at work, using a variety of devices and networks. They expect these devices and networks to operate together in a seamless manner.^(-107-)

Figure 41: Findings of the National Audit Office survey of residential consumers (September 2002)

Most people spend less than (GBP) £100 per quarter on their fixed line telephone services 42% spend less than (GBP) £50, 43% spend between (GBP) £50 and (GBP) £100 and 15% spend over (GBP) £100. Service is more important to people than cost Having a reliable service and having problems satisfactorily dealt with were 'essential' or 'very important' to nearly 90% of respondents. The convenience of contacting others, and others being able to contact you were 'essential' or 'very important' to over 80% of respondents. The ability to control expenditure, and the cost incurred each time others were called, were 'essential' or 'very important' to around 70% of respondents. Poor service would motivate many people to change their telephone company About six in ten respondents said they would be 'highly likely' or ' fairly likely' to change the company providing their home fixed line telephone if they had problems making or receiving calls. Nearly two in ten said they were 'highly unlikely' to change, particularly retired people and those in social groups DE. Savings would also motivate many people to change their telephone company, but even substantial savings would not motivate a substantial proportion of consumers to change 32% of consumers would be 'fairly' or 'highly' likely to change for a saving of 10%; 53% of consumers for a saving of 25%; and 68% for a saving of 40%. In the last two years, most people have made no changes to their home telephone service nearly seven in ten respondents had made no changes to the way they buy their residential fixed line telephone service in the last two years. Only one in ten had changed or added to the companies that they use. People said that making changes to telephone services has been easy in the last two years Many people were not aware of indirect access suppliers Four in five respondents were not able to name a single indirect access supplier.

I.15 Consumers increasingly use SMS as an additional communication tool, as it offers the ability to communicate in previously 'inappropriate' situations, such as the office or lecture rooms. There also appears to be some demand for 'on the move' entertainment services and remote access to email and voice messaging.^(-108-)

I.16 In 2002, the Henley Centre found that the majority of the population claim to be 'always reachable' via their mobiles. However, this masks substantial differences between consumers. As Figure 42 shows, many older consumers do not have a mobile phone. Among those that do, many still regard it as primarily for 'emergency' use.^(-109-)

Exhibit 42: Telephony penetration by age group^(-110-)

I.17 This trend is important for two reasons. First, it implies a need for interoperability between networks and devices. Consumers will value a telecoms industry that delivers devices which work seamlessly across access networks. Second, it raises the prospect of a group of residential consumers, primarily older people, whose consumption of telecoms services is increasingly divergent to the mainstream. It is important that telecoms regulation takes account of the requirements of each of these increasingly diverse categories of consumer.

Increasingly personal use of telecoms

I.18 Consumption and purchase of telecoms services is increasingly personal, rather than being household or workplace-based.^(-111-) At its simplest level, this is a function of increased mobile penetration - because mobile handsets are typically owned by individuals, not by households. However, there is also a trend towards consumers wanting a more personal experience from suppliers, and towards consumers wanting to put themselves more in control of editing, creating and personalising media content.

I.19 The personalised experience consumers want from suppliers encompasses all aspects of the supplierconsumer relationship - for example, the bundles of services consumers take, the user interface, the menus and address books, the tariffs they use and the layout of their bill.

I.20 There are a number of examples of the trend towards consumers wanting to put themselves more in control of personalising media content. The growth of ring tones is one example. Another is the rising demand for services, such as Lycos and Yahoo, which store personal preferences and deliver the right content or service to individuals at the right time. Self-scheduling and self-creation of digital content are also increasingly common. For example, digital camera penetration is growing very rapidly.

I.21 This trend is important because of the opportunities it creates for telecoms suppliers. On the positive side, it creates opportunities for innovative products around customisable services - for example, online storage of digital photos, or musical dial tones. On the negative side, it creates opportunities for suppliers to 'lock in' customers and discourage switching, because of the time and effort consumers would have to spend customising the service from a new supplier (for example, by entering names into a new address book in a mobile phone). Although an element of switching costs (for example, the time involved) is unavoidable, and operators' need to recover costs incurred in supplying the customer should be borne in mind, switching barriers should not be permitted to inhibit effective competition.

Increasing demand for customisable, transparent bundles of services

I.22 Ofcom's research suggests a tension in consumers' attitudes to bundles of services. On the one hand, they increasingly value the simplicity of having fewer supplier relationships, particularly where they would have to deal with multiple suppliers and potentially with 'buck-passing' between suppliers of related products when problems occur. On the other hand, they want to be in control of content, supplier choice and cost.^(-112-) Bundles of services often do not deliver this control because they make it hard for consumers to compare between suppliers, and because they sometimes oblige consumers to buy services they do not want as part of the bundle.

I.23 Residential consumers' purchase of different services (for example, television, internet and mobile) is often associated with different 'mental wallets'.^(-113-) For example, Ofcom's focus groups found that bundling television and telecoms services is unnatural to many who do not intuitively 'link' the two services, though they may well buy such a package if they want both services. While some consumers responded to marketing of bundled fixed telecoms deals with multichannel TV by switching from BT to cable operators,^(-114-) this may have been driven more by a desire for cable rather than satellite TV as opposed to a desire for a bundled TV-telecoms package.

I.24 Many product bundles make the purchase decision more difficult, not easier, for consumers. Some residential consumers find comparison between suppliers difficult when tariffs are bundled, sometimes because suppliers bundle services in a complex way which makes their individual prices opaque. This difficulty in comparison makes the purchase decision complex for consumers, and may discourage switching between suppliers because of the extra time and effort involved.

I.25 This trend is important because of what it implies about what many residential consumers might like a well-functioning telecoms market to deliver. They might value the simplicity that bundles provide. But they might like bundles to be customisable (so that they included only the services that are desired, and none that are not), and to have minimum standards of clarity to enable comparison between different bundles.

Increasing demand for bandwidth

I.26 As discussed in Annex H, residential broadband penetration now stands at a fifth of homes with internet,^(-116-) penetration has been increasing rapidly, and is yet to show signs of slowing. Oftel found that nine in ten broadband adopters had previously used a slower (narrowband) internet connection. Of these, eight in ten agreed that they were unhappy with their previous connection speed and that broadband offered the minimum speed they required.^(-117-) As Figure 43 shows, residential consumers who have upgraded from narrowband to broadband tend to use many more on-line services, and in particular more ' bandwidth-hungry' applications.

Figure 43: Applications used, by connection type^(-117-)

I.27 However, it is important to bear in mind that around 50 per cent of residential consumers do not have any internet access at home at all. Of these, Oftel found that around two-thirds were not interested in getting it, mainly due to lack of interest, need or understanding. Interest in having the internet at home is strongly correlated with age group. As Figure 44 shows, current internet penetration and future interest is significantly lower among the over-55s, with the lack of easier home PC ownership a barrier for many. Therefore, increasing demand for bandwidth is by no means universal among residential consumers.

I.28 This is important because it implies that there is likely to be further divergence in residential consumers in the future. On the one hand, younger consumers with internet access may migrate to broadband and start using the internet in new ways. On the other hand, many older consumers may remain without any internet access at all. Regulation needs to consider the needs of both of these groups.

SMEs

I.29 SMEs make up just over a quarter of consumer telecoms spending. As Figure 45 shows, roughly half of their spending is on fixed telecoms, but this is declining both as a proportion of the total, and in absolute terms.

I.30 Ofcom has identified a number of trends in the SME market, based on earlier Oftel research. To some extent, the trends in behaviour of SME consumers are similar to those of residential ones. SMEs typically use the same set of services - fixed voice services, internet access and mobile. They similarly value time and effort highly, often because they have more productive ways of spending their time. The trends in SME consumer behaviour are:

• time and energy are becoming as important as money (as for residential consumers);
• desire for streamlined purchasing options;
• increasing requirements for connectivity any time, anywhere (as for residential consumers); and
• increasing demand for bandwidth (as for residential consumers).

I.31 Where these trends are substantially different to those for residential consumers, they are set out below.

Desire for streamlined purchasing options

I.32 Oftel's research^(-118-) indicated that being able to source all telecoms services from a single supplier was an important requirement for many SMEs, with 82 per cent citing the importance of this in their purchase decision. Three-quarters claimed the availability of a single bundle for all required services was important in their choice of supplier. The results of this research are illustrated in Figure 46.

Figure 44: Internet penetration by age group^(-119-)

Figure 45: SME consumers' spend on telecoms^(-120-)

Figure 46: Importance of attributes when choosing a telecoms supplier^(-121-)

I.33 That said, the same research found that slightly more SMEs had increased the number of suppliers they used than had reduced it. However, this is likely to be due to the impact of the greater range of telecoms services consumed over the last ten years. There are indications of businesses buying more services on a bundled basis, particularly among medium sized businesses. Forty-five per cent of medium sized businesses claimed to be buying more services in this way (see Figure 47).

I.34 This trend is important because it implies that in order to compete, suppliers need not only to be price competitive, reliable and offer good customer services, but for many customers they also need to be able to bundle together different products too. Therefore suppliers offering a single type of telecoms product (for example, internet access) may be at something of a disadvantage.

I.35 This trend may also decrease SMEs' propensity to switch between suppliers. As suppliers provide more services, the disruption caused by a change in supplier, and therefore the effort in making the change, is likely to be greater.

Figure 47: Changes in telecoms purchasing and decision-making in the past ten years^(-122-)

Increasing demand for bandwidth

I.36 The internet has become an essential business tool for most SMEs. Sixty-eight per cent of SMEs are currently connected to the internet, with penetration higher amongst medium businesses (97 per cent) than small (67 per cent).^(-123-)

I.37 Currently, a third of businesses with internet access claim to use broadband, with usage increasing according to business size, as shown in Figure 48. There is evidence that this is an ongoing trend. For example, one in five SMEs claim they are likely to consider switching to broadband at current prices.^(-124-) As businesses have upgraded to broadband, business penetration of narrowband internet has fallen.

Figure 48: Internet, broadband and narrowband penetration among SMEs^(-125-)

I.38 Connection speed is overwhelmingly the biggest influencing factor in SMEs' decisions to obtain broadband. In Oftel's research, this feature was mentioned by eight in ten (78 per cent) of SMEs using broadband that had upgraded from narrowband. Similarly, this aspect was also mentioned by six in ten SMEs using broadband that had not previously been connected.^(-126-) Connection speed is also the reason most frequently given by businesses considering upgrading from narrowband.

I.39 This trend is important because it suggests that the internet is becoming an ever more important tool for SMEs, and that they are using it more as a result. Ability to access broadband, and the price and performance of the broadband connection, are likely to be increasingly important determinants of SMEs' competitiveness.

Large corporate consumers

I.40 Large corporate consumers have a very different mix of telecoms spending to residential and SME consumers. As Figure 49 shows, their spending is dominated by value-added services - tailored, bespoke network solutions that interface with the customers' IT systems.

Figure 49: Large business telecoms spend^(-127-)

I.41 Ofcom's research indicates three key trends in large corporates' use of telecoms:

• increased complexity of telecoms requirements;
• purchasing from fewer suppliers; and
• new trends in IT causing demand for greater bandwidth.

Increased complexity of telecoms requirements

I.42 Telecoms provide the network infrastructure over which large corporates' increasingly complex IT systems run. Because networks need to be optimised for, and to interface with, these IT systems, large corporates increasingly do not have the network design or management skills in-house. Therefore, there is a trend towards purchasing bespoke managed network solutions from telecoms providers. This is reflected in the substantial increase in the spend on value-added services shown in Figure 49.

I.43 Because of this, the decision-making point in large corporate buyers is changing. Traditionally, voice telecoms services were purchased by companies like any other essential, but non-strategic resource. The purchase decision has traditionally been made by the procurement department based on considerations of price and quality, and it was relatively easy to switch suppliers if performance was poor. Due to the need to interface with IT systems, the whole telecoms purchase decision is increasingly made instead by Chief Information Officers (CIOs).

I.44 This trend towards increased complexity is important for a number of reasons. First, it is harder for corporate customers to switch suppliers. Bespoke systems designed for a particular company are expensive for rivals to replicate or to upgrade. Even if they can do so (for example, by taking advantage of a step change in technology), the disruption to large corporate consumers of a change in network supplier is immense. For some customers, it could take up to six months full-time work for a team to project manage such a change of supplier.

I.45 Second, corporates are selecting suppliers on more criteria than just price and quality. The capability of a particular telecoms company to offer a particular bespoke solution is often a more important criterion. A wide range of suppliers in the market is particularly important to large corporate customers where there are only a few suppliers capable of supplying the required solution.

I.46 Third, systems integrators provide much of the bespoke systems design to some large corporate customers, and buy network capacity from telecoms operators. These types of companies are a growing sector in the telecoms market, and represent a competitive threat to network-based telecoms companies, who typically earn very low margins on capacity they sell via such intermediaries.

Purchasing from fewer suppliers

I.47 Because of the increased complexity and complementarity inherent in the telecoms networks they are buying, many corporate consumers are seeking to reduce the number of telecoms suppliers that they rely upon. This is for a number of reasons. Problems can arise where different suppliers' networks interface with one another. Companies want to be able to go to one point of contact to diagnose and fix a problem in their networks, without having first to identify which supplier's network the problem originates in.

I.48 This trend is important because it creates a greater need for network reach on the part of suppliers of corporate telecoms. If an inability to reach all of a company's sites disqualifies a telecoms supplier from a particular contract, then suppliers with greater reach are likely to be rewarded, and suppliers with smaller networks are likely to find it harder to compete. Telecoms suppliers relying on others' networks to supply a solution may also be at a disadvantage, if customers perceive that their immediate supplier is not in complete control of quality and fault management.

New trends in IT causing demand for greater bandwidth

I.49 Meetings that Ofcom has had with IT suppliers and telecoms companies suggest a number of trends in the IT industry which are likely to feed a greater requirement for bandwidth between a business's sites. This is likely first to impact the large corporate sector.

I.50 The first trend is IT infrastructure consolidation by business consumers. Rather than having separate servers on individual sites, and linking them together, there is a trend towards a powerful server on one site, linked to other sites by high capacity networks. The second trend is outsourcing software management. Companies with complex and bespoke software solutions are increasingly outsourcing the hosting and/or management of those solutions to software companies. Whether the software is hosted off-site, or whether the software vendor needs access to the company's network, the result is an increase in the need for bandwidth. A possible future trend may be grid computing. Rather than having a single server, this technology would allow individual computers on multiple sites to act together like a single server.

I.51 The importance of all of these trends from the point of view of telecoms is that they are likely to result in substantially higher demand for bandwidth from corporate customers.

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Footnotes:

100:- Ofcom market intelligence estimates. Figures are nominal.

101:- Oftel research analysis, 2001/2002.

102:- Measuring potential consumer savings, Oftel, April 2003.

103:- Source: Ofcom qualitative research, January 2004.

104:- Source: Helping consumers benefit from competition in telecommunications, National Audit Office, July 2003.

105:- Source : Oftel residential consumer research, November 2003.

106:- Source: Helping consumers benefit from competition in telecommunications, National Audit Office, July 2003.

107:- Source: Henley Centre.

108:- Source: Ofcom qualitative research, January 2004.

109:- Source: Henley Centre research, Planning for consumer change, 2001.

110:- Source: Oftel research, 2003.

111:- Henley Centre research, Planning for consumer change, 2001.

112:- Source: Ofcom qualitative research, January 2004.

113:- Source; Henley Centre, Planning for consumer change, 2003.

114:- Source: Oftel Research, November 1995.

115:- Source: Oftel Research, November 2003.

116:- Source: Oftel residential consumer research, August 2003.

117:- Source: Oftel residential research, August 2003.

118:- Source: Oftel SME research, November 2003.

119:- Source: Oftel residential research, November 2003.

120:- Source: Ofcom market intelligence. Figures are nominal.

121:- Source: Oftel SME research, November 2003.

122:- Source: Oftel SME research, November 2003.

123:- Source: Oftel SME research, November 2003.

124:- Source: Oftel SME research, November 2003.

125:- Source: Oftel SME research, August to November 2003.

126:- Source: Oftel SME research, November 2003.

127:- Source: Ofcom market intelligence. Figures are nominal.

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