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1.1 In December 2003, Ofcom (the Office of Communications) announced a Strategic Review of Telecoms (the 'Telecoms Review'), to take place throughout 2004. The Review will take an over-arching look at the workings of the UK telecoms sector. It will assess whether the sector is delivering benefits to consumers, its future prospects, and the impact of alternative regulatory approaches. The outcome of the Review will be a new settlement for telecoms regulation.

1.2 The Telecoms Review will be in three phases. Phase 1 examines the current position and prospects for the telecoms sector, and should necessarily be quite brief. Phase 2 identifies and assesses options for Ofcom's strategic approach to telecoms markets. Phase 3 weighs up these options. The Review asks five fundamental questions, which will be the focus of Phases 2 and 3. At this stage, we invite stakeholders to give us their initial views on the following:

Question 1: In relation to the interests of citizen-consumers, what are the key attributes of a well-functioning telecoms market?

Question 2: Where can effective and sustainable competition be achieved in the UK telecoms market?

Question 3: Is there scope for a significant reduction in regulation, or is the market power of incumbents too entrenched?

Question 4: How can Ofcom incentivise efficient and timely investment in next generation networks?

Question 5: At varying times since 1984, the case has been made for structural or operational separation of BT, or the delivery of full functional equivalence. Are these still relevant questions?

1.3 This consultation document addresses the issues relating to Phase 1 of the Review. It reviews the current performance of the telecoms sector and assesses its future prospects.

1.4 The European regulatory framework for communications networks and services provides the over-arching context for Ofcom's approach to regulation. The UK fully supported its creation and played a leading role in its development. The UK has been assiduous in implementing the framework, effectively and on schedule, and Ofcom has carried on the work of Oftel (Office of Telecommunications 1984 - 2003) completing the reviews of specific markets required by the European Directive. Having done so, we believe it is now time to reflect on the future challenges for regulation. As the Review progresses, we will share our conclusions with our regulatory peers in Europe and with the Commission, and in return will want to draw on their knowledge and experience.

1.5 Telecoms regulation in the UK has its roots in the 1984 privatisation of BT. Although regulation has become very much more complex and, over time, has changed subtly in its objectives, many fundamental assumptions and regulatory tools have remained unchanged for 20 years. Yet in that time, telecoms has changed almost beyond recognition. Phone penetration is now almost ubiquitous; mobile penetration has risen from zero to around 75 per cent of adults; around 50 per cent of homes now have internet access; and broadband access is increasingly important to many households and businesses. The sector is now facing more fundamental changes, driven by changes in technology, consumers' demands and the financial environment.

1.6 Ofcom is a new regulator with a new set of duties. We have a statutory duty to reduce regulation where possible. Much of the detailed telecoms regulation introduced in the past was envisaged by many to be temporary, to allow competition to develop and to protect consumers while it did so. Given the fundamental changes in the telecoms sector over the last 20 years and its rapidly changing future, it is important that we return to first principles and ask whether there is still a case for such detailed sector regulation.

1.7 Telecoms regulation involves a number of trade-offs. For example, regulators often have to choose between regulation which is better at minimising prices in the short-term, and regulation that, through giving the right incentives to innovate and invest, will deliver price reductions and new products in the longer term. There are also trade-offs between promoting different types of competition - for example, competition on the basis of infrastructure or service provision.

1.8 Ofcom's starting point in making these trade-offs should be the benefits they deliver to the different types of telecoms users, such as low prices, greater choice, better quality and greater accessibility of services. But it is important that we look at what residential, small and big business consumers really value from the telecoms sector. Market research will therefore play an important part in our review.

1.9 The theme of this document is centred on the consumer outcomes and preferences that matter today, and the likely evolutionary paths for the telecoms sector. These will have critical implications for the choices that Ofcom makes on the trade-offs inherent in telecoms regulation. We are therefore asking you what a well-functioning telecoms market should deliver to citizens and consumers, and how Ofcom should weigh up the trade-offs in order to achieve it.

1.10 The main case for sector-specific regulation in telecoms has been that some telecoms companies have market power. The historic approach to regulation concentrated on voice telephony, and particularly on fixed voice. The intellectual case for regulation, and the form it took, developed with that in mind. However, the telecoms sector has entered a new era in which data has already eclipsed voice in terms of network use. Many of the resulting changes in prospect for the telecoms sector are likely to change the sources and extent of market power. It is therefore very important that Ofcom understands the likely nature and extent of these changes before considering any regulatory options. This document focuses on changes in five areas in particular.

1.11 Competition in voice services may change in nature, for two reasons in particular. The first is that competition between fixed and mobile operators
will increase. If fixed and mobile services become economic substitutes for each other, it would be appropriate for regulators to consider a single economic market for voice services.

1.12 The second is that competition to conventional fixed voice services may also come from Voice over IP (VoIP). Already commonly used by business consumers, many commentators are predicting that this service could achieve mass-market take-up among residential consumers, perhaps bundled with broadband services. If so, it could allow new suppliers into the voice market, and existing sources of market power in the voice market may be eroded.

1.13 Demand for broadband is likely to continue to grow. This demand could be met by more of the existing broadband infrastructure (mostly cable and DSL), or possibly by the deployment of platforms using other technologies, such as wireless, satellite, passive optical networks or powerline. The more scope there is for competing access technologies, the less need there will be for regulation focused on broadband access infrastructure. Demand for broadband may reach the point that it surpasses the bandwidth capabilities of DSL and cable as currently deployed. In this case, it would be particularly important to ensure that the necessary investment in future 'broaderband' technologies was not hampered by regulation. One important determinant of this demand is the development of compelling broadband content - the opportunities for successful broadband content business models, and the barriers that may hinder them.

1.14 Packet-based networks using Internet Protocol (IP) are increasingly likely to be used by network operators, rather than traditional circuit-switched architectures. The growing use of IP for both voice and data is also likely to have implications for competition between long distance networks, possibly necessitating new forms of interconnection.

1.15 Evolution in network design is also likely to have important implications for sources of market power and regulatory policy. Functionality and intelligence may continue to increase at the 'edge' of networks (i.e. in terminal equipment); owning the network may therefore be less important for some aspects of the customer experience. If networks increasingly use IP (an open standard), service providers should be able to run any application over them that uses this standard, without needing to control the network. But if network operators use proprietary standards, control over these standards could be an important source of market power. The shift to IP itself also has important regulatory implications. As more and more traffic is diverted to IP networks, the fixed costs of the 'legacy' circuit-switched networks are likely to be spread among fewer and fewer customers. This could raise very important regulatory issues in the future around managing this transition.

1.16 Realignment in the telecoms industry has been predicted by many commentators for some time. This could be in the form of horizontal or vertical consolidation, or through alliances. New entrants may offset this trend towards greater concentration, for example, as telecoms companies who currently supply one type of telecoms product (e.g. mobile) supply another (e.g. fixed). There will also be an increasing convergence between the telecoms and media sectors as audio and video content is consumed over telecoms networks. These trends are important for telecoms regulation. Consolidation, alliances and market entry inevitably change market structure, with the result that the regulatory approach may need to be re-thought. For example, such changes may lead to more effective competition, or alternatively, to the creation of new forms of market power.

1.17 This document asks for your views on these changes, and what they imply for telecoms regulation. But similarly important is the impact that regulation itself is likely to have on the market's transition towards many of these changes. We are therefore asking for your views on two effects in particular.

1.18 First, investment in telecoms infrastructure is sensitive to the regulatory regime. If this regime is unpredictable, or aims to reduce prices at the expense of allowing reasonable returns to risky investment, it could deter investment. Although investment is not an aim of regulation in its own right, telecoms is a capital-intensive business, and so it is particularly important that regulation does not lead to under-investment in the sector.

1.19 Second, regulation designed to protect consumers, or to support consumer choice, can have many benefits. For example, it can make switching between suppliers easier, or protect consumers from unscrupulous suppliers. But there is sometimes a trade-off, because over-regulation can adversely affect the risks and returns that operators perceive in introducing new products. Our initial research indicates that consumers resent a lack of comparability and clarity in pricing; it may be important for the regulator to take an active role in providing, or signposting, information that enables consumers to make informed choices.

1.20 Finally, as the telecoms market evolves and competition develops, it will be important to examine the funding and provision of universal services. As we see change in the range of telecoms products that consumers use, and in the technologies used to provide them, it will also be important to examine the scope of universal service obligations. This document seeks your views on these issues.

1.21 The responses that Ofcom receives to this consultation document will be critical to our understanding of the way the telecoms sector is likely to evolve. In turn, our expectation for this evolution will fundamentally affect the assessment of alternative regulatory approaches that we will take in Phase 2. Therefore, it is very important that we hear the views of all interested parties to this document, including telecoms operators and service providers, telecoms equipment manufacturers, consumer groups and telecoms consumers, financial institutions, Government departments and others. Responses to this document are requested by Tuesday 22 June 2004.

1.22 In addition to the five fundamental questions for the Review as a whole, Figure 1 lists the Phase 1 questions that we are asking you to respond to in this document.

Figure 1: Phase 1 Questions in this consultation document*

6. How successful is the UK telecoms sector currently in delivering benefits to citizens and consumers? 7. How rapidly and extensively will fixed and mobile networks become substitutes for one another? 8. What impact will Voice over IP have on the telecoms market? 9. How rapidly and extensively will broadband be taken up in the UK, and what are the regulatory implications of such growth? 10. What scope is there for new, competing broadband platforms to be rolled out, and which technologies are most likely to be used? 11. When are operators likely to move towards 'all IP' architectures, if at all? 12. What are the implications of 'all IP' networks for the way networks interconnect with one another, and for the scope of competition? 13. Is there likely to be widespread demand for services that require 'broaderband' networks to be rolled out and, if so, how will such infrastructure be supplied? 14. How rapidly are broadband content businesses likely to emerge, and what factors will affect their viability? 15. How will future network evolution, such as growth of intelligence at the edge of networks, and the increased importance of control over technical standards and interfaces, affect the requirements of telecoms regulation? 16. Will it become uneconomic for operators to maintain the existing circuit-switched architecture at some point and, if so, when? What regulatory issues will this transition to IP networks raise? 17. Are consolidation, alliances, market entry or other forms of market evolution likely? What will their implications be for telecoms regulation? 18. What impact do different regulatory approaches have on investment decisions in telecoms, and what regulatory approaches does this imply that Ofcom should adopt? 19. What is t he right role for consumer policy? What impact do different approaches have on telecoms companies' perceptions of risk and return? 20. What role should Ofcom take in signposting, providing, or ensuring that the market provides clear information to consumers, enabling them to make effective choices? 21. How may universal service arrangements need to evolve in response to changes in the telecoms market?

Footnotes

* The five fundamental questions for the Review as a whole are listed within the Foreword section

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