Home > Media and Analysts > Speeches and Presentations > 2004 > Apr > 28|04|04

28|04|04

Briefing on Ofcom and telecommunications

Stephen Carter, Chief Executive, Ofcom

This session is a briefing on Phase One of our Strategic Telecommunications Review and I will come on to that in a moment. But those of you who were at the last converged occasion - the Westminster Media Forum - four weeks ago will have heard me make clear that, in broadband, there is a nexus of interrelated decisions we need to take while the Strategic Telecommunications Review is being conducted. The market will not wait for 12 months. Equally we want to avoid taking decisions, on which operators base their investment plans, which are subsequently at variance with the outcome of the Review.

I therefore promised that by the end of April we would set out a working hypothesis for broadband - a direction of travel - that was consistent with the emerging work in the Strategic Review. This would give the operators guidance and a context as each of the individual decisions on broadband are made.

Today is nearly the end of April, so slightly ahead of our self-imposed target, I will also set out that broadband overview today.

But first, the Strategic Telecommunications Review.

A quick reminder about why we are doing it.

Sir Bryan Carsberg, one of the founding fathers of telecoms regulation, usefully reminds me, that if one goes back to 1984, when BT were partially privatised, the world was a fundamentally different place. As a network, BT largely ran on mechanical switches, there were over 240,000 customers waiting for a residential line, the fault repair statistics were eye watering, and we did not live in a culture where the managers had freedom to manage. As a consequence there was a significant background concern that as BT was the single telecoms monopoly, it had 100% control of a highly unionised, key national asset.

Enter privatisation, enter RPI - x, enter interconnect rates set by the DG, enter the mobile duopoly of Vodafone and Cellnet, and then still in my view one of the most damaging pieces of regulation, the licensing of 100 plus local and fragmented cable franchises which has taken 20 years to consolidate.

That was the position in the market in 1991 when there was last a strategic drains up on telecommunications - the duopoly review. Since then the market has changed very significantly: with the increasing shift from fixed switched voice to data and mobile; with the growth in the numbers of competitors at all points in the value chain; and, having for a time pinned our hopes on infrastructure competition at retail level being provided by the cable companies, as a country we came relatively late to alternative wholesale and retail products - e.g. WLR, LLU and CPS as a means of driving significant competition.

Our Strategic Review looks forward over the next decade - at ways in which technology and the markets will develop - to provide the context for a new settlement in telecommunications regulation.

The Review is the third in the overarching series we are doing at Ofcom. The first of these was our report on digital switchover in television, published at the beginning of April. It was determinative in its recommendations. The second was Phase One of our Review of Public Service Broadcasting published last week. That was directional and mapped out some clear propositions and changes that most people can agree are facing the public service broadcasting institutions.

This Phase One of the Telecommunications Strategic Review is less determinative than either of those. That is not because we have not been giving a great deal of thought to the issue. Believe me, we have and we welcome the input we have had so far from stakeholders. But, it is a fact that the telecommunications market is more complex than broadcasting with many more significant players, layers and technology changes. As a factor of that, unlike in broadcasting or wireless spectrum, which we will come to in the Autumn, the answers are less self-evident at this stage.

What we have done is to frame five broad questions which we think the Review needs to answer.

• What are the key attributes of a well functioning market?
• Where can effective and sustainable competition be achieved?
• Is there scope significantly to reduce regulation?
• How can the regulatory framework encourage efficient and timely investment in next generation networks?
• Are structural or operational separation of BT or the delivery of full functional equivalence still relevant questions?

Note the phrasing of that last question and that it comes last. That is deliberate. Since 1984 that question has been the elephant in the corner of the room. And if there is an elephant in the corner, we think it better to acknowledge that fact rather than try to pretend it does not exist.

But on this question Ofcom is genuinely agnostic. And we strongly hope that it will not be the focus of everyone's input to the Review. As we all know, today's telecommunications market is many layered and complex and is unlikely to become less so in the coming years. Indeed, some of the forces we identify in the Report could make the market more competitive. So we should be cautious in reaching for any single, magic-bullet solutions.

I repeat, on this issue Ofcom is agnostic.

This Phase One report sets out where the market is today.

The UK's telecommunications sector performs well in international terms, with a wide range of operators and one or two genuinely world class players. But we do not perform outstandingly well. Some of that early lead of being first with privatisation and first into mobile competition is being eroded.

Contrary to the hopes and expectations in 1984, the regulator has not been able to do itself out of a job. Thirdly, as other countries - particularly in Europe, where markets are not dissimilar from ours - are experimenting with other approaches, we need to study those approaches to see what lessons we can learn.

The Phase One report is very much a consultation document. It seeks views and input on 16 specific questions which flow from the key trends the report identifies - including:

• the increasing blurring of fixed and mobile markets
• the scaleable development of IP technologies and therefore IP networks and products;
• the evolution of networks as intelligence moves from the centre to terminal devices, de-layering as all-IP architectures replace traditional structures (and with all that means for interconnection between networks);
• importantly, broadband (which I come to in a moment) and in particular the prospects for the deployment of next generation broader-band networks;
• and the possible realignment and consolidation within the sector.

Each of these trends will have major implications for competition, for where the balance of market power moves, for investment, for the consumer and the framework for universal service. Input on all these issues is crucial to help us in the next stages of the Review.

Phase Two will be completed in the Summer and Phase Three by the end of the year, to give us - we hope - a regulatory framework that is fit for purpose over the next decade.

Broadband Overview

Let me turn now to the shorter term questions around broadband, particularly wholesale broadband.

To recap quickly on what it is and where it goes. The roll-out of broadband has accelerated rapidly over the past two years, prompted partly by the initial competition from cable and as BT's senior management have brought broadband centre-stage as a focus of BT's business strategy. Some 3.2 million residential consumers now use broadband, mostly at speeds of up to 512k via DSL or cable modem. Business consumers also have a wider range of products available to them. BT has committed to enable exchanges covering 99.6% of the UK population for broadband when the relevant trigger levels for demand have been reached.

There is competition at retail level, both on price (Tiscali £15.99 to BT Yahoo £28), the speeds available (from 128k to 3MB), and on the individual ISPs' content services. Consumers can buy broadband services from a very wide selection of suppliers.

The picture in wholesale DSL supply of broadband is, however, one where BT is dominant. It is very difficult to procure a wholesale DSL broadband service from anyone other than BT. Ofcom believes that effective competition at DSL wholesale level is necessary to allow the retail sector best to serve business and residential consumers with the breadth of product innovation, range, quality and price.

As so often in telecommunications, different groups of people describe broadly the same things using different terms. That can confuse unnecessarily. So on this question of definition the next slide hopefully provides a translation service. In what follows, I will use the BT product families as the terms of art.

BT's wholesaling of broadband is currently regulated under ex ante competition powers at two key points in the network value chain. BT is currently not regulated ex ante in the wholesale service it provides directly to ISPs at the IP Network layer (the IPStream family of products- so-called Option 4). That family of products therefore provides the benchmark 'market' price. The introduction of capacity based charging (recently proposed by BT) which rewards purchasers' scale - is in principle welcome. But it makes those un-regulated benchmarks less visible and transparent. So, in its impact on the regulated section of the market and on competition, Ofcom will keep a close watching brief. Where BT is regulated ex ante is for interconnect for Alternative Network Operators (Altnets) at the ATM layer (the DataStream family of products); and at the local loop (the LLU line-sharing and fully unbundled family of products). (The so-called Options 2 and 3)

The further up the value chain interconnect is made, the greater scope there is for Altnets to provide product innovation, range and price points to compete with BT and each other; but by the same token, the greater the investment needed both in alternative core networks and to provide nationwide points of interconnection with BT's network.

IPStream is widely by used by ISPs to compete with BT Retail (the BT Yahoo Product) in broadband. While there are, from time to time, allegations of a margin squeeze between the price of IPStream and the retail price of BT's product offering, and concerns about provisioning, each of which Ofcom considers on their individual merits under its concurrent ex post Competition Act powers, the generic concern expressed by the ISPs is that it is the lack of competition further upstream that constrains product innovation, range and pricing.

DataStream currently priced on a per user per month rental plus a one-off 'migration charge' of £50 per user, has so far had limited take-up (about 200,000). Concerns expressed by the Altnets range over: the margin between DataStream and IPStream products, the size of the one-off migration charge, the pricing structure of the interconnect between core networks and BT's distant nodes and the provisioning and other features of the product (what we call the 'Attendant Issues').

Wholesale competition at the Local Loop level is much further behind the UK's most successful EU counterparts. Germany has over 3 million unbundled lines (albeit mainly used for narrowband traffic). As a function of much reduced prices France has a LLU market that is growing very rapidly - 40,000 lines each month - and is providing an increasingly broad, innovative and higher bandwidth range of products and services. Italy and Spain are also increasingly the chosen destinations for international investors in this part of the broadband value chain - itself an indication of a more favourable regulatory and competitive framework than the UK currently provides.

In contrast to other EU countries, the UK has only about 11,000 unbundled lines. The few operators who have emerged are primarily catering for metropolitan business and high end consumers, for whom system reliability, advanced products and price, relative to leased-line alternatives, are the attractions. In the small business and residential consumer market, there is a general consensus- which Ofcom shares - from users, from would-be competitors, from Parliament, and, encouragingly, from BT's senior management itself, that UK prices are significantly adrift from European best practice. In terms of provisioning processes, UK practices can best (if charitably) be described as 'bespoke'. These processes do not appear, in their current state, to be fit for scaling and 'industrialisation'. This is a major challenge if the UK is not to be left behind in broadband development.

Ofcom's generic approach to competition

Ofcom believes that consumer benefits are maximised by sustainable, long-term competition at both the service and infrastructure level because they are inter-reliant. Each without the other too easily risks being commoditised solely into competition on price. Innovation, product development and commitment in both services and infrastructure are needed for effective long-term competition.

In infrastructure, we believe that the framework should encourage and reward the development of reach and scale and innovation by operators. That includes BT; as well as the Altnet operators, for whom regulatory policy may play a bigger part in their business planning. Ofcom's aim is also to avoid so incentivising entry at any one part of the value chain that, when the market or technology moves on, the Altnets (or BT) have been falsely encouraged to invest in assets that are then 'stranded'.

In services, the framework should surely seek to encourage and reward operators who can create sustainable innovative products which are resilient to normally competitive and rational price changes by the incumbent. Of course, this is dependent on resilient wholesale prices and processes.

Furthermore as our Strategic Review document suggests, we need to encourage the development of and investment in next generation IP Networks, whether DSL or cable, capable of carrying high capacities of data for residential as well as business users. Clearly 3G mobile is one example of this. As are new forms of wireless broadband at 3.4 MHz.

Framework proposals for DataStream and LLU

The European framework and indeed our own aspirations toward light-touch regulation support the general principle that there should be regulation at only one point in the value chain where that is practicable.

At present, Local Loop Unbundling and DataStream/ATM Interconnect have some complementary features for competition. LLU allows a high degree of product and price differentiation. But it requires significant investment and competition is likely, for some time to come, to be focused on metropolitan/larger urban areas with high population density and shorter distances from the local exchange to the core network.

DataStream allows less product and price differentiation than LLU (but more than IPStream) and is dependent on the current configuration of BT's data transport network. It does however allow competitors more rapid entry to the market, is less capital intensive and complements national broadband competition by providing economic access in rural and less densely populated areas. Some operators also see DataStream as a route to customer volume - effectively, a migration path towards a mass market approach to LLU either separately or in tandem.

Ofcom therefore intends for the time being to maintain regulation at both the ATM Interconnection level and in LLU. However, in line with the overall principles I set out some moments ago, were significant price reductions and equally significant process improvements to lead to the development of thriving LLU-based competition, then Ofcom would, on the basis of hard evidence of such successful competition, revisit the need to retain regulation of DataStream in those areas where LLU had taken off. Trigger points could be some combination of price, process, numbers of operators or numbers of users.

Earlier this year Ofcom consulted on the Market Review of wholesale broadband access, on the basis that there was a single national market; that BT had Significant Market Power in that market and proposed a number of remedies, including setting ex ante a 'retail minus' margin for DataStream products based on the price of IPStream product family.

The final determination of the Market Review will be published in the week beginning 10 May. The actual margin setting process will conclude three to four weeks later and will take account of BT's new Capacity Based Charging tariffs and the volume discounts offered therein.

In setting any regulated price, whether on a 'cost plus' or 'retail minus' basis, the central basis of the calculation is cost-orientation based on the theoretically efficient new entrant. When new or emerging markets are involved this will necessarily entail producing a potential price range within the boundary of proper cost-orientation. In exercising its judgement, Ofcom will have close regard to the generic approach to competition I have just set out. Ofcom will be mindful of the risk of setting margins and prices such that excessive incentives are created for investment in assets which could be 'stranded' as a result of market developments or technology changes in the configuration of BT's network.

Ofcom will similarly have in mind the objective of encouraging scale and reach in considering the appropriate price structure for the DataStream product family (for example on Virtual Path Breaks) and the other Attendant issues that have been raised during the consultation.

So, in other words, our timetable is:

• in the week beginning 10 May we will publish our final statement on the wholesale broadband access market review and consult on the principles of the LLU Market Review
• In the week beginning 31 May we will consult on the retail minus margin between DataStream and IPStream.
• In week beginning 7 June - and this is relevant to business users - we will publish our decision on the Leased Lines Market Review and the initial consultation on Partial Private Circuit price control
• In August we will consult on the detailed market review and pricing issues in LLU, leading to a decision on that before the year end.

Talking timetables, Ofcom is, as promised, today announcing its proposed determination of the dispute between Tiscali, Thus and BT on the volume migration charge from IPStream to DataStream and indeed other migration activities. Based on cost-orientation and the benefits to all end-users from the potential to switch suppliers, Ofcom proposes to determined the migration charge to be £11 per user, down from its current price of £50 per user.

BT has, of course, had visibility of the figures, as part of these cost calculations. They notified us yesterday that they had decided of their own accord to make an announcement in this regard later today.

In terms of Local Loop Unbundling Ofcom will, as I say, publish its first Market Review, for consultation, in the week beginning 10 May. Ofcom cannot, of course, pre-empt what pricing decisions will flow from the Review. But it would be surprising if at the end of the process, UK prices were not aligned much more closely with European best practice, where price reductions and growing user volumes form a virtuous circle.

In terms of provisioning for LLU, the processes are not fit-for-purpose for scale. The processes need to be successfully industrialised. Whilst the right prices are a critical condition for success, the right processes are also a necessary condition. Over the coming weeks therefore Ofcom will be discussing with BT and the other operators, mechanisms to ensure that the processes and attendant issues for regulated broadband products are timely, scaled and effective.

The market is now ready for investment, rationalisation and consolidation. The last three years have been torrid for the telecoms industry both in infrastructure, OEMs, innovation and scale development of new technology applications. But we are either through and/or at the point of visibility of improved operating performance, cash-flow, customer focus and some network rationalisation.

Now we can look forward with some enthusiasm to the next few years.

We have, as we have said, seen some significant progress on retail broadband, but rather more limited wholesale and/or infrastructure competition.

Conclusion

This then is in part a call to the industry.

To BT to be serious on wholesale prices and processes - to the cable industry in its role of providing local access and retail competition - to the Altnets in creating sustainable long-term business models - to the mobile operators in their role in innovation and competitive supply - and to the resellers and other service providers that certainly the broadband market is ready for more product and price innovation.

Our role as the regulator is to deal with the day-to-day as we have exemplified today on broadband and establish a post-European directive framework of next generation regulation for next generation networks.

Ends.

Back to top