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08|02|06

Keynote Presentation - CMA Conference 2006

Sean Williams, Board Director, Ofcom
8th February 2006

CMA speech

Please view the original presentation slides (PDF, 107Kb)

Introduction

I am Ofcom’s newest executive director, having joined the board in January. I have been with Ofcom for the last three years. My particular responsibilities are for the Competition Group, where the team design and implement Ofcom’s economic regulation and competition policies in telecoms and broadcasting. For you, that means that we are the ones who mandate various wholesale services to be provided by BT and set their prices so that alternative networks can compete in providing you with services. My own work in the last two years has been focused on delivering Ofcom’s broadband strategy in 2004, based on LLU, and leading Ofcom’s negotiating team in respect of the Undertakings we are accepted from BT last year at the end of our strategic review of telecoms regulation, establishing its new business division Openreach.

Anyway I am delighted to be here this morning because this audience represents a very important and powerful force in determining the future of telecoms in the UK. Ofcom can set various rules with the intention of allowing markets to operate effectively. But our objective is to get to the point where as far as possible it is competition that drives market outcomes not regulation. So it is your hands, in the process of successful customer-supplier relationships, that the future of the telecoms markets will to a large extent be determined.

[Slide 1] The brief the CMA have provided me is to offer a few thoughts on the future development of the industry from our perspective. So what I thought I would do in the next 15 minutes or so is to structure these thoughts in three parts: first a brief account of recent developments; second a summary of Ofcom’s strategic approach to telecoms regulation; and third some perspective on the main regulatory issues for us in telecoms in 2006. I am not, I hope, going to give you death by Powerpoint, but I do have a few visual props.

Recent developments

[Slide 2] It is many a speech that begins “we live in times of great change”, but it is certainly true in the communications sector in the last few years.

Overall the sector has been growing, as this chart shows: strongly in mobile communications; the loss of fixed line revenues somewhat offset by the growth in broadband. TV spend has also been growing.

[Slide 3] Specific services have spread rapidly over the last two years. As this chart shows, broadband connections have grown from 2m to 9m, 3G mobile from practically nothing to 3.5m, just in the time since Ofcom’s formation

[Slide 4] Underlying this we have changes in technologies resulting in convergence at three levels, platforms, devices and services

Convergence in platforms is allowing traditional analogue services to be offered on digital platforms. One obvious example is Voice over Internet Protocol: VOIP now accounts for getting on for 30% of voice calls in France. How soon before VOIP reaches that level of penetration in the UK? This convergence at platform level will drive substantial change in the markets in the next few years. It provides opportunities for cost reduction and service innovation, but it requires investment and risk.

Another obvious example is the convergence of wireless and fixed line networks. As more spectrum comes available, with more spectrum for Wifi and Wimax technologies, the conceptual boundaries between fixed and wireless networks will become blurred, and services will expected in future to be able to roam across both.

Convergence on digital platforms is driving convergence of services. The obvious example is TV services being delivered over broadband connections. This may not be a primary concern for this audience as corporate communications buyers. But it is in a sense an experience that corporate communications has had for some time, telecoms services that provide high volume data services in addition to traditional voice services. We have seen very rapid developments in this space in recent months, with the launch of Google’s content portal, Sky’s acquisition of Easynet and many other developments.

The third level is convergence of devices, telephones – like BT’s Fusion phone – operating on both fixed and mobile networks, PCs providing voice as well as internet services, mobiles providing mobile TV services. The mobile TV trial in Oxford which has been conducted by O2 and Arquiva has had positive reception from users.

And may be out of all this convergence comes a new battleground, the communications hub, the gateway to all communications services: who will make their mark in this space? Will it be an established base of Satellite set-top boxes or BT’s plans for combined broadband and digital TV boxes, or any one of a number of others?

This convergence has been reflected in sweeping changes in the industry structure. In a period of less than 6 months we have had the merger of the cable companies, ntl and Telewest, and their further bid for Virgin Mobile; the acquisition of Energis by Cable & Wireless, on top of its previous acquisition of Bulldog; the acquisition of Easynet by BSkyB; the acquisition of Your Communications by Thus, the acquisition of O2 by Telefonica, the acquisition of One.Tel and Tele2 by Carphone Warehouse: has there been a 6 month period with so many large transactions? Not for a long time.

[Slide 5] On top of this, we have seen substantial investment announcements in relation to local loop unbundling, as set out on this chart: and this is by no means all: AOL for instance is not listed. There is a real prospect now, for the first time since regulators began to struggle with LLU, that competition at this level is taking off.

What we are seeing is the emergence of multiple players achieving scale through consolidation and investment in a converging communications market.

Strategic Review

It is in this context that Ofcom has undertaken its strategic review. After almost two years of work in research and analysis of options and detailed negotiation of solutions, it concluded last September and set a framework for the regulation of the sector.

[Slide 6] Our perception was that customers in the market would be increasingly demanding and that suppliers would have to respond to these needs, by differentiating services based on have some real ownership of the value added in provision, which means investment in infrastructure and extending reach.

All that would mean there would be a need for continuing investment. But the industry was characterised by highly complex regulation, fragmented supplier base, little appetite for investment and a systematically imbalanced competitive playing field.

[Slide 7] Why had this situation arisen? Our view was that it was the result of the basic economics of the sector. High fixed costs and economies of scale create economic bottlenecks, particularly in the access and backhaul networks, which are very unlikely to be competitive in the foreseeable future. BT has had the advantage of owning these bottleneck assets and of vertical integration between them and its other wholesale and retail operations. The result has been that competitors have suffered from slow and inferior product development which has left BT with a systematic competitive advantage in the market.

[Slide 8] This is powerfully illustrated, I think by the development of LLU. If LLU had been implemented effectively on day one, how different the market structure would look today: currently there are only 200,000 LLU lines, while broadband based on DSL has grown to 7m lines.

[Slide 9] So in consequence we devised a strategy towards telecoms regulation. We intend to promote competition based on investment in infrastructure as deep in the network as it is likely to be effective and sustainable.

We will differentiate our approach to the prospectively competitive and uncompetitive parts of the network.

In the uncompetitive parts – the access and backhaul networks particularly – we will take a tough utilities style approach to regulation, with a defined regulatory assets base, a low cost of capital and low prices, because we do not think new entry is likely. We have mandated that BT provides real equality in terms of access to these bottleneck assets, which I shall describe some more the next slide.

In the potentially competitive parts of the sector, we will take a much more deregulatory approach. I will return to this in moment.

[Slide 10] Real equality of access has two parts. At the service level it consists of what we call equivalence of inputs: that is BT must use exactly the same wholesale products as its competitors, on the same terms and conditions and through the same systems. That takes away their incentive to provide inferior products or to delay product developments.

At the same time we have required BT to establish a separate business unit within the BT Group, Openreach, to own and operate the bottleneck assets. This is intended to take away any advantage they may gain by undue influence and information flows passing between Openreach and BT’s other activities. Openreach is there to serve all its customers on an even handed basis.

That is the nub of our strategy for telecoms regulation. Our objective is to make operational separation, the creation of Openreach, work, rather than seek structural separation of the business.

[Slide 11] We also agreed a range of other provisions in the undertakings which I do not have time to go into how. There are other organisational boundaries in BT. They have made commitments about designing a pro-competitive next generation network. They have established an internal compliance board to act as an internal regulator.

[Slide 12] In potentially competitive markets, we are actively seeking to deregulate. We want competition to drive market outcomes not regulation. Our focus is on retail markets firstly, then on markets with high value products and in areas of high geographical concentration, as being the ones in which competition is most likely to emerge soonest.

We have relaxed the retail price control on BT. We are considering whether we need a retail price control at all after it comes to an end this summer. We have deregulated various wholesale voice markets too. We are developing policies concerning possible deregulation in the market for large business customers, allowing BT more freedom to compete without disclosing its prices, and to offer bespoke pricing packages. We are investigation whether BT no longer have market power in some geographical areas in some products, particularly leased lines.

Implications

[Slide 13] What does all this mean for you the business user and you the supplier?

Well as I said at the outset, it is for you to make the market work effectively. All we can do is set some ground rules.

We believe that where a supplier has to buy wholesale inputs from BT they should be on the same footing as BT itself, buying the same inputs on the same standards at the same prices. That should provide the foundation for effective competition.

We have opened up competition based on infrastructure investment, to provide opportunities for innovation and differentiation, particularly based on LLU. This means an investment need.

With fit-for-purpose wholesale inputs being provided on the same basis to everyone, all competitors will be freer to design products, pricing and packages which suit customer needs without the constraints of regulation. They will need to make that commitment to respond to customers’ needs in a world of accelerating convergence that I described earlier.

What it needs is the expertise of salesmen who really understand their customers’ needs, and customers who are appropriately demanding of their suppliers to take the opportunities for progress in an unconstrained market environment.

My worry is that the underlying state of competition, particularly in the corporate market is not that healthy yet. Because of over-capacity and the high proportion of fixed costs in telecoms networks, pricing has been driven to a point not far above short run marginal costs, without the prospect of achieving an adequate return on capital investment. That is not sustainable in the long run.

I don’t think this is a problem that the regulator can or should try to solve. We cannot constrain prices so that adequate returns are guaranteed.

The only way out of this bind is by exploiting the opportunities for differentiation services which take the edge of price competition. In an environment of as much technological and service level changes as we see today, there are plenty of such opportunities available to suppliers who can make the necessary investments.

What I suspect that means, however, is that the period of consolidation in the industry may not be at an end, as companies try to find the scale necessary to make the investments needed, particularly in next generation networks.

[Slide 14] As we head off into 2006, Ofcom’s agenda will be focused on four high-priority strands of policy work affecting telecoms: the implementation of BT’s undertakings, the development of policy towards next generation networks, the review of the European regulatory framework and the release of spectrum.

2006 is the critical year of implementation by BT of its commitments. By the end of the year they are due to have delivered new systems of service delivery to what we call “the equivalence of input” standard, and started using them themselves, for wholesale line rental, wholesale broadband access and local loop unbundling. They have to do this at the same time as restructuring their internal organisation to create Openreach and not missing their own commitments for delivering their 21st Century Network. That is a challenging agenda. Ofcom can’t do it for them but we will do what it can to make that all achievable.

Next generation networks will be a second major area of policy development for us. We are aiming to establish a new industry body to take forward plans for the deployment of next generation networks across the whole industry. At the moment organisations wanting to build next generation networks are effectively waiting to see what BT will do: they know everyone will have to interconnect with the only ubiquitous network; so there is no point investing until they know which way BT has jumped, which effectively gives BT a first mover advantage. BT meanwhile is doing its best to consult in an open manner on its developments, through its Consult21 programme. Our conception is to take the main decisions into an industry body so that everyone can move together at the same pace

The three particular issues we intend to focus on early are the commercial model of NGN interconnection. No supplier can confidently construct a business case for NGN investment if they do not know the basis on which that investment will earn revenues in future. So establishing the commercial model early is vital to making rapid progress with investments.

At the same time we want the industry body to come to a view about how NGNs will interconnect and how access can be appropriately provided to the higher levels of intelligence in NGNs. We want this process to look profoundly not just at the question of delivering services that are available today but to consider how services may evolve in future.

Ofcom in the meantime will be taking forward its own responsibilities for regulatory policy: how should we think about market structures in an NGN world? What happens to the mandated wholesale products? How is the evolution of wholesale products to be managed, to provide continuity for competitors but not grandfathering rights to use legacy products? We are trying to provide as much clarity as we can as soon as we can to help the market go forward.

Getting the whole system moving together, the commercial, strategic, financial and regulatory decisions this year is an important objective on the way to delivering new and valuable services to end users. It will be a period of substantial change.

The third important area of activity will be in the release and liberalisation of spectrum. We are engaged in a very substantial programme of releasing spectrum into the market: the DECT guard bands at 1400 MHz; L band which is adjacent to the 1800 MHz 2G mobile spectrum, bands formerly used for TETRA mobile radio; the 2.6 GHz 3G expansion band, which is a large block of spectrum; and of course, looking further into the future, we are considering what to do with the broadcasting spectrum released by digital switchover.

This is a bigger and more ambitious programme of spectrum release than has ever been attempted before. It will provide many opportunities for new wireless services and competitors. At the same time we are seeking to liberalise the restrictions on what particular blocks of spectrum can be used for and how they are traded, which again we hope will encourage the development of innovative new services and more efficient use of spectrum.

The fourth area of priority is in the evolution of the European regulatory regime. The Commission has called for input into its deliberations which we are about to submit. It will consult formally later in the year.

Ofcom’s basic view is that the framework works well. It is an analytically sound and robust approach to what we call ex-ante regulation, which has the merit of being consistent with approaches taken in ex-post competition law. We are not looking wholesale changes in the framework.

However, we have two broad objectives. First we want to see the framework consistently implemented in other European countries. In the UK we have completed all the market reviews required of us, except one – international roaming – and are just starting on a second round – with a wholesale broadband market review this year – while some other countries haven’t even put the legislation in place yet. Consistent implementation is a priority. I see this as a more important priority than greater harmonisation within the framework itself. Implementation will provide a more open basis on which global and European-wide organisations can compete in Europe.

The second objective is a set of incremental improvements to the framework. We would like more opportunity to consider markets together, as we did in our strategic review, not individually as the framework requires. We need to have the flexibility to adapt market definitions rapidly to newly emerging NGN technologies. We need to adapt some aspects which our experience has taught us do not work easily, such as in relation to Universal Service Obligations.

Whereas for the last two years Ofcom has been focused on working out its own strategy for telecoms regulation and implementing that strategy, in the next year we will be investing much more time in taking that agenda forward within the international fora.

So that it is. The last two year’s have been a time of great change, which is set to continue for the coming years, through convergence and consolidation. Ofcom has propounded a clear strategy for telecoms regulation, which is based on encouraging competition through infrastructure investment as deep in the network as it is likely to be effective and sustainable. In the coming year we will be focused on implementing that strategy, both the new undertakings that BT has given and our deregulatory agenda. We will be proactive in taking modifying our regulatory approach to the changing circumstances of the market, particularly in relation to next generation networks and spectrum liberalisation. And we will be taking our approach abroad.

But the success of these markets is in your hands, in the ability of all participants in the market to make change happen to the benefit all customers and end-users.

Thank you very much