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02|03|07

NITA NGN Conference, Copenhagen: Wednesday, 28 February 2007

Investment and competition in Next Generation Networks: The Ofcom model

Peter Phillips, Senior Partner,
Strategy & Market Developments, Ofcom

It’s good to be here today – not only to be in beautiful Copenhagen – but because the transition to next generation networks creates some of the most important and interesting challenges all regulators face.

We all know that different countries face different issues – and certainly there is no single magic solution for everyone. But I’d like to share with you how we at Ofcom are approaching these challenges – as well as learning from the Danish experience too.

Next generation networks are risky and cost huge amounts of money. As a result, some people might argue that there is an inherent regulatory conflict between promoting investment and ensuring competition. I will argue that you can get both efficient investment and at the same time ensure effective competition. And I think we’re on the way to achieving that in the UK. I’ll explore with you this morning why we think that is.

So today I will cover two things:

• how we are handling core Next Generation Networks
• our initial views on the regulation of Next Generation Access

But before I discuss next generation networks, I’d like to start first with our overall approach to telecoms regulation.

In 2005, Ofcom completed a two year strategic review of telecommunications because the existing regulatory model was failing. It was leading to weak competition and weak investment.

Existing regulation didn’t guarantee fair access to the monopoly parts of the BT network. It was complex and unpredictable – which made investment risky. ……… So competitors resold BT products not products based on their own infrastructure – making it hard for them to differentiate themselves. This in turn meant BT had little incentive to invest or innovate. Yet elsewhere there was the prospect that there was too much regulation.

After a lot of negotiation, we agreed a settlement with BT…. with the aim of creating the conditions for sustainable, investment-rich competition in the UK.

The key features of this settlement were:

• The provision of the same wholesale products……… with the same quality, price and conditions…….so BT bought on the same terms as other competitors.
• The separation of BT’s business handling access to customers’ premises from the exchange – resulting in the creation of BT Openreach….
• BT’s commitment to change the design of its core next generation network – to ensure infrastructure based competition could continue.
• A realistic prospect of deregulation in areas where the market is competitive

So how has the settlement worked? …….Has it been a success?

I believe it has. Here are three visible signs that show it’s working:

BT Openreach has gone from being an idea to a big business in its own right…..……becoming clearly separated from the rest of BT.

Local Loop Unbundling is central to our strategy………………..And already within 18 months of the agreement 1.5 million lines have been unbundled…………..That number is still increasing by 40,000 lines a week. So BT’s competitors are starting to make the big investments that we were looking for.

Retail price controls have been lifted from BT because there is now real competition.

And crucially prices for consumers have tumbled.

So overall, we have a lot of confidence that our approach - guaranteeing equivalent access to enduring bottlenecks – natural monopolies, whilst deregulating elsewhere - is paying dividends.

There are two questions we are often asked about the settlement.

First, does Ofcom believe all other regulators should adopt the same approach in their own markets? And the answer to that is very clear: yes and no.…..

Yes – in that the heart of our approach – guaranteeing equivalent access to enduring bottlenecks, whilst deregulating elsewhere – feels relevant and applicable in all markets. So we are suggesting the EU Framework includes a functional separation remedy. We have that remedy under our national competition law, and we believe all regulators should be able to use it if necessary, subject of course to the power being used in a proportionate and effective way.

But no - in that we are not arguing for the UK approach as a ‘one size fits all’ solution. There are real differences between national markets. As one example, some markets have more extensive access competition from cable – so the incumbent’s infrastructure is a bit less of an enduring bottleneck.

The second question we get asked is whether, in the UK settlement, we promoted competition but in doing so destroyed investment in next generation networks?

The answer to that is no. But this is a fundamentally important issue and I want to address it in more detail. I’ll start with core next generation networks.

Our agreement with BT was designed to fix the problems of past regulation.

But it was also designed to anticipate the problems of the future. Half way through the review, BT announced an upgrade of its core network, what it terms the 21 st Century Network. This is a huge undertaking, involving the complete replacement of its existing core networks throughout the UK with an all-IP next generation infrastructure.

When it’s completed in 2012, the 21 st Century Network will have cost BT some € 15-18bn in total. That’s just for a core Next Generation Network. But BT believes it can deliver a commercial return on that investment, primarily through cost savings. It has not yet firmed up any plans for a Next Generation Access Network, something I’ll come on to in a moment.

Investment in the new network should benefit consumers: leading to cheaper existing services …as well as new services not previously possible. But it could potentially increase BT’s dominance through further economies of scale. So we have had to think about creating the right incentives both for investment and for ongoing competition.

No one would invest € 15bn or more without clarity about future regulation. We have reduced this risk in three ways.

• We said how we would calculate the cost of capital in any regulated wholesale prices for use of the 21 st Century Network.
• We agreed how long wholesale products on the existing network would be available in parallel with the new ones;
• And we agreed how we would treat the costs of operators migrating from existing wholesale products to new next generation products.

To preserve competition, we needed commitments from BT about the way it would design and build its next generation network. Some parts of the 21 st Century Network may be economic bottlenecks where BT would have significant market power. So we ensured BT would design its new network to provide ‘equivalent’ interfaces both to BT’s own retail businesses and to those of its competitors.

Our vision is one of competing next generation networks, not just one. So again, let’s fast forward. As BT starts to make real design choices about its new network with those regulatory principles in mind, it’s clear that there are big unresolved questions about the future of interconnection in the new world. These are not questions which a regulator is best placed to answer. Answering those questions needs real dialogue between BT and its competitors. So our response was to ensure there was an industry body set up to allow that. It’s called NGNuk, and we’ll be working closely with it on these tricky issues over the coming months.

Let me turn now to next generation access – high speed broadband.

Denmark stands out as a success in broadband access. You lead the developed world in current generation broadband penetration. And increasingly you are seeing large scale deployments of fibre.

The debate on next generation access has been quieter in the UK , because right now there appears limited appetite to deploy fibre other than to large businesses.

But this, of course, makes the questions about regulation more pointed. Is there a regulatory problem in the UK which is preventing fibre being deployed?

I think not. The central issue is around the economics of fibre deployment in different countries.

The experience from Japan and Korea shows there are indeed many new services which complement high bandwidth access - gaming, high definition, video telephony and others. But demand from consumers has only taken off when the price for high speed access has come down to levels similar to basic broadband. Consumers are not yet ready to pay a premium for these new services. Yet fibre is estimated to cost more than €200 per urban home passed, plus the costs of the set top box and of acquiring new customers. So the shift to fibre doesn’t obviously create economic value. So why is anyone doing it?

There is no single answer. In America , more fibre has been deployed in part because the typically greater local loop length of the copper network means it can’t support speeds as high as in countries like the UK. And the incumbent US telcos need to catch-up with a strong cable sector which has offered high bandwidth in the big cities for several years. In Paris, Iliad has become the first local loop unbundler to invest in fibre to the home – but its business case relies on the specific characteristics of Paris: there’s easy access to cheap duct which is not available in the UK; there’s a large proportion of multiple dwelling units, again a difference from the UK; and the pay-TV offers in France are generally poorer than those in the UK.

Given these different market realities, we are sceptical about adopting the US model which removes regulation to incentivise incumbents to deploy fibre. As Mrs Reding noted, it is those member states where competition has been most vigorously pursued which have the strongest record for investment and take up of new services. If that is true in copper there is no reason why it should not be so in fibre. Conversely, even a temporary regulatory holiday for incumbents could lock out effective competition for a long time to come.

So in our view competition through real equality of access will remain the right approach. But we may also need to consider how we apply it.

The business case for next generation access appears pretty uncertain in the UK. It’s not our job to incentivise operators to make particular investments – but it is our job not to distort incentives either. We need to reflect in wholesale charges the real risk incurred at the time companies invest.

There is also a tricky question as to where in the network remedies would be applied. There is no reason why the architecture of next generation access must mirror existing copper networks. There may be no technical need for a local exchange – which is the main focus for current access regulation. Depending on the technology choices made by industry, any of the options of duct access, unbundling or bitstream access might be the best place to intervene to secure effective, innovative competition.

And we will have to consider what next generation access means for existing copper-based access products - and how those who are driving choice and innovation for consumers using local loop unbundling might migrate to new technologies in the future.

Not everyone is prepared to wait for the market to deliver next generation networks. In many parts of the EU, we are seeing significant commitments of public money to fund or underwrite public sector next generation access schemes.

I am sceptical that some of the schemes envisaged will constitute value for money for the taxpayer. Many of them assume a market failure exists because the market has not provided a product for which there appears to be rather weak demand at present.

However, value for money issues are not a matter for Ofcom. What does concern us is the appropriate regulatory treatment of such schemes.

A publicly funded high speed broadband network deployed early will probably kill the case for any private sector investment. So the public network will become the de facto monopoly. We have just published - along with the UK Government - guidance on what kinds of publicly funded broadband scheme are acceptable and how these networks should be regulated.

Finally, I’d want to discuss some longer term issues.

Next generation networks will accelerate the convergence of services and technologies. Increasingly, all kinds of devices will be connected to IP networks, offering a rich abundance of new services.

It’s an exciting prospect which promises much for consumers everywhere. But what does it mean for regulators?

This transition will change the nature of the economic markets we regulate, blurring the boundaries between areas which are now distinct. There may be much greater substitution between fixed and mobile platforms. And new sources of competition may emerge in the delivery of premium content, particularly from high speed broadband.

We should really welcome these developments – they should increase competition and allow deregulation, bringing more innovation and choice for consumers. But they do bring new issues for consumers too. I’m going to mention a couple which we are starting to think about.

First, convergence may bring greater complexity for consumers. As the bundling of wide and varying ranges of services becomes the norm, comparing products to make informed buying decisions may become harder. In addition, switching from one supplier to another may well become much harder too. Transferring TV, broadband, fixed voice and mobile simultaneously and seamlessly is not a trivial task, even if suppliers are willing to co-operate. Both of these may reduce the positive effects of competition.

Second, next generation access seems likely in time to raise questions of social equity. Over 99% of people in the UK are connected to broadband enabled exchanges. But the economics of deploying high speed broadband mean there may well be big differences in availability between rural and urban areas. It isn’t yet clear whether society will decide there are services dependant on high speed broadband – not just existing broadband - which are essential to provide for everyone. But if there are, some hard choices would need to be made in defining the basic broadband entitlement and how that was to be delivered. Regulators should help to inform that discussion.

So in conclusion, our view is that the challenge posed by next generation networks is not between competition or investment, but how we can best stimulate both. Our belief is that guaranteeing equivalent access to enduring economic bottlenecks while deregulating elsewhere is the best way to do that. We’re already seeing that approach is consistent with a massive investment in core next generation networks. And we’re sure it will be the right way for us to approach next generation access too. There are still many challenges ahead, but huge opportunities when we surmount them – as I’m confident we will in the years ahead.

 

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