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Home > Media and Analysts > Speeches and Presentations > 2007 > Nov > LBS Global


12|11|07

LBS Global Communications Consortium Conference - Regulation, investment and the consumer interest

David Currie, Chairman, Ofcom

Introduction

Good Morning. Before I launch into my keynote address this morning, I cannot let the occasion pass without noting that this conference is, in effect, Professor Len Waverman’s swansong at London Business School before returning to his native Canada to become Dean of the Haskayne School of Business at the University of Calgary. It is a good move for Len and good news for the Haskayne School of Business. But it is a loss for economic and public policy debate here in London.

Len joined me as a colleague as part of the Regulation Initiative which I had founded at LBS, and from that base launched the highly successful Global Communications Consortium. The GCC has made the LBS a lively and respected forum for ideas and expression in our sector. We have not always agreed, and we may not today, but we can all agree that under Len’s leadership the GCC has helped to foster a constructive and informed debate around the issues of communications convergence of which this excellent two-day conference is part.

My talk this morning is billed in the flyer as ‘Convergence and the challenges ahead’. What I want to focus on this morning is regulation, investment and the consumer interest. Because that is where the debate is centring. What is the best framework to encourage economically efficient investment and innovation to meet the explosion of consumer needs that convergence has thrown up?

Convergence is the product of the coming together of the processing and storage power of the PC, the transmission speed and power of the networks and the creativity and imagination of our audiovisual industries. And, unlike last time, now the technological delivery can match the marketeers’ claims.

It throws up substantial new opportunities to meet, at a profit, consumers’ increasing desires for control, mobility and participation in their consumption of communications services.

Ofcom’s latest Annual Communications Market Report, published in the summer bears out these trends:

But alongside these three ‘big wave’ consumer trends, convergence is throwing up major disruption to the business models of the last century. When RadioHead launched their latest- highly successful- album as, in effect, a piece of internet shareware; when Prince launches his as a web promo for the concerts and the merchandising which is where he actually monetises his talent, the record companies’ old business model is truly and irrevocably broken.

At the more mundane level of the classified ad and the radio slot, the internet has removed the financial underpinning of the regional and local press and local commercial radio. They must find new revenue streams or wither on the vine.

In fixed line, the more far-sighted CEOs saw several years ago that the former cash-cow: voice calls- would, in the converged IP world, simply become a bundled commodity, and acted accordingly to diversify into new product lines and business models.

In audio-visual, the jury is still out, not about the direction of travel but about the destination and who will survive the journey. Audience and revenue fragmentation is a fact. But, like organic foods in supermarkets, some content and some packaging seems able to command an increasing premium as it addresses the increasingly personalised world we inhabit.

Smart aggregation is the key – aggregation of such premium content with easy access to the long tail together with platform and device delivery.

The prize, in the converged world, is to become the effective controller of the home hub. The consumer’s destination of choice for the full range of converged services.
That requires significant risk-taking, significant investment and the knowledge of when, where and how to invest combined with slick and seamless execution.
If I knew how to do all that, frankly I would not be here today. I’d be out there, busy doing it.

But there is a number of people and organisations who think they can. Good. That’s how markets work. Our job as regulator is to help them. Let me set out how I think we can best do so; and why some of the voices who pose an alternative, incumbent-led investment strategy for high capacity broadband or even a managed duopoly infrastructure competition model may not have all the right answers.

Competition and Investment in fixed line

Our consistent approach has been to promote competition as deep as possible in the infrastructure as is effective and sustainable. In broadband in the UK the alternative infrastructure provider – cable – led the way, spurring a response from BT in the early years of this decade. But cable passes only about 50 per cent of all homes. And there has been little evidence of appetite to invest to extend that footprint.

If one wants competitive broadband available to as many homes as possible – and we do – then in the UK context cable needed to be complemented as a pro-competition mechanism by local loop unbundling. That involves two elements. Firstly a wholesale price that is economic, which we have had since the end of 2004; but secondly, reliable, timely and predictable provisioning of local loops and backhaul. The problem, the developed world over, with the second of these is that where the incumbent controller of the last mile is also competing vigorously in the retail market, the incentives are all wrong.

It does not even require active non-price discrimination. All that is needed is for the incumbent not to try their hardest to achieve reliability, timeliness and predictability to disrupt significantly the launch by competitors of a rival retail proposition. A significant mismatch between the promise of a marketing campaign and consumers’ actual experience of waiting weeks or even months to get what is promised can do significant and lasting damage to a competitor’s market entry.

In the UK we have sought to limit that mismatch of incentives through Functional Separation. That is, the undertaking by BT Group to place the natural monopoly parts of its business into an operationally separate unit – Openreach; combined with clear and specific requirements for equivalence of input in monopoly wholesale product so that all downstream competitors get the same key inputs at the same price at the same time and on the same terms.

I do not want to over-claim for functional separation as a universal panacea. It is not full infra-structure competition, only partial; but it is certainly not correct to characterise it, as some do, as solely a form of services competition. It is not a remedy for all places nor for all time: I certainly don’t buy the argument that functional separation is irreversible, and if technology advances to allow genuine access competition, then its time would be up. Furthermore different market conditions in the different member states of the European Union are such that any claims for a one size fits all solution should be approached with great caution. But our experience of Functional Separation has been sufficiently positive that we fully support the European Commission’s proposal to include it among the possible Remedies in each national regulator’s toolkit to be used if, but only if, the NRA thinks it is right for the circumstances of its own market, and in concert with other remedies already available to NRAs.

In the UK we had tried pretty well everything else over the previous 20 years with at best partial success. We inherited from Oftel a fragmented competition dependent on drip feed support from the regulator, and an intrusively micro-regulated BT with hundreds of separate regulatory interventions into its business without achieving the goal of effective competition in telecoms. When I was appointed to Ofcom, at my first meeting with Christopher Bland and Ben Verwaayen, I said that there must be a better way of doing things, and that was the germ that grew into the undertakings, functional separation and equivalence of input.

I firmly believe that functional separation has created greater certainty for BT’s competitors, allowing them to make significant investment in new infrastructure. And we have seen a wave of new investment by well-resourced competitors like BSkyB, O2, Tiscali and Carphone Warehouse. To give a sense of scale, the broadband capital expenditure of just one of these companies – Sky, who happen to have published their figure – is £250 million.

Functional separation may have had some transactional costs for BT. But as they recognised early on, it can also bring them benefits. As regulation focuses on the business unit that manages the natural monopoly assets, the rest of the Group can think like, be managed like and run like a competitive international-focused plc not a regulated business. And as regulator we can step back increasingly from regulation both at retail level where we ended price regulation 15 months ago and increasingly at wholesale level. We expect further deregulatory measures in due course.

As for the consumer, there are now over 3.2 million unbundled lines with 100,000 more being added every month – a huge shift from the 100,000 unbundled lines just two years ago. 52 per cent of all households now have broadband. Three in five homes have a choice of four or more broadband suppliers. Four in five are served by an unbundled exchange with at least one LLU operator.

That competition has brought innovation both in service and in price. Competing operators have attached ADSL 2 plus kit to the dark copper loop providing higher speeds and VOIP. BT has upgraded its consumer proposition in response. Average headline speeds doubled last year to just under 5 Mbits per second. And prices have fallen. Headline prices are down 9 per cent over the past year; more if one includes the effects of “free” broadband as part of a wider bundle of services.

But we are on a one-way demand escalator. And there will inevitably come a time when copper will reach its limits. Consumers will want much higher headline speeds both for bandwidth-hungry applications and because they will become fed up with the effect of contention ratios on their own service and congestion in the wider net. That demand will provide the investment incentives for next generation networks.

Indeed, at the level of the core network, the next generation is already happening. The challenges are of timely interoperability standards, inter-connect and the re-design of regulation to continue to deliver the core purpose – effective inter-connect and designing in equivalence of input to secure competition – in a very different technological environment.

That work is vitally important but complex, detailed and technical. So I will not dwell on it today, save simply to observe that BT alone is spending £10 billion on its core NGN and that over the last couple of years its share price has moved favourably by comparison with the incumbent operators in continental Europe. Now these are, of course, proxies but they do suggest that the UK’s approach has not troubled the capital markets nor yet constrained BT’s ability or appetite to undertake efficient investment.

And “efficient investment” are the key words when it comes to Next Generation Access. It should be no part of a regulator’s brief to secure investment for its own sake. Misdirected or premature investment leads to allocative inefficiency in the wider economy. Rather, the regulator’s job should be to enable investment when a competitive market is ready for it and to ensure that there are no perverse incentives in the way which artificially constrain new investment.

It is that thinking which underpins the approach in our current consultation on next generation access. Our core principles are straightforward:

That is one approach. Ours. There are others who use words like “incentives” and “forbearance” to argue more or less explicitly for a different approach.

In other words keep the price of copper high and there will be incentives for the alternative infrastructure operator, cable, to upgrade their network and increase their footprint. Secondly, eschew any wholesale access regulation on the incumbent’s fibre access network to encourage them to build one.

Let me take those, related, arguments in turn and in the European context. First there is the obvious concern that artificially holding up the price of the copper network gives the incumbent every incentive to sweat their asset for as long as possible and to defer investing in fibre. Secondly, there could well be something in the argument if there was a wide-footprint cable network where the incremental cost of upgrade is limited as in the US. But that is not the case on the ground across most of Europe.

Even in the UK, where the cable network is largely digital, the upgrade costs at the head-end and cost differentials for high speed modems make the upgrade challenging. (Though there are some welcome high speed trials issuing DOCSIS 3 modems.) But in markets like Germany where the cable network is widespread, it is mostly analogue and the upgrade costs are beyond anything that comparative price signals from the copper network could rationally incentivise. Only 3 per cent or so of German broadband connections today are by cable modem (compared with nearly 25% in the UK). And in markets like Spain, Italy and France the cable footprint covers only 30 or 40 per cent of households. So there would be the added and usually very expensive costs of primary infrastructure – digging up the roads to you or me.

There may be some infrastructure that can be re-used. In Paris and Lyons the sewers are large enough to be used as an alternative source of primary infrastructure for fibre. But this is very much a niche investment spurred by the accident of history that gave those cities extensive, vaulted sewers.

So let me move on to the second argument – ‘forbearance’ – which assumes that the cable network is strong enough to provide a competitive constraint on the incumbent telco. In the European context this is like the classic economist’s solution “Let us assume we have a can opener”. But it is a description of the situation in the USA.

If we had the same conditions as pertain in the US, Ofcom might have made a different call. US loop lengths are such that LLU is not the prospective route to broadband it is in much of Europe. And for historic reasons, it is cable that had the pre-eminent platform and which upgraded its network to deliver broadband and ‘triple play’ in the dense urban areas first. The incumbent telcos are playing catch-up. And, the platform-specific nature of regulatory rules meant that our fellow regulators never had the option of applying regulation consistently to both the cable and incumbent telco platforms. In those circumstances, forbearance and the acceptance of an infrastructure duopoly may well be a rational, least-bad response to the situation on the ground.

In dense urban areas there is competition to provide very high speed fibre-based broadband. But there are also several concerns being voiced in the USA. If Metropolitan America is all right, Small Town America may have only a monopoly broadband provider and 10 per cent none at all. The net neutrality debate has wings in America because of real fears that legitimate discernment – traffic prioritisation – will tip over into undue discrimination by vertically integrated content and platform operators. And there is increasing angst in Congress and in the public prints about the comparative level of broadband take-up.

In short, while the model may be appropriate for America, it is not a natural global export. And it is one that relies for future competition heavily on the promise of wireless.

Investment and Innovation in Wireless

Which is my cue to move from fixed-line to wireless in our context.

Wireless spectrum is a critical resource for innovation. It is vital for services that can address the consumer’s increasing desire for mobility. And the sunk cost of old networks aside - new wireless networks are likely to be cheaper to establish and operate than fixed networks.

In the longer term, technological developments in wireless may affect the judgement of what is and what is not an ‘enduring bottleneck’, as new wireless technologies may start to substitute in whole or in part for fixed networks.

It is in spectrum that the greatest prize for Europe may lie in the Framework Review now underway. The key is liberalisation across Europe. That is, making as much spectrum as possible available on terms of service and technology neutrality in place of the old command and control approach of picking applications and technologies for each spectrum band.

Taken together with a clear signal at EU level that licences should permit secondary trading, this approach could unlock the potential of the European single market, allowing operators and equipment sellers to harmonise through the market around the strongest and most effective technologies. Such an approach would be likely to enhance further the economic value of the 350 or so megahertz below the 3 GHz band that we aim to release to the market over the next three years or so.

Of course there are significant issues of transition. We do not start with a clean slate. We need to make sure that as liberalisation is extended it genuinely promotes competition rather than allowing incumbent firms to preclude it. And, as we move towards market mechanisms we need to make sure that there continue to be ways of ensuring that public policy goals like defence or universal service can be met, and that this is done in the most efficient way possible.

We have been applying our new approach to the high-value spectrum that will be released by digital switchover - the so-called digital dividend. Many organisations have claimed that they should be given privileged access to this resource on the grounds that they will deliver social value. We have looked at their case, and will continue to do so. But we are not so far persuaded that there are over-riding public policy needs that could only be met by allocating spectrum.

Content and Platforms

I have spoken so far about the technologies for delivery rather than about what is delivered – content – which is, after all, a key if not the key consumer benefit from convergence. The challenges for the market are two-fold:

On both of these questions we are at a point of uncertainty and transition. The growth areas in new media have been user generated content, social networking and the convenience factor of time-shifting for the brand and user extension, mainly of our public service broadcasters, through Podcasts and variants of the i-Player. The main beneficiaries in financial terms have been the successful aggregators of this content – Facebook, YouTube and Google.

Beyond these, what works well on traditional media – premium content – continues to work well, differently sliced and diced, in the new world. There may come a time when the acquisition of such content is as critical in the new world as it was in the old linear broadcasting world. A competition regulator might have some concern if access to such content were monopolised and that monopoly used to leverage a dominance in the old world to dominance in the new. But that is quite a high hurdle. The fact that IPTV may be slower to take off in this market and some other European markets than say the USA or Far Eastern markets may have more to do with the relative maturities of the Pay TV market and the strength of the free-to-air offering than it has to do with any consumer detriment.

Over the longer-term the question those interested in regulatory or public policy need to ask is ‘Why and for how long should differential platform regulation continue?’ To be sure there have been differences of history about how we have got to where we have on fixed or mobile, cable, satellite or terrestrial. But convergence will increasingly blur the distinctions between those platforms. The AVMS Directive marks a sensible start in that direction for content regulation; though it is a staging post on the journey not stable end-point. It sensibly recognises the place of co- and self- regulation. But longer-term we may need to look beyond that to what has been called “self-organised regulation” – peer regulation by those communities who use the content. The internet’s equivalent of de Tocqueville’s communities of active citizens.

This is a challenge but not an impossible ideal. Wikipedia is a start in that direction: the iterative community process essential to self-organising regulation; coupled with technology-led universal and usable tagging meta-data so that the user always knows what they are getting. And can trust it or not, use it or not, filter it or not, as we choose. Regulation will be democratised. The invisible hand can work for us as citizens, as well as consumers.

It may be, for some time to come at least, that terrestrial remains different. It is simply so constrained as a platform relative to the others that access to it will remain special. It is interesting that, first amendment or no, in discussion with the regulator and public policy makers in America there is a sense that the networks are special and should be oases of higher standards of morals, decency and wholesomeness than is found elsewhere.

But for the other platforms, differential regulation is beginning to look increasingly anachronistic.

A half-Schumpeterian Conclusion

There are some commentators who go on from here to argue that all of these platforms and all the players who in one sense or another touch them are all in the same larger market made possible by convergence.

And that we should in consequence stand back from micro-managing regulation, from nit-picking market definitions and let Schumpeterian technology-driven change shape the market in the consumer interest.

I confess, in conclusion, that on this test I am half-Schumpeterian (if one can be and it is not like the logical impossibility of being half-pregnant).

I do not accept that simply because we can put the logos of 20 or so companies on a consultancy PowerPoint slide with some dotted lines between them, they are ipso facto in the same market. There remains an important place in competition economics for careful market definition, aided by trusty old friends like the SSNIP test.

Equally I have some sympathy with the view that, in some of the traditional market definitions in our sector, the grist has been ground exceedingly small. Are Pay TV and Free to Air TV still wholly separate markets any more? Or is the distinction between premium content and the rest?

Are the traditional distinctions in the advertising sales market between local radio and local newspapers still as valid, as local online advertising makes inroads into both?

So competition authorities in our sector should not regard traditional market definitions as Shibboleths. Indeed we may need to be ready to put resource into more frequent market review to ensure that market definition keeps up with the new realities of convergence.

I will conclude with a question and an observation. First, the question: is the hurdle to Schumpeterian innovation higher where the bottleneck is physical than when it is intangible – be it copyright, bundling or software? After all, the Port at the Bay of Naples has been an essential facility through sail to steam to diesel to hydrofoil. Its essence seems immune to innovation and technology change. It seems it would take a Vesuvian eruption rather than a Schumpeterian gale to shift it.

In our sector is the ‘Last Mile’ or last few hundred yards in the same category?

Lastly, an observation: there are very few if any regulatory actions that do not have at least some unintended consequences. Perfect competition as an outcome is a mirage: competition is instead a process by which consumers and producers seek new knowledge to enable the production of new goods or existing goods at lower cost thus enhancing welfare. It is to enable this process rather than towards some micro-managed perfect outcome that regulatory effort should be directed.

And it should be directed with humility: the humility that recognises that innovation rather than regulation is generally what moves the market and consumer welfare forward. It is innovation rather than regulation that has dealt with apparently unshiftable positions of market dominance. It was not the Department of Justice enquiries that ended the dominance of Big Blue. It was an upstart software company called Microsoft. In turn they too came to the competition authorities’ attention with several cases in the USA and in Europe; but what has really shaken them up is an upstart search engine company called Google. In turn Google too are now just beginning to come to the competition authorities’ attention; and no doubt the cycle will repeat itself again.

Our primary job as regulator is to assure the conditions are right to allow such innovation, and from it the price competition and quality that delivers the consumer interest.

Thank you.


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