S.1 This statement and direction sets out a requirement on BT to provide cost oriented backhaul services. Local loop unbundling (LLU) backhaul is a wholesale service which provides capacity between an LLU operator’s (LLUO) equipment at a BT local exchange and an LLUO’s point of interconnection with BT’s network. Backhaul is a component of a wholesale DSL service. It is therefore one of the wholesale network inputs needed for the provision of retail broadband services.

S.2 As part of the consultation, Oftel identified markets for backhaul links, which provide capacity from a local exchange to BT’s trunk network, and backhaul trunk, which provides capacity across BT’s trunk network. Backhaul links form two separate markets: links provided by leased lines (LL) and those provided by Local Area Network extension services (LES). Oftel considers that the markets for LL backhaul links and LES backhaul links are not effectively competitive. Oftel has concluded that the backhaul trunk market is prospectively competitive.

S.3 Oftel has considered the state of competition in the relevant retail and wholesale markets and concluded that LLU will not be fully effective in promoting retail broadband competition unless BT provides backhaul at cost orientated prices.

S.4 Oftel has therefore directed that:

• BT shall provide backhaul to LLUOs on reasonable terms, including cost oriented prices and an appropriate service level agreement. BT shall ensure that the pricing for network elements common to PPCs and backhaul are consistent; and
• fixed compensation payments shall be payable where BT fails to meet its obligations under the service level agreement (SLA).

S.5 External Tie Circuits are required to connect a distant co-location site to BT’s main distribution frame (MDF) at a local exchange. Oftel has considered the competitiveness of this market and concluded that BT has market power in the provision of external tie circuits.

S.6 Oftel has therefore directed that BT should:

• reduce the mark-up included in the charges for external tie circuits to a level no more than that for the external tie circuit pull-through service;
• amend the connection charges for tie circuits to remove the cost of additional planning time, in line with the January 2002 publication Statement and Direction on certain of BT’s charges for Local Loop Unbundling distant and physical co-location;
• amend the rental charges for external tie circuits and the external tie circuit pull-through service to reflect only maintenance costs (equal to 7.43% of the capital value of the tie circuit); and
• remove any replacement cost element from the rental charge for external tie circuits.

2.1 Backhaul provides a capacity that conveys telecommunications services delivered by means of a Metallic Path Facility (MPF), from an LLUO’s co-location site, which is connected to a BT MDF, to an LLUO’s point of connection with BT’s network. There are likely to be various types of backhaul depending on the type of co-location employed by the LLUO, and the type and location of the point of interconnection with BT’s network. LLUOs may choose to self-provide backhaul or purchase backhaul from another Annex II operator. However, Oftel considers that LLUOs will require BT to provide backhaul in most cases (due to the high cost of build required for operator provided backhaul).

2.2 Oftel has specified a range of backhaul products in Annex A. The Director has removed the words "Ethernet presented" from the product definition (h), as set out in paragraph 6 of Annex A of the draft Direction, as he thinks it appropriate not to limit this product type to a specific type of protocol, in order to give greater flexibility of delivery. If LLUOs require alternative products, Oftel expects BT to develop these products provided it is technically feasible and there is reasonable demand.

2.3 In the 17 December 2001 consultation on backhaul services, Oftel defined four retail markets for broadband Internet access: business asymmetric, business symmetric, residential asymmetric and residential symmetric. SDSL leased lines are part of a broader market for low bandwidth leased lines. Oftel has also defined three separate wholesale markets for backhaul: backhaul trunk, local loop (LL) backhaul links and LES backhaul links. These LES backhaul links provide a point-to-point connection and are a form of short-haul data service.

2.4 It is necessary for operators wishing to provide LLU services to purchase backhaul from BT in most cases due to the high cost of build required for operator provided backhaul. Oftel has concluded that the markets for broadband Internet access, LL backhaul links and LES backhaul links are not prospectively competitive, while the market for backhaul trunk is prospectively competitive. Moreover, BT’s market power in LL backhaul links and LES backhaul links means that LLU will not be effective in enabling the development of competitive broadband Internet markets. As this market is not competitive, BT has the ability to charge a price higher than would be possible in a competitive market. Therefore, in the absence of cost oriented backhaul, LLUOs will not be able to compete effectively with BT in the provision of retail broadband services. In order to ensure that LLU is fully effective in promoting competition in broadband Internet access, Oftel has directed BT to provide cost oriented backhaul trunk, LL backhaul links and LES backhaul links as described in Annex B.

2.5 To encourage competition in the market for retail broadband services, it is necessary for operators to be able to compete on an equal footing with BT. If operators were placed at a competitive disadvantage due to BT preferring its own business, this would act as an entry deterrent by disincentivising new operators from entering the market and preventing existing operators from competing on equal terms.

2.7 The Director General considers that backhaul falls within the scope of EC Regulation 2887/2000 on unbundled access to the local loop (the EC Regulation) as a related facility within the meaning of Article 2 of the EC Regulation. He also considers that it falls within Directive 97/33/EC of the European Parliament and Council on interconnection in Telecommunications with regard to ensuring universal service and interoperability through the application of the principles of Open Network Provision (‘the ICD’).

2.8 The ICD defines interconnect as "the physical and logical linking of telecommunications networks used by the same or a different organisation in order to allow the users of one organisation to communicate with users of the same or another organisation, or to access services provided by another organisation. Services may be provided by the parties involved or other parties who have access to the network".

2.9 A telecommunications network is defined as: "transmission systems and, where applicable, switching equipment and other resources which permit the conveyance of signals between defined termination points by wire, by radio, by optical or by other electronic means."

2.10 Trunk, LL and LES backhaul are transmission systems because they permit the conveyance of signals between defined termination points. Consequently, the provision of LLU backhaul falls within the definition of the ICD as two telecommunication networks will be physically and logically linked.

2.11 Under Regulation 6(3) of the Telecommunications (Interconnection) Regulations 1997 (‘the Interconnection Regulations’) (which implements Article 9(3) of the ICD) the Director may, in pursuit of the aims stated in Regulation 6(1) of those Regulations, intervene at any time in order to make a direction specifying issues which must be covered in an interconnection agreement, and to specify conditions that must be observed by one or more parties to such an agreement.

2.12 The aims listed in Regulation 6(1) of the Interconnection Regulations include the need to stimulate a competitive market and the principles of non-discrimination (including equal access) and proportionality. LLU backhaul is needed to allow unbundling of the local loop to be fully effective in enabling competition in broadband services. Effective LLU will help stimulate a competitive market in broadband Internet access. LLU backhaul is also required to ensure that BT is unable to discriminate in the provision of backhaul to itself and other wholesale DSL providers.

2.13 Interconnection for leased lines under Regulation 6(3) of the Interconnection Regulations is provided by BT pursuant to Condition 45.1 of its Licence and as such is a Standard Service (as defined in BT’s Licence). Under Condition 57 of its Licence, BT is prohibited from unduly discriminating or unduly preferring its own business in respect of interconnection. In respect of such services BT is also required to ensure that its charges are cost-orientated (Condition 69.1 of BT’s Licence).

2.14 The Director General’s view is that the appropriate interpretation of the requirement for prices to be cost-orientated cannot be considered in isolation from the extent of competition for the service in question. For example, if the provision of the service in question was effectively competitive or moving towards a competitive market structure then Oftel would be likely to interpret the requirement for cost orientation as meaning any price between the long run incremental cost (LRIC) floor and stand alone cost (SAC) ceiling, subject to any relevant combinatorial and non discrimination tests also being satisfied. However, if by contrast the relevant economic market was not competitive (ie not effectively or prospectively competitive), then Oftel would be inclined to interpret the cost orientation requirement to mean that prices should be set on a LRIC basis with some allowance for common cost recovery. On the other hand, if it appears that market power is not likely to persist, such that effective competition is in prospect, Oftel would generally consider lighter regulation, for example regulation based on the principles of non-discrimination, to be more appropriate.

2.15 The Director General believes that his view on cost-orientation is consistent with the approach taken by the ICD, Recital 10 of which states that:

2.16 The Director General expects BT to set prices in consultation with interested operators within this framework and expects that the price for backhaul link and trunk should be priced on the same basis as PPC terminating segments. Backhaul is a similar product to PPCs and therefore consistency of approach is needed. Oftel's market definitions have reflected the close links between backhaul and PPC products and Oftel considers trunk backhaul and PPC trunk segments to be in the same market. Leased line backhaul links and PPC terminating segments are also defined as being in the same market. The effect of paragraph 4 of the Direction is to ensure that BT's charges for LLU backhaul are consistent with its charges for the elements which are common to PPCs. The Director is currently in the process of resolving a dispute concerning BT's pricing of PPCs. If in resolving that dispute the Director requires BT to alter its prices, paragraph 4 of the Direction will require BT to ensure that its LLU backhaul charges are consistent with the new PPC charges, at that time.

2.17 The interaction of Conditions 45 and 69 of BT’s Licence requires that charges for Standard Services are reasonably derived from the cost of providing the service, based on a forward looking incremental cost approach (except to the extent that the Director considers it appropriate to apply another cost standard). In the event of a dispute, the Director will consider the appropriate cost standard in assessing what would be a cost-orientated price.

2.18 The ICD requires BT to adhere to the principle of non-discrimination with regard to interconnection offered to others. BT must apply similar conditions in similar circumstances to interconnecting organisations providing similar services. In addition BT must provide interconnection facilities and information to others under the same conditions and of the same quality as it provides for its own services, or those of its subsidiaries or partners. As operators rely on BT for the provision of backhaul in the majority of cases, it is necessary that they have a degree of certainty regarding the level of service that BT will deliver. If BT fails to deliver an appropriate level of service to operators, this will detrimentally affect the service that operators are able to offer to consumers. This may act as a disincentive to consumers from taking service from LLU operators. It is important, in order to stimulate a competitive market, that LLUOs can effectively compete with BT. In order to do this they must have guarantees that LLU backhaul will be provided on reasonable terms, including terms for provisioning and repair. BT must, therefore, ensure that the service level agreement (SLA) relating to the supply of LLU backhaul does not, in any way, put an LLUO at a competitive disadvantage.

2.19 It is, therefore, appropriate that the SLA relating to the supply of LLU backhaul includes provision for the payment of fixed compensation, to be payable by BT where it fails to fulfil its obligations under the SLA.

2.20 In October 2001, Oftel completed an investigation into distant and physical co-location charges. The investigation concluded that BT was over-recovering certain costs for distant co-location. On the 18 January 2002, the Oftel Statement and direction on certain of BT’s charges for Local Loop Unbundling distant and physical co-location, (‘the 2002 Statement’) was published. This set out the pricing principles that Oftel expected BT to use when setting charges for both BT and operator provided external tie circuits. The statement stopped short of directing the prices that BT should set for BT provided tie circuits, as important issues relating to the competitiveness of the market for these circuits were under review in the consultation on backhaul services.

2.21 The consultation on backhaul services has concluded that BT has market power in the provision of external tie circuits.

2.22 Article 4(2) of the EC Regulation gives the Director the power where justified to impose changes on the reference offer for unbundled access to the local loop and related facilities. Article 4(3) of the Regulation permits the Director to intervene on his own initiative where justified in order to ensure non-discrimination, fair competition, economic efficiency and maximum benefit for users.

2.23 Cost orientated prices for BT provided external tie circuits are required to ensure competitive prices for external tie circuits, as operator self provide is unlikely to constrain BT’s prices to competitive levels. Cost orientated external tie circuits will stimulate competitive wholesale DSL services, as external tie circuits are required for LLUOs who utilise distant co-location to provide wholesale DSL services.

2.24 The 2002 Statement considered several issues relating to BT’s rental and connection charges for BT provided external tie circuits and the BT pull-through service for OLO provided external tie circuits. The Statement concluded that:

a) BT should not recover the cost of additional site visits caused by LLUO planning mistakes through the connection charges for external tie circuits or the tie circuit pull-through service. Instead, Oftel was of the view that BT should introduce a per-occasion, hourly call-out charge whenever LLUOs’ planning mistakes resulted in BT having to perform extra work;

b) BT should not include a replacement cost element in the rental charges for external tie circuits and tie circuit pull-through service, which should only comprise the costs of maintaining the external tie circuits; and

c) BT should reduce the rental charges for BT provided external tie circuits and for the tie circuit pull-through service to reflect only maintenance costs (equal to 7.43% of the capital value of the external tie circuit). The capital value of the tie circuit is to be calculated by subtracting any mark-up and bad debt provision from the connection charge for the tie circuit.

2.25 As Oftel was still consulting on the competitiveness of the market for external tie circuits in the Backhaul consultation, it was not considered appropriate for Oftel to direct in the 2002 Statement on many of the conclusions in paragraph 2.24, above. The Statement did make clear, however, that Oftel would direct on these issues once the competitiveness of external tie circuits had been decided.

2.26 Given the conclusions of paragraphs 2.21 to 2.23 above and the conclusions of the 2002 Statement, Oftel has concluded that BT should:

a)remove the cost of additional site visits from the connection charges for BT provided external tie circuits;

2.27 The capital cost of an external tie circuit can be calculated by adding together the costs of the store items and labour required to provide that tie circuit. No overheads or mark-ups should be included in the capital cost. Oftel has calculated the capital cost by removing the mark-up, which contains cost elements for bad debt provision and wholesale selling, from the connection charge.

2.28 BT has argued that the capital cost of duct should be included in the capital cost of external tie circuits when calculating the rental charge for external tie circuits. The purpose of the tie circuit rental charge is to allow BT to recover the ongoing costs it incurs in maintaining the tie circuit. Oftel recognises that there may also be costs associated with maintaining duct, but does not believe that it is appropriate for BT to recover these costs through the external tie circuit rental charge.

2.29 The cost of installing duct is charged for on a bespoke basis, separately from the cost of installing an external tie circuit. Oftel therefore believes that if BT wishes to recover its costs of maintaining duct, it should introduce a separate charge. This charge should be cost oriented and take into account factors such as the likelihood of damage to the cable and who any duct is shared with.

2.30 In the 2002 Statement, Oftel advised that it would be seeking a written assessment from BT of the costs and benefits of bringing the co-location project in-house. BT provided this information on 18 April 2002.

2.31 After analysis of BT’s response, Oftel is satisfied that, given current LLU volumes, it is not unreasonable for BT to use external project management. BT currently outsources its own building project work to third parties and, as a result, no longer employs the specialists necessary to handle the LLU project management in-house. Given the current volumes for LLU build, Oftel is satisfied that it is reasonably cost effective for BT to use third parties when they are required, than to employ a specialist in-house team itself on a full-time basis.

3.1 The consultation invited comments from interested parties on a number of issues. Oftel received responses to the consultation from 186K, Alcatel, BT, Bulldog Communications, Cable and Wireless, Easynet, Fibernet, Kingston Communications, NIACT, Thus, VNL and WACT.

3.2 This part of Chapter 3 provides a summary of the views expressed by the respondents in reply to the questions asked as part of the consultation. BT chose not to respond to the specific questions asked as part of the consultation, but instead provided comments on the consultation document as a whole. The issues raised by BT in response to the consultation are detailed later in this chapter.

3.3 Generally respondents recognised that there were close links between PPCs and backhaul. However, Easynet stated that leased lines would not be effective for the provision of backhaul as the key element of backhaul is the connection between MDFs and the LLUO’s own point of presence and that PPCs may not always be the most effective method for such a connection. Other issues were raised (ie requesting the aggregation of backhaul links and permitting LLUOs to specify the configuration of links) and these are addressed later in this chapter.

3.4 Respondents agreed that BT should provide interconnection at all layers of both the SDH and MSH networks. For Oftel’s view on this issue, please see paragraph 3.33 below.

3.5 Respondents saw little need for backhaul bandwidth of less than 2 Mbit/s. One respondent requested that backhaul be offered at 2 Mbit/s and above. The majority of respondents agreed that they would be interested in purchasing bandwidth of 34 Mbit/s and above.

3.6 The respondents generally agreed with the retail and wholesale market analysis set out in the backhaul consultation document.

3.7 Respondents agreed with Oftel’s conclusions on this issue.

3.8 Respondents agreed with Oftel’s conclusions.

3.9 Respondents agreed with Oftel’s conclusions. One respondent provided confidential information on the level of new duct build required for LLUOs for self provided and for BT provided external tie circuits. This supported Oftel’s conclusion that where LLUOs self provide external tie circuits, there is a larger amount of new duct required and higher costs involved than would occur if BT provided these circuits.

3.10 Therefore in light of the above, Oftel has concluded that it should direct BT in the manner summarised in S.4 and S.6, above.

Oftel response:

3.11 The Annex to the EC Regulation contains a minimum list of items, which must be included in a reference offer for unbundled access to the local loop. The inclusion of the word "minimum" in both Article 3 and the Annex clearly demonstrates that this list is not exhaustive. Furthermore, if related facilities only covered those items contained in the Annex to the EC Regulation, there would have been no need to define the term "related facilities" in Article 2 of the EC Regulation.

Oftel response:

3.12 The Director General considers that it is not legally appropriate to import a test under EC competition law in order to define the word "necessary" by reference to case law based on a different legal and economic concept concerning essential facility.

Oftel response:

3.13 As stated in Chapter 2, the Director is not using his powers under the EC Regulation.

Oftel response:

3.14 The Director General has justified his power to intervene under the EC Regulation by reference to the market conditions and the fact that the cost analysis finds that backhaul will be a material cost element in the provision of broadband Internet and data services. Both these factors are set out and discussed in Chapter 3 of the consultation document and Chapter 2 of this explanatory memorandum. Nonetheless, for the reasons set out on Chapter 4 of the consultation document and Chapter 2 of this explanatory memorandum, the Director is not intervening pursuant to the EC Regulation, but under the Interconnection Regulations.

Oftel response:

3.15 The information contained in paragraph 3.28 of the consultation document is confidential. This information merely confirms the analysis set out in the proceeding paragraphs, that LLU backhaul represents a significant cost component of providing wholesale DSL services. The analysis on which this conclusion is based is clearly set out in the consultation document and thus allowed ample opportunity for BT and other parties to comment.

Oftel response:

3.16 The legal basis for intervention under the ICD is set out in Chapter 2.

Oftel response:

3.17 The Director General has not confused the definition mentioned in paragraph 4.6 of the consultation document with the definition of a leased line. The definition of a telecommunications network, upon which the statement in paragraph 4.5 is based, is to be found in Article 2(1)(c) of the ICD.

3.18 Furthermore, it should be noted that interconnection, as defined by the ICD, includes the physical and logical linking of telecommunications networks used by the same or a different organisation in order to allow the users of one organisation to communicate with users of the same or another organisation, or to access services provided by another organisation (emphasis added).

Oftel response:

3.19 The EC Regulation (at Article 3) states that notified operators shall meet "reasonable" requests for unbundled access to the local loops and related facilities. Paragraph 4.8 of the consultation document seeks only to clarify Oftel’s interpretation of what a "reasonable" request for backhaul services might be. BT retains the ability to refuse a request on the basis of objective criteria relating to technical feasibility or the need to maintain network integrity. The guidance set out in paragraph 4.8 would in no way prevent BT from refusing to provide backhaul on these grounds.

Oftel response:

3.20 Article 9(3) of the ICD, as implemented by Regulation 6(3) of the Interconnection Regulations, allows the Director General to intervene at any time in order to make a Direction. Where an agreement already exists, and there is no dispute, the Director may only in exceptional circumstances make a direction for changes to be made to an interconnection agreement.

3.21 There is currently no agreement between BT and the OLOs concerning the wholesale provision of LLU backhaul. The Director is, therefore, not proposing any changes to be made to any existing interconnection agreements. Consequently, there is no requirement in this instance to show that this is an exceptional circumstance. The Director can intervene pursuant to the aims stated in Regulation 6(1) of the Interconnection Regulations and as set out in this explanatory memorandum and the Direction (in particular, the need to stimulate a competitive market and the principles of non-discrimination, including equal access, and proportionality).

Oftel response:

3.22 Oftel recognises there is evidence of a higher level of market entry in Central London and possibly other metropolitan areas than elsewhere in the country. However, for the following reasons Oftel does not consider it appropriate to define a separate market for Central London LLU backhaul:

• the boundaries of Central London would be difficult to accurately define, since they are blurred and are subject to change over time; and
• it is not clear that the extent of competition across Central London or other metropolitan areas is similar across the whole area. Notably, some parts of Central London are still not subject to competitive pressures. This is illustrated by a number of LLUOs having reported the existence of sites in Central London at which there are no alternative (to BT) providers of backhaul.

Oftel response:

3.23 Oftel’s initial conclusions (set out in the December 2001 consultation) were based on the information that was available to Oftel at that time. Oftel has since updated its analysis, as outlined in its final version of the Phase 1 Direction to resolve a dispute concerning the provision of Partial Private Circuits, which was published on 14 June 2002, (‘the PPC Phase 1 Direction’). Oftel’s conclusions remain unchanged by the new data.

Oftel response:

3.24 Updated revenue and volume figures, together with an explanation of Oftel’s rationale behind its choice of market share data, are provided in the final version of the PPC Phase 1 Direction.

Oftel response:

3.25 Please see Oftel’s response at paragraph 3.22 above.

Oftel response:

3.26 Oftel recognises that LLUOs retain the ability to supply their own external tie circuits. However, BT has an existing network of duct, whereas other operators will have to dig new duct to self provide new circuits. There will be significant sunk costs for other LLUOs to self provide a tie circuit network equivalent to BT’s, creating barriers to entry in this market. This gives BT market power in the supply of external circuits.

Oftel response:

3.27 LLUOs cannot use distant co-location without an external tie circuit. Whether substitutes exist for external tie circuits will depend on whether viable alternatives to distant co-location are available to LLUOs. A possible alternative is physical co-location. Oftel does not consider that physical co-location is always a viable substitute to distant co-location, as it may have significant disadvantages over distant co-location, for example:

• there may be a lack of space at the physical co-location site; and
• LLUOs will have less control over costs at a physical co-location site.

Therefore, physical co-location and internal tie circuits will not constrain the prices of external tie circuits at distant co-location sites. Accordingly, it would be inappropriate to define internal and external tie circuits as being in the same market.

Oftel response:

3.28 Oftel has not suggested that BT use its existing metallic access network to supply external tie circuits but, rather, the network of duct that the circuits sit in. Given that BT’s access network is not used to provide the external tie circuits, BT’s concerns about the ANFP are unfounded.

Oftel response:

3.29 As outlined at paragraphs 3.12 and 3.13 above, Oftel does not consider that the EC case law concerning essential facility is relevant in this instance.

Oftel response:

3.30 Oftel is surprised at BT’s claim that it does not include a mark-up on external tie circuits. BT has previously provided a spreadsheet to Oftel, which clearly indicates that a mark up is included. Oftel recognises that there is some justification for including a mark-up to cover actual and reasonable costs such as wholesale and bad debt costs, which would not otherwise be recovered. However, there is no justification for including an additional mark-up, which is not related to or intended to recover costs. Consequently, Oftel believes that BT should reduce its mark-up so that it is no higher than that for the tie circuit pull through service.

Oftel response:

3.31 As expressed in its January 2002 Statement, Oftel is of the view that BT should not recover the cost of replacing an external tie circuit through the rental charge for that circuit. The rental charge should only cover the cost of maintaining the external tie circuit. Oftel rejects BT’s claim that it should not be obliged to maintain an external tie circuit after a certain point in its life. Given that the rental charge covers the cost of maintaining the external tie circuit, BT should be obliged to maintain the circuit for the period that the rental charge is levied. If the circuit is in need of replacement then a new circuit should be installed and the appropriate charges levied.

Oftel response:

3.32 Oftel understands that this request is based on the desire of operators to ensure resilience. Backhaul links, like PPCs, are available with or without resiliency and so it is already possible for operators to achieve this requirement. Oftel does not consider a direct link between two MDF sites to be compatible with the ICD, as there would be no linking of networks.

Oftel response:

3.33 Oftel agrees with the respondent’s view that permitting operators to interconnect at all layers of BT’s network would enable operators to have a greater degree of flexibility in planning their own network build. This approach would be consistent with the methodology set out in the consultation on PPCs. Accordingly it is Oftel’s view that BT should make wholesale backhaul services available at any point on its network.

Oftel response:

3.34 The Direction accompanying this explanatory memorandum requires BT to provide backhaul circuits and refers to the provision of a ‘transparent transmission capacity’. Oftel has not specified the type of traffic (eg voice) that can be transmitted and as such, this is a commercial decision for the operator concerned.

3.35 In relation to the request for <2Mbit/s services, Oftel has obtained the views of interested parties (see paragraph 3.5 above). Operators stated that in general, they would only be interested in purchasing bandwidth of 2 Mbit/s and above. Oftel considers that it is unlikely that a backhaul service of less than 2 Mbit/s would be required, even were operators to have relatively low volumes of customers at each DSLAM. Therefore, it is not considered appropriate to require BT to provide bandwidth of <2 Mbit/s.

3.36 Operators are able to transmit ATM traffic over backhaul once suitable equipment has been installed. The decision whether or not to install such equipment is the commercial decision of the operator concerned.

Oftel response:

3.37 BT needs to be able to monitor and manage network provided services such as backhaul and can only do this by terminating services on BT provided equipment and using appropriate connection to BT’s network management resources.

Oftel response:

3.38 BT is required to provide backhaul links from co-location sites to a point of connection. With this arrangement it is possible for operators to receive multiple backhaul links over a single point of connection. However, where BT is providing multiple backhaul links it should utilise its network in such a way as to minimise costs and charge the operators accordingly.

Oftel response:

3.39 Oftel understands that it is very unlikely that an MDF would not be on an SDH node. Oftel has imposed a requirement on BT to provide wholesale backhaul services at a cost oriented price. It has not prescribed how BT should deliver these services to operators, whether using SDH or alternative technology. Therefore, the issue of whether or not an SDH node is at an MDF site will not impact on BT’s ability or obligation to provide a backhaul service.

Oftel response:

3.40 Under the Network Information Planning Principles (NIPP) BT is required to publish a description of its network structure to those holding licences under Section 7 of the Telecommunications Act 1984 and those who have formally applied for such a licence. As such, it is not considered to be appropriate to impose a further requirement on BT to provide this information.

Oftel response:

3.41 Oftel’s reasons for limiting its assessment to the provision of broadband services are set out in Annex B.

Oftel response:

3.42 Oftel assessed BT’s market power in the backhaul links and trunk markets for the UK as a whole. Oftel found that the market for backhaul links is not effectively competitive and that the market for backhaul trunk is prospectively competitive.

3.43 Oftel acknowledges that the degree of competition varies by area. However, due to the difficulties of defining boundaries and the fast pace at which boundaries are likely to change, such an approach is rarely practicable. Additionally, in areas where more intense competition is observed, it is not clear that this competition is uniform across the whole of these areas. Oftel has therefore concluded, on the grounds of a lack of evidence and on the grounds of practicability, that a regional split of the backhaul market is not justified.

3.44 The main determinant of competition is the level of expected traffic density. Therefore the degree of competition is more likely to vary by metropolitan and non-metropolitan areas rather than by whether the location is in England or Wales.

Oftel response:

3.45 Oftel does not wish to instruct BT which technology it should use to provide particular services. Oftel has recently directed that BT should trial an SDSL ATM interconnect service if requested to do so.

Oftel response:

3.46 Oftel does not need to take a view on this for the purposes of resolving this issue.

Oftel response:

3.47 On SDSL see 3.45. This is a leased line issue and will not be dealt with under backhaul.

Oftel response:

3.48 Oftel agrees and considers BT to have market power in the supply of external tie circuits and that the market is not effectively competitive.

Oftel response:

3.49 Oftel has analysed BT’s market power and considered options for regulatory intervention on a consistent basis for both ATM interconnection and LLU backhaul. Chapter Four of the ATM interconnection explanatory memorandum explains how Oftel reaches a view on whether retail minus or LRIC plus prices may be appropriate for any regulated product and in particular sets out the reasons why Oftel set charges on a retail minus basis for ATM interconnect.

Oftel response:

3.50 Oftel recognises that backhaul is a similar product to PPC and that consistency of approach is needed. For this reason Oftel issued the LLU backhaul consultation document on the same day as Phase 1 of the PPC draft Direction.

3.51 Oftel’s market definitions reflect the close links between the backhaul and PPC products. Oftel considers trunk backhaul and PPC trunk segments to be in the same market. Leased line backhaul links and PPC terminating segments are defined as being in the same market. In the Phase 1 PPC Direction, Oftel defined two terminating segments markets – low and high bandwidth. This is not inconsistent with Oftel’s single market definition for backhaul links, as these are effectively only available at high bandwidths.

Oftel response:

3.52 Oftel is of the view that where co-location is delivered on time but backhaul is not, then if the LLUO suffers loss as a result of the late delivery of backhaul, it should be able to claim fixed compensation under the SLA.

Oftel response:

3.53 Oftel does not believe that a requirement to provide cost orientated backhaul services would lead to a reduction in the range of retail data services offered by BT. The extent of retail products offered is a commercial decision for BT. Anyone adversely affected by the withdrawal of a BT product would retain the option of approaching Oftel to request that the issue be investigated.

Oftel response:

3.54 Oftel does not consider this issue relevant as the LLU backhaul Direction specifies products whereas BT offers its PPC products following the negotiations pursuant to the PPC Direction in March 2001.

Oftel response:

3.55 Oftel does not consider this measure to be necessary. Once the Direction has been imposed, BT is obliged to comply with it. Anyone who believes that BT has not fully complied with the provisions of the Direction retains the ability to approach Oftel and ask that any alleged non-compliance be investigated.

Oftel response:

3.56 Oftel considers that the pricing of BT Egress should be on a cost oriented basis. BT has confirmed that it considers the current pricing of BT Egress to be compliant with this requirement. As such, it is not considered to be necessary to explicitly include BT Egress in the final backhaul Direction. BT Egress is an LLU product and Oftel expects it to be priced in accordance with the LLU pricing principles. BT claims that it is and Oftel has received no information or assertions to the contrary.

Oftel response:

3.57 Condition 47 of BT’s licence sets out the price notification periods that must be given before any changes in BT’s charges can take effect. Oftel considers that a notice period in excess of the requirements of Condition would not be proportionate or necessary in this instance.

ATM service: data services using Asynchronous Transfer Mode technology, such as BT’s Cellstream service or Energis’s Cellconnect.

Bandwidth: the physical characteristic of a telecommunications system that indicates the speed at which information can be transferred. In analogue systems, it is measured in cycles per second (Hertz) and in digital systems in binary bits per second (bit/s).

Copper or metallic line: the main transmission medium used in telephony networks to connect a telephone or other apparatus to the local exchange. Copper lines have relatively narrow bandwidth and so have limited ability to carry broadband services such as video unless combined with an enabling technology such as ADSL.

De-averaging: the move from a single averaged tariff or charge to separate ones based on differing geographical areas or types of service.

Digital subscriber line access multiplexer (DSLAM): it is located in the co-location space of an operator at an exchange site. It is composed of a multiplex and the DSL modems necessary to operate DSL services over the loops served by the LLUO from the exchange.

Digital Cross Connection node: A node in BT's Private Circuit network where circuits at 64kbit/s and below can be cross-connected between differing 2Mbit/s tributaries.

Digital Junction Switching Unit (DJSU): a tandem switch used to connect between DLEs in the London area.

DLE (Digital Local Exchange): the telephone exchange to which customers are connected, usually via a concentrator.

DMSU (Digital Main Switching Unit): connects calls between DLEs and also other DMSUs and form the backbone of the trunk network.

Geographically averaged prices: prices established by averaging the costs of network elements across the country so that customers in different areas of the country do not pay different rates.

Incremental costs: the capital and operating costs that arise as a result of the provision of the ‘increment’. In contrast to fully allocated costs, the incremental costs include only those costs that are caused by the provision of the increment.

Internet: a global network of networks, accessed by users with a computer and a modem via a service provider.

Internet Protocol (IP): a set of instructions describing how to address and transfer information across a network. The Internet is a public network consisting of many interconnected IP networks.

Leased line: a permanently connected communications link between two premises dedicated to the customers’ exclusive use. Also known as a private circuit.

Local loop: the access network connection between the customer’s premises and the local PSTN exchange, usually a loop comprised by two copper wires.

Long-run incremental cost (LRIC): the cost avoided through no longer providing the output of a defined increment. For example, the cost of call conveyance is the cost which would be saved in the long run if this service were no longer provided

Mbit/s: Mega (million) bits per second. A measure of the speed of transfer of digital information.

PPC: a generic term used to describe a category of private circuits that terminate at a point of connection between two operators’ networks. It is therefore the provision of transparent transmission capacity between a customer’s premises and a point of connection between the two operators’ networks. It may also be termed a part leased line. It includes terminating segments.

Plesiochronous Digital Hierarchy (PDH): an older method of digital transmission used before SDH which requires each stream to be multiplexed or demultiplexed at each network layer and does not allow for the addition or removal of individual streams from larger assemblies.

Public Switched Telephone Network (PSTN): the complete network of interconnections between telephone subscribers.

RCU (Remote Concentrator Unit): The lowest level of BT's PSTN hierarchy. Customer lines, which are generally copper wires, are concentrated/multiplexed and routed to a DLE.

Synchronous Digital Hierarchy (SDH): a method of digital transmission where transmission streams are packed in such a way to allow simple multiplexing and demultiplexing and the addition or removal of individual streams from larger assemblies.

Symmetric Digital Subscriber Line (SDSL): a technology that allows the use of a metallic line to send a large quantity of data in both directions.

Terminating segment: A terminating segment is capacity between a customer’s premises and an operator’s point of connection at Tier 1 of BT’s SDH network.

Video-on-demand: a programme or film sent independently to a customer in response to his individual request. This contrasts with broadcast television, which is sent simultaneously to all customers able to receive it.

A.1 BT’s SDH network is arranged in three main tiers. The tier structure relates to the capacity of the nodes and interconnecting transmission paths. The network comprises a top layer mesh of around 60 Tier 1 nodes, situated in trunk buildings which usually also accommodate a BT trunk tandem switch (DMSU, DJSU or WAT). Subordinate to the Tier 1 mesh are Tier 2 rings. Tier 2 nodes (around 600 in number) are situated in buildings in towns and cities that usually have either a trunk tandem switch or a DLE. Subordinate to Tier 2 rings are Tier 3 rings. Tier 3 nodes (around 1000 in number) are mainly situated in buildings housing local concentrators. Other serving exchanges for private circuits connect to Tier 3 nodes using Plesiochronous Digital Hierarchy (PDH) transmission.

A.2 However, many Tier 2 rings are physically remote from the Tier 1 mesh, so an intermediate set of rings, known as ‘supersets’, connect the remote Tier 2 rings to the Tier 1 mesh. The Tier 2 nodes that are situated on the supersets are sometimes referred to as Tier 1.5 and these can be considered as an intermediate layer in the hierarchy, where they exist. There are around 100 such nodes.

A.3 BT has an extra tier-less overlay network called the Marconi Synchronous Hierarchy (MSH) network. This is a broadband SDH network that BT uses to switch at 622 Mbit/s. This network carries circuits at 622 Mbit/s to 2.4 Gbit/s. BT has around 120 MSH A nodes and around 700 MSH B nodes. Products (f) and (g) below (see paragraph A.6), which relate to the higher bandwidth backhaul (622Mbit/s to 2.4Gbit/s), connect across BT’s MSH network.

A.4 Customers may be connected to any of the tiers. For example customers could be connected to Tier 2, 1.5 or Tier 1 nodes for the provision of circuits at 2 Mbit/s and above.

A.5 Oftel recognises that LAN extension services (LES) can be used for backhaul instead of an SDH based transmission medium. This service provides a point-to-point fibre connection. There is no use of SDH as the underlying transmission medium. A customer sited handover is proposed for LES, as an In Span Interconnection (ISI) is not considered to be practical at this stage. This is because an ISI handover of LES would involve the Licensee providing a portion of the LES circuit handing over In-Span via a fibre splice. Many LES circuits have end-to-end network management and, thus, it would not be possible to provide suitably managed LES via ISI. There could also be problems with the splicing of different types of fibre. Oftel will consider interconnection issues associated with provision of LES circuits in the forthcoming determination on LES circuits as part of the Phase II PPC determination. LES backhaul links will be limited to a radial distance of less than 25 km due to the nature of the product.

A.6 The Direction in Annex D, below, requires BT to offer to enter into an agreement to provide the following backhaul circuits: the provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive), between a LLUO’s equipment at a Licensee’s MDF site and a point of connection with an LLUO’s Applicable System connected to the nearest appropriate Licensee SDH node to the customer. Such node could be a Tier 3, Tier 2, Tier 1.5 or Tier 1 node;

a) the provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive), between a LLUO’s equipment at a Licensee’s MDF site and a Point of Connection with an LLUO’s Applicable System connected to the nearest appropriate Licensee SDH node to the customer which is superior in the hierarchy to the node defined in (a) above, where such node exists. Such node could be a Tier 2, Tier 1.5 or Tier 1 node;

b) the provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive), between a LLUO’s equipment at a Licensee’s MDF site and a point of connection with an LLUO’s Applicable System connected to the nearest appropriate Licensee SDH node to the customer which is superior in the hierarchy to the node defined in (b) above, where such node exists, and which could be a Tier 1.5 or Tier 1 node;

c) the provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive), between a LLUO’s equipment at a Licensee’s MDF site and a Point of Connection with an LLUO’s Applicable System connected to the nearest appropriate Licensee SDH node to the customer which is superior in the hierarchy to the node defined in (c) above, where such node exists, and which is a Tier 1 node;

d) the provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive), between a LLUO’s equipment at a Licensee’s MDF site and a point of connection with an LLUO’s Applicable System connected to any Licensee SDH Tier 1 node;

e) the provision of transparent transmission capacity by the Licensee, at all bandwidths from 622 Mbit/s to 2.4 Gbit/s (inclusive), between a LLUO’s equipment at a Licensee’s MDF site and a point of connection with an LLUO’s Applicable System connected to the nearest appropriate Licensee MSH node to the customer;

f) the provision of transparent transmission capacity by the Licensee, at all bandwidths from 622 Mbit/s to 2.4 Gbit/s (inclusive), between a LLUO’s equipment at a Licensee’s MDF site and a point of connection with an LLUO’s Applicable System connected to any appropriate Licensee MSH node; and

g) the provision of dedicated transmission capacity by the Licensee, at all bandwidths from 10 to 1000 Mbit/s (inclusive), between a LLUO's equipment at a Licensee’s MDF site and a site within an LLUO's Applicable System connected to an appropriate Licensee node within a distance of 25 radial km.

B.1 This annex presents a detailed discussion of Oftel’s understanding of the retail and wholesale markets relating to LLU backhaul and an assessment of BT's market power in these markets.

B.2 There are two dimensions to the definition of a relevant market: the relevant products to be included in the same market and the geographic extent of the market(s). Oftel's approach to market definition follows that used by UK competition authorities (please note this link will take you to the Office of Fair Trading website) and is in line with those used by European and US competition authorities. Market boundaries are determined by identifying constraints on the price-setting behaviour of firms. There are two main competitive constraints to consider: how far it is possible for customers to substitute other services for those in question (demand-side substitution); and how far suppliers could switch, or increase, production to supply the relevant products or services (supply-side substitution) following a price increase.

B.3 The concept of the 'hypothetical monopolist test' is a useful tool to identify close demand-side and supply-side substitutes. A product is considered to constitute a separate market if a hypothetical monopoly supplier could impose a small but significant, non-transitory price increase without losing sales to such a degree as to make this unprofitable. If such a price rise would be unprofitable, because consumers would switch to other products, or because suppliers of other products would begin to compete with the monopolist, then the market definition should be expanded to include the substitute products. However, the relevant market is not necessarily the smallest that it is possible to define using the hypothetical monopolist test. It may be appropriate to include in the relevant market, a number of products (or areas), in the supply of which competitive conditions are homogeneous.

B.4 Firstly retail markets will be defined and then wholesale markets will be considered in relation to downstream retail markets. This approach is followed, as the definition of a retail market is likely to affect the assessment of whether market power in a related wholesale market exists. For example, the breadth of a retail market may determine whether a provider of wholesale services has market power in the wholesale market.

B.5 The relevant wholesale market will generally be as broad as the relevant retail market. For example, there are two different retail services, one of which is provided using wholesale input A and the other using wholesale input B, perhaps using entirely different technologies. If the two retail services are sufficiently close substitutes to compete in the same retail market the relevant wholesale market will usually include both A and B. So, even if there was a sole supplier of A, say, this might not be sufficient to establish that upstream power existed.

B.6 A complexity is that the same wholesale input might be used in the supply of a range of retail services, which compete in different retail markets. Some of the retail services might compete in markets that only included other retail services provided using similar wholesale services. In such cases, the appropriate wholesale market definition would be relatively narrow.

B.7 Oftel acknowledges that the industry is changing rapidly and accepts that market definition might also change overtime. Whenever possible, likely future developments of the industry are considered in order to assess the magnitude of some of the changes that may occur.

B.8 Oftel considers that the key products available over unbundled local loops are broadband Internet access, leased lines and video on demand (VOD). Internet access, leased lines and VOD are different products with different features and may form part of separate markets ie VOD is not likely to be a substitute for Internet access or vice versa. Hence the market definitions will begin from the premise that these products are part of separate markets. Firstly, broadband Internet access will be considered and then, leased lines and VOD.

B.9 Internet access via DSL enabled copper fibre has three distinguishing features which are not available in practice on PSTN and ISDN Internet access. It is fast (because of higher bandwidth), it is always on (ie no dial up required) and it allows content (eg music clips, video clips) which are not practically available with narrowband access. DSL Internet access differs from leased line or fixed link Internet access in that it is asymmetric and it usually has contended backhaul. For a discussion of the definition of the narrowband Internet access market, see Oftel’s effective competition review of dial-up Internet access, January 2002.

B.10 Oftel research suggests that 89% of residential users of the Internet use dial-up narrowband access (May 2002), while research on SMEs suggest that 55% used dial-up narrowband access (May 2002). When the research information on the SMEs is broken down between small and medium businesses, 56% of small businesses and 31% of medium businesses used dial-up narrowband. The next most popular means of accessing the Internet was ISDN, 54% of medium businesses, 35% of small businesses and only 3% of residential users used ISDN to access the Internet. Leased lines were used to access the Internet by only 11% of medium business, and only 3% of small business. Broadband (DSL/Cable modem) Internet access is used by 9% of small businesses and 17% of medium businesses. This data sums to greater than 100%, as some business customers use more than one means of accessing the Internet. The Oftel research suggests that dial-up narrowband access is currently the most important means of accessing the Internet for residential users and small businesses and an important means of access for medium size businesses.

B.11 A first issue arises when making a distinction between narrowband and broadband products: can they be seen as being part of the same market, or as being separate markets? For the purpose of the market analysis, Oftel defines broadband as always-on Internet access above 128 Kbit/s and narrowband as Internet access at up to and including 128 Kbit/s. Although BT’s ADSL price reductions in April 2002 mean that the price differential between narrowband and broadband access has reduced, Oftel still considers it to be large enough for the two products to be in separate markets. The price of flat rate PSTN dial up narrowband Internet access is about £12-15 per month, whereas the cheapest DSL broadband Internet access is around £20 to £35 per month and the cheapest cable modem broadband Internet services are available for £25 to £35 per month. In addition, the set-up costs for broadband Internet access are considerably higher than for narrowband access. Equipment and connection charges for broadband range from £55-£120, whereas narrowband Internet equipment starts from as little as £15-£20.

B.12 The definition of the market or markets for Internet access may be dependent on whether the starting point is narrow or broadband access (for more information on asymmetric substitutability, please refer to the OFT's Guideline, Market Definition, OFT 403, March 1999). It is possible that broadband access may constrain the prices of narrowband access, but narrowband access may not constrain the price of broadband access. Technological development often results in the introduction of higher quality, technologically more sophisticated products in technology-intensive industries. In such situations, it is reasonable to believe that the price of the lower quality product is increasingly constrained by movements in the price of the higher quality product. This is on the basis that it is likely that sufficient customers will have a willingness to pay for higher quality that is greater than the cost differential. A monopoly supplier of narrowband access may find it unprofitable to raise its prices significantly as consumers would be increasingly encouraged to switch to the high quality high speed product. However, the opposite might not be true as sufficient broadband users are likely to attach a relatively high value to the higher quality product which relates to the specific functionalities that the product has and that cannot be provided by the narrowband product. Hence, from the viewpoint of broadband access, broad and narrowband access may form separate markets.

B.13 It might also be the case that there exist two distinct groups of customers, those with a high willingness to pay for the functionality offered by high-speed Internet access and those with a relatively low willingness to pay. In these circumstances it might be that neither high- nor low-speed products would provide a competitive constraint on the pricing of the other for these groups of customers. High- and low-speed Internet access products could thus form separate economic markets when considering either set of products.

B.14 Consumers’ valuations of high-speed products may change over time, as the more widespread availability and the lower prices of high-speed access translates into the supply of new products which could not be offered otherwise. The change in valuation implies that if broad and narrowband were part of the same market at present, this may well change. It is likely that in the future consumers’ valuation of high-speed products will be increasingly greater, as awareness and expectations adjust to the more widespread availability of high-quality products. A monopolist who provides high-speed products would then be in an increasingly better position to retain its customers following a non-transitory price increase, since the valuation consumers would attach to high-speed products is likely to exceed the cost differential plus the price increase. In other words, they would become so used to the quality/services that they would need a much larger price differential in order to be induced to switch to low-speed access. This would imply that, when considering high-speed products, the markets for low- and high-speed Internet access would be separate, provided supply-side substitution does not constrain the hypothetical monopolist of high-speed access. Supply side substitution is considered further below.

B.15 A further difference between ISDN and PSTN Internet access and broadband technologies, such as DSL and cable modem, is that ISDN and PSTN are dial-up technologies. Dial-up access is less convenient than always on access in that it requires the user to dial-up whenever access is required. Consumers may therefore be prepared to pay more for always-on services. In this case, the availability of competitive dial-up access may not constrain the prices of always-on access to competitive levels.

B.16 In light of the differences in speed, expected future developments in broadband content and the convenience of always-on connections compared with dial-up access, Oftel considers that the availability of competitive PSTN and ISDN Internet access will not constrain the price of broadband Internet access such as DSL to competitive levels.

B.17 There are a variety of technologies for providing always-on broadband Internet access: DSL, cable modem, leased lines and fixed link access. Fixed links and leased lines provide a dedicated capacity between a customer and an ISP, however fixed links differ from leased lines in that they may be switched and need not provide a capacity when not in use. These differences are likely to result in fixed link having a lower cost compared with an equivalent leased line. Moreover, there are significant differences between DSL and cable modem Internet access and leased line and fixed link Internet access. Leased lines and fixed link Internet access provide symmetric access ie the same capacity upstream as downstream and they also provide uncontended backhaul services ie users do not share backhaul capacity. It is possible to provide symmetric and uncontended Internet access using SDSL (although such a product is not currently available), however leased lines and fixed links cannot be provided as contended and asymmetric access. As set out in the market analysis in Chapter Three of the consultation document, the level of contention in the backhaul element has a significant impact on cost. There may also be significant differences between the cost of the DSL enabled local loop and the cost of leased lines local ends.

B.18 These differences suggest that leased lines and fixed link Internet access will have a significantly higher cost than contended and asymmetric DSL and cable modem Internet access. Therefore the availability of competitive leased line or fixed links access is unlikely to constrain pricing of DSL and cable modem services to competitive levels. The ability of an SDSL provider to provide broadband Internet access market depends on wholesale access to DSL technology. Therefore the potential for substitution from SDSL symmetric access into broadband Internet access will not increase the competitive constraints on a supplier of wholesale DSL services by broadening the retail market for Internet access. These differences between DSL and leased lines/fixed links suggest that there may be more than one broadband Internet access market.

B.19 The analysis has so far proceeded on the basis that there is one broadband Internet access market. However, Oftel considers that a number of broadband Internet access markets can be distinguished: business symmetric, business asymmetric, residential symmetric and residential asymmetric broadband Internet access. The needs and willingness to pay for high bandwidth services of residential and business consumers is likely to be quite different. Business users are likely to have greater need for broadband services and lower contention requirements; some businesses are likely to have a greater need for upstream capacity. This suggests that not only may there be separate business and residential markets for broadband access. There may also be a separate market for symmetric and asymmetric Internet access.

B.20 Residential users are likely to tolerate higher contention ratios and have lower bandwidth demands than business users. Oftel research suggests that SMEs have a significantly higher willingness to pay for broadband services than residential users. In an Oftel survey, small businesses indicated they would be willing to pay £66 per month, while medium businesses indicated they would be willing to pay £108 per month. This compares with the figure of around £20 for residential users. Some residential and business users will require higher upload or more symmetric capacity than other residential or business customers. This is because some business customers are likely to make available information and provide customer services on web sites, while some residential customers may require upload capacity for Internet based video games. Business customers are likely to require more bandwidth and lower contention levels than residential customers, as businesses are likely to have a number of users sharing their Internet access and have a lower tolerance of delays than residential customers. Business users are also likely to require a more tailored level of customer support and a higher level of network reliability. These differences suggest that on the demand side, a hypothetical monopolist of business Internet access may profitably sustain prices above competitive levels for business Internet access. This is because business users would not switch to residential Internet access due to its lower speed and quality of service, even if the price of business Internet access were raised above competitive levels.

B.21 It is also likely that a hypothetical monopolist may be able to sustain the price of symmetric broadband Internet access above competitive levels, even where asymmetric broadband Internet access is competitively provided. This is because customers with high upload requirements would not switch from symmetric to asymmetric access, if the price of symmetric access were raised above competitive levels. Equally, the competitive provision of symmetric broadband Internet access may not constrain a hypothetical monopolist of asymmetric broadband Internet access to pricing at a competitive level due to the higher costs of providing symmetric broadband Internet access.

B.22 A chain of substitution may link the business symmetric market to the residential symmetric Internet access and in turn to the asymmetric business market, which could then be linked, to the residential asymmetric market. However it is unclear to what extent these products are currently available and how they will constrain each other’s prices. Therefore, from the perspective of the demand side, Oftel considers that there are four markets for broadband Internet access.

B.23 On the supply side, there is a question as to whether supply side substitution would constrain the ability of a hypothetical monopolist in these markets to raise prices above competitive levels. At a retail level, there are likely to be barriers for a retail provider of residential Internet access moving into the business market. The different level of service required may make it difficult for a supplier of broadband Internet access to residential customers to substitute rapidly into a market for business users. On the other hand, most ISPs appear to supply both business and residential customers, although a few ISPs appear to focus on one group of customers. The top three ISPs were the same for residential customers as for small and medium business customers. While this evidence may suggest that the differences between business and residential customers are not sufficient to make it difficult for an ISP to serve both groups of customers, it could also mean that most ISPs participate in both markets.

B.24 In any case, supply side substitution from one of these markets into any other of these markets will require access to the wholesale broadband services. However the purpose of this market analysis is to determine whether the breath of the retail market will constrain an operator with market power in the provision of wholesale broadband services. The conclusion is that whether or not symmetric business and residential Internet access, asymmetric business Internet access or residential asymmetric Internet access are in the same or separate markets would not limit the exercise of market power in the related wholesale market.

B.25 Oftel has defined four broadband Internet access markets: asymmetric business and residential broadband Internet access and symmetric business and residential broadband Internet access.

B.26 DSL can provide both Internet access and local ends of leased lines. Oftel expects that SDSL (Symmetric DSL) will be used to provide leased lines at bandwidths of up to approximately 2Mbit/s. However SDSL products are not yet widely available in the retail market.

B.27 Oftel considers that uncontended SDSL and leased lines of equivalent bandwidth provide the same service and therefore should be considered to be in the same market. Oftel considers that it is likely in certain circumstances that SDSL will cost less than leased lines provided by other technologies, although there is insufficient evidence to reach a definitive conclusion. If SDSL is a significantly lower cost technology than other means of providing local ends for leased lines, then this may raise issues for the assessment of market power.

B.28 It is possible that this retail product is constrained by the presence of pay TV, pay-per-view, digital TV and video/DVD rentals, usage of video recorder or a combination of these products. For example, a customer may consider video rentals together with video recording of pay TV programmes to be a potential substitute for video-on-demand products. What is less clear is whether these possible substitutes are sufficient to constrain the prices for VOD to the competitive level.

B.29 Unfortunately, meaningful empirical data on the extent to which consumers view these products as substitutes is not currently available, as VOD products are only currently available in the London area and there is relatively low take-up of them. Whilst the extensive libraries and the watch-when-you-want facilities (amongst others) available via VOD retail products are to some extent distinct from the potential substitutes, it is not clear whether they are sufficiently distinct to create a separate economic market. It is thus not possible to conclude whether BT possesses retail market power in the provision of VOD services. As a corollary of this, it cannot be concluded at this stage whether or not BT’s wholesale market power in the provision of backhaul will raise potential issues of leverage into VOD.

B.30 BT’s ability to exercise market power in the retail markets for broadband Internet access will depend whether the related markets for wholesale services are effectively competitive. BT will not be able to exercise market power in VOD if this product is part of broader markets with alternative wholesale supply. In the provision of low bandwidth leased lines, it is unclear what the implications of any market power BT has in the wholesale DSL markets may have for the provision of SDSL leased lines. While from the perspective of the customer, SDSL and other types of leased lines may provide the same service, it is difficult to draw definitive conclusions as to whether SDSL leased lines have a significantly lower cost structure than other types of leased lines. If SDSL leased lines were lower cost than other leased lines, then market power in wholesale DSL services may raise issues for the provision of SDSL leased lines. If LLU was not fully effective in the absence of cost orientated backhaul, BT may not provide SDSL leased lines or raise prices of SDSL leased lines above competitive levels, if PPCs were a higher cost technology than SDSL leased lines. However, if PPC/leased lines have a similar cost structure as SDSL leased lines, there will be no issue of market power given the availability of cost orientated PPCs.

B.31 The wholesale market analysis will define the relevant wholesale markets and consider the extent of BT’s market power in these markets.

B.32 This section considers wholesale market definitions in light of the conclusions on retail market definitions.

B.33 Oftel considers that there are separate wholesale markets for:

• access, symmetric enabled access and asymmetric enabled access;
• LL backhaul/PPC terminating segments and LES backhaul links;
• backhaul trunk/trunk leased lines;
• external tie circuits; and
• co-location space.

B.34 The wholesale services required to provide broadband Internet access are: access (including the local loop), backhaul including both trunk and link, and co-location space. A wholesale DSL provider may also utilise ATM or IP technology on the core network; however, ATM/IP technology is not required for backhaul. BT’s wholesale DSL service provides all of these services as a combined wholesale DSL service to operators and service providers. As noted above, this product provides a competitive constraint on BT’s ability to exercise market power in the retail market for broadband Internet services. Co-location space is not considered in this paper as it has been separately addressed as part of the LLU process (see Oftel’s investigation of BT's non-participation in the Bow Wave Process, the 'non-discrimination complaint’, July 2001).

B.35 Oftel considers that backhaul can be split into two distinct markets, one market for trunk backhaul (beyond the first Tier 1 in terms of the SDH network, broadly equivalent in PSTN terms to inter-tandem transmission) and one market for link backhaul (from MPF up to the trunk network). This market analysis has strong parallels with the market definitions of wholesale leased lines, where separate markets for trunk and segmenting segments have been defined. A detailed discussion of the separate markets for trunk and terminating segments is set out in the Phase 1 PPC Direction (June 2002). In brief, trunk backhaul and link backhaul are complements rather than substitutes, therefore a hypothetical monopolist of backhaul links will be able to raise prices above competitive levels without demand side switching to backhaul trunk. Supply side substitution from backhaul trunk to backhaul link is also unlikely due to the high sunk costs of building backhaul links. Similarly, Oftel believes that trunk backhaul is part of a separate market as trunk backhaul is not a substitute for backhaul link or access.

B.36 In the Phase 1 PPC Direction, Oftel considered that the trunk market was between SDH Tier 1 nodes. In terms of the MSH network (see Annex A, for a description of the MSH network), the trunk segment will lie within the 120 MSH A nodes. Oftel understands that the MSH A nodes are the nodes which receive high traffic volumes and that MSH A nodes are also ATM nodes. It seems unlikely that OLOs will find it economic to build out to all MSH A nodes, as OLO build out is currently limited to not more than 30 to 40 nodes. Oftel considers that the trunk network will be consistent across both MSH and SDH networks, as OLOs will utilise POCs for both MSH and SDH backhaul traffic. Therefore, Oftel has defined the trunk network for the MSH network in parallel with the definition of the trunk for the SDH network. The definition of trunk for the SDH network is at Tier 1, therefore only MSH nodes that are located coincident to Tier 1 SDH nodes are defined as trunk nodes.

B.37 Oftel considers that backhaul trunk is likely to be in the same market as PPC trunk segments, as customers are likely to consider PPC trunk segments to be reasonable substitutes for trunk backhaul and suppliers of PPC trunk segments are likely to be able to easily enter the market for trunk backhaul. This is because both backhaul trunk and PPC trunk segments involve the provision of dedicated capacity within Tier 1 of BT’s SDH network. On the demand and supply side, PPC trunk segments and backhaul trunk are substitutes for each other. Therefore, a hypothetical monopolist of trunk backhaul is unlikely to be able to sustain a price increase above competitive levels, as customers would switch to PPC trunk segments and suppliers of PPC trunk segments would switch into the provision of trunk backhaul.

B.38 A wholesale leased line terminating segment equates to access and link backhaul. Backhaul link and access are likely to form separate markets for the same reason as backhaul link and trunk form separate markets. The products are demand side complements rather than substitutes. On the supply side, an operator who had built out to the concentrator unit (CU) is likely to face significant costs in extending their network to the customer. Therefore a hypothetical monopolist of access would be able to sustain prices above competitive levels, even if backhaul links were competitively provided.

B.39 Oftel considers that access enabled for broadband services is a separate market from access. Enabling access requires an operator to incur significant sunk costs at each local exchange or concentrator to provide the capacity to provide broadband access. On the demand side, narrowband access will not be a substitute for broadband access, as narrowband access does not have a broadband capacity. On the supply side, the sunk costs of enabling access are likely to deter supply side substitution from narrowband access. Enabled access includes products such as cable modem and DSL access. Oftel considers that there are likely to be separate markets for asymmetric and symmetric enabled access related to the retail markets for asymmetric and symmetric Internet access. On the demand side, asymmetric access will not provide a reasonable substitute for symmetric access. On the supply side, it is unclear whether there would be significant cost barriers to switching from asymmetric to symmetric access or vice versa. On this basis, Oftel defines separate markets in asymmetric and symmetric access. There are no related business and residential markets for enabled access, as there are no relevant distinctions between business and residential enabled access.

B.40 There are two backhaul link products: leased line (LL) backhaul links and LES backhaul links. LL backhaul links are links provided using leased line type circuits on BT’s SDH or MSH network. These circuits are not PPCs, as they do not originate/terminate at a customer site, however they do use the same type of network. LES backhaul links are links provided using LES (LAN (Local Area Network) extension services) circuits to connect an operator’s telecommunication equipment at a co-location site with a point of connection. Oftel considers that LES backhaul links and LL backhaul links are likely to be in separate markets, as a hypothetical monopolist of LL backhaul circuits would be able to raise LL backhaul circuits above competitive levels, even where LES backhaul links were competitively supplied. From a customer perspective, LES and LL links may not be good substitutes, as LES links are limited to distances of less than 25 km and are likely to cost significantly less than LL backhaul links. It is unclear whether suppliers of LL links would switch into the provision of LES links in the case of a price increase above competitive levels by a hypothetical monopolist of LES links, due to the differences in the technologies. Even were supply side substitution to occur, in practice it would be unlikely to provide a competitive constraint on BT, as it is the only operator with the ubiquitous network that could potentially supply LES links across the UK. Therefore, Oftel considers LES backhaul links to be a separate market.

B.41 Local Loop backhaul links and PPC terminating segments both involve the provision of dedicated capacity using the same technology from Tier 1 to an MDF site or a end user. From the perspective of a customer, a PPC includes the local end from the MDF site and therefore may not be used to provide capacity from the MDF site to a point of connection. However, a supplier of PPC terminating segments should be able to enter the market for backhaul link, provided it can obtain access into the relevant BT exchange sites. Oftel understands that BT is providing a backhaul egress product that will provide fibre capacity between the OLO’s DSLAM and footway box outside the exchange. This should enable an operator who provides PPC terminating segments to switch into providing LL backhaul link. Therefore, a hypothetical monopolist of LL backhaul links would not be able to sustain prices above competitive levels, due to the ability of a supplier of PPC terminating segments to enter the market.

B.42 A bundled wholesale end-to-end DSL service is not a substitute for any of the individual components discussed above, as purchasing the DSL service necessarily involves buying all the components of this service. Therefore wholesale DSL will form part of a separate wholesale market.

B.43 PPC terminating segments are available at a range of bandwidths, from 64 Kbit/s to 2.4 Gbit/s. In theory LL backhaul links could be purchased at all bandwidths, though in practice operators will only require services at 34 Mbit/s and above. However, it is important to identify the appropriate markets before assessing market power. In the Statement accompanying the Phase 1 PPC Direction, Oftel concluded that low bandwidth terminating segments should be defined as up to and including 2Mbit/s and high bandwidth segments as all those above 2Mbit/s. LES backhaul links are only available at high bandwidths and therefore a distinction between low and high bandwidths is not required.

B.44 The application of the hypothetical monopolist test to segments above 2Mbit/s shows that, in response to a small but significant increase in their price, it is unlikely that either supply side substitution from, or demand side substitution into, low bandwidth segments would take place. On the demand side, low bandwidth terminating segments are not likely to constrain the price charged by a hypothetical monopolist of high bandwidth terminating segments, because of the difference in price, speed and quality between an aggregate of low bandwidth leased lines and a high bandwidth leased line. High bandwidth segments are currently available at bandwidths ranging from 34Mbit/s up to 622Mbit/s (in the past it also was possible to buy 8Mbit/s circuits from BT. Currently no new circuits are provided at this bandwidth. Oftel considers that the existing 8Mbit/s circuits should be included in the high bandwidth market). For a customer using a 34Mbit/s segment, a multiple of 2Mbit/s segments is not a cost effective substitute as the retail rental price of 34Mbit/s leased line is approximately 600% greater than a 2Mbit/s leased line. Therefore, the availability of low bandwidth circuits would not constrain a hypothetical high bandwidth monopolist to maintain competitive prices. This comparison is based on BT’s current prices. These prices may be above the level that would prevail in a competitive market, but Oftel considers that this does not affect the conclusions derived from the comparison because Oftel understands that the costs underlying the provision of terminating segments also reflect significant cost differences.

B.45 Above 2Mbit/s, Oftel considers that there is likely to be a chain of substitution between bandwidths: 34Mbit/s segments are likely to be substitutes for 45Mbit/s circuits, both in terms of capacity, quality and price, 45 Mbit/s are likely to be substitutes for 140Mbit/s or 155Mbit/s, and so on for higher bandwidths. Hence it can be argued that there is chain of substitution that links high bandwidth terminating segments, but that this chain is broken between 2Mbit/s and 34Mbit/s terminating segments, as described above.

B.46 On the supply side, it is necessary to distinguish two cases. The first is when an OLO is already supplying circuits to the premises and the second is when an OLO has to roll out duct and fibre to extend its network to the premises of the customer. In the former case, the necessary network is already in place, hence the sunk costs that would have to be incurred in switching provision from low to high bandwidth circuits are low and supply substitution is likely to take place. However, this may be limited to OLOs providing 1 and 2 Mbit/s terminating segments, since the technology used for lower bandwidths is different and, therefore, the cost of switching into to high bandwidth services is higher. In the latter case, a supplier of low bandwidth terminating segments may enter the market for high bandwidth terminating segments in response to a significant price increase. This is because the sunk costs it would have to incur are likely to be low compared with likely revenues, as the operator has an access network for low bandwidth services. Nevertheless, even though possible, supply side substitution from low to high bandwidth is unlikely to actually happen since there are few OLOs who provide low bandwidth segments and no suppliers of exclusively low bandwidth segments. Therefore, it can be concluded that from the point of view of high bandwidth terminating segments, low and high bandwidth circuits form separate markets. It is also true that separate markets exist from the perspective of customers and suppliers of low bandwidth terminating segments. This analysis is not set out in this annex as backhaul is only likely to be demanded at high bandwidths, but can be found in the market analysis annex of the Phase 1 PPC Direction.

B.47 This analysis is consistent with the evidence available from the leased line market, although no information has been collected on the wholesale market, nor is the information broken down into local ends, link and trunk/core. However, all leased line operators have entered the high bandwidth retail leased lines market, while there has been little entry below the 2 Mbit level. No operator has entered the low bandwidth market alone.

B.48 Oftel concludes that there is a market for high bandwidth terminating segments and LL backhaul links. As LL backhaul links are likely to be only demanded at high bandwidths, the LL backhaul links will be defined as only including high bandwidth backhaul links.

B.49 Oftel also examined the issue of the appropriate geographic boundaries of the market, as there is evidence of a higher level of entry in Central London. However, it concluded that there was not sufficient evidence to justify a geographic segmentation of the market.

B.50 In the leased line review, Oftel concluded that the main factor which determines whether entry will occur in the market for the provision of terminating segments is the existing and expected level of traffic density in the area. Oftel still considers that traffic density is the main factor that drives entry. It therefore believes that competition in the provision of terminating segments is likely to vary between geographic areas of different density and that entry is more likely in areas where traffic volumes are sufficiently high to justify the sunk costs of entry.

B.51 In the leased lines review Oftel singled out the Central London zone (‘CLZ’) (defined as the 020 7 area) as a potential geographic market. Oftel has considered this issue again and it appears that some entry in the supply of PPC terminating segments above 2Mbit/s has occurred. It would appear that this is mainly concentrated in the CLZ and a few other metropolitan areas. Entry, however, appears to be confined only to limited parts of these metropolitan areas and, from evidence on the supply of backhaul to LLU providers, Oftel understands that there are parts of central London which still lack alternative suppliers for terminating segments.

B.52 This evidence may suggest a geographic segmentation of the market for high bandwidth terminating segments into metropolitan and non-metropolitan. However, it would be very difficult to define the boundaries of these two geographic markets. As discussed above, even within metropolitan areas there are zones with more competition and zones with much less competition. The boundaries between more and less competitive areas are rather blurred and are likely to shift over time. Oftel therefore considers that at present it would not be appropriate to define separate geographic markets and proposes to define a single national market for high bandwidth terminating segments/ LL backhaul links. Nevertheless, as discussed above, this market is characterised by varying degrees of competitive pressure and any analysis or policy intervention will take this into account.

B.53 For the purposes of this explanatory memorandum, Oftel interprets market power to mean the ability to raise prices above the competitive level in the relevant market for a non-transitory period without losing sales to such a degree as to make this unprofitable. Oftel has assessed BT’s market power on the basis of evidence relating to barriers to entry, market shares, price trends, and entry into the market and profitability.

B.54 Oftel considered that BT had market power in access when it mandated the unbundling of the local loop in 1999. Oftel still considers that BT has market power in the provision of wholesale access via the local loop. This market includes not just the provision of access by means of a copper exchange lines but also cable and satellite and fixed wireless technologies.

B.55 While the provision of access by means of satellite and fixed wireless may constitute a viable alternative to access over the local loop at some point in the future, such services are not widely commercially available. As such, they do not and will not, in the short to medium terms, provide a competitive constraint on BT’s behaviour in the provision of access. It is further the case that cable access does not provide a sufficiently significant competitive constraint on BT’s position in the provision of access to make the market either competitive or prospectively competitive. BT’s share of total exchange lines remains very high at 82% (December 2001). Whilst this figure has been eroded in recent years, it was 85% in June 1999, this decline in share is very gradual.

B.56 BT’s local network is ubiquitous and BT is likely to remain the primary supplier of local access in the near future – the UK appears to have already witnessed the bulk of cable access rollout that is seen as economic by such operators.

B.57 There are considerable entry barriers to achieving a significant share of the local access market. BT and some OLOs have already incurred sunk costs associated with entering the access market. Therefore, whatever the pre-entry price set by these operators, what matters for the profitability of new entry is the price that would arise from competition between firms post-entry. If the expected post-entry price is such that the entrants’ post-entry profits fail to recover the sunk costs of entry and if the entrant foresees this, then entry will not take place. Accordingly, the threat that BT (and others) would reduce prices post-entry may deter OLOs from entering the access market.

B.58 This strategic entry barrier is reinforced for any particular OLO by the fact that other firms may be preparing to enter at the same time. This creates an increased risk of excess capacity post-entry and so a low post-entry price thus further deterring entry.

B.59 In addition BT’s economies of scale and scope, which are not available to the entrant, may reinforce its strategic advantage. The economies of scale and scope are, in part, due to the ubiquity of BT’s network and legacy effects derived from its former monopoly status. The effect of these is to lower the marginal costs faced by BT. From the point of view of a potential entrant, it is less profitable to compete with an incumbent firm who has a lower rather than higher marginal cost level, because the incumbent is likely to compete more aggressively the lower its marginal costs. Thus, the economies of scale and scope mean that the risk of not recovering sunk entry costs is greater and the strategic entry barrier is more effective.

B.60 Given BT’s continuing high market share in access lines, coupled with the substantial entry barriers facing new entrants seeking to gain a significant share of the local access market, Oftel concludes that BT possesses persistent market power within the wholesale access market such that it has the ability to raise prices above the competitive level in the relevant market.

B.61 BT’s market power in access may in part be addressed by LLU, which provides the opportunity for LLUOs to rent access lines from BT and enable the lines by installing DSL technology at an exchange. However, it could be argued that if BT does not have market power in enabled access then fully effective LLU will not be necessary to contribute towards competition in the broadband Internet access markets. This section considers the evidence of BT’s market power in enabled access.

B.62 BT’s DSL rollout has to date involved 1,115 DSLAMs which have the potential to DSL enable around 66% (15 million) of BT’s access lines. Cable modem rollout has thus far enabled 11.3m lines (Telewest: 4.7m; ntl: 6.6m) with the potential to provide broadband cable availability. It is therefore the case that BT currently possesses in excess of 57% of the UK’s broadband enabled addressable access lines. This coupled with the ubiquity and size of their access network provides BT with the potential to possess increasingly large shares of the achieved (actual subscribers) asymmetric enabled access markets. This data does not distinguish between asymmetric and symmetric enabled access. However, Oftel understands that both BT and cable operators only offer asymmetric access, therefore Oftel considers this data relates only to the asymmetric enabled access market.

B.63 Figure B.1 sets out the number of actual broadband subscribers to whom cable’s and BT’s enabled access is being used as a current input (either directly or via re-sale). The latest figures for both cable and DSL (published in June 2002) show that cable operators have 60% (36% ntl, 24% Telewest) and Kingston 1% of the 693,000 broadband subscribers, BT has 39%. BT’s share has declined from 53% in December 2000.

B.64 Oftel considers that placing too much reliance on these current subscriber figures is not appropriate at this relatively early stage in the development of broadband services. The market share figures are in their infancy and the number of subscribers is changing rapidly, they are therefore not yet a very reliable indicator of market power.

B.65 Prior to April 2002, BT’s DSL enabled products were significantly (£10-£20) more expensive than those offered by the cable companies. Since BT’s decision to reduce its wholesale prices for DSL enabled products from April 2002, retail prices for ADSL have been broadly in line with those for cable broadband. This has led to BT’s market share stabilising and even starting to increase again.

B.66 Apart from DSL enabled access, the only substantial alternative technological method of currently supplying broadband enabled access is via cable, coupled with cable modems. Both BT and cable operators are sinking considerable costs to enable their networks to provide broadband enabled access. The resulting rollouts to date were discussed earlier.

B.67 Given today’s technologies, it is necessary to have access to either a copper or cable network to provide wide-scale broadband origination (enabled access and backhaul), there are considerable barriers to building such a network. It appears to be the case that the UK has already witnessed the bulk of cable access rollout that is currently seen as economic by such operators.

B.68 Other access provision technologies, such as broadband wireless access, may offer competitive alternatives to copper and cable broadband access in the future. However, this and other new technology-based broadband constraints, such as Digital TV, are longer-term prospects that will not have a significant effect in the short to medium term. It is further the case that none of these DSL-competing delivery routes will (individually or collectively) provide scope for near-ubiquitous access in the near future. Even cable networks at present pass only around 52% of UK homes, compared to around 95% passed by BT. For the next few years copper and cable will be the primary routes for the delivery of higher bandwidth services to the mass market. Given BT’s intentions to DSL-enable further exchanges where demand is shown and the ubiquity and size of its network, BT has the potential to possess increasingly large shares of broadband subscribers.

B.69 In terms of symmetric access, if both BT and the cable operators had equal capacity to offer symmetric enabled access, then on the basis of the current information outlined above, Oftel considers that BT would have market power. However, Oftel understands that the cable operators’ deployment of symmetric enabled access may be limited to low volumes. Therefore, BT may face less competitive constraint from cable modem for symmetric enabled access. Low bandwidth PPCs may also constrain BT’s market power in symmetric enabled access. However it is unclear whether low bandwidth PPCs have sufficiently low cost to constrain DSL access to competitive prices.

B.70 Oftel concludes that in the absence of fully effective LLU and due to the relative position of cable, BT possesses market power in both symmetric and asymmetric enabled access such that it has ability to raise prices above the competitive level in this market for a non-transitory period without losing sales to such a degree as to make this unprofitable.

B.71 As Oftel considers that LL backhaul links are part of the same market as PPC terminating segment, the market analysis for LL backhaul links is based on information from the leased lines market. Retail leased line market information is used, as little information is available on wholesale leased lines as PPCs were only launched on 1 August 2001. Prior to that date, OLOs purchased retail leased lines to provide end-to-end leased lines to their retail customers. Therefore retail leased line market data provides a useful indication of the wholesale markets for PPC terminating segments and access.

B.72 A key factor in assessing BT’s market power in the backhaul market is the extent of strategic entry barriers. Strategic entry barriers arise in LLU backhaul due to the existence of sunk costs and the asymmetry in timing of the network build out between the incumbent and the LLUOs. Strategic entry barriers were also considered to be a key factor by Oftel in BT’s dominance of the market of terminating segments.

B.73 If operators decide to build LL and LES backhaul links, they incur high sunk costs. Sunk costs include costs of digging and ducting fibre from a concentrator site (or a customer’s premises in the case of leased lines) to the operator’s trunk network. There are approximately 5,600 concentrator sites in the UK. Costs are ‘sunk’ because they are unrecoverable if the operator were to exit the market. Operators are deterred from entering the market because they face a significant risk of not being able to recover their fixed costs of entry. This is primarily because of the strategic advantages enjoyed by BT but these are also reinforced by the behaviour of other operators and BT’s economies of scale and scope.

B.74 BT has already incurred the sunk costs of entering the market. Therefore, whatever the pre-entry price set by BT, what matters for the profitability of the entrant is the price that would arise from competition between firms post-entry. If the expected post-entry price is such that the entrants’ post-entry profits fail to recover the fixed costs of entry and if the entrant foresees this, then entry will not take place. Accordingly, the threat that BT would reduce prices post-entry deters operators from entering the market for terminating segments.

B.75 This strategic barrier is reinforced for any particular operator by the fact that other firms may be preparing to enter at the same time. This creates an increased risk of excess capacity post-entry, and so a low post-entry price, thus further deterring entry.

B.76 In addition, BT’s economies of scale and scope, which are not available to the entrant, may reinforce its strategic advantage. The economies of scale and scope are, in part, due to the ubiquity of BT’s network and legacy effects derived from its former monopoly status. The effect of these is to lower the marginal costs faced by BT. From the point of view of a potential entrant, it is less profitable to compete with an incumbent firm who has a lower (rather than higher marginal cost level) because the incumbent is likely to compete more aggressively the lower its marginal costs. Thus, the economies of scale and scope mean that the risk of not recovering fixed costs of entry is greater and the strategic entry barrier is more effective.

B.77 BT’s market share in the retail leased lines market provides an indication of its likely share of the market for LL backhaul links/PPC terminating segments, in the absence of further regulation (although the retail leased lines include trunk segments and local access which are not part of backhaul links). Tables 1 and 2 set out BT’s market share by revenue and volume in the low and high bandwidth leased line markets.

Sources: Oftel Market Information and data from operators

Sources: Oftel Market Information and data from operators

B.78 The data presented in both Table 1 and Table 2 above suggests that BT has a share of 76% (by either revenue or volume) of the UK low bandwidth terminating segment market, and 35% (36%) of the high bandwidth market by revenue (volume). Further, Oftel, as discussed in the Leased Lines Review, estimates BT’s share of the wholesale terminating segment market to be higher than its retail market share. This is due to the fact that, prior to the availability of PPCs, OLOs had to purchase retail leased lines from BT to provide links to customer sites and, therefore, a portion of OLOs’ leased lines are likely to incorporate BT’s terminating segments. This would imply that BT’s share of the markets for wholesale terminating segments is greater than its share in leased lines.

B.79 Oftel understands that much of the competitive entry into the high bandwidth leased lines market is in metropolitan areas and that there is limited or no competition to BT in other parts of the UK. Operators potentially require backhaul from any of BT’s 5,600 MDF sites. It seems likely that there is little or no competitive constraint on BT at some of these sites. If BT’s prices were geographically averaged, it may be argued that limited competition in some areas would not matter, as competition in other parts of the country might keep prices down. However, BT’s leased line prices are geographically de-averaged to some extent, which suggests that competitive pressure in metropolitan areas will not constrain prices in other parts of the UK. Oftel therefore considers that BT’s significant market share in the terminating segment market and the geographically limited nature of competition indicates that BT has market power.

B.80 Oftel does not have market share data for LES backhaul or for retail LES services. Oftel understands that BT is currently the primary supplier of LES backhaul, although the market is still at an early stage of development.

B.81 As part of the leased lines review, Oftel considered the profitability of BT’s leased lines business.

B.82 The rate of return for Megastream leased lines presented in Table 3 above is well in excess of Oftel estimate of BT’s cost of capital of 13.5% and well above the rate of return on its whole systems business of 22% (1998/99). The Director has not requested profitability data on this basis for any period subsequent to 1999/2000. Oftel does not have corresponding profitability information for LES services, however Oftel’s estimate of the rate of return on BT’s shorthaul data services is 100% in 1998/99 and 104% in 1999/00. Oftel understands that retail LES services are part of the product group of shorthaul data services.

B.83 These estimates are based on Current Cost Accounting Fully Allocated Costs (FAC). In the leased lines review Oftel expressed some concerns that FAC profitability measures may be dependent on the methodology chosen to allocate common costs. However, in the case of leased lines, some of the costs of leased lines are common with PSTN services and BT's PSTN wholesale and retail services are subject to price cap regulation. Where a consistent data set is used to derive leased line and PSTN FAC profitability figures then there is a stronger case for relying on the leased lines FAC profitability figures as evidence of whether or not returns on leased lines are excessive. BT's flexibility in allocating costs between PSTN and leased lines is restricted by PSTN price regulation. In this case, it could not be argued that a higher return from leased lines is required in order to make up for a lower recovery of common costs on PSTN services. While, it is possible to investigate further the issue of excessive pricing of leased lines via combinatorial tests, such a study requires detailed information on common costs between leased lines and all other parts of BT’s regulatory business and includes the profitability of other parts of BT which share costs with leased lines. Earlier Oftel work on this issue for the August 2000 statement indicated that there are considerable uncertainties in making this calculation for retail leased lines. Therefore, Oftel considers that the very high rates of return on BT’s retail leased lines on an FAC basis provides some evidence to suggest that, in the case of leased lines, BT is earning excessive returns. Oftel considers that the profitability of wholesale terminating segments is likely to be higher than for retail leased lines, as BT sells terminating segments at retail prices but incurs lower costs

B.84 Price movements over time and comparisons of prices between suppliers are an indicator of the degree of independence from its competitors that a firm enjoys when setting its prices.

B.85 Oftel has compared BT’s prices for retail leased lines by comparing revenue per circuit from BT and OLO market data and by comparing BT and C&W price lists. This revenue per circuit data suggests that BT and the OLOs have similar prices for 34 Mbit/s circuits and that BT may have significantly higher prices for higher bandwidth circuits than some operators. The price lists suggest that BT and C&W may have similar prices, however C&W may offer non-published discounts on the listed prices. Some caution needs to be exercised in drawing conclusions from this information as it is based on averages derived from revenue and volumes of circuits. Therefore the estimate of price differences does not take into account differences due to the lengths of the circuit or the particular quality of service offered by BT or operators.

B.86 As part of the PPC market analysis, Oftel has updated the benchmarking of prices for leased lines that it included in the leased lines review. This exercise compares price trends for individual circuits over the last five years. The prices used refer to the UK, the EU average price and the price for the third cheapest EU country (prices are presented using the Euro exchange rate expressed in terms of Purchasing Power Parities). Oftel does not have international benchmarking comparisons for LES services.

B.87 In 1996 the UK price for a 30km 64k circuit was below average and close to the price for the third cheapest EU country, but by 2001 the UK's relatively strong position had been eroded with the UK moving from below average to above average. The same proved true for a 30km analogue circuit. As for a 30km 2Mbit/s circuit, the UK position moved from being well below average to being about average.

B.88 Due to a lack of price information, it is impossible to perform a comparison of price trends for high bandwidth circuits over five years. Hence the comparison is limited to 34 Mbit/s and 155 Mbit/s and to the last 24 months. The overall conclusion that has been derived from this benchmarking exercise is that UK prices for these two types of circuits appear to have increased relative to those of the third cheapest country. For example UK prices for 2km 34 Mbit/s circuits are now 164% higher than those of the third cheapest country, while they were only 59% higher in 1999. In general the UK's position has declined relative to third cheapest over the last eighteen months.

B.89 These results suggests that UK customers are not getting the best deal when compared to other European countries, especially for high bandwidth circuits.

B.90 As part of its assessment of whether BT has market power, Oftel has examined BT’s prices (excluding discounts) for high bandwidth circuits between 1997 and 2001. Oftel has not examined price trend information for LES services.

Note: Prices include rental and connection charges and assume that the length of the link required is 30km. Prices exclude discounts and CLZ prices.

B.91 Figure B.2 represents the price trend in real terms, ie allowing for inflation, for circuits from 8 Mbit/s up to 155 Mbit/s. It shows that, overall, BT’s annual price trends have remained relatively flat.

B.92 There were substantial reductions in the prices for 34Mbit/s, 45 Mbit/s and 155Mbit/s circuits at the end of 1998. Prices in real terms fell by 25%, 25% and 33% respectively in that year. This is largely accounted for by a reduction in installation prices. Prices for circuits at 140 Mbit/s increased due to a rise in the annual rental. However, provision of services at these bandwidths is very recent and some adjustment of prices may be expected at this early stage whilst the market settles at an appropriate price. What Figure B.2 shows clearly is that in the last year there have been no substantial price changes at any of the bandwidths shown.

B.93 Oftel has considered whether the stability of prices in real terms for all digital circuits reflects a lack of competitive pressure. In order to make such an assessment it is necessary to understand what has happened to costs over the time period. Oftel’s investigation into costs suggests that the cost volume relationship (CVR) for leased lines is relatively low. This implies that for any given increase in volumes, total costs rise by a smaller proportion and so average costs fall. Given that the volume of BT’s digital leased lines has increased significantly over the past few years, the low CVR suggests that, in a competitive market, prices of digital leased lines should have fallen significantly.

B.94 In Oftel’s view, the failure of BT’s prices to fall in line with what might have been expected by the evidence on CVRs and volumes is evidence of the limited scope of competition.

B.95 On balance, Oftel considers that the evidence on profitability, market share and pricing are consistent with BT having persistent market power in the provision of LL backhaul links. While less evidence is available to reach a conclusion on LES backhaul links, Oftel considers that similar barriers to entry are likely to exist for providing LES and LL backhaul links. The profitability of short haul data services suggests that BT is facing little competitive constraint in providing these services. Therefore, Oftel considers that BT will have market power in the provision of LES backhaul links.

B.96 Oftel considers that BT has market power in the provision of LL and LES backhaul links in the UK on the basis of the significant barriers to entry into these markets. Oftel considers that the backhaul trunk market is likely to be potentially competitive on the basis of lower barriers to entry and the evidence of entry into the trunk market for leased lines. Oftel considers that BT has market power in access and asymmetric and symmetric enabled access. While LLU has the potential to provide some competitive constraint on BT’s market power in asymmetric and symmetric enabled access, it will not be effective without the provision of LL and LES backhaul links at competitive prices. Therefore, if cost orientated backhaul is not provided by BT, its market power in the markets for broadband Internet access will not be constrained to any extent by LLU.

B.97 In terms of SDSL leased lines, BT’s market power in backhaul services may raise issues of market power in the provision of SDSL leased lines, such lines have a significantly lower cost structure than other leased lines. However, as BT will be obliged to provide cost orientated backhaul to enable competition in the broadband Internet access markets, it is not necessary for Oftel to reach a view on whether backhaul is required for the purpose of providing SDSL leased lines alone. Operators providing leased lines will be able to obtain cost orientated backhaul, as backhaul will be provided on a non-discriminatory basis, and therefore Oftel has not needed to reach a view on whether backhaul is required for providing leased lines.

B.98 For VOD services, it is not clear that separate retail markets exist and therefore it is unclear whether BT would leverage its market power from backhaul services into the relevant retail markets. However, Condition 57 of BT's Licence prohibits it from unduly preferring its own business, or unduly discriminating, as respects interconnection of any description which it provides pursuant to Part C of its Licence (ie Conditions 44-50A). This means that BT cannot unduly discriminate in the provision of LLU backhaul services on the basis of the service that an LLUO provides.

B.99 The market analysis for backhaul is consistent with the market analysis in the price control review and the FRIACO determination, which found that the DMSU to customer segment of these services was not effectively competitive.

Indicative amendments to BT’s external tie circuit prices

The table below summarises the price changes that Oftel believes BT should make to its annual charges. They are based on Oftel’s conclusions in this document, the conclusions from the 2002 Statement and on BT’s current interconnect price list (please note this link takes you out of Oftel's website).

1. The Secretary of the State granted to British Telecommunications on 22 June 1984 a licence (the ‘BT Licence’) under section 7 of the Telecommunications Act 1984 (the ‘Act’) for the running of the telecommunication systems specified in Annex A to that licence;

2. By virtue of Section 109 of and paragraph 20 of Schedule 5 to the Act, the BT Licence has effect as if granted to British Telecommunications plc (‘BT’);

3 The Telecommunications (Interconnection) Regulations 1997 (the ‘Regulations’) and Condition 45 of the Licence implement Directive 97/33/EC of the European Parliament and Council on interconnection in telecommunications with regard to ensuring universal service and interoperability through application of the principles of open network provisions (the ‘Directive’);

4. Condition 45.5 of the Licence requires BT to comply with the requirements of any directions given pursuant to Regulation 6(3) of the Regulations;

5. Regulation 6(3) of the Regulations allows the Director, in pursuit of the aims stated in Regulation 6(1), to intervene at any time in order to make a direction specifying issues which must be covered in an interconnection agreement, and to specify conditions that must be observed by one or more parties to such an agreement;

6. The aims listed in Regulation 6(1) include the need to stimulate a competitive market and the principles of non-discrimination (including equal access) and proportionality;

7. Local Loop Unbundling (‘LLU’) backhaul is required to connect traffic originating on unbundled loops to a point on or in an Operator’s core network for subsequent conveyance to a service provider. Operators will require backhaul connection from an Operator’s co-location facility to a point of interconnection with BT’s network in order to provide a wholesale or retail Digital Subscriber Line (‘DSL’) services across the UK;

8. LLU backhaul is needed to enable effective unbundling of the local loop. Effective LLU will stimulate competitive markets in broadband Internet access;

9. LLU backhaul is also required to ensure that BT is unable to discriminate in the provision of backhaul to itself and other wholesale DSL providers;

10. For the reasons set out in Annex B of the Explanatory Memorandum to this Direction, the Director considers BT to have market power in the markets for backhaul links and trunk;

11. The Directive defines interconnect as "the physical and logical linking of telecommunications networks used by the same or a different organisation in order to allow the users of one organisation to communicate with users of the same or another organisation, or to access services provided by another organisation. Services may be provided by the parties involved or other parties who have access to the network";

12. The Directive defines a telecommunications network as: "transmission systems and, where applicable, switching equipment and other resources which permit the conveyance of signals between defined termination points by wire, by radio, by optical or by other electronic means";

13. LLU backhaul is a transmission systems because it permits the conveyance of signals between defined termination points. Consequently, the provision of LLU backhaul falls within the definition of the Directive as two telecommunication networks will be physically and logically linked.

14. As stated in Chapter Two of the Explanatory Memorandum attached to this Direction, the Director has powers to make a determination in relation to backhaul under both under the EC Regulation and the Directive;

15. In the interests of legal certainty the Director considers it more appropriate, in order to ensure the provision of LLU backhaul throughout the United Kingdom to use his powers pursuant to the Regulations;

16. Annex I, Part 2, of the Directive defines a leased line as "telecommunications facilities which provide for transparent transmission capacity between network termination points and which do not include on-demand switching (switching functions which the user can control as part of the leased line provision). They may include systems which allow flexible use of the leased line bandwidth, including certain routing and management capabilities";

17. LLU backhaul falls within this definition because it is transparent transmission capacity between a Digital Subscriber Loop Multiplex (‘DSLAM’), at a Main Distribution Frame (‘MDF’) site, and a Point of Connection with an Operator’s Applicable System, both of which are network termination points, and it does not include on-demand switching;

18. Condition 69.1 of BT’s Licence states that the "Licensee shall secure, and shall be able to demonstrate to the satisfaction of the Director, that the charges offered, payable or proposed to be offered or payable by an Operator to the Licensee for each Standard Service provided pursuant to an agreement entered into pursuant to Condition 45 of this Licence are reasonably derived from the costs of providing the Service based on a forward looking incremental cost approach…";

19. Recital 10 of the Directive states that: "…whereas the level of [interconnection] charges should promote productivity and encourage efficient and sustainable market entry, and should not be below a limit calculated by the use of long-run incremental cost and cost allocation and attribution methods based on actual cost causation, nor above a limit set by the stand-alone cost of providing the interconnection in question";

20. The Director considers that the appropriate interpretation of the requirement for prices to be cost-orientated cannot be considered in isolation from the extent of competition for the service in question;

21. If an interconnection service was provided in an effectively competitive market or a market moving towards a competitive market structure, the requirement for cost-orientation as set out by the Directive is any price between the Long Run Incremental Cost (‘LRIC’) floor and Stand Alone Cost ceiling, subject to any relevant combinatorial and non-discrimination tests also being satisfied;

22. If by contrast the relevant economic market was not effectively competitive then the Director, without fettering his discretion, and subject to the facts of the particular case, would be minded to interpret the cost-orientation requirement to mean that prices should be set on a LRIC basis with some allowance for common cost recovery;

23. It is important, in order to stimulate a competitive market that Operators can effectively compete with BT, in order to do this they must have guarantees that LLU backhaul will be provided on reasonable terms, including terms for provisioning and repair;

24. Paragraph 1 of Part I of Schedule 3 of the Regulations requires BT to adhere to the principle of non-discrimination with regard to interconnection offered to others. BT must apply similar conditions in similar circumstances to interconnecting organisations providing similar services. In addition BT must provide interconnection facilities and information to others under the same conditions and of the same quality as it provides for its own services, or those of its subsidiaries or partners;

25. Pursuant to Condition 57 of its Licence BT must not (whether in respect of the charges or other terms or conditions applied or otherwise) show undue preference to, or exercise undue discrimination against, particular persons or persons of any class or description (in any markets) as respects interconnection of any description provided pursuant to Condition 45 and this Direction;

26. BT must, therefore, ensure that the Service Level Agreement (SLA) relating to the supply of LLU backhaul must not in any way put an Operator at an unfair competitive disadvantage as regards BT or another Operator;

27. It is, therefore, appropriate that the SLA relating to the supply of LLU backhaul includes provision for the payment of fixed compensation payments to be payable by BT where it fails to fulfil its obligations under the SLA. This will ensure that BT has an economic incentive not to discriminate in the level of service it provides to itself and to an Operator; and

28. For the reasons given in these recitals and set out in more detail in the Explanatory Memorandum accompanying this Direction, and having considered the representations made in response to the draft of this Direction published on 17 December 2001, and the matters set out in Regulation 6(1) of the Regulations, the Director believes that it is appropriate to make this Direction.

Pursuant to Regulation 6(3) of the Regulations the Director General of Telecommunications makes the following Direction:

1. BT (the ‘Licensee’) shall within eight weeks of the date of publication of this Direction, offer to enter into an interconnection agreement with any Operator, within a reasonable period of the Operator’s written request, in which the Licensee offers to provide the products defined in the Annex to this Direction (‘LLU Backhaul’) on reasonable terms. Without prejudice to the generality of this requirement, terms will not be considered reasonable if they are not cost-oriented or if they fail to include a Service Level Agreement (‘SLA’) such as could be expected to be negotiated in a competitive market.

2. The Licensee shall supply LLU Backhaul to Operators at cost-orientated prices.

3. The Licensee shall not (whether in respect of the charges or other terms or conditions applied or otherwise) show undue preference to, or exercise undue discrimination against, particular persons or persons of any class or description (in any market) as respects the supply of LLU Backhaul. The Licensee may be deemed to have shown such undue preference or to have exercised such undue discrimination if it unfairly favours to a material extent a business carried on by it in relation to the provision of LLU Backhaul and, in particular, the SLA relating to the supply of LLU Backhaul.

4. The Licensee shall ensure that its charges for LLU Backhaul are consistent with its charges for those elements which are common to LLU Backhaul and partial private circuits.

5. The interconnection agreement for the supply of LLU backhaul by the Licensee shall include an SLA relating to the supply of LLU Backhaul. This SLA shall include provision for the reasonable payment of fixed compensation by the Licensee to an Operator in cases where the Licensee fails to fulfil its obligations under the SLA relating to the supply of LLU Backhaul.

6. Except as otherwise defined in this Direction:

6.1 paragraph 4 of the BT Licence shall, with the necessary changes, apply to this Direction as it applies to the BT Licence; and

6.2 terms defined in the BT Licence or in the recitals hereto shall have the same meanings for the purposes of this Direction.

7. Unless otherwise stated, this Direction shall enter into force on the date of its publication.

Jim Niblett
Director of Broadband and International Affairs
5 August 2002
A person authorised under Paragraph 8 of Schedule 1 to the Telecommunications Act 1984

(A) The provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive) between a Local Loop Unbundling Operator’s (‘LLUO’s’) equipment at a Licensee’s MDF site and a Point of Connection with an Operator’s Applicable System connected to the nearest appropriate Licensee Synchronous Digital Hierarchy (‘SDH’) node to the customer. Such node could be a Tier 3, Tier 2, Tier 1.5 or Tier 1 node.

(B) The provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive) between a LLUO’s equipment at a Licensee’s MDF site and a Point of Connection with an Operator’s Applicable System connected to the nearest appropriate Licensee SDH node to the customer which is superior in the hierarchy to the node defined in (A) above, where such node exists. Such node could be a Tier 2, Tier 1.5 or Tier 1 node.

(C) The provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive) between a LLUO’s equipment at a Licensee’s MDF site and a Point of Connection with an Operator’s Applicable System connected to the nearest appropriate Licensee SDH node to the customer which is superior in the hierarchy to the node defined in (B) above, where such node exists, and which could be a Tier 1.5 or Tier 1 node.

(D) The provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive) between a LLUO’s equipment at a Licensee’s MDF site and a Point of Connection with an Operator’s Applicable System connected to the nearest appropriate Licensee SDH node to the customer which is superior in the hierarchy to the node defined in (C) above, where such node exists, and which is a Tier 1 node.

(E) The provision of transparent transmission capacity by the Licensee, at all bandwidths between 2 Mbit/s and 155 Mbit/s (inclusive) between a LLUO’s equipment at a Licensee’s MDF site and a Point of Connection with an Operator’s Applicable System connected to any Licensee SDH Tier 1 node.

(F) The provision of transparent transmission capacity by the Licensee, at all bandwidths from 622 Mbit/s to 2.4 Gbit/s (inclusive) between a LLUO’s equipment at a Licensee’s MDF site and a Point of Connection with an Operator’s Applicable System connected to the nearest appropriate Licensee Marconi Synchronous Hierarchy (‘MSH’) node to the customer.

(G) The provision of transparent transmission capacity by the Licensee, at all bandwidths from 622 Mbit/s to 2.4 Gbit/s (inclusive) between a LLUO’s equipment at a Licensee’s MDF site and a Point of Connection with an Operator’s Applicable System connected to any appropriate Licensee MSH node.

(H) The provision of dedicated transmission capacity by the Licensee, at all bandwidths from 10 to 1000 Mbit/s (inclusive) between a LLUO's equipment at a Licensee’s MDF site and a site within an Operator's Applicable System connected to an appropriate Licensee node within a distance of 25 radial km.

1. The Secretary of State granted to British Telecommunications on 22 June 1984 a licence (the "BT Licence") under Section 7 of the Telecommunications Act 1984 (the "Act") for the running of the telecommunication systems specified in the BT Licence;

2. By virtue of Section 109 of and paragraph 20 of Schedule 5 to the Act, the BT Licence has effect as if granted to British Telecommunication plc ("BT");

3. Condition 83 (the "Condition") of the BT Licence obliges BT to make available access to its local lines to consumers, space in its exchanges, use of certain circuits and reasonably necessary ancillary services (together "Access Network Facilities"), including the provision of Co-location, so that other licensed operators having interconnection rights under EC Directive 97/33 and the regulations made under it ("OLOs" or "Operators") can provide telecommunications services (including ADSL services) over those lines. The process is known as local loop unbundling;

4. Paragraph 17 of the Condition provides that BT shall provide Access Network Facilities at a charge or charges to be agreed between the parties or, in default of agreement, to be determined by the Director General of Telecommunications (the "Director");

5. Paragraph 19 of the Condition requires BT to secure that the offer of an agreement to provide any of the Access Network Facilities under the Condition contains only terms and conditions which are reasonable;

6. On 18 December 2000 the European Parliament and the Council adopted a Regulation on unbundled access to the local loop (EC 2887/2000) (the "EC Regulation");

7. Article 3(1) of the EC Regulation requires notified operators (as defined in the EC Regulation and of which BT is one) to publish, from 31 December 2000, and keep updated, a reference offer for unbundled access to their local loops and related facilities, on terms set out in the EC Regulation. The reference offer for unbundled access to local loops run by BT is known as the Access Network Facilities Agreement ("ANF Agreement") which, for the purposes of this Direction, includes the relevant parts of BT's Price List;

8. Article 4(1) of the EC Regulation requires national regulatory authorities in each member State (which in the United Kingdom is the Director) to ensure that charging for unbundled access to the local loop fosters fair and sustainable competition;

9. Article 4(2) of the EC Regulation gives the national regulatory authority the power where justified to impose changes on the reference offer for unbundled access to the local loop and related facilities. Article 4(3) of the Regulation permits the national regulatory authority to intervene on his own initiative where justified in order to ensure non-discrimination, fair competition, economic efficiency and maximum benefit for users;

10. Article 3(3) of the EC Regulation requires BT to make charges for related facilities to unbundled access to the local loop (including space at its exchanges) set on the basis of cost-orientation;

11. The Director published, on 18 October 2001, a statement and draft direction concerning BT's charges for Local Loop Unbundling distant and physical co-location;

12. It is appropriate that this Direction be based on the Director's powers under both the EC Regulation and the Condition; and

13. For the reasons given in these recitals and set out in more detail in the Explanatory Memorandum accompanying this Direction, and having considered the representations made in response to the draft of this Direction published on 17 December 2001, the Director believes that it is necessary to make this Direction.

Pursuant to Article 4(2)(a) and Article 4(3) of Regulation EC 2887/2000 and Condition 83 paragraphs 17 and 19 of the licence granted to British Telecommunications plc under section 7 of the Telecommunications Act 1984, the Director General of Telecommunications makes the following Direction:

1. The connection charge levied by BT for External Tie Circuits shall not include the cost to BT of additional site visits caused by Operator planning mistakes.

2. The rental charge levied by BT for External Tie Circuits shall not include any cost element concerning the replacement of External Tie Circuits.

3. BT shall reduce the mark-up on the rental and connection charges for BT provided External Tie Circuits, including the charges it levies for additional 100 pairs of cable and 100 metres of cable, to no more than the level it charges for External Tie Circuit pull through, or as otherwise directed from time to time by the Director.

4. BT shall reduce the rental charge for BT provided External Tie Circuits to 7.43% of the capital value of an External Tie Circuit, or as otherwise directed from time to time by the Director.

5. For the purposes of this Direction:

a) The "capital value" of an External Tie Circuit shall be calculated by removing BT’s mark-up from the connection charge for a BT provided External Tie Circuit;

b) paragraph 4 of the BT licence shall, with the necessary changes, apply to this Direction as it applies to the BT Licence;

c) the terms defined or described in the recitals to this Direction shall have the meanings given to them there; and

d) terms defined in the EC Regulation and in the BT Licence shall have the same meaning for the purpose of this Direction.

6. This Direction shall come into force seven days after the date of its publication and shall apply to all offers for the provision of External Tie Circuits made by the Licensee after 17 January 2001.

Jim Niblett
Director of Broadband and International Affairs
7 August 2002
A person authorised under Paragraph 8 of Schedule 1 to the Telecommunications Act 1984