• broadband services and the potential for competition

• promoting competition more generally in telecoms

• the difficult times faced by players in the market

• ….. and the implications for how OFCOM will need to work.

Not quite as broad ranging as the Budget main course coming up later this afternoon but a fairly significant starter (!)

First I would like to set the context. We are at a key time in the development of electronic communications markets:

• stock markets are very cautious about telecoms and media shares certain operators are in financial difficulties and
• significant change to regulation of this sector is in prospect in terms of EU directives and the move to OFCOM.

Broadband strategy

There has been a lot of 'noise in the system' about broadband. I would like to focus on some key facts and to explain how Oftel's approach to broadband.

First, some facts:

Over 180,000 consumers now use ADSL while over 280,000 consumers have high speed services using cable modems.

So since broadband was launched 18 months ago, we are rapidly approaching half a million UK consumers signing up for high-speed services.

The rate of take up in the UK compares well to other countries. For example, current UK take up rates are comparable to France, despite the fact that both cable modem and DSL services were launched earlier in France.

I am confident that growth will continue. The industry will develop innovative content and services, attracting more consumers to broadband.

Oftel’s work on unmetered dial-up access means the UK has a large potential market of experienced users.

The competitive regulatory regime has encouraged the cable networks to offer an equivalent product, meaning that the UK now has one of the largest markets in Europe for cable modem. And prices for UK cable modem services have been amongst the lowest in Europe for residential customers - while BT's recent wholesale price reduction are bringing retail ADSL prices down, much closer to cable modems.

Second, Oftel's broadband strategy - delivering a competitive broadband market. In relation to broadband, our objectives are:

Oftel’s long term aim is to achieve a level of competition in broadband markets that will ensure that consumer and business needs can be met without the need for regulation – ie effective and sustainable competition. There is unlikely to be a ‘single solution’, whereby broadband is delivered using one technology only. Consumer needs vary greatly and the market is best-placed to decide how, and with which technologies, this can best be achieved.

As with much of Oftel’s work, an important issue is, ensuring that regulation strikes the appropriate balance between ensuring that an adequate variety of services is delivered to meet consumer needs, and maintaining incentives for investment in infrastructure. Oftel’s aim is to pursue a strategy that will ultimately deliver both.

Competition at all levels of the value chain

We believe that competition between delivery routes for broadband plays an important role in achieving sustainable competition. In particular it should contribute to ensuring that different product specifications are available to meet consumers’ varying needs and encourage technological innovation and improvements in efficiency. Competition at the infrastructure level should in turn feed through to competition in the provision of services, providing consumers with a choice of packages, pricing structures and customer service options.

The approach that Oftel has taken to regulatory broadband and other markets is based on four fundamental principles:

• Appropriate market definition. A clear and precise definition of the appropriate market must be the basis for any assessment of whether regulation is appropriate in the particular market, taking into account all potential substitute products and technologies;

• Market power test. Regulation should be justified on the basis of an economic assessment of market power - where a company is able to set prices above a competitive level on a sustained basis.This is clearly against the interest of the consumer and competition and so regulation is necessary. The level of market power should be regularly reviewed and in markets where competition is effective regulation should be removed. It may be appropriate for different levels of regulation to be applied depending on the strength of market power and whether it is being eroded;

• Regulation justified on basis of objectives. Obligations should only be applied to the extent necessary to meet the objective of promoting effective competition in the provision of broadband access and services and ensuring that consumer needs are met in the absence of effective competition; and

• Setting appropriate terms and conditions. Regulation should be a proportionate and reasonable response to the problem identified. It should address the problem at hand while not undermining the development of effective competition in the longer term. This means in particular that the conditions applying to obligations, and particularly the pricing conditions, should not undermine incentives for operators to invest in competing infrastructures or innovate in the provision of technologies or services.

As a general rule, Oftel will continue to apply this principle in the following way. Where market power is entrenched, markets are relatively mature, and there is little prospect of effective competition in the short-medium term, prices should be set on cost-based terms. This should ensure that competitors are able to provide an effective alternative investing in their own infrastructure to the extent possible, but using inputs where necessary from the wholesale supplier.

On the other hand, where competition, while not yet effective, is developing, prices should be set in a way that allows for market entry by competitors that are at least as efficient than the wholesale supplier, while maintaining incentives for operators to invest in competing infrastructures and services. Such an approach is also likely to be appropriate where the services being provided are new and/or risky and the relevant markets new and/or immature. Cost-based price control in these circumstances could harm investment in the new services and competing services and another basis – for example wholesale prices set just below the retail level- may be appropriate.

In addition, Oftel would ensure that any particular product mandated could reasonably be supplied ie that it did not represent an undue burden on the operator supplying it, requiring it for example to provide services in the absence of any apparent demand or invest without prospect of making a reasonable return.

How has this strategy been applied in practice?

• Oftel required the provision of unbundled loops and shared access on cost-based terms because it is highly unlikely that competition will develop between networks in the local loop. Cost based access will encourage competing operators to build out infrastructure further into the network whilst having regulated access to the customer over the last mile connection where BT’s market power persists. This should enable competitors to innovate in the provision of broadband services and deliver tailored packages to end-users or service providers;

• requiring the provision of partial private circuits (PPCs) on cost-oriented terms encouraging operators to compete in the provision of leased circuits as far as possible while having regulated access to the customer over the non-competitively supplied element of BT’s network;

• encouraging (and requiring where necessary) the provision of appropriate DSL wholesale products on a non-discriminatory basis. This enables operators and service providers to compete with the wholesale supplier on the efficiency of their service provision and the range of packages offered to meet customers’ needs. The pricing of this wholesale product should nonetheless maintain incentives for operators to build further into the network and compete in providing broadband infrastructures; and

• not imposing regulatory obligations on cable networks, broadband fixed wireless or 3G networks in the absence of market power by any operator in these markets.

Promoting competition more generally

But Oftel is not just about promoting competition in broadband. Oftel has, as one of its four high level operational objectives, the achievement of 'effective competition - benefiting consumers'. It seeks to do this by promoting competition at all levels in both networks and services. This translates into actions which are both pro-active and re-active:

• pro-actively developing a framework within which competition can flourish by removing barriers to entry. For example, establishing an interconnection regime so other operators can connect on cost based terms with BT's network. Also making it easy for consumers to switch suppliers by introducing fixed and mobile number portability); and

• re-actively responding, in a way that is consistent with its strategy, to individual suppliers requests for access to and interconnection with networks of dominant operators.

In most of the 1990s, the focus was on developing infrastructure competition in both the fixed and mobile sectors. This strategy was to a considerable extent successful in establishing alternative networks over the UK with:

• over half of UK households now covered by cable networks;

• four UK-wide mobile networks;

• for business customers, key business areas of major cities covered by one or more alternative metropolitan networks; and

• significant capacity in trunk networks between major cities.

In investment terms, some £8 billion was invested in UK telecoms networks of all types in both 2001 and 2000 and builds on substantial investment in the 1990s by cable, BT, mobile and other operators of around £50 billion.

In the last few years, development of infrastructure competition has slowed down as the cable companies finish their build rates and the mobile industry achieves full national coverage. At the same time there has been greater demand from service providers for access to BT's network, particularly in relation to unmetered internet access and to broadband services. Oftel's response has been to use its discretion, both in granting access to the network and also in setting the terms and conditions on which access is to be made available.

In seeking a balance between the various objectives of protecting consumers, promoting competition and encouraging investment and innovation in the provision of telecoms services, account has been taken of whether services in question are new and the degree of risk facing the operators in providing them. Typically the extent of regulation for 'new' services provided by BT is less intrusive in order to avoid undermining its incentives to invest in such services - the 'cost plus' or 'retail minus' choice as I have described for broadband.

The greater emphasis on developing access to networks, both by other network providers and particularly by service providers in recent years, does not reflect a policy change away from infrastructure competition. Oftel's goal is to have competition at all levels in provision of wholesale and retail services. The regulator cannot predict, nor can it create, investment in infrastructure amongst aspiring entrants. Oftel sets the rules consistent with its overall strategy and in response to the needs of new entrants and overall impact on the market.

For example, only last week BT announced their intention to introduce a new broadband wireless access service to enable people to have broadband access for their lap top computers at airports and railway stations. A new service delivered by new technology - and something no one could have predicted five years ago.

Initiatives to enable local loop unbundling and carrier pre-selection could be seen as moves away from infrastructure competition. This is not the case. All require some level of investment and that in LLU is significant. Each has a role to play in meeting consumer demands, but they do not fundamentally change infrastructure opportunities and are part of a policy for competition at all levels. The recent difficulties experienced by telcos in raising funds to invest are more a feature of turbulent capital markets than a result of regulatory uncertainty.

Where new opportunities for infrastructure competition arise in future, (eg introduction of spectrum trading on a widespread basis) then Oftel (or its successor) will need to be both pro-active in seeking opportunities to promote further competition in infrastructure and respond positively to requests to promote such competition.

Where there is sufficient, self-sustaining competition then Oftel can withdraw from promoting competition. This is unlikely to come about until there is sufficient infrastructure competition that will itself, develop and sustain services competition over competing networks.

In the absence of competitive pressure Oftel has imposed retail price controls on BT's residential prices. These have saved consumers an estimated £400 million over the last four years. Now that competition through indirect access and carrier pre-selection is increasing, Oftel intends to lift price controls when prices have fallen by an agreed amount. A recent report from the NAO praised the way Oftel has used price reviews to drive down the costs of the major utility networks while the quality of the service delivered has improved.

Are we choosing the right basis for intervention? Judge this by considering the outcome of the action. Where the outcome has been on a sustainable basis to improve the deal for consumers in terms of prices paid, choice available, improvements in quality of service and value for money, then the initiative can be seen to be appropriate. In those cases where an initiative has not initially succeeded consideration needs to be given to whether there are on going prospects for competition and how best to achieve this.

What does the evidence show

- how much do consumers pay

Comparing what UK customers pay with customers in other leading economies – USA, France, Germany and Sweden ( and Italy for mobile) shows the UK residential customer pay less than average for fixed services, mobile , metered and unmetered internet (the latter are not generally available in other European countries).

Prices for UK business are around average for fixed voice services.

UK consumers get a good deal for unmetered dial-up Internet (again which is not generally available in Europe), though the position is less good for metered Internet access.

- levels of take up

High and increasing levels of take up of services in the UK electronic communications market – 75% of adults with a mobile phone, 45% of homes with Internet access, 39 % of homes with digital TV on top of 93% of homes with fixed link phones. All these indicate positive developments in the consumer marketplace.

Oftel’s approach to promoting competition

But, you may ask 'how does the strategy work in tough capital market conditions particularly for competitors to the incumbent?' The stock market has undoubtedly been a roller-coaster over the past couple of years and Oftel is definitely not in the business of forecasting share prices. Instead I would point to the following features:

Firstly

• the underlying overall growth in revenues and usage has continued over 2000 and 2001 despite the stock market fluctuations. Revenue growth is over 10% a year for the last four years and, while growth in volumes of traffic on telecoms networks for traditional services has been relatively flat, the volumes of internet related traffic is close to doubling year on year.

Secondly

• substantive build of alternative infrastructure has taken place and the key issue is now about using these networks ….. and the pressure this puts on the incumbent to respond. To illustrate this pressure it is worth noting that BT’s share of total call volumes has fallen from just over 80% in 1997 to 65% by 2001.

Against this background each case for Oftel taking action to promote competition is considered in relation to Oftel’s overall strategy and options appraised for fit with the strategy. The action taken will depend on:

• the market analysis undertaken ( market definition, assessment of market power); and

• identification of appropriate action in relation to the prospects for competition.

The drivers for making these assessments and coming to decisions are from two sources:

• EU requirements to carry out reviews, over the period to summer 2003, of all markets where market power has been identified;

• requests from individual suppliers for interconnection/access to the networks of players with market power.

These two processes which will overlap and interact provide both an element of predictability (in terms of EU reviews) and reactiveness to demands from the market players. To this extent, the outcome of these activities cannot be forecast precisely. Oftel's aim therefore is to foster the conditions for competition to develop effectively in all markets through:

• clearly establishing a framework for analysis and evaluation that stakeholders understand; and

• consistently and transparently applying its strategy in relation to decisions taken.

Implications for OFCOM

Major investment by UK telecoms players has been made over the past decade or so - some £60 billion plus - in telecoms networks. This represents a significant proportion of the total investment in the UK economy over that period. It is vital that in establishing OFCOM there is a continuity of confidence of investors and stakeholders in the regulatory regime. This means OFCOM will need to recognise

• that promoting competition to benefit consumers is the key driver that underpins its regulation of networks - we are not talking about a static, one network industry - the prospect of convergence which means different networks and delivery systems with more capacity and more flexibility as to what they carry, being able to compete with each other because they can increasingly carry the same or equivalent services.

• networks will be expensive to build so there will be a need to reduce barriers to entry - so the economically efficient use of radio spectrum will be critical - implying that spectrum trading - recommended by the recent review by Professor Cave - is introduced as promptly and as widely as possible.

• the importance of clarity of analysis when considering issues which are primarily about networks and economic regulation and distinguishing these challenges from consideration of other issues which are primarily about content and not about economic regulation

• the importance of transparency of process so all stakeholders are clear as to why OFCOM is involved and the reasoning for any action it decides to take. This means undertaking rigorous option appraisals matched to the scale of the decision in hand.

Summary

In closing, I would like to re-cap on a few key points

• regulation in a dynamic industry such as electronic communications is about setting a framework within which competition can develop - that is what we have done for broadband and we are starting to see the effects coming through now;

• more generally Oftel has pursued an approach of promoting infrastructure competition where it is available … and encouraging development of service provider competition - where that is demanded and where it represents the main opportunity to regulate for competition;

• investors are key to getting competition and they need certainty and transparency about the regulator's likely actions;

• OFCOM will need this approach to ensure continuity of investment to deliver a converged electronic communications sector that benefits consumers.