November 1997
This statement sets out the conclusions from the Oftel investigations into three of BT’s Internet services namely BTNet, BT Internet and Campus World. The central concern underlying these investigations was whether the relevant business enjoyed an unfair cross-subsidy. These businesses are new services.
For the purpose of BT’s licence, to demonstrate an unfair cross-subsidy in respect of a new business, it is necessary to demonstrate that the business would not achieve an adequate commercial return over a suitable period, and that this has or could have an adverse effect on competition. An adequate commercial return needs to be at least greater than BT’s weighted average cost of capital (WACC); this presently stands at 12.5%.
It is Oftel’s view, on the evidence it has, that at present BTNet is not pricing in a predatory manner nor is it in receipt of an unfair subsidy or cross-subsidy. However Oftel recognises that independent Internet service providers are deeply concerned by BT’s entry into Internet market. Given BT’s strong position in adjacent markets such as PSTN telephony, ISDN and private circuits provision, Oftel regards this as a particularly sensitive issue. Therefore, rather than close its investigation, Oftel proposes to closely monitor the situation over the coming months.
Oftel has found that assumptions concerning costs and growth made in the business plan for BT Internet in the medium term (2–3 years) are also reasonable and do not rely on resisting market entry to competitors for success. Oftel accordingly finds no grounds at present to believe there is any unfair cross subsidy of this product but will continue to monitor the situation.
The Campus World results show that it is on course with its current business case, and its business case reveals a healthy Internal Rate of Return over a reasonable period. Therefore, Campus World is not presently in receipt of a subsidy. Furthermore the information from those in the market and the present pricing structure demonstrates that the losses being suffered by Campus World, for the time being, are not presently having a material effect on competition. Again, Oftel will continue to monitor the situation.
1.1 This statement sets out the conclusions from the Oftel investigations into three of BT’s Internet services namely BTNet, BT Internet and Campus World. The central concern underlying these investigations was whether the relevant business enjoyed an unfair cross-subsidy. These businesses are new services.
Unfair cross-subsidy
1.2 For the purpose of condition 20B.15 of BT’s licence, to demonstrate an unfair cross-subsidy in respect of a new business, it is necessary to demonstrate that the business would not achieve an adequate commercial return over a suitable period, and that this has or could have an adverse effect on competition. An adequate commercial return needs to be at least greater than BT’s weighted average cost of capital (WACC); this presently stands at 12.5%.
Condition 20B.15
1.3 Under condition 20B.15 of BT’s licence, the Director can issue a direction in respect of a business where he is satisfied on the basis of the information available to him that a business is in receipt of an unfair cross-subsidy and that the subsidy has or could have a material effect on competition.
Oftel analysis
1.4 In cross-subsidy cases, Oftel conducts both a financial and a competition analysis of the business concerned. As part of the financial analysis Oftel will look to see that the relevant business plan is based on reasonable assumptions and does not rely for its success on stifling competition. Where there is no previous financial history on which to decide whether a business plan is reasonable, Oftel may examine similar businesses to test the underlying assumptions. Where the business plan appears reasonable and the predicted internal rate of return (IRR) is adequate, Oftel will then look to see whether the actual performance of the business matches the forecasts in the business plan.
1.5 The competition analysis is an economic analysis of the relevant market. Identification of the relevant market is a crucial first stage in identifying whether a subsidy could have a material effect on competition and involves establishing what realistic alternatives are available to consumers. Once the relevant market has been identified, Oftel will then assess whether the subsidy could have an adverse effect on competition. In doing so, Oftel will take into account various factors including loss of market shares to other operators or suppliers, pricing (including price depression), the financial position of competitors and BT’s relative position to other operators in the market itself.
Enquiries concerning this statement should be directed to Philip Taylor on 0171 634 8829.
Product description
2.1 BTNet, launched in December 1994, is part of BT’s portfolio of Internet access services and is aimed at connecting heavy Internet users, primarily business users, to the Internet. It provides a largely dedicated Internet access service. The BTNet service options include Direct which uses private circuits, Relay which uses Frame Relay, and Switched Multi-Megabit Data Service (SMDS). These are all available with a BT maintained CPE router (eg Relay ‘plus’).
2.2 BTNet has five points of presence (PoP) in the UK, and from the London PoP BTNet is connected to the US and to Europe via an EBONE node in Paris. The transatlantic link is a 45 Mbit/s connection into MCI in the US. Other services available through BTNet include e-mail hosting/forwarding, web site hosting, domain registration, equipment leasing and consultancy.
Competition analysis
The market
2.3 There are two main ways to access the Internet:
a) Dial-up/modem using an ordinary telephone line to connect to an Internet service provider (ISP); and
b) dedicated link giving permanent access to an ISP.
BT also provides dial-up services, allowing customers to access the Internet through BT Internet and through a joint venture, with News International, LineOne. About 80 operators such as Demon, UUNet, PSInet and BTNet offer dedicated link Internet access in the UK. About 200 operators offer Internet access generally. The market for Internet services has grown rapidly over the past several years. The demand for Internet access is reported to be growing currently at about 10% per month.
Demand-side substitution
2.4 Demand-side substitution considers the choices available to customers in terms of what alternative goods or services are realistic substitutes. The three main deciding factors in the mind of the consumer in relation to Internet access appear to be quality of service, speed and price. The breadth of choice for customers in choosing which Internet access method to use is wide. For instance, the main method of providing dedicated link Internet access utilises leased lines. However, a number of providers, including BTNet, also offer other high speed links such as Frame Relay.
2.5 Oftel recognises that the difference in price at the extremes between leased line Internet access and modem/PSTN access can be large – depending on usage. However the difference in quality of service between a 64k leased line and basic rate ISDN access can be quite small. Likewise, the differences between highspeed modems utilising the PSTN and basic rate ISDN can be small. This means that although leased lines and modem/dial-up may not be direct substitutes for one another, the prices for these services are constrained by intermediate alternatives eg access via leased lines. BTNet provides Internet access to corporate users and large organisations. Recent figures indicate however that 43% of corporate Internet users still use dial-up modem/PSTN for access (source: Durlacher Qtrly Internet Report). This reveals a significant overlap in the type of customer targeted by dial-up Internet access providers and dedicated link access providers such as BTNet.
Supply-side substitution
2.6 Providers of dial-up Internet access and dedicated link Internet access utilise similar equipment, support services and general business organisation. This appears to suggest that dial-up Internet access providers are in a good position to offer dedicated link access services as well. Indeed a number of the most significant ISPs already offer both dial-up and dedicated link access as part of their portfolio of product offerings. The barriers facing those ISPs offering modem dial-up who wish to extend their services to dedicated links appear to be low eg leased lines are available to ISPs from BT and other operators at the same price as BTNet would pay. Oftel recognises that investment in extra backbone capacity could be an obstacle to dial-up providers in offering dedicated link Internet access. The backbone in the UK is provided largely by members of LINX (London Internet Exchange) which comprises 31 members linked into Telehouse in London’s Docklands. LINX comprises BT, other large telecommunications companies (eg AT & T, CWC, Global One) and large ISPs (eg Demon and UUNET Pipex). As far as Oftel is aware smaller ISPs do not have any problems renting backbone capacity.
Market definition
2.7 A market definition provides a basis for analysing competition and in particular it helps a competition authority to judge whether a particular activity is having a material effect on that market. For the purposes of this present investigation, Oftel views the relevant market in which BTNet competes as the market for Internet access in the UK. The complainant has contended that the relevant market is the narrower dedicated link market. Oftel recognises that there is some support for this proposition including branding issues, but the present analysis however supports the Oftel view of market definition. It is worth noting that BTNet also operates in the wholesale Internet access market (the Internet backbone market) as a backbone provider. However the present complaint does not extend to activity in this market.
2.8 It is difficult to get reliable estimates of the total size of the market and the market shares of individual Internet access providers. Instead the table below shows the growth and shares of the dedicated link Internet access segment over a two year period:
| Service Provider | 1995 | 1997 | Average monthly growth | Numbers |
| UUNet | 44% | 33% | 5.5% | 1470 |
| BTNet | 8% | 12% | 15% | 530 |
| Demon | 8% | 11% | 13% | 490 |
| PSINet | n/a | 5% | n/a | 240 |
| INS | 4% | 4% | 11% | 190 |
| Others | 36% | 35% | 8% | 1500 |
Average monthly growth..................10.5%
(Source: Durlacher Report 1997)
Barriers to entry
2.9 Examining the barriers to entry that exist in a market gives a competition authority an idea of whether certain anti-competitive practices are feasible or not. If barriers to entry are low, for instance certain anti-competitive practices such as an unfair subsidy or predatory pricing would be less feasible as a market strategy. In the market for the provision of Internet access, barriers to entry appear to be quite low and consist mainly of capital outlay on computer equipment, i.e. routers, hosts and servers and rental of backbone capacity. It has been estimated that the start-up costs of a dial-up Internet Access business could be as low as £25–30,000.
The complaint
2.10 Oftel received a complaint in early 1995 from a competing service provider alleging that BTNet was pricing in a predatory fashion in that it was:
a) differential pricing: BT was offering services with the ability to perform similar functions as the BTNet service at a price (for connection and the first 5 year’s service) more than 9 times the price of the BTNet service;
b) retail pricing: on the basis that BTNet must pay full retail price for its use of the network, BTNet’s pricing was below cost; and
c) providing free introductory offers: BTNet was offering to subscribers a free initial period of subscription.
In addition to the above specific allegations, the complainant also alleged that BTNet was in receipt of an unfair cross-subsidy.
Oftel’s investigation
Allegation of predatory pricing
2.11 Oftel considered whether the wide price differential between GNS X.25 service and the BTNet service provided any support for the complaint of differential pricing against the BTNet Service. However, Oftel concluded that while there may be some overlap of functionality and use between the two BT services, they served different markets using different technology and network infrastructure. Therefore the cost differentials do not of themselves support the complaint of predatory pricing.
2.12 Oftel has investigated the allegation of predatory pricing. Predatory pricing requires the alleged predator to attain market power through its predatory action. In so doing, the alleged predator would be able to recover the short term losses by making supra-normal profits later. The apparently low barriers to entry would indicate that any predatory behaviour would not be feasible. Oftel compared the 1995 prices for connection and rental charged by various service provider and BTNet. The table below shows the current prices for the provision of a 64K leased line dedicated access.
| Service Provider | Charges for a 64K leased line dedicated access Internet connection |
||
| Connection Charge £ | Annual Rental Charge £ | Total£ | |
| Demon | 1,000 | 7,200 | 8,200 |
| BTNet | 999 | 5,500 plus circa £2300 minimum for supply of leased line) | 8,799 |
| UUNet | 1,000 | 9,500 | 10,500 |
(Source: Oftel)
The prices shown above are for a connection outside London in the UK. As can be seen, BTNet is priced around the same level as Demon. Further, there does not appear to be any noticeable drop in prices or price depression in general. Indeed, a price leader cannot be readily identified at the moment, although one may emerge if there is consolidation among ISPs or as the market becomes more mature.
2.13 Not only would market analysis suggest that predation is not feasible as a strategy but also BTNet’s actual tariffs do not appear to suggest that it has been pricing below cost. Oftel is of the view that there is price competition between market participants, but not an extreme differential between suppliers.
Free introductory offers
2.14 Free introductory offers are not an uncommon industry practice. In this particular case, the offer did not continue beyond the national launch of the service.
Allegation of unfair cross-subsidy
2.15 Oftel has also been investigating whether BTNet has been in receipt of an unfair subsidy. A start-up business such as BTNet will inevitably produce a negative cashflow in its infancy. This is due to the initial capital expenditure and low initial revenue levels at the start.
2.16 Where Oftel investigates an allegation of unfair subsidy against a new BT business it will look first to see whether the business plan predicts that it will achieve an internal rate of return greater than the cost of capital. Secondly Oftel will look to see whether the assumptions made in the business plan are reasonable. Thirdly, if there is a subsidy, Oftel will then need to assess whether it is having or could have a material effect on competition.
2.17 Oftel has been monitoring BTNet’s performance against its business plan. When the product was first launched in December 1994, BT predicted a rapid growth in number of customers until the end of the financial year 1996/97. Thereafter the customer base was forecast to grow at a reasonable rate.
2.18 The performance from launch up to the end of financial year 1996 was poorer than forecast in that BTNet failed to achieve the number of connections forecast. This has resulted in the forecast revenue being lower than predicted. The performance for financial year 96/97 however was slightly better than projected. Although BTNet did not achieve the number of connections forecast in the business plan, it would appear that it had maintained tight control over its costs in order to keep the actual loss down.
2.19 It is Oftel’s view that BTNet has now moved beyond the start-up phase and Oftel would now expect the product to move into profitability by the end of financial year 1997/98. In April this year Oftel warned BT that if BTNet failed to match its present business plan, the Director General would be inclined to take enforcement action. On the basis of the 1996/97 out-turn figures it would appear that BTNet is now on course with its business plan and may be able to achieve a positive cashflow during this financial year. The assumptions in the business plan appear to be reasonable. At present therefore, Oftel does not consider that BTNet is in receipt of an subsidy or cross-subsidy.
Effect on competition
2.20 It appears unlikely, given BTNet’s present market share and pricing, that BTNet could have a material effect on competition in the short term. However because of market dynamics and the hectic pace of change in the Internet market, Oftel proposes to monitor closely BTNet and the relevant market.
Conclusion
2.21 It is Oftel’s view, on the evidence it has, that at present BTNet is not pricing in a predatory manner nor is it in receipt of an unfair subsidy or cross-subsidy.
2.22 Oftel recognises that independent Internet service providers are deeply concerned by BT’s entry into Internet market. Given BT’s strong position in adjacent markets such as PSTN telephony, ISDN and private circuits provision, Oftel regards this as a particularly sensitive issue. Therefore, rather than close its investigation, Oftel proposes to closely monitor BTNet’s performance against its business plan over the coming months. Oftel will, of course, act swiftly if it were to become apparent that BTNet was unlikely to match its business plan and if there was evidence that current subsidy or cross-subsidy is having, or is likely to have, a material effect on competition.
BT Internet’s Plan 180
3.1 Following BT Internet’s price reductions in March this year, Oftel has been conducting its own investigation of BT Internet. In particular Oftel has been looking to see whether the price reductions can be properly supported in the BT Internet business plan and that the assumptions about BT Internet in the plan are reasonable. The price change that prompted the Oftel enquiry was the introduction of BT Internet’s Plan 180. Plan 180 is a charging scheme whereby customers use BT Internet on a measured time usage basis and was introduced at the end of March 1997. Under Plan 180, BT charges £4 +VAT for the first three hours each month and £2 +VAT per hour thereafter - this is similar to some other ISPs (Internet Service Providers) such as CompuServe and America On Line. BT Internet also provides an unlimited time service which is charged at £10 per month (+VAT).
Benchmark analysis
3.2 Oftel has conducted a comprehensive benchmark analysis of the accounts of two similarly sized ISPs. This involved a thorough analysis of the ISPs’ internal accounts and management information, comparing the various costs and predictions for growth with BT Internet’s business plan. BT’s estimated and actual growth rates so far appear to be in line with the market in general; its assumptions as to future growth and costs are consistent with those of other operators.
Revenue & growth
3.3 We have now received the July figures for the uptake of BT Internet. This shows that BT Internet has attracted sufficient subscriber numbers to match the business plan for BT Internet. This has meant that BT Internet growth appears to be broadly in line with its predictions and is not based on driving competitors out of the market.
3.4 The BT Internet business case is due to turn cashflow positive by the end of 1998/9 (the second financial year) and to have recovered its original capital outlay by the end of 1999/2000. The financial results for the six months from April to September this year show that BT Internet is on track with its business case. On these facts therefore BT Internet is not in receipt of an unfair cross-subsidy.
Competition analysis
The market
3.5 There are about 250 Internet Service Providers offering Internet access in the United Kingdom. This is an increase of about 25% in six months (from about 200 six months ago). The demand for Internet access is reported to be growing at 10% per month. This would indeed facilitate new entrants into the ISP market, which is evidenced by the growing number of ISPs. New services have also come on-line in the past year with BT’s Line One providing content in the form of articles and newspaper style information, together with games, reference and home shopping facilities. BT also provides Campus World, HomeCampus, Wireplay (games service) and BTNet (dedicated Internet access primarily for business). The number of ISPs offering ISDN/Leased Line access also seems to be increasing (up from about 10 to 23 in just six months). The market therefore appears to be maturing and growing, with some ISPs seeking niches in which to develop. The market still appears competitive.
(Source: Internet Magazine, Feb. and Sept. ’97 and Durlacher Qtrly Internet Report, see also the preceding BTNet statement)
Substitutability
3.6 Demand-side. Given the wide scope of functionality of the Internet (e-mail, FTP, and the World Wide Web itself), there are few alternatives to Internet access per se. These include general telecoms services, television and postal services. There does not seem to be one encompassing substitute.
Market share
3.7 Estimates at BT Internet’s current market share are about 5% (source: Emap). BT Internet’s sales growth in the market for Internet access is broadly in line with that of the industry in general; ie 10% per month. Oftel does not expect that BT Internet’s Plan 180 will have an adverse effect on competition.
Barriers to entry
3.8 The barriers to enter this market appear to be low consisting of expenditure on computer hardware, software telecoms links and computer expertise. The estimated cost of setting up as an ISP can be as low as £25-30,000. The low barriers to entry and the growth rate of the market means that there are still a significant number of Internet service providers entering the market (about 50 ISPs have entered the market in the past six months).
Relevant market
3.9 The provision of Internet access services.
Pricing and estimated customer numbers
3.10 Few UK ISPs seem to have copied BT and introduced a time based charging system as well as an unlimited use charge. Assessment of prices in the market is further complicated by various free introductory offers. For instance ISPs such as Virgin and MSN have offered or are offering a free month’s worth of Internet access. BT Internet does not currently offer such introductory inducements.
| Sample Internet access prices compared | |||
| Internet Service Provider | Price/ un-limited access per month | Price/time based charging | Subscriber Numbers/ market share % |
| BT Internet | £11.75 (inc VAT) | £4.70 for 3 hours and then £2.70 per hour | 70,000/7% |
| Demon Internet | £10 + VAT | n/a | 120,000/12% |
| Global Internet | £9.99 + VAT | n/a | 35,000/3.5% |
| Cable & Wireless Internet Dial | £10 (inc VAT) | n/a | unknown |
| America On-Line | n/a | £4.95 for 3 hours and then £2.35 per hour | 230,000/23% |
| CompuServe | n/a | £6.50 for 5 hours and then £1.95 per hour | 350,000/35% |
| Microsoft Network (MSN) | n/a | £4.95 for 3 hours and then £1.95 per hour | 130,000/13% |
| ClaraNet | n/a | £4.69 for 5 hours and then £1.77 per hour | Unknown |
(Subscriber numbers source: EMAP Online UK ISP subscriber league table (conservative estimates), 1 November 1997)
Conclusion
3.11 Oftel has tested the 1996/7 financial year’s results against the business plan. The results for its subscriber growth and cashflows are in line with the predictions in its business plan. The growth rates are also broadly in line with those experienced by the industry in general. On this basis, Oftel has found that assumptions concerning costs and growth made in the business plan for BT Internet in the medium term (2–3 years) are also reasonable and do not rely on resisting market entry to competitors for success. On those assumptions, the IRR presented in the business plan appears very healthy and considerably in excess of the Weighted Average Cost of Capital for BT of 12.5%. Oftel accordingly finds no grounds at present to believe there is any unfair cross subsidy of this product. Oftel intends however to monitor the market closely over the coming months.
Product description
4.1 Campus World is an Internet access service aimed at schools and colleges. It offers both internet access and content over the internet. It was formally launched on 8 September 1995 although its progenitor Campus 2000 has been in existence since 1993. Campus 2000 was a text only service, whereas Campus World is a multimedia service using a different technology and Internet platform.
4.2 Campus World is an on-line service provider which provides internet access and content geared to educational needs. It provides multimedia educational content within a protected environment (the so-called ’walled garden’). It is a world wide web service with links to key education sites on the internet.
Main competitors
4.3 The main competitor to BT in this market is Research Machines (RM) with its Internet for Learning service (IFL). Other relevant providers in the market include America On Line (AOL) which provides some educational content, and small specialist local Internet access providers.
Types of customers
4.4 Schools and colleges of further education are the prime target customers. It is worth noting that BT has introduced a sister product, HomeCampus which gives similar access as Campus World but to individual residential customers.
Competition analysis
Substitutes and interchangeability
4.5 The main candidate for demand-side substitute for a Campus World type product would appear to be Internet access generally. However Campus World is an educational service designed around the UK curriculum and for this reason simple Internet access is a poor substitute. It is for this reason that the main substitute is not easily interchangeable with Campus World. For instance we understand some schools often use ordinary Internet access providers as well as specialist educational ISPs at the same time.
Barriers to entry
4.6 A barrier to entry into this market for other internet service providers is the actual provision of educational content. This would be likely to necessitate an ISP taking on educational professionals. Other start up costs would also be the cost involved in marketing specifically to schools. These may be more significant than appears at first, judging by the few companies that have targeted this market.
Relevant market
4.7 For the purpose of this investigation Oftel has taken the relevant market at present as the provision of internet access plus related educational content for schools and colleges.
Prices and other factors
4.8 BT has from the 1 September 1997 dropped the price of Campus World. For a single user the following tariff applies:
a) Content only (using any ISP) £10 per month
b) Walled Garden £15 pm
c) Walled Garden and proxy Internet access £17.50 pm
Content only includes full use of all Campus World’s content, a full Internet mail account (10 addresses) and an unlimited publishing area. The Walled Garden subscription includes dial up access to Campus World including access to all listed Internet sites, a full Internet mail account and an unlimited publishing area. The third option includes dial up access to Campus World and access to the World Wide Web, a full Internet mail account and an unlimited publishing area. RM charge the equivalent of £12.50 per month for Internet access and access to IFL, that is £5 less than Campus World’s walled garden and Internet access.
Size of market
4.9 Presently the market contains 5-6,000 schools (with around 11,000 accounts) which have an Internet link. There is a possible market size of about 35,000 schools and colleges. For secondary schools alone, the market is thought worth approximately £4 million per annum.
Market shares
4.10 RM and Campus World together share about two-thirds of the market. Oftel recognises, however, that market share figures can be misleading in that some schools use both RM IFL and BT’s Campus World.
Cross subsidy
4.11 Campus World’s results for the 1996/7 financial year that it is still on target with the current business case. Although revenues have been less than those predicted in the business case, BT has offset this by reduced costs. On this basis, the IRR for the product presented is well above the BT’s weighted average cost of capital of 12.5%.
Material effect on competition
4.12 Oftel has been concurrently investigating whether the losses sustained by Campus World have had a deleterious effect on the market. The market of education internet service provision is led by Research Machines (RM) and Campus World. RM appear to have the largest market share.
4.13 Information from competitors in the market reveal that there is no evidence that Campus World has depressed market prices and that instead the reduction in growth is thought, by some in market, to stem from the near saturation in the dial-up market. This would be supported by the present pricing levels of Campus World relative to its competitors.
4.14 Coupled with the strong position of others in the market there is no evidence that any losses suffered by Campus World have harmed competition.
Conclusion
4.15 The Campus World results show that it is on course with its current business case, and its business case reveals a healthy Internal Rate of Return over a reasonable period. Therefore, Campus World is not presently in receipt of a subsidy. Furthermore the information from those in the market and the present pricing structure demonstrates that the losses being suffered by Campus World, for the time being, are not presently having a material effect on competition.
4.16 Oftel intends to monitor this market closely over the next year.
Cost of capital
A firm’s cost of capital can be defined as the rate of return that could be earned in the capital market on securities of equivalent risk. For a firm financed by debt and equity such as BT, the cost of capital will be a weighted average of its cost of capital from both sources.
Cross-subsidy
The use of profits derived from the sale of one good or service to finance losses made by another.
Basic frame relay
A packet data communications service providing a signalling and data transfer mechanism between endpoints of the public network. Frames are routed by the network on permanent virtual circuits according to address information embedded in the frames.
FTP
File transfer protocol provides a basic service for the reliable transfer of files from one machine to another.
Internal Rate of Return (IRR)
The discount rate which equates the revenue streams of a project with the costs of the project, also known as Economic Rate of Return.
ISDN
Integrated Services Digital Network. A network providing end-to-end digital connectivity, supporting a wider range of narrowband services than available across the PSTN.
PSTN
Public switched telephone network. The telecommunications networks of the major operators, on which calls can be made to customers of all PSTNs.
Service providers
Those who provide services over telecommunications networks to the public at large.
Basic SMDS
A high-speed connecitonless data service which provides access to BT’s SMDS network, currently at access class rates up to 25Mbit/s.
Basic X.25
A layer 3 packet data communications service which provides access to an X.25 public switched network where the access circuit is a permanent or continuous link to the network from the customer’s premises.
