2.1 The decisions Oftel has to take about the structure of the price control will have a direct impact on consumers, on BT and on the rest of the UK telecoms industry. They will affect these different stakeholders in different ways. It is important, therefore, that the objectives Oftel is seeking to address through the price control are clarified and discussed so that there is a wide understanding of the way Oftel will be taking the decisions before it.
2.2 Section 3 of the Telecommunications Act 1984 sets out the overarching statutory duties of the Director General. The Director General considers that the best way of addressing all these duties is to focus Oftel's work on the overall goal of seeking "the best deal for the customer in terms of quality, choice and value for money". This clearly puts customers very much at the centre of Oftel's thinking.
2.3 In the Director General's view the principal means of achieving the goal he has set is through the promotion of effective competition in the UK telecoms market. If competition is effective it drives down prices and costs, it spurs innovation and efficiency and provides choice. The corollary is that where monopoly persists or competition is not fully effective, then regulation has to take on the tasks of promoting efficiency and bearing down on costs in order to provide the benefits and protection for customers that effective competition would otherwise have delivered.
2.4 Oftel aims to deliver its goal by pursuing five objectives:
2.5 These high level objectives apply across the totality of Oftel's work. Clearly not everything Oftel does will address all these objectives at once - some actions are relevant only to a single objective, others may address one or more objectives, sometimes there may be tension between meeting one objective or another and a choice has to be made. In making decisions on the price control arrangements there may be areas where there will be conflict between objectives and Oftel is seeking views on how, in those circumstances, the balance between objectives should be set.
2.6 There will obviously be a number of judgements to be made about the various elements which combine to form the overall package of price controls. It is important however to be clear that, overall, the Director General will have to be satisfied that the controls still allow an efficient BT to earn a reasonable rate of return on its business.
2.7 Before considering how far each of Oftel's objectives might be addressed in the price control review, it is important to be clear about what Oftel means by the "best deal" for customers and by "effective competition".
2.8 Oftel's overall goal of maximising quality, choice and value for money is deliberately three-headed. It is not just about price - the other elements are important too. Nor is the goal a static one. Oftel wants to ensure that the benefits to customers from its activities are not just for the immediate future but are enduring.
2.9 The availability of choice, quality and keen prices in the long term can best be achieved through the existence of a number of operators and suppliers of services in the market. That is why Oftel sees the promotion of effective competition as the prime means of delivering its goal. But it has to be effective competition. Ineffective competition, artificially maintained, does not generate the efficiency-promoting rivalry needed to reduce costs and prices and to create new services and new ideas. It does not produce the dynamic benefits which actually deliver what the customer wants.
2.10 Effective competition ensures that costs are driven down to those of an efficient operator and that supernormal profits are squeezed out. In the absence of competition, price caps are intended to mimic this effect and to induce efficiency in the dominant operator. Where the dominant firm is also a monopoly supplier the immediate benefits to customers in lower prices are evident. In a market like the UK telecoms market now, and even more over the price control period, the static and dynamic benefits of the price cap are not quite so straightforward.
2.11 The price control applies only to BT but it will have a much wider effect. It will be a major determinant of the level and structure of both retail and wholesale prices across the industry. In the past, price controls have been determined against the background of very limited competition in the market. The UK market over the period of the forthcoming price control will be very different (see Chapter 3). Competitors have already gained a foothold in all segments of the market but are only just gaining strength. The market is changing rapidly and growing strongly, with the deployment of new technology and the convergence of broadcasting, telecoms and computer industries opening up new services for both business and residential users. The period of the price control should be one with the potential for greatly increased competition to BT in all sectors and rapid changes in, and expansion of, the market.
2.12 Price control will directly affect the economics of competitors' businesses as well as BT's and it is therefore important when considering the new arrangements - all the other parts of the price control package as well as the value of X - to look not just at the immediate static effects they will have on consumer prices but also to be aware of the dynamic impact the whole package will have on the development of competition and the longer term consumer benefits which flow from that.
2.13 The price control arrangements are a major instrument of regulatory policy but there are many other instruments Oftel can use to further its objectives. Oftel does not expect the price control arrangements can be used to address each of its objectives. The role expected of the price control therefore needs to be considered against the background of broader regulatory activity addressing each objective.
2.14 The telecoms market is not a single market for a homogenous product but a series of complicated, interrelated markets for different products. Operators owning competing infrastructure may be both competitors with BT in the provision of network and retail services but also purchasers of BT's network services.
2.15 Oftel has already made clear that for the next price control period it wants to consider the introduction of a network charge cap on interconnection charges as well as a retail cap. Instead of Oftel determining annually charges for BT's network services (excluding those which are determined to be competitive), Oftel would determine charges at the start of the price control period and set a network charge cap to operate during it. BT would then be free to set interconnection charges as it chooses, within specified floors and ceilings. This proposal is set out in more detail in Chapter 5.
2.16 The network charge cap would be set taking account of efficiency improvements which can be expected from BT's network over the charge cap period. Oftel has undertaken a comparative study of the efficiency of similar large telecoms operators and will ensure through the mechanics of the network charge cap that costs can be squeezed down to those of an efficient 'benchmark' operator. In this way, interconnecting operators using BT's network will face efficient interconnection charges which can then be reflected in retail prices to consumers. (Copies of the comparative study are available from Oftel - see inside front cover.)
2.17 The impact of retail and network price caps on other operators, or potential new operators, will differ depending on which area of the UK market they are active in. Clearly a loose retail price cap (low value of X) will benefit all operators offering retail services - they have to better BT's prices to gain business and if BT's prices are higher than they might be under a tighter price cap then the margin of profit for all operators is clearly greater. But, of course, customers lose out - certainly in the short term as prices are higher than they might have been.
2.18 The impact of a network charge cap will be somewhat different. If BT's interconnection charges are squeezed down to those of an efficient operator then this might tend to deter some new entrants from building infrastructure or dissuade some current operators from expanding their infrastructure. Competitors would benefit as purchasers of BT's network services from a tight network charge cap but they would be unlikely, in the early stages of new investment in infrastructure, to be able themselves to beat the charges BT would offer them for interconnection and use of the BT network. A tight network charge cap could, therefore, actually deter some competing infrastructure investment - if it made it cheaper to use BT's network than to build your own. It would also make it difficult for BT's competitors who are seeking to offer network services to other operators. They would find themselves competing against BT's charges set at the level of an efficient, established operator.
2.19 On the other hand, not to press for as tight a cap as is reasonable given the level of efficiency improvements which could be expected over the period would be to seek to promote, on a false basis, competition that was not fully effective and would require customers to pay higher prices in the short term.
2.20 There is clearly some tension between Oftel's desire to promote network competition and the squeeze the price control could place on the margins of some other network operators. Oftel does not consider, however, that it should compromise the objective of seeking maximum efficiency in BT's costs in order to promote network competition. It has other instruments to do this. A soft price control is not an appropriate means to further this objective. Moreover, for some operators a reduction in the charges for services they buy from BT would be to their advantage. A reduction in essential input prices will help to increase the potential market for the derived services which use those inputs. Oftel considers that setting a demanding productivity goal for BT so that its network charges are reduced as low as it is reasonable to expect could overall be beneficial to network competitors as prices will more closely reflect costs.
2.21 To the extent that a tight network charge cap will drive down interconnection charges, service providers will benefit and the price control will help Oftel's objectives here. It will, however, not be completely to the advantage of new service providers using BT's network to carry their services: BT's service businesses competing with them will also obtain reduced terms from BT Network.
2.22 Oftel is currently reviewing the charging arrangements for service providers' access to BT's network where the service provider does not have, or is not part of a group having, an individual licence. At the moment they pay retail prices for network use. Oftel is concerned that this is jeopardising the efficient development of new services over the network. Oftel has consulted widely on this and new proposals will be set out in a consultative document to be published in two weeks time. The decisions on the new service providers' regime will have a direct effect on the network charge cap. If charges for service providers move from the current retail rate, this will affect BT's revenues. Exactly how this will impact on the price cap arithmetic will depend on forecasts of growth for the service market and on who is entitled to service provider terms.
2.23 Oftel considers that it will directly address the issue of services competition through the new interconnection arrangements to be covered in the forthcoming consultation document. The price control arrangements will have an impact on the services market through the interconnection arrangements decided but this is essentially a by-product of Oftel's objective of seeking greater efficiency in BT's operations. It is not the result of direct policy to use the price control purposely to promote services competition. Oftel does not see the promotion of services competition as significantly influencing the choices to be made in the current review.
2.24 A price cap approach provides a good broad control of cross-subsidy if the cap is confined to monopoly services. In these circumstances, it acts to prevent price rises on monopoly services which could otherwise be used to compensate for anti-competitive reductions in those market segments where there is competition. In addition, the price control arrangements may need to contain some provisions to prohibit BT from raising prices again after it has dropped them in order to prevent pricing activity which destabilises competitors. Oftel's proposals for a network charge cap also envisage restricting BT's freedom to set interconnection charges so that these fall between incremental and stand alone costs. This will help to ensure that prices are not predatory or otherwise anti-competitive.
2.25 Oftel considers that the structure of the price control arrangements could make a helpful contribution to furthering its Fair Trading objective.
2.26 Oftel wants to ensure that better quality of service, choice and value for money are available to all groups of customers. Oftel is concerned, for example, that residential customers should secure a reasonable share of the benefits of competition compared with business customers; and that customers living in remote rural areas, the elderly and people with disability, and people on limited incomes also get a fair deal.
2.27 Oftel is working to achieve this objective in a number of ways. The policy of geographic averaging of BT's prices for basic telecommunications services ensures that customers in all parts of the United Kingdom benefit from any price reductions that BT introduces. Everyone gets access to and usage of the network on the same terms. This is guaranteed for the future for the basic voice telephony services covered by the definition of universal service. (The definition of universal service and possible future changes are considered in the forthcoming consultative document.)
2.28 Oftel is putting in place robust mechanisms to secure affordable access to basic voice telephony for all residential customers across the UK. BT is currently considering, with strong encouragement from Oftel, the introduction of a range of tariff packages for residential customers which will give more flexibility and choice. The new universal service regime which will be set out in the consultation document will replace the current Light User Scheme with a more effective scheme to make access affordable to residential customers on limited incomes, and will also include means of allowing consumers to manage and control their telephony costs better. In addition, new measures which allow functionally equivalent access to the network for people with disabilities will be considered for inclusion in universal service.
2.29 Oftel will be carrying out more systematic monitoring activity to assess the extent to which different customer groups are benefiting from the regulatory regime. This will include an analysis of the spread of competition and choice, changes in service quality and availability, and the impact of pricing changes on different customer groups.
2.30 While Oftel believes the above measures represent the most effective means of achieving its objective of fair shares of benefits, the price control review may also make a contribution. Future rules on what services and tariff packages are covered in the basket can influence the distribution of benefits. Oftel therefore sees the achievement of a fair share of benefits as a secondary objective of the price control review. It would welcome views on this.
2.31 Many customers are enjoying now the benefits of a competitive marketplace for telecommunications, although only in certain parts of the UK and in certain sectors of the market. The benefits of competition will spread further over the next price control period. Yet not everyone will realise these benefits. Price control plays a central role in protecting customers from the pricing behaviour which a dominant firm could otherwise exercise in a market which remains uncompetitive. In the absence of effective competition, the regulation of prices is the only way in which the monopolistic tendencies of a dominant operator to charge excessive prices can be curbed. Price control is particularly important in the residential and small business markets, where competition is still developing.
2.32 The retail price cap clearly has a direct effect on reducing prices to customers for services where competition does not yet provide any restraint. A network cap will act to drive down wholesale prices, which should in turn lead to lower retail prices.
2.33 Oftel is also seeking to protect customers in other ways. Oftel is working with BT to place more information in the public domain on customer calling patterns. This will allow better comparison of tariffs to be made between operators, thus making it easier for customers to make informed choices. Comparable performance indicators of service quality between different fixed network operators will be published in the New Year if this is considered to be in customers interests.
2.34 Oftel performs an important advocacy and redress function
for customers where service quality has failed or where charges are inappropriate. Oftel has also ensured that improved complaints handling procedures by BT and other operators are in place, accompanied by comprehensive Consumer Codes of Practice.
2.35 Oftel considers that the price control review will have a positive role in protecting customers in market segments where competition is not yet fully effective and where retail prices might otherwise be unfairly high compared to what would be expected in a competitive market. The retail price control will act to squeeze down prices to those which an efficient operator would offer in a competitive market. Oftel would not propose to put services where there is competition into the price control basket but would focus where competition is not biting on prices and costs and where consumer protection is still needed.
2.36 Oftel's initial views are that in light of its goal, its key objectives and the range of other regulatory instruments it can apply for different purposes, its central objectives in this price control review are:
- to protect customers in markets where competition is not yet effective, and
- to promote maximum efficiency in BT.
A secondary objective will be
- to chose price control structures which, where appropriate, further the fair trading objective
and, subject to consultation, it may be possible that price controls will help
- to ensure all customers share the benefits of competition.
2.37 As a subsidiary but nonetheless important objective Oftel will keep the price control arrangements as straightforward and uncomplicated as possible so that it is clear how regulation will operate in particular circumstances.
2.38 Oftel recognises that the effect of price controls on the development of network and service competition cannot be ignored but these considerations will not drive Oftel's decisions in this review.
Oftel welcomes views on this initial position.
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