3.1 In those markets where competition is not considered to be sufficiently well developed to generate incentives for efficient production, innovation and cost-related pricing, regulation is necessary to protect the customer from monopolistic price increases. Markets for those services outside the price control basket are assumed to be competitive while for services which are not competitive - either because BT does not face any competition or because such competition as exists has not developed sufficiently to constrain BT's behaviour - price control is necessary.
3.2 A key issue for this price control review process is to evaluate which markets can be regarded as being competitive at present; which markets may become competitive over the time-span of the next price control period and which markets are unlikely to see any significant competitive developments. Thus, part of the work of the price control review will involve examining the range of retail services covered by the price control basket in order to assess whether there is effective competition in the markets for those services so that they could be removed from price control.
3.3 It is likely that competition will develop more quickly and effectively in retail rather than network services where BT retains substantial power. For this reason the focus of much of this chapter is on the likely extent of competition in retail services. The development of competition in network services is addressed briefly in this chapter. This will feed into consideration of future arrangements for interconnection charges in a network charge cap (see Chapter 5).
3.4 In order to determine whether there is effective competition in the market for a particular good or service, it is first necessary to develop a robust definition of that market.
3.5 Oftel's approach to defining relevant product markets for regulatory purposes follows the approach used by the main UK competition authorities (ie the Office of Fair Trading and the Monopolies and Mergers Commission). The approach focuses on the existence of constraints on the price-setting behaviour of firms (in the absence of price control). This requires that the definition of a market for a product, or group of products, takes into account not only whether substitution is possible on either the demand- or supply-side but also what the appropriate geographical scope of the market might be.
3.6 On the demand-side it is necessary to examine the constraints on suppliers imposed by the choices available to customers. On the supply-side consideration is given to the extent to which a small but significant price rise might encourage other producers to switch existing production capacity in order to supply that product. Thus, the sole producer of a product in a given area could only sustain a higher price if customers were unable to switch, in significant numbers, to alternative products or to suppliers in other locations or if other producers could not easily switch capacity to supply the same or similar products to customers at the new higher prices.
3.7 This approach is broadly similar to that used by the US antitrust authorities. The US Department of Justice defines markets primarily in terms of the demand-side but recognises that firms for which supply-side substitution is a feasible and a likely response to a price increase should be treated as participating in the relevant market.
3.8 The key idea that underlies this approach to market definition is pricing behaviour: the test is whether a sole supplier of a particular product would find it profitable to increase the price. If such a sole supplier would find it profitable to increase price, then that product or service constitutes a distinct market.
3.9 This approach to market definition is intended to have a general applicability outside the scope of the price control review: for instance, in the context of examining allegations of anti-competitive behaviour.
3.10 Once the basis for the definition of a market has been established, the analysis moves on to consider whether there is effective competition in that market. Oftel envisages a competitive market as one in which no firm is able to act independently (in terms of either pricing behaviour or output decisions) of any of the other firms competing in that market or a market in which an incumbent firm's behaviour is effectively constrained by the threat of entry from firms outside the market. In this situation no firm should be able to raise and sustain its prices above the 'competitive level'.
3.11 However, this approach should examine not just whether a firm is 'dominant' (ie has the ability to act independently etc) but also whether the market could be characterised as potentially collusive: although there might not be a dominant firm in a market, that does not automatically imply that the market is fully competitive.
3.12 The concept of effective competition thus goes beyond the issue of whether a single firm is dominant or not. At the same time, the notion of effective competition in a multi-operator environment has to take into account whether competition is efficient and sustainable.
3.13 Assessing the degree to which BT now faces effective competition in any given market will need to take into account a range of factors encompassing not just the structure of the market but also the conduct of firms in that market. There is no unique indicator of a competitive market: for instance, market share figures on their own are a poor indicator of market power. Oftel will need to examine a range of factors such as the changing pattern of market shares over time; the degree of concentration in the market; the price history of the market; the degree of excess capacity that competitors possess; barriers to entry (and exit) together with the history of entry into and exit from the market and the way in which firms compete in the market (eg whether they compete on the basis of price, after sales service or other factors).
Oftel would welcome views on the approach it has adopted for defining markets and for assessing the degree of competition in those markets.
3.14 Employing the approach described above Oftel has defined a set of markets for various retail telecommunications services which are likely to be relevant for the current price control review. The full list of markets is set out at Annex C. Of those markets, the following are covered by the current price basket: access to the PSTN (ie connection of and exchange line rental); inland switched calls (ie local and national calls which are considered to be part of the same market - this covers both voice and fax traffic); IDD calls; operator assisted calls/Directory Enquiries (known as DQ); and specially tariffed voice services (eg 0800, 0345 etc).
3.15 It can be argued that local and national calls constitute separate markets but Oftel proposes to regard them as being part of the same market because there is increasingly little difference between the network infrastructure (in terms of the conveyance and the number of switching stages) used to provide these calls.
3.16 Access and inland calls have been identified here as separate markets. Although the provision of network access and call services have traditionally been supplied by the same network operator, it is important to consider whether access to the network might constitute a separate economic product market from usage of the network. Oftel recognises that customers want access to the network and to send and/or receive calls over the network. But customers may take access and some services from one operator and some services from another or a customer might not want to make any calls but they might want to be in a position to receive calls. Identifying access and calls as separate markets does not mean that a carrier is unable to enter the market for access provision but it does draw attention to the different infrastructure requirements of the two services.
Oftel would welcome views as to whether the separation of local and long-distance calls and the separation of the provision of access and call services is valid for the purposes of evaluating and monitoring effective competition.
3.17 Inland and international private leased circuits are subject to separate price caps. Oftel considers the separate product markets for these services to be: low capacity inland private circuits; high capacity inland private circuits; international leased low capacity circuits, and international leased high capacity circuits.
3.18 Services currently not subject to price caps include: telex; calls from payphones; ISDN lines; vision circuits; value added and data services (VADS); the supply of terminal equipment; and mobile voice and data services.
3.19 In all over 64 per cent of BT's current turnover is covered by price controls.
3.20 Market definition should not be a static concept: competitive and technological developments can change the demand/supply characteristics of a market. There is thus the need to revisit the definitions of the markets for these services from time to time as technology changes. At the same time, in an industry where technological developments are rapid, there is also a need to look ahead to try to anticipate how markets may develop in the future and thus to include a dynamic element to market definition. Significant technological changes might require a re-evaluation of the coverage of price controls.
3.21 As well as the need to consider shifts in market definition within the sphere of telecommunications services, there is also the need to consider technological changes as they affect the relationship between telecommunications services and other entertainment and information services in a wider communications market.
3.22 An important issue is the prospect of the convergence of different information delivery mechanisms. In August 1995 Oftel issued a consultative document, "Beyond the Telephone, the Television and the PC", which set out some of the key issues surrounding the emergence of broadband switched mass-market services and invited comments on future regulatory arrangements.
3.23 To date Oftel's focus has been on switched services: that is a service provided over a network which is capable of routing signals and messages from one line to any other line in the network (eg a point-to-point distribution system). Oftel is also involved in the regulation of certain unswitched services: an unswitched system is one in which a signal is broadcast from one site in the network to all other sites (eg a point-to-multi point distribution system such as TV broadcasting). Oftel is responsible for regulating NTL's transmission network which is used to broadcast Channels 3 and 4.
3.24 Historically, switched services have tended to be services which did not require high capacity or bandwidth, whereas unswitched services (such as broadcasting) tended to be bandwidth intensive. Increasingly, with digitalisation, both broadcast and telecommunications services will be delivered over the same networks and this would suggest that markets could need to be defined more widely than at present to take this into account. Technological developments such as digital transmission, together with the capacity afforded by optic fibre cable, already allow the delivery of some higher bandwidth services over switched systems: for example video-on-demand supplied over the PSTN.
3.25 Other technological advances include the development of software which allows the computer networks that make up the Internet to handle voice traffic and thus potentially circumvent the existing regulatory regime.
3.26 The impetus for the convergence of telecommunications and entertainment markets is clearly driven by underlying technological factors. However, the timescale for the emergence of services based on the convergent technology (eg wideband and broadband switched mass-market services) is uncertain and this in turn means that the regulatory implications of continuing to define separate markets are also uncertain. This suggests that it is appropriate, at this stage, to maintain the market definitions for telecommunications services set out above.
Oftel would welcome comments on the extent to which the emergence of services based on the convergence of delivery technologies needs to be considered in the context of this price control review and whether it is correct at the current stage of market development to to treat the broadcasting and telecommunications markets as separate markets.
3.27 As well as examining the degree of competition within an economic product market Oftel also believes that it is important to gain an understanding of (and to monitor) the distribution amongst customers of the benefits from increased competition in the UK telecommunications markets. This may influence the future scope and nature of the price controls. For instance, the table "Who has Benefitted from BT's Price Changes" in Annex B illustrates that until recently the main direct beneficiaries of BT's price changes have been business customers rather than residential customers, although residential customers will have benefitted indirectly from the lower costs that businesses faced and from constraints on rental charges. All customers benefit from a more efficient telecoms operator.
3.28 Customers can be grouped in many different ways. Oftel has chosen to draw up some broad customer categories based on two main groups. These groups are businesses and residential customers and these have then been further sub-divided. For businesses the sub-division is based primarily on the size of the telecoms spend. For residential customers the size of the telecoms spend is used together with the income level of the household. The customer groups are set out in Table 3.1 (Annex C provides a more detailed description of these customer groups).
Oftel would welcome views as to whether this is the most appropriate segmentation of customer groups.
Table 3.1: Customer Groups: Business and Residential Categories.
Business
(i) Global customers;
(ii) Large Businesses
- multisite
- other large businesses;
(iii) Small and Medium Sized Enterprises (SME)
- medium sized
- medium small
- small;
Residential
(i) "Comfortable" residential
- high spenders
- medium spenders
- low spenders;
(ii) "Less comfortable" spenders
- just affordable
- hard up low users
- people who can't use a phone;
(iii) The unphoned.
3.29 The next sections move on to consider, in general terms, competitive developments since 1991 and attempt to anticipate potential developments through to the year 2001. Most of what follows will focus on market developments in terms of new entrants to the various markets and the prospects for new entry to translate into actual effective competition. This Chapter also discusses some of the broader industry trends which will influence competition.
3.30 Since its establishment the UK regulatory regime has encouraged the development of alternative infrastructure to BT. Since the ending of the duopoly policy in 1991, the increased liberalisation of UK telecommunications markets has resulted in a dramatic increase in the number of operators: there are now over 150 licensed PTOs.
3.31 Nevertheless, BT remains vertically integrated and is still by far the largest operator in the UK. It is the only operator with a national coverage and which the only one which is active in all sectors of the market. BT's network is the most comprehensive in the UK for both long distance and local terminations and virtually all of its competitors' calls have to originate or terminate on BT's local network.
3.32 The entry, since 1991, of new PTO licence holders strongly suggests that the extent of competition in the markets for various telecommunications products and services in the UK has increased. Many customers now have a choice of telecoms operator and operators are increasingly forced to compete against one another for business. Increased competition together with increased choice for customers is likely to raise customers' expectations which in turn could promote competitive developments.
3.33 Nevertheless the impact of liberalisation to date has been uneven across customer groups and in geographical reach. For instance, residential customers in urban areas are likely to have a choice of operator whereas those in rural areas will not. Large multi-site businesses may also experience a relatively low level of competition because few operators have the reach and ubiquity to provide services to all their branches.
3.34 Table 3.2 shows that in the financial year 1994/95 these new entrants were still establishing themselves and had yet to make much of an inroad into BT's share of the largest markets. BT's most recent interim results, however, have revealed that the number of BT residential exchange lines has fallen for the first time, albeit by 0.2 per cent. Competition is thus beginning to bite.
Table 3.2: Market Shares for Fixed Link Telephony - Retail Call Revenues in 1994-95.
Market Share
Type of call BT Mercury Kingston & others
Local and 88.8 8.6 2.6
national calls
Outgoing 70.0 24.5 5.5
international
Value added and 88.8 9.3 1.9
other systems
business calls
Network Competition
3.35 BT's network is the most comprehensive in the UK: it has an unparalleled degree of geographical coverage and ubiquity. Although other operators, such as Mercury, the cable companies, Energis, Ionica, Scottish Telecom, Norweb, and Torch are constructing their own competing networks and some may even achieve comparable geographic coverage (eg Ionica) to BT, it is unlikely that any one of them will be able to replicate BT's access to customers.
3.36 The ubiquity of BT's network means that the terms and conditions on which competing operators can interconnect with it are of vital importance to the continuing development of competition in the UK: they exercise an important influence on the extent to which the other operators can compete with BT on price and the extent to which competition at the wholesale level can translate into effective competition at the retail level to the benefit of final customers.
3.37 Network competition is still developing and Oftel believes that, over time, some or all of the markets for wholesale interconnection services - apart from call terminations - will become increasingly competitive. This will reduce the need for regulation in this area. In the interim however, given the importance of interconnection charges for the development of competition overall, Oftel believes that they still need to be regulated but through the broad control of a network charge cap rather than through the detailed annual determination of charges as at present. These issues are discussed at greater length in Chapter 5.
3.38 As well as specific market developments, there are a number of important general industry trends which will influence the development of competition across a range of markets.
3.39 Paragraphs 3.22-3.26 above have explored the implications convergence may have on competition in due course. Another important development in the field of telecommunications has been the increasing demand from multinational companies to purchase a complete 'package' of telecommunications services on an international or even global scale from one operator. Various national PTOs have responded to this by forming alliances with other national operators in order to be able to provide a complete cross-border service. For instance, there is the Unisource consortium which comprises the PTOs from Sweden, the Netherlands and Switzerland and which has in turn become part of AT&T's WorldPartners alliance; the Concert joint venture between BT and MCI, and the prospective Atlas alliance formed between France Telecom and Deutsche Telekom.
3.40 At the same time, there is the prospect of the increasing liberalisation of telecommunications regimes in other countries. In the EU there is the proposed liberalisation of some telecommunications infrastructure in 1996 and the proposed full-scale telecommunications liberalisation with the implementation of the interconnection and licensing Directives in 1998. There are also discussions taking place, under the auspices of the World Trade Organisation, about telecoms liberalisation on a global basis. Alliances can thus facilitate the exploitation of opportunities that become available in other countries: for instance, BT has linked up with the German company VIAG ahead of deregulation in Germany, as well as establishing links with operators in Norway and Denmark.
3.41 There is the prospect in the UK of the 'commoditisation' of transmission services as the price of transmission moves down towards the underlying cost of provision, thus squeezing the margin on the supply of transmission services. This is likely to force carriers to extend their operations into service provision and to develop differentiated products offerings: ie to move up the value chain. The number of service providers is thus likely to increase.
3.42 Such market developments could be enhanced by changes to the regulatory regime. Oftel will shortly be publishing a consultative document on the future regulatory regime for service providers.
3.43 The biggest change in the markets which are subject to price control has been the increase in choice available to many customers: in areas passed by cable companies customers now have access to an alternative service provider to BT, and the entry of new operators has also meant that there is increasing competition in the provision of transmission services. Perhaps the most significant competitive developments have occurred in the provision of IDD calls with the introduction of International Simple Resale (ISR) on a number of routes. There are now some 30 operators licenced to provide ISR and competition on these routes has forced down the price of IDD calls substantially.
3.44 The increase in the number of PTOs has also increased the degree of competition in the provision of high capacity inland private circuits but the there appears to be little prospect of significant competition in the provision of low capacity inland private circuits.
3.45 In other markets such as operator assisted and DQ calls and specially tariffed services competition has been slower to develop but there are indications that competition could emerge in these areas. Annex C contains a more detailed discussion of the competitive developments in these markets as well as a discussion about the prospects for future competition. The Annex also contains a series of questions which invite comments about the prospects for the development of effective competition over the next price control period.
3.46 The retail markets which are not subject to price control are also reviewed in Annex C. As well as the markets for VADS and mobile services, which are generally regarded as competitive, there is also a review of other markets, such as payphones, where the prospect of further deregulation could encourage more competition. For a number of other services which are currently outside price control Oftel also invites comments as to the degree of effective competition in those markets in the future. Chapter 6 discusses the implications of these assessments for future price controls.
3.47 The degree of competition that BT faces across a range of markets is likely to increase as the current state of competition intensifies in some markets or as competition is introduced into markets in which there is currently little or no competition.
3.48 It is possible to develop a market/customer matrix using the market definitions and customer grouping proposed earlier in the Chapter to try to represent schematically the current pattern of competition and perhaps to chart how it might develop in the future.
3.49 In order to distinguish simply between the different degrees of competition, one might consider the following "index" of competition:
3.50 In October Oftel wrote to a number of operators inviting them to complete a version of the market definition/customer grouping matrix as a way of testing how different operators viewed the prospects for the development of competition over the next 5-6 years. Oftel proposed that operators assume that the current regulatory regime is extended through to the year 2001. Table 3.3 attempts to reflect the range of views using the index.
3.51 Most operators saw the continued development of competition across the range of markets through to 2001 with the largest increases in the degree of competition being experienced in the business sector and in urban areas. There was general agreement that competition for access and inland calls would increase although few operators envisaged that, by the year 2001, these markets would warrant a '4' on the competitiveness index - ie few anticipated that they would be fully competitive by then. Operators were more optimistic about the development of competition for IDD calls.
3.52 Opinion about the development of competition in the provision of operator assisted/DQ calls was divided. Some operators envisaged a gradual move to a more competitive environment while others saw the degree of competition actually declining. Most operators anticipated that specially tariffed services would become more competitive.
3.53 Few operators saw any significant development of competition in the provision of low capacity inland private circuits but a number were of the opinion that high capacity inland circuits would be close to being fully competitive by 2001. Most operators viewed international private circuits as only relevant for the larger business customers and again most anticipated that the largest competitive developments would take place in the high capacity market. However, fewer operators anticipated that this market would be fully competitive by 2001 compared to those who considered the inland high capacity circuit market would be competitive.
3.54 Virtually all the respondents considered that other markets such as the VADS and terminal equipment markets were fully competitive and most considered that the mobile markets were close to being fully competitive.
3.55 BT was generally more optimistic about the overall development of competition: it viewed certain markets as already moving towards being fully competitive and anticipated that competition would develop across most markets and across most customer groups.
TABLE 3.3: Market Definition/Customer Grouping Matrix.
Access Inland calls IDD Calls
Customer '95 '97 '01 '95 '97 '01 '95 '97 '01
Global 2 2/3 3 2 2/3 4 2 2/3 4
Large Businesses 2 2/3 3 2 2/3 3/4 2 2/3 3/4
SME 2 2 3 2 2/3 3 2 2 3/4
Residential 1/2 2 2/3 1/2 2 3 2 2/3 3
Op. asst/DQ Specially tariffed Inland services low capacity
CUSTOMER '95 '97 '01 '95 '97 '01 '95 '97 '01
Global 1 1/2 2/3 2 3 3/4 1 1/2 2
Large 1 1/2 2/3 2 3 3/4 1 1/2 2
Businesses
SME 1 1/2 2/3 2 2 3/4 1 1/2 1/2
Residential 1 1 2/3 n.a n.a n.a n.a n.a n.a
Inland International International high capacity low capacity high capacity
CUSTOMER '95 '97 '01 '95 '97 '01 '95 '97 '01
Global 3/4 3/4 4 1 1/2 3 2 2/3 3
Large 3 3 4 1 1/2 2/3 2 2/3 3
Businesses
SME 2/3 2/3 3/4 n.a n.a n.a n.a n.a n.a
Residential n.a n.a n.a n.a n.a n.a n.a n.a n.a
3.56 The next price control will cover an important period in the competitive development of telecommunications markets in the UK and especially in those markets which are currently subject to price control. Where possible Oftel wishes to do away with unnecessary regulation and to let competition provide the necessary incentive mechanism for providing customers with the choice of services, quality and prices.
Oftel would welcome views on the likely extent and pace of competitive developments, on their impact on the scope of the price control framework for the next price control period from 1997 and Oftel's analysis of the potential development of competition in Annex C.
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