6.1. As noted earlier, the best incentive mechanism for providing customers with the right services, quality and prices is competition. In many areas where BT operates, competition is only now developing and BT still possesses substantial market power. This means that, in the absence of regulation, BT could exploit its market power in these areas to raise prices and make excessive profits. For this reason, in these areas, BT's prices must be regulated.
6.2. However, the precise form of price control is important in delivering the kind of outputs expected from competition. The following sections examine a number of the important aspects of the retail price control which will need to be considered for the current review.
6.3. Chapter 3 sets out Oftel's proposed definition of markets for regulatory purposes and considers the present state and likely future development of competition in them. This Chapter considers the treatment of those markets which are currently subject to the retail price cap and which are now or are likely to become sufficiently competitive to be removed from its scope.
6.4. Oftel recognises that it may not be possible to be completely certain in advance that a market will in fact be effectively competitive during the price control period. The possibility of error in timing remains. There may therefore be a case for some sort of 'safety-net' for services which might be removed from the basket. There would then be three groups of services. The first group would be those services which are not competitive and remain subject to price control. The last group would be those which are fully competitive and completely free of price control. The intermediate group, comprised of services which were now believed likely to be competitive after 1997, might be removed from the price cap basket but be made subject to a 'safeguard cap' such as RPI+0% to mitigate the consequences of error (similar to the 'lid' proposed for network charges and described in paragraphs 5.32 - 5.33). Alternatively, the safety net might be set with some regard to expected trends in costs or prices in the relevant market if a cap set at RPI+0% were felt to be insufficiently exacting.
Oftel would welcome views on the suggestion that three groups of retail markets should be distinguished and that a 'safeguard cap' should be applied to those newly removed from the basket. Views would also be welcome on whether this safeguard cap should be set at RPI+0% or should take account of expected price or cost movements.
6.5. Annex C lists the separate markets identified by Oftel as an appropriate segmentation (views on this have been invited). In Table 6.1 these are shown together with Oftel's present view of their status under the new price cap, making the distinction between the three groups of markets described above. The main features of the table are discussed below.
Table 6.1
Market Segment In Basket RPI + 0% No Control Access Y Inland Switched Calls Y IDD Calls Y Low Capacity Private Circuits (all Y analogue and digital up to 64 kbit/s) High Capacity Private Circuits Y (digital greater than 64 kbit/s) International Leased Low Capacity Y Circuits International Leased High Capacity Y Circuits Operator Assisted Calls/DQ Y Specially Tariffed (Voice) Services Y (eg 0800, 0345 etc.) Telex Y Payphones Y* Basic Rate ISDN Y Primary Rate ISDN Y Vision Circuits Y Value Added Services (i) Network Y Management/Support Services Value Added Services (ii) Y Messaging/Transactional Services The Supply of Terminal Equipment Y Analogue Mobile Y Digital Mobile Y
* Paragraphs 6.11 - 6.12 discuss the treatment of payphone prices and in particular the possibility that they could be linked to the prices of other inland calls.
6.6. The state of competition in these retail markets was discussed in Chapter 3. In the cases of Access and Inland Switched Calls, competition is insufficiently developed to permit removal of these markets from the price cap. Chapter 3 also described, however, a number of developments in the market for IDD calls. There is already significant potential competition on routes where ISR operates, and competition is likely to continue to grow on these and others, the more so as liberalisation of telecoms markets in Europe and elsewhere gathers pace.
In the light of this, Oftel would welcome comments on the possible removal of IDD calls from the price control basket. Comments would also be welcome on whether they should be made subject to a maximum increase of RPI+0% and on whether this safeguard cap should be applied to each individual price or to IDD calls in aggregate.
6.7. It may be appropriate for certain voice telephony services to be removed from the cap. In the case of Operator Assisted Calls/DQ, Chapter 3 described Oftel's proposals to open up this market. In addition, BT argue that these services are already priced below cost. Oftel is therefore minded to remove these services from the basket but to make them subject to a safeguard cap of RPI+0%.
6.8. In the case of specially tariffed voice services, Oftel again believes that there are good prospects for competition between operators supplying these services for reasons set out in Chapter 3. Oftel is therefore minded to remove these services from the basket but to make them subject to a safeguard cap of RPI+0%.
Oftel would welcome comments on whether it is appropriate to remove Operator Assisted Calls/DQ and Specially Tariffed Voice Services from the basket and make them subject to a safeguard cap of RPI+0%. Comments would also be welcome on whether the RPI+0% cap should be applied to each individual price or to these services in aggregate.
6.9. Several of the market segments listed in Table 6.1 come under the general heading 'voice telephony'. It is necessary to consider whether any voice telephony services currently outside the price cap should be brought within it. For example, many users have expressed concern about the price of calls to mobiles (ie calls which terminate on mobile phones but originate on BT's fixed network), currently outside the cap. BT has the same degree of market power in respect of these calls as with other inland switched calls because of its dominance of originating ends. This suggests that there is a case for capping the prices of calls from BT to mobile phones (prices of calls from mobile networks would not be directly affected by this).
6.10. The difficulty with including calls to mobiles in BT's price cap is that the bulk of the price of the call is made up of the payment to the mobile operator, which is outside BT's direct control. On the other hand it is possible to argue that the present arrangement gives BT little incentive to control this element of cost and that it would be in a strong position to negotiate the level of charges with the mobile operator. The price of calls to cable operators, where a similar argument could be applied, are already capped. Alternatively, the cap could be placed on the price of the call excluding outpayments. There could however be a difficulty in that BT might be willing to see the level of outpayments rise as this would benefit Cellnet in which it is the major shareholder.
Oftel would welcome comments on the appropriateness of including calls to mobiles in BT's price cap and on how this might best be done.
6.11. Oftel does not believe that it would be appropriate to bring payphone charges into the basket for two reasons. Firstly, as described in Chapter 3, there is the prospect of some competition between payphone operators and secondly, BT's payphones as a whole are not highly profitable.
6.12 However it is recognised that there is concern among users about payphone charges. One proposal, which Oftel believes has merit, would be to link the price of payphone calls to that of another call type. For example, payphone charges might be required not to exceed a certain ratio of local or national call charges. Alternatively, an explicit estimate of the net cost of providing payphones could be made and applied as an uplift to the price of local or national calls.
Oftel would welcome views on the proposal not to cap payphone prices but to link them to the price of other calls and the best means of so doing.
6.13. At present ISDN prices are not subject to price control. There has, however, been some concern that the prices for access to BT's ISDN services are excessive, that this reflects BT's dominance in this market and that they operate as a brake on the use of higher bandwidth. As noted in Chapter 3 (paragraph 3.101), BT is the only supplier of 'basic rate' ISDN service although Mercury also offers a 'primary rate' service. ISDN is still a relatively new service and, as described earlier, it is not desirable to reduce the incentive to develop innovative services by unnecessary controls. However, since ISDN has now been in existence for several years Oftel believes that, in a competitive market, prices could be expected to fall.
Oftel is therefore inclined to include ISDN prices in the new price control but would welcome views on this issue and on whether, if included, they should be placed in a separate basket or in the main PSTN basket.
6.14. A similar question concerns the new broadband switched mass-market services (BSMS) which are expected to develop over the period of the next price cap. Oftel published a consultative document on these services in August. This set out a proposed regulatory framework for such services when provided by a dominant network operator. It also highlighted two issues relevant to the setting of the price cap.
6.15. First, it will be necessary to assess the costs associated with investment in broadband services and to forecast the revenue which BT expects to earn from provision and carriage of such services during the period of the next price cap and to take this into account in setting X. Customers for basic services will expect to benefit from the exploitation of economies of scope (at their simplest, the spreading of common costs over a larger total output - see paragraph 4.10) arising from the provision of broadband services. However, they should not be expected to contribute to the cost of upgrades required only for the provision of broadband services (see paragraphs 4.33 - 4.34).
6.16 The second issue is whether the prices of such services should themselves be subject to the price cap. The view taken in the August document was that, initially, BSMS will need to be keenly priced in order to win market share from established products. Price capping was not envisaged for the foreseeable future, although prices would need to be published, unbundled and non-discriminatory. However, action, including the possibility of price control, would be considered if necessary.
Oftel believes that the approach outlined in the August consultative document on the regulation of broadband switched mass market services, principally that the prices of such services should not be capped unless it proves necessary to do so, is correct, but would welcome views on this issye.
6.17. Oftel has considered whether there should be separate caps for business and residential services. In many areas, there is greater competition to provide services to businesses than to households. This means that, firstly, business services may be in less need of regulation and, secondly, if BT is free to determine the balance of prices within an overall price cap, it may choose to favour business customers over residential ones. Therefore it might be thought appropriate to introduce separate caps or perhaps even to remove the cap from business services entirely.
6.18. There are, however, a number of good reasons not to do so. Firstly, there are considerable elements of common costs in the provision of essentially the same services to different categories of user.
6.19. Secondly, it needs to be borne in mind that, historically, BT's business customers have been subsidising residential users. Thus some change in the balance of prices in favour of business customers could be economically justified. Oftel has proposed that BT should be given freedom to rebalance exchange line rentals and call charges. As part of this package,measures would be put in place to protect low-use residential customers. In addition, Oftel continues to monitor the effect of price changes on the median residential bill, although since 1993 there has been no formal constraint. The experience of the last two years (see Annex B.3) shows that residential customers have benefited from price cuts resulting from price cap pressure and increasing competition. Thus it might be unnecessary to create separate price caps.
6.20. However, under present arrangements, BT has a considerable amount of freedom to target price changes. It will have greater flexibility if it agrees to the removal of the RPI+2% constraint on exchange line rentals. The most appropriate response in future may be for Oftel to intervene under the conditions of BT's licence aimed at anti-competitive behaviour if monitoring reveals that any BT action is likely to have a disproportionate negative effect on particular sectors or raises competition concerns.
Oftel would welcome comments on whether and under what circumstances it might be appropriate to introduce separate price control arrangements for business and residential services and on what monitoring would be encessary to ensure that there was no disproportionate negative effect on particular groups.
6.21. Control of the prices of private circuits is currently by means of three separate baskets of services, each subject to a RPI+0% cap together with individual price caps on all circuits. The three baskets are inland analogue, inland digital and international circuits. Individual circuits are subject to caps of RPI+2% for analogue circuits and RPI+1% for digital circuits. There are two main questions concerning the regulation of private circuit prices: i) is any control now required?; and ii) are separate sub-caps required?
6.22. The first question depends on whether the market for private circuits is now sufficiently competitive for price control to be unnecessary. In Chapter 3 (pararaph 3.74), it is argued that customers for analogue and low capacity digital private circuits do not have an effective choice of supplier. For this reason it is proposed to retain the control on the prices of analogue private circuits. It was suggested in Chapter 3 that it was more appropriate to divide private circuits on the basis of capacity rather than simply into digital and analogue categories and comments on the appropriate threshold were invited. The logic of this suggests that low-capacity digital private circuits should be included in the price cap along with analogue private circuits.
6.23 In recognition of the increasing competition which BT faces in the market for high capacity digital private circuits (see Annex C, paragraphs C.40 C.41), it is proposed to make them subject to a safeguard cap only. Given that the present constraint is RPI+0%, this need not be a significant change.
Oftel would welcome comments on the proposal to retain controls on analogue and low capacity digital private circuit prices but to subject prices of high capacity digital private circuits only to a safeguard cap. Oftel would also welcome comments on the level of any safeguard cap and on whether limits on individual private circuit prices should be retained.
6.24. As noted in Annex C (paragraphs C.42 - C.43) BT continues to possess significant market power in the market for international private circuits. However, in view of likely progress with liberalisation of international telephony markets, it is possible that the market for international private circuits will become competitive (on the basis of the tests outlined in Chapter 3) during the next price control period. In these circumstances, Oftel believes it could become appropriate to make them subject only to a safeguard cap.
Oftel would welcome comments on the proposal to continue control of prices of international private circuits and on whether provision should be made to remove the control if the market becomes sufficiently competitive.
6.25 Separate controls on private circuit prices were introduced to address complaints from business users about the volatility of prices from year to year. Oftel proposes to retain separate caps for analogue (including-low capacity digital) and high-capacity digital private circuits in recognition of the different degrees of competition faced by BT and the proposed differences in the treatment of the various private circuit markets. In particular, the possibility that the price control might be removed from international private circuits during the price control period means that they must be retained in a separate basket so that, if the control is lifted, the caps for other services do not have to be reset.
Oftel would welcome views on the proposal to retain separate caps for analogue (inclding low-capacity digital) and high-capacity digital private circuits and for international private circuits.
6.26. In Annex C (paragraphs C.44 - C.45), it was argued that, in the light of the recent order made against BT in respect of the prices of its vision circuits, it was necessary to consider whether they should be capped. Whilst the problems of discrimination and non-publication of prices have been addressed by the order, concern over the level of prices and BT's market power in this area remains. Therefore Oftel is minded to subject vision circuits to price control.
Oftel would welcome comments on the proposal to subject vision circuits to price control and on whether they should be subject to an individual price cap.
6.27. BT's ability to discount its retail tariff is controlled under Condition 17 of its licence which prohibits undue discrimination or preference. Condition 17A was inserted at BT's request as part of the 'duopoly modifications' in 1991 and has the effect that, provided BT complies with certain guidelines agreed in that year, it will not contravene Condition 17 in offering certain discounts.
6.28. The guidelines in effect allow BT to offer discounts against the published tariff (although these do not count against the price cap) increasing annually in steps of 20% of the difference between the published tariff and fully allocated cost up to August 1995, since which time BT has been able to price down to fully allocated cost. The aim of the guidelines is to allow BT to compete for large contracts but to place a restraint on its ability to prevent efficient competitors entering the market.
6.29. The issue of whether BT should be given greater freedom to offer discounts to large customers was considered in Oftel's December 1994 Consultative Document 'A Framework for Effective Competition'. Oftel's conclusion in the light of responses to that document, set out in its July 1995 Statement, was that no immediate extension of further flexibility to BT to enable it to target large volume users was desirable because of the potential damage to effective competition. The views of large users themselves were mixed. It remains Oftel's view that experience of BT's ability to price down to fully-allocated cost is required before further flexibility is granted and, in any case, there is scope - possibly quite significant - for BT to offer larger discounts within the existing guidelines.
Oftel believes it is appropriate to deal with the question of BT's scope to offer discounts outside the price control process and has undertaken to keep it under review.
6.30. The modifications to BT's licence following the Duopoly Review made it easier for BT to offer discounts to high volume users. The revenue reductions resulting from these discounts were treated as part of the required reductions in charges under the RPI-6.25% formula. During the two years up to July 1993 BT progressively introduced and enhanced high user discounts which largely benefitted business customers, while increasing its standard prices. As well as distributing the benefits of price control mainly to business rather than residential users, such behaviour could have damaged competition. One result of the 1992 price control review was the removal of such high user discounts from the price control basket. This meant that BT could not obtain credit in the basket from further increases in the value of discounts.
6.31. A new condition was introduced into BT's licence in 1993 to ensure that BT could not withdraw its volume discounts without otherwise compensating its customers. The Director General decided that BT would have to maintain the value of its optional packages and discounts (the 'discount yield') in aggregate at their pre-August 1993 level, or make compensating reductions in other controlled prices.
6.32. Annex A to Oftel's July 1995 Statement sets out the proposed treatment in the context of the current price cap for any new packages offered by BT for residential users as a consequence of the lifting of the constraint on line rentals. These packages will not count towards the price reductions required under the current price cap.
6.33. When the cap is reset these packages could either remain outside the basket (as at present) or some, or all, of them could be brought within it and X could be adjusted so that the financial implications for BT were the same in either case. However, there are also non-financial difference between the approaches.
6.34 If all packages are inside the basket BT is given the maximum flexibility to target price reductions onto some kinds of customer. This would better mirror the position of a firm in a fully competitive market, but it also increases the potential scope for anti-competitive behaviour by BT.
6.35 If packages are kept outside the basket BT has to spread its price reductions more evenly across its total customer base in order to meet the basket control. This is more restrictive on BT, but it does ensure a more even distribution of the benefits of the price reductions required under price control. On the other hand, the restrictions on BT can be seen as a handicap on meeting competitive pressures.
6.36 Until details of any new packages are known, their precise basket treatment cannot be determined. However, Oftel's intention is that BT should be free to meet competitive pressures by targeting price reductions (as long as this was not, in itself, anti-competitive or otherwise contrary to its licence) but should not be able to achieve this by keeping prices high in markets where there was less pressure. There may be a case, however, for relaxing this constraint if the framework for dealing with anti-competitive practices is strengthened and if competition has developed sufficiently across all market segments so that there are few, if any, markets where BT could, in practice, keep prices high.
Oftel would be grateful for views on whether any new tariff packages offered by BT in the context of the lifting of the constraint on line rentals should be brought within the price control basket.
6.37. Since 1989 the effect of BT's price changes on residential customers has been assessed by monitoring the impact on a bill constructed to represent a typical residential subscriber at the median consumption level. The 1988 price control review led to an informal understanding between the Director General and BT that the Median Residential Bill (ie the quarterly bill of a typical residential customer) should not rise by an amount greater than the rate of inflation. Following the Duopoly Review the informal understanding became a formal constraint in BT's licence.
6.38. The RPI constraint on the Median Residential Bill became redundant, and was removed from BT's licence, in 1993 following the 1992 review which limited changes to most individual prices to RPI. Nevertheless, Oftel has continued to monitor the effect of BT's price changes on the Median Residential Bill. This monitoring has confirmed that such a customer has benefitted from price reductions in the first two years of the current controls.
6.39. However, the median bill is not the only way to represent an average consumer. Oftel has proposed a number of broad categories of business and residential customers which are then further sub-divided. For residential customers, the categories are defined on the basis of telecoms spend and income level as follows:
Table 6.2
Estimated telecoms Number of
spend households
Comfortable Residential*
High Spenders > £70/quarter 3.5 to 4.5m
Medium Spenders £35-£70/quarter 8.5 to 9.5m
Low Spenders < £35/quarter 2.5 to 3.5m
Less Comfortable Residential
Just Affordable £35-£70/quarter 2.5 to 3.5m
Hard-up Low Users < £35/quarter 1.5 to 2.5m
Unable to use a phone (hearing 0.3 to 0.5m
impaired) individuals
The Unphoned 2.0 to 2.5m
*Those households with a gross income level greater than £7,500 pa
6.40. Oftel believes that it should monitor the effect of price changes on all the categories of consumer shown in the above table, not just the median bill. However, Oftel does not believe that it should now impose formal limits on the Median Residential Bill.
Oftel would welcome comments on whether, as part of future controls on BT's prices, specific limits should be put on the effect of price changes on the Median Residential Bill or on other representative customer bills. In addition, views would be welcome on whether and how the segmentation outlined above could provide a useful basis for monitoring BT's price changes.
6.41 Service quality may be as important to some retail customers as price. It is an important element to consider in any review of price controls because of the potential for price/quality trade-offs. The price capped firm clearly may have an incentive to reduce quality below the level which would be provided in a competitive market. This is because, with prices fixed, the firm could in theory reduce costs and so increase profits by reducing quality. For this reason, it may be necessary to take regulatory action to ensure that an acceptable quality of service for retail customers is delivered by BT. The key question is what regulatory action is likely to be the most effective.
6.42 One option might be to seek to tie quality control into the price cap in some way. The pros and cons of this approach are described below, followed by an outline of alternative measures Oftel is taking to address the quality of service issue. It is worth bearing in mind one key point, which tends to differentiate telecoms from traditional utilities as far as quality is concerned: the market is far more dynamic, with technology and competition both driving service innovation. Customers' views of acceptable service quality change over time as a result. It is therefore important not to view service quality as a static issue which could remain constant for the period of the price control: it will not.
6.43. In theory, it might be possible to incorporate a quality index in the price cap in such a way as to mimic the workings of a competitive market. However, there are a number of important difficulties with this approach. The valuation which customers place on marginal quality improvements is not known with any precision and neither is the cost of achieving them. Perhaps more importantly, quality of service has many dimensions which would have to be combined in a single index. This would require a system of weights which reflected customers' relative valuations of the various aspects of quality. Clearly, the construction of such an index would require huge amounts of data, and would still be difficult to achieve with such a dynamic and subjective issue as service quality. In addition, it would have the disadvantage that customers would not have any redress against poor service. For these reasons, Oftel believes that it would not be desirable to introduce an explicit quality index into the price cap.
6.44. An alternative way of seeking to deliver quality outputs from the price control process could be to specify quality targets or standards that BT would be expected to achieve. These could be set for matters like repair times, fault rates, complaints handling and requests for service provision. They could be monitored and if BT consistently and significantly failed to meet the targets then there could be grounds for reviewing price levels. Alternatively mandatory customer compensation schemes could be triggered.
6.45. This approach, although superficially attractive, also has a number of drawbacks. Firstly Oftel would need to decide, on behalf of customers, what targets to set. This is difficult in a fast moving area like telecoms service provision, and Oftel would need to make judgements about what to include and what standard was appropriate. More importantly, perhaps, there could well be perverse incentives with this approach, as demonstrated when target setting has been applied in other service industries. In any performance standard setting, there is always a strong likelihood that the organisation responds by making the minimum standard become the maximum: the incentive to further improve quality in a particular service area is lost. It is often also the case that an organisation will respond by concentrating its quality of service effort only into the areas regulated by performance standards, neglecting others. So unless a comprehensive list of standards is set at the outset (which could be very long and complex), and kept under constant review, customers could end up losing out; while quality improved in regulated areas, it could decline in others.
6.46 For these reasons, Oftel has chosen not to impose formal quality standards on BT. Oftel has instead followed a three-stranded strategy to encourage BT to improve its service quality for residential and business customers. This strategy is customer responsive, and allows dynamic changes in quality over time to be accommodated.
6.47 Firstly, Oftel monitors and publishes BT's quality of service statistics on a regular basis. These statistics measure the call success rate; network reliability; service provision; repair service; directory assistance; operator service; and public payphone availability. Oftel also monitors BT's complaints statistics and reviews these alongside the complaints about BT's service received by Oftel direct from customers. Oftel takes up issues where service quality is causing concern to customers with BT, and performance is often improved as a result.
6.48. Secondly, Oftel has endorsed BT's Customer Service Guarantee Scheme which clearly states the standards of service which BT customers can expect and offers compensation to customers where these standards are not met. Oftel has also formally approved BT's Complaint Handling Procedures. These procedures have been cited as an example of good practice by the Citizen's Charter Complaints Task Force.
6.49 Thirdly, Oftel is working with BT and the other fixed link operators to develop Comparable Performance Indicators on quality of service for publication. The intention is to publish the first set of data in the New Year provided this is seen to be in the interests of consumers. Further indicators will be developed and should be published in 1996 and beyond. This information, which will allow customers to compare and contrast actual performance between telecoms companies over time on a like for like basis, is likely to be more meaningful and useful to customers than a set of performance standards imposed on BT alone.
6.50 Oftel believes that these approaches, together with the commercial imperative of maintaining a reasonably acceptable level of quality for customers in the face of growing competition, provide BT with more effective incentives to improve customer service quality than those which seek to incorporate service quality within the price cap.
Oftel does not propose to introduce a formal quality requirement into price control arrangements but will instead promote quality improvements through the three-stranded strategy described above. Oftel would welcome views on this approach to monitoring BT's quality of service.
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