Summary

Chapter 1        Introduction

Chapter 2        Background to investigation

Chapter 3        Summary of representations made

Chapter 4        Relationship between BT’s costs and prices

Chapter 5        International price comparisons

Chapter 6        Competition in the provision of leased lines in the UK

Chapter 7        Conclusions

Chapter 8        Recommendations/Further areas of concern

Annex A        BT’s prices for leased lines

Annex B        Suppliers of leased lines in the UK

Annex C        Survey of leased line users

Glossary

In December 1997, Oftel opened a preliminary investigation into the pricing of national leased lines in the UK following representations that prices were excessively high relative to those in the US and to certain other European markets.

Oftel believes that regulatory interference in markets should be kept to a minimum focussing on those areas where competition is not sufficiently developed in order to protect the consumer.

In line with this policy, Oftel’s investigation has sought to both assess the claims of the representations that UK prices are higher than elsewhere and to establish whether there are any significant barriers to the development of effective competition.

BT’s cost information suggests that overall returns for leased lines are below those made by the Retail Systems Business in total.

International benchmarking studies suggest that for an average basket of leased line lengths and for the majority of bandwidths, BT’s UK prices are not significantly above those in the major European countries.

Competition in the provision of high bandwidth circuits (in particular 2Mbit/s and above) appears to be developing within the UK and this has acted as a constraint on these prices in the absence of regulatory price controls.

Competition for the provision of analogue circuits and digital circuits below 64kbit/s is limited. However, the price cap on these baskets acts as the constraint on prices and the incentive to improve efficiency. This price cap will be reviewed as part of the 2001 Price Control Review which will begin during 1999.

Other operators will not always have sufficient infrastructure in place to offer customers a full end-to-end leased line service and will therefore need to purchase ‘final mile’ circuits from other operators. BT does not appear to be pricing such circuits in a manner which distorts competition, although where BT receives cost savings from providing such ‘final mile’ circuits to other operators as opposed to other customers, these are not always reflected in the retail price charged.

BT should extend its partial private circuit product (BT’s Link to a Point of Interconnection product) to all bandwidths and allow operators to receive the same volume and term discounts applicable to retail leased lines.

OLOs should address the perception held by many customers that the quality of service provided on circuits which are part provided by a number of operators (eg when ‘final mile’ circuits are purchased to form a ‘multi-vendor’ circuit) is much lower than that offered by an operator capable of providing a full end-to-end service.

1.1 Leased lines provide permanently connected point-to-point communications links dedicated to the customer’s exclusive use. Leased lines are used for dedicated voice channels and for the transfer of data and images. Revenues generated by connection and rental charges are estimated to be worth around £1.8bn in 1997/8, with BT accounting for around 88% of this figure.

1.2 In 1996, Oftel concluded a review of the regulatory controls on BT’s prices. Oftel’s statement Pricing of telecommunications services from 1997 (June 1996) set out the following conclusions on leased lines:

• the development of infrastructure competition would be constrained if BT was obliged to offer wholesale leased lines to other operators under condition 13 of its licence;
• the market for high capacity (over 64 kbit/s) digital circuits was competitive and would therefore not be subject to any retail price controls from 1997; and
• competition was not sufficiently developed for analogue and low capacity digital circuits (64kbit/s and below) and so price controls of RPI+0% would be placed on these two baskets of circuits.

1.3 However, it was also recognised in this statement that BT’s competitors often rely on BT’s local loop in providing their services. Oftel therefore undertook to consider the potential for abuse in the supply of these circuits if the need arose.

1.4 Towards the end of 1997, the DTI and Oftel received representations from a number of large business users that prices of national leased lines within the UK were excessively high relative to those in the US and to certain other European markets.

1.5 In the light of the representations, a preliminary investigation was opened in December 1997. The aim of the investigation has been to address whether the level of prices in the UK raised any regulatory or competition concerns. The investigation has centred solely on national leased lines between sites within the UK and does not deal with the UK half of international circuits. Oftel is separately assessing further representations about the level of BT’s international half circuits.

1.6 Oftel recognises that the price of leased lines is an important cost input into UK businesses. Oftel’s goal is to achieve the best possible deal for the customer in terms of quality, choice and value for money. Oftel believes that the best way to deliver this goal is to promote effective competition which should enable customers to choose operators on the basis of price and quality of service which will place pressure on operators to improve both. Lower prices should then increase the incentives for operators to improve efficiency. Regulatory interference in markets should be kept to a minimum focussing on those areas where competition is not sufficiently developed in order to protect the consumer.

1.7 In line with this policy, Oftel’s investigation has sought to assess the representations and establish whether there are barriers to the development of effective competition.

1.8 This investigation therefore examines:

• the relationship between BT’s costs and its prices;
• international comparisons of leased line prices; and
• the competitive situation in the UK and its impact on prices.

1.9 This statement sets out Oftel’s findings from this investigation.

1.10 Comments on this statement are invited, particularly on the points made in chapters 7 and 8. It would be helpful to receive any views by 31 January 1999. Comments should be addressed to:

James Tickel
Compliance Directorate
Oftel
50 Ludgate Hill
London
EC4M 7JJ

Tel: 0171-634-8826
Fax: 0171-634-8949

or e-mail

2.1 This chapter sets out the background to the current investigation into BT’s charges for leased lines in the UK. It provides a brief description of what a leased line is and sets out details of the revenues generated by the provision of leased lines in the UK. There is then a description of BT’s portfolio of leased line products and an analysis of its current pricing structure, followed by a summary of the current regulatory and competition rules applying to the pricing and pricing of leased lines.

2.2 A leased line is a permanently connected communications link between two premises dedicated to the customers’ exclusive use. There are data-only services, voice-only services and services combining voice, data and image. The cost of a leased line is usually dependent on its length and bandwidth and independent of usage. Leased lines are therefore appropriate for use between any two locations which are in contact with each other at regular intervals or for long periods. Examples of the uses of leased lines include interconnecting the local area networks on a business’ different sites (LAN-to-LAN interconnect), providing branch sites with access to centrally held databases, providing videoconferencing links between sites, and electronic data interchange (EDI) between suppliers and their customers.

2.3 A BT leased line consists of:

• a copper or fibre connection from location A to the nearest BT local exchange (LXa);
• (if necessary), a trunk connection to the nearest BT local exchange to location B (LXb), usually – but not always – via the Digital Main Switching Unit (DMSU); and
• a copper or fibre connection from LXb to location B.

 

A ----------------LXa------(DMSU----------------------------------DMSU)------LXb----------------B

{ local end             }{                                              main link                                          }{      local end     }

2.4 In some instances premises A and B are connected to the same local exchange (own exchange circuits).

A------------------LXab--------------------B

{     local end         }{          local end              }

2.5 For another operator to offer a customer a full end-to-end service over its own network between any two locations it must either install or have installed copper or fibre between the premises and the nearest point(s) of presence (PoP) on its network and if necessary between these points of presence. If an operator does not install a complete link between the premises it can still offer and provide a leased line to this customer by purchasing a link from the premises to its PoP (see below).

A-----LXa------LXpop-----PoP--------------------------------------PoP----LXpop------LXb-----B

{     purchased from              }{                  operators’ trunk circuit             }{          purchased from     }
       other operator                                                                                                 other operator

2.6 Leased lines are provided over analogue and digital circuits up to maximum bandwidth in the UK of 155 Mbit/s and can be delivered using Synchronous Digital Hierarchy (SDH) or Plesiochronous Digital Hierarchy (PDH) technologies. The choice of circuit type, bandwidth requirement and delivery technology will depend on a number of factors including the intended use of the circuit (eg basic voice requires low capacity while image transfer requires high capacity), the speed of voice, data or image transfer needed, the intensity of use of the circuits and the required level of security and resilience of the circuit (SDH circuits usually proving higher resilience).

2.7 The main users of private circuits in terms of numbers of circuits and revenue are those requiring a national internal private network for voice, data and image transfer between a number of locations and include retail operations such as high street stores and banks, information providers and telecoms operators themselves, including mobile operators. Leased lines within central London are in high demand for conducting transactions and relaying information on the financial markets etc.

2.8 Oftel estimates that around 25% of the revenues of all national leased lines in the UK market are accounted for by the provision of analogue circuits. By number of circuits this translates into roughly 50%. Similarly a large number of digital circuits are low capacity – ie 64kbit/s or below – indicating that a significant share of leased lines are used for voice traffic and for simple data transfer. Dealer rooms in and around the City of London account for a large proportion of dedicated voice circuits.

2.9 The majority of high volume digital circuits (above 64kbit/s) are 2Mbit/s presentations. The volume of leased lines above 2Mbit/s is relatively small at the present time, but is expected to see the most rapid growth. The largest customers such as banks, the major high street retailers, large on-line information providers and IT companies are likely to generate the most immediate demand for high capacity circuits.

2.10 Table I below sets out Oftel’s estimate of the total size of the national leased lines market in 1997/8. Chapter 6 provides an estimate of the breakdown of these figures by different bandwidths.

2.11 BT offers the following range of analogue and digital circuits (BT product names used):

• SpeechLine: analogue circuits specifically designed for direct voice transmission.
• KeyLine: analogue circuits dedicated to low speed data transmissions.
• KiloStream: digital circuits in speeds from 2.4kbit/s to 64kbit/s can provide data and voice transmissions.
• KiloStream N: digital circuits available in increments of 64kbit/s from 64kbit/s to 1024kbit/s. Provided over X.21 interface for data transmissions or G.703 for voice.
• MegaStream: high speed digital circuits over 2, 8, 34, 45, 140 and 155Mbit/s for large volumes of data and voice traffic.
• MegaStream Genus: 2, 34, 45, 140 and 155 Mbit/s circuits delivered over Synchronous Digital Hierarchy (SDH) technology which offers increased resilience over circuits provided over Plesiochronous Digital Hierarchy (PDH).

2.12 Connection charges for analogue and KiloStream circuits are based on a fixed charge for each local end plus a fixed charge for the main link. Connection charges for KiloStream N and MegaStream circuits are only charged for each local end. Connection charges for MegaStream circuits vary with bandwidth.

2.13 Delivery of analogue and KiloStream circuits is usually over copper which is normally already present. However, delivery of KiloStream N and MegaStream circuits at the local end can be over either copper or fibre. If the service cannot be delivered over the existing plant, then the connection charge for the initial circuit to a site is higher. Connection charges are 50% cheaper for each local end where appropriate plant already exists. For MegaStream circuits there is also a discounted charge for all subsequent circuits to a particular premises, even though this may potentially require further plant to be installed.

2.14 Rental charges usually consist of:

• a fixed rental charge per local end;
• a fixed rental for the main link; and
• a per km charge for the main link based on the radial distance between the local exchanges serving each end of a link.

The per kilometre charge often varies with a higher per km charge for the first 15km than for all subsequent kilometres. Rental charges increase with bandwidth. Table A1 at Annex A shows a comparison of BT’s leased line rental charges for different bandwidths.

2.15 As set out above, MegaStream Genus circuits offer increased resilience using SDH technology. Table A2 at Annex A shows the premiums paid for the SDH circuits over the equivalent bandwidth PDH circuits.

2.16 As well as distance and bandwidth, rental charges also vary for circuits where both ends are within the 0171 central London zone (CLZ) and circuits where one or both ends are outside this area. CLZ circuits are sometimes priced for a whole circuit and sometimes at the same local end charges as non-CLZ, but with a specific fixed price for the main link independent of its length. Differentials in pricing inside and outside the CLZ will therefore differ for circuits depending on the pricing structure, whether it is own-exchange and on the length of the main link. A general rule is that the difference will be greater when comparing circuits with longer distance main links (although there is an obvious constraint on the length of these links given that both ends must be wholly within the 0171 exchange area). Table A3 at Annex A sets out differences between prices within CLZ and those outside for both own-exchange circuits and circuits with a 5km main link. For high capacity circuits, rentals are almost 50% cheaper with both ends inside the CLZ.

2.17 In the last price control there were two inland private circuit baskets with the price cap for analogue leased lines set at RPI + 1% and for digital leased lines at RPI + 2%. Under the existing price control – introduced in 1997 – digital circuits over 64kbit/s were removed from the digital basket. The price caps for inland analogue leased lines and for inland digital leased lines with a capacity of 64 kbit/s or under were both set at RPI + 0%.

2.18 As well as the price cap, BT’s pricing of all circuit types is subject to its licence obligations which among other things prohibit unfair cross-subsidy, undue discrimination between customers and the abuse of a dominant position.

2.19 The EU Leased Lines Directive (Directive number 92/44/EC amended by 97/51/EC) places obligations on operators deemed by the national regulatory authority (NRA) to have significant market power (SMP) in the supply of leased lines in a particular geographic area. Oftel has determined for the purposes of this Directive that BT in respect of the UK (excluding Hull) and Kingston Communications in respect of the Hull area have significant market power. BT and Kingston are therefore obliged to provide a minimum set of leased lines consisting of ordinary quality voice bandwidth analogue, special quality voice bandwidth analogue, 64kbit/s digital and 2Mbit/s digital presentations. Furthermore, the Directive requires that the prices for these circuits are transparent, non-discriminatory and cost-oriented.

3.1 In December 1997, the DTI and Oftel received representations from large users that prices of leased lines in the UK market compared unfavourably with tariffs charged in the US and in certain European countries.

3.2 The representations highlighted the importance of telecommunications for the UK economy. Examples highlighted how telecoms prices – and in particular the price of leased lines – were a significant input cost in the provision of electronic information services. Further representations have been received during the investigation again stressing that for UK companies to be internationally competitive in developing electronic services, they needed access to leased lines at comparable or lower prices than other countries.

3.3 The representations compared prices of a 300km 2Mbit/s circuit in the UK with elsewhere and stated that prices in Sweden were 66% lower and prices in the US were 51% lower. Comparisons were also made between average EU prices and those in the US and cross-border tariffs within the EU and comparable length circuits in the US. The representations called for regulatory action to address these problems.

3.4 The remit of this review has been to assess the concerns raised about the level of BT’s national leased lines within the UK and does not cover the UK half of international leased lines.

3.5 As indicated in chapter 2, BT’s prices for analogue circuits and digital circuits of 64kbit/s and below are controlled by a price cap of RPI+0%. For other circuits, BT is free to price as it chooses within the terms of its licence and competition rules.

3.6 The representations state that BT’s prices in the UK are at ‘too high’ a level compared with those available elsewhere. It is therefore important to assess the extent to which BT’s prices may be at high levels by reference to BT’s costs of providing leased lines and also by reference to international comparisons. This assessment may give some indication of whether BT was making higher returns on the provision on leased lines in the UK than on other products or higher returns than those made by operators in comparable countries. It may also suggest that BT was providing leased lines inefficiently. However, any such assessment is unlikely to give conclusive answers due to the difficulties of identifying what level of return is reasonable for this specific product group or what represents efficient costs. Furthermore, international comparisons have to be viewed in the context of valid reasons for cost differentials between countries.

3.7 Therefore, any indication that BT’s prices may be high needs to be assessed in parallel with an assessment of the development of effective competition in this area. In practical terms, if BT was making returns above those which other operators would require to enter the market, then Oftel would expect that those other operators would enter the market. Similarly, if other operators felt they could offer a more efficient service than BT and make sufficient returns to justify market entry, then it would be expected that they would do so. The potential problem in both these cases is that barriers to entry may exist.

3.8 This investigation therefore needs to examine whether competition is emerging in the provision of leased lines above 64kbit/s and, if not, whether there are any significant barriers to market entry which could be remedied by regulatory action. For instance, Oftel’s 1996 statement Pricing of Telecommunications Services from 1997, recognised that BT’s competitors often rely on BT’s local loop in providing their services. Oftel therefore identified that terms on which BT supplies these ‘final mile’ circuits to other operators may potentially act as a barrier to those operators providing leased lines in competition with BT.

3.9 In summary, this investigation examines:

• the relationship between BT’s costs and its prices;
• international comparisons of leased line prices;
• the competitive situation in the UK and its impact on prices; and
• whether significant barriers to entry exist, in particular whether BT’s pricing of short distance ‘final mile’ circuits may be distorting competition.

4.1 This chapter examines BT’s costs of providing leased line services within the UK and the returns made relative to these costs. It also examines whether returns are higher for short distance ‘final mile’ circuits than longer distance circuits.

4.2 In accordance with its licence, BT produces fully audited annual regulatory accounts which break out the costs and revenues of BT’s UK operations into the following Businesses: Network; Access; Retail Systems Business; Supplementary Services Business; Apparatus Supply Business; and Residual. Furthermore, audited accounts are also produced for nine ‘Activities’ within the Retail Systems Business, including ‘Retail Systems Business – private circuits’. These regulatory accounts are produced to a methodology set in accordance with BT’s Accounting Documents, which include the Detailed Attribution Methodology.

4.3 Table II sets out the regulatory accounts for RSB – private circuits for the last two years.

4.4 Table III puts these figures in the context of costs and revenues for the RSB as a whole for 1997/98.

4.5 The cost information above for private circuits includes BT’s revenues from the UK half of international private leased circuits (IPLCs). As part of this investigation Oftel requested that BT provide a breakdown of the regulatory figures for 1996/7 by showing separately the network and retail costs of providing national analogue, KiloStream/ KiloStream N (below 2Mbit/s) and MegaStream (2Mbit/s and above) circuits, and also showing an ‘end-to-end’ network and retail return on capital employed (ROCE). These figures suggest that BT made a ROCE on a current cost accounting (CCA) basis of just over 20% on KiloStream and MegaStream circuits and almost 15% for analogue circuits.

4.6 Chapter 3 stated that Oftel recognised that BT’s competitors often rely on BT’s local loop in providing their competing leased lines services. The terms – especially the prices – on which BT supplies these ‘final mile’ circuits to other operators could therefore potentially act as a barrier to those operators providing effective competition to BT. That is, if BT’s short distance final mile prices were relatively high, this could prevent other operators from offering a competing service where they needed to leased BT circuits to complete their leased line offering.

4.7 To assess the pricing of BT’s final mile circuits relative to longer distance circuits, Oftel requested information on BT’s costs of providing shorter distance local end circuits. This was to identify whether returns on these shorter distance circuits were higher than the overall returns. BT provided cost information for own-exchange MegaStream and KiloStream circuits to give an indication of the relationship between the revenues and costs associated with final mile circuits.

4.8 The 1996/97 cost information provided indicated that BT was actually making negative returns on MegaStream own-exchange circuits, while returns for KiloStream own-exchange circuits were lower than those for total KiloStream circuits. This suggests that higher returns are made on circuits with a main link (ie longer distance circuits).

4.9 This cost information is supported to some extent by the analysis of BT’s pricing structure prior to November 1998 set out in Annex A. Table A1 shows that analogue and MegaStream 2 own-exchange circuits (which make up the majority of all MegaStream circuits) are priced particularly low relative to circuits with main links when these ratios are examined alongside other leased line products. This analysis takes account of price changes in November 1998 which increased the price of 2Mbit/s own-exchange circuits and reduced the price of longer circuits.

4.10 Overall returns for leased lines – as shown in BT’s regulatory accounts and in a further breakdown of costs and revenues provided for the purposes of this investigation – are positive across analogue, KiloStream and MegaStream circuits, but are below those made by the RSB in total.

4.11 The more detailed cost information provided by BT on short distance circuits does not support the argument that it could price short distance circuits at relatively high levels in order to restrict competition. In fact, the evidence suggests that these prices are low relative to the costs of provision and the price of longer distance circuits. This may reflect higher competition in shorter distance circuits within city centres, such as London, and cable franchises.

4.12 However, this may also be a concern in that BT may be pricing short distance circuits at such low levels relative to cost that infrastructure investment from OLOs is actually discouraged. BT has recently ‘rebalanced’ its pricing structure for 2Mbit/s circuits by increasing the price of local end circuits and reducing the charge for the main link with the result that own-exchange MegaStream 2 circuit rentals have risen by about 10% and other rental prices have remained the same or fallen with the biggest price falls for circuits with longer main links (by over 8%). The impact of this rebalancing on the returns for own-exchange circuits and on incentives for infrastructure investment remain unknown.

5.1 The conclusions in chapter 4 are based on the cost information provided by BT and say nothing of the validity of BT’s cost apportionment methods or on the efficiency of BT’s network. International comparisons can provide an indication of whether prices in the UK suggest that higher returns are maintained in the UK than elsewhere or of whether BT’s costs are less efficient than elsewhere (this may also be an indication that BT’s cost attribution methodology is inappropriate).

5.2 As set out in chapter 3, the original representations quoted prices charged in a number of different countries and suggested that UK prices were significantly higher than those in the US and in certain other European countries.

5.3 Oftel has therefore analysed a recent benchmarking studies comparing prices in the UK with those in Europe and the US.

5.4 A recent study by Ovum (National Leased Circuits: Carrier Tariffs, Discount Policies and Service Levels 1997, Ovum reports, 1997) used recognised OECD methodology to compare the prices of a basket of circuit lengths in the UK and elsewhere. In general, these comparisons showed BT prices for 64kbit/s and 2Mbit/s leased lines compared more favourably with prices elsewhere than suggested by the initial representations.

5.5 In particular, the comparison of US and UK prices revealed that although BT’s basket prices were more expensive than certain US operators, when a compound US price was taken using the prices of three operators, BT’s prices were lower for analogue, 64kbit/s and 2Mbit/s circuits.

5.6 The report also contradicted certain other claims made in the representations. For instance, the report stated that Sweden’s 1997 prices for a basket of 2Mbit/s circuits were about 38% lower than those offered by BT. This price differential, though significant, was lower than the differential quoted in the original representations made to Oftel.

5.7 This does not invalidate the figures provided in original representations which clearly quoted the prices which a particular company was charged in the different countries and these prices would have reflected the discounts that company was able to obtain in each country.

5.8 Indeed, when Oftel asked for comments from the original complainants on the difference between the findings of the Ovum report and the original representations, the issue of discounts was raised. Large companies in the US are able to negotiate higher discounts than are available in the UK. In the UK, volume and term discounts are available up to a combined 35% off BT’s list prices, but these are published discounts which are not negotiable for individual companies under the terms of BT’s licence. Therefore, any comparison of general price levels in the UK and other countries is complicated by discounts.

5.9 However, the Ovum report was based on an OECD basket methodology made up of different circuits lengths and customer types obtaining different discounts. It therefore takes account of the discounts available, but averages the effect of these across different customers. It is Oftel’s view that this methodology is valid and gives a more relevant understanding of how UK prices compare with those in other countries.

5.10 The Ovum report also stated that 1997 basket prices of 2Mbit/s circuits in Germany were around 13% below those offered by BT, but comparable to those offered by CWC in the UK. Prices in France, the Netherlands, Spain and Italy were all higher than BT prices, particularly in the latter two countries.

5.11 Ovum’s breakdown of the baskets for each bandwidth into various circuit lengths provides some support for BT’s cost information which suggested that own-exchange 2Mbit/s circuits may be underpriced. The report showed that BT’s charges for short distance circuits compared more favourably with charges in other countries than its charges for longer distance circuits. It is worth noting that this is supported by the original representations which showed BT to have the lowest price for a 2Mbit/s 5km circuit out of all the countries compared (including the US and Sweden).

5.12 The Ovum report also compared basket prices for 34Mbit/s and 140Mbit/s circuits. Not all countries in the report offered 140Mbit/s circuits and the volume of circuits over 2Mbit/s is limited at the moment. However, strong growth is expected in demand for these circuits. The report showed BT’s 1997 prices for 34Mbit/s and 140Mbit/s circuits were considerably higher than the basket prices for these circuits in other countries. BT’s prices for these circuits have recently fallen by up to 35%, but the Ovum report indicates that they were falling from a relatively high level. Without an indication of more recent price changes in the other countries, it is not clear what the effect on the comparisons would be.

5.13 It is Oftel’s view that the Ovum report provides a relevant comparison of international leased line prices.

5.14 Although the Ovum report is more favourable than the original representations about the level of BT’s prices compared to elsewhere, it still undoubtedly shows that BT’s UK prices are above those in certain other countries, notably Sweden and Germany. However, price differentials between UK and other countries could exist for a number of reasons. Costs in other countries could be lower because of differences in network topology or in demographics between countries. For instance, long distance traffic volumes in the US are considerably higher than in the UK and so unit costs would be expected to be lower for operators. Alternatively, the price differentials could suggest that BT was making higher margins on the provision of leased lines than operators elsewhere or they could suggest that BT was providing a similar service at less efficient costs than operators in other countries. To fully assess whether any individual international price comparison was valid would require further analysis of the costs of providing leased lines in each country.

5.15 Given that the magnitude of the price differentials for the majority of bandwidths does not suggest that BT’s pricing is significantly above that in the major European countries (BT’s pricing was 10 – 15% above Germany and 10 – 15% below France), such an analysis was not immediately justified. It was considered more important for this investigation to assess the level of competition in the UK to understand whether high prices or inefficient production could be maintained.

6.1 Chapters 4 and 5 have provided information on the returns made by BT on the provision of leased lines within the UK and on how BT’s prices compare with those in other countries. However, this information says nothing of whether BT would be able to reduce prices and still maintain an adequate margin on the provision of its leased line product or whether BT could improve its efficiency in the provision of leased lines and pass these savings on to consumers.

6.2 Ideally, (as set out in chapters 2 and 3) the pressure to reduce prices should come from competitive forces within the market place and not from detailed and prescriptive regulatory rules on how BT sets its prices. If BT’s returns were above those that other operators would demand for offering a competing service, it would be expected that those operators would enter the market and undercut BT. A similar outcome would be expected if other operators believed they could offer a more efficient service than BT. Evidence that competition from other network operators was emerging at the time of the 1997 Price Cap Review prompted the decision to remove the price cap on leased lines with capacity greater than 64kbit/s. The expectation was that competition would continue to emerge and would place downward pressure on BT’s prices. As competition in analogue and low capacity digital leased lines was not emerging, price caps of RPI + 0% were placed on these two baskets of services.

6.3 This chapter summarises the results of a review of the level of competition in the provision of leased lines in the UK. This review involved contacting the majority of leased line providers in the UK and conducting a survey of users to assess the impact this competition was having. It also assesses recent price trends in order to view the effect of competition and the price caps on BT’s prices.

Supply: access to local ends

6.4 As stressed previously, crucial to the development of competition in the supply of leased lines to the UK market is the ability of OLOs to obtain access to ‘final mile’ circuits. Many operators now have trunk networks or local loops within major conurbations, but they will still often face a buy or build decision when bidding for a new customer who is not directly linked to their network.

6.5 The main restriction on investing in the local loop is the high cost of digging fibre to a premises along with the uncertainty of future revenue streams. These restrictions are therefore less where required links are shorter – and therefore cheaper – and future revenue is more certain. Competition can be expected to develop as OLOs extend their networks. Recent consolidation in the cable industry will provide CWC and NTL with the ability to add increased local coverage to their extensive trunk networks, reducing their build costs in those cable franchises.

6.6 Competition is also likely to develop at faster rates in the major conurbations – ie where there is a concentration of businesses needing leased lines and where any investment is likely to lead to large amounts of business. The level of competition within central London is an example of this (see below). OLOs are also more likely to make investment in direct links where long term contracts are signed or where the provision of leased lines forms part of a range of telecoms business to customers.

6.7 If the build decision is not feasible, OLOs have the choice of purchasing a circuit between the premises and their network from another operator.

6.8 Many OLOs have arrangements with each other to provide tail or main link circuits. However, given the spread of BT’s network, other operators may often face no alternative to purchasing these links from BT. The potential for BT to price its circuits in such a way as to distort competition has been addressed above and it would appear given BT’s cost information that short distance ‘final mile’ circuits at priced at fairly low levels. This would suggest that the infrastructure competition developing in major conurbations is placing pressure on these circuits.

6.9 As set out previously, BT’s rental pricing for leased lines is based on a set charge for each local end and a charge for the main link between the two local exchanges (usually based on a fixed element and a per km element). As referred to in chapter 2, when OLOs purchase circuits from BT linking their nearest point of presence with the BT network and the customer premises they will normally be charged for two local ends and – if necessary – for the trunk. However, when the OLO requires a link from a premises to a designated point of interconnect with the BT network, BT does not supply two local ends as the connection is at the DMSU:

A--------LXa-----------DMSU-------------------------------------------DMSU----------LXb-------B

Point of                                                              Point of
Interconnect                                                      Interconnect

{         BT network          }{                              OLO network                          }{          BT network          }

6.10 BT’s Link to a point of Interconnection product – also know as a partial private circuit – is available only to OLOs and only to a designated point of interconnect to the BT network. It is priced at an equivalent level to a retail private circuit minus the cost of one local end and minus 50% of the fixed charge for the trunk circuit.

6.11 At the present time this is only available for 2 Mbit/s circuits. Other operators have complained that as the term and pool discounts available on MegaStream 2 circuits are higher that those on links to a point of interconnection, MegaStream circuits are still often the cheaper option. The take up of this product has therefore been fairly low.

6.12 The four OLOs with national trunk networks all offer national leased line services. However, this is mainly restricted to the provision of leased lines of 2Mbit/s and above.

6.13 CWC offers leased lines over PDH and increasingly SDH technology at rates from 64 kbit/s to 145 Mbit/s over PDH and 155 Mbit/s over SDH. However, CWC is now withdrawing from the supply of n x 64kbit/s lines and focussing on 2Mbit/s and above. CWC’s recent acquisition of cable franchise operators will increase its presence in the local loop while a major investment programme will extend the reach of its network.

6.14 NTL offers leased lines of 2Mbit/s and over using SDH technology. Like CWC its acquisition of cable franchise operators will provide greater scope for offering end to end leased lines to more customers.

6.15 Energis offers leased lines of 2Mbit/s to 155Mbit/s over SDH technology. Energis’ network runs along the national electricity grid. Local coverage is limited to large corporate customers when the economics are acceptable. Energis is currently investing in metropolitan fibre networks in London, Birmingham and Manchester in partnership with Deutsche Telecom and France Telecom with this programme concluding in 1999.

6.16 Racal provides a range of leased lines, but at the present time these are almost exclusively supplied to the privatised rail industry under the contracts of the old British Rail Telecoms network. Racal is not yet heavily involved in marketing circuits using this network to other customers.

6.17 The greatest concentration of competition in the provision of leased lines is within the central London zone (0171 area). Demand for circuits within the CLZ is high, increasing the incentive for operators to invest in building links to customer premises. These operators can also supply local ends to other operators.

6.18 COLT supplies a range of circuits over SDH technology from 2.4 kbit/s to 155 Mbit/s from in the area bordered by Docklands in the east, Hammersmith in the west and Camden in the north of the CLZ. Worldcom and Energis have also completed metropolitan infrastructure in London and can offer national circuits.

6.19 NORWEB in the Manchester and the North east area, Torch in major conurbations in parts of Yorkshire and Scottish Telecom in Scotland all offer end-to-end leased line services within their area and face the same buy/build decision for the local end as the national trunk network operators. These operators may also act as local-end providers for the national trunk network operators.

6.20 Kingston Communications provide a full range of leased lines – analogue and digital – in the Kingston-upon-Hull area. Operators with cable franchises also offer leased line services within their local franchise areas and can supply local end links to other operators.

6.21 It is clear from the survey that competition is focussing on the higher bandwidth digital circuits (2Mbit/s and over) and will be constrained by an operator’s ability to provide ‘final mile’ tail circuits. Annex B summarises the choice of national leased line providers within the UK.

6.22 The ‘build’ decision is clearly driven by the expected revenue and returns to be obtained from the provision of the circuit – which are perceived to be higher for OLOs for circuits of 2Mbit/s and above – and also by the amount of work that will be required to build the final mile – the focus on 2Mbit/s and above is also driven by the fact that OLOs are installing fibre links. As operators expand their networks, particularly within city centres, they are more likely to be willing to directly connect customer’s premises and more likely to be able to offer lower prices to customers. Conversely, where ‘final mile’ circuits need to be purchased from other operators the price charged to customers is likely to be higher. Further development of infrastructure competition is therefore important.

6.23 In order to assess the views the industry on the development of competition, Oftel sent out a questionnaire to a number of large business users. Questionnaires were also sent to user groups such as the Telecom Managers Association and the Telecom Users Association who then circulated these questionnaires to their members. This meant that a range of different sized users from high street stores to local authorities were consulted. Annex C tabulates some of the main findings of the survey.

6.24 Oftel received 60 responses in total to this questionnaire. Every respondent used BT for the provision of at least some of their circuits while 36% of respondents used only BT.

6.25 However, the results also suggested that an increasing number of alternative suppliers were available. For instance, the results of the survey confirmed that CWC was the alternative provider of choice, with 43% of respondents taking some circuits from this operator. Furthermore, 16% of respondents used some circuits from either COLT or WorldCom who mainly provide circuits in the central London area. Given that the survey was conducted on a national basis this is indicative of the level of competition within central London.

6.26 Oftel also met with a number of users to discuss further their experiences of the market. The main theme to come out of these meetings was that consumers had concerns about purchasing leased lines if operators were not willing to build local infrastructure to provide an end-to-end circuit. This view was supported by the wider survey results where 65% of respondents did not use an available alternative operator because the supplier could not offer an end-to-end service.

6.27 One concern was that this would effect the quality of the service delivered by the operator on the circuit. For instance, if faults occurred in the circuit customers feared that the need for two or more operators to liaise would inevitably lead to delays in the repair process. Customers needed to be convinced that strict service level agreements (SLAs) and efficient lines of communication were in place between operators before they could consider purchasing this type of ‘multi-vendor’ circuit.

6.28 The concern amongst customers was even greater concern where other operators proposed to purchase ‘final mile’ circuits from BT. First, this would effectively mean that the operator could only offer a level of service on the circuit which was as good as that offered by BT – ie the operator would be purchasing a retail circuit from BT on the same terms of service as the customer would get if it dealt directly with BT. Second, customers often wanted to use circuits from operators other than BT in order to provide extra security and resilience to their existing BT circuits. If these other operators used BT circuits to provide the service this would not meet the customer’s requirements.

6.29 Customers were much less concerned about using a number of different operators to supply separate end-to-end leased lines. That is, if operator A was only able to provide 50% of a customers’ total circuit requirements end-to-end, then most customers saw no problem in using operator A for those circuits only and other operators for the remainder of their needs. Only 11% of respondents said that dealing with a number of operators caused them problems, mainly due to the increased contract management needed at the customer end.

6.30 Some customers (about 15% of those with an alternative to BT) expressed concerns about the resilience of circuits provided by operators other than BT. These concerns were not expanded upon, but may explain a degree of inertia amongst customers to use alternative offerings. There was no evidence from this investigation to suggest that leased lines provided by OLOs were less resilient than those offered by BT.

6.31 Some of the larger users who Oftel met did not have such negative perceptions of the alternative offerings, but one customer did express some concern that when they had tendered for a national provider of their leased lines the offers from OLOs had not necessarily been attractive. Another customer also referred to some caution on the part of all operators – BT included – to provide wideband solutions at ‘attractive’ prices. Many of the larger customers appeared keen to utilise the opportunities offered by high bandwidth circuits, but stated that prices were still high and that alternative operators often wanted customers to sign long term contracts or tie the provision of leased lines with other telecoms business before investing in high bandwidth infrastructure for companies. These comments were made prior to BT’s announced price cuts in circuits of 34Mbit/s and above.

6.32 When asked whether alternative operators were cheaper than BT, only 45% of respondents responded affirmatively, although there was no indication that other operators were more expensive that BT. Responses suggested that circuits offered by local cable operators within their franchise areas were the cheapest alternatives. Some of the larger customers complained that prices from the major national alternatives always seemed to shadow those of BT by about 10 – 20% and inferred that this was an indication that competition was not operating effectively.

6.33 A wide range of customers were surveyed (inside and outside of London, urban and rural, high and low bandwidth requirements) so it could be expected that some respondents would talk of increased levels of competition and lower prices on offer from other operators, while others claimed that they faced little or no alternative to BT.

6.34 However, there was a clear indication that users wanted to see effective infrastructure competition in the supply of leased lines. Concerns about ‘multi-vendor’ circuits particularly when these were a mixture of OLO and BT circuits show that users would prefer an end-to-end choice and are probably willing to pay a premium to BT if it is the only operator who can provide this service. There would appear therefore to be an incentive for OLOs to build out their networks to provide an alternative to BT and where this is not feasible to ensure that SLAs are established with other operators to provide ‘final mile’ circuits in order to satisfy the customers that ‘multi-vendor’ circuits can provide an efficient and resilient service.

6.35 In order to give a better representation of competition in the market, estimates have been made of the split of total national leased lines into four categories: analogue; digital up to 64kbit/s; digital from 128kbit/s to 1024kbit/s; and digital 2Mbit/s and above. The following table is based on information provided by a number of operators during the course of this investigation and on information gathered by Oftel as part of its general market information. It shows the varying degrees of competition to BT in the different market segments:

6.36 Growth in these market segments differs dramatically with rapid growth for circuits over 2Mbit/s. There will therefore be a shift in the share of circuits over 2Mbit/s over time, so that the major growth in leased line consumption will be in those circuits where BT is already experiencing the greatest competition. Particularly strong growth is expected for circuits of 34Mbit/s and above, although these circuits currently account for a small fraction total leased lines. Competition in the supply of n x 64kbit/s circuits appears to be falling with the withdrawal of CWC from the supply of these circuits. That aside, competition appears to be developing in the areas where it was expected.

6.37 The impact of this growth in competition on prices is to a large extent dependent on the prices these competitors charge. Competitors to BT are not obliged to publish tariffs and are also not obliged to offer the same terms and conditions for service to every customer. The actual prices offered will therefore often vary on a case by case basis.

6.38 However, anecdotal evidence from both the operators and users indicates that pricing in London is very competitive. Our survey of users suggests that other operators often undercut BT by 30-40%. Local cable operators outside London may be undercutting BT by as much as 50% for circuits totally within the franchise area. However, if a national operator needs to purchase BT ‘final mile’ circuits, the overall price may only be slightly cheaper.

6.39 The following table sets out the changes in BT’s prices compared to its permitted increases under the previous price control regime (up to 1996/97):

6.40 This indicates that while BT had the flexibility to increase the prices for both digital and analogue leased lines prices, it has reduced in absolute terms the price of digital leased lines overall while increasing the price of analogue leased lines at about the rate inflation.

6.41 A closer examination of the individual digital circuit types shows that for 64kbit/s presentations and under, BT has not changed its pricing since 1991 meaning that prices have fallen in real terms. However, greater falls have been evident for 2Mbit/s circuits. The table below demonstrates how prices have fallen for different lengths of 2Mbit/s circuits outside central London since 1994 in absolute terms. The figures also suggest that the highest price cuts have applied to the longer distance circuits.

6.42 At the present time, the clear majority of MegaStream circuits are 2Mbit/s presentations. Revenues from higher bandwidth circuits are limited at present, but are expected to grow at the fastest rates. As shown before, rental charges increase with bandwidth. Although the premiums paid for higher bandwidth circuits are less than the higher capacity received (ie a MegaStream 155 circuit with a 15km main link costs around 20 times as much as a similar length MegaStream 2 circuit but provides over 77 times the capacity) there were complaints from users in Oftel’s survey that charges were particularly high for high bandwidth services and that these were constraining demand for these services.

6.43 In July 1998, BT cut the connection charges of 34, 45, 140 and 155 Mbit/s circuits by up to 80%. Prior to July 1998, connection charges for 155 Mbit/s circuits were 18 times as much as those for 2 Mbit/s circuits. They are now only 3 times as big. BT also reduced rental charges by between 5% and 40% depending on the length of circuit. BT claims these reductions were in response to falling share of the high bandwidth business. The following table sets out the effect of these reductions and shows that there was also a ‘rebalancing’ element to the price changes in that longer distance circuits were reduced by a greater amount.

6.44 The analysis above would suggest that competition is increasing in the provision of circuits of 2Mbit/s and above and that this is reducing BT’s prices in the absence of price caps. Price caps for analogue and low capacity digital circuits are constraining these prices. These are due to be reviewed in 2001 and this process will start during 1999. The reduction in competition for n x 64kbit/s circuits causes some concern, but prices will still be constrained by the close substitution links with 2Mbit/s circuits.

6.45 However, there are constraints on competition due to the need to provide ‘final mile’ circuits. BT enjoys an advantage over other operators because of its ubiquity in the local loop and because customers prefer to buy leased lines from an operator who can provide an end-to-end service over its own network or who can guarantee that a multi-vendor circuit will have high levels of service. Alternatives to BT may not, therefore, be either available or considered acceptable to some customers. BT is therefore likely to be able to maintain some premium over other operators. However, the pricing of OLOs’ leased lines will still constrain BT’s pricing and the magnitude of any premium is likely to fall as OLOs begin to tackle the concerns customers currently have with using alternative suppliers to meet their leased lines needs.

6.46 Competition also varies geographically. Competition in central London is strong and this is reflected in low prices. Competition outside London is focussed on major conurbations and on larger customers. However, the geographic averaging of leased line prices outside London means that competition in one area will effect prices elsewhere.

6.47 Oftel recognises that OLOs will often need to purchase ‘final mile’ circuits while their network reach is extended. OLOs clearly have a role to play in improving the perceptions customers have of ‘multi-vendor’ circuits. This may involve establishing service level agreements to ensure that high levels of quality and resilience are maintained.

6.48 Although there does not appear to be evidence that BT’s pricing of short distance circuits which are used by OLOs as ‘final mile’ circuits are overpriced in a way which restricts the development of competition, Oftel does have concerns about BT’s partial private circuit product. The concerns are with regard to the discount structure in operation – which effectively means OLOs do not receive the cost savings to BT of providing a partial private circuit to an OLO rather than a MegaStream 2 circuit – and the fact that this product is only available for 2Mbit/s presentations.

7.1 This investigation has set out to assess whether BT’s pricing of leased lines in the UK could be unduly high. Oftel has therefore:

• examined the returns BT makes on leased lines relative to its costs;
• compared BT’s prices in the UK to those offered in other countries;
• analysed BT’s pricing of ‘final mile’ circuits to identify whether this may be restricting competition;
• considered the competitive situation in the UK leased lines market to identify whether barriers to market entry could mean high returns or low efficiency could be maintained; and
• analysed recent trends in BT’s charges for leased lines to assess the impact of competition in the absence of price caps.

7.2 Oftel’s conclusions are as follows:

• BT’s overall returns for leased lines are positive for analogue, low capacity digital and high capacity digital leased lines, but are below those made by the Retail Systems Business in total.
• The magnitude of the price differentials for the majority of bandwidths does not suggest that BT’s prices for national leased lines are significantly above those in the major European countries. A report by Ovum suggested that BT’s average basket of circuit lengths and bandwidths was priced 10-15% above the price in Germany (which compared with CWC’s UK basket price) and 10-15% below the price in France.
• However, this information says nothing of whether BT would be able to reduce prices and still maintain an adequate margin on the provision of this product or whether BT could improve its efficiency in the provision of leased lines.
• Downward price pressure and incentives to improve efficiency are best developed by ensuring that competition continues to emerge rather than detailed and prescriptive regulation of BT’s pricing.
• Competition will best develop where other operators provide competing infrastructure to BT.
• Competition in the provision of circuits of 2Mbit/s and above appears to be developing within the UK and this has acted as a constraint on these prices in the absence of regulatory price controls.
• Oftel recognises that other operators will on occasion need to purchase ‘final mile’ circuits. Therefore, where BT receives cost savings from providing such circuits to other operators connecting to a point of Interconnect, these should be reflected in the retail price charged, in order to ensure that BT is not pricing such ‘final mile’ circuits in a manner which would distort competition for end-to-end circuits.
• OLOs need to address the perception held by many customers that when ‘final mile’ circuits are purchased to form a ‘multi-vendor’ circuit, the quality of service on the circuit will be lower than that offered by an operator capable of providing a full end-to-end service.
• Competition for the provision of analogue circuits and digital circuits below 64kbit/s is limited. The price cap on these baskets acts as the constraint on prices and the incentive to improve efficiency. This price cap will be reviewed as part of the 2001 Price Control Review which will begin during 1999.

7.3 Given the above and in order to ensure that competition continues to develop and place pressure on operators to increase efficiency and improve the service delivered to customers, Oftel has some areas of concern on which we would welcome comments. As these are not directly related to the complaints of high prices, we will examine these areas separately and are closing the investigation into the level of BT’s national leased lines prices on the grounds that there is no case for regulatory action.

8.1 BT’s cost information suggested that prices of own-exchange circuits are cross-subsidised by other circuits, particularly those with long distance main links. Oftel is concerned that this may send out the wrong signals to other operators about investment decisions in local networks. As indicated in chapter 6, BT has recently amended its prices for MegaStream 2 circuits in order to begin the process of rebalancing the price of own-exchange and long distance circuits to better reflect costs. This process will involve an increase in the price of own-exchange circuits and a reduction in the price of longer distance circuits.

8.2 Oftel would welcome views on what effect BT’s current pricing structure is having on other operators’ ‘buy or build’ decisions. Comments are also welcome on the effect any further re-balancing may have on consumers.

8.3 Oftel recognises that in order to compete fully with BT, other operators may have no alternative but to purchase ‘final mile’ circuits from BT. Oftel does not believe it is appropriate to oblige BT to offer a wholesale product at cost to other operators because of the impact on infrastructure investment, nor is there any supporting evidence that these ‘final mile’ circuits are overpriced in order to frustrate competition (indeed, the opposite may be true). Nevertheless, there would appear to be scope for BT to extend its offering of the partial private circuit product which offers other operators the savings BT makes on providing a circuit from a premises to an OLOs designated point of interconnect at the DMSU (ie one local end).

8.4 BT argues that there is no demand for this product and so it has no plans to extend its availability beyond the current 2Mbit/s. The slow take up of the product so far can partly be attributed to the fact that it has only been offered for 2Mbit/s circuits and the fact t