Oftel’s review of the mobile market
Statement issued by the Director General of Telecommunications
July 1999
Chapter 1 Outcome of consultation on competition in the mobile market
Chapter 2 Competitive supply of mobile services
Chapter 3 Approach to indirect access
Chapter 4 Future regulatory environment
Chapter 5 Conclusions and next steps
Annex 1 Competition in the mobile market: consultation and responses
Annex 2 Indirect access for mobile networks: consultation and responses
Annex 3 Economic commentary to longer consultation responses
Annex 4 Implementing indirect access
This document summarises Oftel’s views on the state of competition in the mobile market today. It follows on from two consultative documents issues in February: Competition in the mobile market, and Customer Choice: indirect access from mobile networks.
In Chapter 1 of the document Oftel confirms its findings that the market is not fully competitive. However, competition continues to develop and Oftel’s conclusion is that price controls on calls from mobile phones are not currently necessary. Oftel’s prime goal is to secure for the customer the best possible deal in terms of quality, choice and value for money. With this in mind, it has set in place a mechanism to review price trends in more depth and will re-assess the competitive situation in September 2000, once a full year of data is available.
The consultation also considered the requirement on BTCellnet and Vodafone to provide wholesale airtime to service providers. This provision is a requirement in their licences now. Under the terms of the new licences which will shortly be introduced as a result of the implementation of the EU Licensing Directive, it is proposed that operators having what is termed Market Influence should similarly be obliged to supply wholesale airtime to service providers. Oftel will shortly launch a formal consultation to determine which operators have market influence. The analysis of the market undertaken to date suggests that Cellnet and Vodafone have market influence and Oftel would expect to put this forward for formal consultation.
The question of the continuation of an obligation to supply mobile service providers has raised quite fundamental questions about the nature of competition in the mobile market. Responses to the consultation have raised issues relating to the nature of what is supplied, whether a regulatory obligation to supply is necessary, and if so, on which operators. Oftel needs to balance its overall desire to withdraw from regulation where competition is effective, with a need to promote competition in the market, if the market is less than fully competitive. Chapter 2 discusses the development of the obligation to supply wholesale airtime and proposes that a new approach is taken, with regulation moving to a narrower focus on the provision of unbranded airtime and away from regulation of branded packages. Chapter 2 also announces that Oftel is undertaking a formal investigation with a view to taking appropriate enforcement action in respect of potential unfair cross-subsidy and undue discrimination in favour of tied service providers.
Independent service providers have played an important role in developing the initial market for voice services. Responses to the consultation and recent approaches to Oftel have also shown an increasing range of data and other enhanced services which may potentially be available using mobile networks. Such services may combine elements of mobile and fixed, or use value-added information such as traffic data combined with network location information. Access to Internet services via mobiles is set to become increasingly important. Chapter 2 of the Statement also emphasises the importance of ensuring access to networks is made available to third parties wishing to develop innovative new services. Whilst no new regulatory intervention is envisaged at this stage, it should be noted that the mobile operators control access to radio spectrum which is not available to others. Oftel’s objectives include the promotion of competition at both network and service level. It strongly supports the government’s intention to offer five 3G licences. However, it believes that competition at service level is also important to help ensure that customers benefit from the full range of the technological possibilities.
Chapter 2 of the document asks for consumer and industry comments on the change of regulatory focus away from the regulation of branded packages.
In Chapter 3, Oftel also confirms its intention to mandate Indirect Access (IA) under the European Union Interconnection Directive to the networks of BTCellnet and Vodafone. This decision will increase customer choice in respect of how calls are handled; that is, once an outgoing call has left the mobile network, the customer will be able to choose from any alternative carriers which offer this service. Oftel has concluded that potential IA operators and the mobile networks should seek to settle the terms and conditions for the provision of IA access through commercial negotiations. To help in this process, Oftel reaffirms its view that retail-minus is the correct principle for the charging of IA services and sets out in detail the way in which it may be implemented if Oftel is called upon to determine the charges.
Responses to the consultation have highlighted the uncertainty surrounding the review in the year 2000, in particular the impact of any change to licences in respect of the obligation to supply to service providers if the market is deemed to be fully competitive. Chapter 4 sets out Oftel’s current thinking on its approach to a potential complaint in such a situation. It recognises the continued role of service providers in such a market, emphasising that in a competitive market intervention should not be necessary. However, the mobile market presents a potential barrier to entry caused by the scarcity of radio spectrum. Oftel is concerned to ensure that this does not result in anti-competitive behaviour and has powers to deal with such activity should that be necessary.
The final chapter of the document re-iterates Oftel’s key conclusions and details next steps to be taken.
Annexes to the document contain:
Note: many respondents questioned the use of different terms such as market power, Significant Market Power and Market Influence. These terms are explained more fully in the glossary. They derive from the different ways in which EU directives are termed, and in some cases (Market Influence) from a particular UK licensing approach. The terminology in these Directives is important, since they guide much of the regulatory framework. New licences are due to be issued to mobile operators shortly. For the avoidance of confusion, the document tries to refer to market power in general terms when talking about the position of different players in the market now, and Market Influence when discussing what might happen when the new licences are in place.
Outcome of consultation on competition in the mobile market
Introduction
1.1 The key proposals presented in both the consultation documents published in February 1999 were based on Oftel’s analysis of competition in the mobile market. That found that Vodafone and BTCellnet have market power.
1.2 This Chapter explains the outcome of consultation on:
and Oftel’s conclusions:
1.3 Oftel’s conclusions from the responses to the consultation on indirect access for mobile networks is set out in Chapter 3.
The results of consultation
1.4 Responses to issues raised in both of the consultation documents published in February are also summarised in Annexes 1-3 together with Oftel’s responses to key points raised.
Finding of the market analysis and continuation of the licence requirement to provide wholesale airtime to service providers
1.5 None of the points raised in responses to Competition in the mobile market has persuaded Oftel that the conclusions to be drawn from the analysis should be different. Oftel therefore maintains that Vodafone and BTCellnet have market power in the market for mobile services. This means that the absolute requirement in current licences for them to provide airtime to service providers will remain in place.
Market Influence
1.6 The new standard mobile licences to become effective through implementation of the EU Licensing Directive in the UK will contain a condition requiring the provision of airtime to service providers. But this will not be an absolute obligation. It will only be triggered if the Director General has determined that the licensee has Market Influence in the market for mobile services.
1.7 In February, Oftel sought views on whether the market analysis contained in the document had taken into account all the relevant factors which the Director General should consider in making a Market Influence determination. Responses to the document were mixed on this point. A number of respondents who supported Oftel’s proposal also expressed the view that Oftel should determine Vodafone and BTCellnet as having Market Influence.
1.8 Oftel is reviewing the market again in order that it can initiate the process for making a determination when the new licences are granted if that is necessary. This review is employing the same methodology as the previous one, the results of which were published in February. Work to date has not revealed any significant shifts which have altered Vodafone’s and BTCellnet’s overall position in the market and so Oftel does not anticipate a different outcome. Oftel therefore expects to start the determination process as soon as the new licences take effect. Transitional arrangements will ensure that the existing requirement for Vodafone and BTCellnet to provide airtime to service providers will continue following the granting of new licences and until the determination process is completed.
Regulatory control of prices and the price monitoring study
1.9 In Competition in the mobile market, Oftel explained why it believes that regulatory action to control the prices of calls from mobile phones is currently inappropriate. Most respondents to the consultation agreed with this assessment. This has contributed to Oftel’s conclusion that it will not intervene to control the prices of calls from mobile phones.
1.10 In February, Oftel considered the level of competition between the four mobile networks and looked at the impact that this was having on the price of calls. It found that prices were coming down having fallen by about two thirds since 1990. Oftel’s expectation is that this downward trend will continue as traffic volumes continue to increase, costs reduce, and competition intensifies. If this does not happen, Oftel will again consider the possibility of direct regulatory action to control mobile prices. To assist its judgement on this important issue, Oftel is establishing a more comprehensive study to monitor retail price movements. Results of the study will be a key input to the review of the market to be undertaken next year. The methodology to be employed for the study is explained in detail in a separate consultation document being published in July.
1.11 Until the comprehensive study is underway, Oftel will continue to monitor price movements using its own analysis and consultancy reports. Initial results of the monitoring, which is based on a methodology which calculates the average of the five cheapest packages for particular patterns of use, show that over the first half of 1999, prices have continued to fall. This is illustrated graphically in Graphs 1 and 2 below.
Graph 1: Mobile telephony price trends – monthly subscription
Graph 2: Mobile telephony price trends – Pre-paid
1.12 The graphs show price movements on this basis for subscription and pre-paid tariff packages respectively. They show that prices have continued to fall, most especially for high spending subscription customers who have seen reductions of around 30% by this measure. Price cuts have been particularly prevalent over the last couple of months with all the operators introducing new tariff packages. Clearly, this does not reflect the experience of all customers. The more comprehensive study (referred to in paragraphs 1.10 and 1.11 above) will reflect as accurately as possible the impact of price changes on as wide a cross-section of customers as possible.
Further review of the market in the year 2000
1.13 A number of respondents to consultation have commented that the prospect of a further review in the year 2000 will create uncertainty and instability in the market. Oftel is determined to secure the best deal in terms of quality, choice, and value-for-money for mobile customers. It has identified that competition between the four networks is growing stronger and, consistent with its overall policy, believes that this will deliver the best deal to customers whilst unnecessary regulatory intervention could stifle the development of competition. Review of the market in the year 2000 is a key stage in Oftel’s monitoring that effective competition is continuing to develop and delivering the best deal to customers. Oftel therefore remains committed to the review. As stated above, the results of the price monitoring study which Oftel is establishing will be a key input to the review in the year 2000.
1.14 Oftel recognises the review next year could be a cause of uncertainty in the market– particularly with regard to the future of the direct obligation to provide airtime to service providers and the fact that it will be de-triggered in the licences of all operators at such time as none of them are determined as having Market Influence. Oftel therefore explains in Chapter 4 of this Statement how it expects that the Director General will fulfil his duty to ensure that reasonable demand is met in such a situation.
Competitive supply of mobile services
Regulatory strategy
2.1 Oftel’s long term strategy is to withdraw from regulation as competition develops and to allow normal market pressures to determine the shape of the telecomms industry. In many respects, the prospects for vigorous competition in the mobile sector seem encouraging; there are four flourishing mobile network operators and the auction of spectrum for third generation technology will allow at least one more competitor to enter the market. On that basis, it is arguable that Oftel could remove regulatory controls now and allow all four operators to judge for themselves whether, and on what terms, to supply mobile services to service providers and others who wish to use those services as components of their own retail products. However, unlike the market for provision of fixed telephony, shortage of spectrum imposes an absolute barrier to entry into mobile network provision. This factor, which will be taken account when assessing market influence, combined with market developments which indicate increasing reliance on access to mobile networks by operators and service providers wishing to provide innovative services, suggests that Oftel should exercise caution before withdrawing regulatory controls.
2.2 Regulatory controls on the mobile network operators, if well designed, can facilitate the development of competition in the provision of services by enabling innovative companies to enter that market and establish a presence which, in due course, the operators may be unable to ignore. At that point, regulatory controls become superfluous. However, attempts to sustain through regulation a sector of the industry which has little chance of long term survival without regulatory protection, are likely to be counter-productive and will merely add an unnecessary cost to the industry. Oftel’s strategy is to apply regulatory controls to ensure that customers get a fair deal from the mobile industry, without putting unnecessary cost on to customers by over-regulation.
The impact of regulation so far
2.3 When the first licences were granted to BTCellnet and Vodafone, these companies were prohibited from supplying services directly to end users and all such services had to be supplied through distinct subsidiary or independent companies. The intention was plainly to facilitate the growth of competition in the provision of services to end users. For a time, this model did facilitate the entry of a large number of service providers competing to sell differentiated services and, as a consequence, the market grew rapidly. More recently, this sector of the industry has seen large-scale consolidation with many independent service providers being acquired by the operators. Nevertheless, across the last year or so about half of all airtime minutes on the Vodafone network and a quarter of all airtime minutes on the BTCellnet network were supplied to end users through service providers which are independent of the operators, indicating that customers value the services offered by such companies.
2.4 Consolidation has also been paralleled by a tendency for the services and tariffs of independent service providers to approximate to those of the operators’ own service providers. There may be many reasons for this, but the structuring of wholesale airtime products in forms which shadow the operators’ own retail products, the offering of bonuses and discounts to service providers which are willing to promote the operators’ brands and the provision of assistance with marketing programmes reinforcing those brands have played a large part. If this process continues, independent service providers may find themselves forced to become little more than the managers of franchise-type operations. Some may find this role profitable, and some operators may choose to distribute some of their services by this route, but it is unclear what purpose would be served long term by a regulatory obligation to operate in this way.
2.5 Independent service providers have also been constrained by wholesale airtime prices which, relative to prevailing retail prices, fail to offer a reasonable margin on which to operate. There is evidence that although, in accordance with their licence obligations, BTCellnet and Vodafone may have charged independent service providers and those within its Group the same prices for wholesale airtime, these operators have conducted a margin squeeze by cross subsidising service providers within their Group with profits taken at the wholesale level. Here again, this has limited the ability of independent service providers to compete with differentiated products.
Enforcement action
Wholesale prices
2.6 As was explained in the February consultation document, Competition in the mobile market, Condition 40 of BTCellnet’s licence and Condition 45 of Vodafone’s licence provide that, where the Director General is satisfied that the licensee is unfairly cross subsidising, among other things, its Direct Business or any activity carried out by another member of the Licensee’s Group, the licensee shall take such steps as the Director General may direct for the purpose of remedying the situation. Since 1994, the Director General has required both BTCellnet and Vodafone to submit quarterly returns demonstrating compliance with a formula devised by Oftel to measure whether tied service providers have achieved a minimum rate of return on subscriptions. A service provider’s failure to achieve a minimum rate of return may indicate that the operator is unfairly cross subsidising that service provider’s operations and thereby squeezing, for anti-competitive purposes, the margin of competing independent service providers. Such cross-subsidy may also be caught by the prohibition on undue preference and undue discrimination in Condition 9 of the Vodafone and BTCellnet licences.
2.7 Following consultation in 1997, Oftel set the required rate of return at 1.5% per month. Both BTCellnet and Vodafone have failed to achieve this return of 1.5% per month.
2.8 Oftel considers that failure of service providers within each operator’s Group to recover the cost of capital for an undertaking of this kind is an indicator of potential unfair cross subsidy. In the light of this prima facie evidence, Oftel has launched a formal investigation with a view to taking appropriate enforcement action. In deciding whether to issue a Direction or to take other enforcement action, the Director General will take account of factors including:
Strategy for the future
The nature of the wholesale product
2.9 Oftel believes that the interests of consumers will be served best where suppliers can enter the market to offer a wide variety of innovative services. However, it seems unlikely that independent service providers (including fixed operators) will be able to contribute to the provision of such services unless they have access to airtime on reasonable terms which allow them to devise their own tariffs and services. Independent service providers will need to develop strong independent brands and differentiated products if they are to have a chance of surviving without long term regulatory protection.
2.10 The February consultation document, Competition in the mobile market, asked if there might be merit in reviewing whether the obligation to supply wholesale airtime should relate to branded bundled services and/or to unbranded airtime packages. Some responses to the consultation and subsequent informal discussions have suggested that competition and innovation could be enhanced if wholesale airtime is available in a form which allows service providers more freedom to devise and promote their own services. Oftel therefore wishes to take forward the consultation with a view to refocusing the existing regulatory obligation to supply airtime more narrowly on the provision of unbranded airtime.
2.11 Most wholesale services offered by BTCellnet and Vodafone bundle an amount of airtime with the fixed charge for each customer remaining connected to the network and being able to receive incoming calls. The nature of these bundles of airtime and fixed charges closely shadows the retail services offered by service providers within each operator’s Group. For example, Vodafone expresses its wholesale prices in the form of recommended retail prices less a variable discount. This gives independent service providers little opportunity to develop their own distinctive packages and may inhibit competition. Oftel would welcome comments on whether the making available of airtime in "unstructured" form which would give independent service providers greater freedom would enhance competition.
2.12 Oftel hopes that commercial considerations alone will cause the operators to offer unbranded and unstructured wholesale products. However, if the operators fail to do so, Oftel would need to consider whether this reflected a market failure which could result in harm to consumers. If this was the case, the Director General would need to consider action to ensure that independent service providers are offered wholesale services in a form which allows them reasonable discretion to design and promote their own differentiated retail tariffs. Enforcement action could then be taken under existing licence conditions. In deciding what is reasonable in this context, Oftel is likely to consider a range of factors including the potential impact on network and services competition, as well as the benefits to consumers. At the same time, as with its proposals for indirect access described in Chapter 3 of this document, Oftel is concerned not simply to create opportunities for arbitrage which would undermine beneficial price discrimination.
2.13 As the present generation of service providers have had little opportunity to do other than engage in resale of branded and packaged services, Oftel recognises that they will require an extended period over which to develop their own brands and products and, therefore, Oftel proposes that BTCellnet and Vodafone should be required to maintain supplies of branded airtime for a reasonable transition period. After an appropriate point in the transition period, any regulatory obligation to offer branded and packaged products to service providers or distributors would lapse, although operators will continue to be free to offer such products on a commercial basis. For this reason, Oftel believes the refocusing of any regulatory obligation on the provision of unbranded airtime should be viewed as a liberalising measure.
2.14 Oftel invites comments on the approach set out in paragraphs 2.9 to 2.13. Oftel seeks comments on potential consumer and competition benefits in moving to unbranded airtime, and on forms of "unstructured" airtime which may be supplied. In particular, service providers and operators are invited to comment on the commercial importance to independent service providers of the current obligation imposed on BTCellnet and Vodafone to allow independent service providers to use the top level network brands when promoting competing services. Oftel also seeks comments on what should be the minimum transition period during which BTCellnet and Vodafone should be obliged to continue supplying independent service providers with branded packaged services for resale.
Mobile operators’ regulatory accounts
2.15 Oftel is reviewing the effectiveness of the current accounting separation provisions in mobile licences, particularly in the context of Indirect Access (see Chapter 3 of this Statement) and the new mobile PTO licences currently being finalised by the DTI. Oftel is also concerned that, in the absence of published accounts reflecting the regulatory businesses defined in the BTCellnet and Vodafone licences, it is unclear which bonuses, discounts and marketing support programmes are funded at the network level by the Systems Business in order to stimulate incremental use of a network and which are intended to promote the brands and products of service providers within a licensee’s Group. In the former case, any discounts, bonuses and marketing support programmes offered to service providers within the operator’s Group should be made available on non discriminatory and objective terms to independent service providers. In the latter case the costs of such initiatives should be borne by service providers within the operator’s Group and should be taken into account when assessing whether those service providers have recovered their cost of capital.
2.16 Condition 39 of BTCellnet’s licence and Condition 44 of Vodafone’s licence require those operators to maintain separate accounts for each of the businesses defined in the licence. Those licences also allow the Director General to call for copies of accounting statements prepared on this basis. In recent years, Oftel has not called for such accounts. Operators are, however, reminded of their obligation to maintain separate accounts, crucially for the Systems Business and the Direct Business. Operators should be clear which regulatory business each Discount, Bonus and Marketing Support programme is intended to support and will therefore be obliged to fund.
Competitive supply of enhanced services
Airtime services
2.17 Oftel will shortly publish a consultation paper which explores regulatory and competition issues arising from the proliferation of Pre-paid services. That document sets out Oftel's view that the way in which the network operators offer pre-pay services via their direct businesses does not allow independent service providers to offer competing services in every respect, as the functions which record credit levels and entitlement to calls are integrated with the network. This may have the effect of putting independent service providers at a disadvantage and consequently it may be the case that the network operators are unduly preferring their own direct businesses compared to the independent service providers. However, the paper will also acknowledge that a complete engineering separation between Pre-pay functionality and the mobile networks may give rise to additional costs which ultimately would have to be passed on to customers. For that reason, Oftel will be seeking views on the most efficient way to promote greater competition in the provision of Pre-paid services.
2.18 More broadly, Oftel wants to ensure that functionality which delivers more than basic conveyance, and which, from a practical engineering point of view, is capable of being supplied competitively by service providers and others, is not bundled with basic conveyance services. This will enable the development of innovative and value added services.
Information services
2.19 Oftel is aware of growing interest in the provision of location-specific information services. BTCellnet’s TrafficLine service is widely known, and Vodafone has recently announced that it is trialling location-specific services with the AA. In both cases, the information provider is reliant on access to network-based functionality which records the location of the mobile handset. Under the terms of Condition 8 of the Vodafone and BTCellnet licences, where such functionality is supplied to service or information providers within the operator’s Group (or more widely) the terms on which that functionality is being supplied must be published and, under Condition 9 of the licences, its supply should be made available on non discriminatory terms to others who seek it. In addition, where a service provider or information provider requires access to network-based functionality which is not currently being made available, it is possible, depending on the nature of the access required, that this may fall under the access provisions of Article 4.2 of the Interconnection Directive (ICD), which require SMP operators of fixed and/or mobile networks to provide access to their networks at points other than the network termination points offered to the majority of end users. BTCellnet and Vodafone have both been designated as having SMP in the mobile market and, therefore, are subject to this obligation.
2.20 Location-specific information services may be expected to proliferate. In the medium term, conveyance of such services and provision of access to location data can be expected to generate additional network revenue for the operators and as such may present attractive market propositions to those operators. However, at this early stage in a developing market Oftel believes it is important to ensure that competing suppliers of location-specific information services have access to the network-based data which they may reasonably require in order to establish a competitive and, ultimately, self sustaining presence in this market. Oftel will be watching commercial developments carefully to ensure that the obligations of Conditions 8 and 9 of the licences are complied with.
Summary of matters on which Oftel is seeking further views
2.21 Oftel invites comments on the approach set out in paragraphs 2.9 to 2.13. Service providers and operators are also invited to comment on the commercial importance to independent service providers of the current obligation imposed on BTCellnet and Vodafone to allow independent service providers to use the top level network brands when promoting competing services.
2.22 Service providers and operators are invited to comment on what should be the minimum transition period during which BTCellnet and Vodafone should be obliged to continue supplying independent service providers with branded packaged services for resale.
2.23 Full details of where to send responses are contained within Chapter 5 under the heading ‘Consultation’.
2.24 Oftel is consulting separately on the regulatory framework for Pre-paid mobile services and the extent to which these may be supplied competitively.
Approach to indirect access
Introduction and summary
3.1 The consultation document Customer choice: Oftel’s review of indirect access for mobile networks (February 1999) set out aspects of this issue on which Oftel wishes to gather views. This Chapter summarises Oftel’s conclusions in the light of the consultation responses. These form the basis of the determinations the Director General will shortly make in resolution of the two disputes on indirect access for mobile networks he has to address.
3.2 In summary, having taken account of the representations and comments made in the consultation, Oftel has concluded that there should be an obligation to provide Indirect Access (IA) on the two mobile networks that are parties to the dispute, BTCellnet and Vodafone. The grounds for this conclusion are set out below.
3.3 Oftel has also concluded that the parties should seek to settle the terms and conditions for the provision of the IA services, particularly the level of charges, through commercial negotiations. However, to help in this process, Oftel reaffirms that in its view retail-minus is the correct principle for the charging of IA services on mobile networks, and will be the principle it will apply if it is required to re-intervene should the parties not be able to reach agreement. Also to help in this process, in Annex 4 Oftel sets out its view on how a retail-minus approach to charging for indirect access for mobile networks should operate.
Principle: Basis of Oftel’s conclusion that IA should be an obligation
3.4 Indirect access for mobile networks is an interconnection service in the same way as indirect access on the fixed networks is an interconnection service. It is therefore a service to which Article 4(1) of the Interconnection Directive (ICD) applies. That is: organisations authorised to provide public telecommunications networks have an obligation to negotiate this interconnection service with other such organisations. In UK licences this is expressed in terms of an obligation to "offer to enter into an agreement". These provisions will continue to apply, as now, to BTCellnet and Vodafone, operators designated as having significant market power, when the new mobile licences which implement the Licensing Directive enter into effect. Under the ICD, if, as in the two cases now before the Director General, these negotiations, or offers, do not result in agreement and the dispute is referred to the Director General, he has to consider the issue in the light of the criteria set out in Article 9(5) of the ICD.
3.5 Oftel set out its views on the application of these criteria in the February consultation document, identifying those it believed to be especially relevant to the issues raised by these two cases. Oftel has reviewed this preliminary assessment in the light of the comments received in the consultation. It confirms its view that IA services are necessary to meet the interests of users and for the promotion of competition and of innovation, considering in particular that IA adds a new dimension to the packaging and tariffing of calls not available through service providers. Annex 2 sets out the argumentation behind this conclusion.
3.6 Oftel has reviewed carefully the representations made by some commentators that some of the ICD criteria would favour rejection of the requests for IA on the two mobile networks. These criteria were, principally, those concerned with the availability of alternatives and restrictions on resources. Oftel nevertheless confirms its view that none of the alternatives offer the market the same benefits IA can offer and that the demands on resources, while not negligible, are not excessive. The background to these assessments is in Annex 2 and Annex 4.
Which mobile networks should have the obligation?
3.7 The determinations to be made by the Director General only apply to the operators who are parties to the disputes. However, Oftel believes that it should set out its likely approach if in the event any disputes between IA operators and the other two newer networks are referred to it. This outline must naturally be subject to the caveat that any dispute referred to the Director General will be considered on its merits in the light of the particular features of the dispute and the situation at the time.
3.8 In Oftel’s view, under present conditions, if an IA operator and one of the networks without market power were in dispute over IA, Oftel would not expect to impose an obligation on the network operator. This would be consistent with Oftel’s approach in other areas (notably on the airtime obligation). If such network operators conclude that IA operators do not provide profitable opportunities, then the regulator should not intervene to second guess their commercial judgement. Once IA is implemented on any network, that network may well have a competitive advantage over other networks as more attractive to customers: offering them more choices and access to alternative, potentially cheaper, suppliers of high value calls.
3.9 The determining factor in Oftel’s conclusion that BTCellnet and Vodafone should have an obligation to provide IA services is that both have market power. At present, market power is determined by the fact that these two networks are designated as having significant market power (SMP) under the terms of the Interconnection Directive.
Who should have the right to indirect access?
3.10 Indirect access is an interconnection service. All those who qualify for interconnection rights under the UK implementation of the Interconnection Directive (ICD) will therefore qualify, within the terms of that implementation and of the Directive itself, for IA for mobile networks. The criteria for qualification for interconnection are set out in Annex II of the ICD. Oftel has consulted on how the qualification criteria will operate in the UK. Its Statement Rights and obligations to interconnect under the EC Interconnection Directive was published in April 1999, and is available on Oftel’s website (http://www.oftel.gov.uk).
Charging basis: retail-minus
3.11 A number of the responses questioned the use of retail-minus as the costing basis, some with detailed economic arguments. The main economic arguments are reviewed in Annex 3. Oftel has taken these representations very seriously. Nevertheless it remains of the view that retail-minus is the appropriate basis for charging for indirect access for mobile networks. Retail-minus is not a concept invented by Oftel, but is based on wide external discussion of the economic principles that should apply to charges for services which are essential inputs to final products, but have to be acquired from suppliers also competing in the same end market. Oftel considers it is the appropriate concept for IA for mobiles given the current state of competition applying in the mobile market which is different from that applying in the fixed market. This is explained further in paragraph 3.16. Indirect access for mobiles is not the only market in telecommunications where Oftel considers retail-minus appropriate. It is used for Calls and Access services provided by BT, and is proposed for roaming on existing second generation (2G) mobile networks by any new entrant third generation (3G) operator.
3.12 The prime objections to the retail-minus concept for IA on mobile networks can be summarised under the following three headings: that it is based on the Efficient Component Pricing Rule (ECPR) and that this is flawed or inapplicable in this instance; that the evident disadvantage of the alternative concept of cost-plus charging (rapid loss of income for the networks) can be circumvented by modifying rates of return; and that it is impracticable. These objections are discussed in turn in the following paragraphs.
Basis for applying the retail-minus concept
3.13 Annex 3 sets out Oftel’s arguments for the validity of the retail-minus concept applied to IA for mobile networks, including the role of the underlying concept of ECPR. The key, but not exclusive, argument is that retail-minus provides a way to ensure that competition is focused on those elements of the total retail call where the IA operator and the network operator are genuinely in competition – and to ensure that this is efficient competition. Annex 3 also discusses another argument in favour of retail-minus – that it avoids a major change in the regulatory framework which increases regulatory risk. A third argument for retail-minus is that it also avoids regulatory intervention dictating the pace of changes in retail prices. As Oftel confirmed in Chapter 1, Oftel considers such intervention as unnecessary and potentially damaging to the market in the light of its conclusion that the mobile market is becoming competitive.
Respondents’ proposals to modify cost-plus concept through additional rates of return
3.14 Many of the responses advocate cost-plus as the appropriate basis for IA charges. The arguments against the cost-plus approach were very fully set out in the February consultation document under the heading of Option 1. Oftel has not seen anything in these responses that is new argument or strong enough to overturn the objections to cost-plus at this stage of the development of the mobile market.
3.15 An adaptation to the concept of cost-plus has been suggested to meet the major objection – that it would damage present and future investor confidence. This adaptation is that Oftel should add to the appropriate cost of capital an additional rate of return. Such regulatory intervention to manage rates of return would be an indirect way of introducing a retail price control in the mobile market, which Oftel considers unnecessary in the light of the increasing competitiveness of this market.
3.16 Some responses have questioned why this retail-minus concept is applied to indirect access on mobile networks whilst for indirect access on BT’s network the basis is cost-plus using current cost and long run incremental cost (LRIC) principles. In Oftel’s view, cost-plus for indirect access (call origination) on BT’s network was clearly the appropriate basis in 1984 when competition in fixed networks and fixed services was just starting in the face of a dominant incumbent network operator. Conditions are quite different in the mobile market in 1999. In the market for fixed PSTN indirect access call origination, conditions have also moved on since 1984. For the next retail and interconnect controls from 2001, Oftel will review the appropriate charging basis in public consultation.
Impracticability
3.17 Oftel has looked further at the data and data handling requirements of a system for setting IA charges on a retail-minus basis. It has had initial discussions with one of the operators. These show that the task, while far from trivial, is not as formidable as might appear at first sight. Paragraphs 3.21-3.25 below summarise Oftel’s preliminary view on how IA at retail-minus can be operated. A more detailed explanation is at Annex 4.
The determination and how the obligation will be applied
3.18 The obligations to provide IA services do not need to be implemented by licence modifications under Section 12 of the Telecommunications Act 1984 but will be applied through the process of making determinations to resolve the two disputes. Formally, the Director General intends to present draft determinations to the parties to both disputes shortly after this Statement: with a request for their comments within three weeks; and to make the determination as soon as he has considered any representations. The determinations will have immediate effect and their date will be the starting point for the deadlines for concluding agreements to supply IA services, and for implementing these agreements. The determinations will impose obligations to provide IA services and will set a period of three months for the parties to each dispute to reach commercial agreement; they will also require the implementation of the agreements within one month of each agreement being settled. As noted above, the determinations will not set the level of the IA charges – which Oftel expects to be settled as part of these commercial agreements.
3.19 If commercial agreement on charges is not reached within the three months set by the forthcoming determinations, then Oftel will have to determine the level of the IA charges. This could introduce further delay. To prevent this, Oftel intends to make interim determinations of the charges in light of the information to hand and following the principles of the system set out in Annex 4. Oftel will make further final determinations of the IA charges as soon as it has sufficient information. The second determinations will include provision for adjustments for any differences between the final charges and the interim charges. Oftel expects to make the interim determinations within one week of the end of the three months or of both parties to a dispute declaring that they cannot reach agreement, whichever is the earlier. The timetable for implementation of the agreements would remain at one month from the date of their agreement. This should minimise any additional delay.
3.20 If any of the parties fail to act as required by the determinations, the Director General’s recourse will be to issue an Order under Section 16 with immediate effect. Any further failure to conform with the determination would expose the failing party to third party damages.
Description of likely form of a retail-minus basis for charging for indirect access for mobile networks
Background
3.21 Whilst Oftel has concluded that it should leave setting the level of the charges for IA to negotiations between the parties, it believes that it is helpful to this process if it sets out the basis on which it would expect such agreements to be reached. These details are in Annex 4. Oftel will be happy to discuss these details with the parties, separately or jointly and to act as facilitator to this process of reaching commercial agreement without being part of it.
Range of IA charges to match retail prices
3.22 Oftel has concluded that there should in principle be an IA charge to match each retail call price. Alternatives involve a greater or lesser degree of risk of inefficient competition. Oftel recognises that at first sight this suggests a daunting amount of calculation. However, as set out in Annex 4, Oftel believes that the numbers of IA charges that will have to be calculated is not as large as might be feared. Oftel considers these numbers will be manageable if the avoidable and additional costs are only calculated once a year for each retail service and used to establish the percentage relationship of costs and retail price for each IA service. This percentage would be applied to the initial retail price and to any subsequent changes in the price until the annual recalculation. For each service there would be two IA charges – one to correspond with the daytime retail price and the other to match the evening/weekend retail price.
3.23 The numbers of calculations could be reduced further if it is possible to group avoidable costs for some services. Some degree of grouping already exists in the current structures of international retail call tariffs where each operator typically has about fourteen charge groups of geographically related countries whose common retail tariff in part reflects common costs. Annex 4 outlines ways in which grouping of costs could be extended whilst guarding against the increasing risk of inefficient competition which grows with each successive degree of averaging.
Verification of costs
3.24 Sound information on both avoidable and additional costs is essential if IA operators are to be confident that the charges they pay are fair. This information must be derived from the accounting records of the network operators; it will require setting up principles for defining relevant costs and their allocation, and establishing audit to ensure the allocation principles are fair and have been applied. Oftel has noted the parallel concern expressed in the written responses and in public fora by respondents, particularly ISPs, that the charges they pay should not only be fairly derived but fairly applied. That is: the charges they pay the mobile network for their customers’ use of the mobile network in originating calls that are routed to them for delivery, should be matched by identical transfer charges for the use of the same elements of the mobile network as constituent parts of end-to-end calls supplied by the mobile network to the mobile operator’s down stream retail arms. Oftel’s view is that this should not be a concern, Oftel believes that, by construction, the way the IA charge is derived will automatically mean that the charges are the same.
Subsidies
3.25 Although in general the mobile network’s retail costs are to be deducted as ‘avoidable’, there is one set that will not be deducted. These are the initial handset and signing on subsidies. These are costs incurred by the network operator to bring the customer on to the system; they are not related to provision of retail calls – but are recovered in the call tariffs. Since the IA operators benefit from the subsidy in terms of the wider number of customers they can target, it is proper that they should contribute to the subsidy.
Summary
3.26 In the light of the consultation, Oftel now confirms that, in the disputes between INMS and Vodafone and INMS and BTCellnet, the Director General will make determinations that will require Vodafone and BTCellnet to offer IA services to INMS. The terms and conditions, particularly the charges, are to be concluded in agreements within three months from the formal passing of the determinations, and that implementation shall be within one month of the conclusion of an agreement. Oftel will expect the charges to be based on retail-minus principles. It expects to put the proposed determination to the parties in the next few days and will require them to make any views known within three weeks.
3.27 Since Vodafone and BTCellnet are obliged not to unduly discriminate or prefer in the provision of services, the effect will be that any operator who qualifies will be entitled to IA services from them on the same conditions.
Future regulatory environment
4.1 Some responses to the February consultation document argued that the prospect of further review of the market in the year 2000 will create unnecessary uncertainty, in particular, with regard to the continuation in the licences of mobile operators of specific requirements to provide mobile airtime. Oftel is committed to the review for the reasons explained in Chapter 1.
4.2 Oftel recognises that regulation should not be a cause of uncertainty. Oftel is therefore making a clear statement now about the future of the obligation on networks to provide mobile airtime, and on its expectation that reasonable demands for service will be met.
4.3 In February, Oftel stated its policy "to ensure that reasonable demand from service providers is met, either through the operation of effective competition or, failing that, through regulation". That policy remains in place. Indeed, the Director General has a duty under Section 3 of the Telecommunications Act 1984 to secure that reasonable demands for telecommunication services are satisfied. This duty was clarified by the judgement in R v. Director General of Telecommunications, Ex Parte Cellcom and others (judgement of 26 November 1998).
4.4 The following paragraphs explain again how Oftel expects that reasonable demands will be met through the operation of a competitive market, and how it would approach any complaint that this was not happening in practice.
Effective competition and reasonable demand
4.5 In an effectively competitive market, and in the absence of any other market failures, competition would be the primary means by which the best deal on prices, quality and choice is secured for customers. For this reason, Oftel’s strategy is to withdraw from regulation where markets are found to be effectively competitive.
4.6 No operator can have Market Influence if a market is effectively competitive. This means that obligations to supply mobile services triggered by a determination that an operator has Market Influence would not apply if the mobile market is found to be effectively competitive. Oftel has concluded that effective competition is possible in the mobile market and that there are signs that such competition is emerging. Therefore, it is possible that, at some time in the future, no operator will be subject to the absolute obligation to supply wholesale airtime to service providers which will (in the new licences) be subject to a Market Influence trigger.
The role of service providers
4.7 This does not mean that independent service providers will have no role in a competitive mobile market. Competition will mean that the networks will have to use all efficient channels to market and Oftel expects that the networks will wish to continue to work with independent service providers where they provide this, as there are already signs that they will. For example a high proportion of airtime in both the Vodafone (around a half over the past year) and BTCellnet (around a quarter over the past year) networks are provided to independent service providers, and services like BTCellnet’s ‘TrafficLine’ are provided in partnership with content providers. In a fully competitive market, there would be a presumption that, if networks did not wish to use independent service providers as a route to market, then it would not be efficient for them to do so, and regulatory intervention to require this would not only be inappropriate but counter-productive. This is consistent with standard competition analysis which makes no presumption against vertical integration. For example, the Competition Act Guidelines state that "few of these [vertical] agreements will raise competition concerns. This is because competition will only be affected if market power is present at one or both levels", that is if the market is not effectively competitive.
The importance of access to mobile networks and possibility of market failure arising from barriers to entry
4.8 However, Oftel recognises that the structure of the mobile market and, in particular, the entry barrier arising from the limited supply of spectrum, mean that competition issues could arise again in future even after the market has been found to be competitive, as a result of future market developments. Oftel believes that access to mobile networks is likely to become increasingly important as consumers look for additional functionality from mobile communications and ‘one stop shop’ solutions for both their fixed and mobile communication needs. Clearly, the exact form of services which may emerge cannot be predicted. However, it is clear that, with the introduction of technologies such as General Packet Radio Service (GPRS) - which will enable quicker and more efficient transmission of data – on existing networks, and the upcoming availability of third generation (3G) mobile spectrum, there is going to be increasing scope for provision of high bandwidth data applications, including access to the Internet. Oftel is especially concerned to ensure that reasonable demands for access to mobile networks continues to be met so as not to stifle innovation in the development of new services for which such access is required. With this in mind, Oftel will continue to investigate carefully any complaints of anti-competitive practices which might arise if and when obligations to supply are removed.
Remedying market failure
4.9 In the event of a complaint of a refusal by all four operators to supply airtime to a service provider requesting it, Oftel would then investigate whether this would lead to a diminution of competition and whether there was evidence of market failure. Oftel would consider carefully whether the service providers’ demands were reasonable and the grounds for refusing them. If Oftel concluded that the refusal to supply was the result of market failure, and that the demands were reasonable, Oftel would then take action to ensure that the demands were met. The market failure may be found to result from the possession by one or more operator of Market Influence in which case the Director General would determine that the operators in question had Market Influence and hence re-trigger the requirement to provide airtime to service providers.
The Competition Act 1998
4.10 Even if no operator has Market Influence individually, it is still possible that competition issues will arise in the mobile market. In this event, Oftel could investigate the matter under the Competition Act 1998. If it then found that two or more network operators were jointly dominant and that there was an abuse of that dominance, Oftel could take appropriate action to remedy the abuse. Under the Competition Act 1998 the Director General has powers, concurrently with the Director General of Fair Trading, to require termination of breaches of the Act, and to impose financial penalties in respect of such breaches. The Act also provides that the Director General can impose interim measures to prevent serious and irreparable damage in respect of suspected breaches. Oftel has published guidance on the Competition Act in Guidelines on the application of the Competition Act in the Telecommunications.
Continuation of supply
4.11 In the event that the requirements on Vodafone and BTCellnet are removed (ie at such time as they are determined as no longer having Market Influence), it will be appropriate for there to be arrangements to ensure that existing contracts for supply of wholesale airtime to service providers are guaranteed for a period of transition to any new arrangements which may be applied. This period will be reviewed in the light of experience when the absolute obligation to provide wholesale airtime was removed from the licences of Orange and One2One in April 1998. In that case, the period was one year. Oftel will review the need for modifications to the licences of Vodafone and BTCellnet to ensure that these transitional periods can be instituted in the event that they are determined as not having Market Influence.
Conclusions and next steps
5.1 Oftel is grateful for the responses to its consultation documents in February. The constructive debate has contributed to the analysis presented in this document.
5.2 As the document shows, Oftel continues to believe that the market is not fully competitive as yet, although competition continues to develop. We therefore do not intend to impose price controls at this stage, although we will be monitoring price developments in depth over the coming year with an intention to review this issue in the year 2000. Similarly, we do not propose any changes to the obligation on BTCellnet and Vodafone to supply airtime to independent services providers on non-discriminatory terms.
5.3 In terms of the future direction of the market, we would like to see the industry moving towards the availability of airtime which enables the development of wide range of innovative services which add value for the customer. The wide range of Internet services being developed over the fixed network serves as an illustration of the value which we hope customers will be able to gain from their mobile phones in future. No new regulatory intervention is envisaged in this respect.
5.4 The mobile market presents particular challenges to the regulator as the market develops. The market has moved from being one based on business users to one where consumers make up the majority of subscribers. Technology and the development of competition in the fixed market mean that demand for access to mobile networks for a wide range of innovative services is likely to increase. There is a tension here: on the one hand, the market is moving towards effective competition. On the other, we have pressures both from consumers and industry to intervene in the market. We also need to consider the impact of EU developments on the UK market.
5.5 Oftel’s goal is to secure for the customer the best possible deal in terms of quality, choice and value for money. Our objective is that wherever possible this goal is delivered through competition. However we may also need to regulate where competition is not sufficient to secure a good deal for customers.
5.6 This statement proposes no new regulatory intervention, besides that already signalled for Indirect Access.
Next steps
5.7 For the purposes of clarity, below are the next steps which are envisaged in terms of Oftel’s involvement in the mobile market.
Oftel is seeking the views of consumers and industry on the proposals contained in paragraphs 2.9-2.13 of Chapter 2 by 6 August 1999. There will then be a 3 week further period during which comments on the representations made during the first period are invited; this will end on 27 August 1999.
Comments should be made in writing and sent to:
Michael Richardson
Regulatory Policy Directorate
Oftel
50 Ludgate Hill
London, EC4M 7JJ
Tel: 0171 634 8916
Fax: 0171 634 8924
E-mail: mrichardson@oftel.gov.uk
Written comments will be made publicly available in Oftel’s Research and Intelligence Unit except where respondents indicate that their responses, or parts of it, are confidential. Respondents are therefore asked to separate out any confidential material into a confidential annex which is clearly identified as containing confidential material. In the interests of transparency, respondents are requested to avoid confidentiality markings wherever possible. Appointments to view written comments in Oftel’s Research and Intelligence Unit, which must be made in advance, can be arranged by ringing: 0171 634 8761 (fax: 0171 634 8946).
Oftel would like to set up a link between this Consultative Document and any responses placed on respondents own Internet pages. Please contact Lauren Ryner at Oftel on 0171 634 8753 or by e-mail to arrange this. Confidential responses should not be sent via the Internet.
Oftel has a free e-mail based mailing list to help people stay informed about the work that Oftel is doing. Each time an Oftel document is published and placed on Oftel’s web site subscribers to the list receive an e-mail informing them about the document. If you would like to join please click here.
Alternative Formats
Copies of the full Consultative Document are available on disk.
The Summary is available in large print, Braille, and tape formats.
Please contact the Oftel Research and Intelligence Unit on 0171 634 8761, or by e-mail, or call textphone 0171 634 8769 for more information.
Competition in the mobile market: consultation and responses
Consultation background
1 In February 1999, Oftel published a consultation document which presented the findings of a review of competition in the mobile market. This document sought comments on Oftel’s assessment that competition in the mobile market is increasing, but not yet fully effective. Views of consumers and industry were received by 1 April 1999, and comments on these responses were invited by 19 April 1999.
Who was consulted?
2 The consultative document was to generalist and specialist telecommunications consumer groups including Oftel’s Advisory Committees on Telecommunications, National Consumers Council, Consumers Association, Telecommunications Managers Association and the Telecommunications Users Association. All leading telecommunications companies (including through the Operator Policy Forum and the Other Licensed Operators Group) were consulted, including service providers (through the Service Provider Forum), other Government departments and other NRAs.
List of respondents
3 Responses were received from the following organisations (in alphabetical order):
Comments on these responses were received from the following organisation:
Summary of consultation responses received
4 Responses were received from the four main mobile network operators, other licensed operators, service providers and their representatives, businesses and consumer groups.
5 The responses answered the seven direct statements and questions raised in Chapter 4 of the consultation document, considered more generally competitiveness in the mobile market and questioned the definition of the market.
6 The main themes of the responses are summarised below and, in particular, the summary focuses on issues that were raised in more than one response. An Oftel comment has been provided in response to each of the main themes summarised below.
Main focus of responses
7 Many issues raised by the consultation are discussed in the main text of this Statement. This annex summarises some of the main themes which are not covered in the main text, and explains Oftel’s reaction to them. Some responses included substantive economic papers; more detailed analysis of the economic arguments can be found in Annex 3.
Market influence
8 Some respondents expressed concern about the introduction of the Market Influence concept, arguing that the trigger and its operation were not sufficiently clear or transparent.
The new standard licence which will become effective through implementation of the Licensing Directive in the UK includes a list of factors which the Director General may take account of in determining that an operator has Market Influence. These factors are elements of the standard test for market power recognised and applied by competition authorities around the world, and also consistent with the methodology employed by Oftel in its assessment of the mobile market published in February 1999. Oftel has published draft Guidelines on Market Influence and these will be formally published later this year.
Barrier to entry
9 Some respondents suggested that, although the scarcity of radio spectrum is a barrier to further entry to the mobile market, the current number of operators is more a result of natural consolidation than the inability of others to enter the market. Others suggested that market entry is taking place and cited the example of Dolphin, which has announced plans to provide services using spectrum in the TETRA band.
The market has changed since Orange and One2One launched their services. This means that the four operator structure of the market which emerged when the GSM 1800 licences were granted is unlikely to be the limit of the market currently. A key factor is rapid expansion of the market much of which was not predicted.
It is too early to reach any conclusions about whether Dolphin will effectively compete with the GSM operators. Dolphin’s plans indicate the possibility that it may compete to a limited extent in the provision of some services, and it will be instructive to see whether customers regard the services as substitutable and whether Dolphin competes on price with the GSM networks. Oftel’s review of the mobile market in the year 2000 will take account of the impact of Dolphin if appropriate.
Access for disabled customers
10 One respondent said that competition will not be sufficient to ensure that mobile services meet the needs of some disabled customers.
Oftel is aware of the special needs of people with disabilities and the usefulness of mobile phones to this section of the community. It has, therefore, committed itself to look at policy relating to the provision of mobile telephony for people with disabilities.
The DTI is currently considering an Oftel recommendation on the regime to be applied in the fixed telephony market in order to meet the needs of people with disabilities. Oftel’s review of mobile telephony will start as soon as the DTI’s work on the fixed telephony market is complete.
Handset subsidy
11 One respondent argued that the handset subsidy distorts the market and airtime and that handsets should be therefore be available at an unbundled price.
As indicated elsewhere in this Statement, Oftel believes that movements in prices are increasingly driven by competition. Some current tariffs (eg Pre-pay) indicate that handset subsidies are becoming less significant. This trend seems likely to continue as the cost of handsets comes down. It is worth noting that any move towards provision of unbranded and unstructured airtime (see Chapter 2) may provide opportunities for the provision of tariffs which do not include a handset subsidy.
Cost of calls to other mobile networks
12 One respondent expressed concern about the differential in price between calls from a mobile network which terminate on the same network and those which terminate on other mobile networks.
Calls between mobile networks will be included in the price monitoring study explained in Chapter 1 (and in further detail in a separate document to be published in July 1999). Any excessive pricing should therefore show up in this monitoring. Oftel will consider an investigation if there continue to be concerns about these prices.
Indirect access for mobile networks: consultation and responses
Consultation background
1 In February 1999, Oftel published a consultative document setting out its proposals for the implementation of Indirect Access on mobile networks. Views of consumers and industry on the proposals were sought by 1 April 1999, and comments on these responses were invited by 19 April 1999.
Who was consulted?
2 The consultative document was to generalist and specialist telecommunications consumer groups including Oftel’s Advisory Committees on Telecommunications, National Consumers Council, Consumers Association, Telecommunications Managers Association and the Telecommunications Users Association. All leading telecommunications companies (including through the Operator Policy Forum and the Other Licensed Operators Group) were consulted, including service providers (through the Service Provider Forum), other Government departments and other NRAs.
List of respondents
3 Responses were received from the following organisations (in alphabetical order):
Comments on these responses were received from the following organisations:
Summary of consultation responses received
4 Responses were received from a mix of consumer groups and telecomms industry players.
5 Responses covered all the key issues and specific questions for consultation as set out in Chapter 6 of the consultation document.
Main focus of responses
6 The vast majority of the (albeit non-mobile network operator) responses supported the mandating of Indirect Access, on a cost-plus basis, from all four established GSM network operators. In contrast, the four established GSM network operators, together with affiliated organisations holding a financial interest, were against the introduction of Indirect Access in any form, although they indicated that they would prefer it to be charged at retail-minus should Oftel decide to introduce it. Some responses included substantive economic papers; more detailed analysis of the economic arguments can be found in Annex 3.
Commentary on Oftel’s evaluation of how the Article 9(5) ICD criteria should be applied in resolving this dispute over IA for mobile networks
7 Oftel understands the views expressed by some commentators that there is already plenty of competition at the service level and that adding to the numbers of competitors does not necessarily guarantee a greater degree of competition. Nevertheless, Indirect Access by its very nature, opens up new areas of competition since the IA operator can control how its calls are treated once they have left the mobile network. This adds a new dimension to the packaging and tariffing of calls that is not available to the service providers who resell the mobile networks’ calls and have no control over how the calls are handled (nor of the costs incurred in handling them) and whose freedoms to package the tariffs are restrained by the structure of the charges they pay to the mobile operator for the total call. Oftel believes it would be wrong to deny customers the opportunity to have wider ranges of choice and innovation offered to them; or to restrain these potential development by denying the IA operators their rights to interconnection and hence the opportunity to demonstrate that they can indeed attract customers.
8 Oftel has reviewed the representations made by some commentators that some of the ICD criteria would favour rejection of the IA proposals: notably the criteria that there are technical and commercial alternatives and that the resources required exceed the benefits. The question of commercial alternatives has been discussed in the paragraph above. There are no exact technical equivalents – although the Mobile Virtual Network Operator (MVNO) concept, on which Oftel is consulting separately, would provide an alternative way of transferring calls off the mobile network so that they are routed and packaged differently from those handled entirely by the network operator. However, the MVNO application goes even further than IA in opening up alternatives - whilst at the same time having some restrictions compared with the call-by-call control IA gives the calling customer to select their preferred supplier for particular calls. On practicality, Oftel is encouraged by the reaction of some of the networks and its own analysis to date that a workable system for developing and administering a retail-minus system can be reached. The variation in call prices is much less than the variation in tariff packages – most of the variation in fact comes from the inevitable proliferation of international charges to the different countries of the world, even so they are typically concentrated into fourteen groups.
9 Oftel understands the concern expressed by all the networks – but particularly those more recently established – that they had no reason to incorporate IA in their corporate strategies in planning their network investment, securing finance and forecasting returns. It also recognises that there will be parallel concern, in the minds of organisations considering bidding in the auction of the spectrum rights for the third generation (3G) mobile networks and services, over the risk that the returns on which they base their bids and investments may be eroded by the impact of IA competitors. Oftel does not believe that this provides a sufficient ground of itself for denying IA operators their right to IA interconnection services. It does however emphasise the importance of the terms under which IA is implemented on mobile networks, particularly the basis for charging for the service. The retail-minus approach provides for this in that on calls where the IA operator has displaced the network operator for the conveyance and delivery of calls beyond the mobile network, it preserves the profit margin the network operator earns on the call. (The network operator’s revenue is reduced but the reduction should be exactly matched by the costs saved). Conversely on incremental traffic, the mobile network gains both additional revenue and profits which would not be available without IA.
Economic commentary
Oftel comments on longer responses to the February consultations
1 Oftel has received a large number of comments on its two consultation documents Competition in the mobile market and Customer choice: Oftel’s review of indirect access for mobile networks. Oftel has reviewed them and considered the arguments put forward in preparing the foregoing Statement. The main focus of responses are also summarised in Annexes 1 and 2.
2 In addition, some respondents prepared expert commentary, or drew Oftel’s attention to relevant academic work. Oftel has attempted to provide a rather fuller response to these comments in this Annex. The responses covered in this Annex are those from: Fusion, who forwarded a paper by Chris Doyle and Jennifer Smith; Prof. J. Hausman who wrote a submission on behalf of Vodafone; and Mobilicom, who referred Oftel to work by Prof. Economides. The fact that a response has not been included here does not of course mean that it has not been taken into account. However, many of the points made in other responses were also covered in these longer submissions.
LBS paper on receiver pays and qualified indirect access principles for mobile telecoms, by Chris Doyle and Jennifer Smith
Summary
3 The two main arguments of this paper are:
The paper devotes most attention to the former and the price of calls to mobiles. This issue has now been dealt with by the MMC (see MMC: "Cellnet and Vodafone", 1999), so the paper has to some extent been overtaken by events. The proposal for qualified indirect access appears to have similarities to that for virtual networks, on which Oftel has just published its consultation document, Mobile Virtual Network Operators: Oftel inquiry into what MVNOs could offer consumers.
Called party pays
4 The authors attribute the relatively high prices charged for making calls to mobile phones to:
5 Oftel agrees that spectrum scarcity is a significant entry barrier. However, customer contracts may be becoming less important, particularly with the growth of pre-pay. Number portability is also now in place. In addition, Oftel believes that it is important to distinguish between competitive conditions in the market in calls from mobiles and those in the market for calls to mobiles. Oftel has classified mobile call termination as a bottleneck.
6 Oftel agrees that "called party pays" has the merit of offering a potentially deregulatory approach to the problem of excessive prices for calls to mobiles. However, it has important drawbacks. In particular, it is widely held to have stunted the growth of the mobile market in the US, for example because subscribers switch their phones off rather than risk receiving unwanted calls which also cost them money. The US regulator, the Federal Communications Commission (FCC), has opened public consultation on a proposal to remove regulatory obstacles to the offering to consumers of calling party pays, which it hopes will stimulate mobile phone usage, as an alternative to the current US called-party pays system. In the light of this and the absence of any compelling advantages for called party pays, Oftel has concluded that the MMC’s preferred approach is likely to be the best way forward.
7 In addition, it is not clear that called party pays for calls to mobile networks would address the market power of the fixed network which in practice would continue to require regulation. Therefore it would appear not to be a complete solution. Called party pays could also reduce competitive pressure on call origination prices, where Oftel believes it to be becoming more intense.
8 Use of CLI and, for example, tariffs where the first minute of each incoming call is free have been suggested as ways of overcoming some of the drawbacks of called-party pays found in the US. However, such tariffs themselves appear to introduce a distortion because they do not reflect underlying patterns of cost causation. This distortion may be vulnerable to exploitation by customers making large numbers of very short calls. It is more usual for there to be a minimum fee or call set-up charge in order to reflect call set-up costs and to discourage the making of large numbers of very short calls.
Qualified indirect access
9 Doyle and Smith consider three options for indirect access:
It should be noted that these authors use the term indirect access in a way which differs from the standard interpretation of the term, that is, the short-code access which is dealt with in Chapter 3 of this Statement. Their interpretation of indirect access appears to have similarities to the Mobile Virtual Network Operator (MVNO) concept. Oftel believes that the issues raised by the possibility of access by MVNOs need to be carefully considered and therefore Oftel is consulting separately on this issue.
10 Oftel agrees that customers may benefit from additional choice provided by indirect access operators. This view is reflected in the proposals set out in the Statement. However, Oftel believes that it is also necessary, with extra choices, still to maintain incentives to invest in networks, particularly to provide third generation services.
11 As proposed, QIA would require IA to be provided to Annex II operators satisfying conditions relating to variety, innovation and multi-access. However, Oftel believes that it would be very difficult to draw a line between innovative services and non-innovative ones in a way which did not appear arbitrary. It would also be likely to require considerable regulatory involvement. In addition, it could also be difficult to decide what a meaningful offer of such services would constitute ie at what prices and with what coverage and quality of service. It might also be difficult to prevent operators whose main aim was arbitrage taking advantage of this criterion. Oftel believes therefore that there would be serious practical difficulties in implementing this proposal.
12 The authors argue that UIA, which would allow anyone with Annex II status to have IA, "would damage the prospects for those operators seeking to establish a wide range of telecommunication services because margins on voice would be cut dramatically and this would erode the revenue streams needed for small start-up operations seeking to deliver innovative offerings". Under their proposal, there could thus be a substantial transfer of profits from the network operators to the indirect access operators, but it is less clear that customers would benefit from this if high margins are maintained by restricting entry. Oftel’s view is that the best balance between the needs of customers, indirect access operators and network operators (or, more properly, the short- and long-term interests of customers) is achieved by allowing unrestricted indirect access at retail-minus terms using short access codes (as noted above, the issue of MVNO access is being consulted on separately). This does not create a separate subclass of IA operators with preferential access to networks and does not damage incentives to invest in networks, but allows efficient competition where IA operators are providing services which substitute for those of the network operator. In addition, Oftel notes that the argument that IA operators need a particular level of revenue in order to finance investment would seem to presume some kind of capital market imperfection since finance should be available for investment which is expected to be profitable.
Competition in the mobile market: response from Vodafone and Professor Hausman
13 This section provides some comments on the response from Vodafone, including the Annex by Professor Hausman, to Oftel’s two consultative documents.
14 Vodafone argue that the mobile market is competitive and that no regulation is necessary. However, there is also some support for Oftel’s proposals in that, for example, Vodafone believe that one of the retail-minus options for indirect access is workable. Professor Hausman’s analysis is also consistent with Oftel’s position in many respects, although his conclusion is different.
Market definition
15 Vodafone argue that "share of customer base is a potentially misleading statistic" and "it is much more important to consider whether there is effective competition for new customers". It is true, as Oftel’s consultative document states, that attention should not be focussed on a simple snapshot of market share. Therefore Oftel also looks at trends in market shares, which reflect shares of new customers, as well as other indicators.
16 In addition, Oftel believes that it would be misleading to focus on shares in a "market for new customers alone". It is doubtful whether net new connections could be considered to represent a market as an economist would define it. Net new connections is the difference between two often much larger numbers, gross connections and churn. Thus it is determined by the ability to attract gross new subscribers and the ability to retain existing customers. Although there are some switching costs, given the high rates of churn experienced, it seems likely that new and existing subscribers are in the same market as each other. In principle, it seems likely that the same factors which encourage retention of existing subscribers also attract new ones, aided no doubt by switching costs which tend to favour operators with large existing subscriber bases. It may also be worth noting that an analysis based only on shares of net new subscribers may appear to have some unwelcome implications in some circumstances. For example, a company starting with a complete monopoly in a slow-growing market would very likely suffer a net loss of subscribers ie a negative share of net new subscriptions if even a token amount of competition was introduced. This would not however mean that it had no market power.
17 Vodafone asserts that the mobile and fixed markets should be considered as a whole, on the grounds that some mobile tariffs are cheaper than some fixed ones. Whilst this is true of some mobile tariffs, in general mobile tariffs remain significantly higher. However, in principle, mobile services could substitute for fixed services to a significant extent. GSM networks can cater for both voice and data, and provide many of the enhanced services available on the fixed networks. In practice, the extent of substitution has so far been limited by the higher prices and lower quality of mobile calls. Whilst reductions in some off peak tariffs have reduced them to levels comparable with those of BT’s fixed network, a significant mobile premium has remained in most peak rate tariffs. In addition to the higher prices, mobile speech quality and data throughput are lower, in building coverage is patchy and dropped calls are much more common than on the fixed network. Mobile performance is also inferior for fax machines and modems. These performance and price differentials have so far restricted the extent of substitution of fixed services by mobile and its competitive effect on fixed tariffs. Oftel therefore agrees with Prof. Hausman that the mobile and fixed markets are separate.
18 A distinction can be made between substitution on a call-by-call basis and complete replacement of the fixed exchange line by a mobile phone. Customers who have both a fixed and a mobile phone may be relatively easily persuaded to switch between them for individual calls by price differentials. It may be much more difficult to persuade customers who already have a fixed line to replace it with a mobile system, particularly if they wish to use it for data applications. However, there is already anecdotal evidence that some customers, in particular those who have never had a fixed line, are choosing a mobile as their only phone in preference to a fixed line.
19 The extent of substitution may increase as the mobile networks expand and evolve to cater for more advanced forms of data transmission and as costs fall. For example, Orange’s public position is that it aims to compete with and even replace the fixed network and, since the publication of the consultative document, One2One has announced significant price cuts accompanied by statements that BT’s fixed services were seen as the main target. Improved quality and lower off peak mobile tariffs may mean that the fixed line will be used increasingly for data traffic while the mobile will increasingly be regarded by some customers as the principal voice communication medium. Some analysts are stating that they expect significant substitution to take place within the next five years. However, mobile operators’ costs are likely to remain above fixed levels. Consumers may well be prepared to pay some premium for the additional convenience of mobiles but full substitutability of residential fixed lines by GSM is unlikely as long as a significant price premium remains. Oftel will consider again how far mobile services substitute for fixed in its next review of the mobile market in 2000.
Price trends
20 Vodafone comments that the Analysys price series does not illustrate the full impact of price reductions. This may be because it did not include the latter part of 1998 when there were a number of price reductions. However, it was the best information available to Oftel at the time. More recent data are included in Chapter 1 and Oftel has in hand a new system to improve its assessment of retail price movements.
21 It is important to remember that Oftel’s definition of market power requires prices to be raised "above the competitive level" (see paragraph A9 of Competition in the mobile market), not the current level. An inability to raise prices above current levels does not therefore invalidate a finding of market power if current prices are above competitive levels. The persistently high rates of return earned by Vodafone seems to indicate that prices are currently above the competitive level, which in the long run would allow an adequate rate of return to be made but not supernormal profits.
22 Vodafone argues that its high profits are the result of efficiency, not market power. Vodafone may be more efficient than, for example, BTCellnet. This seems to be the view taken by the MMC in its report on calls to mobiles (MMC: "Cellnet and Vodafone", 1999, para.2.308, p 73). However, BTCellnet also appears, on the data available, to make supernormal profits, which suggests that the market is less than fully competitive. In a fully competitive market, one would expect Vodafone’s profits measured by ROCE to be eroded as competitors were forced to increase their own efficiency or exit. The fact that these profits have not been eroded suggests that the market is not yet effectively competitive.
23 Vodafone argues that ISPs are not being squeezed by the networks but by competitive pressure at the retail level. However, whilst competition may have an impact on retail prices, the wholesale price should also be adjusted to maintain an adequate margin at the service provider level. The rates of profit shown in the consultative document and discussed above indicate that there is plenty of scope for this.
Barriers to expansion
24 Prof Hausman argues that Orange and One2One would have a strong incentive to increase supply if either Vodafone or BTCellnet increased their prices above competitive levels because prices are significantly above marginal costs and because of the absence of 'barriers to expansion'.
25 Oftel agrees that the impact of growth in the market could be pro-competitive (for example paragraph 2.14 of Competition in the mobile market). However, Oftel also believes that other indicators should also be taken into account, including switching costs, perceived coverage differences, time lags in expansion, and the relative size of the existing customer base which would affect the incentive to cut prices to attract new customers.
US experience
26 Oftel does not believe that the observation that US prices fell after the removal of the obligation to offer mobile IA demonstrates that mobile IA is harmful to consumers. Correlation does not imply causation. The cause of the price reductions may have been the introduction of additional competition at the network level at the same time. Professor Hausman argues that this was not the case because the first price reductions occurred before new network entry but this was also the experience in the UK where Vodafone and BTCellnet began to cut prices in anticipation of entry by One2One and Orange.
Double marginalisation
27 Double marginalisation occurs where one firm, eg a producer, supplies another independent downstream firm, eg a retailer or service provider and both have market power. The downstream firm takes the producer’s wholesale price, including any supernormal profits which the latter is able to earn as a result of its market power, as its own marginal cost and adds it’s own mark-up to this. It can be shown that, where there is market power at both levels and if prices are linear, double marginalisation results in higher prices, lower output and lower profits than if the firms were vertically integrated.
28 However, for double marginalisation to be a problem, it is necessary for there to be market power at both levels in the vertical chain. As entry as an IA operator is likely to be relatively easy, it seems unlikely that the IA operator would be able to add a significant margin. Moreover, the IA operator will continue to face competition from the service providers tied to the network operators and this will also restrain its ability to add an excessive margin. Lastly, even if there were market power at both levels, double marginalisation could be relatively easily avoided by the use of two-part tariffs. This is because the upstream firm can extract its profit in the form of a fixed fee with per unit charges then being at marginal cost. The downstream firm then faces the correct marginal cost when setting prices. For these reasons, Oftel does not believe that double marginalisation is likely to be a significant problem in practice.
Innovation and efficiency
29 Prof Hausman argues that IA, even at retail-minus will reduce innovation. By contrast, potential IA operators argue that it is they who will introduce the innovative new services. Oftel’s proposal has the merit of allowing this to be tested. In addition, to the extent that IA provides additional competitive pressure, this may serve as a further stimulus to innovation.
30 Oftel recognises that IA may involve some increase in transmission and switching costs and some increase in regulation. However, Oftel’s retail-minus proposal would mean that IA operators could succeed in entering the market only if they can compete efficiently with the network in supplying the substituted parts of the service.
31 If IA operators are successful in gaining traffic, then the bargaining power of the mobile network operators, vis-a-vis the suppliers of long distance conveyance, may be reduced. But this would not necessarily be to the detriment of customers. Firstly, competition from IA operators could ensure that a greater share of the benefits of any remaining bargaining power is passed on to customers. Secondly, if the wholesale supply of long-distance conveyance is competitive (or at least prospectively so, as Oftel believes) then the exercise of buyer power by mobile network operators could actually distort the market to the detriment of final customers, particularly where the network operator also has market power in the supply of mobile services to final customers.
Indirect access over mobile networks: response by Mobilicom
32 The main point of Mobilicom’s response is that the Efficient Component Pricing Rule (ECPR) is an inappropriate basis on which to set the charges made by the mobile network operators for access to their networks. For this to be a criticism of Oftel’s proposal for access charges to be based on ‘retail-minus’ it is necessary for this proposal to rely on the ECPR for validity.
33 Mobilicom proposes instead that the access charge should be set on the basis of ‘cost-plus’. These charges could however include a rate of return in excess of the cost of capital in order to maintain incentives to invest in networks. It is not clear however how this rate would be determined and it seems likely that a large measure of subjective judgement would be involved.
34 Moreover, the adoption of such an approach would be an intervention by the regulator in the management of a market which Oftel believes is already showing clear signs of becoming effectively competitive – and in which, hence, returns should be set by the market place not by the regulator. Intervention to control prices by regulation could only be justified where there is market failure which over a given period is unlikely to be remedied – and hence intervention by the regulator on behalf of the consumer to mimic competitive pressures is justified. It is fundamental from Oftel’s analysis of the current mobile market that the state of competition and prospective competition in the market (apart from calls to mobile) does not justify this intervention.
Does Oftel’s proposal depend on the ECPR?
35 It is not the case that Oftel’s proposal is dependent entirely on the ECPR for its justification. A number of reasons for preferring retail-minus were set out in the consultative document which do not wholly depend on the ECPR but reflect other policy considerations. For example, intervention to require access at cost-plus could increase regulatory risk and have damaging effects on network competition both now and in third generation. However, Oftel believes that its approach is broadly consistent with the ECPR.
A brief outline of the ECPR
36 Essentially the ECPR provides for the price of access (interconnection) to an incumbent's network to include the incumbent's opportunity cost, that is the profit which the incumbent foregoes by providing access to an entrant rather than providing the final service to the consumer. The (or two of th