Contents

Draft Direction

Background and summary

Chapter one – Technical issues

Chapter two – Market analysis

Chapter three – Consultation

DRAFT DIRECTION UNDER REGULATION 6(6) OF THE TELECOMMUNICATIONS INTERCONNECTION REGULATIONS 1997 ("THE REGULATIONS") RELATING TO A DISPUTE BETWEEN BRITISH TELECOMMUNICATIONS PLC AND VODAFONE LIMITED CONCERNING THE PROVISION OF PARTIAL PRIVATE CIRCUITS

Whereas:

(A) The Secretary of State granted to British Telecommunications on 22 June 1984 a Licence ("the BT Licence") under section 7 of the Telecommunications Act 1984 ("the Act") for the running of telecommunications systems specified in the BT Licence;

(B) By virtue of section 109 of, and paragraph 20 to, Schedule 5 of the Act the BT Licence has effect as if granted to British Telecommunications plc ("BT");

(C) The Secretary of State has granted to Vodafone Limited ("the Operator") a Licence under section 7 of the Act for the running of telecommunications systems specified in the Licences;

(D) In July 2002 the Director General of Telecommunications ("the Director") received a request from the Operator to determine a dispute outlined in the explanatory memorandum ("the Memorandum") accompanying and attached to this Direction;

(E) Regulation 6(6) of the Regulations provides that where there is a dispute concerning interconnection between organisations, the Director shall, at the request of either party, take steps to resolve the dispute. The Direction which the Director makes to resolve the dispute shall represent a fair balance between the legitimate interests of the parties, and shall be notified to the parties in accordance with Regulation 8(3). The parties are entitled to a full statement of the reasons on which the Direction is based;

(F) The Director has considered, inter alia, the information provided by the parties and the matters set out in Regulation 6(8) of the Regulations. The principal points are summarised in the Memorandum accompanying and attached to this Direction;

(G) The Regulations place upon the Director the general responsibility to encourage and secure adequate interconnection in the interests of all users;

(H) On 24 January 2003 the Director issued a draft of this Direction and accompanying Memorandum;

THEREFORE:

Pursuant to Regulation 6(6) of the Regulations, and having considered, inter alia, the views of the parties and those matters set out in Regulation 6(8) of the Regulations, the Director makes the following Direction to resolve the dispute between BT and the Operator:

1. Except as otherwise defined in this Direction, words or expressions used shall have the same meaning as in the Act, BT’s Licence or BT’s Standard Interconnection Agreement, as appropriate.

2. BT shall offer to provide to the Operator, within a reasonable period of the Operator’s written request, transparent transmission capacity at all bandwidths up to and including 2 Mbit/s between a radio base station and a Point of Connection with the Operator’s Applicable System connected to the nearest appropriate digital cross connection node.

3. BT shall provide to the Operator the products set out in paragraph 2 of this Direction at cost-orientated prices and on non-discriminatory terms.

4. BT shall provide to the Operator the products set out in paragraph 2 of this Direction on terms and conditions which, where appropriate, are comparable to the provisions relating to service level agreements, forecasting penalties and migration set out in the Director’s two PPC Directions published on 14 June 2002 and 23 December 2002.

5. This Direction shall form part of the interconnection agreement between BT and the Operator.

6. This Direction shall take effect on the day it is published.

Jim Niblett

Director, Broadband and International Affairs
A person authorised under Paragraph 8 of Schedule 1 to the Telecommunications Act 1984

Background and summary

S.1 This explanatory document accompanies the draft Direction published on 24 January 2003 concerning the dispute between BT and Vodafone regarding the provision of partial private circuits (PPCs). A PPC is a generic concept that describes a category of private circuits that terminate at a point of connection between two operators’ networks.

S.2 On 25 July 2002, the Director received a request from Vodafone to determine a dispute between the company and BT. The dispute concerned BT’s alleged refusal to supply PPCs to Vodafone. Vodafone wishes to connect its radio base stations to its mobile telephone exchanges (MTX) using PPCs rather than the existing retail leased line products. Vodafone currently purchase the BT retail product known as Netstream 16 Long Line. At present, BT does not offer a wholesale equivalent to this product which Vodafone could utilise. Vodafone wish BT to provide the same product, delivered over a point of interconnection on wholesale terms.

S.3 In order to assess this referral by Vodafone, the Director has considered whether:

(i) the requested product comes within the scope of the Interconnection Directive

The Director has previously concluded – in December 2000 – that PPCs are an interconnection service within the scope of the Interconnection Directive. Article 2(1)(a) of the Interconnection Directive defines interconnection as

In this dispute, the Director is satisfied that where Vodafone’s network connects with BT, for onward transmission through BT’s network to Vodafone’s base station, there is interconnection.

(ii) there is a genuine dispute

The complainant informed Oftel that they signed BT’s Standard PPC Handover Agreement in July 2002. Both parties have confirmed that they are in dispute regarding Vodafone’s request that BT provide partial private circuits ie the wholesale product that BT currently provides to operators – to connect radio base stations to the mobile telephone exchanges. On the basis of these statements, and his investigation of the issues, the Director is satisfied that this is a genuine dispute.

(iii) the request was reasonable

The Director has examined the information supplied by both Vodafone and BT. Vodafone has provided figures to indicate a reasonable level of demand for the requested product, particularly as they are currently purchasing a retail equivalent. Vodafone have outlined that the provision of links between their radio base stations (RBS) and MTX is of fundamental importance to their business operations. On the basis of this analysis, and given that a significant amount of the retail leased lines could migrate to the wholesale product, the Director is satisfied that the request is reasonable.

(iv) BT has market power in the relevant market

The Director’s market analysis indicates that BT does have market power in the relevant market. The details of the Director’s market analysis, including a discussion of BT's market power, are found in chapter 2 of this document.

(v) the Director’s duty to secure and encourage adequate interconnection in the interests of all users to provide maximum economic efficiency and gives maximum benefit to end users

The Director believes that his proposal will enable Vodafone to operate their network more efficiently and potentially offer a more cost effective service to end users. This is also addressed in S.4 below.

S.4 In considering his responsibilities under Regulation 6 (8), the Director believes there are a number of benefits from his proposed action. He notes that the provision of radio base station backhaul circuits is crucial to the operation of Vodafone’s network. A cost reduction in this provision could therefore promote greater network efficiency, and thus facilitate innovation and investment for the provision of mobile telephony. The Director also believes the reduction in Vodafone’s costs in this area could bring resultant benefits to end users. The Director’s proposed action could provide multiple, additional benefits for end users in terms of price, products and service.

S.5 Condition 45 of BT’s licence requires BT to meet interconnection requests which are reasonably required to meet all reasonable demand. The Director has set out above why he considers that Vodafone’s request is reasonable and why there is reasonable demand for the product. Consequently, the way the Director proposes to resolve the dispute is complementary to BT’s licence obligations.

S.6 Having determined the above matters, the Director has therefore taken steps to resolve the dispute as provided for in Regulation 6(6) of the Interconnection Regulation Directive.

S.7 The draft Direction issued with this document proposes that BT supplies radio base station links on wholesale terms to Vodafone and other qualifying operators, where requested. The product would be a wholesale equivalent of the current retail product that Vodafone purchase. The draft Direction proposes that BT provide this product to Vodafone at cost orientated prices and on non-discriminatory terms.

S.8 The Director also proposes that, where appropriate, BT should provide Vodafone with terms for items including service level agreements, forecasting and migration that are comparable with those in Oftel’s Direction on partial private circuits issued in December 2002. The Director believes that the general principles regarding such items are applicable to this dispute. He believes this is justified given that the product requested is technically analogous to PPCs. However, he also recognises there may be certain parts of Oftel’s phase one and phase two Directions for PPCs which do not fully correlate to this dispute. This includes areas such as migration timescales. The Director welcomes views on such matters, as part of this consultation.

S.9 The Director believes that his proposal is a fair balance between the parties’ legitimate interests, as required by The Telecommunication (Interconnection) Regulations 1997. As outlined in S4, he believes his proposal should promote efficient use of Vodafone’s mobile network and ultimately benefit end users.

S.10 All representations regarding this consultation should be made to the Director by 21 February 2003.

Chapter 1

Technical issues

1.1 Vodafone has a complex network of RBS providing their mobile radio network. This network supplies the company’s mobile phone services to customers. The RBS are located all across Great Britain to provide the cellular network that the company requires.

1.2 Vodafone has a core Synchronous Digital Hierarchy (SDH) network – the company operate this network themselves whilst leasing the fibre. This core network links Vodafone’s mobile telephone exchanges together. Each RBS must have a connection, either direct or indirect, to the MTX. Currently, these connections are provided either by microwave links or copper/fibre leased lines, typically of 2Mbit/s capacity (see figures 1 and 2 below).

Vodafone’s request

1.3 Vodafone wishes to connect their RBS to the MTX using partial private circuits (PPCs) rather than the existing retail leased line products. Vodafone require transparent transmission capacity, at all capacities, between a mobile operator’s premises and a point of connection with an operator’s applicable system, connected to an appropriate BT Synchronous Digital Hierarchy node.

1.4 Vodafone claims that it is heavily reliant upon BT to supply the connections for the RBS sites. Vodafone believe that BT is obliged under the Interconnection Directive to supply the requested circuits as PPCs to Vodafone as an Annex II Operator. Vodafone maintain that the retail products they currently purchase are entirely analogous to PPCs.

BT’s response

1.5 BT claim that under the PPC contract, PPC products are interconnection services which it is not required to supply to Vodafone. Under the PPC contract between BT and Vodafone, a PPC is defined as

BT believes that using this definition, the reference to 'Third Party Building' excludes Vodafone’s RBS sites.

Technical diagrams

1.6 Please see figures 1 and 2 below, for Oftel’s diagrammatic representations of the RBS/MTX, and a typical 2Mbit/s leased line.

Figure 1: Diagrammatic representation of RBS/MTX

1.7 These retail leased lines are delivered to MTX sites in Vodafone’s network in aggregate VC-12 (2Mbit/s) form on an STM-4 bearer (622Mbit/s). This is entirely analogous to how 2Mbit/s PPCs are delivered to an STM-4 POC.

1.8 In figure 2 below, a number of the 2Mbit/s circuits are passed over the interconnection to connect to Vodafone’s network. Vodafone also use a number of kilostream circuits for certain RBS sites but these could be handed over in the same fashion with a number of kilostream-N services crossing the interconnection on a 2Mbit/s bearer. Up to 31 64kbit/s circuits can be carried in a 2Mbit/s bearer.

1.9 There is no technical difference between the retail products that BT provides to Vodafone and the PPC products. In effect, the retail circuits currently provided to Vodafone could be reclassified ('migrated') to wholesale products analogous to PPCs without any physical adjustment to the circuits.

Figure 2: A typical 2Mbit/s leased line

Chapter 2

Market analysis

2.1 This analysis of the radio-base station backhaul circuit market describes the product in terms of characteristics, buyers and suppliers, then identifies the economic and geographic relevant market(s) in which these circuits fall, and finally assesses the market power position of BT in these relevant markets.

Product

2.2 The product in this request for a determination is the radio base station backhaul circuit offered by BT.

Description

2.3 A radio base station backhaul circuit provides transparent transmission capacity at a range of bandwidths, typically N*64kbit/s and 2Mbit/s between a mobile operator’s premises and a point of connection with an operator’s applicable system connected to an appropriate BT Synchronous Digital Hierarchy node.

2.4 Both parties in this dispute have confirmed that this product is technically analogous to a PPC.

2.5 At present, this product is not covered by the definition of a PPC set out in the Oftel direction issued in December 2002, mainly because of the specific reference in the PPC definition to a third party or customer premise. The term PPC is defined in the glossary attached to the phase one Direction on PPC issued on 14 June 2002 as a "generic term used to describe a category of private circuits that terminate at a point of connection between two operators’ networks. It is therefore the provision of transparent transmission capacity between a customer’s premises and point of connection between two operators’ networks."

2.6 The radio base station backhaul circuits bought by Vodafone generally operate at 2 Mbit/s; the other circuits bought for that purpose are of a capacity below 2 Mbit/s. Vodafone have provided the Director with confidential information regarding circuit length.

2.7 Radio base station backhaul circuits can be delivered by means of different technologies: on copper, on fibre, or by means of radio. The market analysis focuses on radio base station backhaul circuits as a function, independently of the technology by which it is delivered.

Buyer description

2.8 The buyers of such products are typically the mobile operators.

Supplier description

2.9 The suppliers of the radio base station backhaul circuits are the same as those supplying PPCs and leased lines.

Market definition

2.10 There are two dimensions to the definition of a relevant market: the products to be included and the geographic scope. The Director’s approach to market definition follows that which is set out in the Office of Fair Trading guidelines on market definition and is in line with those used by European authorities.

Product market definition

2.11 Product market boundaries are determined by identifying constraints on the price-setting behaviour of firms. There are two main competitive constraints to consider: how far it is possible for customers to substitute other services for those in question (demand-side substitution); and how far suppliers could switch, or increase, production to supply the relevant products or services (supply-side substitution) following a price increase.

2.12 The 'hypothetical monopolist' test is a useful tool to identify close demand-side and supply-side substitutes. A product constitutes a separate market if a hypothetical monopoly supplier could impose a small, but significant, non-transitory price increase above the competitive level without losing sales to such a degree as to make this unprofitable. If such a price rise would be unprofitable, because consumers would switch to other products, or because suppliers of other products would begin to compete with the monopolist, then the market definition should be expanded to include the substitute products. The relevant market is not necessarily the smallest which it is possible to define using the hypothetical monopolist test. It may be appropriate to include in the relevant market, a number of products (or areas), in which the competitive conditions for supply are homogeneous.

Demand-side substitution

2.13 In this case, the demand-side substitution analysis aims at identifying to what extent mobile operators could and would switch away from radio base station backhaul circuits if the hypothetical monopolist were to raise the price of this product above its competitive level by a small but significant amount.

2.14 Since radio base station backhaul circuits are technically analogous to PPCs, their production costs should be similar and hence radio base station backhaul circuits price should also be similar to PPC charges at the competitive level. The radio base station backhaul prices at competitive level may differ from PPC charges determined by the Director in the PPC phase two Direction (see: www.oftel.gov.uk/publications/broadband/leased_lines/ppc1202/direction.htm) if these backhaul links appear to be more often located in rural areas than PPCs. However it is reasonable to take the newly set PPC charges as a (lower bound) proxy for a radio-base station backhaul circuit price at competitive level. Note that the radio-base station backhaul circuit prices quoted at present by BT and OLOs are those of retail leased lines. They are approximately 50 per cent higher for connection and 20 per cent higher for rental than the competitive price.

2.15 For the demand-side substitution analysis, it is firstly helpful to identify the existing and potential substitutes for radio-base station backhaul circuits, in terms of functionality. In terms of functionality, a mobile operator has several options to link its radio-base station to the rest of its network, besides buying radio base station backhaul circuits. It could choose to self-provide using fibre, to use microwave point to point radio links, or to use another radio access technology (such as point to multi-point).

2.16 For each of these potential demand-side substitutes, the Director has examined the extent to which substitution would take place if the price of radio base station backhaul circuits was raised by about five to ten per cent above its competitive price. In other words, the Director has investigated the power of these substitutes to constrain radio-base station backhaul circuits to a competitive price level.

2.17 To self-provide radio-base station backhaul circuits using fibre is an expensive alternative for a mobile operator (without its own fixed network), even in major urban centres, because of the low radio base station density. The costs would be very high, similar to those of an entrant in the leased lines market. Hence it is unlikely that a mobile operator would switch to self-provision using fibre if the price of the radio base station backhaul circuits was raised by five to ten per cent above its competitive level. Indeed even at the present price, which is that of retail leased lines, some mobile operators do not currently self-provide.

2.18 Microwave point to point radio links are already used for sites located in rural areas when they are more cost effective than leased line connectivity via copper or fibre. This radio technology is used for a significant percentage of backhaul links. These microwave links often provide a lower level of resilience than an equivalent leased line. These links can be engineered to be more resilient but at much increased cost. If a hypothetical monopolist was to raise the price of radio base station backhaul circuits by five to ten per cent above the competitive level (which means quoting a price still lower than the existing one), it is unlikely that there would be any significant switch to the use of point to point microwave radio.

2.19 The cost and performance of using another radio access technology are in practice still unproven. Hence considerations relating to another radio access technology does not appear at present to be relevant for the sake of this analysis.

2.20 The above hypothetical monopolist considerations seem to indicate that none of the identified demand-side substitutes are in a position to provide a competitive constraint on the pricing of radio-base station backhaul circuits.

Supply-side substitution

2.21 The supply-side substitution analysis looks at the extent to which potential producers would start supplying radio-base station backhaul circuits if the price was to be raised five to ten per cent above its competitive level.

2.22 Given that radio base station backhaul circuits are technically identical to a low-bandwidth PPC, any supplier of low-bandwidth PPC or of low-bandwidth leased lines could supply these radio-base station circuits. Hence, the competitive conditions are expected to be homogenous between radio-base station backhaul circuits and low-bandwidth PPCs. Therefore supply-side substitution exists. As a consequence, radio-base station backhaul circuits and low-bandwidth PPCs are in the same relevant product market. For convenience, this market will be referred to below using PPC terminology. Although, as noted above, the definition of PPC excludes radio base station backhaul circuits, the two products are technically the same and so this approach avoids creating additional terminology which might create confusion.

2.23 In his PPC phase one Direction of June 14, 2002, the Director based his market analysis on the fact that a PPC may be composed of both a terminating segment and a trunk segment, depending on where the OLO interconnects with BT’s SDH network. The Director confirmed that he views the terminating segment markets and trunk segment market as separate. The fact that radio-base station backhaul circuits are identified in the same market as low bandwidth PPCs does not modify the Director’s finding concerning the separation of the low bandwidth terminating segment market and the trunk segment market. Indeed, radio base station backhaul circuits also consist of two wholesale elements: a low-bandwidth terminating segment and (possibly) a trunk segment.

2.24 A trunk segment is the capacity between serving centres for leased lines and circuits located at the Tier 1 level of the SDH network. The Director believes that trunk segments constitute a separate product market, as trunk segments are not a substitute for terminating segments and competitive conditions do or may differ between them.

2.25 A terminating segment is the capacity between a user’s premises and the point of connection (POC) between BT and an OLO’s network at Tier 1 level (or lower) of the SDH network. The Director considers it appropriate to define terminating segments as extending up to the Tier 1 level. The reason is that it does not appear economic to expect OLOs to roll out their network to all other nodes at lower levels in the SDH network because of the large sunk costs associated with it.

2.26 In the PPC phase one Direction (see www.oftel.gov.uk/publications/broadband/leased_lines/ppcs0602.htm), the Director confirmed the conclusion that two product markets could be distinguished, namely low-bandwidth terminating segments and high-bandwidth terminating segments, using the hypothetical monopoly test for demand-side and supply-side substitution. From a demand-side substitution point of view, the Director considered that the chain of substitution between terminating segments of different but close capacity breaks at the 2 Mbit/s capacity. From a supply-side substitution point of view, the Director was of the view that the absence of supplier providing only low-bandwidth terminating segments combined with the differences in technology required to supply high and low-bandwidth terminating segments would make supply side substitution unlikely.

2.27 To reach these conclusions, the Director carefully investigated the issue of separation between low and high bandwidth terminating segments. Indeed, the definition of the market or markets for terminating segments may be dependent on whether the starting point is high bandwidth segments or low bandwidth segments. The detailed considerations involved in this investigation can be found in the paragraphs C.36-C.43 of the PPC phase one Direction, June 14 2002.

2.28 For demand-side substitution, the idea is that low and high-bandwidth terminating segments are not likely to constrain each other’s hypothetical monopolist’s competitive price because of difference in price, speed, costs, and quality between high and low bandwidth. As regards supply-side substitution from low to high bandwidth, the argument is that no terminating segment supplier only supplies low-bandwidth and hence there exists no low-bandwidth terminating supplier that could provide a competitive constraint on a high-bandwidth supplier. For supply-side substitution from high to low bandwidth, the argument is two-fold. Firstly, a supplier is unlikely to be requested to supply with low-bandwidth a site that it already supplies with high-bandwidth (the instance in which it is affordable to do so). Secondly, a high bandwidth supplier may require different technology to supply sub 1Mbit/s terminating segments. This could constitute a barrier to entering the supply of sub 1Mbit/s terminating segments. Overall the analysis suggests that substitution from high into low bandwidth terminating segments or from low to high bandwidths will not occur and, therefore, that low and high bandwidth terminating segments form separate markets.

2.29 In the present request for a determination, all the radio-base station backhaul circuits are low-bandwidth circuits. Hence, the Director concludes that the product markets for radio-base station backhaul circuits relevant for this draft Direction are the trunk segment market and the low-bandwidth terminating segment market.

Geographical market definition

2.30 The Director also examined the issue of the appropriate geographic boundaries of these relevant product markets in which the radio base station backhaul circuits fall.

Geographic market for trunk segments

2.31 In the market analysis on which PPC phase one Direction was based, the Director analysed the issue of geographic market for trunk segments as follows. As for the geographic extent of the trunk segment market, there appeared to be little scope for supply-side and demand-side substitution between different areas of the UK. However, the competitive constraints that BT faced appeared to be similar across the whole of the UK. Entry appeared to be fairly uniform across the country, a number of OLO have built out national core networks and formerly regional operators were in the process of extending their networks to allow national trunk coverage. This led the Director to form the view that the trunk segment market is a national market.

2.32 The Director considers that a national market remains appropriate. Indeed there does not seem to have been significant development on the trunk segment market since the 14 of June 2002 when the PPC phase one Direction was published.

Geographic market for low-bandwidth terminating segments

2.33 As for the low-bandwidth terminating segment market, the Director concluded in the PPC phase one Direction (14 June 2002) that it was appropriate to identify a national market for low bandwidth terminating segments. For his analysis, the Director considered that the key criterion for identifying the geographical boundaries was entry. As far as the provision of low bandwidth circuits is concerned, the evidence collected by Oftel shows that the level of entry has been very low across the regions. Therefore, given the relative homogeneity of competitive condition in the country, the Director considered it appropriate to define a national market for low bandwidth terminating segments.

2.34 The Director considers that a national market for low-bandwidth terminating segments remains appropriate. The reason is that very few changes have been observed on this market since the publication of PPC phase one Direction.

Conclusion

2.35 The above economic and geographic market definition considerations lead the Director to identify the relevant markets for radio base station backhaul circuits to be the national low bandwidth terminating segment market and the national trunk segment market.

Market power assessment

2.36 The radio base station backhaul circuits are in the same market as low-bandwidth PPCs. That is, the national low-bandwidth terminating segment market and the national trunk segment market. This section discusses the Director’s assessment of BT’s market power in these markets. The market power assessment builds on the market power analysis discussed in Oftel’s June 2000 PPC phase one Direction.

BT’s market position in the trunk segment market

2.37 The Director considered that the market for trunk segments is not yet effectively competitive. BT has market power because it remains the only supplier in much of the country thanks to its ubiquitous network, because it enjoys significantly greater economies of scale than the other operators do, and because its vertical integration enables it to satisfy customers’ uni-vendor preferences. However, the Director believes that, given the entry that had occurred and the likelihood of further entry, the market for trunk segments may become competitive.

BT’s position in the low-bandwidth terminating segment market

2.38 The Director has based his assessment on an analysis of the barriers to entry that characterise this market. Given the relationship between low bandwidth terminating segments and low bandwidth retail leased lines, the Director has, whenever appropriate, relied upon evidence from the low bandwidth retail leased lines market as proxy for evidence for the low bandwidth terminating segment market.

Entry barriers

2.39 A key factor in assessing whether or not an operator has market power is the existence of any barriers that may limit entry into the market and, thus, give it freedom to set prices above the competitive level. Entry barriers consist of costs that must be borne by an OLO entering a market, but not by the incumbent. In the context of low-bandwidth terminating segments the most relevant barriers are those that arise from the existence of sunk costs and the asymmetry in timing of entry in the market. In order to provide terminating segments an OLO has to incur high costs to dig and duct fibre from the customers’ premises to the its trunk network. These costs are 'sunk' because they are unrecoverable if the OLO were to exit the market. Therefore, the OLO faces the risk of not being able to recover the costs.

2.40 The existence of high sunk costs affects entry in several ways. First, the profitability of entry depends on the nature of competition post-entry. Post-entry price competition is expected to be stronger the more entry costs are sunk. Secondly, BT has already entered the market and incurred the sunk costs. Therefore, whatever the pre-entry prices BT sets, it can credibly threaten a potential entrant that it would reduce prices if it were to enter the market. Thirdly, since other firms may be preparing to enter at the same time, there is an increased risk of excess capacity post-entry. All three situations show low post-entry price, which deters entry by potential entrants.

2.41 The two PPC Directions aimed at stimulating competition in the provision of retail leased lines by requiring BT to supply terminating segments on a cost oriented basis. The objective was to help the OLOs to overcome some of the key barriers to entry. To buy leased lines from OLOs is an alternative that is already used by mobile operators to obtain radio base station backhaul circuits. However given the location of many of the radio base stations in rural areas, where OLOs have not rolled out their own network, this alternative appears to be of limited relevance for mobile operators. The availability of PPCs at cost oriented price as set by PPC phase two Direction might thus help to alleviate the difficulty faced by OLOs to supply at reasonable costs leased lines in rural areas. However, it is not yet known how long it will take for competition to pass the PPC price reduction on to the leased line price. In addition, the passing on of the price reduction is expected to take longer for low bandwidth leased lines.

2.42 Economies of scale and scope, which are not available to the entrants to the same extent as to BT, are likely to strengthen the incumbent’s advantage. In the present case, these economies of scale and scope are mostly due to the ubiquity

of BT’s network and to the legacy effects of its former monopoly status. The effect of these economies is to lower the marginal costs faced by BT compared with those of OLOs. From the point of view of a potential entrant, it is clearly less profitable to compete with an incumbent who has low marginal cost, because the incumbent will compete more aggressively the lower its marginal costs. This means that BT’s economies of scale and scope increase the risk of not recovering fixed costs of entry, and enhance the strategic entry barrier.

Market share

2.43 Information on market shares, including how they have developed over time, is a useful indicator in the assessment of market power. Market power is more likely to exist if a firm has persistently high market shares. In the absence of data on low-bandwidth terminating segments markets, the Director has used market shares in the corresponding low-bandwidth retail leased lines markets as a proxy of its likely share of the low-bandwidth terminating segments markets. Table 1 and table 2 set out BT’s market shares by in the low bandwidth leased line markets by revenue and by volumes respectively.

2.44 The Director considers that retail low-bandwidth leased line market share provides a reasonable proxy for low-bandwidth terminating segments. The reason is that the Director estimates that BT’s share of the low-bandwidth terminating segment is higher than its retail low-bandwidth leased line market share. This is because, prior to the availability of PPCs, OLOs had to purchase retail leased lines form BT to provide links to customer sites and, therefore, a portion of OLO’s leased lines are likely to incorporate BT’s terminating segments.

Table 1: Estimated revenue market shares for low bandwidth retail leased lines

Source: Oftel market information

Table 2: Estimated volume market shares for low bandwidth leased lines

Source: Oftel market information

2.45 In general, the Director considers market shares by revenue to be better indicators in the assessment of market power, since they incorporate information both on volumes and on the level of prices. Nevertheless, volume shares are always useful to support the interpretation of revenue shares. Therefore, the Director has considered both sets of data in arriving to his conclusions.

2.46 The data presented in both figure 1 and figure 2 above suggest that BT has a share of 76 per cent (by either revenue or volume) of the UK low bandwidth retail leased line market. Further, the Director estimates BT’s share of the terminating segment market to be higher than its retail market share. This is due to the fact that, prior to the availability of PPCs, OLOs had to purchase retail leased lines from BT to provide links to customer sites and, therefore, a portion of OLOs’ leased lines are likely to incorporate BT’s terminating segments. This would imply that BT’s share of the markets for terminating segments is greater than its share in leased lines.

2.47 Given BT’s market and the barriers to entry that exist, the Director is of the view that BT has market power in the market for low bandwidth terminating segments.

Conclusion

2.48 The Director considers that BT has currently market power in the national market for trunk segments. But the entry that has occurred and is expected to occur leads the Director to the view that the market may become competitive ie that BT’s market power will be eroded in the next few years.

2.49 The Director considers that BT has market power in the provision of low bandwidth terminating segments in the UK. The Director has reached this conclusion on the basis of the significant barriers to entry that characterise this market and on the basis of BT’s high market share in the low bandwidth retail leased lines, used as a proxy for BT’s market share in the low bandwidth terminating segment market.

2.50 Hence, the Director concludes that BT’s market power status covers the radio base station backhaul circuits.

Chapter 3

Consultation

3.1 The purpose of this consultation exercise is to obtain views on the Director’s proposals to resolve a dispute referred to him by Vodafone. The Director will consider all relevant comments before making any final Direction.

3.2 The Director is publishing the draft Direction together with this explanatory document so that interested parties may have a reasonable opportunity to make representations. Once the Director has considered any representations, he will if appropriate, issue a Direction and explain the reasons for this decision.

3.3 Representations must arrive at Oftel’s offices no later than close of play on 21 February 2003. The Director will not take into consideration any representations which arrive after this deadline.

3.4 Where possible, respondents should e-mail their representations in writing to steve.burniston@oftel.gov.uk. However, respondents can alternatively mail or fax their comments to the address below. Please let us know if you are unable to respond using these methods, so that we can consider alternatives.

3.5 The contact details for responses are as follows:

Steve Burniston
Oftel
Compliance Directorate
50 Ludgate Hill
London
EC4M 7JJ

tel: 020 7634 5361
fax: 020 7634 8772
e-mail: steve.burniston@oftel.gov.uk

Further copies of this document

3.6 This document is viewable on Oftel’s website, www.oftel.gov.uk. We can supply paper copies, large print, Braille, disc and audio formats upon request. Please contact Oftel’s Research and Information Unit on 020 7634 8761 to discuss these matters, or contact them via e-mail on infocent@oftel.gov.uk.

Publication of representations

3.7 In the interests of transparency, the Director intends to publish all representations made to him regarding this consultation. The Director will not publish comments where respondents have stated they wish their views to be confidential. Respondents should therefore separate any confidential material into an annex, which they should clearly mark as confidential. Oftel will take steps to protect the confidentiality of all such material.

3.8 Interested parties can view the non-confidential responses to this document on the Oftel website. They will be available in the Publications section under Responses to Oftel consultations. They will also be available to view at Oftel’s Research and Information Unit. Please note, that appointments must be made in advance by telephoning 020 7634 8761, or e-mailing infocent@oftel.gov.uk.