Contents

Direction

Summary

Chapter 1 Background

Chapter 2 Market analysis

Chapter 3 The Director’s responses to issues raised during consultation

Chapter 4 Interconnection Regulations

Chapter 5 Conclusion and issues arising from this Direction

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 with a bandwidth capacity up to and including two megabits per second 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.

Chris Kenny

Director of Compliance

23 June 2003

A person authorised under Paragraph 8 of Schedule 1 to the Telecommunications Act 1984

Summary

S.1 This explanatory document accompanies the Direction published by the Director on 24 June 2003 concerning the dispute between BT and Vodafone regarding the provision of Partial Private Circuits (PPCs).

S.2 After considering the issues and representations made to him by both parties, the Director issued a draft Direction regarding this dispute on 24 January 2003. On further considering matters, after receiving responses to his consultation exercise, the Director has decided to proceed with making a final direction to BT regarding this dispute.

S.3 The Director has therefore taken steps to resolve the dispute as provided for in Regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997. The Direction issued by the Director with this document requires BT to supply RBS backhaul circuits on wholesale terms to Vodafone, where requested. The product will be a wholesale, functional equivalent of the current retail product that Vodafone purchase.

S.4 The Direction mandates that BT provides this product to Vodafone at

• cost oriented prices and

• on non-discriminatory terms.

This is in line with BT’s current regulatory requirements, under Condition 57 and 69 of its licence.

S.5 The Direction also states that, where appropriate, BT should provide Vodafone with terms for items including;

• Service Level Agreements;

• Forecasting; and

• Migration

These terms should be comparable with those in Oftel’s direction on Partial Private Circuits issued in June 2002 and December 2002.

S.6 This Direction applies to leased line services at the wholesale level, where BT has been designated as having Significant Market Power. The same conclusion has been made as part of the Director’s Phase 1 and 2 directions regarding PPCs. The Director’s analysis for this dispute is also consistent with his analysis in the Leased Lines Market Review document of BT’s market power in the markets for the provision of Symmetric Broadband Origination and wholesale trunk services, which include RBS backhaul circuits.

S.7 RBS backhaul circuits are wholesale inputs into the provision of retail services provided by mobile operators. The Director’s intent through this Direction is to remedy failures in the relevant upstream, wholesale markets. The market failure at the wholesale level arises because BT has market power. This allows BT to quote a price for the wholesale inputs (RBS backhaul circuits) at a level exceeding the costs and to maintain it at a high level without facing sufficient competitive pressure. Since this wholesale product is an interconnection service needed to provide retail mobile services, the Director is aware that these higher input costs are distorting the mobile operators network provision decisions and that this leads to higher prices for the retail mobile telephony services. This is not an efficient outcome, and leads to welfare losses.

S.8 In considering his responsibilities under Regulation 6 (8) of the Interconnection Regulations 1997, 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 will therefore promote greater network efficiency, and thus facilitate innovation and investment for the provision of mobile communications (voice and data services). The Director believes the availability of input at lower costs will increase competitive pressure in the retail market and so ultimately benefit end users of mobile services in terms of price, and potentially in non-price factors such as quality.

S.9 In conclusion, the Director believes that the Direction is a fair balance between the parties’ legitimate interests, as required by The Telecommunications (Interconnection) Regulations 1997.

Chapter 1

Background

1.1 Vodafone has a complex network of radio base stations (RBS) forming their mobile radio network. This network supplies the company’s mobile phone services to customers. The radio base stations 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 (MTX) 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.

1.3 Vodafone currently purchase BT retail products. At present, BT does not offer a wholesale equivalent to the products which Vodafone could utilise. Vodafone has asked that BT be required to provide the same product, delivered over a point of interconnection, on wholesale terms.

1.4 On 25 July 2002, the Director received a request from Vodafone to determine a dispute between the company and BT. Both parties have subsequently 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 MTX.

Chapter 2

Market analysis

Introduction

2.1 In accordance with Regulation 6(8) of the Interconnection Regulations, the Director has taken into account the relative market positions of the parties to the dispute by considering the relevant economic and geographic markets and determining if BT has market power in those markets.

roduct Market definition

2.2 RBS circuits are wholesale inputs required for the provision of retail mobile telephony services. In this dispute, these circuits offer transparent transmission capacity by means of a permanently connected link between the mobile operator’s premises and a point of connection with an appropriate BT SDH node. These circuits might include some trunk component if the mobile operator requires RBS backhaul circuits that pass through trunk network to the mobile base station. See figure 1 below . The product outlined below is in fact technically equivalent to the product BT is currently providing Vodafone.

Figure 1: RBS backhaul circuits

2.3 RBS backhaul circuits can be delivered by means of different technologies; on copper, on fibre, or by means of radio. This market definition focuses on RBS backhaul circuits as a function, and includes all of the technologies by which they are delivered.

2.4 Although they can be currently purchased as leased lines or radio links, RBS backhaul circuits are also technically equivalent to a PPC. The radio base station can be viewed as equivalent to the end user’s premises with traffic being carried to the appropriate point of interconnection on the mobile operator’s (‘MOLO’s’) network.

2.5 For the purpose of this Direction, the Director focuses on RBS backhaul circuits with bandwidth up to 2Mbit/s because these are the products that have been referred to him by Vodafone in the present dispute.

2.6 The Director has considered two ways to address the issue of whether or not RBS backhaul circuits and PPCs are in the same relevant market. Both reach the same conclusion – that they are part of the same market.

2.7 The Director’s first approach relies on the fact that RBS backhaul circuits and PPCs are technically equivalent. Because of this technical equivalence, he views them as essentially the same product and therefore considers that they are part of the same relevant product market, whatever they are labelled.

2.8 Notwithstanding the first approach, the Director’s second approach considers RBS backhaul circuits and PPCs as different products and assess the relevant market by identifying what constraints may apply to a hypothetical monopolist in the provision of RBS backhaul circuits. These potential constraints arise on the demand side if customers such as Vodafone are able to switch to other, substitute services. A supply side constraint concerns the ease with which potential competitors could transfer production to supply RBS backhaul circuits and constrain the existing suppliers. The Director carries out this demand side and supply side substitution analysis, putting aside BT’s practice of refusing to sell PPCs to a mobile operator. This is because it is precisely the practice that the Director is investigating in this Direction.

2.9 The Director notes, however, that even if he were to define the market on the basis of BT’s practice, his conclusions about market power and appropriate regulatory action would be unaffected.

Demand-side substitution

2.10 If a hypothetical monopoly provider of RBS backhaul circuits were to raise its prices by 5-10 per cent above the competitive level, customers of RBS backhaul circuits would have the possibility of switching away from these RBS backhaul services in favour of PPCs, possibly including a trunk segment. Indeed PPCs are wholesale products that offer the functionality of a transparent transmission capacity by means of a permanently dedicated link between a customer’s premise and a point of connection between the two operators’ networks.

2.11 In addition, because of their technical equivalence, the costs of RBS backhaul circuits and PPCs are not expected to be significantly different and their prices at competitive level are likely to be close. Hence, if a hypothetical monopolist of RBS backhaul circuits would raise its price by 5 to 10 per cent above the competitive level, the customers of these circuits would find it attractive to switch to PPCs priced at a competitive level. In a competitive environment, a supplier of PPCs is unlikely to refuse to supply a PPC to serve the purpose of linking a radio base station to the mobile switch. This means that RBS backhaul circuits and PPCs are viewed as substitutes by consumers and hence are found in the same relevant wholesale markets.

Supply-side substitution

2.12 Supply-side substitution possibilities refer to a low cost form of entry that could take place within a relatively short period of time and provides an additional constraint on the pricing behaviour of the hypothetical monopolist that has not been captured in the demand-side analysis.

2.13 The Director has examined if there are any other suppliers who could exert an additional constraint by entering rapidly and without significant sunk costs into the supply of RBS backhaul circuits. The Director considers that the cost structure of a supplier doing so would be similar to that of a new entrant into PPCs and would involve significant sunk costs. Therefore there is no additional constraint on the supply side that has not already been considered on the demand side, or is taken into account in the assessment of barriers to entry and market power.

Conclusion

2.14 RBS backhaul circuits and PPCs are part of the same relevant wholesale markets. As discussed below, these are the markets for symmetric broadband origination (for the local access part) and wholesale broadband trunk segment (for the trunk part).

Symmetric broadband origination

2.15 In his market review consultation document issued in 11 April 2003 www.oftel.gov.uk/publications/eu_directives/2003/eu_leased_lines/index.htm the Director has defined a wholesale market in symmetric broadband origination services. Symmetric broadband origination services provide symmetric capacity from a customer’s premises to an appropriate point of aggregation in the network hierarchy. Symmetric broadband origination services may be contended or uncontended. Uncontended services provide dedicated capacity from one end of the service to another. Uncontended services include the following:

• terminating segments, forming all or part of partial private circuits (PPCs) when supplied by BT to another operator;
• local loop unbundling (LLU) backhaul services; and
• radio base station (RBS) backhaul circuits.

2.16 However the Director also considered that there was a strong case for arguing that a chain of substitution exists between uncontended and contended symmetric broadband origination services. This is because on the demand side, there is a continuum of contention levels at which an application might be offered and it is reasonable to assume that consumers would switch from one contention level to the next if they were faced with a 5-10 per cent increase in the price. On the supply side, it would be reasonably easy for a supplier to switch between offering contended and uncontended services as there appears to be no major cost or barrier in doing so. To the extent that there are different suppliers of contended and uncontended symmetric broadband origination, supply side substitution is present.

2.17 The Director therefore defined the product market for symmetric broadband origination to also cover contended services using Symmetric Digital Subscriber Line (SDSL) technology.

2.18 The demand for symmetric broadband origination is a derived demand from the retail services in which it is an input. Based on the extent of demand side substitution in retail leased lines, which provides the largest derived demand for symmetric broadband origination, the Director proposed that there was a separate market for symmetric broadband origination at speeds up to and including 8 Mbit/s. This was because the demand-side factors suggest that breakpoints in the chain of substitution between low and high bandwidth circuits occur between 8 Mbit/s and 34 Mbit/s circuits. The Director subsequently considered if supply side substitution could broaden the markets. He concluded that supply side substitution was not feasible because of the need to incur significant sunk costs of network build to enter the market for a higher bandwidth origination segment. Since the biggest operators already provide both low and high bandwidth segments, there can be little or no additional constraint beyond that already captured on the demand side. Hence there is not sufficient supply side substitution to justify including high (defined as 34 Mbit/s up and including 155 Mbit/s) and low (defined as 8 Mbit/s and below) bandwidth symmetric broadband origination services in the same market.

2.19 One of the relevant markets in which the RBS backhaul circuits referred to in this dispute fall is therefore the wholesale market for low bandwidth symmetric broadband origination (up to and including 8 Mbit/s) since these RBS backhaul offer at most 2 Mbit/s of capacity.

Wholesale broadband trunk conveyance

2.20 In the market review consultation document the Director also discussed the markets for broadband trunk conveyance services. Trunk conveyance services are used where the operator does not have a point of connection close to its customer base. The operator then buys a longer PPC or RBS backhaul service which includes a trunk segment across a core transmission network, which provides a link between origination services where an operator does not have available network to its nearest point of interconnection. Trunk conveyance can be used to provide a range of downstream retail services in a similar manner as those provided by means of symmetric broadband origination services. PPCs, LLU backhaul services and RBS backhaul circuits may involve some trunk conveyance services.

2.21 On the demand side, trunk and symmetric broadband origination are not demand side substitutes since they relate to dedicated capacity provided across different elements of a network. On the supply side, a hypothetical monopolist in the provision of either trunk segments or symmetric broadband origination would not be able to substitute into the other input without incurring the significant sunk costs required to build another part of a network. Therefore the Director concluded that trunk and symmetric broadband origination constitute distinct wholesale markets. Based on evidence supplied by BT regarding the extent of other operators’ networks, the Director has considered that, in terms of BT’s network, BT’s Tier 1 nodes provide the appropriate cut-off point between the two markets.

2.22 The Director does not consider it appropriate to define distinct markets for trunk segments at different bandwidths. This is because trunk segment traffic can be aggregated so that higher order systems can be used at the trunk level.

2.23 The second market in which RBS backhaul circuits fall is therefore the market for wholesale trunk segments.

2.24 In the draft Direction, the Director identified that all RBS backhaul circuits are low-bandwidth wholesale transparent transmission capacity circuits. The Director concludes that the relevant product markets for RBS backhaul circuits are the wholesale broadband trunk segment market and the low-bandwidth symmetric broadband origination market.

Geographic market

Symmetric broadband origination (‘SBO’)

2.25 There appears to be limited scope for supply and demand side substitution between symmetric broadband origination services in different parts of the UK. On the demand side, symmetric broadband origination between a given pair of locations is not an adequate substitute for symmetric broadband origination between another pair of locations, except at the most micro level, because demand is location-specific. On the supply side, if the hypothetical monopolist raised prices above the competitive level it might be possible for another operator to enter and invest in the infrastructure necessary to supply wholesale symmetric broadband origination in a particular area. However, this is likely to be time consuming and involve sunk costs, and so supply-side substitution is unlikely to be present. There may be some scope for supply side substitution within a particular area, with the result that it is possible to extend market definition somewhat but this is unlikely to result in the definition of a national market.

2.26 However, it is not practical to define a very large number of local markets, nor is it feasible to define markets individually since the boundaries of each market are likely to be blurred. This issue is particularly relevant for radio base station backhaul circuits. Due to the presence of self-provisioned backhaul circuits, and different levels of build by the operators, there are dissimilar competitive conditions and prospects of entry between mainly rural and mainly urban areas in the use of radio base station backhaul circuits. However the distinction between the areas that can be classified as rural and urban is difficult and blurred. Therefore for practical purposes, the geographic extent of the market will be considered to be a national one. The constraint imposed by self-provision is assessed in the analysis of market power, below.

Wholesale trunk segments

2.27 There appears to be limited scope for demand and supply side substitution between trunk segments in different areas of the UK. On the demand-side it is clear that a trunk segment connecting two Tier 1 nodes located in different cities is not substitutable for a trunk segment connecting Tier 1 nodes in two other cities. On the supply side substitution is similarly unfeasible given the substantial sunk costs barriers to entry that exist in the supply of trunk segments between a given pair of nodes. The implication is that it would be appropriate to define markets individually on a route by route basis. This may be feasible but would be impractical, as it would involve defining a very high number of markets. This is why it seems appropriate to consider a national market for wholesale trunk segments and take account of local variations in the assessment of market power and in any remedies.

Conclusion of the market definition analysis

2.28 The above product and geographic market definition analyses lead the Director to conclude that the relevant markets for RBS backhaul circuits are the national low bandwidth symmetric broadband origination market and the national wholesale trunk segment market.

2.29 In reaching his conclusion on market definition, the Director has taken into account his analysis carried out as part of the Leased Lines market review consultation document published in April 2003.

2.30 The Director is aware that the above conclusion on SBO reads differently from the conclusions reached in the draft Direction. The differences are the inclusion of contended SDSL services, LLU backhaul, and 8 M/bts in the low bandwidth SBO market. He believes that these differences are minor and do not substantively change his analysis of this dispute. Indeed the two sets of relevant markets are very close to each other, with the present relevant market for the local access part being slightly wider than the previously defined one that served for the consultation. The relevant market for the trunk segment is unchanged.

2.31 The Director notes that even if he were to define RBS backhaul circuits and PPCs in separate relevant markets, the Director would end with the same conclusion that BT has market power in the relevant market for RBS backhaul circuits. This is explained in the market power assessment section.

Market power assessment

Symmetric broadband origination and wholesale trunk

2.32 The relevant product markets for RBS backhaul circuits are the low bandwidth SBO market and the wholesale trunk segment market. The Director concluded in the Phase 1 and 2 PPC Directions that BT had market power in both markets on the basis of BT’s ubiquitous network, economies of scale and of scope, significant barriers to entry, including sunk costs. The Director has provisionally reached a similar conclusion in the market review consultation document, namely that BT has market power in both markets on similar grounds.

2.33 For the purpose of the present Direction, the Director has taken into account the information available to him from these market power assessment exercises, and has widened his analysis by considering specific features of the RBS backhaul technologies. He concluded that BT has market power in the low bandwidth SBO market and the wholesale trunk segment market.

2.34 He reached this conclusion for the low-bandwidth symmetric broadband origination market on the basis of the ubiquity of BT’s infrastructure, BT’s ability to exploit economies of scale and scope, and the existence of significant barriers to entry including sunk costs. As a former monopolist, BT’s network has a ubiquitous coverage across the UK, which gives it a considerable advantage in terms of provision. This ubiquity cannot be easily duplicated by other undertakings. BT’s ability to exploit economies of scale arises from the significant volume of traffic that it always carries in any given area compared to other fixed network operators. This is because BT’s customer base is larger than that of any other operator at the local accesses level for low bandwidth symmetric broadband origination. In addition, BT offers a wider range of products than most operators and can therefore exploit economies of scope. In particular, BT can share the ducts used for symmetric broadband origination with other products and services in a significant way compared to other operators, due to the range of products that it offers and the traffic it carries. Therefore, it is in a more advantageous position than other operators.

2.35 The Director reached the conclusion that BT has market power in the trunk segment based on an analysis of the ubiquity of BT’s infrastructure and number of routes subject to little or no competition, barriers to entry, economies of scale and scope and the relatively high percentage of terminating segments with which trunk segments were purchased from BT. On the basis of the information available to him, the Director inferred that in a significant percentage (on average – 45 per cent) of routes BT is the only trunk supplier and that on an even larger percentage (on average 60 per cent) of routes there is, at most, one alternative trunk supplier besides BT. The Director also derived that a high percentage (about 55 per cent) of PPCs sold by BT included a trunk segment. BT’s ability to benefit from larger economies of scale and scope for the trunk segments is due to the same factors as those mentioned above for SBO.

The use of RBS backhaul circuits

2.36 The products relevant to this Determination are RBS backhaul circuits. Although such circuits are part of the market for symmetric broadband origination, it is useful to look at some features of these specific circuits and of their provision in a way that complements the above market power analysis.

2.37 The Director has obtained information from mobile operators on their network characteristics. In particular, the mobile operators supplied him with details of the sources of their RBS backhaul circuits or links. The information he received shows that, in general, mobile operators tend to both self-provide and purchase RBS circuits. On the basis of that information, the Director was able to assess the importance of each supplier of RBS backhaul circuits as of February/March 2003. He did so by estimating the number of circuits supplied by each of these suppliers to all five mobile operators and by dividing this estimate by the estimated total number of existing RBS backhaul circuits (whether self-provided or purchased, fixed or radio). The above estimations indicate that BT supplies approximately 55% of all these RBS backhaul circuits and that none of the five mobile operators supplies (individually through self-provision) more than about 20 per cent of all the RBS backhaul circuits. The other suppliers of RBS backhaul circuits put together are estimated to account for about five per cent of the RBS backhaul circuits total supply (please note that the individual details of the above suppliers are confidential).

2.38 Assuming that the relevant market was much narrower than SBO and only consisted of RBS backhaul circuits, BT’s figure would be a market share that is consistent with market power. However, the Director considers that a key issue in establishing market power is whether any buyer power from mobile operators can act to constrain the prices of BT to the competitive level. This is why he has considered if there are pressures from mobile operators that can constrain BT’s prices to the competitive level.

2.39 A mobile operator has two main options to link its radio base station to the rest of its network. It could purchase a RBS backhaul circuit (at present in the form of a leased line or a radio link) or it could self-provide these circuits until they are aggregated at a certain point and then carried over higher capacity leased lines.

Competitive pressure from other RBS backhaul circuit non-mobile providers

2.40 If a mobile operator wished to purchase a RBS backhaul circuit, it has the choice of a number of fixed network operators in addition to BT. Indeed, the information provided by the mobile operators to the Director shows that they have also purchased these circuits from operators other than BT. However the market share of these operators is significantly lower than that of BT, which suggests that mobile operators still tend to use BT as their main provider of RBS backhaul circuits. The evidence received by the Director shows that alternative providers of RBS backhaul circuits (non-mobile operators) have very small individual market share, each well below five per cent. There are at least two reasons for this.

2.41 First is the ubiquity of BT’s network, which allows it to supply RBS backhaul circuits in areas where other operators are not present, particularly in rural areas. The Director is of the view that BT may be further exploiting its ubiquity advantage by offering a discount scheme based on total purchased volume, which strengthens its ubiquity advantage. An entrant that enters in some selected areas is not in a position to offer a similar type of discount. However, to enter the entire market in order to offer a similar type of discount is too costly.

2.42 Second, BT’s ability to exploit larger economies of scale in any given area due to the traffic size carried on its network means that it is in a position to offer a price based on lower unit costs for any given area.

Competitive pressure from self-provision by mobile operators

2.43 The Director has examined if the self-provision of RBS backhaul circuits is likely to constrain the pricing of a purchased RBS backhaul circuit. The Director has used evidence provided by the mobile operators on their network structures to assist in his analysis.

2.44 Until the early 1990s, due to the regulatory regime in place at the time, mobile operators were not allowed to self-provide. This meant that their networks have been developed on the basis of purchasing leased lines or microwave radio links as RBS backhaul circuits. Since then, mobile operators have been allowed to choose whether to build their networks themselves or to buy RBS backhaul circuits from other suppliers. Mobile operators which started to develop their network beyond that date (ie Orange, T-Mobile, and Hutchinson 3G) predominantly opted for self-provision by means of microwave radio point to point links because this has been a cheaper option than to buy for the type of network they wished to build. This does not, however, demonstrate that there are sufficient constraints on BT’s prices, because the decision by these operators could have reflected the excessive existing price charged by BT as a result of its market power.

2.45 The Director has considered whether mobile operators would opt to self provide if BT raised the price of RBS backhaul circuits above the competitive level. If the mobile operators were entirely reliant on purchasing RBS backhaul circuits, self-provision through fixed technology such as fibre or copper would require significant investment to be made. These cost structures would be quite similar to that of an entrant in the SBO market as discussed in detail in the market review consultation document. For the same reasons as set out in that document, these costs would prevent these mobile operators from providing a sufficient constraint on BT, with its ubiquitous network.

2.46 Self-provision through microwave radio would not be suitable for operators whose networks are based on the purchase of RBS backhaul circuits. This is because many of their sites would not necessarily have line of sight that could enable microwave radio technology to be used. Hence these operators would find many of their sites unsuitable for self-provision through radio. They would need to incur significant investment costs in acquiring new sites to provision RBS backhaul circuits through microwave radio. Hence the threat of self-provision by these operators will only become effective if the costs of self-provision are below the costs of buying from BT.

2.47 The Director has also considered if mobile operators already using a mix of self-provision and RBS backhaul circuits purchase would switch to more self-provision if BT’s price of the RBS backhaul circuits were to be raised by five to 10 per cent above the competitive level. The Director has examined evidence provided to him that shows those operators who have built a significant proportion of their network themselves choose to purchase backhaul circuits in sites where it has not been practical to self-provide by means of microwave radio. The following reasons have been stated to the Director as to why it was not practical to use microwave radio at these sites:

• sites where line of sight is unavailable;
• urban sites (below roof level) where capacity is better served by leased lines;
• sites where there are demands for increasing cell site capacity;
• sites in specific geographic locations, sites such as shops or airports requiring in-building applications, and;
• sites which require roadside microcellular applications.

Since self-provision at these sites is not technically practical, it is unlikely that such operators would choose to substitute their purchases of RBS backhaul circuits with self-provision if they encountered a SSNIP by the hypothetical monopolist.

2.48 The Director considers that the above considerations on the sources of competitive pressures (or the lack thereof) help him to understand how the pattern of mobile network provision (that is, the ratio between build and buy) has evolved over the last five years. This ratio has remained relatively stable for the earlier mobile operators but has varied for later mobile operators. In fact, the percentage of purchased RBS backhaul circuits of the former operators is very high and has not changed by more than 2.5 per cent during this period whereas that of the later mobile operators has significantly increased. The information submitted points thus towards an increase in fixed, purchased RBS circuits reliance. The mobile operators explained how the variation in their own build/buy ratio reflects the stage of their network development and/or the constraints they face while doing so.

The Director recognises that mobile operators have built out their networks very differently, with some operators having chosen to significantly self-provide the RBS backhaul circuits. However, it is the Director’s view that for all the reasons outlined above, self-provision by mobile operators does not provide a competitive constraint on BT’s price of RBS backhaul circuits.

Conclusion

2.49 The Director has concluded, for the purposes of this investigation, that BT has market power in the provision of low-bandwidth symmetric broadband origination and wholesale trunk services, including radio base station backhaul circuits.

Chapter 3

The Director’s responses to issues raised during the consultation period

3.1 On 24 January 2003, the Director issued a consultation document and draft Direction relating to this dispute. In this publication, the Director invited comments on his proposals, which included the requirement for BT to supply the requested product at cost oriented prices and on non-discriminatory terms. The Director received a number of responses, including submissions from both companies which are party to this dispute.

3.2 This chapter reviews the principal issues, mainly those raised by BT.

(i) Interconnection and related matters

BT’s comments

3.3 BT disagreed whether this dispute could be investigated by the Director as an interconnection service, and within the scope of the Directive and Regulations.

3.4 In its response BT claimed that the product which Vodafone is requesting (ie 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):

• does not fall within the definition of ‘interconnection’; and
• is not a leased line.

3.5 In addition BT claim that the Director’s analysis is not compatible with the new EU electronic communications regime.

The Director’s views

Interconnection

3.6 Whether the Director has the power to resolve the dispute depends on whether the product in question falls with Article 9(5) of the Interconnection Directive (Directive 97/33/EC) as implemented by Regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997. Article 9(5) applies where there is an interconnection dispute. "Interconnection" is defined as:

3.7 A telecommunications network is defined as: "transmission systems and, where applicable, switching equipment and other resources which permit the conveyance of signals between defined termination points by wire, by radio, by optical or by other electronic means."

3.8 For a product to be considered interconnection two criteria must be fulfilled:

• there exist, at least, two telecommunications networks and
• those networks are physically and logically linked.

3.9 The product requested by Vodafone – and indeed the product BT is currently providing Vodafone – fulfils both these criteria, and therefore falls within Article 9(5) because:

• Vodafone’s network is a transmission system as it conveys signals between defined termination points and the product requested by Vodafone also conveys signals between defined network termination points (i.e. a Vodafone radio base station and a Vodafone mobile switch); and
• Vodafone’s network and BT’s network (i.e. the product requested by Vodafone) are physically and logically linked at the Vodafone mobile switch.

Leased line

3.10 The Interconnection Directive defines leased line services as:

3.11 The product which Vodafone is requesting – and indeed the product BT is currently providing Vodafone – falls within this definition because it is transparent transmission capacity between two network termination points, namely; the point of connection with BT’s applicable system at the Vodafone mobile switch; and the Vodafone radio base station.

The new EU regime

3.12 This dispute is being considered in the context of the current regulatory regime, and therefore the governing regulation is that contained in the Interconnection Directive and implemented by the Telecommunications (Interconnection) Regulations 1997. The recently published leased lines market review document discusses the issue of how the provision of RBS backhaul links may be required in the new regime.

(ii) Infrastructural competition

BT and operators’ response

3.13 In response to the Director’s draft Direction issued on 24 January 2003, some responses questioned the effect a Direction may have upon infrastructural competition for the provision of retail leased lines. BT also stated that the Director’s proposals would result in BT building other operators’ networks for them, when the operators may otherwise be able to finance such development themselves.

The Director’s views

3.14 The Director believes that this Direction will have no material, negative, impact on the ability of OLOs to purchase PPCs and compete successfully in the downstream market for retail leased lines. The Director views this Direction as complementary to his PPC Directions.

3.15 The Director believes that by requiring BT to price RBS circuits at cost oriented levels, this should stimulate efficient build/buy decisions by MOLOs. The Director believes that the Direction should lead to greater efficiency in the development of mobile networks by facilitating better resource allocation.

3.16 Higher economic efficiency is usually achieved when economic decisions are based on prices or charges that are cost-reflective. By requiring RBS backhaul circuit charges to be cost-oriented, the Director will enable mobile operators to base their decisions concerning the provision of RBS backhaul circuits on price signals reflecting costs more closely. The resulting improved resource allocation for RBS backhaul provision will free up resources and increase welfare. The Director considers that mobile networks will benefit from this Direction because it will facilitate greater efficiency; this in turn is welfare-improving and further facilitates benefits to consumers.

3.17 The Director’s is not requiring BT to supply at charges below costs, since these charges should be cost oriented. The Director is not setting the charges in this Direction.

3.18 The Director believes that it is a mischaracterisation to state that the direction will result in BT building other operators’ networks for them. RBS backhaul circuits supplied by BT to Vodafone and other operators will, to a substantial extent, be laid through existing BT ductwork. This implies that the overall volume of work needed to supply (and the costs thereby incurred) will be considerably lower on the part of BT than if self supplied. If Vodafone were able to lay their own cables through existing BT ducts, it is quite possible that they would choose to self-supply as a matter of course.

(iii) Product description

BT’s comments

3.19 BT queried the product description as outlined in Oftel’s draft direction dated 24 January 2003, suggesting that RBS backhaul circuits are complete not partial private circuits, and therefore not technically equivalent to PPCs.

The Director’s comments

3.20 As explained in chapter 2, RBS backhaul circuits are technically equivalent to Partial Private Circuits. The fact that an RBS circuit is not a partial circuit has no relevance either to its technical nature or to the market analysis needed to determine the dispute.

(iv) Network configurations

BT’s comments

3.21 BT asserted that the different configurations of the mobile networks create distinct demand and supply patterns for each operator. BT suggests that these various configurations also impact upon price, making an overall comparison with PPCs invalid. BT also suggests that the volume pool discounts available to Vodafone and others that use the existing products are further evidence of diversity in provisioning and price. BT also suggests that the level of self-provision of microwave links is an indication that there are adequate constraints on the market under investigation.

The Director’s views

3.22 The Director agrees that there are differing patterns of use for retail leased lines and alternative technologies by mobile operators, such as microwave links, and has received more information regarding this matter during the investigation (please see section The use of RBS backhaul circuits on page 15). However, as outlined in his market analysis in chapter 2, the Director concludes that there are not adequate constraints on BT’s pricing of RBS backhaul circuits in these markets. Therefore, the Director believes it is reasonable to mandate BT to provide cost based RBS backhaul circuits.

(v) Demand-side substitution issues

BT comments

3.23 BT does not agree that the technical parallels between RBS circuits and PPCs allow comparisons to be drawn between their prices. BT therefore suggested it was inappropriate for Oftel to take PPC charges as a lower bound proxy for RBS circuits at the competitive level.

3.24 BT states that Oftel has assumed low to zero price elasticities and has not considered the relative prices and quantities of radio links and the price-cost margin. BT has suggested that radio technology is a viable alternative to capacity over fixed networks.

The Director’s comments

3.25 The Director accepts BT’s point that the likely difference between the RBS backhaul circuit prices and the PPC charges might be smaller than that between the leased line headline prices and the PPC charges if the percentage volume discount enjoyed by mobile operators for their RBS backhaul circuits purchase is large. However this is not critical to the Director’s proposed conclusion that BT has market power.

3.26 On the basis of the information received during the consultation period, the Director is now in a position to state that he views fixed and radio RBS backhaul circuits to be demand-side substitutes. Indeed the evidence submitted to the Director indicates that the mobile operators do not view the quality difference between these two technologies to be material. This evidence also shows that mobile operators use both technologies in significant though varying proportions. The Director is thus confident that his previously adopted technology-neutral approach remains appropriate. This means that fixed and radio RBS backhaul circuits are in the same relevant market.

(vi) Supply side substitution issues

BT’s comments

3.27 BT has disputed Oftel’s use of the Tier 1 level as the "breakpoint" in the definition of the terminating segments. BT has also disputed the correlation between retail leased line provision and RBS circuit provision.

The Director’s comments

3.28 The Director has previously outlined his views regarding the Tier 1 breakpoint in his analysis of PPCs in the Phase 1 and 2 documents he issued in 2002. In his market review consultation document referred to earlier, the Director outlined that RBS backhaul, LLU backhaul and PPC services are comprised of terminating segments and trunk segments. The Director reiterated his earlier findings in his PPC publication that these terminating and trunk segments are in different markets and that Tier 1 in BT’s SDH network was the break point separating the two markets. The Director stated that using the Tier 1 as a break point will result in prices that are more closely related to the cost of circuit provision up to the limit of BT’s market power.

3.29 The Director notes that mobile operators have certain options to link their RBS to the rest of the network that are not readily available to most leased lines end-users. Indeed, in many circumstances microwave radio can be used for RBS circuits. Also, since the mid-nineties mobile operators have been able to opt for self-provision. The extent of the constraint imposed on BT by the availability of radio technology and self-provision by the MOLOs is considered in detail in the previous Chapter as part of the market power assessment. The Director concludes that there is not an adequate constraint on BT’s RBS backhaul circuit prices.

(vii) Market power assessment

BT comments

3.30 BT considers that Oftel cannot rely on the possibility that threat of predation by BT can act as an entry barrier, without any evidence of exclusionary behaviour. BT also believes that Oftel’s analysis does not take into account the possibility that MOLOs could use their countervailing buyer power to get the price of radio base station backhaul circuits close to the marginal costs. BT also disagrees that it benefits from a first-mover advantage in supplying RBS circuits.

The Director’s comments

3.31 Although there is currently no evidence of exclusionary behaviour, the Director maintains that one of the most important reasons for BT’s market power in low-bandwidth symmetric broadband origination is that of significant entry barriers. This is explained in greater detail in the market review consultation document referred to earlier, and also in the Director’s PPC document. The most important barriers that have been identified are the ubiquity of BT’s infrastructure, BT’s ability to exploit economies of scale and of scope, and the high sunk costs of ducting and fibre.

3.32 The Director considers that MOLOs are not in a strong position to exercise their countervailing buyer power. In his reasoning in chapter 2 he sets out the reasons why the constraints imposed on BT by alternative fixed operators and self provision by MOLOs are limited.

3.33 BT has a first-mover advantage because it has developed a ubiquitous network when it was a state monopolist so that now a considerable part of these network development costs are sunk. BT’s cost advantage over competing fixed networks is likely to be even larger in rural areas, where they typically do not have established networks.

Chapter 4

Interconnection regulations

4.1 In order to assess this referral by Vodafone, the Director has considered how his findings are consistent with the application of the Telecommunications (Interconnection) Regulations 1997. He has specifically considered whether;

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

4.2 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…."the physical linking of telecommunications networks used by the same or a different organisation to communicate with users of the same or another organisation, or to access services provided by another organisation."

4.3 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 stations, there is interconnection. Please see chapter 3 for a further discussion of this issue, including an analysis of BT’s views.

(ii)There is a genuine dispute

4.4 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

4.5 It is clear that the links between Vodafone’s RBS and MTX are of fundamental importance to its business; the links are an essential component of Vodafone’s network. Prior to the Director issuing the draft Direction on 24 January 2003, Vodafone provided figures to indicate a reasonable level of demand for the requested product. The figures provided by Vodafone to the Director showed that Vodafone purchased [ ] RBS backhaul circuits from BT.

4.6 As a minimum, it could be expected that all these services currently purchased as leased lines would migrate to the new wholesale product.

4.7 The Director subsequently obtained further information from the other principal mobile operators in order to assess the issues across the whole industry (please see The use of RBS backhaul circuits in chapter 3). This contained details of the different network configurations, factors that influence operators’ purchasing patterns and views on future developments.

4.8 On the basis of the above information, which also showed that there may also be similar demand from other operators for the new product, the Director remains satisfied that the request is reasonable.

(iv) The relevant market positions of the parties to the dispute

4.9 The Director’s market analysis indicates that BT has market power in the relevant markets. The details of the Director’s market analysis, including a discussion of BT's market power, are found in chapter 2 of this document. Following his publication of the draft Direction on 24 January 2003, the Director obtained information from BT and the main mobile operators which confirmed that BT is the major provider of RBS backhaul circuit links across the industry.

(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

4.10 Based on the information he received during his investigation, and referred to in (iii) above, the Director believes that his proposal will enable Vodafone to operate their network more efficiently and, in turn, offer a more cost-effective service to end-users.

(vi)Regulatory obligations imposed on the parties

4.11 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 consistent with BT’s licence obligations. Condition 69 of BT’s licence requires such products to be provided at cost oriented prices. Condition 57 requires the products to be provided on non-discriminatory terms

Chapter 5

Conclusion and issues arising from this Direction

The Direction

5.1 Having considered the evidence made available to him, the Director has concluded that BT should supply Vodafone with a wholesale variant of the existing retail product. The Direction is contained on pages 3 and 4 of this document.

5.2 The Director has identified a number of issues which are the result of BT’s SMP in the relevant market he has analysed. Excessive pricing for RBS backhaul circuits raises the costs of supplying mobile services and leads to higher prices at the retail level. It may also distort mobile operators’ choice of input and investment decisions. The Director believes this leads to an inefficient allocation of resources, and results in welfare losses to end-users. The Director believes that this Direction will remedy the problems he has identified in the upstream market for RBS backhaul circuits, and lead to a more efficient allocation of resources within the industry.

5.3 In line with the obligations on an undertaking with Significant Market Power, BT should provide the product to Vodafone at cost oriented prices, and on non-discriminatory terms.

PPCs Phase 1 and 2

5.4 The Director considers that certain principles arising from Oftel’s Phase 1 and Phase 2 PPC Directions are applicable to this dispute, including providing guaranteed levels of service through Service Level Agreements. He believes this is justified given that the product requested is technically equivalent to PPCs. The Director believes it is not necessary at this stage for him to prescribe the precise details of how issues such as SLAs, migrations and forecasting should apply for the provision of wholesale radio base station backhaul links. The Director believes that these issues are best settled through commercial negotiation.

5.5 The Director expects BT to use its best endeavours to ensure the general principles contained in previous Oftel PPC Directions apply to the provisions outlined in this Direction. This should ensure that the potential benefits accruing to Vodafone are not outweighed by unfavourable contractual terms in items such as migration charges. The Director will take further action to generate adherence to these principles as necessary.

5.6 BT has suggested that this Direction could undermine the impact of The Phase II direction on PPCs issued by the Director. The Director intended those directions to address the lack of competition for the provision of retail leased lines. The Direction issued regarding RBS backhaul circuits addresses a problem in the upstream provision. This Direction is therefore complementary, rather than contradictory to earlier Directions the Director has issued.

Future requests

5.7 Whilst this dispute concerned 2 Mbit/s RBS backhaul circuits, the Director would expect, without fettering his discretion, to come to a similar conclusion in respect of requests for similar services at most other bandwidths.

The scope of this Direction

5.8 Finally, the Director considers that this Direction does not set a precedent in relation to the broader stance of Oftel or Ofcom on the balance between infrastructure and service based competition. He considers that the issue raised is a standard interconnection dispute, albeit in a novel area, and the procedures he has followed in resolving it are consistent with his past policy and practice.