Chapter 5

Call origination

Service definition in the UK excluding the Hull Area

5.1 Call origination is the service that conveys calls originating on a customer’s exchange line from the remote concentrator to and over the local exchange.

Figure 5.1: Call origination

Service definition in the Hull Area

5.2 Call origination in the Hull Area is different from the rest of the UK. Kingston is the only provider of call origination services in the Hull Area and provides a call origination service that differs in the following ways:

• in the Hull Area there are no separate local and tandem exchanges. All exchanges are local/tandem; and

• all originated calls use a single, averaged origination service that may or may not include conveyance between the local/tandem exchanges.

Relationship between the wholesale and retail markets

5.3 As discussed in chapter 3, consideration of the relevant retail markets logically precedes the analysis of the wholesale markets, since the demand for wholesale services is derived from the demand for retail services. The call origination market is therefore defined by reference to the relevant retail call markets.

Retail market definitions

Retail product market

5.4 In order to define the relevant retail product markets, it is necessary to consider whether:

• fixed narrowband calls and Internet access are distinct from other types of calls and Internet access; and
• different fixed narrowband call types should each form distinct markets.

Fixed narrowband calls vs. other types of calls

5.5 In order to establish whether fixed narrowband calls are distinct from other types of calls, it is necessary to consider whether:

• calls and Internet access from fixed line phones are distinct from calls and Internet access from mobile phones; and
• narrowband Internet access is distinct from broadband Internet access.

Fixed vs. mobile

Demand side substitution: fixed and mobile voice

5.6 Chapter 4 discusses the issue of whether calls from mobile phones are substitutable for calls from fixed line phones and concludes that due to the current price premium on mobile calls, the two types of calls fall into separate markets.

Demand side substitution: fixed and mobile Internet access

5.7 Chapter 4 discusses the reduced functionality of Internet access on a mobile phone compared to a fixed line. In addition, the prices for Internet access over mobile networks are also generally high relative to Internet access over fixed lines. Therefore, there is no effective demand side substitutability.

Demand side substitution: fixed voice and mobile SMS

5.8 Consumer research in November 2002 (published January 2003) found that the most significant reason for using SMS over fixed voice telephony was convenience. The next most frequently cited reason was that it is generally perceived as cheaper than making fixed voice calls.

5.9 However, Oftel does not consider that SMS would constrain the pricing of fixed voice calls. SMS is an imperfect alternative to voice. Although there is some potential for rapid-fire SMS ‘conversation’, SMS does not afford sufficient opportunity for immediate conversation and interaction to be substitutable for voice calls. In addition, it is not obvious that sending a text message is a low cost alternative to a voice call (a number of exchanges of SMS messages to hold a ‘conversation’ would cost a significant amount).

5.10 Moreover, as Oftel’s consumer research found that among the most frequently cited reasons for consumers using SMS, were convenience, the fixed line being in use (either for voice or Internet access) and privacy, this would suggest that SMS is best seen as an adjunct to fixed voice telephony.

Supply side substitution: fixed and mobile

5.11 Chapter 4 concludes that there is no opportunity for supply side substitution due to the significant sunk costs involved in building both a fixed and mobile network. In addition, the lack of spectrum availability is a significant barrier to entry into the mobile market.

Conclusion: fixed and mobile

5.12 The Director considers that there are separate retail markets for voice calls and Internet access from fixed and mobile phones.

Narrowband vs. broadband

Demand side substitution: narrowband and broadband

5.13 As discussed in Chapter 4, metered Internet access users are distinguished by the fact that they tend to be low volume users of the Internet. They are also consumers who would prefer to vary their monthly payments according to their hourly usage of the Internet and therefore do not place great value on unlimited access. There is a substantial price difference between broadband and metered Internet access for a light user. In order for these services to be in the same market, there would need to be a high value placed on the increased functionality of broadband access.

5.14 Unmetered narrowband access and broadband share the feature of unlimited access to the Internet. Therefore, it is possible that customers may perceive unmetered narrowband access as a closer substitute than metered narrowband access for broadband access. However, at current price differentials, broadband is significantly more expensive than unmetered narrowband. There are, however, some unmetered narrowband users who own a second line dedicated to the Internet. This offers them the facility to use the telephone at the same time as the Internet and an almost ‘always-on’ capability. The price of the monthly rental for the second line including the monthly subscription for unmetered narrowband is comparable to the price of a broadband Internet access product. For these customers, broadband might be an effective substitute. However, it is not likely that the number of such consumers is large enough to effectively constrain the price of narrowband services.

Supply side substitution: narrowband and broadband

5.15 If a monopoly supplier of narrowband Internet access were to raise its prices, it is possible that an operator supplying wholesale broadband access could supply side substitute. A broadband operator could use its network (cable modem/DSL) but at a lower bandwidth. The higher costs of a broadband network, however, would make it uneconomic to use it to supply narrowband services due to the relatively low level of per customer revenue in the provision of narrowband services.

Conclusion: narrowband and broadband

5.16 The Director is of the view that there are separate retail markets for narrowband and broadband services.

Disaggregation of fixed narrowband call types

5.17 Having assessed whether fixed narrowband calls are distinct from mobile calls and Internet access, and broadband Internet access, it is necessary to consider whether the different types of fixed narrowband calls should each form distinct markets. This section considers whether:

• metered calls are distinct from unmetered calls;
• geographic calls are distinct from non-geographic calls;
• different non-geographic call types are distinct from each other; and
• residential calls are distinct from business calls.

Metered vs. unmetered

Demand side substitution: metered and unmetered

5.18 Both retail voice calls and retail data calls are available on a variety of tariff packages. An example for voice calls is a metered charge during the day and a flat (or free) charge during the evening and/or weekends. An example for data calls (Internet access), is a metered charge with variable monthly bills and a flat charge prepaid monthly.

5.19 On the demand side, it could be argued that a voice call made during the day is not substitutable for a call made during the evening or at weekends. This is particularly true for calls that need to be made during normal working hours, whereas for social calls, calling during the evening or at weekends may be a cheaper substitute. Therefore, the willingness of consumers to pay for daytime weekday calls and evening and weekend calls may be different. It could be argued that the provision of daytime weekday calls at a metered rate and the provision of evening and weekend calls at a flat rate take account of the different willingness to pay for the two types of calls.

5.20 A similar argument can be made with regard to Internet access calls. Recent Oftel consumer surveys suggest that substitution between metered and unmetered access is limited (see also EU Market Review: Consultation on wholesale unmetered narrowband Internet termination, March 2003). According to the November 2002 survey (published January 2003), 82 per cent of residential metered Internet customers have only ever used this mode of connection and 75 per cent of unmetered Internet customers have only ever used this type of connection. Switching from metered to unmetered tariffs has occurred to a greater extent than from unmetered to metered, which no doubt reflects the later introduction of unmetered access. As would be expected, heavier Internet users are more likely to use unmetered packages and such consumers are less likely to find a metered alternative an acceptable substitute. Similarly, metered access users are likely to be low-volume users who might find that the premium that they would have to pay for unmetered access is not justified in relation to their level of usage. It appears unlikely that the proportion of consumers who would switch between metered and unmetered is significant enough to constrain the price of each service.

5.21 There may also be a significant proportion of consumers for whom non-price factors affect their decision to use metered or unmetered access and which therefore restricts substitutability between the two. In the case of metered access, these non-price factors might include the desire to maintain flexibility of expenditure, perhaps to reflect variations in the funds available from month to month and the perception of greater value for money compared to unmetered. In the case of unmetered access, users are more likely to value the security of a constant monthly payment and the freedom to access the Internet at any time.

5.22 It does not appear that metered and unmetered calls are effective substitutes on the demand side.

Supply side substitution: metered and unmetered

5.23 A potential entrant would have to incur significant sunk and fixed costs in building a fixed narrowband network that can provide metered or unmetered calls. This is a significant barrier to entry. Potential entry cannot therefore exercise a competitive constraint on the pricing of a metered or unmetered product.

Conclusion

5.24 The Director is of the view that there are separate metered and unmetered calls markets.

Geographic vs. non-geographic calls

Demand side substitution: geographic and non-geographic

5.25 Geographic calls are calls to a specific geographic location. Non-geographic calls are made up of a number of types of calls that offer the consumer an information service or a value-added service, such as directory enquiries (DQ) service, personal numbering services (PNS) or number translation services (NTS). Calls to NTS services make up the large majority of non-geographic calls and include calls to freephone charitable helplines and premium rate information services.

5.26 As geographic and non-geographic calls provide different types of services, it is unlikely that consumers will find one an effective substitute for the other.

Supply side substitution: geographic and non-geographic

5.27 The only competitive constraint on the pricing of these calls can come from potential entry but as discussed in the earlier sections, such entrants would need to incur significant sunk costs. Therefore, they cannot competitively constrain the pricing of geographic and non-geographic calls.

Conclusion: geographic and non-geographic

5.28 The Director is of the view that there are separate retail markets for geographic and non-geographic calls.

Dissaggregation of non-geographic call types

Demand side substitution: non-geographic call types

5.29 This section broadly considers three types of non-geographic calls: DQ services; PNS; and NTS. Each call type serves a particular purpose, such as DQ services provide directory information, PNS allows the called party to be reached anywhere regardless of location, and NTS provide emergency, freephone and value added services. It could be argued, for example, that if the price of a DQ call was raised above the competitive level, customers might switch to a DQ service provided behind an NTS number. But the fact that these numbers belong to specific number ranges means that the customer would have to remember a longer number range and a different number range each time he decided to switch. From a customer’s viewpoint this may be a barrier to switching. Any demand side substitutability that might occur would therefore not be at the level that would constrain the monopolist.

Supply side substitution: non-geographic call types

5.30 As above, the fact that each non-geographic call type has its own specific number range, means that consumer’s associate certain number ranges with certain services and therefore may be reluctant to switch numbers for the same type of service. A retailer would therefore have to persuade consumers to use a different number range and that would involve significant marketing costs and pricing below the monopolist’s price for particular non-geographic numbers. This would therefore limit supply side substitutability. On the other hand, it could be argued that the wholesale input to all types of non-geographic calls is the same across all services and a retailer would only need to request an allocation of new number ranges in order to supply the substitute service. However, as discussed in Chapter 3, such supply side substitution possibilities cannot provide a constraint on a hypothetical monopolist provider of such services.

Conclusion: non-geographic call types

5.31 The Director is of the view that there are separate retail markets for non-geographic call types.

Residential vs. business

Demand side substitution: residential and business

5.32 Competitive conditions are typically not homogenous in the supply of calls to residential and business customers. Suppliers are able to separately identify residential from business customers and effectively charge different prices to each (ie via different tariffs). The ability of the suppliers to successfully price discriminate between residential and business users suggests that demand side substitution between business and residential customers is unlikely to be significant enough to undermine a price rise by a hypothetical monopolist.

Supply side substitution: residential and business

5.33 As discussed in Chapter 4, because business and residential customers tend to be in different geographical locations, the scope for supply side substitution may be limited. A provider of services to business customers would need to incur significant sunk costs to switch to provide services to residential customers and vice versa.

Conclusion

5.34 The Director considers that there are separate retail markets for residential and business calls.

Initial conclusions on the retail markets

5.35 The Director considers that fixed narrowband calls and Internet access are distinct from mobile calls and Internet access, and broadband services.

5.36 The Director also considers that there are distinct fixed narrowband calls markets for the following call types:

• metered and unmetered calls;
• geographic and non-geographic calls;
• non-geographic call types; and
• residential and business calls.

Retail geographic market

5.37 The geographic boundary of the relevant market is defined using the same approach as the product market definition, ie using the hypothetical monopolist test. The geographical market is the area within which the demand side and/or supply side substitution can take place. It is necessary to consider whether a price increase by a hypothetical monopolist in the narrowly defined area would encourage operators outside the area to begin to offer services to customers in the area and whether customers could switch to suppliers located outside the area. If supply and/or demand side substitution is feasible, then it is appropriate to expand the geographic market boundary.

5.38 BT’s charges for calls are geographically uniform with the exception of the Hull Area where BT does not have a direct access network. BT is required to set geographically uniform tariffs for analogue calls and Oftel is proposing to continue to require it to do so under its Universal Service Obligations in the new regime. Oftel considers that it is correct to include the potential effect of this regulation when defining the relevant geographic market.

5.39 BT’s uniform pricing of calls means that any response by BT to competition in a given area in the form of lower prices would apply throughout the country, excluding the Hull Area. Therefore, it is correct to define a national market excluding the Hull Area where a single national pricing constraint holds. This suggests that the geographical extent of the relevant markets should be regarded as the whole of the UK excluding the Hull Area and the Hull Area. Oftel notes that this national market exhibits local characteristics, for example in the cable franchise areas.

5.40 The only network provider in the Hull Area is Kingston. Therefore, Kingston is isolated from the competitive constraint deriving from the operation of BT’s geographical averaging described above because BT is not currently competing in the Hull Area.

Wholesale market definition

5.41 This section considers the relevant wholesale market definitions in light of the conclusions on relevant retail markets.

Wholesale product markets

Fixed narrowband call types

Demand side substitution: call types

5.42 The analysis of the retail markets concluded that at the retail level different call types are not substitutes on the demand side. This is because each call type has a different functionality (eg metered and unmetered, geographic and non-geographic) that is not perceived to be substitutable by consumers. Where different call types use different wholesale inputs (eg metered call origination and unmetered call origination), those inputs are unlikely to be viewed as effective demand side substitutes. There may be some call types where the wholesale input is the same such as for geographic and non-geographic calls. However, non-geographic calls require an additional wholesale origination input that provides suppliers of such calls with billing access to the customer. Where this is the case, such types of wholesale call origination would also not be viewed as demand side substitutes.

Supply side substitution: call types

5.43 A characteristic of fixed communications networks is the existence of significant economies of scale and scope. As any provider of call origination will seek to exploit the economies of scale and scope, it will tend to provide call origination services for a number of different call types.

5.44 This suggests that competing providers of call origination services compete for customers rather than in relation to particular services. This distinction is important because it reinforces the view that providers of call origination would compete to provide a range or basket of services across a customer’s exchange line rather than offering only limited services across many exchange lines. Such competition means customers choose the provider who can provide the range of services at the lowest price. The fact that call origination services face a common pricing constraint suggests that all call origination services should be treated as part of the same wholesale market.

Conclusion: call types

5.45 Although call origination services are not effective substitutes on the demand side, the fact that typically only one fixed provider would supply a range of call origination services to the consumer means that these services are linked by a common pricing constraint. Wholesale call origination services can therefore be considered part of one single market.

Residential vs. business

Demand side substitution: residential and business

5.46 Although residential and business customers have different demand characteristics at the retail level, the fact that wholesale charges are the same for call origination provided to competing providers regardless of whether the service is being provided to residential or business customers suggests that residential and business call origination are in the same market.

Supply side substitution: residential and business

5.47 On the supply side, since residential customers and business customers tend to be located in different geographical locations, the extent of supply side substitution, is limited. In order to compete against a supplier of origination to residential customers, a supplier of origination to business customers would need to incur significant costs and take the time to build out its network to residential customers.

Conclusion: residential and business

5.48 For the purpose of market definition, the Director considers that there is a single market for residential and business call origination.

Wholesale geographic market

5.49 BT’s charges for all types of calls are geographically uniform with the exception of the Hull Area where BT does not have a direct access network. This means that any response by BT to competition in a given area in the form of lower prices would apply throughout the country, excluding the Hull Area. This suggests that the geographical extent of the relevant markets should be regarded as the whole of the UK excluding the Hull Area and the Hull Area.

5.50 The only provider of call origination in the Hull Area is Kingston. Therefore, Kingston is isolated from the competitive constraint deriving from the operation of geographical averaging described above because BT is not present in the Hull Area.

Demand side substitution

5.51 The demand for call origination in the Hull Area is derived from retail demand for calls in the Hull Area. On the demand side, in response to an increase in the price of call origination in the Hull Area it is unlikely that consumers (and hence providers purchasing call origination) would seek to move their location to outside of the Hull Area. Therefore, a call origination product being offered in an area outside of the Hull Area would not be considered a substitute for call origination in the Hull Area.

Supply side substitution

5.52 On the supply-side, if a hypothetical monopolist were to raise the price of call origination, a provider outside the Hull Area could enter the market by investing in the appropriate infrastructure to offer a call origination. The cost of such investment is likely to be significant and involve sunk costs. Therefore, the supply of call origination from a supplier outside the Hull Area is unlikely to constrain the pricing behaviour of a hypothetical monopolist in the Hull Area.

Initial conclusions on the relevant wholesale markets

5.53 The Director is currently of the view that the relevant markets are:

• call origination on fixed public narrowband networks in the UK excluding the Hull Area; and

• call origination on fixed public narrowband networks in the Hull Area.

Forward look

5.54 the Director has considered the likelihood of competitive or technical developments that might effect the markets identified in paragraph 5.55. The Director’s view is that such developments are not currently in prospect and it is unlikely that he would consider changing the above conclusions within an 18-24 month period.

Relationship between this market definition and the Commission’s Recommendation

5.55 In Chapter 4, it has already been explained what the Director must do before making a market determination and that he must take due account of the European Commission’s SMP Guidelines and Recommendation.

5.56 The European Commission has, in its Recommendation, defined the following as a relevant market in accordance with Article 15(3) of the Framework Directive:

"Call origination on the public telephone network provided at a fixed location. For the purposes of this Recommendation, call origination is taken to include local call conveyance and delineated in such a way as to be consistent with the delineated boundaries for the markets for call transit and for call termination on the public telephone network provided at a fixed location".

5.57 The Director has given careful consideration to that definition of the relevant market. However, he proposes a different market definition to that in the Recommendation.

5.58 The European Commission in its Recommendation has identified a single market that includes call origination and local-tandem conveyance (LTC) and local-tandem transit (LTT). The Director considers that it is necessary to define separately the call origination market and the LTC and LTT market because he is of the view there are different competitive conditions present in each of the markets in the UK. The local exchange is the closest point to an end user that operators can connect to in a network. By connecting at the local exchange, operators are able to provide LTC or LTT themselves. Therefore, in the LTC and LTT market, there is the potential for competition from both alternative direct access networks and those operators connecting to other networks and providing LTC or LTT themselves. The only competition in call origination is from alternative direct access networks and the potential for competition is therefore much more limited.

Assessment of market power in the UK excluding the Hull Area

Assessment of SMP against the relevant criteria

5.59 The following analysis provides an assessment of SMP in the provision of call origination on fixed narrowband telecommunications networks in the UK excluding the Hull Area against Oftel’s published SMP criteria. The Director is of the view that the key criteria are market shares and ease of market entry.

Market share

5.60 As explained in chapter 4, a market share over 50 per cent leads to a presumption of dominance.

5.61 Although BT faces competition in call origination from other providers of direct access networks, its market share in call origination is greatly in excess of those of its competitors. Oftel estimates BT's current market share for call origination by volume to be around 75 per cent across all customers or 82 per cent for residential customers over the last three years (this is shown in the table below). Market shares by revenue are not available.

5.62 This market share information includes volumes of call origination services supplied to indirect access (IA) providers and carrier pre-selection (CPS) providers (suppliers of voice calls who do not own their own direct access networks). Those providers providing IA and CPS to customers with lines from BT have to purchase call origination from BT, and hence including such volumes provides BT’s total market share. Table 5.1 illustrates the trends in BT’s market share over the last three years.

Table 5.1: BT’s share of call origination minutes

Source: Oftel Market Information

5.63 BT’s overall market share has generally been stable over the last three years. For residential customers, however, BT’s share has increased over this period by three percentage points. This corresponds to the reduction in the share of cable providers. One of the possible reasons why this has occurred is that BT has been actively competing in this market with significant reduction in its retail prices over this period and bundling retail calls with other services such as access, Internet access, mobile access and satellite television. Although cable providers have traditionally offered retail calls, television and Internet access as a package, their networks do not cover the whole of the UK.

5.64 BT's share of business call origination has reduced by five percentage points over the three year period. This is likely to be due to competition from non-cable, direct access providers.

5.65 The market share information creates a presumption that BT has SMP in the wholesale call origination market. The existence of SMP is confirmed by consideration of the limited number of competitors that exist and the extent of barriers to entry faced by potential entrants.

Ease of market entry

5.66 One of the most important types of entry barrier is that of sunk costs. A potential entrant will only incur the sunk costs of investment if it expects to recover the sunk costs as well as the ‘avoidable costs’ of production (i.e. the costs that the provider would avoid if it were to stop the activity with the costs incurred). The incumbent, on the other hand, has already made its investment and so will stay in the market as long as it can cover its avoidable costs. The incumbent may then be able to exploit this asymmetry by signalling to the entrant that, if it were to enter the market, prices would be too low for the competitor to recover its sunk costs and entry would then be deterred.

5.67 Substantial barriers to entry are faced by new entrants, especially in building direct access networks for residential customers, who are spread over a larger geographic area. As a result, competing providers have tended to build their networks in densely populated areas like bigger towns and cities, which allows the costs to be recoverable over a larger base of consumers in a single area.

Economies of scale

5.68 There are significant economies of scale (density) that characterise communications networks. This means that total costs can be minimised at large levels of volume. Therefore, for an entrant to compete effectively with a large incumbent, it would need to obtain a large share of the market. Generally, the networks of alternative providers to BT are smaller and less likely to be able to take advantage of economies of scale (density).

Absence of or low countervailing buyer power

5.69 BT’s retail activities make it the largest purchaser of call origination and therefore BT is the only provider that theoretically would be able to exert countervailing buyer power in the purchase of call origination services. However, it is unlikely to use this power to constrain its own prices and thus reduce its revenues. Therefore, there is little or no countervailing buyer power in this market.

Easy or privileged access to capital markets/financial resources

5.70 BT is a large and well-established company with a long track record and a relatively diversified business and is perceived to have stable cash flows. It has a strong credit rating and investors are likely to view it a less risky proposition than relatively newer entrants. It is therefore likely that BT would face lower borrowing premiums than its competitors.

Switching costs

5.71 Providers have indicated in their responses to the information request for this review, that they could incur significant costs in switching suppliers of call origination. In general, these costs relate to supplying the call origination provider with routing tables for call numbers. Establishing contracts with a new supplier also carries with it the risk of creditworthiness of the supplier, lack of information on resilience and reliability of transmission. If a provider relies on a number of companies to originate its calls, then this adds additional levels of complexity and significant costs.

Initial conclusion on significant market power in the UK excluding the Hull Area

5.72 The Director is of the view that BT has SMP in the market for call origination on fixed narrowband networks in the United Kingdom excluding the Hull Area.

Forward look

5.73 Due to the significant entry barriers in call origination, it is unlikely that new providers would enter in a significant manner to reduce BT's level of SMP. Oftel is also of the view that the cable companies are unlikely to further rollout their networks in the immediate future. It does not, therefore, appear likely that there will be any developments that will affect the finding of SMP within the next 18 to 24 months.

Assessment of market power in the Hull Area

Assessment of SMP against the relevant criteria

5.74 The following analysis provides an assessment of SMP in the provision of call origination on fixed narrowband telecommunications networks in the Hull Area against Oftel’s published SMP criteria. The Director is of the view that the key criteria are market shares and ease of market entry.

Market shares

5.75 There has been some entry into this market from competing providers using leased line tails and radio links. However, this entry has been limited and Oftel considers Kingston to have a near 100 per cent market share in the call origination market in the Hull Area. This leads to a presumption of dominance.

Ease of market entry

5.76 The barriers to entry in the call origination market in the Hull Area are similar to those in the call origination market in the rest of the UK. A major entry barrier is sunk costs. To enter this market in any significant way would require substantial build of a direct access network to premises in the Hull Area. Where the recovery of the investment needed for such build is uncertain, it would deter entry as explained above. In addition, the Hull area is of a smaller size and market volumes are lower than the rest of the UK. This exacerbates the problem of cost recovery of investment for a new entrant when compared to the incumbent.

Absence of or low countervailing buyer power

5.77 Kingston as the largest purchaser of call origination, is the only provider that theoretically would be able to exert countervailing buyer power in the purchase of call origination services. However, it is unlikely to use this power to constrain its own prices and thus reduce its revenues. Therefore, there is little or no countervailing buyer power in this market.

Switching costs

5.78 There could be significant costs involved in switching. In general, these costs relate to supplying the call origination provider with routing tables for call numbers. Establishing contracts with a new supplier also carries with it the risk of creditworthiness of the supplier, lack of information on resilience and reliability of transmission. If a provider relies on a number of companies to originate its calls, then this adds additional levels of complexity and significant costs.

Forward look

5.79 Due to the significant entry barriers in call origination, it is unlikely that new providers would enter in a significant manner to reduce Kingston’s level of SMP. It does not, therefore, appear likely that there will be any developments that will affect the finding of SMP within the next 18 to 24 months.

Initial conclusions on significant market power

5.80 For the reasons set out above, the Director is of the view that BT has SMP in the market for call origination on fixed public narrowband networks in the UK excluding the Hull Area.

5.82 For the reasons set out above, the Director is also of the view that Kingston has SMP in the market for call origination on fixed public narrowband networks in the Hull Area.

 Chapter 6

Local-tandem conveyance and transit

Service definitions

Local-tandem conveyance

6.1 Local-tandem conveyance (LTC) is the service that an originating or terminating operator provides to convey calls between a local exchange and a tandem exchange.

Figure 6.1: LTC I

 Figure 6.2: LTC II

 Local-tandem transit

6.2 Local-tandem transit (LTT) is a service a transit operator provides to convey calls between the local exchange of one operator and the tandem exchange of another operator.

Figure 6.3: LTT

Market definition

Product market

Local-tandem conveyance and local-tandem transit substitution

Demand side

6.3 If a hypothetical monopolist supplier raised the price of LTC, an operator purchasing LTC could switch to purchasing LTT if the cost of the two services were similar. Both services involve the cost of transmission of traffic and the switching cost at the tandem exchange. However, LTT is likely to involve the costs of extra switching (which will be passed through to the LTT purchaser) and/or extra interconnect links, as the call will be conveyed through an additional transit operator. These costs are likely to be less significant for operators with significant volumes of traffic and therefore operators with large volumes of traffic could constrain the price of LTC.

6.4 In the event of a hypothetical monopolist supplier raising the price of LTT services, an originating operator could switch to purchasing LTC from the terminating operator or could itself build out to the local exchange of the terminating operator and self-provide LTC. This level of investment would only be justified at large volumes of traffic.

Supply side

6.5 If an originating or terminating operator provides LTC, it would be able to provide LTT if it was connected to a second operator so that the call only transits its network and originates and terminates on the other two networks. As already stated above, LTT is likely to involve extra costs as a result of additional switching and/or interconnect links but these costs are likely to be less significant for operators with significant volumes of traffic.

6.6 An operator providing LTT services could easily provide LTC for calls that originate and terminate on its network.

Conclusion

6.7 The Director considers that LTC and LTT services are in the same market.

Geographic market

6.8 The geographic boundary of the relevant market is defined using the same approach as the product market definition ie using the hypothetical monopolist test. The geographical market is the area within which demand side and/or supply side substitution can take place. It is necessary to consider whether a price increase by a hypothetical monopolist in the narrowly defined area would encourage operators outside the area to begin to offer services to customers in the area and whether customers could switch to suppliers located outside the area. If supply and/or demand-side substitution is feasible then it is appropriate to expand the geographic market boundary.

6.9 BT currently sets geographically uniform prices for LTC in all areas, except for the Hull Area where BT does not have a direct access network. BT’s uniform prices mean that any response by BT to competition in a given area in the form of lower prices would apply throughout the country, excluding the Hull Area. This suggests that the geographical extent of the relevant markets should be regarded as the whole of the UK excluding the Hull Area and the Hull Area. Therefore, it is correct to define a national market excluding the Hull Area where a single national pricing constraint holds.

6.10 The only network provider in the Hull Area is Kingston. Therefore, Kingston is isolated from the competitive constraint deriving from the operation of BT’s geographical averaging described above because BT is not currently competing in the Hull Area. The product market in the Hull Area is different from the rest of the UK and Kingston does not provide an LTC or LTT service. The product market in the Hull Area has been explained in Chapter 5.

Initial conclusions on the relevant market

6.11 The Director considers that the relevant market be defined as the market for LTC and LTT on fixed public narrowband networks in the UK excluding the Hull Area.

Forward look

6.12 The Director has considered the likelihood of competitive or technical developments that might effect the market definition in paragraph 6.11. The Director’s view is that such developments are not currently in prospect and it is unlikely that he would consider changing the above conclusions within an 18-24 month period.

Relationship between this market definition and the Commission’s Recommendation

6.13 In Chapter 4, it has already been explained what the Director must do before making a market determination and that he must take due account of the European Commission’s SMP Guidelines and Recommendation.

6.14 The European Commission has, in its Recommendation, defined the following as a relevant market in accordance with Article 15(3) of the Framework Directive:

"Call origination on the public telephone network provided at a fixed location. For the purposes of this Recommendation, call origination is taken to include local call conveyance and delineated in such a way as to be consistent with the delineated boundaries for the markets for call transit and for call termination on the public telephone network provided at a fixed location".

6.15 The Director has given careful consideration to that definition of the relevant market. However, he proposes a different market definition to that in the Recommendation.

6.16 The European Commission has identified a single market that includes both call origination and LTT and LTC. The Director considers that it is necessary to separately define the call origination market and the LTC and LTT market, because there are different competitive conditions present in each of the markets in the UK. The local exchange is the closest point to an end user that operators can connect to in a network. By connecting at the local exchange, operators are able to provide LTC or LTT themselves. Therefore, in the LTC and LTT market, there is the potential for competition from both alternative direct access networks and those operators connecting to other networks and providing LTC or LTT themselves. Indeed, the distinction is important because, in the UK, it has been observed that operators are building their networks to the local exchange, making competition possible in the provision of LTC and LTT. As discussed above in Chapter 5, the only competition in call origination is from alternative direct access networks and competition is therefore much more limited.

Assessment of market power

6.17 This section assesses competition in the provision of LTC and LTT on fixed public narrowband networks in the UK excluding the Hull Area.

Assessment of SMP against the relevant criteria

6.18 The analysis below provides an assessment of SMP in the LTC and LTT market against Oftel’s published SMP criteria. The key criteria are market shares, ease of market entry and economies of scale.

Market shares

6.19 As explained in chapter 4, a market share over 50 per cent leads to a presumption of dominance.

6.20 Oftel estimates BT’s market share of the LTC and LTT market to be in the region of 55 per cent of total LTC and LTT call minutes. BT has provided the percentage of originating and terminating call minutes for which it provides LTC. These percentages have been applied to BT’s total share of the originating and terminating markets to derive BT’s share of the total LTC and LTT market. These calculations have assumed that all originating calls have an equivalent LTC or LTT segment.

6.21 The difference between BT’s call origination market share and its market share for LTC and LTT is accounted for by the FRIACO traffic that is taken off at BT’s local exchanges, for which BT does not provide LTC. FRIACO traffic, which is BT originated, is groomed off at the local exchanges for onward conveyance on IP networks. FRIACO traffic currently accounts for approximately a quarter of BT originating traffic.

6.22 BT’s market share indicates that BT has market power in the provision of LTC and LTT services.

Ease of market entry

6.23 There are two ways in which operators can provide LTC or LTT in competition with BT: either on their own direct access network or by connecting at BT’s local exchange and providing LTC or LTT for BT originating calls. As discussed in chapters 4 and 5, there are considerable barriers to entry in providing an alternative direct access network.

6.24 There are operators that connect to BT’s local exchanges and provide LTC for calls that originate on BT’s network and terminate on their own networks. However, the majority of operators do not connect at the local exchange and have to purchase LTC from BT to convey the call to the tandem exchange where they are more likely to be connected. There are, at present, 746 BT local exchanges and only three operators connect to more than 500 local exchanges, whilst nine operators connect to more than 100 of them. Many of these connections are for data traffic.

6.25 The capital costs of building out to BT’s local exchanges are significant. It may be commercially appropriate to connect to some local exchanges where the volume of traffic justifies it, but in most cases the volume of traffic to any one local exchange is quite small. Very few operators have actually built out their own networks to BT’s local exchanges and many only do so only where these local exchanges are co-located with BT tandem exchanges, or where they can interconnect using Interconnect Extension Circuits (IECs). Over long distances and smaller volumes of traffic, the cost of IECs is considerable in relation to the margins operators can expect to make.

6.26 Operators consider that purchasers of wholesale services (eg indirect access providers and Internet service providers) would require traffic to be delivered to all parts of the UK and that they would therefore need to provide a national service in order to compete with BT. To be able to do so, operators would need to connect to between 80 per cent and 100 per cent of BT’s local exchanges. Building out to such a high number of local exchanges where there may be potentially low volumes of traffic is a considerable barrier to entering this market.

6.27 One operator has also made the point that, unless an operator has full connectivity to all BT local exchanges, sophisticated billing systems would be necessary to distinguish between calls delivered to local exchanges and those delivered to tandem exchanges.

Economies of scale

6.28 There are significant economies of scale that characterise communications networks. This means that total costs can be minimised at large levels of volume. Therefore for an entrant to compete effectively with a large incumbent, it would need to obtain a large share of the market. Generally, the networks of alternative providers to BT are smaller and less likely to be able to take advantage of economies of scale.

Overall size of the undertaking

6.29 BT’s network is ubiquitous, spread over approximately 8,000 local exchange concentrators and 746 local exchange processors. A fully meshed national network of 106 tandem exchanges provides national connectivity. It has the majority of exchange lines to retail consumers in the UK and 77 per cent of calls originate on its network. A significant number of these calls are BT to BT calls where the call does not leave BT’s network and BT provides all the wholesale conveyance services necessary to convey the call, including LTC.

6.30 BT’s size and ubiquity are key factors in BT’s continuing level of market power in the LTC and LTT market.

Absence of or low countervailing buyer power

6.31 BT’s retail activities make it the largest purchaser of LTC services and therefore BT is the only provider that theoretically would be able to exert countervailing buyer power in the purchase of call origination services. However, it is unlikely to use this power to constrain its own prices and thus reduce its revenues. Therefore, there can little or no countervailing buyer power in this market.

Easy or privileged access to capital markets/financial resources

6.32 Different types of operators might compete in the market for LTC. These may be operators who do not own a direct access network but are backbone operators providing transit and conveyance services. The difficulties discussed under the ease of market entry and economies of scale criteria may make it harder to justify offering a commercially viable LTC or LTT service in competition with BT and therefore such operators may face higher borrowing costs than BT.

Product/services diversification (eg bundled products or services)

6.33 Although there are entry barriers in both call origination and LTC, there is more potential for competition in the LTC and LTT markets as operators build out to BT’s local exchanges. However, many operators still purchase both call origination and LTC from BT. BT, therefore, has the ability to bundle call origination and LTC services in such a way as to create entry barriers in the LTC segment and foreclose the market to other competitors.

Forward look

6.34 Oftel has considered developments in this market, such as continuing growth of FRIACO traffic and the provision of an LTT service, however, it does not appear likely that there will be any developments that will affect the finding of SMP within the next 18 to 24 months.

Initial conclusions on significant market power

6.35 For the reasons set out above, the Director is of the view that BT has SMP in the provision of LTC and LTT on fixed public narrowband networks in the UK excluding the Hull Area.

Chapter 7

wholesale transit services

7.1 There are three services, based upon the configuration of BT’s network, that could broadly be categorised as transit:

• inter-tandem conveyance;
• inter-tandem transit; and
• single transit.

Service definitions

Inter-tandem conveyance

7.2 Inter-tandem conveyance (ITC) is the service an originating or terminating operator provides to convey calls from one of its tandem exchanges to another. It also includes the conveyance of calls between a tandem exchange and a specific type of tandem exchange called an International Switching Centre (ISC) for international calls.

Figure 7.1: ITC provided by an originating operator

figure 7.2: ITC provided by terminating operator

Inter-tandem transit

7.3 Inter-tandem transit (ITT) is the service an operator provides to convey calls between its tandem exchanges when a call originates and terminates on networks other than its own.

Figure 7.3: ITT

7.4 The main difference between ITC and ITT is the number of exchanges that are used for each service. ITC is only ever included as part of a call origination or termination service and therefore it only includes the use of a single transit exchange. The use of the other exchange is included in the LTC charge. ITT is never included as part of an origination or termination service and therefore it includes the use of both tandem exchanges.

Single transit

7.5 Single transit is the service an operator provides when a call originates and terminates on networks other than its own and the originating and terminating operators are directly connected at the same transit operator’s tandem exchange. The call is therefore transited through a single tandem exchange.

Figure 7.4: Single transit

Market definition

Product market

ITT and ITC substitution

Demand side

7.6 If a monopolist supplier of ITT increased its price, an originating operator could switch to purchasing ITC from the terminating operator or provide ITC itself. In order to do either, there must be a connection (through an interconnect link) present between the terminating and originating operator. It is quite likely that an ITT supplier was initially chosen because such a connection was not present. The economic viability of building interconnect links between two operators is dependent on the volume of traffic that is expected to flow between them. At large volumes of traffic, this cost would be justified and ITC could act as a constraint on the pricing of ITT services. As ITC involves one less switching stage, it is likely to be cheaper than ITT over the same distance and traffic volumes.

7.7 If a monopolist supplier of ITC (eg the terminating operator) increased its price, an originating operator could switch to purchasing ITT if a transit operator was directly connected to both itself and the terminating operator. However, as ITT involves an additional switching stage, ITT involves higher costs (that are likely to be passed through to the ITT purchaser) for the same distance and traffic volumes. These costs may not be significant over longer distances.

7.8 ITT is an effective substitute for ITC if it allows a small operator to gain access to the economies of scale of a large operator. Consider, for example, a call originating on operator X’s network in London, and terminating on operator Y’s network in Edinburgh. These operators might interconnect directly, in which case one of them will provide the ITC service. However, the cost of building a link from London to Edinburgh may be too high for the volume of traffic. Therefore, it may be cheaper to buy ITT from a larger operator, such as BT, who is present at those exchanges. In this case, economies of scale offset to a degree the costs associated with the additional switching stage.

Supply side

7.9 To understand if an operator supplying ITC services could supply substitute in the event of a monopoly supplier of ITT services raising its price, it is useful to consider an example. Assuming a monopolist was providing ITT for the transmission of traffic between operators Y and Z, if an originating operator X was providing ITC to operators Y and Z at different tandem exchanges, it would also be in a position to provide ITT between those tandem exchanges for traffic between Y and Z, see Figure 7.5.

Figure 7.5

ITT provided by monopolist

7.10 It is likely that an operator who provides ITC to several other operators has an extensive interconnected tandem network that would make such substitution feasible. Even if operators had no direct connections between the relevant tandem exchanges at which they provide ITC, they could always provide transit through an indirect routing system. Such an indirect routing system may be less efficient than a direct connection, but the costs associated with this lower efficiency are not likely to be significant. Supply side substitution is therefore dependent on an operator having a number of direct connections with other operators. If an operator is already providing ITC to a number of different operators, connections will be in place to provide ITT between those operators.

7.11 Alternatively, in response to a rise in price of ITT, the originating operator purchasing ITT could decide to provide ITC itself, if the cost of building a direct connection with the terminating operator was justified by the volume of traffic.

Conclusion

7.12 The Director is of the view that the terms of competition in both ITT and ITC services are such that each service provides a competitive constraint on the pricing of the other. Therefore ITT and ITC services are part of the same market.

Single transit and ITT/ITC services

7.13 The difference between ITT/ITC and single transit is that, while in the former the transit operator needs to be connected to the originating and terminating operator at different tandem exchanges, in the latter it needs to be connected to both at the same tandem exchange. In the case of single transit, traffic between the originating and terminating operators therefore transits at a single exchange.

7.14 ITT and ITC are essentially transmission services, whereas single transit is a ‘connection’ service that connects two operators who are not directly connected. Single transit is generally used where there are insufficient incentives to establish a direct connection between two operators.

Demand side

7.15 If a hypothetical monopolist increased the price of ITT/ITC, an originating operator purchasing these services could switch to purchasing single transit from a transit operator if it was connected to the same tandem exchange of the transit operator as the terminating operator. Single transit is therefore not only dependent on the originating operator being connected to the transit operator but also on the terminating operator being connected to the transit operator at the same tandem exchange. Single transit therefore requires a much higher level of connectivity than ITT/ITC. The costs of establishing this level of connectivity are significant, especially for small operators with limited traffic. Given current rates of build out, it is unlikely that operators will create a level of interconnection that will allow buyers of ITT/ITC to substitute to purchasing single transit.

7.16 If a hypothetical monopolist were to increase the price of single transit, operators could not easily substitute to purchasing ITT/ITC because this would require both the operators to have connections to a transit operator at different exchanges. Although in practice many operators are connected to transit operators at different tandem exchanges, establishing new interconnections would come at significant cost.

Supply side

7.17 Any operator who successfully offered a single transit service would be connected to many operators at several tandem exchanges. Therefore, it should be able to supply side substitute and offer an ITT service between two operators.

7.18 An operator currently offering ITT/ITC services would need a much higher level of connectivity with other operators to supply substitute to offer single transit services. This would require significant investment and build to a large number of other operators’ tandem exchanges. Therefore, it is unlikely that a provider of ITT/ITC would be able to supply substitute in a way that constrained the prices of a hypothetical monopolist.

Conclusion

7.19 The Director is of the view that single transit is in a separate market to the ITT/ITC market.

Geographic market

7.20 The geographic boundary of the relevant market is defined using the same approach as the product market definition, i.e. using the hypothetical monopolist test. The geographical market is the area within which the demand side and/or supply side substitution can take place. It is necessary to consider whether a price increase by a hypothetical monopolist in the narrowly defined area would encourage operators outside the area to begin to offer services to customers in the area and whether customers could switch to suppliers located outside the area. If supply and/or demand side substitution is feasible then it is appropriate to expand the geographic market boundary.

7.21 BT currently sets geographically uniform prices for ITC, ITT and single transit services in all areas, except for the Hull Area where it currently does not have a network. BT’s uniform prices mean that any response by BT to competition in a given area in the form of lower prices would apply throughout the country, excluding the Hull Area. This suggests that the geographical extent of the relevant markets should be regarded as the whole of the UK excluding the Hull Area and the Hull Area. Therefore, it is correct to define a national market excluding the Hull Area where a single national pricing constraint holds.

7.22 The only network provider in the Hull Area is Kingston. Therefore, Kingston is isolated from the competitive constraint deriving from the operation of geographical averaging described above because BT is not present in the Hull Area. The product market in the Hull Area is different from the rest of the UK and Kingston does not provide ITC, ITT or single transit services. The product market in the Hull Area has been explained in chapter 5.

Initial conclusions on the relevant market

7.23 The Director considers that the relevant markets should be defined as:

• inter-tandem conveyance and transit on fixed public narrowband networks in the UK excluding the Hull Area; and
• single transit on fixed public narrowband networks in the UK excluding the Hull Area.

Forward look

7.24 The Director has considered the likelihood of competitive or technical developments that might effect the markets identified in paragraph 7.23. The Director’s view is that such developments are not currently in prospect and it is unlikely that he would consider changing the above conclusions within an 18-24 month period.

Relationship between this market definition and the Commission’s Recommendation

7.25 In chapter 4, it has already been explained what the Director must do before making a market determination and that he must take due account of the European Commission’s SMP Guidelines and Recommendation.

7.26 The European Commission has, in its Recommendation, defined the following as a relevant market in accordance with Article 15(3) of the Framework Directive:

"Transit services in the fixed public telephone network. For the purposes of this Recommendation, transit services are taken as being delineated in such a way as to be consistent with the delineated boundaries for the markets for call origination and for call termination on the public telephone network provided at a fixed location"

7.27 The Director has given careful consideration to that definition of the relevant market. However, he proposes a different market definition to that in the Recommendation.

7.28 The European Commission has identified a single market that includes all transit services. The Director considers that it is necessary to separately define the ITC/ITT market and the single transit market, because he is of the view that different competitive conditions are present in the supply of these services in the UK. Competitive conditions differ in these two markets because entry barriers are much higher in the single transit market due to the high level of connectivity necessary to supply single transit services. These points are discussed in more detail in paragraphs 7.15 to 7.16 above and paragraph 7.55 below.

ITT/ITC assessment of market power

7.29 This section assesses competition in the provision of ITC and ITT on fixed narrowband networks in the United Kingdom excluding the Hull Area.

Assessment of SMP against the relevant criteria

7.30 The analysis below provides an assessment of SMP in the ITC and ITT market against Oftel’s published SMP criteria.

Market shares

7.31 As explained in chapter 4, a market share over 50 per cent leads to a presumption of dominance. There may still be concerns about dominance where an undertaking has less than 40 per cent, depending on the size of market share relative to that of its competitors.

7.32 Calculation of market shares in the ITC and ITT market is a difficult exercise since there is no published information on total market volumes. Oftel has therefore had to rely on industry players to provide the relevant data on the extent of conveyance and transit they purchase or provide. However, not all operators have responded to Oftel’s information request and hence, it has been difficult to calculate market volumes. In seeking to discuss market shares, Oftel has taken the view that the volumes carried by the smaller operators are likely to be insignificant when compared to those of the larger operators.

7.33 Due to the manner in which respondents have provided information and the non-availability of total market volumes, it may be relevant to consider the possible market share for the relevant services singly to identify if any conclusion can be drawn on the total market shares.

7.34 Only four other operators apart from BT have provided information on the volumes of ITT that they provide. The resulting market shares of these operators are shown in figure 7.6. BT clearly has the largest market share.

Figure 7.6: Market shares for ITT

Source: Data provided by operators

7.36 The ITT portion of the market is significantly smaller than the ITC portion. BT only uses ITC for its own originating calls. It also provides over double the volumes of ITC than ITT for other providers’ calls. This means that BT’s market share in the ITC/ITT market would be higher than its share in ITT and this leads to a presumption that BT has SMP in the provision of ITC/ITT.

7.37 Market shares, however, are not the sole determinant of market power. As will be seen in the following discussion, there are other criteria that contribute to the findings of SMP in the market.

Ease of market entry

7.38 There are fewer entry barriers in the market for inter-tandem transit and conveyance compared to the LTC and LTT market. This is because there are fewer of BT’s tandem exchanges (at present, 106 tandem exchanges compared to 746 local exchanges) to which operators have to connect to.

7.39 There are a number of operators with a high level of connectivity to BT’s tandem exchanges. Twelve operators connect to more than 50 tandem exchanges, and nineteen operators connect to more than 30 such exchanges. These operators have typically built out to those tandem exchanges for the transmission of their own traffic in order to self-provide ITC rather than purchasing it from BT. With connections in place at many exchanges, some of the bigger operators are in a position to provide ITT services to other operators. However, this would still involve establishing direct connections with these other operators that would mean significant investment and only commercially viable where there is sufficient flow of traffic between the two operators.

7.40 The barriers to entry are higher in establishing direct connections with operators other than BT. Achieving sufficiently high volumes to justify the capital investment is in practice inhibited by the fact that BT originates and terminates the largest volume of calls. Therefore, most traffic will flow to and from BT’s network and not between other operators’ networks.

7.41 Although there is some competition in the market, it does not appear to be at the level where it has constrained BT’s prices to its cost. BT’s Regulatory Accounts show that the margin between BT’s costs and prices has increased between 1997/98 and 2000/01. The lack of pressure on BT’s prices may also be due to purchasers of a number of interconnection services preferring to use BT through a standard contract for interconnection rather than have a number of contracts with different transit operators. This provides further incentive for BT to maintain its high prices, without the risk of losing significant market share. These factors further indicate that BT has SMP in the provision of ITT/ITC.

Economies of scale

7.42 It is the ability to exploit economies of scale in providing ITC or ITT that make supply side or demand side substitution feasible. For operators to exploit economies of scale, they must be able to achieve a high utilisation of their interconnect links which is only possible with large volumes of traffic.

7.43 Apart from a few large operators, most operators that are present at the tandem exchanges are of smaller size and carry smaller volumes of traffic. Therefore, they cannot benefit from the same economies of scale as BT. Due to the significant sunk costs involved, even the larger operators are unable to match the size of BT’s tandem network. In order to compete with BT on price they would need to have sufficient scale to bring their overall costs below that of BT.

Overall size of the undertaking

7.44 BT’s network is ubiquitous, spread over approximately 8,000 local exchange concentrators and 746 local exchange processors. A fully meshed national network of 106 tandem exchanges provides national connectivity. It has the majority of exchange lines to retail consumers in the UK and 77 per cent of calls originate on its network. A significant number of these calls are BT to BT calls where the call does not leave BT’s network and BT provides all the wholesale conveyance services necessary to convey the call, such as LTC and ITC.

7.45 BT’s size and ubiquity is a key factor in BT’s continuing level of market power in the ITC and ITT market.

Absence of or low countervailing buyer power

7.46 BT’s retail activities make it the largest purchaser of services in the ITC and ITT market and therefore BT is the only provider that theoretically would be able to exert countervailing buyer power in the purchase of call origination services. However, it is unlikely to use this power to constrain its own prices and thus reduce its revenues. Therefore, there can be little or no countervailing buyer power in this market.

Easy or privileged access to capital markets/financial resources

7.47 BT is a large and well-established company with a long track record and a relatively diversified business and is perceived to have stable cash flows. It has a strong credit rating and investors are likely to view it a less riskier proposition than the relatively newer entrants. It is therefore likely that BT would face lower borrowing premiums than its competitors.

Product/services diversification (eg. bundled products or services)

7.48 ITT/ITC services are more competitive than call origination or LTC services. Many smaller operators continue to purchase call origination and LTC from BT. This provides BT with the ability to bundle call origination, LTC and ITT/ITC services in such a way as to make it difficult for competitors to compete in the provision of ITT/ITC. BT could provide the ITT/ITC services at a very low price, if it was purchased as part of a bundle along with call origination and LTC. This low price would deter many operators who wished to compete successfully in the market.

Switching costs

7.49 Operators in their response to Oftel’s information request for this review have mentioned switching costs in relation to ITC and ITT. Establishing contracts with a new supplier carries with it the risk of creditworthiness of the supplier, lack of information on resilience and reliability of transmission. In addition, in cases where an operator cannot offer national coverage there will be additional costs associated with the requirement to purchase transit services from a number of operators.

Forward look

7.50 The Director expects competition to develop in this market in two ways: firstly, with other operators building out to more tandem exchanges and being able to substitute BT services with their own or a third party purchase; and secondly, as competition in the retail market develops, this will further open up the market. However, the Director does not consider that these developments will affect the finding of SMP within the next 18 to 24 months.

Initial conclusions on significant market power

7.51 For the reasons set out above, the Director is of the view that BT has SMP in the provision of inter-tandem conveyance and transit on fixed public narrowband networks in the UK excluding the Hull Area.

Single Transit assessment of market power

7.52 This section assesses competition in the provision of single transit on fixed narrowband networks in the United Kingdom excluding the Hull Area.

Assessment of SMP against the relevant criteria

7.53 The analysis below provides an assessment of SMP in the single transit market against Oftel’s published SMP criteria.

Market shares

7.54 BT is the only operator that provides single transit to any notable extent. Oftel considers BT to have a near 100 per cent market share of the single transit market.

Ease of market entry

7.55 In order to provide a single transit service, an operator has to be connected to both the originating and terminating operators at a single tandem exchange. This requires a higher level of connectivity than ITC or ITT services. It is Oftel’s view that most operators only have a Point of Presence at BT’s tandem exchanges and are physically located further away from the exchange. Therefore, the establishment of connections with operators other than BT will require building further interconnect links. As already discussed above, establishing direct connections with operators other than BT is only commercially viable where there is sufficient flow of traffic between the two operators. Achieving sufficiently high volumes is in practice inhibited by the fact that BT originates and terminates the largest volume of calls. Therefore, most traffic will flow to and from BT’s network and not between other operators’ networks.

7.56 The low volume of calls over which investment costs can be recovered is a substantial barrier to entering the single transit market.

Economies of scale

7.57 As argued above, establishing direct connections with many operators is only justified where there is sufficient traffic flowing between two operators. Therefore economies of scale are very important to commercially justify offering a single transit service. Since BT appears to be the only operator offering single transit, it is able to exploit the economies of scale present in offering the service. BT’s regulatory accounts show that the fully allocated costs of providing single transit have fallen by 42 per cent from 1997/98 to 2000/01. BT’s prices (which are currently regulated) are very close to its cost. As discussed above, because of BT’s share of originating traffic, it is not likely that any other operator will be able to achieve the same volumes and hence the average costs that BT has. BT is, therefore, likely to have enduring SMP in the market for single transit.

Overall size of the undertaking

7.58 BT is the operator with the largest network. It has the majority of access lines to retail consumers in the UK and most calls originate and terminate on its network. As a result, most operators have to connect to its network and it therefore has a high level of connectivity with all operators. It is this level of connectivity that enables BT to provide single transit services.

7.59 BT’s size and ubiquity, is a key factor in BT’s continuing level of market power in the single transit.

Easy or privileged access to capital markets/financial resources

7.60 BT is a large and well-established company with a long track record and a relatively diversified business and is perceived to have stable cash flows. It has a strong credit rating and investors are likely to view it a less risky proposition than relatively newer entrants. It is therefore likely that BT would face lower borrowing premiums than its competitors.

Switching costs

7.61 Operators are unable to switch their provider of single transit as only BT currently provides this service. However, establishing contracts with a new supplier carries with the risk of creditworthiness of the supplier, lack of information on resilience and reliability of transmission. In addition, in cases where an operator cannot offer national coverage there will be additional costs associated with the requirement to purchase single transit services from a number of operators.

Forward look

7.62 Given the nature of large investments in communications infrastructure and the general recession in global communications markets, it does not appear likely that there will be any developments that will affect the finding of SMP within the next 18 to 24 months.

Initial conclusions on significant market power

7.63 For the reasons set out above, the Director is of the view that BT has SMP in the provision of single transit on fixed public narrowband networks in the UK excluding the Hull Area.

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