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| Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit markets, consultation - 17 March 2003 | |
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Chapter 9Approach to remediesIntroduction 9.1 As set out in chapters 4 to 7, the Director proposes that BT has SMP in the following markets in the UK excluding the Hull Area:
9.2 The Director also proposes that Kingston has SMP in the following markets in the Hull Area:
9.3 Chapter 8 explains that the Director is minded to conclude that interconnection circuits can be considered as a technical area related to the markets where the Director has initially found SMP. The relevant interconnection circuits are:
Definition of the dominant provider 9.4 Clause 42 of the Communications Bill provides that a person to whom an SMP service condition is applied must be a communications provider or person who makes associated facilities available and a person whom Ofcom has determined to have SMP in a specific market for electronic communications networks, electronic communications services or associated facilities. 9.5 The Director considers it appropriate to prevent a person to whom an SMP condition is applied (ie the dominant provider) which is part of a group of companies, exploiting the principle of corporate separation. That is to say, the dominant provider should not use another member of its group to carry out activities or to fail to comply with a condition, which would otherwise render the dominant provider in breach of its obligations. 9.6 Article 16 of the Framework Directive requires that, where a national regulatory authority determines that a relevant market is not effectively competitive, it shall identify "undertakings" with significant market power on that market and shall on such "undertakings" impose appropriate specific regulatory obligations. For the purposes of EC competition law, "undertaking" includes companies within the same corporate group (Viho v Commission Case C-73/95 P [1996] ECR I-5447), for example, where a company within that group is not independent in its decision making. 9.7 Accordingly, the Director considers it appropriate that the obligations proposed in this consultation document and draft notification shall apply to:
The need for ex-ante regulation 9.8 Clause 83(1) of the Communications Bill provides that, where SMP is found, Ofcom "shall...set conditions...as they consider appropriate". This implements Article 8 of the Access Directive. The European Commission’s SMP guidelines state that this means that national regulatory authorities must impose one or more SMP conditions on a dominant provider. These indicate that Ofcom (or Oftel in the interim period) must impose at least one SMP condition on a dominant provider. 9.9 However, Recital 27 of the Framework Directive states that ex ante regulation should only be imposed where there is not effective competition and where competition law remedies are not sufficient to address the problem. Oftel’s own guidelines on regulatory option appraisal note that Oftel will consider the option of no formal ex-ante regulation in its option appraisal process (see www.oftel.gov.uk/publications/about_oftel/2002/roa0602.htm. for further details.) 9.10 In this light, Oftel considers below whether ex-ante regulation is justified in the markets identified above or whether it would be sufficient to rely on competition law alone to address market failures caused by SMP in these markets. Introduction 9.11 As a competitive market will produce a more efficient outcome than a regulated market, the promotion of competition is central to Oftel’s goal of securing the best deal for the consumer in terms of quality, choice and value for money. 9.12 Where markets are effectively competitive, ex-post competition law is sufficient to deal with any competition abuses that may arise. However, without the imposition of ex-ante regulations to promote actively the development of competition in a non-effectively competitive market, it is unlikely that ex-post general competition law powers will be sufficient to ensure that effective competition becomes established. For example, this is because ex-post powers prohibit abuse of dominance rather than the holding of a dominant position. Ex-ante powers can be utilised to reduce the level of market power in a market and thereby encourage effective competition to become established. 9.13 The risk is not all one way as use of some ex ante measures can themselves limit or add nothing to the development of competition. Oftel has recognised this in removing some regulation where markets are not effectively competitive – for example in the removal of airtime provision requirements on Vodafone and 02. Characteristics of communications markets in general 9.14 Generally, the case for ex-ante regulation in communications markets is based on the existence of market failures which, by themselves or in combination, mean that competition might not be able to become established if the regulator relied solely on its ex-post competition law powers established for dealing with more conventional sectors of the economy. Therefore, it is appropriate for ex-ante regulation to be used to address these market failures and entry barriers that might otherwise prevent effective competition from becoming established. By imposing ex-ante regulation that will promote competition, it may be possible to reduce the need for such regulation as markets become more competitive, with greater reliance on ex-post competition law. 9.15 The European Commission has also stated, in paragraph 3 of section 3.2 of the Explanatory Memorandum to its Recommendation, that ex-ante regulation is justified: "[…] where the compliance requirements of an intervention to redress a market failure are extensive (eg the need for detailed accounting for regulatory purposes, assessment of costs, monitoring of terms and conditions including technical parameters etc) or where frequent and/or timely intervention is indispensable, or where creating legal certainty if of paramount concern.[…])." This is the case for many markets where persistent SMP leads to a risk of a firm setting excessive prices and the need for efficiency incentives, where a charge control would be justified, or where there is likely to be a need for intervention to set detailed terms and conditions for access to networks. Market dominance 9.16 Although communications markets have in general become increasingly competitive over time, this is from a position in which most were controlled by a legacy monopoly operator. The increase in competition that has occurred inevitably reflects the imposition of ex-ante regulation to counter the market power of the legacy operator. Moreover, despite this, the legacy operators remain, in the Director’s view, strongly dominant in a number of key markets. Therefore, it may be appropriate to continue to impose ex-ante regulations in these markets in order to ensure that effective competition can become established. Network externality effects 9.17 Externality effects are present in many communications markets. In particular, the network externality effect, which means that the value of a network to its users increases more than proportionately with the number of subscribers, gives the large incumbent network a great advantage over potential competitors. For example, the value of a large network might be little affected if it refused to deliver calls to or accept calls from a much smaller entrant, but the latter might find it impossible to attract subscribers as a result. As a consequence, this would enable the incumbent to exclude rivals from the market by refusing to interconnect with them or doing so only on onerous terms. 9.18 General ex-post competition law powers may not be sufficient to address the effects of the network externality effect. This is because the network externality effect generally re-enforces a dominant position and under general competition law there is no prohibition on holding a position of dominance. Therefore, it may be more appropriate to address the impact of network externality through ex-ante obligations, for example by requiring interconnection with the incumbent’s network. Entry barriers 9.19 Communications networks are characterised by economies of scale, that is, average costs fall as output increases. Economies of scale result from the fact that a high proportion of the costs of a telecoms network are fixed whilst marginal costs (the costs of an extra unit of output) are relatively low. Whilst the extent of economies of scale varies in different parts of the network, their existence means that a large network will tend to have lower average costs than a smaller one. Successful entry by new network operators will therefore require significant investment and most of this will be sunk costs, in the sense that the costs will not be recoverable if the entrant decides to exit the market. Significant sunk costs create an asymmetry in the market between incumbents and potential entrants that the former could exploit to deter entry, if allowed to. Incumbents could exploit this asymmetry by signalling to a potential entrant that if it were to enter the market prices would be too low to cover sunk costs. Entry might therefore be deterred. 9.20 Also, although entry at the retail level by operators without their own networks is likely to require relatively smaller sunk investments, it is also likely to require regulated supply of wholesale inputs if retail competition is to become established where there is market power at the network level. 9.21 Therefore, in communications markets, especially where there is a requirement for larger sunk investments, ex-ante regulation is appropriate to address the effect of this barrier to entry. Options for regulation 9.22 The Communications Bill sets out the obligations that the Director can impose if he finds that any undertaking has SMP. Those obligations relevant to this market review are as follows:
9.23 Any SMP conditions to be imposed must comply with the tests set out in the Communications Bill. The Director must also bear in mind the duties set out in clause 4 of the Communications Bill. In particular, each SMP condition must be appropriate (see clause 83(1)) and pass the tests set out in clause 43 of the Communications Bill, namely that each condition must be:
9.24 In accordance with Oftel’s regulatory option appraisal guidelines, Chapter 10 and chapters 13 to 16 discuss the advantages and disadvantages of each proposed remedy.9.25 Chapter 10 discusses whether any of the above-mentioned obligations (apart from carrier selection and carrier pre-selection, which are discussed in chapters 11 and 12) are appropriate to impose in the markets within this review where it is proposed that BT and Kingston have SMP. 9.26 Chapters 11 to 15 discuss specific remedies relating to the provision of particular services within the markets covered by this review where it is proposed that BT and Kingston have SMP. These services are as follows: Wholesale exchange line services
Call origination services
9.27 Chapter 16 considers cost accounting and accounting separation requirements necessary to facilitate verification of compliance with obligations such as a requirement not to unduly discriminate and a charge control. Chapter 10General remedies10.1 The following chapter considers the options for remedies in response to the proposed findings of SMP in Chapters 4 to 7. The general need for ex-ante regulation to address SMP has been considered in the previous chapter. Requirement to provide network access on reasonable request 10.2 As the market analysis in the previous chapters has shown, considerable investment is needed to provide networks in competition with BT and Kingston. It may be economically viable to build direct access networks in some areas or backbone networks covering parts of the UK. However, the level of investment that would be needed to achieve the same ubiquitous coverage as BT and Kingston is prohibitive to entry into these markets. Therefore, a requirement on providers with SMP to provide wholesale access to their network facilitates competition in downstream markets by enabling competing providers to compete without the need to invest in a ubiquitous network. 10.3 In the absence of any obligation on BT and Kingston to provide access to their networks, competition in downstream markets is likely to be limited. Market entry will be limited by the high costs of a ubiquitous network and therefore there will be less choice with fewer players competing for retail customers. The proposed requirement, therefore, has potentially significant advantages for competitors and customers, in that it enables competition to develop at the retail level. 10.4 An access obligation might have disadvantages if it obliged BT and Kingston to provide access on uneconomic terms. However, Oftel proposes that the obligation be framed in terms of the dominant provider being required to provide access to its network on reasonable request. Oftel does not intend that all requests should be met and has set out how it might assess a reasonable request for access in its statement Imposing access obligations under the new EU Directives, September 2002. 10.5 Essentially, the term ‘network access’ applies to any wholesale service that enables competitors to deliver their own services to customers. It is a broad term and includes interconnection services. Further details about the definition used in the Directives can be found in Oftel’s access guidelines referred to above. 10.6 Clause 83(3) of the Communications Bill allows the Director to impose appropriate SMP conditions requiring the dominant provider to provide network access, to allow use of the relevant network and to make available the relevant facilities. 10.7 The proposed condition will apply to the following markets, where BT and Kingston have initially been found to have SMP, and technical area:
10.8 The proposed condition to be imposed on BT and Kingston can be found in Annex A. 10.9 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director in proposing this condition has considered all the Community requirements set out in Clause 4 and in particular the requirements to promote competition, to secure efficient and sustainable competition and to secure the maximum benefits for persons who are customers of communications providers, as set out in paragraphs 10.2 and 10.3. 10.10 Clause 43 requires conditions to be objectively justifiable, non-discriminatory, proportionate and transparent. The proposed condition is objectively justifiable, in that it relates to the need to ensure that competition develops to the benefit of consumers. It does not discriminate, in that it is imposed on both BT and Kingston and no other operator has SMP in these markets. It is proportionate, since it does not require BT and Kingston to provide access if it is not technically feasible. It is transparent in that it is clear in its intention to ensure that BT and Kingston provide access to their networks, as set out in paragraphs 10.4 and 10.5. In addition, the Director has set out how he might assess whether requests for access are reasonable in the Access Guidelines referred to above, and further discussion of the terms and conditions that might accompany an obligation to provide access on reasonable request is set out below. 10.11 In addition, the Director has taken into account all the factors set out in Clause 83(4). In particular, there has been consideration of the economic viability of building networks to achieve ubiquitous coverage and the need to ensure that the requested access is reasonable and therefore feasible to provide. Requirement not to unduly discriminate 10.12 A requirement not to unduly discriminate will ensure that BT and Kingston are unable to discriminate in favour of their own retail activities and that therefore competing providers purchasing their wholesale products are placed in an equivalent position. 10.13 Where providers with SMP are vertically integrated, like BT and Kingston, they may have an incentive to provide wholesale services on terms and conditions that favour their own retail activities in a way that would have a material adverse effect on competition. In particular, they may have incentives to charge competing providers more than the amount charged to their own retail activities (transfer charge) for wholesale services, to increase the costs of competing providers and give themselves an unfair competitive advantage. They might also provide services on different terms and conditions, for example with different delivery timescales, which would disadvantage their retail competitors and in turn consumers. The proposed requirement has advantages for competitors to BT and Kingston in that it offers them some measure of protection against anti-competitive activity. This should benefit consumers as competition develops. 10.14 An obligation of non-discrimination might have disadvantages if it prevented discrimination that was economically efficient or justified. However, the proposed condition provides that there should be no undue discrimination. Oftel has considered how it might treat undue discrimination in its Access Guidelines. This statement notes that any obligation with respect to undue discrimination has the objective of preventing behaviour that has a material adverse effect on competition. This does not mean that there should not be any differences in treatment between undertakings, rather that any differences should be objectively justifiable, for example, by differences in underlying costs of supplying different undertakings. The statement also notes that in the Director’s view, there is a rebuttable presumption that a vertically integrated SMP operator discriminating in favour of its own retail activities or between its own different activities would have a material adverse effect on competition (paragraph 3.9). This view would also apply to discrimination in relation to the underlying components of services. 10.15 Clause 83(6) of the Communications Bill allows the Director to impose an appropriate SMP condition requiring the dominant provider not to discriminate unduly against particular persons or against a particular description of persons, in relation to matters connected with network access. 10.16 The proposed condition will apply to the following markets, where BT and Kingston have initially been found to have SMP, and technical area:
10.17 The proposed condition on BT and Kingston can be found in Annex A. 10.18 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director in proposing this condition has considered all the Community requirements set out in Clause 4 and in particular the requirements to promote competition, to secure efficient and sustainable competition and to secure the maximum benefits for persons who are customers of communications providers, as set out in paragraph 10.13. 10.19 Clause 43 requires conditions to be objectively justifiable, non-discriminatory, proportionate and transparent. The Director considers that this proposed condition is objectively justifiable, in that it provides safeguards to ensure that competitors, and hence consumers, are not disadvantaged by BT or Kingston discriminating in favour of their own retail activities or between its own different activities. It does not discriminate, in that it is imposed on both BT and Kingston and no other operator has SMP in these markets. It is proportionate in that discrimination is only prohibited if it is undue. Finally, it is transparent in that it is clear in its intention to ensure that BT and Kingston do not unduly discriminate as set out in paragraph 10.14. In addition, Oftel has given guidance as to how it might treat undue discrimination in its Access Guidelines. Basis of charges 10.20 In competitive markets, the price of services would be driven down to competitive levels by the commercial judgement of the companies in the market. However, where competition does not provide pricing constraints, it is necessary for ex-ante regulation to intervene to prevent excessive pricing. Such intervention should have as its objective moving the market from a situation of monopoly to one of effective competition. 10.21 Without some intervention in pricing, dominant providers are likely to want to charge excessive prices, in order to maximise profits by increasing their revenues and the costs of competing providers. A requirement not to unduly discriminate may exert some downward pressure on charges, to the extent that the dominant provider’s retail activities may seek lower charges and its wholesale activities would be required to charge the same to all other providers. However, this may not necessarily be the case and the dominant provider will still have incentives to set its charges at a level to maximise its overall profitability. Higher wholesale charges are likely to mean that competing providers will need to have higher retail prices and are therefore less able to compete in the retail market. In the long-term this may result in market exit. 10.22 Ex-ante regulation requiring charges to be based on long run incremental costs (LRIC), with appropriate mark-ups for costs which are common across products and for recovery of the cost of capital, is appropriate in many communications markets. As set out previous chapters, economies of scale combined with high sunk costs pose particular competition problems in the communications industry. Under normal competition principles, a price as low as short-run marginal cost might be considered not to be anti-competitive. However, in communications markets, short run marginal costs can be very low or even zero. An incumbent's price based on short run marginal costs could then deter entry as it would not reflect the price that potential entrants would need to charge to cover fixed sunk costs. Long run incremental cost is therefore preferred as the cost floor in communications markets as this includes fixed costs. This is the case whether regulation is ex-ante or ex-post. As set out in The Competition Act 1998 - the Application in the Telecommunications Sector, long run incremental cost is also preferred by Oftel as the cost floor for ex post regulation. 10.23 It is not always the case that a requirement for a specific charging basis is appropriate. It may be sufficient to rely on a requirement to not unduly discriminate, as set out above. This may be appropriate in markets where competition is developing and a specific charging basis would be a disproportionate response to the state of competition. However, in the majority of the markets considered in this review, SMP is persistent and therefore ex-ante measures to control the charging basis are appropriate. This applies to both BT and Kingston. The exception to this is the market for ISDN 30 services, where competition at the wholesale level and the existence of substitute services mean that a basis of charges condition is not appropriate. This is discussed further below. Basis of charges condition 10.24 Clauses 83(9) and (10) and Clause 84 of the Communications Bill allow the Director to impose appropriate conditions in relation to the basis of charges. 10.25 The Director proposes to impose on BT and Kingston a requirement for charging on the basis of LRIC plus an appropriate mark-up for common costs and for an appropriate return on capital employed. The proposed condition allows the Director to determine that a price need not be set on such a basis and therefore if BT wishes to set a price on any other basis, it must apply to the Director for permission to do this. 10.26 The proposed condition will apply in the following markets, where BT and Kingston have initially been found to have SMP, and technical area:
10.27 The proposed condition on BT and Kingston can be found in Annex A. 10.28 Oftel expects that most new services that are introduced into the relevant markets will be covered by the same pricing rule. This is because new services in the same markets would be expected to be subject to the same competitive conditions as existing services. This does not however mean that the dominant provider cannot recover costs appropriate to new wholesale services. The recovery of efficiently incurred costs for new wholesale services was discussed in Oftel’s Access Guidelines. 10.29 Although the expectation is that new services will be treated in the same way as existing services, there may be occasional exceptions to this rule, where the new service is innovative and thus warrants a different regulatory approach. There are a number of ways in which such services can be dealt with, including the following:
10.30 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director has considered all the Community requirements set out in Clause 4 and in particular the requirement to promote competition and to secure efficient and sustainable competition, as set out in paragraphs 10.20 and 10.21. 10.31 Clause 43 requires conditions to be objectively justifiable, non-discriminatory, proportionate and transparent. The Director considers that the proposed condition is an objectively justifiable and proportionate response to the extent of competition in the markets analysed, as it enables competitors to purchase services at charges that will enable them to develop competitive services to the benefit of consumers, whilst at the same time allowing BT and Kingston a fair rate of return that they would expect in competitive markets. It is non-discriminatory in that it is imposed equally on BT and Kingston and no other provider has SMP in these markets. Finally, it is transparent in that it is clear in its intention to ensure that BT and Kingston charge on a particular basis, as set out in paragraph 10.25. 10.32 The Director considers that the tests in Clause 84 have been met. As noted above, there is a risk that, in situations where SMP is persistent, pricing will be distorted and not at competitive levels. The proposed condition is appropriate in order to promote competition and provide benefits to end users by enabling competing providers to buy wholesale services at levels that might be expected in a competitive market. 10.33 The extent of investment of the dominant operator has been taken into account as set out in Clause 84(2) and the proposed obligation provides for a mark-up for an appropriate return on capital employed. ISDN 30 10.34 As noted in chapter 4, the market conditions for the supply of ISDN30 are somewhat different to those in the other markets considered in this review. Potential supply side substitutes exist such as ISDN30 over a 2Mbit/s leased line that can represent a cost-effective alternative as long as the utilisation of the leased line is high (ie the number of channels provisioned is high). This form of competition is preferable to simple resale of BT’s ISDN30 service, since it exposes a greater part of the value chain to competition. Oftel considers that setting a LRIC plus mark-up based charge for ISDN30 would discourage the investment that is required to promote this form of competition. 10.35 There is further downward pressure on ISDN30 prices from regulation of ISDN2 and the potential substitution between the two services. Supply side substitution of ISDN30 over a 2Mbit/s leased line breaks down when the utilisation of the ISDN30 service is low (ie the number of channels provisioned is low). However, in this scenario, it may be possible to substitute multiple ISDN2 lines for a low-utilisation ISDN30 line. This may make it difficult to sustain a price per channel for ISDN30 that is significantly higher than the price per channel for ISDN2. Some downward pressure on prices should therefore be provided by setting the proposed conditions in respect of ISDN2 only, supplemented by a requirement not to unduly discriminate in respect of both ISDN2 and ISDN30. 10.36 The Director therefore proposes that there should be no ex-ante pricing rule for ISDN 30. Charge control 10.37 Where there is a risk of a firm setting excessive prices due to a lack of competition in the market, a charge control with transparent, easy to monitor compliance conditions can help ensure that firms do not abuse their dominant position and that competition develops to the benefit of consumers. 10.38 The need for ex-ante regulation in the form of a charge control is further demonstrated by the issue of common cost recovery. Within communications markets, there are frequently significant economies of scope. This means that it is more efficient for the same firm to supply a number of different services rather than for each to be provided by a different firm. It also means that there are likely to be significant common costs that cannot be attributed to the provision of any one service. 10.39 The existence of significant common costs complicates the assessment of excessive pricing under ex-post powers, since it may be difficult to establish that prices in any one market are excessive without taking into account the extent of common cost recovery from other markets. A requirement for prices simply to be below stand-alone costs (the sum of incremental and common costs) could allow the firm to make excess profits, since it would in effect allow multiple recovery of common costs. The corollary of these excess profits is of course the reduction in consumer welfare caused by prices being above and hence quantities below the competitive level. 10.40 A charge control will include the allocation of common costs to the provision of certain services, thereby avoiding the problems outlined above. 10.41 Charge controls can also introduce benefits in addition to ensuring that a firm with SMP does not price excessively. In particular, the RPI-X form of charge control creates incentives on the charge controlled operator to increase its efficiency, thereby imitating the effect of a competitive market. If Oftel were to rely on its ex-post powers to prevent excessive pricing, this efficiency benefit would be foregone and there could be an incentive to disguise high profits by inflating costs. Type of charge control 10.42 The two main forms of regulation are a RPI-X control and a rate of return control. Under the former, the firm is prevented from increasing prices by more than inflation minus X percent per annum. Under the latter arrangement, the firm is required to earn no more than the specified rate of return in each year. This is a form of cost plus regulation and requires the level of allowable costs to be assessed annually. 10.43 RPI-X regulation has a number of advantages over rate of return control. Crucially, it provides very clear incentives to the firm to minimise costs. If the firm can reduce its costs below the level expected when the cap was set, then the firm retains the increased profits, at least for the period until the cap is reviewed. In addition, it avoids overly intrusive and bureaucratic regulation. Price controls are not set every year according to the rate of return earned in the year, but for a period of years, and they are not revisited until the end of the period. 10.44 By contrast, rate of return control has poor incentives to productive efficiency, because the firm does not benefit from cost reductions. Indeed, rate of return control may encourage the firm to expand its asset base beyond the efficient level in order to increase its total allowed return. 10.45 However, because RPI-X regulation can result in prices being either above or below costs, the undertaking is exposed to greater risk than under rate of return regulation. This point was considered in the recent NAO report on Pipes and Wires, HC723, April 2002. The NAO noted that the corollary of this is "two very significant benefits: first that the uncertainty is borne by the companies and their shareholders…rather than by customers; and second…price cap regulation is associated with strong incentives on companies to reduce costs by increasing efficiency." The NAO concluded that "RPI-X has been successful to date" in achieving "substantial improvements…in efficiency" at the same time as "customers have seen lower prices and higher quality of service". 10.46 On balance, Oftel believes that the promotion of efficiency is more likely to benefit customers and result in lower prices than re-setting prices annually and basing these on costs that are not necessarily efficiently incurred. This is substantiated by the illustrative results of a cost-benefit analysis conducted for five of the current charge control baskets. Although the results can only be illustrative because they are based on certain parameter assumptions, they are an indication of the very significant benefits that regulation can bring to consumers. These benefits do not vary by a significant degree even when sensitivities within a broad range are carried out on the assumptions. The analysis can be found in annex E. 10.47 In markets where competition has started to develop and charges become increasingly driven by competitive forces, charge controls are less appropriate because of the potential for a charge control to adversely distort behaviour in the market to the detriment of consumers. Instead, a safeguard cap (eg an RPI-0 per cent price control) is applied, as it is less likely to create perverse incentives in the market and will provide continued protection for consumers while competition continues to develop. It is intended that safeguard caps will be kept until competition is developed to a sufficient extent that consumers no longer need protection in this form. The regulator will be able to rely on competition and its general competition law powers to ensure that competition continues to develop and consumers are protected. Charge control proposal on BT 10.48 In setting a charge control for most of the markets in this review, Oftel has the option of a new control or the continuation of the existing control. In many of the markets identified in this review, a charge control is already in operation. The current controls are known as the Network Charge Controls and are set to run for a four year period. The level of ‘X’ varies according to the type of service. 10.49 The advantages of setting a new control include the ability to assess the most up to date market and cost data. However, setting a new control has some significant disadvantages. It is a key element of RPI-X price controls that the regulator should not intervene within the charge control period to reset the value of ‘X’, unless changes in market conditions are of such magnitude as to threaten the regulated provider’s ability to finance its activities. If the regulated provider believed that the regulator would intervene to reset a higher value of ‘X’ if profits were higher than expected, it would have a reduced incentive to seek cost reductions. Oftel believes that it is highly desirable to avoid re-opening charge controls in mid-period due to these incentive effects. Value of X 10.50 In setting the values of ‘X’, Oftel needs to consider the benefits of regulatory stability; the incentive properties of RPI-X regulation; the need to ensure that any forecast assumptions are reasonably derived from available data; and consumers’ best interests. The ‘X’ factor also needs to ensure that BT is required to make real efficiency gains whilst ensuring sustainability. Oftel has considered all of these factors in putting forward its proposals for the value of ‘X’. 10.51 Market share and growth are two key variables used in modelling the appropriate value of ‘X’. Overestimating or underestimating market growth or market share could lead to charge controls being either too lenient (if they were underestimated) or too severe (if they were overestimated). Oftel has therefore revisited these key assumptions that it used in assessing future market share and growth when setting ‘X’ from October 2001 and compared them with broad market trends seen in the interim period. The results are shown in the following tables: Table 10.1: Change in market growth
Source: Proposals for Network charge and Retail price controls from 2001, February 2001 (forecast) and Oftel Market information (actual). Forecast market growth rates are annual averages for the period 2000/01-2004/05. Table 10.2: BT market share
Source: Price control model (forecast) and Oftel market information (actual). The forecast market share figures for calls are annual averages for the year ending March 2005. Note: forecast and actual 2002 figures may not be strictly comparable because the former were based on actual data available in late 2000 whereas the latter may reflect subsequent adjustments and data revisions. 10.52 Oftel has found that rates of growth in total call volumes have been somewhat lower than expected, whilst BT's market share has not declined as rapidly as expected. However, these two effects tend to offset each other in the calculation of ‘X’. In any event, the central market growth and share assumptions used to formulate the current ’X’ still lie within the range of current plausible outcomes. 10.53 The value of ‘X’ is set to allow BT to earn its cost of capital by the end of the period. It should also ensure that BT has increased its efficiency by the end of the charge control period. This means that ‘X’ needs to be set to incentivise and ensure that BT can remove inefficiencies that might be present when the control is set and further improve its efficiency beyond this. 10.54 In setting the current Network Charge Controls, NERA undertook a benchmarking study in order to assess BT’s comparative efficiency with best practice. NERA’s report, The comparative efficiency of BT, July 2000, produced a range of estimates of BT’s comparative efficiency against best practice in achieved industry efficiency. In formulating the current ‘X’, Oftel used the mid-point of the NERA range. Given the relatively short space of time since the report was produced and the use of the mid-point from the study, Oftel believes that the efficiency gains that BT will have been able to achieve since then do not make it necessary for a new comparative study to be undertaken. Charge control condition 10.55 Clauses 83(9) and (10) and Clause 84 of the Communications Bill allow the Director to impose appropriate charge controls in relation to matters connected with the provision of network access. 10.56 The proposed condition on BT can be found in Annex A. It requires that charges for services do not increase by more than RPI minus a value of X that varies according to each market. The services and values for X are set out in the draft condition. It applies to current services in the following markets and technical area:
10.57 The new regulatory regime needs to take effect from 25 July 2003. This is six days before the end of the current charge control year for current services in both the wholesale analogue exchange line services markets and just over two months before the end of the current charge control year for current services in the remaining markets. Oftel does not believe that there is any benefit to be gained from changing the starting date for each charge control year and therefore proposes that the year should continue to start on either 1 August or 1 October. This would leave a gap between the end of the controls under the present regime (24 July 2003) and the commencement of the controls under the new regime. For this period, Oftel proposes to prevent BT from increasing its charges for current services in the markets listed above. The product management, policy and planning (PPP) surcharge 10.58 The product management, policy and planning (PPP) surcharge covers BT’s costs associated with establishing and maintaining interconnection relationships. Movements in these costs are not therefore related to call volumes. Whereas BT’s costs in providing interconnection services, such as call origination, reduce with increases in call volumes, its costs associated with establishing interconnection relationships do not. This is one of the main reasons why the Director considers it appropriate to separately charge control PPP. 10.59 BT is allowed to make a PPP surcharge on inland conveyance interconnection services once per minute for any inland conveyance call. Oftel believes that this is an equitable way for BT to recover such costs, as those that purchase the largest volume of conveyance interconnection services pay the most. NTS retail uplift 10.60 The Director is proposing to apply a charge control to the NTS retail uplift. The detailed discussion of this is contained in chapter 14. Charge control proposal on Kingston 10.61 The Director has considered whether a charge control remedy is appropriate for Kingston in the markets where it has been initially found to have SMP. The Director has already proposed that Kingston should be subject to a requirement to provide access on reasonable request, not to unduly discriminate and to provide services on a LRIC plus mark-up basis. Kingston has been subject to equivalent conditions under the existing regulatory regime following Oftel’s review of telecommunications markets in the Hull area in 1998. Despite these requirements, there has been limited market entry at the wholesale level in the Hull Area. Lack of market entry is likely to reflect the commercial decisions of other operators and indicates that more stringent regulation would have limited impact. 10.62 Further, the Director considers that extensive monitoring and compliance systems that would be required with the imposition of a charge control would not be proportionate. 10.63 In view of the above, the Director does not propose to impose a charge control on Kingston. The Director considers that such regulation is not a justified and proportionate response to the characteristics of the communications markets in the Hull Area. It seems clear a charge control would lead to substantial costs being incurred by both Oftel and Kingston, with little benefit in the way of increased competition at the wholesale level leading to lower prices for consumers. Communications Bill tests 10.64 The Director considers that the proposed condition on BT meets the tests set out in the Communications Bill. The Director has considered all the Community requirements set out in Clause 4 and in particular the requirement to promote competition, to secure efficient and sustainable competition and to secure the maximum benefits for persons who are customers of communications providers, as set out in paragraphs 10.37 to 10.47. 10.65 The Director considers that the proposed condition meets the tests set out in Clause 43 of the Communications Bill. It is objectively justifiable in that the benefits of RPI-X price controls are widely acknowledged as an effective mechanism to reduce prices in a situation where competition does not act to do so. Although a charge control condition is not proposed for Kingston, it is not discriminatory for the reasons set out in paragraphs 10.61 to 10.63. The proposal to keep the current values of X is proportionate, as the current values of X are within the range to be expected. The proposed charge control therefore gives achievable targets for BT and accurately reflects the cost reductions that it could be expected to make across the full period of the control. Finally, the condition is transparent in that it is clear in its intention to control BT’s charges whilst creating efficiency incentives. 10.66 The Director considers that the tests in Clause 84 have been met. As noted in paragraph 10.37, there is a risk that, in situations where SMP is persistent, pricing will be distorted and not at competitive levels. The proposed condition is necessary in order to promote competition and to provide benefits to end users in that it acts to reduce charges for wholesale inputs to retail prices in the absence of competition reducing prices. In addition, the proposal for an RPI-X control promotes efficiency as discussed in paragraph 10.56. 10.67 Clause 84 requires the extent of the investment of the dominant provider to be taken into account when setting a charge control condition. The extent of BT's investment is taken into account by setting X so that BT's projected rate of return on capital in the last year of the charge control is equal to BT's cost of capital. In 2001, Oftel estimated the pre-tax nominal cost of capital of BT's regulated business to be in the range of 13.41 to 13.78 per cent, with a mid-point of 13.5 per cent (rounded to the nearest 0.5 per cent). The Director is of the view that this estimate remains well within a reasonable range, given that, in the period since this estimate was produced, neither the underlying parameters, nor the Director's preferred method of estimation, have changed in a manner that would imply a higher estimate. Transparency 10.68 The fact that details of the services offered by the dominant provider are made public can help with the development of competition. This section considers whether there should be a requirement on BT and Kingston to publish details of charges, terms and conditions within a Reference Offer (RO), whether charges should be notified in advance, whether technical information should be notified in advance and whether there should be a requirement to publish key performance indicators to monitor quality of service. 10.69 Clause 83(6)(b) of the Communications Bill allows the Director to impose appropriate obligations requiring the dominant provider to publish information for the purpose of securing transparency. Clause 83(6)(c) allows the Director to impose appropriate conditions requiring the dominant provider to publish the terms on which he is willing to enter into an access contract. Requirement to publish a Reference Offer10.70 A requirement on communications providers with SMP to publish a reference offer (RO), has two main purposes: to assist transparency for the monitoring of potential anti-competitive behaviour and to give visibility to the terms and conditions on which other providers will purchase wholesale access services. This helps to ensure stability in markets and, without it, incentives to invest might be undermined and market entry made less likely. 10.71 The publishing of a RO will potentially allow for speedier negotiations, avoid possible disputes and give confidence to those purchasing wholesale access services that they are being provided on non-discriminatory terms. Without this, market entry might be deterred to the detriment of the long-term development of competition and hence consumers. 10.72 The proposed condition will apply to the following markets, where BT and Kingston have initially been found to have SMP, and technical area:
10.73 The published RO must set out such matters as:
10.74 In addition, BT and Kingston must include in the published RO, the amount charged to their own retail activities (transfer charge) and the underlying components from which the amount is derived, for the equivalent service that it provides to competing providers. 10.75 The proposed condition on BT and Kingston can be found in Annex A. 10.76 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director has considered all the Community requirements set out in Clause 4 and in particular the requirement to promote competition, to secure efficient and sustainable competition and to secure the maximum benefits for persons who are customers of communications providers, as set out in paragraphs 10.70 and 10.71. 10.77 The Director considers that the proposed condition meets the tests set out in Clause 43 of the Communications Bill. It is objectively justifiable in that it requires that terms and condition are published in order encourage competition and provide stability in markets. It is proportionate, in that only information that is necessary to ensure that that there is no material adverse effect on competition is required to be provided. It does not discriminate in that it is applied to both BT and Kingston and there are no other providers with SMP in these markets. Finally, it is transparent in that it is clear in its intention to ensure that BT and Kingston publish details of their terms and conditions, as set out in paragraphs 10.73 and 10.74. Requirement to notify charges 10.78 Notification of charges at the wholesale level can further assist competition by giving advanced warning of charge changes to competing providers purchasing wholesale access services. The latter is important to ensure that competing providers have sufficient time to plan for such changes, as they are likely to want to restructure retail prices in response to charge changes at the wholesale level. Notification of charges therefore helps to ensure stability in markets and without it, incentives to invest might be undermined and market entry made less likely. 10.79 Notification of charges has certain disadvantages, particularly in markets where there is some competition. It can act as a disincentive to competition, in that competitors can see the published charges of the dominant provider in advance and adjust their pricing strategies accordingly. 10.80 On balance, however, Oftel considers that the advantages of notification of charges outweigh the disadvantages. In the markets where SMP remains persistent, there is a high level of reliance by competitors on the provision of access services to enable them to compete with the incumbent operators. It is possible, however, to reflect the development of competition in adjusting the notification period for particular markets. 10.81 The proposed condition will require 90 days notice of charge changes in the markets where SMP is persistent. These are the following markets and technical area:
10.84 The proposed condition on BT and Kingston can be found in Annex A. 10.85 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director has considered all the Community requirements set out in Clause 4 and in particular the requirement to promote competition and to secure efficient and sustainable competition as set out in paragraphs 10.78 to 10.80. 10.86 The Director considers that, in accordance with the tests set out in Clause 43 of the Communications Bill, the proposed condition is objectively justifiable, non-discriminatory, proportionate, and transparent. It is objectively justifiable, in that the benefits of publication and notification of charges outweigh any possible disadvantages. It is proportionate, in that the period of notice is significantly reduced in markets where there is competition is developing. It does not discriminate in that it is applied to both BT and Kingston and there are no other providers with SMP in these markets. Finally, it is transparent in that it is clear in its intention to ensure that BT and Kingston provide notification of charge changes, as set out in paragraphs 10.81 to 10.83. Requirement to notify technical information 10.87 Under the proposed Requirement to publish a reference offer, BT and Kingston are required to include technical information in their RO. 10.88 However, advance notification of changes to technical terms and conditions is important to ensure that competing providers are able to make effective use of wholesale services provided by BT and Kingston. Changes to technical information must be published in advance so that competing providers have sufficient time to prepare for them. For example, a competing provider may have to introduce new equipment or modify existing equipment to support a new or changed technical interface. Similarly, a competing provider may need to make changes to their network in order to support changes in the points of Network Access or configuration. 10.89 The proposed condition requires the notification of new technical information 90 days in advance of providing new wholesale services or amending existing technical terms and conditions. Oftel considers that 90 days is the minimum time that competing providers will need to modify their network to support a new or changed technical interface or support a new point of access or network configuration1 10.90 Technical information includes new or amended technical characteristics, including information on network configuration, locations of the points of Network Access and technical standards (including any usage restrictions and other security issues). Relevant information about network configuration is likely to include information about the function and connectivity of points of access, for example, the connectivity of exchanges to end users and other exchanges. 10.91 The proposed condition will apply to the following markets, where BT and Kingston have initially been found to have SMP, and technical area:
10.92 The proposed condition on BT and Kingston can be found in Annex A. 10.93 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director in proposing this condition has considered all the Community requirements in Clause 4 and in particular the requirement to promote competition and to encourage service interoperability as set out in paragraph 10.88. 10.94 The Director considers that the proposed condition meets the tests set out in Clause 43. It is objectively justifiable in that it enables competing operators to make full and effective use of Network Access. It does not discriminate in that it is imposed on both BT and Kingston and no other operator has SMP in these markets. It is proportionate in that 90 days is the minimum necessary to allow competing providers to modify their networks. It is transparent in that it is clear in its intention that BT and Kingston notify technical information as set out in 10.89 and 10.90. Consultation on interfaces 10.95 Current regulation on BT includes a requirement to consult on interfaces where so directed by the Director. This was imposed to ensure that BT could not impose unnecessary costs on competing operators by specifying a proprietary interface. However, Oftel recognises that communications providers are constrained in their choice of interface by the standardised nature of most communications equipment. In addition, Oftel believes that the scope for further modifications to traditional PSTN equipment, where BT was most likely to be able exert control over interface specifications, is likely to be limited in the future, as operators and equipment manufacturers increasingly look to other technologies. 10.96 Therefore, Oftel now considers it unlikely that BT would be able to exert control over interfaces in a way that could have a material adverse effect on competition. Consequently, the Director does not currently consider that imposing a condition requiring consultation on interfaces would be proportionate. Transparency as to quality of service 10.97 Undue discrimination might take place by a dominant provider delivering or supporting services to its own downstream activities more quickly than it does for competing providers. For example, in the quicker provisioning of lines or FRIACO circuits or in faster fault response times. 10.98 It might be argued that a dominant provider should provide wholesale services to competing providers using the same operational processes and interfaces that it uses to supply itself. However, the high cost of replacing legacy systems means that this will not always be practical. Instead, Oftel considers that the most objectively justifiable and proportionate means of monitoring whether undue discrimination is taking place, is to require the delivery of the same operational performance to competing providers as a dominant provider delivers to itself. Specifically, this means that Key Performance Indicators (KPIs) such as ordering times and fault response times must be the same. 10.99 Oftel believes that the only means of ensuring that there is no undue discrimination as to quality of service is by imposing a requirement to publish such information. Without such a requirement, Oftel believes that it would be impossible to monitor that the different operational processes used by dominant providers were delivering an equivalent quality of service. 10.100 The Director therefore proposes that BT be subject to a requirement to publish data on a specified set of KPIs, the format and frequency of which will be determined by the Director. The Director does not propose that Kingston be subject to this requirement because Kingston’s supply of wholesale services are of insufficient volume for the publication of KPI data to be statistically meaningful. 10.101 The proposed condition will apply to the following markets and technical area:
10.102 The proposed condition on BT can be found in Annex A. 10.103 Oftel considers that it would not be proportionate to require BT to publish a large number of KPIs, covering all aspects of operational performance. Instead, Oftel intends to select a small number of KPIs that are representative of key business processes and that are necessary to ensure compliance with the requirement not to unduly discriminate. There is also a potential conflict between a requirement to publish performance data, in order to provide transparency, and the need to maintain commercial confidentiality. The scope of the publication requirement will take account of this. The Director proposes to address these issues in a separate consultation, covering all the relevant market reviews. This will set out the Director’s proposals for the specific KPIs to be covered by the proposed condition, as well as the publication process and frequency. The Director expects this consultation document to be issued during 2003. The intention is that the first publication period will commence at the beginning of 2004 10.104 The Director considers that the proposed condition meets the tests set out in the Communications Bill. The Director in proposing this condition has considered all the Community requirements in Clause 4 and in particular the requirement to promote competition and to secure efficient and sustainable competition by ensuring that BT provides an equivalent quality of service to competing providers as it provides to itself. 10.105 The Director considers that the proposed condition meets the tests set out in Clause 43. It is objectively justifiable in that it is the only means of ensuring that a dominant operator provides an equivalent quality of service to other operators as it provides to itself. The condition does not unduly discriminate between providers. Although an equivalent condition is not proposed for Kingston, it is not discriminatory for the reasons set out in paragraph 10.100. The condition is proportionate because the dominant provider will only be required to publish data on a small number of KPIs that are representative of key business processes, rather than a complete set of KPIs that cover all aspects of operational performance. Finally it is transparent in that it is clear in its intention to monitor undue discrimination in relation to quality of service as set out in paragraph 10.100. Statement of requirements 10.106 During Oftel’s consultation on Imposing Access Obligations under the new EU Directives, September 2002, some communications providers raised concerns about the Statement of Requirements (SoR) process used to request new wholesale products from BT. This SoR process was agreed between BT and other providers and is not the result of regulatory intervention. When this commercial process fails, the result is often a request for a dispute resolution by Oftel. 10.107 Oftel has received further representations that the SoR process should be set out in specific obligations on dominant providers. Such obligations would represent an increase in regulation. Whether or not this additional regulation is justified will depend on the scale of the failings of the current SoR process and this might vary from market to market depending on the nature of the wholesale products required. Rather than set out a detailed proposal for these additional obligations as part of this market review process, Oftel would first like to request additional evidence and supporting arguments for the extension of regulation to the process of requesting new wholesale products from dominant operators in the markets covered in this review. If necessary, Oftel will conduct a separate consultation on imposing obligations at a later date. 10.108 If regulation of the SoR process is necessary, Oftel believes that the following obligations would be worth considering: A. Publication of reasonable guidelines on requesting a new product 10.109 This obligation would oblige a dominant provider to publish the required content and form of a request for a new wholesale product. Oftel believes that such guidelines would contribute to an efficient process by ensuring that the dominant provider receives accurate product descriptions and would give requesting providers confidence that requests are handled in a consistent and fair manner. B. Provision of information for the purpose of making a request for a new product 10.110 This obligation would oblige a dominant provider to supply sufficient technical information to enable competing providers to construct proposed product specifications that are efficient and meet their reasonable requirements. A dominant provider should not refuse access to such information on the basis of confidentiality although it may make it subject to a non-disclosure agreement. C. Process for dealing with requests for new products 10.111 This obligation would set out the timescales for:
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