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Summary Annex A Notification
and proposed SMP conditions for BT and Kingston A new regulatory regime S1 A new regulatory framework for electronic communications networks and services will enter into force in the UK on 25 July 2003. The basis for the new regulatory framework is five new EU Communications Directives that are designed to create harmonised regulation across Europe and aimed at reducing entry barriers and fostering prospects for effective competition to the benefit of consumers. Four of these Directives (referred to as the new Directives in this Summary) are intended to be implemented via a new Communications Act. S2 The new Directives include requirements National Regulatory Authorities (NRAs), such as Oftel, to carry out reviews of competition in communications markets, to ensure that regulation remains appropriate in the light of changing market conditions. Pursuant to the Electronic Communications (Market Analysis) Regulations 2003 (the ‘Regulations’) Oftel is carrying out this review of Fixed Narrowband Retail Markets (the ‘Review’) and is consulting on market identification, designation of SMP (or not) and the SMP conditions proposed to be adopted on or after 25 July 2003. Scope of this review S3 This Review considers the following retail fixed narrowband markets:
S4 The document contains an analysis of where Oftel’s proposed market definitions differ from those set out in the European Commission’s Recommendation on relevant product and service markets. Conclusions on Significant Market Power S5 Oftel has considered whether Significant Market Power (SMP) is held by any providers in the markets, taking into account of the European Commission [Commission Guidelines on market analysis and the assessment of significant market power under the Community regulatory framework for electronic communications networks and services.] and Oftel SMP Guidelines.[Oftel's market review guidelines: criteria for the assessment of significant market power - www.oftel.gov.uk/publications/about_oftel/2002/smpg0802.htm] S6 In the UK geographic area (excluding the Hull area), the Director General of Telecommunications’ (the 'Director') initial view is that BT has SMP in the following markets:
S7 In the Hull area the Director's initial view is that Kingston has SMP in the following markets:
Regulatory remedies S9 The Director considers it appropriate to propose the following remedies on BT and Kingston in the markets where the Director is proposing that they have SMP:
S10 The Director considers that the proposed conditions in this Review meet the tests in the Communications Bill. The measures proposed will ensure efficient and sustainable competition in the markets and protect consumers while competition develops. S.11 In the Hull area, Kingston has a similar position of dominance to BT in the markets considered. The Director therefore proposes that it be subject to a similar regulatory regime, but that this should reflect matters of proportionality, recognising the smaller size of the potential market and the smaller number of potential competitors to Kingston in the Hull area. S12 Oftel is also seeking views on the application of the undue discrimination requirements in respect of pricing for business services. Consultation S13 The Director is seeking comments on his proposals by 30 May 2003. Once he has considered all responses, the Director will publish his final proposals and these will take effect from 25 July 2003. S14 Comments should be sent to Alan Pridmore, Oftel, 50 Ludgate Hill, London EC4M 7JJ. E-mail: alan.pridmore@oftel.gov.uk Tel: 020-7634 8910. A full list of the questions to which Oftel is seeking responses is in Annex G. S15 The Director’s Notification under Regulation 6 of the Regulations of the proposed market definitions, SMP designations and SMP conditions are contained in Annex A to this document.
Chapter 1 A new regulatory regime 1.1 A new regulatory framework for electronic communications networks and services will enter into force in the UK on 25 July 2003. The basis for the new regulatory framework is five new EU Communications Directives as follows:
1.2 The new regulatory framework is designed to create harmonised regulation across Europe and aimed at reducing entry barriers and fostering prospects for effective competition to the benefit of consumers. 1.3 The Framework Directive provides the overall structure for the new regulatory regime and sets out fundamental rules and objectives which read across all the new directives. Article 8 of the Framework Directive sets out three key policy objectives which have been taken into account as relevant in the preparation of this consultation document, namely promotion of competition, development of the internal market and the promotion of the interests of the citizens of the European Union. The Authorisation Directive establishes a new system whereby any person will be generally authorised to provide electronic communications services and/or networks without prior approval. The general authorisation replaces the existing licensing regime. The Universal Service Directive defines a basic set of services that must be provided to end-users. The Access and Interconnection Directive sets out the terms on which providers may access each others’ networks and services with a view to providing publicly available electronic communications services. These four Directives must be implemented in the UK and in other EU Member States on 25 July 2003. The fifth Directive on Privacy establishes users’ rights with regard to the privacy of their communications. This Directive was adopted slightly later than the other four Directives and has an implementation date of 31 October 2003. Implementation 1.4 In the UK, it is intended to implement the four main Directives through a new Communications Act. The Communications Bill was introduced into the House of Commons on 19 November 2002 and is available at www.communicationsbill.gov.uk. The latest version of the Communications Bill is that which was amended in Committee in the House of Commons on 6 February 2003. It can be found at that website (References to the Communications Bill in this document are references to that version of the Bill). The Bill may continue to be subject to change as it proceeds through Parliament. 1.5 It is intended that the Communications Bill will receive royal assent by 25 July 2003. However, in the event that the Communications Bill does not receive royal assent by 25 July 2003, the government has acknowledged that implementation will need to occur by Statutory Instruments made under the European Communities Act 1972 for an interim period until the Bill enters into force. Further, if the Communications Bill does receive royal assent by 25 July 2003, it is expected that OFCOM will not be ready by the summer to assume all of its duties foreseen by the Communications Bill. Should that be the case, the Communications Bill makes specific provision to enable Ofcom’s functions to be carried out by the Director or the Secretary of State for a transitional period. For these reasons, this document refers to the Director rather than Ofcom. 1.6 Article 16 of the Framework Directive provides that analysis of the relevant markets for the purpose of the new regime should be carried out as soon as possible after the adoption of the European Commission’s Recommendation on markets. The Recommendation was adopted on 11 February 2003. This market review is the preparatory work required as to the analysis of markets required by the new regime. In the UK, the Electronic Communications (Market Analysis) Regulations 2003 (SI 2003/330) ("the Regulations") confirm the Director’s ability to carry out this preparatory work. Pursuant to the Regulations, Oftel is consulting on the market identification, designation of SMP (or not) and the SMP conditions proposed to be adopted on or after 25 July 2003. Regulation 8 of the Regulations enables the Director to confirm his proposals before 25 July 2003. They will then be given effect on 25 July 2003 by the new Communications Act or the interim regime introduced by Statutory Instruments. Market reviews 1.7 The new Directives include the requirement that National Regulatory Authorities (NRAs) such as Oftel should carry out reviews of competition in communications markets, to ensure that regulation remains proportionate in the light of changing market conditions. Oftel already carries out market reviews as part of its long term strategy, focusing on effective competition as the best means to deliver a good deal for consumers. 1.8 Oftel is now conducting a series of market reviews under the Regulations. Oftel aims to have the reviews completed by 25 July 2003 to ensure that any appropriate and proportionate regulation flowing from them is in place for the commencement of the new regime on that date. 1.9 Each market review has three stages:
1.10 More detailed requirements and guidance concerning the conduct of market reviews are provided in the Directives, the Communications Bill, the Regulations and in additional documents issued by the European Commission and Oftel. As required by the new regime, Oftel will take the utmost account of the two European Commission documents discussed below in this market review. Recommendation on relevant product and service markets 1.11 The European Commission has identified in its Recommendation on markets, adopted on 11 February 2003 ("the EU Recommendation"), a set of product and service markets within the electronic communications sector, which are to be reviewed by NRAs. The Recommendation seeks to promote harmonisation across the European Community by ensuring that the same product and service markets are subject to a market analysis in all Member States. However, NRAs are able to regulate markets that differ from those identified in the Recommendation where this is justified by national circumstances and where the Commission does not raise any objections. Accordingly, NRAs are to define relevant markets appropriate to national circumstances, taking the utmost account of the product markets listed in the Recommendation. SMP Guidelines 1.12 The European Commission has also issued guidelines on market analysis and the assessment of significant market power ("the SMP Guidelines"). Oftel has produced additional guidelines on the criteria to assess effective competition. These supplement the SMP Guidelines and replace Oftel’s effective competition guidelines issued in August 2000. Regulatory option appraisal 1.13 When considering the appropriate level of regulation if a finding of SMP is found, Oftel will also give consideration to its regulatory option appraisal guidelines published in June 2002. These can be found at: http://www.oftel.gov.uk/publications/about_oftel/2002/roa0602.htm. Markets considered in this review 1.14 The Review of Fixed Narrowband Retail Markets (hereinafter referred to as ‘this Review’) considers the following markets: Access markets
Call markets 1.15 The following call markets are split between residential and business customers.
Notification 1.16 Annex A contains the formal notification of the proposals made by the Director as a result of the review, including the market(s) defined, the designation of SMP and the conditions proposed as a result of the market analysis. This implements the provisions of Regulation 5(1) of the Regulations. 1.17 This document, including the formal notification in Annex A has been made accessible to the European Commission and to the Regulatory authorities in other Member States in accordance with the scheme of the Directives The relationship between the market reviews and Competition Act 1998 and Enterprise Act 2002 investigations 1.18 The economic analysis carried out in this consultation document is for the purposes of determining whether an undertaking or undertakings have SMP in relation to this market review. It is without prejudice to any economic analysis that may be carried out in relation to any investigation or decision pursuant to the Competition Act 1998 or the Enterprise Act 2002.
1.19 The fact that economic analysis carried out for a market review is without prejudice to future competition law investigations and decisions is recognised in Article 15(1) of the Framework Directive which provides that: "…The recommendation shall identify …markets …the characteristics of which may be such as to justify the imposition of regulatory obligations …without prejudice to markets that may be defined in specific cases under competition law…"
1.20 This intention is further evidenced in the European Commission’s SMP guidelines, which state:
1.21 In addition, it is up to all operators to ensure that they comply with their legal obligations under all the laws applicable to the carrying out of their businesses. It is incumbent upon all operators to keep abreast of changes in the markets in which they operate, and in their position in such markets, which may result in legal obligations under the Competition Act 1998 or Enterprise Act 2002 applying to their conduct. Current regulatory environment 2.1 At the present time a number of regulatory measures apply to BT and Kingston in the retail markets considered in this review. 2.2 The current regime is aimed at promoting competition and protecting consumers by ensuring that providers with market power do not charge excessive prices, set predatory prices, bundle retail services or show undue preference to certain customers. 2.3 The following obligations are currently imposed on British Telecommunications plc (‘BT’) and Kingston Communications (Hull) plc (Kingston):
A licence condition prevents BT and Kingston from unduly favouring a customer or a group of its customers
Licence conditions require BT and Kingston to give Oftel 28 days’ notice of changes to tariffs, terms or conditions for use of telephone services. Oftel has, for a trial period, reduced the notification period in these conditions from 28 days to one day for certain retail services (there are certain exceptions). 2.4 The following obligations are currently imposed on BT only:
Condition 70 places controls on BT’s retail prices. The control, which was implemented on 1 August 2002, was set for four years. This control requires that there should be no nominal rise in prices (RPI-RPI). This price control has applied to a group of services known as the price control ‘basket’. The services within this basket are as follows:
The basket control is focused on the expenditure patterns of the lowest 80% of residential customers because when the controls were implemented Oftel believed that it was this group of customers that most needed protection. Other customer groups – high spending residential customers and most businesses – were more likely to be able to benefit from greater competition for their custom, which Oftel believed meant that even if they remained customers of BT their prices would fall because of the effects of competition.
To ensure that BT does not introduce prices that ‘squeeze’ the margins of competitors buying wholesale inputs and damage competitors or prices that could be predatory, a licence condition currently prevents BT from setting prices that are below cost, except where the Director issues a consent.
Market definition Approach to market definition 3.1 There are two dimensions to the definition of a relevant market: the relevant products to be included in the same market and the geographic extent of the market. Oftel’s approach to market definition follows that used by UK competition authorities (see Office of Fair Trading Market Definition Guideline, OFT 403, March 1999, which is in line with those used by European and US competition authorities. 3.2 Market boundaries are determined by identifying constraints on the price-setting behaviour of firms. There are two main competitive constraints to consider: how far it is possible for customers to substitute other services for those in question (demand- side substitution); and how far suppliers could switch, or increase, production to supply the relevant products or services (supply-side substitution) following a price increase. 3.3 The concept of the ‘hypothetical monopolist test’ is a useful tool to identify close demand-side and supply-side substitutes. A product is considered to constitute a separate market if a hypothetical monopoly supplier could impose a small but significant, non-transitory price increase (SSNIP) above the competitive level without losing sales to such a degree as to make this unprofitable. If such a price rise would be unprofitable, because consumers would switch to other products, or because suppliers of other products would begin to compete with the monopolist, then the market definition should be expanded to include the substitute products. 3.4 Throughout this consultation document, markets will be defined first on the demand-side. The analysis of demand-side substitution will be undertaken by considering if other retail services could be considered as substitutes by consumers, in the event of the hypothetical monopolist introducing a SSNIP above the competitive level. 3.5 Supply-side substitution possibilities will then be assessed to consider whether they provide any additional constraints on the pricing behaviour of the hypothetical monopolist which have not been captured in the demand-side analysis. In this assessment, supply-side substitution will be considered as a low cost form of entry which could take place within a relatively short period of time. [The OFT Guidelines on Market Definition, OFT 403, March 1999, consider the relatively short period to be within a year.] That is, for supply side substitution to be relevant, there would need to be additional competitive constraints arising from entry into the supply of the service in question, from suppliers who are able to enter quickley and at low cost, by virtue of their existing position in the supply of other services. 3.6 There might be suppliers who provide other services but who might also be materially present in the provision of demand-side substitutes to the service for which the hypothetical monopolist has raised its price. However, such suppliers are not relevant to supply-side substitution since they supply services already identified as demand-side substitutes. As such their entry has already been taken into account and so supply-side substitution cannot provide an additional competitive constraint on the hypothetical monopolist. However, the impact of expansion by such suppliers can be taken into account in the assessment of market power. 3.7 A third factor that is sometimes an additional consideration is whether there exist common pricing constraints across customers, services or areas such that they should be included within the same relevant market even if demand- and supply- side substitution are not present. 3.8 In defining a relevant market, it is usual to begin with a fairly narrow view and then expand that market to include the relevant substitutes. The European Commission (EC) has identified the following retail markets:
3.9 The Director proposes narrowing the definition of access markets suggested by the EC and also proposes to review calls to mobiles and operator assisted calls. The reasons for identifying these as separate markets are set out below and the extent of competition in these markets is analysed in Chapter 4. Remedies are considered in Chapters 5 and 6. 3.10 It is important to consider whether competitive conditions in the supply of a service vary by customer group and so whether separate markets should be defined for different customer groups and the Director has done so in carrying out this Review. BT has requested that Oftel define a separate market based on business customers spending over £10million per annum on telecommunications services. BT has also requested that Oftel accept that this ‘market’ is competitive and therefore not to impose ex-ante regulation such as price publication and notification requirements. 3.11 Oftel does not accept BT’s proposals for market definition for major business customers. The reasons for doing so are discussed in Chapter 7 on business tariffing issues in which Oftel invites views in respect of its proposed ex-ante regulation of BT’s activities in this area. 3.12 The market definitions that follow are intended to relate to the service being delivered, and not the underlying technology. This means that:
Narrowband access markets: product market definition 3.13 Before defining the relevant narrowband access markets in this review, the Director believes it is helpful to first briefly summarise the different types of narrowband exchange lines and the voice and Internet services that are provided over them to both the residential and business markets in the UK. There is particular emphasis on those service characteristics that differentiate the line types. Exchange line types 3.14 BT and Kingston currently provide the following types of exchange lines over their local access networks:
3.15 The UK cable companies, ntl and Telewest, currently provide the following types of exchange line services over their cable networks:
3.16 A number of other operators provide ISDN access services to larger business sites, using their own fibre or wireless access networks. Most of these exchange lines are ISDN30, since the provision of ISDN2 over fibre or wireless tends to be fairly inefficient. The services offered are similar to the ISDN services offered by BT and Kingston. Access services relevant to residential customers 3.17 Most residential consumers obtain their voice telephony service via either analogue exchange lines, or cable telephony. The requirements for residential telephony are fairly straightforward, including some basic Select Services such as Call Waiting, but not the wide range of Select Services used by business customers. 3.18 Many residential consumers also use an analogue exchange line to provide dial-up Internet access. However, some residential consumers requiring higher bandwidth have upgraded to 128 kbit/s digital exchange lines. The specific services that are included within this category are BT’s residential ISDN2 service (Home Highway) and ntl’s 128 kbit/s cable modem service. Key attributes of these services include:
3.19 Another important characteristic is the type of equipment that consumers connect to the exchange line. Residential consumers will frequently connect multiple terminal devices to a single exchange line. For example, BT’s residential ISDN2 service (Home Highway) allows multiple ISDN devices to be connected to a single exchange line. Residential consumers will not normally connect a PBX to an exchange line. Access services relevant to business customers 3.20 The access services required by business customers can be different to those required by residential customers. Very small businesses such as SoHo (Small Office Home Office) will share similar characteristics to residential users. However, businesses with more than a few employees will often need multiple voice channels. This can be supported via multiple analogue exchange lines, but many larger businesses will meet this requirement by using multiple ISDN channels. Businesses requiring up to 8 voice channels will typically use ISDN2, and businesses requiring in excess of 8 voice channels will typically use ISDN30. These multiple voice channels will normally be routed via a PBX. It is possible to connect multiple analogue exchange lines to a single PBX, and configure these lines so as to share the same directory number. However, many modern ISDN PBXs require ISDN exchange lines. These ISDN exchange lines will often be provided in conjunction with Direct Dialling In (DDI), in order to allow direct dialling to individual PBX extensions. 3.21 The more complex call-handling requirements of many business customers leads to the provision of an enhanced set of supplementary services over a typical business exchange line. For example, BT’s business ISDN2 service supports a much wider range of Digital Select Services than its residential ISDN2 service, including such services as Call Deflection and Call Forwarding. In addition, many larger business customers require a telephony solution that does not just support multiple employees, but also supports multiple sites. 3.22 It is likely that very small business customers are likely to use narrowband exchange lines for both Internet access and voice telephony. However, as the size of the business increases, it becomes more likely that the business will obtain its Internet access via a separate broadband connection or leased line. The primary function of a narrowband business access service (analogue or digital) for larger businesses is to support business telephony. Narrowband access market definitions 3.23 In order to define the relevant access markets, it is necessary to consider whether:
Fixed narrowband access vs. other forms of access 3.24 When considering demand-side substitution it is also necessary to examine the services that customers can obtain, using their retail exchange lines, the demand for which drives the demand for fixed exchange lines. It is thus necessary to also consider the complementary nature of voice telephony and Internet access within the following analysis. 3.25 In order to establish whether fixed narrowband access is distinct from other forms of access, it is necessary to consider whether:
Fixed narrowband access vs. broadband access 3.26 Any potential substitutability between narrowband and broadband access services will be driven by potential substitutability between the applications that the two types of access support. As Oftel considers that, leased lines aside (these are considered later in the analysis), broadband access is predominantly used to support Internet access, it is key to consider the extent to which narrowband Internet access and broadband Internet access are substitutable. 3.27 Substitution between narrowband Internet access and broadband Internet access is mainly relevant to the provision of residential analogue exchange lines and residential 128kbit/s-capable exchange lines. As explained above, Oftel believes that the majority of narrowband business exchange lines support business telephony and not Internet access and, therefore, there is significantly less scope for substitutability between business narrowband exchange lines and broadband Internet access. 3.28 Broadband Internet access via ADSL or cable modems has a number of characteristics that individually or as a group distinguish it from narrowband Internet access via analogue or ISDN exchange lines:
3.29 Increasingly in the future, broadband Internet access will also provide access to a greater range of services such as advanced web pages that can feature bandwidth-intensive features such as high-resolution graphics, animation, streaming audio, and active menus. Another feature of advanced web pages is streaming video; ie, movie trailers, animation, news programs and product advertisements. Demand-side substitution: narrowband and broadband 3.30 In considering whether narrowband and broadband services are effective substitutes, it is necessary to consider whether broadband Internet access services constrain narrowband prices to the competitive level such that a hypothetical monopolist in the supply of narrowband Internet access services would not find a SSNIP profitable. 3.31 Narrowband and broadband Internet access are to some extent demand-side substitutes. Whether or not the extent of substitution is sufficiently large for them to be in the same market turns on the relationship between consumers' relative willingness to pay for the higher quality of broadband Internet access compared with the evolving price and cost differential between broadband and narrowband Internet access. The cost differential is relevant because the competitive level of prices for each service would reflect costs. 3.32 The ideal market information to address this question would be the extent to which movements in the price of narrowband Internet access affects movements in the price of broadband and vice versa. Parallel movements in the two sets of prices would provide prima facie evidence that narrowband and broadband Internet access are in the same economic market on the demand-side. However, decisive evidence on this point is not yet available, due to the immaturity of broadband Internet access services. A robust analysis of narrowband and broadband relative price movements will only be possible as broadband Internet access services mature, prices gravitate to a longer term equilibrium based on maturing underlying costs and broadband and narrowband customers develop a greater understanding of the relative functionalities of Internet access services. 3.33 In the absence of a robust price differential analysis, the question of demand-side substitutability of narrowband and broadband Internet access is considered with reference to:
Narrowband and broadband price differentials
3.34 As is explained in the consultation document, Review of the wholesale unmetered narrowband Internet termination market, published today (‘the Wholesale Fixed Narrowband Market Review ‘) the Director considers there to be two distinct narrowband Internet access retail markets, metered and unmetered. Oftel believes that it is useful to consider each type of narrowband Internet access in turn, as there is the potential for broadband services to impose different pricing constraints on each of them.
3.35 Metered Internet access users are distinguished from other types of Internet access users by the fact that they tend to be relatively low volume users of the Internet. The benefits of a broadband access service are therefore unlikely to outweigh the price premium for broadband access for these types of users given current price differentials. Therefore, if a hypothetical monopolist raised the price of narrowband metered Internet access by 10%, it is unlikely that a sufficient number of these users would switch to broadband to make this price rise unprofitable. Therefore, demand-side substitution with broadband is unlikely to provide a constraint on metered narrowband Internet access.
3.36 Unmetered narrowband and broadband share the feature of unlimited access to the Internet. It is possible therefore that unmetered Internet access users may perceive broadband access as a closer substitute than metered narrowband access users. 3.37 It is useful to distinguish two types of unmetered narrowband users. Typical narrowband unmetered access users are those with a single telephone line connected to the Internet by a modem, paying a flat fee per month. The other type of unmetered narrowband users have a second telephone line that is dedicated to the Internet connection. In addition to the unlimited access, such users would value the ability to use the telephone for voice calls while connected to the Internet that the second line provides. In that sense, the narrowband connection offers them one of the features of broadband. 3.38 It is also useful to consider price differentials between narrowband unmetered access, with both a single line and with two lines, and broadband access. Some examples of current prices are provided in the table below; it assumes that the customer already possesses an analogue exchange line. Narrowband vs broadband price differentials
Source: Suppliers’ web-sites. If not stated otherwise all prices include VAT. 3.39 Given this pricing information, it is necessary to consider whether in the event of the hypothetical monopolist of unmetered narrowband access raising the price by 10%, there would be sufficient demand-side substitution to broadband that would make the SSNIP unprofitable. 3.40 The above table illustrates that monthly rates for a single line unmetered package are much lower than a broadband package and hence even if prices increased by 10%, prices would still not be comparable. Hence it is unlikely that this would constrain a hypothetical monopolist from finding a SSNIP in narrowband unmetered Internet access profitable. There are unlikely to be sufficient narrowband unmetered customers who value the extra functionalities of broadband Internet access enough to pay for this price (and assumed cost) differential between the two types of access. Therefore, demand-side substitution for broadband is unlikely to provide a constraint on unmetered narrowband single line Internet access. 3.42 Turning to consider unmetered narrowband customers with dedicated second lines, the prices paid by these customers are much closer to, and even in excess of, available broadband prices, taking into account connection fees and modem costs. It could, therefore, be argued that at current price levels there is a strong incentive for narrowband customers with a second line to move to some broadband packages due to the additional features that broadband can offer at similar prices. It is likely that many of these narrowband customers will have already switched to broadband. 3.43 Those narrowband customers who still choose to use a narrowband connection with a second line probably do not place a higher value on the additional features of broadband. It seems likely to Oftel that these customers will represent a relatively small proportion of narrowband unmetered customers. Even if all of these second line customers switched to broadband in reaction to a SSNIP by a hypothetical monopolist of narrowband unmetered Internet access, their numbers would be insufficient to render the SSNIP unprofitable. (Oftel is currently undertaking market research in order to verify this view). In addition, there may be customers who do not have the potential to access reasonably priced broadband services and are not likely to have such access in the near future. Faced with a price rise, such customers would not be able to switch and therefore could not constrain the monopolist's ability to raise prices profitably.
3.44 Having considered the demand-side substitutability of narrowband Internet access provided over analogue lines and broadband Internet access, the following considers the potential for demand-side substitution between narrowband Internet access provided over ISDN/128kbit/s-capable digital access services and broadband Internet access. As is explained in detail later in this chapter, the Director defines separate narrowband access markets for: residential analogue exchange line services; residential 128kbit/s-capable digital access services; business analogue exchange line services; business ISDN 2 exchange line services; and business ISDN 30 exchange line services. As noted above, larger business customers’ usage of ISDN2 and ISDN30 narrowband access is primarily to obtain multiple switched voice channels and not Internet access. Consideration here thus focuses on residential 128kbit/s-capable digital access narrowband customers obtaining Internet access. The potential retail substitutability of narrowband access and leased lines (used to provide business voice and data services) is considered later in this chapter. 3.45 Oftel does not consider that residential 128kbit/s-capable digital narrowband Internet access customers would find broadband Internet access an adequate substitute at cost based prices. 3.46 128kbit/s-capable digital narrowband access is currently provided in the UK via ISDN 2 and cable modem services. As explained in detail later in this chapter, Oftel does not consider that BT’s ISDN 2 prices are currently set at the competitive level - ISDN 2 narrowband access is thus not considered in the present analysis. This pricing analysis concentrates on 128kbit/s-capable digital access provided over cable. ntl are currently the only providers of this service. 3.47 Pricing comparisons between ntl’s narrowband unmetered 128kbit/s-capable digital Internet access and broadband Internet access are made simple by the fact that ntl’s 128kbit/s Internet service when taken with cable voice telephony allows simultaneous voice and unmetered Internet calls as with broadband Internet access. This means that a direct comparison between the price of broadband Internet access services offered by ISPs, such as Pipex and ntl, can be made with the price of ntl’s 128kbit/s Internet access service. 3.48 As can be seen from in the ‘Narrowband vs broadband price differentials’ table above, the monthly rental charges for broadband Internet access range from approximately £23.50 to £30 and are also subject to connection and modem charges. ntl’s residential broadband standard price is £24.99 per month plus a connection fee of £25. (This broadband connection fee is currently being waived by ntl as a special offer due to expire on 30 June 2003.) When these prices are compared to ntl’s 128kbit/s Internet access price of £14.99 per month (This includes free rental of cable modem equipment.) with the same £25 connection fee, it is clear that the price of 128kbit/s Internet access is much lower than a broadband package. 3.49 Even if 128kbit/s-capable digital Internet access prices increased by 10%, these prices would still not be comparable to broadband Internet access prices. Hence, it is unlikely that this would constrain a hypothetical monopolist from finding a SSNIP in 128kbit/s-capable digital Internet access profitable, as there are unlikely to be sufficient narrowband 128kbit/s-capable digital Internet access customers who value the extra functionalities of broadband Internet access enough to pay for this price differential between the two types of access. Therefore, demand-side substitution with broadband is unlikely to provide a constraint on narrowband 128kbit/s-capable digital Internet access. 3.50 It therefore appears unlikely that there would be sufficient demand-side substitution between narrowband unmetered Internet access (provided over both analogue exchange lines and 128kbit/s-capable digital exchange lines) and broadband access for these services to be subject to a common pricing constraint. Therefore demand-side substitution with broadband is unlikely to provide a sufficient constraint on a hypothetical monopolist in the supply of all unmetered narrowband Internet access such that it would render a SSNIP unprofitable. 3.51 It is difficult to be precise regarding the relative reduction in retail broadband Internet access rental prices, compared to narrowband, over the course of 2002. This is due to issues relating to the treatment of connection and modem charges, both in terms of the correct period over which to amortise these charges in the absence of mature customer life information and the fact that these charges are subject to numerous special offers in order to win broadband customers. However, over 2002 the Director estimates that the relative price of residential broadband rental generally reduced in the region of 20-30%. It is likely that this was due to a reduction in the underlying costs of providing these still maturing services as operators start to achieve scale economies coupled with an industry desire to encourage broadband take-up. 3.52 As the relative price of broadband Internet access fell so its take-up in the UK rose significantly (for full details of this increased take-up please refer to the Director’s wholesale broadband access review). From confidential information received from both narrowband and broadband Internet access providers the Director believes that the majority of new broadband subscribers in 2002 migrated from narrowband Internet access services. 3.53 However, this switching phenomenon does not provide evidence that a SSNIP by a hypothetical monopolist in the provision of narrowband Internet access would not be profitable. The still substantial price differentials between broadband and narrowband and the following consumer survey evidence suggests that there exists a significant proportion of current narrowband Internet access customers who would not switch given a SSNIP by a hypothetical monopolist such that a SSNIP would be likely to be profitable. (Oftel is currently undertaking market research in order to verify this view) Customer survey evidence 3.54 Oftel research in August 2002 (published in October 2002) Consumers' use of Internet found that 32% of narrowband customers currently using an analogue or ISDN line to access the Internet at home claimed to be interested in upgrading to broadband DSL or cable modem access. This equates to approximately 3 million Internet homes being interested in upgrading to broadband Internet access but the bulk of narrowband Internet access customers, over 6 million, are not. Supply-side substitution: narrowband and broadband 3.55 The potential for supply-side substitution from broadband Internet access to constrain the pricing of a hypothetical monopolist in the supply of narrowband Internet access is not relevant in the present analysis. This is due to the fact that the UK’s largest broadband access network operators are already significantly active in the supply of narrowband services and so will already be included in this market. Any competitive constraint they provide in the narrowband access markets will be captured in the SMP analysis of narrowband access. 3.56 It is also the case that any potential for supply-side substitution between broadband and narrowband Internet access at the retail level that is dependent on the availability of regulated wholesale inputs is not relevant in the present analysis. Conclusion: narrowband and broadband 3.57 Demand-side substitution between narrowband and broadband Internet access is likely to be limited by their distinct functionalities and the associated underlying cost differences in providing the two services. Supply-side substitution by broadband Internet access suppliers into narrowband access is not relevant to the present analysis. Therefore, a hypothetical monopolist in the supply of narrowband Internet access is unlikely to be constrained to pricing to the competitive price level by the availability of broadband Internet access. The Director therefore considers that narrowband access is a separate market from broadband access and this conclusion is unaffected by the use of narrowband services for Internet access. Fixed Narrowband Access vs. Leased Lines 3.58 There are a number of potential links between fixed narrowband access services and the leased lines. Specifically:
3.59 In addressing whether leased lines are demand-side substitutes for ISDN30 or ISDN2, the key point is that leased lines provide only transmission capacity to fixed locations for voice or data services. The fixed narrowband access services we are considering here are intended to provide a switched voice and data access services. In order to provide switched services it is necessary not just to have transmission capacity, in the form of leased lines, but to have access to a switched network that is capable of providing telephony services and an IP network capable of providing IP transit to the core Internet. 3.60 A retail customer does not have access to either a switched network or an IP network and therefore cannot purchase leased lines as a demand-side substitute for narrowband analogue, ISDN2 or ISDN30 exchange lines. 3.61 On the supply-side, the sunk cost of converting a leased line to analogue, ISDN2 or ISDN30 is significant (see the discussion on partial private circuits (PPCs) in Chapter 13) and therefore they are not supply-side substitutes. Conclusion: fixed narrowband access and leased lines 3.62 A hypothetical monopolist in the supply of narrowband exchange lines would not be constrained from conducting a profitable SSNIP by either demand-side or supply-side substitution from leased lines. The Director therefore proposes that they constitute separate economic markets. Fixed Narrowband Access vs. Mobile Access Demand-side substitution: fixed and mobile voice 3.63 For the purpose of voice telephony, mobile phones may be viewed by consumers as adjuncts to fixed line phones; the latter are attached to a place, the former belong to a person and can travel with that person. 3.64 Quantitative research commissioned by Oftel in November 2002, found that only 7% of UK adults use only mobiles to make and receive telephone calls. This is slightly higher than figures found in surveys conducted earlier in the year where approximately 5-6% of UK adults use mobiles only. However, even with this slight rise, it is still apparent that over 90% of UK adults continue to use their fixed line. This seems to indicate that the growth of mobile phones can largely be seen as an adjunct to the fixed market rather than a substitute. 3.65 More detailed analysis from a survey conducted in February 2002 had shown that only about 17% of UK adult consumers use their mobile as their main method of phone calls and, of these, 8 out of 10 have a fixed line at home. Further, the survey found that 77% of residential consumers still consider their fixed line as their main method of making and receiving calls. Consumers who choose predominantly to use only mobiles appear to do so due to the distinguishing feature of mobiles (i.e. the mobility element). 3.66 Evidence of changing call patterns can be found from Oftel’s Market Information. This shows that the number of voice minutes from fixed lines has continued to fall over recent quarters. However, this fall in call minutes from fixed lines has been more than offset by an increase in call minutes from mobile phones, meaning that the overall trend in minutes is still upward. However, it is not sufficient to rely on trends in fixed and mobile call volumes to infer causality, ie substitution from fixed to mobile calls such that these are in the same market. For example, some of the decline in fixed voice call volumes will reflect, to a degree, increased use of e-mail (although as argued below, Oftel does not consider e-mail a substitute for fixed voice calls). Fixed and mobile voice calls 3.67 When considering the potential substitutability of fixed and mobile access, it is important to recognise the effect of "buy-through" such that potential substitutability will also depend on relative call prices (and associated call functionalities) of the two forms of access. 3.68 In considering whether a call from a mobile to a fixed line or to another mobile is an adequate substitute for a call from a fixed line, a number of issues arise. In the first instance, substitution is more likely if the caller already has a mobile and therefore bases their decision on the marginal call price. Oftel’s quarterly residential survey published in August 2002 indicates that the proportion of households with both a fixed and a mobile phone is estimated at 73%. The same survey reports that about two-thirds of consumers with both fixed and mobile phones find occasions on which they use their mobile instead of their fixed telephone. (This proportion is virtually unchanged from two years ago.) This means that just less than one third are not substituting mobile usage for fixed to take advantage of lower prices at certain times, or for convenience. 3.69 However, only a minority of consumers with both fixed and mobile phones use a mobile instead of a fixed phone either at certain times of day or to call certain numbers on the basis of price differences (10% and 9% of consumers, respectively – see Oftel’s quarterly residential survey published in August). 3.70 The size of the price differential between calls from fixed and mobile phones depends on a number of factors including whether the caller’s mobile tariff package provides an allowance of ‘free’ calls in return for a fixed fee. Where users purchase an allowance of free calls with their subscription, the marginal call price may be regarded as zero and this may encourage use of the mobile in preference to the fixed phone. However, the possible scale of substitution of calls from the fixed line may be limited if the allowance of free calls is small relative to the volume of fixed line calls. In addition, whilst some off-peak mobile tariffs are now comparable to some prices for calls on the fixed network, the general price premium for making calls form a mobile suggests that mobile prices do not constrain the prices of calls from a fixed line. [For example, O2's Leisure Time tariff
(£15 monthly subscription and 500 off-peak mins) has the following
prices, which are among the lowest pence per minute (ppm) rates available.
(NB all prices shown below are inclusive of VAT).
3.71 Another consideration arises in the case of substitution by mobile to mobile calls. This is most relevant for fixed to mobile calls. Absent other information, the probability that a call will remain on-net will reflect the market share of the mobile operator in question, which will currently lie between around 24% and 27% on the basis of total subscriber numbers (see Oftel’s quarterly Market Information: Mobile Update, October 2002). However, it is likely to be higher if the caller is a member of a ‘closed user group’. A closed user group can be defined as an identifiable group of people who have an interest in how much it costs to call each other. Nevertheless, it is not always the case that even on-net calls are cheaper than the corresponding fixed to mobile call for given times of day. [This can be seen from the preceding footnote, where calls to O2 from a BT fixed line are cheaper than on-net O2 calls during daytime periods for the Leisure Time tariff (although given the design of the tariff this is perhaps not surprising). With the exception of the Pay & Go tariffs, O2 tariffs where the daytime on-net price is lower than the fixed to O2 price, the weekend on-net price is generally greater than the above fixed to O2 price.] 3.72 Moreover, mobile operators’ traffic-sensitive costs are expected to remain above those of fixed networks. Therefore, starting with both services priced at their respective competitive levels, it is unlikely that a SSNIP above the competitive level of a call originating on a fixed line would induce a sufficient amount of demand-side switching to mobile originated calls. Even with mobile originated calls priced at the competitive level, a significant price differential would likely remain.[To illustrate this, the network charge control model yields a LRIC+EPMU value for fixed call origination to the tandem layer of 0.292ppm for 2002/03. Oftel's modelling of the costs of mobile networks pursuant to the Competition Commission investigation of mobile termination rates yields a LRIC+EPMU figure of 2.494ppm for call origination to the tandem layer (for both the 900MHz and 1800MHz operators). For 2005/06, LRIC+EPMU fixed call origination to the tandem layer is forecast to be 0.234ppm, whereas for mobile call origination to the tandem layer it is forecast to be 2.321ppm. Although call origination is just one element of an end-to-end call, these figures suggest that at the competitive level, the price differential between fixed-to-fixed and mobile-to-fixed calls would currently be around 2.2ppm and three years hence would be around 2.1ppm. This margin is significantly greater than the ppm increase implied by standard application of the SSNIP test at 5-10 per cent, ie 0.015ppm or 0.029ppm (using the current estimated fixed call origination value).] Consumers may well be prepared to pay some premium for the additional convenience of mobiles but full substitutability of residential fixed lines by GSM is unlikely as long as a significant price premium remains. 3.73 One important message coming through from the qualitative results is that a majority of mobile phone calls made by consumers are short convenience calls such as calling someone whilst walking home from the station – the type of call that, by definition, cannot be made from a fixed line. The qualitative analysis suggests that the advent of the mobile has, to a significant degree, expanded the market for making calls, rather than substituting fixed calls, implying that a large majority of mobile calls are an adjunct to fixed calls.
3.74 In terms of comparing overall package prices, Oftel has conducted a comparison of fixed and mobile prices (covering access and calls) over the period December 1998 to December 2002, comparing the overall trends in the best deal available to consumers - using either BT or the cheapest mobile package - for a range of usage profiles. The analysis indicates that for comparable usage packages, mobile prices were, at December 2002, on average about 20% above fixed prices (using BT’s prices as typical for fixed telephony prices). This figure varies considerably for different types of users, with Oftel’s analysis indicating that mobile prices are between 4% and 36% more expensive than fixed depending on the usage profile selected. Thus, for certain types of user the overall price of using a mobile is now quite similar to fixed while for others mobiles are significantly more expensive. Generally, it seems that peak users face the highest premiums for using mobile telephones. 3.75 Mobile prices have, over the past few years, been falling faster than fixed prices, meaning that the gap between them has narrowed. Recent evidence suggests that the rate of decrease of mobile prices has begun to slow meaning that the speed of convergence has also slowed. Oftel’s analysis indicates that between June 2001 and June 2002 mobile prices fell by approximately 4.3% compared with a fall in BT’s prices of 2.7%. Nevertheless, as long as this price convergence continues, then there may begin to be more evidence of mobile substituting for fixed in future. Again it should be emphasised that this comparison is not on the basis of the competitive level of prices. Demand-side substitution: fixed and mobile narrowband Internet access 3.76 Internet access on mobile networks is not an effective demand-side substitute for Internet access on fixed networks. Internet access on a mobile phone currently offers considerably less functionality than on fixed network. For example, only a fraction of the Internet is accessible and only part of this fraction is delivered because of the constraints of screen size on mobile telephones. Further, interactivity is constrained because of the lack of a full-size keyboard. The prices for using Internet access over mobile networks are also generally high relative to Internet access over fixed lines. The extent of substitutability might need to be reviewed in future following the take-up of new mobile technologies offering packet switched services, such as General Packet Radio Service (GPRS) and Universal Mobile Telecommunications System (UMTS, also known as 3rd Generation Communications System). Supply-side substitution: fixed and mobile 3.77 On the supply-side, there appear to be few opportunities for substitution between fixed and mobile services. There are high sunk costs involved in building a fixed narrowband network. Sunk costs are those costs that must be incurred to enter a market but which cannot be recovered on exit. In order for supply-side substitution to exert a competitive constraint on a hypothetical monopolist, there should be no sunk costs incurred in switching. Conclusion: fixed and mobile 3.78 The above considerations of the substitutability of fixed narrowband access with mobile access suggest that the two are not effective substitutes at the retail level on either the demand or supply-sides when being used for either voice telephony or Internet access services. Disaggregation of retail fixed narrowband access services 3.79 Having proposed that retail fixed narrowband access services are distinct from broadband access, leased lines, and mobile access, the following section now considers whether the different forms of narrowband access services should each form distinct markets. There are considerable differences in functionalities afforded by the different access services which are in turn reflected in their retail prices through both the underlying cost differences in their provision and customers’ willingness to pay. This chapter considers in turn whether there are separate markets for:
Business vs. residential access Demand-side substitution: business and residential 3.80 As discussed previously, business and residential users have different needs from the telecommunications services in question. Business users tend to require a greater range of services and use narrowband access primarily for telephony. Residential users, on the other hand, need fewer value-added services and use narrowband exchange lines for Internet access as well as telephony. 3.81 In addition to the different services required by business and residential users, the ability to price discriminate successfully between business and residential customers for essentially the same narrowband exchange line is an indication that there are separate markets for business and residential access. The ability to undertake such discrimination is based upon business customers’ general greater willingness to pay for the various types of exchange line services compared to residential customers. This is coupled with the providers’ ability to identify business customers with sufficient accuracy to make the discrimination profitable. 3.82 BT’s standard domestic analogue line rental is £10.50 per month including VAT, the business equivalent is £16.12 per month (including VAT). Whilst business analogue access services possess some distinctive features, particularly in terms of an entry in the business phone directory, the additional costs of these features do not explain the price difference. 3.83 It is also the case that there are higher retail prices for business ISDN2 customers compared to residential ISDN2 customers. BT’s residential ISDN2 charges are £275 per line for connection and £23 per line per month for rental (including VAT), compared to BT’s ISDN 2/2e ‘Low Start’ business package priced at £292.58 per line for connection and £36.43 per line per month for rental (including VAT). The per-line rental charge to business customers is over 50% higher (including VAT) than that for residential customers. Oftel believes that this price difference is again in excess of the cost differences of providing the two services, for example compatibility with a PBX, which are minimal. 3.84 ISDN 30 narrowband exchange lines are not sold to residential customers who do not require the greater functionalities associated with these lines. Furthermore, ntl’s 128kbit/s-capable digital access is solely a residential service. 3.85 Given this practical ability to price discriminate, a hypothetical monopolist in the supply of narrowband access to business customers would be unlikely to have a SSNIP above the competitive level rendered unprofitable by demand-side substitution to residential access. This is due both to the different demand characteristics discussed above and to the ability of the operators to identify business customers and disallow their use of residential services. 3.86 It is also the case that a hypothetical monopolist in the supply of narrowband access to residential customers would be unlikely to have a SSNIP above the competitive level rendered unprofitable by demand-side substitution to business access due to the current premiums for business customers being well in excess of the price rises relevant to a residential SSNIP above the competitive level. Supply-side substitution: business and residential 3.87 On the supply side, separate hypothetical monopolists in the supply of business and residential narrowband access would be unlikely to have SSNIPs above the competitive level rendered unprofitable by supply side substitution from the other service at the retail level (in the absence of effective wholesale markets). This is because in the UK residential and business customers tend to be in distinct geographical locations. This will reduce the extent of supply side substitution at the retail level because a supplier of narrowband access to business customers would need to incur significant sunk costs and take the time to build out its network in order to compete against a supplier of access to residential customers and vice versa. 3.88 Although smaller businesses in particular may be more likely to locate close to their customers, the fact that retail charges for business and residential access are different suggest separate markets between which operators are capable of setting discriminatory prices. Conclusion: business vs residential access3.89 The above analysis leads the Director to propose that business and residential narrowband access constitute separate markets. Separate analogue, 128kbit/s-capable digital access (including ISDN2) and ISDN30 access Demand-side substitution: analogue and 128kbit/s-capable digital (including ISDN2) access 3.90 There are some key functional advantages of 128kbit/s-capable digital access provided over both cable modems and ISDN 2 technologies compared to narrowband analogue access. These relate primarily to Internet access and telephony capabilities:
3.91 As stated earlier, Oftel believes that residential customers generally use 128kbit/s-capable digital access to provide them with relatively swift Internet access and simultaneous voice telephony, whilst many business customers will use ISDN2 based 128kbit/s-capable digital access to provide multiple voice channels through a PBX. Larger business customers will be less interested in the data functionality of ISDN2. It is thus the case that customers in the separate business and residential narrowband access markets will tend to be attracted to a sub-set of the above additional capabilities compared to analogue access. 3.92 Due to these additional capabilities, 128kbit/s-capable digital access service customers are unlikely to find analogue exchange line services suitable demand-side substitutes. 3.93 Further evidence that analogue access and 128kbit/s-capable digital access are unlikely to be demand-side substitutes for both residential and business customers comes from analysis of the retail price differences that exist between the two types of access. 3.94 BT’s standard residential domestic analogue line rental is £10.50 per month including VAT [BT's quarterly standard rental price for a new telephone line is £31.49. ]coupled with a connection fee of £74.99. BT’s ISDN Home Highway residential ISDN2 package is priced at £275 per line (2 channels) for connection and £23 per line per month for rental. ntl’s residential 128kbit/s-capable digital access costs £25 connection fee and £24.50 per month rental (this includes Internet access and fixed voice telephony access). However, it should be noted that the ntl service includes unlimited Internet access calls, although ISDN2 does not. 3.95 Therefore, the monthly rental for residential 128kbit/s-capable digital access is twice the price of analogue access and whilst there is the potential that these 128kbit/s-capable digital access prices have been set above the competitive level, as will be explained in the following supply-side substitution analysis, the competitive price level of these digital access services would in any event be significantly above that of analogue access. 3.96 Turning to the business market, analogue access and 128kbit/s-capable digital access (ISDN 2) business access are unlikely to be demand-side substitutes given the retail price differences that exist between the two types of access. ntl’s 128kbit/s-capable digital access service provided over cable modems is not sold to business customers. 3.97 BT’s standard business analogue line rental is £16.12 per month including VAT plus a £116.33 connection fee, whereas BT’s ISDN2/2e ‘Low Start’ business package is priced at £292.58 per line for connection and £36.43 per line per month for rental (including VAT). 3.98 Therefore, ISDN2 business access is in excess of twice the price of analogue access. As with residential prices, it is possible that ISDN2 prices have been set above the competitive level. However, the competitive price level of these digital access services would in any event be significantly above that of analogue access. 3.99 The functionality and retail price differences identified between both business and residential analogue and 128kbit/s-capable exchange line services strongly suggest that a hypothetical monopolist in the provision of either analogue or 128kbit/s-capable digital access who attempted a SSNIP above the competitive level, would not find the profitability of this constrained by demand-side substitution in significant numbers towards the other form of narrowband access. This is because existing analogue access customers are unlikely to value the increased functionality of 128kbit/s-capable digital access to the extent of the underlying cost difference between the two less the effect of the SSNIP. Whilst 128kbit/s-capable digital access customers are unlikely to be willing to give up the extra functionalities of their 128kbit/s-capable access (in terms of demand-side substitution towards analogue access) given a SSNIP. Demand-side substitution: 128kbit/s-capable digital (ISDN2) and ISDN30 3.100 ISDN30 is a relatively bespoke narrowband access service designed to cater for larger business sites when compared to single line ISDN 2 services. BT Retail states that the entry level for ISDN30 is 8 channels, and it charges on a per channel basis only above this level. As explained earlier, residential customers do not purchase ISDN 30 services. The relevant demand-side substitutability analysis in this section therefore relates to ISDN 2 services that are also purchased by business access customers. ntl’s cable modem 128kbit/s-capable digital services are only sold to residential customers. 3.101 Business ISDN2 services are designed to cater for smaller business sites with single line ISDN 2 services providing 2 channels. BT Retail states that its ISDN2 service is appropriate for sites requiring up to 8 voice channels. ISDN2 is not generally used for much larger sites, since the PBXs on these sites will normally be designed to support an ISDN30 connection, not a large number of ISDN2 connections. 3.102 It is therefore not cost-effective at current prices for a customer requiring under 8 channels to substitute an ISDN30 service for an ISDN2 service. 3.103 However, the SSNIP test should be conducted from the competitive level of prices (ie cost based prices) for the two services. Whereas ISDN2 is provided over narrowband copper loops, the majority of ISDN30 access is provided over fibre or HDSL enabled copper. It is thus the case that the cost of providing a single line ISDN2 service over copper is considerably cheaper than providing the same access service over either fibre or HDSL enabled copper. The cost of providing ISDN30 over either fibre or HDSL enabled copper will however be considerably cheaper than providing the same service over multiple ISDN2 copper | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
