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| Review of Fixed Narrowband Retail markets - 17 March 2003 | |
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Introduction 6.1 The following chapter considers the options for remedies in response to the initial findings of SMP in Chapter 4 in respect of the markets listed in paragraphs 5.1 and 5.2. 6.2 In the Regulatory Option Appraisal Guidelines published on 28 June 2002 Oftel set out a structured way to assess the advantages and disadvantages of different decision options facing Oftel. Consistent with these guidelines, this chapter considers a range of options for remedies in markets where there have been findings of SMP including an assessment of the impact on various stakeholders and makes a series of recommendations for consultation. 6.3 Chapter 7 considers specific issues relating to business tariffing. Chapter 8 covers the need for obligations for cost accounting and accounting separation. Pricing 6.4 A concern arising from a finding of SMP in retail markets is the ability of the SMP provider to maintain prices at a level higher than they would be if competition were effective. In the absence of competitive pressure, a firm with market power will profitably be able to sustain prices above costs in such a way as to earn economic (ie super-normal) profits. This will involve charging higher prices than under competition and as a result output will be restricted relative to the competitive level. In such instances, excessive pricing will lead to a loss of welfare to the economy as a whole since some customers who value additional units over the resource costs of producing those units will not be supplied. 6.5 Set out below are four policy options to address this concern in respect of the markets where it is proposed that BT has SMP. An analysis of pricing issues in the context of Kingston then follows. BT Pricing option A – no ex-ante controls on retail prices 6.6 One option would be not to have any ex ante regulation but instead to rely on measures at the wholesale level. This option would rely on competition being sufficient to act as a constraint on BT’s pricing behaviour. 6.6 The Wholesale Fixed Narrowband Market Review published today (www,oftel.gov.uk/publications/eu_directives/2003/eu_narrow_term/ ) sets out measures being proposed at the wholesale level to address BT’s dominance in the retail markets. In the document Oftel proposes to continue to require BT to provide IA, CPS and WLR. These measures are intended to promote competition in the retail markets in the Review, which in turn should act as a restraint on BT’s prices. 6.7 However, although competition has been developing at the retail level, particularly through the use of IA and CPS, it has not yet become effective. In residential calls markets in particular, BT maintains high market shares (see discussion in Chapter 4 and Annex C) and returns (see also Chapter 4) . Moreover, Wholesale Line Rental is not expected to begin to have a significant impact on competition in the access and calls markets before the end of 2003. Competitors to BT may take time to emerge and may seek to compete on tariff structure and the impact of the extra competition on prices is as yet uncertain. This suggests that without ex ante regulation, BT may be able to set prices above the competitive level. 6.8 For these reasons and having regard to the relevant duties in Clause 4 of the Bill, namely the promotion of competition and the promotion of EU citizens’ interests, the Director proposes to reject this option. BT Pricing Option B – ex-ante control of retail calls only 6.9 One approach involving ex ante regulation would be to place a control with the aim of reducing BT’s call prices in business and residential markets. Such a control would directly address BT’s pricing in those call markets where it has SMP by requiring that call prices fell by a set percentage below inflation in each year of the control. 6.10 Such a charge control would bring benefits to high spending customers, at least in the short term. However, because of its dominance in the access markets listed in paragraph 5.1, BT would be able to increase line rental charges to recover more of its common costs in order to compensate for reduced returns on calls. Lower spending customers, for whom the line rental forms a large proportion of bills, might therefore see charges overall rising, or not falling significantly, as call prices fell. 6.11 In terms of its effect on competitors, the control rather than competition would tend to be the determinant of prices. This would be in residential and business calls markets where competition has been increasing, through Indirect Access and Carrier Pre-Selection. A calls-based charge control could distort the development of such competition. 6.12 Because of the potential for such a control to affect lower spending customers adversely and to damage the development of competition and having regard to the relevant duties in Clause 4 of the Bill, namely the promotion of competition and the promotion of EU citizens’ interests, the Director proposes not to adopt this option BT Pricing Option C – RPI-X% control of retail access and call prices 6.13 Another approach involving ex ante regulation would be to place an RPI-X% control on a basket of services, including access and calls, where X is set in a way that would seek to eliminate BT’s excess profits over the period of the control. This would be similar to the form of charge control that existed from 1997 to 2002 when a control of RPI-4.5% was placed on BT’s prices for residential customers for a basket of calls and access services based on the spending patterns of the bottom 80% of customers. 6.14 Unlike Option B, such a control would ensure that lower spending customers benefited from price reductions over the period. However, taking into account the measures taken at the wholesale level and increasing competitive pressures in calls markets, the introduction of a similar control would appear not to be proportionate in the current circumstances. It would be using regulation rather than competition to set prices and therefore - as with option B – runs the risk of distorting competition. Moreover, such an RPI-X% control relies on the continuation of excess profits from business and high-spending residential customers to finance losses (measured on a consistent basis) on lower spending customers. This would not be sustainable in a world where increased competition is expected to eliminate persistent excess profits. 6.15 Having regard to the relevant duties in Clause 4 of the Bill, namely the promotion of competition and the promotion of EU citizens’ interests, the Director proposes not to adopt this option. BT Pricing Option D –safeguard control of retail access and call prices 6.16 An alternative option for regulation would be through placing a safeguard control on BT customers’ bills that would allow no nominal price increases, while competition is developing. As BT remains dominant in the provision of access and calls (with the exception of residential 128kbit/s-capable digital access and business international call markets), Oftel considers it necessary to take some ex ante measures to prevent BT from exploiting its significant market power in certain of those markets by increasing overall prices to the detriment of consumers. 6.17 The proposed level of protection – RPI-RPI – would prevent rises in residential customers’ bills while allowing BT to respond to increasing competitive pressure in calls by adjusting the balance between its line rental and call charges. By ensuring that prices do not rise in nominal terms, such a safeguard control reduces the risk of distortion of competition. Competition, rather than regulation, should in future be the main determinant of price reductions. Consumers will have the reassurance that prices will not rise in the transition to effective competition. 6.18 For these reasons the Director proposes to place an RPI-RPI control on BT’s retail prices, based on a basket of services, in the following markets in the UK excluding the Hull area where the Director has provisionally concluded that BT has SMP:
6.19 The Director proposes that the control should apply to all residential access and calls markets where BT has SMP because, through having SMP in these markets, BT has the ability to raise prices significantly above the competitive level in all these markets. 6.20 The Director proposes that such a control should not apply to business markets set out in paragraph 5.1 where the Director has provisionally concluded that BT has SMP. This is because i) competitors are more likely to target higher spending and more profitable customers and ii) BT’s market shares in business markets are generally lower than in residential, suggesting that competition is developing to the benefit of business users. 6.21 The details of the proposed control are set out in paras 6.24 to 6.29 below. 6.22 Nevertheless the speed of the development of competition has implications for the proportionality even of a safeguard control. As competition develops there is a risk, albeit considerably less than that under an RPI-X% control considered under option C (where X > RPI), that a control of RPI-RPI could prevent BT from recovering its costs. The returns from the lowest spending 80 per cent of residential customers, measured on a fully-allocated cost basis, are below the cost of capital. [See Table 2.6: Profitability of BT residential customers by spending deciles in Protecting consumers by promoting competition - Consultation on Oftel's review of the fixed telephony market, 31 January 2002. http://www.oftel.gov.uk/publications/pricing/2002/pcr0102.htm#Chaptertwo]Profits from other higher spending customers allow BT to recover its costs overall. If competition develops as expected the profits that BT makes outside the basket on calls will be competed away and the control may eventually not be sustainable for BT. 6.23 The likelihood of this control being too tight is increased with the introduction of WLR, as BT could lose higher spending customers that currently allow BT to at least cover its cost of capital overall. In view of this concern, and in order to provide BT with an incentive to introduce WLR as quickly and efficiently as possible, the Director proposes to modify the charge control from RPI-RPI to RPI+0 per cent when he is satisfied that a fit-for-purpose WLR product is available and being actively used by competitors. Further details on the requirements of a ‘fit-for-purpose’ WLR product and the competition assessment are set out in Oftel’s Statement on Wholesale Line Rental published in March 2003. The modification to RPI+0% is dependent on the implementation of a fit-for-purpose WLR by BT on a voluntary basis, ie under terms of option 1 as described in the Wholesale Fixed Narrowband Market Review published today. Proposed Safeguard control 6.24 The Director proposes that the safeguard controls, RPI-RPI, should be:
6.25 Under the control, the overall level of prices in the basket would be held constant in nominal terms, but BT would be free to adjust the balance of charges within the control. 6.26 The proposed control is based on the spending patterns of the lowest 80 per cent of residential customers. For these customers the exchange line rental forms a large part of their bills. The control is therefore intended to give BT an incentive not to raise line rental to recover a greater proportion of common costs from its access business until competition develops. Nevertheless the control would protect all residential customers, as price changes/restraints within the basket are likely to be applicable to all residential customers. 6.27 A control set at RPI-RPI has the potential to become unduly onerous for BT if inflation turns out to be unexpectedly high. In order to avoid this, the Director proposes that the control should be limited to RPI-4% if inflation is greater than 4% per year. 6.28 The control would be set to last from 1 August 2003 until July 2006. 6.29 Further details on the operation of the proposed control are set out in Annex D. The draft condition on charge control is set out in Annex A, Schedule 1 to the Notification. Compliance with Tests in Communications Bill6.30 The Director considers that the proposed condition meets the tests set out in Clause 43 of the Communications Bill. It is justifiable, in that it is required to ensure that BT does not exploit its market power by raising prices in markets concerned. It does not unduly discriminate against BT in that although the condition only applies to BT, the condition is imposed in order to address BT’s ability to raise prices above the competitive level in light of its market power in the markets to which the control applies. In addition it is justified to impose such a condition only on BT, rather than Kingston as well, for the reasons set out in paragraphs 6.33 – 6.37. It is proportionate being the least burdensome means of achieving its aim. Oftel considers it has met the requirement of transparency set out in the Communications Bill by setting out the proposed requirements on BT and the justification for the condition. 6.31 In proposing this condition the Director has considered, in accordance with the duty in Clause 4 of the Communications Bill, to act in accordance with the six Community requirements. By protecting customers against excessive pricing it meets the third Community requirement to protect the interest of EU citizens. 6.32 Oftel also considers that the proposed condition meets the tests set out in Clause 87(2) of the Communications Bill. Oftel does not consider that the duties in Clause 4 will be fulfilled by setting SMP conditions in the related wholesale call origination market. This is because conditions on BT and Kingston to provide IA, CPS and WLR have not yet resulted in effective competition in retail access and call markets. As explained in paragraph 6.23, the Director proposes to relax the control once the Director is satisfied that a fit-for-purpose WLR product is available and being actively used by competitors. Q6.1 Do you agree that with the proposal to set an RPI-RPI charge control on BT in those residential retail markets where it has SMP? Kingston Pricing Issues 6.33 Oftel has to consider whether the pricing remedies identified above in respect of BT are appropriate for Kingston in those markets listed in paragraph 5.2 where Oftel has provisionally concluded that Kingston has SMP. In doing so, Oftel has to consider in particular remedies at the wholesale level and the proportionality of measures at the retail level. 6.34 In the Wholesale Fixed Narrowband Market Review published today (www,oftel.gov.uk/publications/eu_directives/2003/eu_narrow_term/ ), the Director has proposed that Kingston should continue to be required to provide indirect access and carrier pre-selection services in response to requests from other providers. The proposed regulation is intended to reduce entry barriers. By enabling entry by potential competitors, it is possible that Kingston’s pricing behaviour will be constrained. 6.35 Kingston is already subject to a number of regulatory obligations designed to facilitate effective competition, following Oftel’s review of telecommunications markets in the Hull area in 1998 (http://www.oftel.gov.uk/publications/1995_98/licensing/398king.htm) . However the lack of actual entry by other operators does not in itself justify the need for additional regulation, since there could be other restraints on prices including the threat of potential entry. 6.36 A safeguard charge control in retail markets similar to that proposed for BT would provide customers with a guarantee that bills overall would not rise. However, Kingston’s retail prices are comparable to (or perhaps lower than) BT’s. Consumer survey evidence (published by Oftel in March 2003) suggests that fixed narrowband residential customer expenditure is around £68 (including VAT) in the Hull area, whereas for the UK as a whole, this figure is higher at £75 (incl. VAT). [ See Oftel survey (www.oftel.gov.uk/publications/research/2003/hullr0303 ) and Oftel's August 2002 residential survey (published in October 2002).]Moreover, internal analysis by Oftel indicates that an average BT residential customer would not incur a significantly different bill if charged Kingston prices.[ Analysis based on BT residential customer expenditure profiles for 2001/02.] 6.37 Therefore, it is arguable that the perceived threat of entry by other operators and the implicit threat of charge control regulation has effectively constrained Kingston’s retail pricing behaviour. In addition, the imposition of a control on Kingston’s prices would require Kingston and Oftel to put in place extensive monitoring and compliance systems. 6.38 In view of the above, the Director believes that retail charge control would lead to substantial costs being incurred by both Oftel and Kingston with little benefit in the way of lower prices for consumers. The Director concludes that a retail charge control is not a proportionate response to the characteristics of the retail telecommunications markets in the Hull area and therefore would not satisfy all the tests in Clause 43 of the Communications Bill. Q6.2 Do you agree with the proposal not to impose a charge control on Kingston? Undue discrimination 6.39 There is a risk that a provider with SMP may exercise undue discrimination against a particular person or persons. In general, a provider can be said to be discriminating when it applies dissimilar conditions to equivalent transactions. Such discrimination may be in various forms including price offers, terms and conditions or information. Such behaviour would represent undue discrimination if it leads to market foreclosure. Two options are considered below to address this issue: Discrimination Option A: 6.40 Under this Option there would be no ex ante regulation. Instead Oftel would rely on the provisions of Chapter II of the Competition Act that prohibit conduct that amounts to an abuse of a dominant position in a market. In The Application of the Competition Act in the Telecommunications Sector published in January 2000, Oftel explained that discrimination may be an abuse of the Chapter II prohibition where, for example, its effect is to exclude competitors from the market in question. 6.41 From the analysis in chapter 4, Oftel has concluded that competition has not yet become effective in those markets listed in paragraphs 5.1 and 5.2. In addition, measures taken at the wholesale level do not prevent undue discrimination at the retail level although when such measures deliver effective competition, ex ante regulations at the retail level on undue discrimination may not be required. In these circumstances, the Director believes that ex-post regulation alone would not be adequate and proposes to reject this option. Discrimination Option B: 6.42 Under this option Oftel would place an ex-ante condition on dominant providers to prohibit undue discrimination in each of the markets to which the condition applies. Oftel has considered how it might treat undue discrimination in its Statement Imposing access obligations under the new EU Directives, September 2002. 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. 6.43 The Director considers that the condition is required to address particular problems, highlighted above, in the retail markets where BT and Kingston have SMP given that measures at the wholesale level have not yet resulted in effective retail competition. A prohibition on undue discrimination would also enable the Director to implement his proposed policy in respect of business tariffing flexibility for SMP providers. As explained in Chapter 7, competition law alone cannot be relied upon to prevent certain pricing strategies which could restrict the development of competition. 6.44 The Director therefore concludes that BT should be required not to discriminate unduly between retail customers in the following markets in the UK, excluding the Hull area:
6.45 For the same reasons, the Director concludes that Kingston should be required not to discriminate unduly between retail customers in the following markets in the Hull area:
6.46 The draft conditions on undue discrimination can be found in Schedules 1 and 2 to the Notification in Annex A. Compliance with Tests in Communications Bill 6.47 Oftel considers that the proposed condition meets the tests set out in Clause 43 of the Communications Bill. It is justifiable, in that it is required to ensure that BT and Kingston do not exploit their market power by discriminating unduly in the retail markets in which they have SMP. It does not discriminate unduly against BT and Kingston because, although it only applies to them, they have SMP. Where providers have SMP discrimination can be effectively applied by the provider in question. Without market power, discrimination can be undermined by competitors or customers and attempted discrimination would not be considered undue. It is proportionate in that it does not prevent the application of dissimilar conditions to different transactions where there are objective reasons for doing so. It is therefore the least burdensome means of achieving its aim ie not capturing discriminatory practices which have an objective justification . Oftel considers it has met the requirement of transparency set out in the Communications Bill by setting out the proposed requirements on BT and Kingston and the justification for the condition. 6.48 In proposing this condition the Director has considered, in accordance with Clause 4 of the Communications Bill, the duty on the Director to act in accordance with the six Community requirements. By preventing undue discrimination, it meets the first requirement to promote competition and the third requirement to protect the interests of EU citizens. 6.49 Oftel also considers that the proposed condition meets the tests set out in Clause 87(2) of the Communications Bill. Oftel does not consider that the duties in Clause 4 will be fulfilled by setting SMP conditions in the related wholesale call origination market. This is because those conditions on BT and Kingston to provide IA, CPS and, in BT’s case, WLR have not yet resulted in effective competition in the markets. It is therefore still necessary to impose regulation to protect against exploitation of market power in retail markets in which BT and Kingston have SMP.Oftel intends to review the markets regularly to assess whether retail competition has developed as a result of regulation in wholesale markets and whether wholesale level regulation alone might be sufficient at some future date. Q6.3 Do you agree with the proposal to place conditions on BT and Kingston preventing undue discrimination in those markets where they have SMP? Price Publication and Notification 6.50 In order for Oftel and other providers in the market to be able to monitor the behaviour of SMP providers for potential abuses such as undue discrimination and below-cost pricing, it is important that information about changes to the SMP providers’ tariffs are available in a transparent and timely manner. 6.51 The options below consider whether such regulatory measures are needed in the markets where BT and Kingston have SMP. Publication/Notification Option A 6.52 Oftel has proposed that there should be a general condition of entitlement that requires all Communications Providers to ensure that clear and up-to-date information is published on their applicable public prices and tariffs and on their standard terms and conditions (http://www.oftel.gov.uk/publications/licensing/2002/enti0502.htm). This implements relevant provisions in the Universal Service Directive. 6.53 Under Option A, there would be no additional publication/notification requirements placed on providers with SMP. This would be an appropriate level of regulation if price changes could be easily monitored and any potential anti-competitive behaviour swiftly identified. 6.54 However Oftel does not favour this option. To allow effective monitoring of other SMP obligations, there should be certainty that dominant providers will publish full details of all their tariffs, including bundled tariffs (see chapter 7 on business tariffing issues for issues relating to bundling), terms and conditions in a timely manner. In addition. Oftel believes that it is important that clear and direct notification of tariff changes is available to the Director and others. Constant monitoring of price lists would create a significant administrative burden for the regulator and other providers. Publication/Notification Option B 6.55 Under this option, dominant providers would be required to publish full details of all its tariffs, including any bundled tariffs (see chapter 7), terms and conditions. They would also be required to provide advance notification of price changes and new tariffs. 6.56 Advance notifications of price changes by SMP providers allow competitors and Oftel to be alerted to those changes. Historically, BT and Kingston have been required to provide notification of price changes in advance: until May 2002, 28 days in advance; since May 2002 one day in advance (save for certain exceptions where the 28-day requirement still applies). 6.57 Advance notification is intended to provide an opportunity for anti-competitive behaviour to be identified and regulatory action taken before damage is done. In practice, regulatory investigation is unlikely to be completed and action taken within a 28-day timescale. Moreover there is a risk that advance notification could have a negative impact on competition. In a market dominated by one player if the dominant player is obliged to publish its prices, there is a risk that smaller players may follow those prices rather than compete more aggressively. In addition advance notification of tariff changes, may remove the dominant provider’s incentive to compete much on price. That is, the dominant provider may consider that price changes are unlikely to give a competitive advantage since competitors will always have time to react and indeed pre-empt the coming into effect of the dominant providers price changes. 6.58 Oftel believes that the risks of a 28-day advance notification period outweigh the potential advantages. Moreover, it is not clear that a 1-day advance period provides additional benefits to a requirement to provide notification on the same day as the price change. 6.59 Oftel recognises the benefits of specific notification but believes that the provision of that notification in advance has few additional benefits and some risks. 6.60 The Director therefore does not propose this option. Publication/Notification Option C 6.61 Under this option, Dominant providers would be required to publish on their websites full details of all tariffs, including any bundled tariffs, terms and conditions. They would also be required to provide notification of price changes, including specific notification to Oftel and publication on their websites, on the same day as introducing or changing the tariff. The requirement to publish bundled charges, terms and conditions would apply to any bundle if at least one service in the bundle included charges, terms and conditions for services in markets to which this condition applies. 6.62 This option provides certainty that all tariffs, terms and conditions would be published and offers the benefits of notification for monitoring purposes without creating the risks of price following by competitors.. 6.63 The Director proposes that the requirement on BT to provide public notification of new tariffs and changes to existing tariffs should apply in respect of the following markets in the UK excluding the Hull area:
6.64 Oftel proposes that the requirement on Kingston to provide public notification of new tariffs and changes to existing tariffs should apply in respect of the following markets:
6.65 Oftel believes that the proposed condition should apply in the same way to all these markets because of i) the proposed findings of SMP and ii) the consequent need for Oftel and competitors to dominant providers to be able to monitor effectively changes to those providers’ tariffs. The need to monitor for potential abuses, such as undue discrimination, applies equally across all the retail markets where a provider has SMP. 6.66 The Director proposes to include a power to disapply the condition by issuing a consent. Such a consent might be granted, for example, for services in these markets where BT has notified Oftel that for a limited period it is not making the services publicly available in order to assess their technical or commercial viability. 6.67 The draft conditions on price publication and notification are set out in Schedules 1 and 2 to the Notification in Annex A. Compliance with Tests in Communications Bill 6.68 Oftel considers that the proposed condition meets the tests set out in Clause 43 of the Communications Bill. It is justifiable, in that it requires that tariff changes can be monitored effectively to prevent anti-competitive practices. It does not discriminate unduly against BT and Kingston - it is not applied to providers without SMP because there are no regulatory grounds for monitoring their prices – their prices would not have a potentially material adverse effect on competition due to the lack of market power. It is proportionate, since it is the least burdensome means of achieving its aim ie enabling the Director and other providers to monitor prices (it does require notification but only on the day of bringing the changes into effect). Oftel considers it has met the requirement of transparency set out in the Communications Bill by setting out the proposed requirements on BT and Kingston and the justification for the condition. 6.69 In proposing this condition the Director has considered, in accordance with Clause 4 of the Communications Bill, the duty on the Director to act in accordance with the six Community requirements. By facilitating the monitoring of prices in order to identify potentially anti-competitive behaviour, it meets the first requirement to promote competition and the third requirement to protect EU citizens. 6.70 Oftel also considers that the proposed condition meets the tests set out in Clause 87(2) of the Communications Bill. The Director does not consider that the duties in Clause 4 will be fulfilled by setting SMP conditions in the related wholesale call origination market. This is because those conditions on BT and Kingston to provide IA, CPS and WLR have not yet resulted in effective competition in the relevant retail markets. It is therefore still necessary to impose such regulation to protect against exploitation of market power in retail markets in which BT and Kingston have SMP.Oftel intends to review the markets regularly to assess whether retail competition has developed as a result of regulation in wholesale markets and whether wholesale level regulation alone might be sufficient at some future date. Q6.4 Do you agree with the proposal to place conditions on BT and Kingston requiring price publication and same-day notification in those markets where they have SMP?
Business tariffing issues Introduction and summary 7.1 BT has requested that the Director consider the scope for relaxing ex-ante regulation in respect of its tariffs for large business customers. This chapter therefore sets out the Director’s proposed approach in respect of business tariffs and applicable ex-ante regulation. The chapter is organised as follows:
7.2 The SMP conditions of relevance to this chapter are price publication/notification and the prohibition of undue preference/discrimination. 7.3 By definition, services supplied in markets in which a communications provider does not have SMP will not be caught by the SMP condition prohibiting undue discrimination. Therefore, provided services supplied in markets in which a communications provider does not have SMP are not bundled with services supplied in markets in which it has SMP, then there is no potential concern over undue discrimination (specifically the horizontal leverage of dominance). 7.4 This chapter therefore discusses how the SMP condition of undue discrimination might be interpreted in the context of bundling across a range of markets in at least one of which the communications provider is dominant. It also discusses the applicability of the SMP condition regarding publication and notification. 7.5 An absence of ex-ante regulation would give a communications provider the freedom to offer unpublished customer specific discounts based on aggregate customer expenditure across a range of services. While competition law may in some instances be adequate to address attempts to leverage dominance and to address concerns over anti-competitive targeting of customers, it is important to emphasise the difference between ex-post tests for anti-competitive behaviour and ex-ante regulation. In the context of the latter one is concerned with addressing market failures – ie by introducing/facilitating competition where it has not previously been present, or at least not to a significant extent. 7.6 A key consideration regarding whether bundling could restrict the development of competition is the ability of competitors to replicate technically and commercially the bundle of services offered by an SMP provider. Replicability is important, since in taking less than the full range of services within the bundle, customers will typically be foregoing an amount of potential discount with the SMP provider. That is, customers face the choice of either buying the bundle from the SMP provider, or buying a service from the SMP provider and a service from a competitor. Customers will only take the latter option if:
is no more than,
Even if the SMP provider’s implicit revenue [The implicit price of a service is obtained by subtracting the unbundled (ie stand alone) price of each other service within the bundle from the price of the bundle. Implicit price-cost tests are relevant, because competitors competing to supply less than the SMP provider's bundle compete against implicit prices. The relevant cost stack will comprise wholesale input charges when a provider is dominant in key input markets. This is in order to test for margin squeeze - ie vertical leverage of dominance - since competitors face input charges rather than input LRICs.] 7.7 A tabular summary of the options for application of undue discrimination in the context of bundling is contained in Annex E. These options are alternative ways in which the SMP conditions in respect of undue discrimination could be applied in the context of bundling. The Director’s preferred option (E(iii) in Annex E) would be to allow published aggregate expenditure based discounts, for all business customers (not just large business customers), subject to
7.8 Charges satisfying these conditions would not be considered as unduly discriminatory. 7.9 Turning to the SMP condition on publication/notification, the Director considers that this is of particular importance in the context of bundling. First, unpublished discount schemes could reduce buyer power and the ability of competitors to identify profitable business opportunities. Second, non-publication would make monitoring and enforcement of anti-competitive behaviour very difficult. Therefore, full details of bundles covering markets in at least one of which a communications provider has SMP should be subject to the publication/notification SMP condition. 7.10 At present, the Director’s view is that the economic markets for business customers constitute single markets that are not differentiated by customer size. The Director will, however, continue to keep this issue under review, to reflect any additional information that becomes available. Background Previous statement on the Director’s approach to bundling issues 7.11 In the October 1998 statement: Tariffing issues: Bundling of inbound and outbound services, the Director set out the principles he would apply in assessing bundled tariffs. These principles remain appropriate today and have been used to inform the Director’s analysis of BT’s latest request for tariff flexibility. The principles are as follows:
BT’s requests for greater tariff flexibility 7.12 BT has argued that a separate market for the supply of telecommunications services to major business customers can be identified, that this market is effectively competitive and that therefore the imposition of SMP conditions would not be justified. 7.13 If SMP conditions were not imposed on BT in respect of its sales to major business customers, it would be in a position to offer unpublished customer specific discounts based on aggregate customer expenditure across a range of services. (This would be in contrast to the present situation of discounts calculated on the basis of expenditure on individual services where these are supplied in markets in which BT is not dominant.) In the absence of SMP conditions, BT would be free to offer unpublished customer specific bundles for major business customers comprising services such as:
Market definition 7.14 BT’s proposed market definition would involve extending the product market across a range of telecommunications services. The Director does not consider that inclusion of these services in the same market definition can be justified either on demand-side or supply-side substitution arguments. Competitive conditions will differ between the individual services within the bundle – ie different call types, access products etc. (as discussed in Chapter 3). Aggregation across a range of services 7.15 The Director’s approach to market definition was outlined in Chapter 3. It is based on application of the hypothetical monopolist test, which consists in identifying substitute services which constrain a hypothetical monopolist’s ability to price above the competitive level. This technique is used to define both the product and the geographic market. 7.16 The way in which suppliers choose to sell services – for example, by offering services in bundles – does not of itself imply that the elements in the bundle are in the same market. Implicitly, BT’s approach to market definition appears to rest heavily on supply-side substitution arguments, ie suppliers of similar services could readily switch to supply competing services for which a hypothetical monopolist attempted to price above the competitive level. However, where services are delivered using different networks and/or appropriately priced wholesale services are not available, supply-side substitution is unlikely. In general, economic market definition should reflect the narrowest set of services that could be successfully monopolised. Narrowing market definition on the basis of customer characteristics 7.17 In general, defining a market on the basis of customer characteristics depends on whether a sufficient number of customers could switch suppliers in such a way as to make it unprofitable for a hypothetical monopolist of the relevant service(s) to raise the price to all customers. If enough customers would switch away from the hypothetical monopolist and such non-captive customers would protect captive customers from a price increase (ie no price discrimination is possible between customer types), the market definition should not be narrowed according to customer-type. 7.18 Therefore, in order for large business customers to be a distinct market for a particular service(s) it would have to be the case that a hypothetical monopolist could price discriminate between large business customers and other customers. While the definition of a ‘large’ customer might usefully be made on the basis of expenditure in a given product and geographic market (eg national calls for the UK excluding Hull), such a definition would have to be evaluated on a case-by-case (ie product market-by-product market) basis. The relevant economic markets 7.19 The remainder of this chapter on business tariffing issues is predicated on the assumption that the market definitions set out in Chapter 3 are retained. The Director does not propose to narrow individual product markets to reflect business customer characteristics on the basis of the evidence available at this time. The Director will, however, continue to keep this issue under review. Q7.1 Can a separate economic market be identified for all telecommunications services purchased by major business customers? Can this be done in a manner consistent with the standard methodology for market definition – ie starting with the narrowest possible product market and applying the SSNIP test? Q7.2 If you consider that a market based on total telecommunications services purchased by major business customers can be identified, how would you measure the size of this market? What would be the market shares of the four largest players by reference to your measure of the market? Could any of those players be deemed dominant? Potential competition issues 7.20 The key competition issues arising from BT’s request are twofold.
Market failure and the sufficiency of competition law – bundling as a potential brake on the development of competition 7.21 A brief outline of tests for anti-competitive effect and intent and case law relevant to discounts and bundling is set out in Annex F. 7.22 In some instances, competition law may provide sufficient redress for anti-competitive bundling or discounting practices. Tests to investigate the potential exclusionary effects of bundling and discount schemes include implicit price-cost tests and combinatorial tests. However, implicit-price cost tests are imperfect. First, it is possible for implicit price-cost tests to be passed and for foreclosure effects to remain. Second, in some instances even if implicit price-cost tests are failed, it is possible for foreclosure effects to be minimal although the conditions under which this might be the case seem unlikely in the present context. (These issues are discussed further in Annex F.) 7.23 Moreover, while implicit prices might be below cost, this may be a profit maximising strategy, absent benefits from foreclosure effects. For example, if common costs are significant, offering services both as a package and on a stand-alone basis (known as mixed bundling) may be the only means for the firm to extract sufficient revenue from customers in order to recover common costs and hence for the services to be supplied at all. Without mixed bundling, the combination of incremental costs and common costs may more than outweigh the revenue available if services are only offered on a stand-alone basis. 7.24 However, in the present context, this efficiency justification for allowing mixed bundling that fails implicit price-cost tests is inappropriate, since the services in question (ie telecoms services purchased by business customers) are already profitably supplied on a stand-alone basis. That is, bundling is not essential in order to increase sales and hence spread the recovery of common costs since revenues from a largely individual (ie non-bundling) pricing strategy are actually sufficient for supply to be profitable. 7.25 A net revenue test can be used to identify possible anti-competitive intent (in contrast to effect). Failure to pass such a test would be consistent with an abuse of dominance (assuming dominance has first been shown). Competition law can however only be used to remedy anti-competitive behaviour given the prevailing structure of the market(s) and generally does not give power to intervene in order to facilitate the move towards more competitive market structures. Specifically, the Competition Act 1998 cannot be used to address a dominant position alone – only the abuse of such dominance. However, monopolistic market structures are typically less socially optimal than competitive market structures – in this sense monopolistic markets are a form of market failure. 7.26 In the business markets for direct access (analogue, ISDN2 and ISDN30), BT owns a geographically ubiquitous legacy network. However, competitors are not able to offer direct access on a geographically ubiquitous basis. They will therefore not be able to replicate packages comprising direct access for multi-site customers, unless they happen to have built out such a network to all customer sites. It could be difficult for competitors to compete even for a limited range of services to multi-site customers. The reason for this is that in taking less than the full range of services within the bundle, customers will be foregoing potential discount with BT. Even if implicit revenue in a given market were greater than or equal to LRIC (including wholesale input charges), customer inertia in dealing with more than one supplier could make them unwilling to switch to alternative suppliers for less than the full range of services that they could otherwise take from BT. Moreover, if a number of services are implicitly priced at or close to LRIC this could further make it difficult for competitors to compete in instances where they are not able to compete across the range of services within the bundle. 7.28 For these reasons it is therefore important that competitors should be able to replicate bundles both technically and commercially. (By this latter condition of replicability it is meant that at least some individual competitors are each able to technically and commercially supply the full range of services within the bundle, or at least supply adequate substitutes.) 7.29 Also, as explained in Annex F, most business telecommunications customers will want to take all or most of the services (for example access and a variety of call types) in a typical bundle. They will therefore prefer discounted bundles of services over single or limited service offerings. This is in contrast to markets where a significant number of customers only wish to consume perhaps one service within a bundle. Moreover, where discounts are based on aggregate expenditure with a given supplier regardless of which specific services are purchased, the number of possible service combinations within a bundle increases, thereby increasing the number of customers likely to purchase on a bundled basis. This effect will be accentuated in the case of telecoms where a large number of services may potentially be bundled. Therefore, implicit prices below cost will be more likely to lead to foreclosure effects in business telecommunications markets because a larger proportion of the customer base will purchase bundles than in many other markets. This reinforces the need for competing suppliers to be able to provide a 'full service' offering and hence for replicability. 7.30 Finally, competition dampening effects will be accentuated if an SMP provider is able to target individual customers or a narrow group of customers. In particular, targeting could be used to maintain a dominant position and restrict the move to more competitive market structures. Other concerns 7.31 The second set of concerns raised by BT’s representations to the Director relate to the lack of price publication. Two objections to the lack of price publication can be made:
Conclusion on the appropriateness of ex-ante regulation and the ex-ante conditions of relevance 7.32 For the reasons set out above, the Director considers that ex-ante regulation remains appropriate in the context of bundling. The SMP conditions which affect an SMP provider’s scope for offering unpublished customer specific bundles are price publication/notification and the prohibition on undue preference/undue discrimination, in Schedule 1 to the Notification at Annex A.
7.33 Moreover, for the reasons set out both in the section above headed Market failure and the sufficiency of competition law and in Annex F, the Director proposes to take the rebuttable presumption that any bundle tariff should pass implicit price-costs for all services within the bundle – ie failure to do so would represent undue discrimination. 7.34 Further, in order not to fall foul of undue discrimination, any bundling strategy would also be expected to pass a net revenue test. Failure to make higher profits (or lower losses) after a price change, compared with no price change (ie a with and without net revenue test) would be consistent with exclusionary intent. Alternative forms of specifying bundle discounts 7.35 To the extent that some form of bundling is permitted, a further issue is whether the aggregate discount scheme might cover:
7.36 The latter approach would effectively enable an SMP provider to tailor packages for particular customers. As each customer will tend to have unique expenditure for different services, specification of these levels of expenditure as eligibility criteria for a discount scheme (even though published) would enable customers to be targeted – ie no other customer is likely to have precisely the same expenditure on different services. Even if structured in the form of bands (rather than unique levels) for service specific qualifying expenditure, targeting would still be feasible. 7.37 Further discussion of the regulatory/competition implications of these two generic structures for bundle tariffs is addressed under option E, below. Options for deregulation 7.38 As previously noted, bundling of services in markets in which a communications provider is not dominant will not in general raise competition concerns. In the case of bundling of services in markets in at least one of which a communications provider is dominant, the Director must consider how to interpret and apply the SMP condition of undue discrimination (as set out in Schedule 1 to the Notification at Annex A). Option A: Bundling (of services supplied in markets in at least one of which a communications provider has SMP) to be viewed as undue discrimination 7.39 Under this option, discount schemes would only be permitted as now – ie calculated across and applied to expenditure levels on individual services (as opposed to calculated across total spend). Advantages 7.40 The advantage of this option is that it would prevent potentially anti-competitive discounts based on aggregate customer expenditure on services supplied in a range of markets (in at least some of which the communications provider has SMP), including where competitors are unable to match the bundles offered. 7.41 This option will also minimise any potential competition stifling effect from bundling even where the bundling might not be strictly in breach of competition law. Disadvantage 7.42 The disadvantage of this option is that it would be disproportionate, since potential customer benefits from bundling would be foregone. In some instances competitors may be able to replicate the bundles offered by an SMP provider and in these circumstances it would not be appropriate to prevent the SMP provider from bundling services. Option B: Bundling (of services supplied in markets in at least one of which a communications provider has SMP) permitted for qualifying large business customers only 7.43 This option would allow an SMP provider to offer discounts based on aggregate customer expenditure for large business customers only, regardless of the services within the bundle. Advantages 7.44 First, at least some customers should be better off as a result of the bundling (ie they pay less for the same level of telecoms spend) and none should be made worse off relative to the pre-bundling situation. (If the bundling strategy is incrementally profitable, there is no need to raise prices to non-qualifying customers in order to restore the pre-bundling level of firm profitability). However, this argument is based on static welfare analysis and ignores dynamic welfare considerations. That is, if the bundling has any foreclosure or competition dampening effects, then customers could well be worse-off in the long run. 7.45 Second, this option would allow some ‘testing of the water’ before extending the freedom to bundle to all business customers. To the extent that concerns remain over existing market structures (ie continued dominance by an SMP provider) and prices persistently exceed costs (for example, as evidenced by high returns on capital employed in a number of markets), there is some justification in restricting an SMP provider’s ability to target smaller business customers. The concern with extending bundling to small business customers would be that these customers will tend to be less profitable than larger ones. Therefore, allowing an SMP provider to offer bundle tariffs for small business customers (which might include effectively targeted discounts achieved via service specific qualifying expenditure), could make it very difficult for competitors to compete with an SMP provider since there is less profit per customer to be had, compared with large business customers. Disadvantages 7.46 First, while this option would address the main concern with option A – of being overly restrictive – it goes too far the other way. In particular, because it would apply to all services, there would likely be numerous instances of bundles which competitors could not replicate technically or commercially. In particular, there are likely to be few instances where direct access (analogue or ISDN) is not a key service within bundles for multi-site customers. As noted previously, the ability of competitors to be able to replicate bundles is important (i) if there is customer inertia (eg, due to transaction costs) in dealing with more than one supplier, (ii) if services within the bundle with which competitors compete directly are implicitly priced at or very close to cost. 7.47 Second, under this option, aggregate expenditure discounts would only be permissible for large business customers. Three objections can be raised to this approach.
Option C: Bundling (of services supplied in markets in at least one of which a communications provider has SMP) permitted for all qualifying business customers 7.48 This option would in effect be as for option B, with the only difference being its applicability to all business customers. Advantage 7.49 This option would offer the same first advantage as option B, without the disadvantages of having to identify ‘large’ business customers. Disadvantages 7.50 First, there will likely be numerous instances of bundles which competitors could not replicate technically or commercially (ie in particular those involving direct access). 7.51 Second, an SMP provider could not only introduce tariffs for small business customers, but do so on a targeted basis (eg via service specific qualifying expenditure levels). For the reasons discussed under option B, targeting of smaller business customers could be a concern. 7.52 Third, one could argue that in allowing an SMP provider the flexibility to design bundles for all business customers, this might result in a highly complex range of tariffs. This could effectively amount to bespoke pricing by the SMP provider, albeit on a published basis. In practice, flexibility in tariff offerings might be self-limiting, but only if aggregate spend discounts with qualifying levels of service specific expenditure are prohibited (as discussed in the following two paragraphs). However, with service specific qualifying expenditures ruled out under this option, a complex range of tariffs could result. 7.53 With service specific qualifying expenditures considered as undue discrimination, it would only typically be profitable to introduce new aggregate expenditure discount levels if an SMP provider were concerned that a particular customer (or small group thereof) was considering switching away from it. In practice such an incremental profitability constraint would be likely to limit the introduction of new aggregate expenditure discounts by an SMP provider. 7.54 To regularly introduce new aggregate expenditure discounts for smaller customers (with aggregate expenditure as the only eligibility criterion) would typically not be profitable if the intention is to retain a particular customer (or a small group thereof) threatening to switch. The lower per customer margin under the new tariff multiplied by the retained number of customers would likely be less than the original, higher, per customer margin multiplied by the slightly reduced customer base. [To illustrate, consider an initial net margin per customer of £1,000 and an initial customer base of 2,000. Suppose that 500 customers are contemplating switching to a competitor unless they obtain a further discount and this discount takes the net margin per customer down to £700. Absent the tariff change total net profit is £1.5M. With the tariff change, total net profit is £1.4M. It is therefore more profitable to lose the switching customers and leave unchanged the existing discount scheme than introduce a further discount in order to retain the customers threatening to switch. In general, provided the ratio of new net margin to old net margin is less than the proportion of non-switching customers (relative to the initial customer base), then it is profitable to leave the tariff unchanged and lose the customers threatening to switch. (NB This analysis assumes that the tariff change does just enough to retain the potentially switching customers and does not do more than this, ie attract new customers.)] Option D: Bundling (of services supplied in markets in at least one of which a communications provider has SMP) permitted for all qualifying business customers, subject to the caveat that competitors are able to replicate technically and commercially the bundles offered by the SMP provider Advantage 7.55 This option would retain the advantages of option C and would further address the disadvantage stemming from lack of replicability on the part of competitors. Disadvantage 7.56 As under option C, an SMP provider could not only introduce tariffs for small business customers, but do so on a targeted basis (eg via service specific qualifying expenditure levels). For the reasons discussed under option B, targeting of smaller business customers could be a concern. Option E: Bundling (of services supplied in markets in at least one of which a communications provider has SMP) permitted for large business customers, subject to the caveat that competitors are able to replicate technically and commercially the bundles offered by the SMP provider 7.57 This option is in effect a hybrid of options B and D. The advantage of replicability as a pre-requisite to allowing bundling (and hence some customer benefit from lower expenditure) is retained (as under D), but the risk of bundling extending to all business customers (even small ones) is avoided (as under B) or at least minimised depending on which variant of option E is adopted (see below). 7.58 Three ways of implementing option E would be as follows:
7.59 As was noted in the discussion of option B, the difficulty with identifying a threshold for separating out business customers (as required for variants i and ii), is the need to identify the criterion/criteria by which this is done and the need to specify the appropriate values of any quantifiable variable(s). One possibility might be total telecoms expenditure (not only with the SMP provider) – for example, £10M p.a. 7.60 Option E (iii) would (as argued under option C) perhaps limit an SMP provider’s scope for designing new tariffs in order to deter smaller customers threatening to switch away from an SMP provider. Recommended option 7.61 On the basis of the arguments set out above, option E would appear to strike the most reasonable balance between delivering customer benefits (ie lower expenditure through bundling and more vigorous price competition) without introducing increased scope for an SMP provider to hinder the development of competition via leverage of dominance. 7.62 Of the option E variants, variant (iii) would seem the most consistent with a rigorous economic approach to identifying competitive pressures. Therefore, the Director’s preferred application of no undue discrimination to bundling can be summarised as follows: i. Aggregate expenditure based discount schemes could be introduced for all business customers; ii. Competitors must be able to replicate the bundle technically and commercially; iii. Implicit price (or revenue) for each service within the bundle must exceed long-run incremental cost (including wholesale charges where the communications provider has SMP upstream); iv. The new tariff must be incrementally profitable (ie pass a ‘with-and-without’ net revenue test); and v. Service specific qualifying expenditures would not be acceptable as a means to further define the discount to which a customer is eligible. (This latter restriction would reduce the scope for targeting and so might be expected to reduce the extent to which an SMP provider offered bundles to small business customers.) 7.63 If a given bundle comprising services supplied in markets in at least one of which the communications provider has SMP passed conditions ii to v, it would not be considered in breach of the prohibition on undue discrimination. It would also be essential (for the reasons discussed above), for full details of such a bundle to be published in accordance with the SMP condition on publication/notification. Q7.3 Of the options presented, do you consider that option E strikes the most satisfactory balance between delivering customer benefits without introducing increased scope for an incumbent SMP provider to hinder the development of competition? Q7.4 Do you consider variant iii of option E – bundling for business customers, but a prohibition of bundling with service specific qualifying expenditures (and hence reduced scope for targeting of small business customers) – as the most methodologically sound and practicable means of implementing option E?
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