Contents

Summary

Chapter 1 Introduction

Effective competition conclusions

Chapter 2 Retail Internet service provision

Chapter 3 Wholesale call origination

Chapter 4 Wholesale Internet call termination

Chapter 5 Wholesale Internet connectivity

Appropriate regulation

Chapter 6 Appropriate regulation

Annexes

Annex A Market research

Annex B Metered and unmetered access

Annex C Comments on individual responses

Annex D Glossary

Summary

S.1 This statement presents the final conclusions of Oftel's review of effective competition in dial-up Internet access. Oftel has assessed the extent to which competition is providing consumers with the best deal in quality, choice and value for money. Oftel consulted on its initial findings in the second half of 2001: Effective competition review of dial-up Internet access and Effective competition review of Internet connectivity ('the consultation'). The conclusions set out in this statement take account of stakeholders' responses and updated market information.

S.2 The markets considered in the review are dial-up, also known as narrowband (as opposed to broadband) and the market definitions are consistent with Oftel's previous market analysis in this area. The review covers one retail and three wholesale markets. The retail market considered here is dial-up Internet access (unmetered and metered) including ISDN. The wholesale markets needed by ISPs to provide retail products are call origination, Internet call termination and Internet connectivity.

Effective competition

S.3 This statement presents Oftel's conclusions of levels of competition in each of the four markets (chapters 2 – 5) and on this basis, what is appropriate regulation (chapter 6).

Retail dial-up Internet access

S.4 Oftel concludes that residential and business dial-up Internet consumers are getting a good deal. The retail market is effectively competitive because:

• UK prices compare with the best in the world and there is a wide range of flat rate and pay-as-you-go packages available;
• the numerous tariff structures available to consumers and large number of ISPs suggest an absence of supernormal profits and pricing above the competitive level; and
• barriers to entry are low and there is an absence of market power.

Wholesale call origination

S.5 Oftel concludes that BT has market power in wholesale call origination and the market is not yet effectively competitive because:

• BT has market power with an estimated share of over 80%; and
• while there is some competition in network infrastructure, continued network charge controls and the availability of quality wholesale products are still essential to protect consumers from possible abuse of market power and to enhance competition.

Wholesale Internet call termination

S.6 Oftel concludes that BT has market power in wholesale Internet call termination. Changes in the wholesale Internet call termination market have affected competition, leading to an increasingly large market share for BT and much higher barriers to entry, in a situation where leverage of market power from call origination into Internet call termination may be possible:

• the move towards unmetered access has resulted in higher barriers to entry for terminating operators wishing to offer unmetered services and limited choice of terminating operator for ISPs wanting to offer unmetered retail packages;
• BT's share of Internet call termination volumes has increased substantially over the last two years; and
• market concentration has increased to an appreciable extent since the consultation.

S.7 As a consequence, Oftel concludes the market is not effectively competitive.

Wholesale Internet connectivity

S.8 Oftel concludes that wholesale Internet connectivity is an effectively competitive market because:

• wholesale prices are falling;
• the choice of suppliers results in improved service and innovation in pricing and packaging;
• it is relatively easy to enter the market and resell capacity; and
• there are a considerable number of suppliers with no one operator having market power.

S.9 Oftel recognises respondents' concerns that bundling Internet connectivity with services in non-competitive markets may introduce switching barriers, and will continue to investigate any specific allegations of anti-competitive behaviour brought to it in this area.

Appropriate regulation

S.10 Oftel's aim is to encourage a regulatory environment that is appropriate to the extent of competition in the market. Therefore, in markets where competition is effective, regulations which promote competition should be removed wherever possible (see Oftel's Effective Competition Review Guidelines, August 2000).

Retail Internet service provision

S.11 Oftel’s conclusion that retail Internet service provision is an effectively competitive market confirms that the absence of formal regulation in this market is still appropriate. To help consumers benefit from this competitive market, Oftel will continue to encourage the industry to produce robust codes of practice for all aspects of customer service, and, in the first half of 2002 will produce guidance for consumers connecting to the Internet.

Call origination

S.12 Continuation of network charge controls and the availability of wholesale interconnection products, such as FRIACO, are essential to protect consumers and prevent BT leveraging its market power into related markets, in particular the Internet call termination market. Oftel does not propose any further regulation of that market at this stage. However, Oftel notes the concerns raised by respondents in relation to the existing FRIACO products. These have not yet been the subject of any formal complaints of alleged anti-competitive behaviour. Oftel would consider any such complaints and will also continue to monitor developments in relation to FRIACO more generally. Oftel is consulting on proposed changes to the arrangements by which BT supplies wholesale unmetered Internet access to other operators: Consultation by the Director General of Telecommunications on amendments to the FRIACO Direction, 28 January 2002. The deadline for responses is 25 February 2002.

Internet call termination

S.13 Oftel concludes that the current regulation in the wholesale Internet call termination market is still appropriate because the market is not yet effectively competitive. BT requested that Oftel deregulate its Internet call termination products, currently Surfport, Surfport24, Webport and Webport24, in particular that Oftel remove the obligation to supply these products, to publish charges and not unduly to discriminate. In view of its market analysis, Oftel has decided not to deregulate as requested by BT.

S.14 Oftel is not however proposing any additional regulatory action in the Internet call termination market at this stage, as it believes this would be disproportionate prior to a resolution being made on a wholesale FRIACO IP interconnection product.

Internet connectivity

S.15 Oftel’s conclusion that Internet connectivity is an effectively competitive market confirms that the absence of formal regulation in this market is still appropriate.

Chapter 1

Introduction

Background

1.1 In January 2000, Oftel published a statement of its strategy, Achieving the best deal for consumers. Oftel’s strategy is to match the level of regulation to the level of competition in telecommunications sectors, reducing formal regulation as competition develops, while continuing to protect and inform consumers where effectively competitive markets cannot do so. In Proposals for implementing Oftel’s strategy, April 2000, Oftel set out its intention to carry out market reviews in a number of broad market sectors, including dial-up Internet access. The aim of market reviews is to assess the level of competition in a particular sector and to ensure that regulation is appropriate to the state of competition. Oftel has published guidelines, Effective competition review guidelines, August 2000, which set out how Oftel conducts effective competition reviews.

Scope

1.2 This review of dial-up Internet access began in October 2000 with a ‘kick-off’ statement: Oftel’s 2000/01 review of the dial-up Internet access market. In summer 2001, Oftel published two consultation documents; Oftel’s 2000/01 effective competition review of dial-up Internet access in July 2001; and Effective competition review of Internet connectivity, in August 2001. As mentioned in the second consultation document, this statement includes the conclusions of both consultation documents and completes Oftel’s 2000/01 effective competition review of dial-up Internet access.

1.3 The reviews looked at whether there was effective competition in four markets:

Oftel’s 2000/01 effective competition review of dial-up Internet access

• retail Internet service provision;
• wholesale call origination; and
• wholesale Internet call termination.

Effective competition review of Internet connectivity

• wholesale Internet connectivity

1.4 This statement sets out Oftel’s conclusions on levels of competition for each of the four markets and its final proposals for appropriate regulation.

Effective competition indicators

1.5 In line with Oftel’s Effective Competition Review Guidelines, August 2000, the consultation documents set out four groups of indicators of effective competition: consumer outcomes; consumer behaviour; market structure; and supplier behaviour. This statement summarises Oftel’s conclusions on levels of competition in each market based on these indicators.

1.6 Oftel's market information has been updated to reflect more accurate data since the consultation document was published. All market information in this document should be regarded as Oftel's best estimate at this point in time.

Chapter 2

Retail Internet service provision

Introduction

2.1 This chapter sets out Oftel's conclusions on levels of competition in the retail Internet service provision market based on the consultation and updated market information. Oftel concludes that the retail market is effectively competitive.

Market definition

2.2 As described in the consultation, retail dial-up Internet access consists of two parts:

• network service – access to the network and the conveyance of calls by a communications company; and
• internet service provision – linking the customer to the Internet and services such as e-mail, content and billing. Service provision can be offered subscription-free or through paying for a subscription, normally consisting of a monthly fee.

2.3 In some cases, these two services are bundled in the same package from a single supplier. In all cases, the customer must obtain both to access the Internet.

2.4 Respondents to the consultation generally agree with Oftel's definition of a retail dial-up Internet access market. Some respondents highlight the growing constraint imposed by other access technologies on the dial-up market. ntl's new entry-level cable modem product, offering consumers an 'always on' service with speeds of up to 128 kbps (comparable with ISDN) for £14.99 a month is a good example of how other access technologies may constrain unmetered dial-up services (currently similarly priced). As take up of ADSL, cable modem and other types of Internet access continues to grow, it may over time become increasingly difficult to identify a distinct dial-up market. Nevertheless, Oftel believes that at present narrowband and broadband services remain distinct markets and should be evaluated separately.

2.5 Therefore, notwithstanding these developments in terms of other access methods, the focus of this review remains on dial-up access, overwhelmingly the predominant means of access among households and small businesses at the present time.

2.6 Some respondents questioned whether metered and unmetered access are in the same or in separate markets. Oftel considers that while this is a difficult issue due to the complexity of the dynamics of the market, Oftel's conclusion is that metered and unmetered access can be seen as being part of the same market, at least from the perspective of metered access (see Annex B).

2.7 This review focuses on the provision of Internet access services and this chapter on the provision of Internet services to the end user by Internet service providers (ISP)s. Oftel recognises that network service providers also play a key role in providing consumers with access to the Internet and that Internet access appears to be a driver of competition in network service provision. Research confirms that homes with Internet access are more likely than non-Internet homes to have a second line and to use a cable supplier (see Annex A.1).

Consumer outcomes

Price

2.8 Respondents generally agree that UK retail prices for dial-up Internet access are indicative of a competitive market and that UK consumers are getting a good deal.

2.9 There is concern among some respondents that BT restricts retail prices. They argue that BT has a large degree of control over what ISPs can offer end users since ISPs (including BT's own ISPs) are dependent on network charges imposed by BT. There are various ways that Oftel regulates to stop BT abusing its position in the call origination market such as network charge controls; these are further discussed in Chapter 3.

2.10 Oftel's latest international benchmarking study presents a snapshot of retail dial-up Internet access prices as at 9 August 2001. The report covers services in France, Germany, Sweden, the UK and the US (the states of Ohio and California). This study is one in a series on dial-up access prices, providing Oftel with price trends in each of the countries covered.

Figure 2.1 Oftel International benchmarking studies of dial-up Internet access

Reports can be found at: www.oftel.gov.uk/publications/research/index.htm

2.11 The August 2001 results show some movement in prices from the previous report. The UK continues to have close to the cheapest prices for both metered and unmetered Internet access for residential users in Europe, but prices in the US now seem to be lower. Prices for business access are broadly similar, although metered access is slightly higher in the UK. However, despite some evidence of ‘catch up’ in other countries, UK consumers continue to benefit from some of the most competitive prices for dial-up Internet access (see Annex A.2).

Range of services (choice)

2.12 Research shows that consumers have moved towards fully unmetered packages and away from the subscription-free model (see Annex A.3). Respondents generally agreed that the move towards unmetered access characterised dial-up Internet access at this time.

2.13 Some respondents comment that cable customers' choice of ISP is more limited than for BT customers, since they can only subscribe to their cable company’s ISP for unmetered access. Whereas BT is required by Oftel to provide an unmetered wholesale service enabling other operators to supply unmetered Internet services using BT's network for call origination (FRIACO), the cable operators are not. This means that a cable customer cannot use an ISP whose unmetered services are based on FRIACO. Oftel's policy is that it should only take regulatory action to impose new open access regulation if the operator of the infrastructure has market power in the relevant market and the benefits to consumers of such a strong regulatory intervention outweigh the costs. As this is not the case at present, on this assessment, it is not appropriate for Oftel to require all other service providers (ie the cable operators) to offer similar wholesale products. Oftel's statement, Open Access: Delivering effective competition in communications markets, April 2001 sets out these principles.

Satisfaction

2.14 In October 2001, 96% of home Internet decision-makers were satisfied with the overall quality of their home Internet service – a figure broadly in line with the fixed telephone and mobile markets.

2.15 In the consultation, Oftel highlighted possible areas of concern as speed of access, quality of customer care and the availability of information. This statement deals with these particular areas of concern.

Figure 2.2 % customers satisfied with various aspects of their home Internet service, October 2001

Source: Oftel, January 2002

Speed of service

2.16 Speed continues to be the least satisfactory aspect of home Internet service with 80% of decision-makers being satisfied (although this is reasonably high). In the same survey, 82% of ISDN and 95% of ‘broadband’ users were satisfied with the speed of their service.

2.17 It is likely that new products will continue to enter the wider retail market, offering varying rates of speed at relative prices. A number of respondents cite developments in broadband access, such as new retail products and self-install modems, that will help meet consumer demand for higher access speeds.

Quality of customer service

2.18 In October 2001, 83% of Internet decision makers said they were satisfied with their ISP's customer care. There was broad consensus among respondents that, despite scope for ISPs to improve in this area, it is in an ISPs' own interest to improve their customer care: good customer service boosts retention and reduces churn and conversely, enables brand development and customer acquisition at the expense of those ISPs with less good performance.

Consumer behaviour

Access to information

2.19 Respondents generally agree that there is a wide range of informal advice available to consumers from independent websites and magazines. However some argue that connecting to the Internet will always involve complex decisions, not only because the Internet continues to be such a new medium for many consumers, but also because there are so many (often minor) differences in retail packages (eg metered or unmetered access, high or low speed, additional services such as e-mail and web space). Indeed there is some concern that lack of information about payment schemes can be confusing for consumers and that, more generally, levels of satisfaction with availability of information are low.

2.20 To substantiate these findings and assess whether there is a role for Oftel and/or the industry to provide consumers with better information, Oftel has carried out detailed research into consumers’ perceptions and use of information. As part of the October 2001 survey, Oftel asked consumers what sorts of information they have used to help them choose an ISP and Internet access package, whether they were satisfied with the availability of information on offer and to what extent it enables them to shop around.

2.21 This research shows that there is some dissatisfaction among consumers with the information available to them about going online. One respondent suggests that choosing an ISP is a complex decision that many consumers (in particular those with little experience of the Internet) would necessarily find difficult. Moreover, only half of Internet consumers shop around before choosing an ISP or Internet package. This type of behaviour is most significant among households who have recently connected to the Internet (see Annex A.4).

2.22 It is worth noting that these surveys do not capture non-Internet user's views on the availability of information about connecting to the Internet. Previous Oftel research has found that potential barriers to earlier connection included lack of information.

Switching

2.23 In October 2001, Oftel research showed that almost half (46%) of Internet decision-makers said their household had changed their ISP at least once. Similarly, almost two in five (38%) decision-makers said they had previously used a different type of package for their home service.

2.24 The majority of ‘switchers’ moved to an unmetered package, accounting for over half (57%) of all switches. 13% of switches were to a similar type of package, but with a different provider. A further 16% of Internet customers also said they were planning to switch in the near future.

2.25 Price was, unsurprisingly, the main reason for changing to a different Internet package, driving three in five switches. Other factors included reliability and service issues, and a change in the household usage patterns. Potential barriers to switching for a small proportion of customers included inertia ("can’t be bothered / too much hassle to change") perhaps indicating perceptions that the process would be difficult or that the perceptions of cost savings or quality enhancement did not justify time investment. A small proportion mentioned technical difficulties and concerns about changing e-mail addresses.

Supplier behaviour

Active competition in terms of price, quality and innovation

2.26 The market has continued to develop rapidly. There has been a definite move towards unmetered access, with all the major, and many smaller ISPs now offering flat rate Internet access from around £13 to £15 a month. Indeed the majority of consumers switching are moving to unmetered packages (see 'Switching' above).

2.27 ISPs are continuing to innovate and offer new access packages offering a variety of speeds and quality of service at various prices, to meet demand from residential and business users.

Competitive pricing

2.28 Oftel received no evidence from respondents to change the initial conclusion that pricing appeared to be at a competitive level. In the absence of detailed information on pricing and profitability, the variety of tariff structures available from ISPs and lack of barriers to entry would suggest that any supernormal profits would be competed away.

Market structure

2.29 Consumers and businesses enjoy a wide choice of service provider. Barriers to entry are low for ISPs wanting to enter the market, particularly for virtual ISPs (VISPs) which provide Internet services to consumers using the equipment and facilities of a real ISP, but under their own brand name. In addition, the availability of FRIACO has enabled ISPs to offer unmetered services at less risk than previously. Unlike many European countries, the UK's incumbent operator (BT) does not have the largest market share in Internet service provision, although its share is increasing.

Market share (based on subscribers)

2.30 Consumers are making use of a range of ISPs and no ISP has a market share that would indicate market power. The following charts show the individual ISP share of residential and business subscribers. (NB Only ISPs with a share of 2% or more are shown. ISPs with less than 2% share are included in the ‘other’ category.)

2.31 Figure 2.9 shows ISP market shares in residential homes (this is not the same as the proportion of consumers using each ISP, as some use more than one). Freeserve, AOL and BT have been the largest ISPs in the residential market throughout the 18-month period shown (sharing 47-55% of the market). Over time, the three ISP's individual market shares have begun to converge. The combined share of those ISPs each with around 2-4% of the market has reduced 10%, most likely as a result of consolidation and mergers (see Tiscali, below).

Figure 2.3: Estimate of ISP share of UK homes

Source: Oftel, January 2002

2.32 Figure 2.10 shows shares in the business market. Similar to the residential market, Freeserve, AOL and BT are the largest ISPs for business users. However a large proportion of businesses continue to use a variety of smaller ISPs, representing the wide variety of choice on offer.

Figure 2.4 Estimate of ISP share of UK businesses

Source: Oftel January 2002

2.33 There is general agreement among respondents that although the market is showing some signs of consolidation, this is characteristic of a maturing market and consumers continue to benefit from a wide range of choice.

Barriers to entry

2.34 Respondents broadly agree that barriers to entry are low for ISPs wanting to enter the retail market. Virtual ISPs (VISPs) run by brands such as football teams and supermarkets are evidence of recent entry into the retail market.

Leverage of market power

2.35 BT has not gained a dominant position in the retail market, despite its dominance in wholesale call origination. However, BT enjoys large market shares of both residential and business consumers. Oftel will continue to monitor market shares and market entry and exit.

Conclusions

2.36 Retail Internet service provision is an effectively competitive market. Residential and business dial-up Internet consumers are getting a good deal. There is a wide range of flat rate and pay-as-you-go packages available and prices are competitive. This is confirmed by low barriers to entry and the absence of any one ISP with market power. Chapter 6 considers the measures Oftel could take to improve consumer awareness of competition.

Chapter 3

Wholesale call origination market

Introduction

3.1 This chapter sets out Oftel's conclusions on levels of competition in the wholesale call origination market based on the consultation and updated market information. Oftel concludes that the wholesale call origination market is not yet effectively competitive.

Market definition

3.2 Respondents broadly agree with Oftel's definition of a wholesale call origination market. The relevant market is call origination across both fixed and Internet telephony. Most end users access the Internet via their fixed telephone company. Wholesale call origination is provided by the operator with access to the end user.

3.3 One respondent suggests that the origination market should not be discussed in isolation from broadband access. In the consultation, Oftel proposed that the convergence of the telecoms and broadcasting markets, and developments in broadband, will increase opportunities for operators wishing to offer services to end users over competing networks. Dial-up call origination over the PSTN will not be the only means of access in a wider retail market. However, for the purposes of this review of dial-up Internet access, wholesale call origination remains a relevant economic market.

Market structure

Market shares

3.4 Respondents broadly agree with Oftel's analysis that BT is dominant in wholesale call origination. Figure 3.1 below shows BT's market share based on its share of individual lines to consumers at exchanges. These figures clearly show BT's continued dominance in the wholesale call origination market with over 80% of all exchange lines.

Figure 3.1: BT's share of exchange lines

Source: Derived from Oftel market information publications

3.5 Without doubt, it is still the case that the rate of decline of BT's share is not rapid. BT remains the dominant player in wholesale call origination.

Barriers to entry and policies to review them

3.6 Oftel believes that competition will provide consumers with the best deal. BT's competitors can provide services to end users by either building their own networks (eg cable operators) or by buying call origination from BT. In the UK, approximately 50% of customers have the option of purchasing services from a fixed operator other than BT. In metropolitan areas there might be more than one alternative service provider.

3.7 Respondents agree with Oftel's initial view that while there is some competition in infrastructure, continued network charge controls and the availability of quality wholesale products are still essential to protect consumers from possible abuse of market power and to enhance competition.

Network charge controls

3.8 As BT is dominant in the provision of call origination and has no incentive to keep its interconnection charges low, its charges for call origination are subject to network charge control. This control is currently set at RPI-10% and is set to last until 30 September 2005.

FRIACO

3.9 A number of respondents state that, as a result of various limitations with the current FRIACO products, BT does not face the same risks and problems as other operators offering unmetered services and has been able to gain a competitive advantage. Oftel considers these issues in Chapter 6, Appropriate regulation.

Supplier behaviour

Recent entry

3.10 There has been no significant recent entry by operators into the wholesale market. However, entry into the market by 'indirect access', 'calls and access' and 'carrier pre-selection' service providers offering end users Internet access, has helped foster competition at the retail level. These types of products, whilst typically using BT's wholesale network, encourage innovation among retail network service providers by bringing new suppliers into the retail market, increasing their customer bases and encouraging market entry. Indeed 50% of residential indirect access traffic is Internet traffic.

Competitive pricing

3.11 As discussed above, BT's charges for call origination will continue to be subject to RPI-X control under the Network Charge Control regime. This limits BT's ability to earn excessive profits as the dominant supplier in the market.

Consumer outcomes and behaviour

Choice

3.12 In the consultation, Oftel argued that Internet access encourages end users to shop around and take advantage of market opportunities in the fixed line market. Research confirms that homes with Internet access are more likely than non-Internet homes to have a second line and to use a cable supplier. As such, the cable operators are able to challenge BT's dominant position in wholesale call origination. These figures are presented in more detail in the context of the retail market in Annex A.1.

Conclusions

3.13 Oftel concludes that wholesale call origination is not an effectively competitive market. BT remains the dominant supplier with an estimated market share of over 80%. There is some competition in network infrastructure, to an extent driven by Internet users, but continued network charge controls and the availability of quality wholesale products are essential to promote competition. Oftel does not propose any further regulation of the market at this stage.

Chapter 4

Wholesale call termination market

Summary

4.1 This chapter sets out Oftel's conclusions on levels of competition in the wholesale Internet call termination market based on the consultation and updated market information. Oftel concludes that the wholesale Internet call termination market is not yet effectively competitive.

Market definition

4.2 Oftel defines the wholesale Internet call termination market as the link between the originating network and the ISP. ISPs are the consumers of wholesale Internet call termination services. The end user does not deal directly with the terminating operator.

4.3 There is general agreement among respondents with Oftel's definition of the wholesale Internet call termination market and the distinction between this and the origination market. However, there is some concern that the boundary between the two wholesale markets is blurring.

4.4 Some respondents argue that the market comprises two sub-markets: metered (competitive) and unmetered (not competitive) – see Annex B. However, there was no overwhelming feeling among respondents that Oftel should consider redefining this wholesale market.

4.5 Whilst acknowledging that the characteristics of supplying unmetered access have had an important impact on the structure of the market, wholesale Internet call termination for dial-up Internet access is a relevant economic market.

Consumer outcomes

Choice

4.6 There is broad agreement that, in general, ISPs have a wide choice of terminating operator. However, respondents raise concerns that ISPs wishing to offer unmetered retail services have a more limited choice. One important reason for this might be the higher barriers to entry faced by operators wanting to offer ISPs unmetered services, see below.

Consumer behaviour

Switching

4.7 Respondents agree that ISPs continue to switch from one terminating operator to another, taking advantage of market opportunities and trying to get the best deal. In addition, it now appears to be more common for ISPs to use a number of different operators, for example to carry metered and unmetered traffic.

4.8 In the first instance, multi-sourcing and switching among ISPs indicates a high level of competition and choice. However, competition could be damaged if all ISPs switched to the limited number of networks who were able to offer them unmetered services. If the trend towards unmetered access continued this could have an impact on the level of concentration in the market, which in turn could raise competition concerns. Indeed there are already increased levels of concentration in the market (see 4.27).

Supplier behaviour

Active competition in terms of price, quality and innovation

4.9 Terminating operators continue to offer new products to ISPs. Several respondents noted that a number of VISPs have continued to enter the retail market. Typical examples of VISPs are those set up by banks and supermarkets. The number of VISPs entering the retail market suggests that a wide range of services are being offered by operators (eg e-mail services) in addition to the core termination service, showing signs of innovation among terminating operators and promoting low barriers to entry (and exit) in the retail market.

Leverage of market power

4.10 A further indication of effective competition would be the limited ability of BT, with market power in wholesale call origination, to lever this market power into wholesale Internet call termination. Oftel currently seeks to prevent leverage of market power from call origination through a series of regulatory measures:

• encouraging the rollout of competing infrastructure;
• network charge controls; and
• ensuring the availability of certain wholesale products (eg NTS and FRIACO).

4.11 Despite these measures, a number of respondents suggest that BT has been able to gain a competitive advantage in Internet call termination as a result of its dominance in call origination. They claim this has been possible through the pricing and 'bundling' of BT's dial IP products and problems associated with FRIACO.

Pricing and 'bundling' of BT's dial IP products

4.12 BT’s Surfport24 and Webport24 products bundle unmetered call origination with call termination. A number of respondents accused BT of leveraging its dominance by bundling its origination and termination in this way. They claim they are unable to compete with these products and that in the absence of a suitable wholesale IP interconnect product, ISPs are buying Surfport24 and BT is gaining market share.

4.13 Oftel will address any complaint that is put to it alleging anti-competitive behaviour in this area. Oftel is currently investigating a complaint that BT's dial-IP products are priced anti-competitively. BT has provided Oftel with details of its pricing proposal documents and other information relating to the SurfPort24 and WebPort24 products. Oftel intends to publish its conclusions soon after the completion of this market review.

Problems associated with FRIACO

4.14 In the consultation, Oftel recognised that the availability of appropriate wholesale products from BT to other operators, such as FRIACO, was essential for raising levels of competition in the termination market. FRIACO allows other operators to compete with BT in offering unmetered services and prevents BT leveraging its market power in the origination market into Internet call termination.

4.15 There is widespread agreement among respondents that, despite imperfections in Number Translation Services (NTS) OLOs have historically been able to compete effectively in the metered Internet call termination services. The NTS revenue model enables ISPs, terminating operators and originating operators to share revenues.. However, a number of respondents argue that the launch of unmetered access has changed the dynamics of the market and certain problems associated with FRIACO, such as payment terms, have increased barriers to entry.

4.16 Oftel is currently considering a number of these issues in the Consultation by the Director General of Telecommunications on amendments to the FRIACO Direction, 28 January 2002. These issues are also addressed in this statement as part of Oftel's conclusions on appropriate regulation (see Chapter 6).

Competitive pricing

4.17 Oftel has received no further information on competitive pricing since the consultation. In the consultation, Oftel suggested that prices were likely to reflect underlying costs, as confirmed by low barriers to entry. However, Oftel's concern that changes in the market may make entry less easy than in the past has been confirmed (see 4.29) and therefore the risk of anti-competitive pricing is greater.

Market structure

4.18 Figure 4.1 shows market shares for all terminating operators since June 1999. Operators are not identified for reasons of commercial confidentiality.

4.19 Figure 4.1 shows significant movement in individual operators' market shares and increased market concentration. Oftel is concerned that BT's market has increased considerably over the period shown.

Figure 4.1: Internet call termination volume shares, April 1999 to June 2001

Source: Oftel

Market concentration

4.20 The three-firm concentration ratio is a widely used, simple indicator of the level of concentration in a market. It results from taking the sums of the market shares of the three largest firms in a market. The three-firm concentration ratio gives a result of 70% for the quarter October to December 2000 (the last set of data considered when Oftel published the consultation document) and a result of 77% for the quarter April to June 2001.

4.21 The three-firm concentration ratio confirms the view that concentration has indeed increased to an appreciable extent in the course of the last two quarters of available data. Oftel's primary concern is the strong growth of BT's share in this market, which takes place in a situation of increasing concentration overall. While BT’s ability to leverage market power from wholesale call origination into wholesale Internet call termination has previously seemed to be limited in the metered segment of the market, this may not be true in the unmetered segment of the market.

Nature of the market is changing

4.22 Oftel's initial conclusion was that although wholesale Internet call termination appeared to be an effectively competitive market, the nature of the market is changing and this has the potential to affect competition. Stakeholders generally agree that demand for unmetered Internet access is leading to a renewed requirement for network infrastructure and that the use of IP networks and associated wholesale products from BT (dial IP products) suggest the nature of the market is changing.

4.23 A number of respondents argue that, though there is more competition in termination than in origination, the introduction of unmetered access has reduced competition in the market and the market cannot be described as 'effectively competitive'.

Barriers to entry

4.24 One of the most noticeable consequences of these changes in the market is that barriers to entry are likely to have increased for terminating operators wishing to offer ISPs unmetered services. There is general agreement that operators wishing to enter the market to provide metered services to ISPs can do so with relatively few problems. Oftel continues to intervene where appropriate – eg in relation to retail uplift and call set up charging issues – to ensure that the NTS regime remains fit for purpose. However, respondents broadly agree that the move towards unmetered services has increased barriers to entry. This is because the network architecture needed to provide a competitive unmetered termination service is much more extensive than that needed in order to provide NTS based services. This more extensive network architecture can also be used to provide economies of scale in the provision of metered services.

4.25 It is Oftel's understanding that only two terminating operators other than BT are offering significant unmetered services based on their own infrastructure, having built out their network to a high proportion of DLEs. Whereas other operators could replicate this type of network rollout, it would only be possible at large expense and only efficient for those carrying similarly large volumes of dial-up Internet traffic.

4.26 Furthermore, Oftel understands that only BT has achieved nationwide FRIACO coverage, providing this through its Webport24 and Surfport24 products. Oftel does not foresee further network competition of this kind in the short to medium term, posing little additional constraint on BT.

FRIACO IP Interconnection

4.27 Oftel has suggested that a FRIACO IP interconnection product might be needed to enable other operators to compete with BT's dial IP products. A number of respondents agreed that IP interconnect would help OLOs compete with BT's dial-IP products and reduce the problem of increased barriers to entry in unmetered access.

4.28 Strength of opinion differs in respondents' views on when IP interconnect should be introduced – some argue it is needed as soon as possible, whereas others argue that it will become necessary in due course. A number of respondents also highlight the limitations of an IP interconnection solution. It would only enable operators to compete on the provision of IP backhaul services and would continue to rely on BT to provide quality and innovative wholesale call origination services.

Conclusions

4.29 Oftel concludes that changes to the Internet call termination market have occurred since publication of the consultation document, and that, among other things, the move towards unmetered access seems to have affected competition in this market. BT's market share has grown substantially and the market has become more concentrated. BT's position is reinforced by increased barriers to entry and economies of scale, leading to limited choice for ISPs in unmetered services and limited additional network competition in the short to medium term. In addition to these changes, there is a risk that BT could leverage market power from wholesale call origination into wholesale Internet call termination, in particular in the unmetered segment of the market. Based on these considerations, Oftel concludes that BT has market power in wholesale Internet call termination and that the market is not yet effectively competitive.

Chapter 5

Internet connectivity

Introduction

5.1 This chapter sets out Oftel's conclusions on levels of competition in the wholesale Internet connectivity market based on responses to the consultation. Oftel concludes that the Internet connectivity market is effectively competitive.

Market definition

5.2 There is broad agreement on the definition of Internet connectivity as the ability to access the entire Internet from a point of interconnection with the Internet, ie a connection to one of the backbone networks that comprise the Internet. The main comment on the market definition is that the geographical market has been unnecessarily constrained. However respondents agree that this does not materially affect the conclusions of the review.

Geographic market

5.3 Respondents note that larger ISPs may find it convenient to buy connectivity outside the UK if faced with a price increase in the UK. Their behaviour would therefore differ from those ISPs buying smaller quantities of connectivity who would not find it profitable to switch to providers of connectivity outside the UK. Oftel acknowledges that both types of behaviour are possible. However evidence of the relative volumes of customers that would switch outside the UK has not been made available. Therefore it is difficult to judge whether the effect of those customers switching would be sufficient to make a price rise unprofitable for a hypothetical monopolist in the UK.

5.4 Similarly, Oftel acknowledges the observation that there is a possibility of suppliers in neighbouring countries supplying UK customers, if UK prices rise. Whilst Oftel agrees that this may be possible, it is not clear to what extent this substitution would be sufficient to make a hypothetical monopolist’s price rise unprofitable and over what geographic area given the cost of international capacity.

5.5 Oftel accepts the potential validity of the arguments presented and therefore the possibility of a wider geographic market. However there is not sufficient evidence to reach a definitive conclusion on this issue and Oftel agrees with respondents' comments, suggesting that any disagreement over the geographic scope of the market does not materially affect the conclusions of this review.

Market structure

5.6 Respondents agree that there is a considerable number of players in this market and some suggest that there are between four and six large players. However, they noted that the relative sizes of the operators are very difficult to assess due to rapidly changing market and possible variations in methodologies for collecting data.

Barriers to entry

5.7 Respondents agree that it is relatively easy to enter the market and resell capacity and that new technology is increasing available capacity.

5.8 Some respondents consider the difficulty of obtaining suitable peering arrangements as an entry barrier and that this depends on carrying substantial volumes of traffic. Oftel acknowledges that peering arrangements can reduce suppliers' costs and improve performance. However, to the extent that entry is possible by reselling alone, it seems that the importance of peering implies scale economies rather than an absolute barrier to entry.

5.9 The difficulty of funding new entrants is also suggested as barrier to entry. However it is Oftel’s view is that the financial market climate is not a particularly good indicator of how strong or weak barriers to entry are in a particular market, as it affects all players in the market and is not an intrinsic barrier.

Supplier behaviour

5.10 There was agreement that having a choice of suppliers results in improved service and innovation in pricing and packaging.

Consumer outcomes

5.11 There is general agreement that prices are falling and that UK prices are competitive compared to Europe. A variety of products are available.

Consumer behaviour

5.12 Nearly all respondents agree that sufficient information is available to ISPs about suppliers of Internet connectivity. Oftel acknowledges one respondent’s comment that it is difficult, if not impossible, to measure quality of interconnect comprehensively and accurately. However, on balance, there is general agreement that the information that is available is sufficient.

Switching

5.13 There is general agreement that in the absence of bundling, switching is relatively straightforward. However, there is support for the view that switching barriers can arise when Internet connectivity is bundled with other services, and in particular with the view that competition problems can arise when such bundling occurs with non-competitive services, such as local access services. Respondents' concerns over the regulation of these services are considered in Chapter 6.

5.14 Some respondents also note that ISPs tend to buy connectivity from more than one operator. Oftel agrees that this would seem to facilitate switching.

Conclusions

5.15 All respondents agree with Oftel’s initial view that the market is effectively competitive. This conclusion is predominantly supported by the following:

• wholesale prices are falling;
• there are a considerable number of suppliers with no one operator having market power;
• it is relatively easy to enter the market and resell capacity;
• the choice of suppliers results in improved service and innovation in pricing and packaging; and
• ISPs have access to sufficient information to inform their choice of supplier.

5.16 Oftel recognises respondents’ concerns that bundling Internet connectivity with services in non-competitive markets may introduce switching barriers, Oftel will continue to investigate any specific allegations of anti-competitive behaviour brought to it in this area, or use its powers to conduct an investigation on its own initiative, as appropriate.

Chapter 6

Appropriate regulation

Introduction

6.1 Oftel’s objective is to obtain the best deal for consumers in terms of quality, choice and value for money by promoting effective and sustainable competition. Oftel's strategy provides a framework to ensure appropriate regulation is achieved, adjusted to the level of competition in the market and focused on the area of concern. Too much, or too little regulation can work against consumers’ interests by deterring investment and innovation.

6.2 This chapter considers the level of regulation appropriate for the markets considered in the review, based on the conclusions reached on the current level of competition in those markets.

Retail Internet service provision market

6.3 Oftel does not currently impose formal regulation in the retail Internet service provision market. In Chapter 2, Oftel has reached the conclusion that the retail Internet service provision market is effectively competitive. Therefore, the absence of formal regulation to promote competition in this market is still appropriate. However, the review has identified that there is scope for improvement in ISP customer service and in consumers’ understanding of the market.

Improving customer service

6.4 As outlined in the consultation, the Government's December 2000 White Paper A New Future for Communications, sees a key role for self and co-regulation, including codes of practice. Oftel, together with other Government departments, is currently promoting industry codes of practice covering all aspects of customer service. These initiatives should help lead to improved customer service. The onus is on industry to produce an effective code – or codes – of practice to cover their relationship with their customers. This will include procedures for dealing with complaints. If the industry fails to deliver, OFCOM will have the power to step in and put in place effective consumer protection measures.

6.5 Oftel hopes that ISPs signing up to the Ombudsman scheme and the proposed codes of practice will enjoy increased confidence among their users. The Implementation Working Group (IWG) responsible for setting up the Ombudsman scheme will consult ISPs regarding inclusion of their products and services. ISPs will be invited to a consultation meeting in February 2002.

Improving consumers’ understanding of the market

6.6 Research shows that there is some dissatisfaction among consumers with the information available to them about going online and only half of Internet consumers shop around before choosing an ISP or Internet package.

6.7 In the first half of 2002, Oftel will produce guidance for consumers connecting to the Internet. The purpose of this guidance will be to encourage a better understanding of the types of packages and different payment schemes available and to enable consumers to take advantage of market opportunities resulting from competition.

Wholesale call origination market

6.8 Oftel currently regulates the call origination market by requiring BT to make suitable wholesale interconnect products available, notably FRIACO for unmetered Internet access, and through regulated network charge controls.

6.9 Oftel has concluded that wholesale call origination is not yet an effectively competitive market and that BT is the dominant supplier. Therefore, continuation of network charge controls and the availability of quality wholesale products, such as FRIACO, are essential to protect consumers and prevent BT leveraging its market power into related markets, in particular the Internet call termination market.

6.10 Oftel does not propose any further regulation of the market at this stage. However, Oftel notes that a number of concerns were raised by respondents in relation to the existing FRIACO products and is able to confirm that many of these are already being discussed, as follows:

a) Payment terms. Some respondents were unhappy that the current FRIACO payment terms mean they must pay for capacity 12 months in advance. Oftel is consulting on the payment terms for FRIACO in its consultation document, Amendments to the FRIACO Direction, 28 January 2002.

b) Overflow. Oftel is facilitating industry discussion and debate on the feasibility of overflow of DLE FRIACO traffic onto non-FRIACO routes.

c) 64k granularity. Respondents argued that a 64k granularity version of DLE FRIACO would reduce barriers to entry. Oftel is, again, facilitating discussions between BT and OLOs on the feasibility of this enhancement.

d) Adjustment ratio. The FRIACO adjustment ratio, which is used to calculate the price of FRIACO, is currently being reviewed by Oftel with the intention of consulting on a draft determination in February 2002.

e) Charges for Intelligent Network (IN) service. Oftel is currently investigating a complaint regarding BT’s charges for the IN dip used in the provision of FRIACO.

6.11 Some respondents also express dissatisfaction with the lead times required for ordering FRIACO and the level of service BT has provided for provisioning of FRIACO circuits. Oftel is prepared to investigate any specific allegations of anti-competitive behaviour that are brought to it.

Wholesale Internet call termination market

6.12 In chapter 4, Oftel concludes that the wholesale Internet call termination market is not yet effectively competitive. Current regulations applicable to the wholesale Internet call termination market place certain obligations on BT in relation to dial-up Internet services, including the obligation to publish charges and not to discriminate or prefer unduly. As discussed below Oftel has decided not to remove these obligations as requested by BT.

6.13 However, Oftel is not proposing any additional regulatory action in the Internet call termination market at this stage, as it believes this would be disproportionate prior to a resolution being made on a wholesale FRIACO IP interconnection product. Oftel is currently facilitating industry negotiations on the development of an appropriate product. FRIACO IP interconnection may have an effect on BT's market share in Internet call termination and on the high barriers to entry that currently characterise the market.

BT’s request for deregulation

6.14 BT has made a request to Oftel to modify the regulatory obligations that apply to its generic ‘dial IP’ services to reflect the extent of competition in the markets for Internet call termination and Internet connectivity from the UK. BT’s existing products in this market are its Webport, WebPort24, Surfport and SurfPort24 products. Specifically, for existing and future services in these markets, it requested that the Director General:

• exercises his discretion set out in Condition 58.1 to remove the requirement to notify, publish and adhere to prices, terms and conditions as currently required under Condition 58; and
• confirm that any discrimination in the provision of the services encompassed by this submission would be unlikely to be deemed ‘undue’ for the purposes of assessment of discrimination under Condition 57.

6.15 In addition, BT later requested, in its response to this consultation, for a determination under Condition 43.1 that the obligations to supply set out in Condition 43 should not apply in relation to Internet call termination services.

6.16 All the services under consideration provide Internet call termination. Given that the Internet call termination market has been found not to be effectively competitive, these regulations are still appropriate to the level of competition. In particular, removing these regulations may increase the risk of BT being able to leverage market power from call origination into Internet call termination and further into the service provision market. Therefore, Oftel will not be deregulating as requested.

6.17 Two of the products, WebPort and WebPort24, include Internet connectivity as part of the product, which Oftel has found to be an effectively competitive market. However, Oftel’s concern remains that market power could be leveraged into Internet connectivity. Therefore, the existence of a competitive market in Internet connectivity does not provide justification for de-regulation of products that bundle an uncompetitive service.

6.18 Oftel is separately issuing a statement following its consultation, BT's regulatory obligations to provide advance notification of price changes and to maintain a published price list. It reviews the impact of the present price publication obligations on BT on the development of competition generally, and assesses whether they can be reduced.

Wholesale Internet connectivity market

6.19 In chapter 5, Oftel concludes that the Internet connectivity market is effectively competitive. This conclusion confirms that the absence of formal regulation in this market is still appropriate. As discussed above, this conclusion does not affect Oftel’s decision not to deregulate BT’s WebPort and WebPort24 products.

Conclusions

6.20 Effective competition in the markets for retail Internet service provision access and Internet connectivity confirms that the absence of formal regulation in these markets is still appropriate. Oftel will promote initiatives to protect consumers and consider ways of helping them take full advantage of competition in the retail market.

6.21 Where Oftel has found markets not to be effectively competitive in call origination and Internet call termination, existing regulations will be maintained. Additional regulatory action is not proposed, as it believes this would be disproportionate prior to a resolution being made on wholesale IP interconnection. However, Oftel is fully committed to ensuring that operators’ concerns with the existing FRIACO interconnection products are addressed appropriately.

Annex A

Market research

A.1 Network service provision

Use of a second line

• Three in 10 Internet homes have more than one fixed line, a small rise from 27% a year ago, and considerably higher than second line penetration in non-Internet homes (6%). The October survey found that second lines were most popular amongst heavy and experienced Internet users (45% and 40%). Internet access was the predominant reason for multi-line use (76%). Other uses of additional lines included business calls (34%), fax (24%), and a dedicated line for particular household members (17%).

Use of a cable supplier

• Homes with Internet access are also considerably more likely than non-Internet homes to use a cable supplier (28% compared to 16% in November 2001). This figure is higher still amongst multi-line Internet homes (47%). 15% of multi-line Internet homes (equivalent to 5% of all Internet homes) had both cable and BT lines. This is shown in figures A.1 and A.2.

Figure A.1 Supplier of fixed lines at homes

Figure A.2 Suppliers used to connect to the Internet

Base: UK homes with Internet access, Oct ’01 (Base: 750)