Contents

Direction

Chapter 1 – Summary

Chapter 2 – Background

Chapter 3 – History of the dispute

Chapter 4 – Responses to the draft direction

Chapter 5 – The Director’s decision and reasons

DIRECTION UNDER THE PROVISIONS OF REGULATION 6(6) OF THE TELECOMMUNICATIONS (INTERCONNECTION) REGULATIONS 1997 OF A DISPUTE BETWEEN CABLE & WIRELESS PLC ("C&W") AND BRITISH TELECOMMUNICATIONS PLC ("BT") CONCERNING BT’S RETENTION FOR THE ORIGINATION OF CALLS TO DQ118 SERVICES

WHEREAS:

A. The Secretary of State granted to British Telecommunications on 22 June 1984 a licence (the "BT licence") under section 7 of the Telecommunications Act 1984 ("the Act") for the running of telecommunications systems specified in that Licence;

B. By virtue of section 109 of paragraph 20 of Schedule 5 of the Act the BT licence has effect as if granted to British Telecommunications plc ("BT");

C. The Secretary of State has granted to Cable & Wireless Communications plc ("C&W") on 5 December 1991 a licence under Section 7 of the Act for the running of a telecommunications system as specified in the licence;

D. On 1 January 1998 the Interconnection Directive (the ‘Directive’) came into force and was implemented in the UK through the Telecommunications (Interconnection) Regulations 1997 (the "Regulations") and conditions in the licences of operators;

E. Regulation 6(6) of the Regulations provides that where there is a dispute concerning interconnection between organisations, the Director General of Telecommunications ("the Director") shall, at the request of either party, take steps to resolve the dispute within six months of the date of the request. The Determination which the Director makes to resolve the dispute must represent a fair balance between the legitimate interests of the parties, and must be notified to the parties in accordance with Regulation 8(3). The parties are entitled to a full statement of the reasons on which the Determination is based;

F. On 23 August 2002, BT issued a pricing letter to C&W. This pricing letter set out BT’s charges for the DQ118 retail price points that had been submitted by C&W;

G. On 28 August 2002 C&W accepted this pricing letter, however it stated that it disputed BT’s retentions as outlined in the pricing letter;

H. On 11 February 2002, in accordance with the provisions of Regulation 6(6) of the Regulations, C&W referred this dispute to the Director for determination;

I. The Director has a duty to encourage and secure adequate interconnection in the interests of all users in a way which provides maximum economic efficiency and gives maximum benefit to end-users;

J. The Director has considered, inter alia, the information provided by the parties and the matters set out in Regulation 6(8) of the Regulations. The principal points are summarised in the Explanatory Memorandum which accompanies, and is published with, this direction;

K. A draft of this direction and the Explanatory Memorandum was issued to interested parties on 24 April 2003. Comments were invited by 22 May 2003;

NOW, THEREFORE:

PURSUANT TO REGULATION 6(6) OF THE INTERCONNECTION REGULATIONS, AND HAVING CONSIDERED THE VIEWS OF THE PARTIES AND THOSE MATTERS SET OUT IN REGULATION 6(8) OF THOSE REGULATIONS, THE DIRECTOR MAKES THE FOLLOWING DIRECTION TO RESOLVE THE DISPUTE BETWEEN C&W AND BT:

1. BT does not have to amend its retention for the origination of calls to DQ118 services as at the date of publication of this Direction.

2. The terms defined in this direction shall have the meaning so defined or described. All other words or expressions used in this direction shall have the same meaning as in the Directive, the Regulations, the Act or the BT Licence as appropriate.

3. This direction shall take effect on the date it is published.

Heather Clayton

Director of Investigations

A person authorised under paragraph 8 of Schedule 1 of the Telecommunications Act 1984

26 June 2003

  Chapter 1 – Summary

1.1 The Director General of Telecommunications (the ‘Director’) has issued a direction in accordance with the provisions of Regulation 6(6) of the Telecommunications (Interconnection) Regulations 1997 (the ‘Regulations’) for the resolution of a dispute between Cable and Wireless plc (‘C&W’) and British Telecommunications PLC (‘BT’).

1.2 C&W referred this dispute to the Director for determination in a letter of 11 February 2003. C&W argued that BT’s retention for the origination of calls to directory enquiries services (‘DQ118’) is excessive. C&W further argued that BT has provided insufficient information as to why BT’s rates for the origination of calls to DQ118 services are approximately 70 per cent higher than for the origination of calls to number translation services (NTS).

1.3 Following this referral, the Director sought the views of the parties to the dispute and considered the submissions made by C&W and BT. The Director issued a draft direction in respect of this dispute on 24 April 2003 to the industry as a whole for consultation. This draft direction stated that BT does not have to amend its retention for the origination of calls to DQ118 services as at the date of publication of the Direction.

1.4 The explanatory memorandum which accompanied this draft direction stated that the Director does not agree with the methodology that BT has utilised in order to derive its DQ118 origination charges, and considered that BT’s DQ118 origination charges should be calculated in a manner that is consistent with the relevant calculation used for NTS services. However, after application of the Director’s preferred methodology, it was found that BT’s current charge is not unreasonable. Comments were requested and have been taken into account in making a final direction.

1.5 The details of the submissions made in response to the draft direction, together with the Director’s reasons for making his decision, are set out in chapters 4 and 5

1.6 The Director remains of the opinion that the relevant calculations used to set NTS charging arrangements are relevant for DQ118 calls. BT’s retention for the origination of calls to DQ118 services should be premised on the network costs and the retail costs that are applied when originating calls to NTS. An adjustment should, however, be made to BT’s retention to reflect the higher (per minute) value of bad debt likely to be associated with DQ118 calls relative to most NTS call types.

1.7 After application of the methodology outlined in the previous paragraph, the Director is still of the opinion that BT’s DQ118 origination retention is not unreasonable. The difference between BT’s charge and the relevant NTS retention represents a reasonable recovery of the higher levels of the bad debt cost associated with the retailing of DQ118 calls. Therefore, although the Director’s principles as outlined in the explanatory memorandum accompanying this direction remain valid, BT is not, as of the date of publication of this direction, required to amend its retention for the origination of DQ118 calls.

Chapter 2 – Background

2.1 The UK retail directory enquiries market was opened up to competition on 10 December 2002. On this date a number of new providers of directory enquiries services began offering services to consumers. These new DQ services operate on six-digit numbers starting 118. Existing directory enquiry service providers are also migrating their services to these new DQ118 numbers. An initial batch of these access codes was allocated to DQ118 service providers prior to the launch of DQ118 services.

Non-geographic traffic

2.2 A call to a DQ118 number is a non-geographic call ie the number used identifies a service rather than a geographic location.

2.3 Some other types of non-geographic traffic are grouped within the category of Number Translation Services (‘NTS’). Examples of NTS traffic include Premium Rate Services (‘PRS’), Freephone Calls, Local Rate Calls and National Rate Calls. NTS is described further in chapter 5. PRS is a subset of NTS for higher value calls costing more than ten pence per minute and, in some cases, single charge calls eg £1 per call.

DQ118 technical arrangements

2.4 The technical arrangements between BT and a DQ118 Service provider will differ according to whether the DQ118 Service Provider has interconnection with BT. If the DQ118 Service Provider has interconnection with BT, a call that has originated on BT’s network will be terminated by the DQ118 Service Provider.

2.5 However, in other cases DQ118 Service Providers will contract with terminating network operators for termination of these calls, as terminating network operators will already have the requisite interconnection with BT. In such cases the terminating network operator will host the DQ118 Service Provider’s DQ 118 number and will terminate calls that are made to that number.

Current DQ118 charging arrangements

2.6 The DQ118 service provider requests a retail price point for its services when accessed by a BT customer. If necessary, BT will create a new charge band, or place the DQ118 service provider's 118 number into a charge band that already exists (if another DQ118 service provider has previously requested that price point).

2.7 BT has published a number of DQ118 price points. There are pence per minute (‘ppm’) and pence per call (‘ppc’) price points, and combinations of a drop charge + pence per minute (starting after the first minute) and drop charge + ppm (from the start of the call). The price points have been set up by BT so far on an ad-hoc basis to meet the requests of DQ118 service providers.

2.8 BT publishes the payments it will make to a terminating operator when the terminating operator terminates a 118 call originated on BT's network (‘DQ 118 POLOs’) (see note one below). BT also publishes the retail price for calls to the corresponding DQ118 service provider's 118 number. The difference between these two numbers is BT's retention. These arrangements are set out in figure 1.

Figure 1: Current DQ118 charging arrangements

NTS charging arrangements

2.9 Charging arrangements for NTS traffic are governed by the NTS charging formula (see figure 2). In summary, the NTS charging methodology allows BT to recover its network costs, and an uplift to allow for retail costs incurred by BT in handling these calls (including a normal return on capital employed). A key distinction between the current DQ118 charging arrangements and the NTS charging arrangements is that the Director sets the retail costs that BT can retain when originating calls to NTS (‘the NTS retail uplift’).

Figure 2: the NTS charging formula:

• the originating operator retains: P-D+C

• the terminating operator retains: D-C

where:

• P is the actual retail price charged by the originating operator to the caller

• C is the pence per minute charge for conveyance over a single tandem segment of BT’s network (multiplied by the number of minutes of the call plus the NTS retail uplift to allow for retail costs incurred by the ONO in handling these calls)

• D is the deemed retail price for the call (including any allowance for discounts and bad debt)

2.10 ‘C’ as described in the NTS charging formula continues to apply (for the purpose of assessing BT’s retention) in accordance with, inter alia, the November 1999 Direction concerning BT’s NTS Conveyance and the December 1999 Statement on the Relationship between Interconnection Charges and Retail Prices for Number Translation Services (see note two below).

2.11 Of relevance to the dispute at hand is the Director’s recent involvement in the setting of the NTS ‘retail uplift’. The Director has recently published a direction in respect of the calculation of the NTS retail uplift (see note three below). This Direction set the retail uplift at 0.22ppm (for NTS calls other than freephone calls).

2.12 Respondents should note that the Director is currently consulting on how the NTS retail uplift will be calculated going forward. This will come into force when the new EU regulatory framework is implemented in the UK. Full details of this consultation can be found in the fixed narrowband wholesale exchange line, call origination, conveyance and transit markets fixed narrowband wholesale markets review consultation document (see note four below). In summary, the Director proposes that the NTS retail uplift should be set by the Director as a charge control. The Director outlined three options for the calculation of this control:

• retail uplift charge control fully based on current retail uplift charge methodology (1994-1995 cost allocation underlying the 1996 price control review);
• retail uplift charge control with glide path from the current methodology to BT fully allocated cost (‘FAC’) allocation;
• retail uplift charge control with base charge and target charge based on BT FAC allocation.

2.13 The Director’s proposed option is to use a retail uplift charge control with a glide path from the current methodology to BT’s FAC allocation (see market review document referenced in previous paragraph). The FAC allocation gives rise to a base year charge (2001-02) NTS retail uplift charge of 0.28 ppm, and a final year (ie 2006-07) charge of 0.30ppm.

2.14 In addition, the cost of originating a call to PRS includes a bad debt surcharge which takes into account the higher level of bad debt associated with these calls vis-à-vis other types of NTS. This is because PRS calls have a high retail value which results in BT incurring greater bad debt expenses where these are expressed on a per minute basis compared to the average NTS call. The Director has also recently issued a direction relating to the PRS bad debt surcharge (see note five below).

Notes:

1. The term POLO is used to describe the payment made to the operator.
2. www.oftel.gov.uk/publications/1999/pricing/nts1299.htm.
3. www.oftel.gov.uk/publications/licensing/2003/nts0303_4.htm.
4. www.oftel.gov.uk/publications/eu_directives/2003/eu_narrow/index.htm.
5. www.oftel.gov.uk/publications/licensing/2003/nts0303_1.htm.

    Chapter 3 – History of the dispute

3.1 In August 2002 BT issued a pricing letter to C&W which set out BT’s retention for the origination of calls to C&W-hosted DQ118 numbers. BT calculated its retentions for the new retail price points that C&W had previously requested. BT’s final proposal was based on:

• BT’s network charges; and
• a basic retail uplift of 0.51ppm, which was based on its estimate of the costs of retailing national geographic calls. This uplift included a Return On Capital Employed (‘ROCE’) of 13.5 per cent. This took the BT uplift to 0.561 ppm.

3.2 On 28 August 2002 C&W accepted this offer, although C&W stated that it disputed BT’s retentions as set out in the pricing letter. It further stated that the pricing letter had been signed in order that the launch of DQ118 services was not delayed. Following acceptance of this pricing letter C&W requested further information from BT on the make up of these charges. C&W has stated that BT was not prepared to provide this requested information.

3.3 C&W subsequently referred this matter to Director for determination in a letter of 11 February 2002. C&W stated that BT’s retention for the origination of calls to DQ118 services is excessive. C&W asked the Director to resolve the dispute by ensuring that BT recovers appropriate costs only.

  Chapter 4 – Responses to the draft direction

BT

4.1 BT noted the draft conclusion that BT does not have to amend its retention for the origination of calls to DQ118 services, but contested the basis of this conclusion.

4.2 BT made representations on the draft direction that fell into two areas. First, BT stated that it had concerns regarding the linkage of DQ118 charges to an NTS-type retention regime. Second, BT stated that it did not agree with the treatment of geographic call substitution as set out in the draft direction.

Linkage of DQ118 charges to an NTS-type retentions regime

4.3 BT stated that it does not accept that all non-geographic numbers should be subject to NTS-type regulation. BT stated that prior to the launch of DQ118 services it had agreed with the Director to introduce a DQ118 charge at a level significantly below the geographic charge level such calls should normally be expected to attract, on the basis that no such linkage be made, but that all cases are considered on their merits. BT stated that it did not consider that the arguments put forward in the draft direction supporting the application of an NTS linked charge are appropriate.

4.4 BT argued that the NTS and DQ118 markets are not similar. BT stated that when NTS regulation was introduced, NTS was an emergent market and the growth of the new market was encouraged. BT stated that for DQ calls the market already existed, and the large part of the effect on competition will be the transfer of the existing market between Operators rather than the growth of increased service choice.

4.5 BT also stated that it is charging its own DQ services the same rates as apply to other operators, so there is no advantage to BT’s competitive position by setting higher origination charges.

4.6 BT stated that it had utilised a charging methodology which incorporated costs associated with national geographic calls. BT stated that it had not attempted to use retail costs associated with DQ products, where costs would have been higher since the revenues associated with DQ products, and which drive some of the costs, are proportionately higher. BT stated that it had used a basis which recovered a regulated rate of return of 13.5 per cent rather than the geographic margin applicable to national geographic calls.

4.7 BT stated the Director’s goal of applying comparable charging regimes to DQ and NTS traffic would result in a recovery rate higher than the present charge that BT makes for calls to DQ118.

Treatment of geographic call substitution

4.8 BT stated that by choosing to regulate DQ118 call origination costs to a level below normal geographic call rates, the Director has effectively imposed additional controls on geographic calls due to the existence of ‘call completion’ on DQ118 services, whereby the caller is connected directly to the number requested rather than having to hang up and redial. BT referred to the Director’s document Provision of Directory Information Services and Products (see note six below), arguing that this document did not cite onward impacts of call completion as one of the objectives of regulation in this area.

4.9 BT outlined text in this document which stated that "The telecommunications industry derives a direct benefit from the use of directory information service and products in that they generate revenues from follow on calls…". BT stated that it is part of this industry, however the direct substitution of geographic calls that occurs when call completion is offered on the back of a DQ118 call is not recognised by Oftel’s approach as set out in the draft direction. BT stated that the existence of call completion is not likely to lead to reduced charges for the customer since the completed portion of the DQ118 call is likely to be charged at a rate closer to a DQ call than at the normal rate of a follow-on-call.

4.10 BT referred to paragraph 5.36 of the draft direction, which stated that call completion services should be seen as a further pressure on BT’s geographic call margins, and that BT’s approach would ‘lock-in’ supernormal returns associated with geographic calls. BT stated that such an approach constitutes regulation over and above that implemented in the last price control review. BT stated that such an approach has no justification, and considered that no valid argument for it is offered in the draft direction.

4.11 BT also stated that "having considered that the issue of geographic call margins on substitutional calls is one intrinsic to delivering the full benefits of DQ competition to customers, the Director undermines this position by section 5.37". Section 5.37 of the draft direction states that "while the competitive pressure generated by call completion services is welcomed, the Director does not expect it to substantially impinge on BT’s geographic call margins. However, even if call completion was to place significant downwards pressure on geographic call prices, this something the Director would welcome". BT stated that section 5.37 indicates the extent to which the Director’s regulatory intentions in relation to DQ are influenced by considerations well beyond DQ competition.

4.12 BT concluded by stating that Oftel’s approach to setting charges for origination of calls to DQ118 services gives rise, on the Director’s computation, to rates in excess of the charges presently set by BT.

4.13 BT stated that the Director concludes in the draft direction that BT’s present charges are acceptable and do not need adjustment. BT stated that the Director’s conclusion is perverse, bearing in mind the charging methodology which the Director considers is appropriate.

4.14 BT stated that either the existing rates for DQ118 origination charges should stand and that Oftel’s draft direction be brought into line with the principles that give rise to those rates, or, if the Director insists on his view as set out in the draft direction, BT should increase its charges in line with the level to which those principles give rise and as indicated by the Director’s calculations in the draft direction.

C&W

4.15 C&W welcomed the Director’s conclusion that the charging arrangements for DQ118 calls should be comparable to those that apply to NTS calls. C&W concluded that this provides a clear framework for the structuring of charges by BT, which, C&W stated, is the dominant UK operator in call origination.

4.16 However, C&W also commented on issues concerning the DQ118 bad debt surcharge and the application of the NTS retail uplift to DQ118 charging and these issues are discussed below.

DQ118 bad debt surcharge

4.17 C&W stated that the justification for inclusion of the PRS bad debt surcharge is based on a lack of information. C&W requested that the Director reconsider his preferred method of the inclusion of the 2 per cent surcharge without modification.

4.18 C&W argued that any bad debt surcharge must be related to the product to which the surcharge applies. C&W stated that the nature of the service accessed by a consumer is a critical factor in the incidence of bad debt. C&W considered that 192 bad debt gives a better guide to the likely levels of bad debt for DQ118 services than does PRS, and C&W requested that BT be obliged to provide reliable information on the levels of bad debt associated with its 192 service.

4.19 In summary, C&W stated that the Director should:

• demand accurate information from BT concerning DQ192 bad debt levels;
• reconsider the relationship between bad debt and service type rather than price; and
• assess the incidence factor for DQ192 bad debt and apply it to DQ118.

Application of the NTS retail uplift to DQ118 charging

4.20 C&W stated that analysis of the retail uplift for NTS shows a number of costs which ought not to be included in the BT DQ118 origination charge. C&W requested that the Director review every element that BT includes in the NTS retail uplift to assess its suitability for DQ118 services. C&W stated that these include:

• Marketing costs. C&W stated that only costs associated with the take-up of BT lines ought to be recovered through the retail uplift, and that costs associated with the marketing of other services must not be included. C&W argued that this is particularly true for DQ118, and that BT’s expenditure on the promotion of other call types and 118500 ought not to be paid for by DQ 118 providers.

• Unanalysed costs for the different SFR sectors. C&W queried the inclusion of such unanalysed costs in the retail uplift.

Note:

6. www.oftel.gov.uk/publications/1995_98/consumer/dqchap.htm

Chapter 5 – The Director’s decision and reasons

5.1 Before setting out the Director’s responses to the representations made in response to the draft direction, the position articulated in the draft direction will be summarised. C&W has disputed BT’s retention when originating calls to DQ118 services.

5.2 The draft direction stated that the Director did not agree with the charging methodology that BT has adopted in respect of its pricing for the origination of calls to DQ118 services. As the Director considers that the rationale for regulation of NTS services is consistent with the rationale for regulation of DQ services, the draft direction stated that it was relevant to calculate DQ origination on the same basis as that used for NTS services.

5.3 The Director based his calculation on the application of the network costs and retail costs incurred by BT when originating NTS calls to BT’s DQ118 origination charge. BT’s network costs were derived from the Network Charge Controls. The Director’s calculation of the NTS retail uplift was considered to cover the retail costs associated with DQ118 call origination. In addition, a bad debt surcharge was applied in order to account for the higher level of bad debt associated with calls to DQ118 services due to the higher retail prices of these services.

5.4 As a result of the application of the Director’s preferred charging methodology, the Director found that BT’s current DQ118 charge is lower than the Director’s charge. However, BT’s DQ118 origination charge had not specifically taken into account the higher level of bad debt associated with DQ calls. The Director found that the difference between BT’s charge and the Director’s charge can be accounted for as a reasonable recovery of the higher level of bad debt associated with the retailing of DQ118 calls. Therefore the draft direction stated that BT did not have to amend its retention for the origination of calls to DQ118 services.

5.5 BT submitted representations to the draft direction relating to two issues of principle. BT contended that it was not appropriate for DQ call origination services to be subject to an NTS-type retentions regime. Second, BT argued that it was incorrect for the Director to consider that calls completed via DQ118 numbers should not lead to a higher BT retention. In conclusion, BT stated that in the final direction the Director should direct either that the existing BT rates should stand and Oftel’s principles set out in the draft direction should be brought in line with the principles that give rise to BT’s rates, or BT’s charges should be brought in line with the level to which the principles set out in the draft direction give rise.

5.6 C&W welcomed the Director’s conclusion that the charging arrangements should be comparable to those that apply to NTS calls. However, C&W disputed two aspects of the detail of the Director’s proposed decision. The first aspect related to the Director’s calculation of the bad debt surcharge to be applied to DQ call origination. The second related to the costs included in the calculation of the NTS retail uplift.

5.7 The Director will now set out the considerations that will enable a final position to be reached in respect of this dispute. These considerations fall under the following headings:

• the relevant market and the position of BT;
• is it appropriate for the Director to base his calculations for DQ118 origination charges on the methodology used for NTS services?;
• is BT correct in stating that the current DQ118 charging arrangements are unlikely to give rise to competition issues?;
• should BT’s DQ118 origination charges be calculated on the basis of costs associated with national geographic calls?;
• is call completion a relevant consideration in calculating BT’s DQ118 origination charges?;
• does the Director’s position on the relevance of call competition constitute unreasonable additional regulation, that takes into account considerations beyond DQ118 competition which contradict previous statements made by the Director?;
• the application of the NTS retail uplift to BT’s DQ118 origination charge; and
• the DQ118 bad debt calculation.

The relevant market and the position of BT

5.8 BT’s retention when originating DQ118 calls constitutes an interconnection product. For the purposes of the Interconnection Directive (97/33) (the ‘Directive’), BT has been determined as having Significant Market Power (SMP) in the markets for fixed public telephone networks and services, and is therefore required to offer interconnection to operators with Annex II status. Article 7(2) of the Directive requires that charges for interconnection are cost orientated and for the national regulatory authority (ie the Director) to require that charges be amended where appropriate. The Director has a general responsibility in Article 9(1) of the Directive to encourage and secure adequate interconnection in the interests of all users, exercising his responsibility in a way that provides maximum economic efficiency and gives the maximum benefit to end-users.

5.9 The Director’s decision is made in accordance with Article 9(5) of the Directive as implemented in Regulation 6(6) of the Regulations in pursuit of these aims taking into account the criteria set out in Regulation 6(8).

Should DQ118 and NTS calls be subject to comparable charging arrangements?

5.10 BT has stated that the Director has erred in principle by stating that the objectives that should underpin regulation of BT’s retention for DQ118 calls are the same as those which underpin regulation of BT’s retention for NTS calls, and the resulting conclusion that NTS charging arrangements should be applied to the origination of calls to DQ118 services. In support of its argument, BT has stated that regulation was applied to NTS when NTS was an emergent market and where introduction of new services was the key aim. However, BT has stated that with DQ calls, a market already existed and the effect of competition will be the transfer of an existing market between operators.

5.11 The Director’s conclusion on the appropriate form of regulation to be applied to NTS call origination was set out in the document Interim Charges for BT’s initial standard services for year ending 31 March 1996 (see note seven below). The guiding objective that NTS call origination regulation sought to achieve was "to promote investment and innovation in services with a telecommunications service component by adequately rewarding those who invest in these services whilst ensuring a fair return for owners of the infrastructure on which the call originates".

5.12 The Director’s objectives in opening up the DQ market to competition are set out in the document Access Codes for Directory Enquiries Services (see note eight below). This document stated that the promotion of competition in DQ service provision should result in a wide range of innovative new services at a variety of prices being offered by DQ118 service providers to end-users. Although DQ services offered by network operators (such as BT’s 192 DQ service) existed at the time of market liberalisation, it was recognised that service-level (rather than network-level) competition was being promoted in order to deliver new services behind short access codes such as call completion, combined classified and standard services behind one number, and services in languages for minority ethnic communities.

5.13 Therefore the Director does not consider that the rationale behind this liberalisation was the ‘transfer of an existing market between operators’. It is clear that in both the NTS and DQ markets, the Director’s goal is to promote competition in order to deliver a wide range of services to consumers at a variety of prices. The launch of different types of DQ services since market liberalisation testifies to the impact of such an approach.

5.14 BT has also stated that the DQ118 market and the NTS market are at different stages of development. Although it may be the case that the NTS market is more mature than the DQ118 market, the Director considers that charging arrangements for each traffic type should still ensure that the benefits of call charges are passed to operators or service providers at the terminating end.

5.15 Finally, despite BT’s argument to the contrary, the Director does not consider that at any time prior to liberalisation of the DQ services market an agreement was reached with BT regarding what constitutes an appropriate DQ118 charging methodology. The Director has at no time approved the methodology which BT currently uses for DQ118 call origination charges.

5.16 In conclusion, the Director remains of the opinion that the objectives of regulatory intervention for both NTS and DQ118 services are similar, and that NTS charging arrangements form an appropriate basis on which to assess BT’s DQ origination charges. After considering arguments made in response to the draft direction, the Director’s reasoning as set out in paragraphs 5.7-5.32 of the draft direction remains valid. This analysis will not be repeated here. However, in summary, the Director stated that the value of ‘C’ that is calculated for the purposes of the NTS charging methodology is also applicable for calculating BT’s DQ118 origination charges.

Is BT correct in stating that the present arrangements are unlikely to give rise to competition issues?

5.17 BT has stated that it will be charging its own DQ services the same rates as apply to other operators, and that consequently it does not gain a competitive advantage from setting higher call origination charges. BT stated that as the cost of originating a DQ call is only a small proportion of the charge for a DQ118 call, it is unlikely to lead to any inhibition of competition in the DQ118 market.

5.18 The Director’s objective in intervening in the DQ market has been to facilitate competition between DQ service providers. For this competition to occur, the Director considers it is necessary for originating operators to undertake the call origination and retailing functions on behalf of terminating DQ service providers (see note nine below). It would not be economically viable for a DQ service provider to establish a billing relationship with each of its customers, as consumers’ spend relatively little on these calls.

5.19 Operators with market power in call origination would not find it in their interest to supply such origination and retailing services, or would only do so at monopoly prices, thus preventing competition, or limiting the gains from competition, in service provision. Regulatory intervention may be required in order to ensure that originating operators with market power charge for these services appropriately. This means a charge that is sufficient for the operator to recover its costs, but does not allow for the recovery of supernormal profits.

5.20 Allowing the recovery of supernormal profits in these charges would have two detrimental effects. Firstly, it would directly reduce consumer welfare as prices for DQ services would be higher than otherwise. Secondly, it would send inappropriate signals to other operators providing call origination services, in considering whether they should enter, or stay in, the call origination market.

5.21 The Director also noted in the draft direction that a cost-based charge would minimise the ability of BT to behave anti-competitively in the downstream market. This is because giving BT the freedom to charge higher wholesale prices provides it with greater flexibility to engage in predatory behaviour. For example, by setting a high wholesale price and a low retail margin BT could drive out competitors in the DQ service provision market, even while making profits on an end-to-end basis. The Director’s view is therefore that charges should be based on the efficient costs of call origination and retailing. This charge will facilitate efficient competition between DQ service providers, as well as between suppliers of call origination services.

5.22 Therefore BT’s market position when originating DQ118 calls, as set out in paragraphs 5.8-5.9 of this document, is a relevant consideration.

Should DQ118 origination charges be calculated on the basis of national geographic costs?

5.23 BT’s proposed charge includes the retail costs associated with a national geographic call. BT stated that the use of DQ192 retail costs would have resulted in higher costs, since the revenues associated with DQ products, and which drive some of the costs, are proportionately higher than for national geographic calls. BT also noted that it used a regulated rate of return of 13.5 per cent rather than the geographic margin which it currently applies to national geographic calls.

5.24 The Director’s draft direction proposed the use of NTS retail costs (including a 13.5 per cent margin) as a proxy for (non bad-debt) DQ 118 retail costs. The Director noted in the draft direction that, in principle, there should be very little difference between the non bad debt costs of retailing DQ, NTS and geographic calls. Any overall difference in costs between NTS, DQ and geographic calls was likely to relate to the different bad debt costs associated with each service. The Director has explicitly accounted for a difference in bad debt costs in his direction.

5.25 The Director has chosen, however, to use NTS retail costs as a proxy as he has made previous directions on these costs, during which he investigated these in a thorough manner (see note ten below). In addition, as part of his market review of narrowband access and call origination markets, the Director has proposed a price cap for NTS retail costs. As part of the development of this price cap he has investigated (and continues to investigate) the appropriateness of the inclusion of certain retail costs into the retail uplift. The Director concludes that the existing and future NTS retail uplifts are likely to provide a good proxy for the non bad-debt costs of retailing DQ 118 calls. Therefore, since the Director considers that there should be very little difference between the non-bad debt costs of retailing DQ, NTS and geographic calls, examining BT’s national geographic retailing costs on the same basis would represent an unnecessary duplication of effort.

5.26 BT claims that the certain retail costs are higher for national geographic calls than for NTS calls, on the basis that, for some common costs, revenues are used as a cost allocation mechanism. However, the Director has already specifically accounted for the higher bad debt costs of DQ118 calls, which are driven by revenues, and has not received any evidence from BT that other retail costs are likely to be higher for DQ118 calls than NTS calls on a pence per minute basis.

Is call completion a relevant consideration in calculating BT’s DQ118 origination charges?

5.27 BT made two representations in this regard:;:

• first, BT stated that it is unreasonable for the Director to refer to downward pressure on BT’s geographic call margins in considering the relevance of call completion, as such considerations are beyond DQ competition, and constitute unjustified ‘additional regulation’ on geographic call prices beyond the scope of DQ118 competition;

• second, BT argued that the Director has previously stated that operators derive benefit from the use of DQ118 services as they generate revenues from follow on calls, and that BT should be able to benefit from a call completion service offered on the back of a DQ118 call.

5.28 In the draft direction, the Director proposed not to allow BT an extra retention for those calls that were ‘call completed’, that is, those calls that begin as DQ calls but then are completed as geographic calls. The Director’s position on this issue is set out in paragraphs 5.33-5.38 of the draft direction. However, in order that BT’s arguments made in response to the draft direction can be addressed, the Director’s position is repeated here.

5.29 In the draft direction, the Director analysed the extent to which the proposed cost-based retention would result in benefits (in terms of lower prices or better services) for end-users of call-completed DQ calls and geographic calls.

5.30 The Director noted that the recent introduction of new DQ118 numbers has substantially reduced barriers to entry into the markets in which DQ services are supplied, and has encouraged the entry of a substantial number of new service providers. Consequently, the Director expected that the increased competitive pressures on existing DQ service providers should push prices for call completed DQ calls towards the cost of the call components (origination, DQ service provision and termination), plus a premium for the value that consumers place on using the call completion service. This implies a reduction in the price that end-users pay for the geographic components of the call. Therefore, the Director expected that the application of a cost-based retention for call completed DQ calls should result in benefits for end-users of DQ services.

5.31 The Director also noted in the draft direction that the level of geographic call substitution that actually occurs via DQ call completion services is, to some degree, within BT’s control. BT can limit the degree of call substitution occurring by ensuring that the difference between geographic prices and DQ prices is maximised – that is, by keeping its geographic call prices low. As such, call completion services should be seen as a further source of competitive pressure on BT’s geographic call margins. This is an area in which BT has historically made super-normal returns and in which the Director has actively been facilitating the development of competition (see, for example, the market review of fixed narrowband wholesale markets) (see note eleven below). Conversely, an approach which included current margins in origination charges would have the effect of ‘locking in’ these super-normal returns.

5.32 Having said this, the draft direction also set out the Director’s view that the impact of call completion should not be overstated – the extent to which consumers will a use DQ service to substitute for a normal geographic service in order to purchase calls will necessarily be limited by having to pay the convenience premium. This can readily be seen by comparing the retail prices of DQ118 services with existing geographic call prices. Hence, while the competitive pressure generated by call completion services is welcomed, the Director did not expect it to substantially impinge on BT’s geographic call margins. However, even if call completion was to place significant downward pressure on geographic call prices, the draft direction stated that this is something that the Director would welcome.

5.33 In the light of this analysis, the draft direction set out the Director’s proposed view that limiting BT to a cost-based retention for call-completed DQ services is likely to result in benefits for end-users. As a result, the Director considered that no further charge should be levied by BT to compensate it for geographic call substitution.

5.34 BT’s arguments in response to the Director’s analysis in respect of the relevance of call completion will now be considered.

Does the Director’s position on the relevance of call completion constitute unreasonable additional regulation, that takes into account considerations beyond DQ118 competition which contradict previous statements made by the Director?

5.35 BT argued that it is unreasonable for the Director to refer to downward pressure on BT’s geographic call margins when considering the relevance of call completion, as such considerations are beyond DQ competition.

5.36 In assessing BT’s argument that downward pressure on BT’s geographic call margins is an unrelated consideration, the Director has considered how this position equates with the criteria that the Director must take into account in resolving disputes, as set out in Regulation 6(8) of the Regulations. In particular, the Director considers that downward pressure on geographic call margins will be in the interests of users. It is the Director’s goal that consumers should have the best deal in terms of choice, quality and value for money. A reduction in the price that end-users pay for the geographic components of the call is in line with this objective.

5.37 BT’s response to the draft direction also argued that the Director was implicitly applying increased regulatory control on geographic calls over and above that implemented in the last Price Control Review. BT stated that this was unjustified. The Director does not believe this is the case. In the Price Control Review, the Director refrained from implementing a restrictive price cap on BT, believing that increasing competition, in conjunction with access regulation, was likely to provide a sufficient cap on exchange line and geographic call prices such that only a ‘safeguard’ cap – expected to be non-binding – was implemented. The Director noted he would be encouraging the facilitation of further retail competition, including through the introduction of a wholesale line rental product. Within this context, the Director does not believe a reduction in BT’s geographic call margins (if it were to occur as a result of use of call completion services) through increased competition would require any change to current Price Control arrangements, given the flexibility and expected non-binding nature of the cap.

5.38 BT has also argued that previous statements by the Director relating to DQ services imply that BT should account for the substitution of geographic calls that occurs when a call completion service is offered on the back of a DQ118 call. The Director’s comment in the document to which BT has referred stated that DQ calls tend to stimulate additional calls, and that this is of benefit to the telecommunications industry as a whole.

5.39 However, this statement was not made in the specific context of the issue that is currently under consideration, which relates to whether BT’s charging for the origination of calls to DQ118 services should take into account calls that are directly connected to the number that has been requested. The Director has clearly stated in the document referenced in footnote six that the availability of call completion for consumers who choose to use was one of the benefits likely to result from the liberalisation of DQ services. Therefore, while the Director does not dispute that call completion is a beneficial service, this consideration is clearly distinct from the issue of whether BT’s DQ118 origination charges should take into account the pressure that completed calls put on BT’s geographic call margins.

5.40 Therefore while the Director is still of the opinion that calls to DQ118 services stimulate additional calls which is of benefit to the industry as a whole, consideration of the relevance of call competition in the context of BT’s charging requires a more detailed analysis of certain specific issues. The Director has carried out this analysis in order to resolve this dispute. In conclusion, the Director considers that no further charge should be levied by BT to compensate it for geographic call substitution due to call completion via DQ118 numbers.

The application of the NTS retail uplift to BT’s DQ118 origination charge

5.41 C&W stated in response to the draft direction that certain costs involved in the calculation of the retail uplift are inappropriate, in particular marketing costs and other ‘unanalysed’ costs. C&W stated that such costs should not be included in BT’s origination charge for DQ118 services.

5.42 The Director has recently considered the relevance of the costs included in the NTS uplift, in the direction at footnote three. In issuing this determination, the Director considered the relevance of all cost categories included in the NTS retail uplift. The Director considers that this reasoning is relevant as the principles that determine whether or not a cost category should be included in the NTS retail uplift are equally applicable to DQ118 traffic. Therefore the Director does not propose to review every element that BT includes in the NTS retail uplift.

5.43 Furthermore, comments on the calculation of the NTS retail uplift that will come into force when the new EU regulatory framework is implemented in the UK are currently being considered in the context of the market review statement that will follow the consultation document outlined at footnote four. If the retail uplift changes, the Director will consider representations that that the conclusions in this document should be revisited.

The DQ118 bad debt calculation

5.44 In addition, C&W stated that there was insufficient information in the draft direction regarding the inclusion of the PRS bad debt surcharge for calculation of the bad debt surcharge associated with origination of calls to DQ118 services. C&W also requested that the Director request information from BT on bad debt associated with calls to the DQ192 service, in order to build a picture of the level and incidence of bad debt associated with this product.

5.45 The Director’s analysis of the bad debt surcharge is set out in paragraphs 5.47-5.56 of the draft direction, and is not repeated here. However, this analysis can be summarised as follows. The draft direction set out the Director’s two approaches that could be used in order to determine the level of bad debt associated with DQ118 calls. First, the Director considered that bad debt could be estimated by assuming that bad debt cost is a constant percentage of revenue across all call types. Second, the Director considered whether to use existing bad debt cost attribution in BT’s regulatory Financial Statements for (inland) DQ192 calls as an estimate for the bad debt costs associated with the DQ192 service.

5.46 In the draft direction, the Director stated that due to imperfections in the DQ192 data that has been received from BT, it was appropriate to use the PRS bad debt surcharge of two per cent of revenue to account for DQ118 bad debt in DQ118 origination charges. The Director considered whether the difference between BT’s proposed charge and the retail uplift used for NTS calls was reasonable in comparison with the estimates for bad debt cost produced using surcharges in the range of 1.5-2 per cent of revenue. The Director’s final calculations on this issue, as outlined in the draft direction, are set out in the following table:

Figure 3: llIustration of the Director’s calculations

5.47 It can be seen from figure 3 that BT’s proposed charge is lower than one that would be set by the Director under his proposed methodology, for a range of different bad debt surcharges.

5.48 However, further to C&W’s representations on the DQ118 bad debt surcharge made in response to the draft direction, the Director has considered bad debt levels for other call types in order to assess whether the range used in the DQ118 draft direction (1.5-2.5 per cent) is reasonable.

5.49 This analysis examined bad debt as a percentage of revenue for BT-OLO Lo-Calls, BT-OLO National Calls, BT-OLO Value Calls, BT local geographic calls and BT national geographic calls for 2001-02. This analysis indicated that bad debt costs in respect of the calls under consideration varied across all call types but were not below 1.5 per cent of revenue, the lowest of the range of estimates set out in the draft direction.

5.50 As a result, the Director considers that the range set out in the DQ draft direction is reasonable. The analysis set out in paragraphs 5.47-5.56 of the draft direction remain the Director’s view on this matter.

Conclusion

5.51 BT has requested that the Director direct either that the existing BT rates should stand and Oftel’s principles set out in the draft direction should be brought in line with the principles that give rise to BT’s rates, or BT’s charges should be brought in line with the level to which the principles set out in the draft direction give rise.

5.52 The principles set out in this Explanatory Memorandum sets out the regulation that the Director would seek to apply to BT’s charging for the origination of calls to DQ118 services. The Director remains of the opinion that the relevant calculations used to set NTS charging arrangements are also applicable to DQ118 calls. BT’s retention for the origination of calls to DQ118 services should be premised on the network costs and the retail costs that are applied when originating calls to NTS. An adjustment should, however, be made to BT’s retention to reflect the higher (per minute) value of bad debt likely to be associated with DQ118 calls relative to most NTS call types.

5.53 It has been necessary to outline this reasoning in order to establish the manner in which the dispute at hand will be resolved. However, after application of these principles, the Director has not found that BT’s current retention for the origination of calls to DQ118 services is set at an unreasonable level.

5.54 BT’s retention when originating calls to DQ118 numbers is set at 0.561ppm. The Director’s retail uplift is set at 0.2228ppm. The Director considers that the difference between BT’s retention and the Director’s retail uplift can be accounted for as a reasonable recovery of the higher level of bad debt cost associated with the retailing of DQ118 calls. Therefore BT is not required to amend either its charging methodology or its retention in accordance with the principles that have been set out by the Director in this explanatory memorandum.

Notes:

7. Interim Charges for BT's initial standard services for year ending 31 March 1996, Determination and Explanatory Document, January 1996.
8. www.oftel.gov.uk/publications/numbering/denq0901.htm, September 2001
9.The role of terminating service provider is commonly separated into terminating network operator and DQ service provider.
10.see document referenced at footnote 3.
11.see document referenced at footnote 4.