A Consultative Document issued by the Director General of Telecommunications

February 2001

Contents

Summary

Chapter 1 Introduction and background

Chapter 2  Effective competition indicators

Chapter 3 The calling party pays principle

Chapter 4 Mobile subscribers and closed user groups

Chapter 5 Behaviour of callers and substitution possibilities

Chapter 6 Market definitions

Chapter 7 Options for regulatory action

Chapter 8 Consultation and timetable for response

Annex A International benchmarking

Annex B Background to mobile industry

Annex C Current and future competitive pressures on mobile termination: Demand-side and other factors

Annex D Consumer research and empirical evidence

Annex E Modelling of long run incremental costs

Glossary

Summary

S.1 In 1998, following a reference by Oftel, the Monopolies and Mergers Commission (now the Competition Commission) concluded that the level of charges for calls made to mobile phones on the BTCellnet and Vodafone networks was against the public interest, and accepted the Oftel proposal that they be capped. As a result, their average charge was reduced by 25% to a ceiling of 11.7 pence per minute for 1999/2000 with subsequent reductions of RPI-9% for the years 2000/01 and 2001/02. Oftel estimates that the charge control will have saved UK consumers in excess of £1 billion over the three years. The controls expire in March 2002, and the purpose of this consultative document is to seek views on whether the controls should be continued or removed, or if some other regulatory action is appropriate.

S.2 This consultative document, therefore, sets out the framework for the analysis of the competitiveness of the mobile call termination market. Since the control was set, the mobile market has grown rapidly and at a rate much greater than that predicted by the Competition Commission (CC). There have also been many new developments, most notably in data services, such as text messaging (SMS), and in the next few years further developments, such as Internet access, and other potential services may further influence the competitiveness of the market.

S.3 For Oftel, the key fact remains that when a call is made to the mobile network, it is the calling party which pays for the call, not the person being called. This means that there is a greatly reduced incentive for the network operators to lower the charges which they make for incoming calls to a competitive level, as it is not their customers who pay for the call. Further, research by Oftel suggests that most residential and business mobile phone owners are not generally concerned by incoming call prices, and that their choice of network is unlikely to be influenced by the charges made by that network for incoming calls. To some extent, the reduced incentive to price at the competitive level may be mitigated by closed user groups (ie groups which all subscribe to the same network) but this is likely to be of marginal impact.

S.4 Oftel has set out a framework to assess effective competition through looking at the impact on consumers, consumer behaviour, supplier behaviour and structural issues. Possible substitutes for mobile call termination, both at a retail and wholesale level, are considered, looking at both demand-side and supply-side factors.

S.5 The consultative document looks at possible definitions of the relevant market for mobile call termination, considering a separate market for each operator, a linked national market for mobile services, or a national market for call termination. Market definition is important in the assessment of market power, which will inform any decision taken on the nature and extent of any regulation.

S.6 The key issue is whether, in the absence of regulation, the mobile network operators could charge excessive prices in relation to cost. If competition does not constrain prices, there are various courses of action that Oftel could follow. First, Oftel could intervene to regulate the charges for call termination via a charge control, such as currently exists, with the cap based on the long run incremental cost of incoming calls. Such a control might apply for two years. A second option would be to intervene to tie termination charges to other charges which are competitive.

S.7 Thirdly, Oftel could attempt to increase competition for call termination by, for example, increasing consumer awareness of the retail pricing structure. Oftel proposes to increase transparency here, but this alone may not be sufficient to constrain charges. Fourthly, if there were evidence of increasing competitive constraints so that in the near future call termination charges were likely to be constrained to the competitive level, regulatory intervention may not be appropriate. No regulatory intervention might also be justified if levels of mobile ownership are sufficiently high, so that high charges for call termination are balanced by lower charges for other services, and that it is the same group of consumers benefiting from these lower charges who were paying the high termination charges.

S.8 If it is decided that regulation is appropriate, questions arise as to which mobile operators should be included in any action. Oftel has not yet made a decision about the four large mobile operators, but any decision will be made according to their market power and behaviour. However, the document concludes that Dolphin is different in kind and is likely to be excluded from regulation.

S.9 This consultative document does not deal with Third Generation (3G) mobile telephony. At present, Oftel considers that it is inappropriate to consider charge regulation on 3G services. Oftel’s current view is that any regulatory intervention resulting from this review would only cover the period up to 2004, by which time the competitive environment for 3G call termination will be much clearer; this is another strong reason for not including 3G in the current exercise.

S.10 Oftel is seeking views on issues and proposals set out in this consultative document by 4 May 2001 and intends to issue a statement with conclusions by 31 July 2001. If these conclusions were to lead to further regulation, this might not be accepted by the operators, and references to the Competition Commission might have to be made. To avoid any ‘gap’ that might occur if this were to happen, Oftel is proposing, separately, licence modifications for BT Cellnet and Vodafone which would continue the current charge controls until a final decision is reached. Formal consultation on these modifications will take place shortly.

Chapter 1

Introduction and background

1.1 When a consumer calls a mobile phone, either from a fixed line or from a mobile phone on another network, the call is generally carried over two distinct networks, the network of the operator to whose network the caller belongs and that of the mobile operator on whose network the call terminates. A call termination charge is a wholesale charge set by an operator for the termination of calls to a phone on its network and is paid by other operators on whose network the calls originate. Termination charges are closely related to the retail prices paid by callers as the retail price of a call from, for example, BT to Vodafone is made up of the termination charge set by Vodafone, which is paid by BT, plus BT’s costs in originating and carrying the call (BT’s ‘retention’).

1.2 Currently, there is a charge control on the termination charges set by BTCellnet and Vodafone. This charge control is due to expire in March 2002 and Oftel is in the process of reviewing the market and deciding whether any regulatory action is appropriate to protect consumers when the current price control runs out.

The current price control

1.3 Following concerns expressed in the past by both business and residential consumers, Oftel conducted a review into the level of the price of calling mobile phones in 1997/1998. In March 1998, a reference was made by the Director General to the Monopolies and Mergers Commission (now renamed as the Competition Commission and subsequently referred to herein as the Competition Commission (CC)) who made an inquiry into the charges made by BTCellnet and Vodafone to fixed network operators (FNOs) for the delivery of calls to mobile phones on their respective networks. In December 1998, the CC concluded that:

• there was insufficient competitive pressure to constrain mobile termination charges and that this was likely to be the case until at least 2002;
• the prevailing charges were substantially in excess of the costs of an efficient operator with 25% share of the market; and
• the level of charges acted against the public interest.

1.4 The Director General implemented the recommendations of the CC in March 1999 by modifying the licences of BTCellnet and Vodafone to reduce their weighted average termination charges for 1999/2000 to a ceiling of 11.7 pence per minute and to provide for further reductions to that ceiling of RPI-9% for each of the years 2000/2001 and 2001/2002.

1.5 The CC also made a separate inquiry on the amount of the retail price that BT keeps ("BT’s retention") on calls to mobile phones. As a result of the CC’s recommendations, an RPI-x price control was imposed on BT’s retention until March 2002.

Impact of the price control

1.6 Table 1 below shows that, since the introduction of these controls in April 1999, the prices of calling BTCellnet and Vodafone have fallen by approximately 33%. Oftel has estimated that the controls will save UK consumers well in excess of £1billion over the three-year period of the controls. The prices for calling Orange and One2One, which were not subject to the CC’s inquiry, have also fallen, but not by as much.

*Price changes include an increase in BT’s retention in December 1999

Table 1: BT’s peak rate retail prices for calls to mobile networks

1.7 Following the introduction of these charge controls, Oftel had to consider requests from BT to determine the level of termination charges of Orange, One2One and Dolphin. The Director General engaged in a number of discussions with the mobile operators and indicated that his preliminary view was that the level of charge which should apply should be based on the CC’s public interest benchmark termination charge established for Vodafone and BTCellnet, adjusted for any cost differences faced by the other operators because of differences in their networks. In each case, before the Director General made a determination, BT reached agreement with the respective mobile operator for termination charges taking into account the Director General’s yardstick and BT withdrew its determination requests. The current mobile termination charges paid by BT are shown in Table 2 below.

Table 2: Termination charges for calls from BT to mobile networks in pence per minute. Source: BT Carrier Price List as at 1.12.2000

Developments since the price control was introduced

1.8 The UK mobile sector is growing, both in terms of subscribers and retail revenue, fuelled by the advent of pre-pay mobile packages. The percentage of the population owning a mobile phone had reached 60% in September 2000, amounting to over 34 million mobile subscribers, and several millions more mobile phones were bought over the Christmas 2000 period. This compares with the CC’s forecasts when it recommended the current price control which assumed an annual average growth rate for incoming calls of 30.5% and the number of subscribers to reach 18.6 million by 2002.

1.9 Table 3 below shows the low, medium and high growth scenarios that the CC used to forecast total minutes and subscribers, alongside the latest available actual figures. Both the actual volume of minutes and the actual number of subscribers have already exceeded the CC’s high growth scenario for the year to March 2002, with subscriber numbers over 60% higher than the CC’s high scenario forecast. The CC’s analysis of mobile costs led to the conclusion that economies of scale exist in mobile termination costs. Therefore, the out-turn of much greater traffic than the CC had forecast means that the current charges are likely to be significantly above costs, as analysed by the CC.

Source: Oftel from CC report, Table 5.11 and Oftel Market Information.

Table 3: Comparison of CC’s forecasts for 2001/02 and actual minutes and subscribers

1.10 At the time of the CC report, Short Messaging Services (SMS) were a relatively unimportant feature of mobile phone use. The use of SMS, primarily a mobile to mobile data message service, has grown extremely quickly with over 1.6 billion SMS messages were exchanged between July and September of 2000, compared to less than 0.3 billion in the same quarter of 1999 (see Table B5 in Annex B for further details). WAP (Wireless Application Protocol) has also been introduced recently allowing limited Internet access from mobile handsets, including the sending and receiving of e-mail using web-based accounts. GPRS (General Packet Radio Service) has started to be rolled out and will increase the ability of mobile operators to offer data services as will broadband ‘3G’ mobile services which are planned to be launched from 2002. This will bring, in addition to voice telephony, new interactive multimedia services to mobile phones, such as video application, fast Internet access and video conferencing.

Scope of Review

1.11 Oftel’s prime concern with mobile termination charges is that they can represent over two thirds of the costs of the originating operator, and as a result their level has a direct bearing on the retail price of calling a mobile phone. Accordingly, Oftel needs to consider both competition for call termination (ie the wholesale product), and competition for calls to mobiles (ie the retail product). Oftel is also concerned with the extent to which behaviour in the retail market for calls to mobiles influences the level of call termination charges in the wholesale market. Whilst competition at the retail level may lead to constraints on termination charges, in some circumstances it would not result in sufficient material competitive pressures at the wholesale level to restrain wholesale charges. Consequently, this review examines both the potential retail and wholesale pressures on call termination.

1.12 The current charge controls on BTCellnet and Vodafone operate specifically on mobile termination charges for calls originating on fixed lines. However, termination of calls from one mobile network to another, known as ‘off-net’ calls, or from the same network (‘on-net’ calls) is becoming increasingly important. Oftel therefore has to examine both the competition issues that arise for termination of fixed to mobile calls as well as mobile to mobile calls.

Cost basis for termination charges

1.13 Oftel’s view is that, whenever regulatory control of charges is required to protect consumers from excessive charging by operators with market power, the most appropriate and economically efficient basis for the charges is long run incremental costs (LRIC). Forward-looking costs are based on a current, rather than an historic, valuation of assets. Charges set on this basis most accurately reflect the resources consumed by the provision of services and correspond most closely to the level which would occur in a fully competitive market.

1.14 The existing controls on Vodafone’s and BTCellnet’s termination charges are based on a fully allocated cost (FAC) historic cost basis. The CC agreed that LRIC was in principle an appropriate costing methodology for setting termination charges. However, in the CC’s view, there had been insufficient work at the time of their inquiry on the LRIC methodology and LRIC costs for mobile networks for them to base their recommendations on a LRIC approach. In order that the relevant information is available, should a further period of charge control be required, Oftel has started a work programme with the industry to establish the LRIC of termination on mobile networks. A brief description of this is set out in Annex E.

Timing and rollover

1.15 If Oftel concludes that the controls are still necessary, sufficient time needs to be allowed for a reference to the CC, in case one is necessary, before the ending of the current controls. In practice, this means that the review must be completed several months ahead of the ending of the controls.

1.16 Oftel plans to reach conclusions and make any proposals for future control in July 2001, about 9 months before the end of the charge control. It may take up to 12 months for a CC inquiry and the implementation of its findings. Accordingly, Oftel is proposing to insert a ‘rollover’ condition into BTCellnet’s and Vodafone’s licences which would allow the existing controls to continue for the duration of any reference to the CC and until new arrangements, if appropriate, are in place. Oftel will commence statutory consultation on draft licence modifications to this effect shortly.

Review of BT’s retention

1.17 The price control on BT’s retention for calls to mobiles does not fall within this project. Oftel has considered it as part of the overall review of BT’s price control, [see Oftel’s Statement Proposals for Network Charge and Retail Price Network Control – January 2001]. Oftel is proposing to roll-over its end date by four months to July 2002 to coincide with the current proposed end date of the price control on other BT retail services.

Mobile Market Review

1.18 Separate to this review, Oftel is also conducting an effective competition review in the broad mobile sector (Mobile Market Review or MMR). However, the MMR is not considering the competitive conditions for call termination on mobile networks relevant to this review. Nevertheless, because of the impact of the wider market conditions on specific markets, the MMR and this review are being conducted simultaneously. Accordingly, this consultative document is being issued shortly after the MMR’s consultative document, entitled Effective Competition Review: Mobile [February 2001], and it is planned that the conclusions of both reviews will be made concurrently in the July 2001.

The Consultation

1.19 This consultative document seeks comments from consumers, operators and other interested parties on the relevant considerations to establish whether further regulatory action is required to protect consumers after the controls on Vodafone’s and BTCellnet’s termination charges expire in March 2002, taking into account likely developments in the mobile market. Since July 2000, Oftel has had a series of meetings with mobile and fixed operators to discuss these issues, so far particularly focussing on the competitiveness of call termination.

1.20 Oftel is aware of the difficulties of accurately assessing the competitiveness of the mobile termination market in the future in such a rapidly changing industry. However, it is necessary that Oftel reaches a decision about whether regulation is still required before the charge controls expire. The decision will be made on the most up to date data possible, and the best informed view of the future of the industry, consistent with the time scale above.

Outline of document

1.21 Chapter 2 outlines Oftel’s approach to assessing the competitiveness of the call termination market, identifying factors which might affect competitiveness and therefore whether there is a need for regulation. These are discussed in more detail in Chapters 3, 4 and 5. Chapter 6 considers the possible market definitions, Chapter 7 discusses some regulatory options if regulation were found to be necessary. Chapter 8 draws together the questions on which Oftel is consulting.

Chapter 2

Effective competition indicators

Introduction

2.1 In accordance with Oftel’s Strategy, Oftel would propose a further period of regulation of mobile termination charges only if competition in the relevant market were found to be insufficient to restrain prices and was expected to remain insufficient after the current charge controls expire. The assessment of the current and future competitive pressures on mobile termination charges is, therefore, central to the current review. This Chapter introduces the analytical framework that is applied and provides a ‘road map’ to that discussion.

Market definition

2.2 Generally, there are two sequential stages involved in competition analysis: an assessment of the relevant market for the particular product followed by an assessment of the market power held by the supplier(s) of that product. Thus, the assessment of competitive pressures faced by the suppliers is preceded by the definition of the relevant market.

2.3 In analysing the effectiveness of competition in the call termination, however, it has been necessary to adopt a slightly different approach. In defining a relevant market, it is usual to begin with a fairly narrow view and then expand that market to include the relevant substitutes. In this case, the most plausible starting point for this analysis would be a market for call termination on each operator (eg call termination on BTCellnet is one market, call termination on Orange is one market). With this starting point, supplier and product are inextricably linked so that the potential substitutes relevant to defining the market are also relevant in determining the degree of market power. For example, a conclusion that the relevant market here was that for call termination on each operator would inevitably also lead to the conclusion that each operator had market power. Thus, it is neither practical nor sensible to separate the analysis of competitive pressures as they relate to each of the market definition and the assessment of market power. Rather, it is better to consider the competitive pressures first (in Chapters 3-5) and then draw out the implications for market definition and for market power (in Chapter 6).

The calling party pays principle

2.4 A major factor to take into consideration when assessing the intensity of competition is the fact that the price of the call to a mobile is paid by the person making the call, not the person receiving that call. For that call, the person making the call has no direct relationship with the mobile operator on whose network the call terminates. This factor, known as the calling party pays principle, is discussed first. (see Chapter 3).

Effective competition indicators

2.5 Oftel’s effective competition review guidelines, entitled Implementing Oftel’s Strategy: Effective Competition Review Guidelines [August 2000], sets out four broad groups of the indicators of effective competition: consumer outcomes, consumer behaviour, structural factors and supplier behaviour. This review takes into account all these indicators and the rest of this Chapter explains how they are taken into account.

Consumer outcomes

2.6 The factor that Oftel considers under this indicator is whether UK consumers are shown to enjoy the ‘best or near best deal’ in comparison with consumers in similar economies. Annex A, which sets out a table published recently by the European Commission, shows the current level of mobile termination charges in the European Union. Despite the existing charge price control, the UK position is shown to be above the EU average.

2.7Another factor is the extent to which prices reflect the underlying costs of provision. There are strong indications, as explained below under the sub-heading entitled ‘Supplier Behaviour’, that the current levels of charges are higher than the cost of provision. Further, BTCellnet’s and Vodafone’s charges are currently based on FAC, whereas Oftel’s view is that long run incremental cost (LRIC) is a more appropriate and economically efficient measure of costs. Oftel is working with the industry to calculate the LRIC of mobile termination. A further factor is customer satisfaction. This is dealt with in Chapter 4 and Annex D.

Consumer behaviour

2.8 The second indicator is whether consumers are able to access and use information to help make effective choices and take advantage of market opportunities. The nature of consumer behaviour is one of the key issues in understanding the extent of competitive pressures on mobile termination charges. The choices made by mobile subscribers, and the role of mobile termination charges in such decisions, is the subject of Chapter 4. The substitution possibilities available to callers to mobile networks, who may be users of the fixed network, are analysed in Chapter 5 and set out in depth in Annex C. The impact that consumer switching behaviour may have upon mobile termination charges is also discussed. Further details of the consumer research conducted so far by Oftel and the plans for future research are included in Annex D.

Market structure

2.9 Because of the current limitations of spectrum, the mobile sector is characterised by high barriers to entry at the network level. There are currently only four large mobile operators: BT Cellnet, One2One, Orange and Vodafone. There is a fifth, relatively small operator, Dolphin, which offers services to business users.

Supplier behaviour

2.10 Oftel will consider the extent of active competition in call termination charges from the behaviour of BTCellnet, One2One, Orange and Vodafone. Oftel has noted that Vodafone and BTCellnet set their charges above the level permitted by the charge controls for the year 1999/2000, albeit by relatively small amounts. This suggests two possibilities: that the price caps were set too low, or that there are few competitive pressures on mobile termination charges. However, the former explanation seems unlikely when considering that the charge control caps set by the CC would have been much tighter (ie the ‘9’ in the charge control of RPI-9% would have been a bigger number) if it had been able to forecast correctly the volume of subscribers and traffic that has been experienced as well as, potentially, if the charge control had been set on a forward-looking LRIC basis. In the second year of the control, Vodafone and BTCellnet have been able to achieve much of their required price reductions to meet the charge controls through increased off-peak traffic, rather than major reductions in headline termination charges.

2.11 Further, Orange and One2One did not reduce their termination charges until Spring 2000, after BT had asked Oftel to intervene to determine charges. Their reluctance to reduce these charges, which were reduced to a level higher than of those of Vodafone and BTCellnet, again provides little evidence to suggest that there are as yet significant competitive pressures on mobile termination charges.

2.12Furthermore, the sale of mobile termination to another mobile operator (rather than a fixed line operator) is a sale to a close competitor in the retail market. This would seem to militate against the reduction of call termination charges. Since call termination charges from one mobile network operator (MNO) are reflected in the retail price of other MNOs, it could be argued that MNOs have an incentive not to reduce call termination charges for off-net mobile to mobile calls because this would allow their competitors to reduce call prices with the result that the MNO that reduced its termination charge is put at a competitive disadvantage. Taking this logic further, MNOs might have an incentive to increase termination charges precisely to raise the costs of their competitors.

Chapter 3

The calling party pays principle

3.1 The implications of the fact that the calling party pays for the call to a mobile phone have a particular impact on the intensity of competition in call termination. In the broad mobile sector, it can be argued that calls to mobiles are just one of a range of mobile services that mobile network operators (MNOs) provide, a range that also includes call origination, billing, customer care etc. For the majority of these services, the use of, and supply of, the service is initiated by and paid for by the mobile owner, ie the end consumer, who makes their choice of network and package based on their satisfaction with these services. However, call termination is different because the demand for this service is initiated by, and paid for by, the caller to the mobile owner, as part of the price of calling a mobile phone. The price for the call to the mobile phone is strongly influenced by the choice of network that the mobile owner has made. Therefore, the implications of the calling party paying are considered first.

3.2 The overall effect of the calling party pays principle in the retail market is that, whereas mobile networks have an incentive to keep the price of those services required and paid for by the mobile owner at a level to attract and retain customers, they have less incentive to keep the price of calls to mobiles low because the callers cannot take their business elsewhere if dissatisfied (the caller has to use that network to reach that particular phone number).

3.3 In the wholesale market, the effect of calling party pays is similar. For calls from fixed to mobiles, calling party pays means that the fixed network operators (FNOs) pay the MNOs to terminate calls on their networks. The MNO has little incentive to keep the price of call termination down, because the FNO will pay this price as they are obliged to ensure calls get through to their end destination. For off-net mobile to mobile calls (ie from one mobile network to a different mobile network), the MNOs pay each other for termination of calls. Again, there is little incentive to keep termination charges low, not least since cutting them would in effect give the MNO’s competitor an advantage by reducing their costs. As in the retail market, then, calling party pays means that an MNO is likely to be able to raise call termination charges above the competitive level without suffering sufficient adverse effects to make the rise unprofitable.

3.4 The problems associated with calling party pays are compounded where the calling parties do not know either the price of calls to mobiles generally, or the price of calling particular networks. If callers to mobiles are unaware or unconcerned by the price of calling mobiles (although transparency of mobile numbers should increase in future as all mobile numbers are now migrating to the 07 prefix), then MNOs do not even face an incentive to set low termination charges in the hope of attracting more calls, since callers will not respond to the price reduction by making more/longer calls.

3.5 Callers may be aware of the general, average, level of prices to call mobiles but they are less likely to be specifically aware of which mobile network they are calling (which can be difficult, especially with number portability) and the differences between calling different networks. This reduces the incentive on MNOs to keep the price of calling their network down through their termination charges. A reduction in the price of calling one network could lead to a perception among callers to mobiles that the average price for calling mobiles had gone down. Therefore, all networks would benefit from any increase in traffic, so that some of the benefit of any increased call volume would go to the operators that had not changed their termination charges.

3.6 Overall, Oftel’s view is that the calling party pays principle results in there being limited incentive for the MNOs to reduce charges to the competitive level; rather there is an incentive for MNOs to keep them high.

3.7 The discussion above addresses the implications of calling party pays on its own and has not yet allowed for other possible demand and supply-side constraints on termination charges, nor for the effects of buyer power. These matters are discussed in Chapters 4 and 5 respectively and in more detail in Annex C.

Chapter 4

Mobile subscribers and closed user groups

4.1 This Chapter considers two types of reason why calling party pays might not result in a lack of effective competition in termination charges. First, there is a discussion of the extent to which call recipients care about the prices of the calls made to their mobile phones and take such prices into account when making their choice of mobile network. Thereafter, the potential importance of ‘closed user groups’ is analysed.

The customer

Bundle of services

4.2 The mobile network operators have disputed the importance of calling party pays. They have argued that mobile subscribers purchase a bundle of services, which includes incoming calls to their mobile as well as outgoing calls and other retail services, such as SMS and data.

4.3 Whilst calling party pays means that mobile owners do not pay for incoming calls, they do, nevertheless benefit from (most) incoming calls. As long as callers to mobiles are sensitive to price, at least to some degree, the more expensive it gets to call a mobile, the fewer calls would be made so reducing the benefit to the potential recipients of such calls, ie the mobile owners. It is possible, therefore, that those owning mobiles might be sufficiently concerned about receiving incoming calls that the prices of calls to mobile would affect their choice of mobile network. If so, this would act as a competitive constraint on mobile termination charges, since an operator that increased its charges would suffer a loss of users on its network.

4.4 However, even though mobile owners benefit from receiving calls to their mobile phones, it might still be rational for MNOs to have high termination charges. Mobile owners periodically make decisions about which network to join. Once they have chosen that network, their choice of tariffs is limited within that network. Thus, it is sensible for MNOs to attempt to offer potential owners the best deal possible on the things they care about most. If these potential owners care less about the cost of calls to their mobiles than they do about the outgoing call charges, line rental or handset cost, then it is profitable for MNOs to have high call termination charges which allow them to have lower charges for the services for which mobile owners pay themselves. The fact that mobile owners purchase a bundle of services does not necessarily alleviate the problem of high call termination charges. The level of call termination set by the MNOs will clearly depend on (their perception of) consumer behaviour.

4.5 Behaviour might be quite different between different groups of mobile owners. Therefore, business and residential customers are considered separately in the discussion below.

Residential consumers

4.6 Generally, Oftel survey data (see Annex D for further information) suggests that residential mobile phone owners are mostly driven by cost when it comes to choosing their mobile phone network. However, they appear to place very little weight on the price of calling their mobiles when they choose their mobile network. Only 15% of potential subscribers found out how much it would cost to call their mobile, and this cost was not thought to be a significant factor in their choice of network. This survey data also suggested that even if it was a significant factor, they might face difficulty in getting and understanding information on costs of calling mobiles.

4.7 Evidence was found that consumer behaviour in relation to network choice varies considerably between groups. Switching behaviour (ie consumers switching from one network operator to another), in particular, differs markedly among different types of residential mobile phone owners. However, switching behaviour will only have an impact on mobile call termination charges if consumers are changing their networks as a result of the cost of them being called.

Business consumers

4.8 Business users of mobile phones appear more concerned about the cost of calling their mobiles than residential users. This – more likely for small and medium enterprises (SMEs) – might be because they depend on calls from clients, or because a significant part of their own phone bill is accounted for by their employees calling mobile phones. Most of Oftel’s existing research is based on SMEs but a survey of a group of large businesses is also being carried out.

4.9 Common reasons for which SMEs had chosen their mobile network service providers included generally good value, good network coverage, best offer available and also historical factors (eg that this provider had always been used). When specifically asked about the cost of calling their mobiles, only 58% were satisfied with the level of the cost. The cost of calls to their mobiles was the least satisfactory aspect of the mobile phone service overall.

4.10 Just under a fifth of SMEs with mobiles had taken steps to reduce the cost for them to call their own mobile phones (ranging from 18% of small businesses up to 28% of medium businesses). Mobile-to-mobile adaptations (which convert fixed to mobile calls to on-net calls – see paragraph C9 in Annex C) proved the most popular step, followed by other, unspecified means which might include, for example, keeping the calls shorter, see table D1 in Annex D.

4.11 Oftel’s research also shows that 51% of SMEs thought that it was important for customers to be able to call them on their mobile phones. Those who thought this was important were also asked if they had taken any steps or would consider taking steps to reduce the cost to customers of calling the business’ mobiles. The most popular measure was simply keeping the call to the mobile short. However, this was followed by choosing the mobile network which is cheapest to call. See table D2 of Annex D.

4.12 Furthermore, the research shows that 28% of SMEs with mobiles (27% of small businesses, 43% of medium businesses) had changed network/service provider, but it is not known what exactly prompted them to do this. The majority of these businesses had found it easy to change. Long-term contractual tie-in was the most common problem for the few businesses that had experienced problems.

4.13 Overall, then, SMEs seem to be more concerned than residential consumers about the costs of calling their mobiles, both for themselves and their customers. A significant proportion appeared to be adapting their behaviour to try to minimise this cost. It seems that SMEs, then, are more likely to bring pressure to bear on call termination charges than residential mobile phone owners.

4.14 However, it does not appear clear that the behaviour of SMEs, or business generally, would be capable of bringing pressure to bear on call termination charges for all consumers. MNOs could respond to pressure from business users by introducing packages specifically to deal with their concerns. Some such packages already exist, involving mobile-to-mobile adaptations or private wires (see explanation in paragraph C30 in Annex C), but further innovations could emerge in the future. In this way, those who are most concerned about call termination charges and who are most able to bring pressure to bear on the operators can potentially choose packages that suit their needs, reducing the pressure on termination charges as a whole (see section below on closed user groups).

Closed user groups

4.15 Another factor to be considered which might mitigate against the effects of calling party pays is the concept of a closed user group (or closed economic group). At the most general level, a closed user group exists where there is an identifiable group of people who have an interest in how much it costs to call each other.

4.16 In a narrow sense, a closed user group exists where those with mobile phones have an interest in how much it costs to call them on their mobile because they pay part of this bill themselves, eg within a family where the mobile owner also pays for the fixed line call charges. If a particular network raised termination charges and thereby the cost of calling its mobiles, members of these groups could decide to switch to a network which cost less to call, or acquire a mobile on the same network as the called mobiles and take advantage of on-net call prices. If the network suffered sufficient loss as a result of such behaviour to make the price rise unprofitable this could constrain that network’s ability to raise termination charges.

4.17 In a wider sense, a closed user group can exist simply because a particular group of people makes sufficient calls within that group so that intra-group calls constitute a significant proportion of their phone bill eg a group of friends. If a particular network raised its termination charges and thereby the cost of calling its mobiles, the members of this group could decide to take advantage of relatively low on-net mobile-to-mobile call prices and switch networks as necessary to ensure that all members of the group were on the same network. Once again, if the network suffered sufficient loss as a result of such behaviour to make the price rise unprofitable this could constrain its ability to raise termination charges.

4.18 The implication of each of these two descriptions of closed user groups is that, for the members of the group, calls to mobiles are included in the bundle of mobile services purchased from the mobile operator. However, for closed user group behaviour to generate pressure on termination charges in general, it must create sufficient incentives for the network to keep those charges low, and it is not clear that this is in fact the case. First, in order for their behaviour to render a rise in termination charges overall unprofitable, these groups must be relatively widespread. Secondly, in order to generate pressure on general termination charges, these groups must not be separable by the operators from the group of mobile users as a whole and it should not be possible to offer them specific tariff packages which address their concerns about the costs of calling mobiles.

4.19 Thirdly, and perhaps most importantly, it is not clear that even widespread inseparable closed user groups would generate pressure on call termination charges. Assuming that closed user groups do not choose their mobile network solely on the amount it costs to call it, it could still be in the interests of a rational mobile network operator to increase its call termination charges in order to offer consumers lower charges for other services, such as calls from mobiles, subscription fees, connection, and indeed offer handset subsidies. In particular, if closed user groups are attracted to networks because of low on-net call prices, it could be rational for the network to have high charges for the termination of off-net and fixed to mobile calls to allow for low on-net call prices. It could even be argued, on this basis, that the more prevalent are closed user groups, and the more MNOs compete for those groups, then the more likely they are to have high termination charges for these services.

4.20 Oftel is seeking further evidence of the existence of closed user groups. Some has been provided to Oftel by operators. It is clear that they are encouraging the development of wider groups, but it is not yet clear that closed user groups actually constrain call termination charges.

Chapter 5

Behaviour of callers and substitution possibilities

5.1 This chapter considers a number of the potential factors which could restrain mobile termination charges.

5.2 A mobile network operator would have its call termination rates constrained to the competitive level if, when it tried to raise them above it, it suffered some adverse effect such that overall the price rise was unprofitable. There are a wide variety of possible constraints on call termination, broadly falling into three categories: supply-side substitution, demand-side substitution and countervailing buyer power. This chapter considers only those which Oftel considers potentially the most important, focussing on pressures on wholesale call termination, with other possible constraints, including the impact of retail substitution discussed in more depth in Annex C.

5.3 In general, the growth of use of mobiles is seen as complementary to the fixed market, rather than as a substitute for it, as the convenience of making or receiving a call on the move suggests that mobile and fixed telephony cannot always be effective substitutes for consumers. However, the degree to which fixed and mobile systems are substitutes, and therefore the degree to which they act as a competitive restraint on mobile call termination, is part of what is being assessed here.

Supply-side substitution

5.4 Mobile call termination charges might be constrained by supply-side substitution. Supply-side substitution occurs when, in response to a rise in price, suppliers of other products switch into the supply of the product whose price has risen. This entry must be sufficiently swift that it can prevent the price rise of the good from being profitable for the firm(s) that tried to implement it. So, if operators were to put up termination charges, some other supplier of call termination could enter the market, undercutting these new prices and making the price increase unprofitable. Therefore for supply-side substitution to be an effective constraint there must be other possible suppliers of call termination who could switch into supplying it relatively quickly and with relative ease.

5.5 Whether the call originates from a fixed line or another mobile, the most obvious potential alternative source of call termination for a particular MNO’s subscribers would be another MNO supplying call termination, since they would already have the equipment and expertise to terminate calls to mobiles. However, this seems unlikely because to terminate calls to particular subscribers requires an operator to have details of their Subscriber Identity Module (SIM card), and these details are currently held only by that subscriber’s MNO. Thus, for one MNO to terminate calls to subscribers of another MNO would require agreement and information sharing between operators, which seems unlikely.

5.6 In theory, a particular supplier of mobile call termination might also face supply-side substitution from suppliers of call origination. However, the strong connection between call origination and call termination mean that all suppliers of call origination are also suppliers of call termination. The possible supplier of call termination to a particular customer will therefore also be the supplier of call origination to that particular customer. Supply-side substitution would therefore effectively mean the operator entering the market to compete with itself, which would seem illogical and, further, unlikely to result in competitive pressure on the call termination charge.

Demand-side substitution

5.7 Demand-side substitution occurs when consumers respond to a rise in the price of a particular good by demanding some other good or service instead. To be an effective constraint on price, the demand-side substitution must be sufficiently rapid and in sufficient volume that it renders the increase in price unprofitable.

5.8 In the wholesale market, there is currently no potential for demand-side substitution. An operator purchasing call termination on another network makes that purchase because he wants to offer calls to that network relating to the number dialled by his subscriber (the caller); calls to other networks are not a close substitute.

5.9 In the retail market, however, there are various possible demand-side substitutes. These could bring pressure to bear on call termination charges if a rise in these charges at the wholesale level generated an increase in the retail price of calling mobiles such that consumers substitute other products for those calls to a sufficient extent to make the increase unprofitable for the MNO. Substitution possibilities are considered for both types of mobile termination: of fixed to mobile calls and of off-net mobile calls.

Substitutions of voice calls

1. Mobile to mobile calls as a substitute for fixed to mobile calls

5.10 If a rise in call termination charges and a subsequent increase in the retail price of calls to mobiles lead a consumer, wanting to call a mobile, to make that call from another mobile rather than a fixed line, the ability of this substituted call to constrain call termination charges depends on its effect on the profitability of the mobile operator.

5.11 If the substitute mobile to mobile call is off-net, then the substitution would have little direct effect on the profitability of the MNO because it would receive the same termination charge as from a fixed to mobile call. This substitution would therefore be unlikely to constrain call termination charges. If the substitute mobile to mobile call is on-net, it could reduce the operator’s profitability. This is because no termination charge would be received and although operator would receive the on-net call charge, this is likely to be less profitable than termination. Thus, substitution of on-net mobile to mobile calls for fixed to mobile calls have the potential to constrain call termination charges.

5.12 Furthermore, mobile-to-mobile calls become a more effective potential constraint on call termination charges when considered in conjunction with the closed user group argument (see Chapter 4). This is because, if the closed user group argument holds, callers who are members of these groups will not only substitute mobile to mobile calls for fixed to mobile calls, but will switch MNOs so that all the group is on the same network (ie the one with the lowest on-net call prices). Thus, the substitution of mobile to mobile calls for fixed to mobile calls within a closed user group could lead not only to the loss of termination charges from calls from another network, but also to the loss of subscribers from one MNO to another.

(2) Mobile to fixed calls as a substitute for off-net calls

5.13 It is possible that consumers could respond to an increase in the price of off-net call termination, and therefore in the price of off-net calling, by substituting mobile to fixed calls. Were this to happen, the terminating network would lose the termination charge altogether. Should such substitution happen in sufficient volumes, it could make a termination charge increase unprofitable and thereby constrain termination charges.

5.14 The question is, however, how close a substitute mobile to fixed calls are for mobile to mobile calls. Although the caller retains the convenience of calling from their mobile, they might lose the greater probability of immediate contact that comes with calling a mobile, compared to a fixed line. There are circumstances in which the difference in likelihood of obtaining immediate contact is relatively low, eg when calling someone whom a caller knows is likely to be at home, the caller might choose to call the fixed line instead of the mobile. However, these circumstances are not sufficiently widespread to make calls from mobiles to fixed lines a close substitute for calls from mobiles to off-net mobiles. Indeed, if they were, it would be hard to see how operators could maintain the price differentials between the two call types that currently exist. So overall, it does not seem that an increase in off-net mobile to mobile call termination charges would stimulate such substitution to mobile to fixed calls as to make the increase unprofitable.

(3) On-net mobile to mobile calls as a substitute for off-net calls

5.15 There is an argument that on-net mobile to mobile calling constrains off-net termination charges which is closely related to the issue of closed user groups. If off-net mobile to mobile termination charges result in high prices for off-net calling, then those who call each other frequently are likely to switch networks so that they are on the same network and can take advantage of lower on-net call prices. Clearly, MNOs might be concerned that by putting up termination charges and encouraging people to switch to the same network they would lose subscribers to other networks. If so, the MNO raising its termination charge would lose profitable call termination minutes and retail profits earned on the subscribers lost to other networks.

5.16 However, the attractiveness of on-net calling will not necessarily result in lower termination charges. If these switching groups are attracted by low on-net call prices, then it could be rational for mobile operators to use high termination charges to sustain low on-net call prices. Further, since termination charges are paid by other mobile operators, in increasing their termination charge they increase the costs and possibly the off-net call prices, of their competitors which could make that MNO look more attractive to potential subscribers.

SMS as a substitute

5.17 In general terms, sending a text messaging (SMS) has some potential to be a substitute for a voice call, but it is clear that in many cases it is not. The extent to which text messages are a substitution for voice, rather than an additional communication, and so potentially could affect the competitiveness of mobile call termination charges, needs to be explored.

5.18 Callers to mobiles could react to an increase in call termination charges and a subsequent increase in the retail price of calls to mobiles by substituting a text message for a voice call. The effectiveness of such substitution in providing a constraint on voice call termination charges depends on its effect on the overall profitability of the MNO. This, in turn, depends on the profitability of each SMS terminated as compared to voice call termination, and on the volumes of substitution involved (one voice call might be replaced with several SMS).

5.19 In order for a substitution to SMS from a voice call to be effective in constraining termination charges for voice calls, the MNO must suffer a drop in profits as a result. Since at the moment those operators who provide voice call termination also provide SMS termination, the implication would be that the operator would in fact be competing with itself which would seem illogical. In addition, if SMS were a sufficiently good substitute for voice calls to mobiles potentially to put voice call termination under a competitive constraint, the logical response from the operators would be to equalise the profitability of providing the two services.

5.20 The current charging regime for SMS termination is in the process of changing from a system where there was no direct charging for terminating text messages, to a system similar to that which exists between operators for voice calls with the originating operator of any SMS keeping the retail price charged to the SMS sender but paying the terminating operator such termination charge as has been agreed, on a per message basis.

5.21 Under this arrangement, if a caller substitutes an off-net SMS from a mobile for a voice call from a fixed line or off-net mobile, the terminating operator loses the termination charge for the voice call but gains the termination charge for the SMS. This substitution is therefore a less effective constraint than under the previous arrangement, under which after substitution the terminating operator received nothing. However, if a caller substitutes an on-net SMS from a mobile for a voice call from a fixed phone, the effect of the substitution is the same as under the previous system, ie the MNO losing the voice call termination charge but gaining the SMS charge.

5.22 The overall effect of the substitution of SMS for voice calls would also depend on the relative profitability of SMS and voice call termination. In the case of calls from fixed lines to mobiles, for substitution to be possible, callers on fixed lines must be willing and able to send an SMS (for example, using a mobile or a web-based service) instead of making a call. It could certainly be argued that SMS are a closer substitute for off-net mobile calls than for fixed to mobile calls, because if a caller has access to a mobile phone he can use that phone either to make voice calls or send SMS. Whether SMS are sufficiently close substitutes to constrain call termination charges therefore depends on the extent to which interaction by SMS is a close substitute for interaction by voice conversation. This is, at present, unclear.

Call back as a constraining factor

5.23 It is also possible at the retail level to substitute a call from a mobile to a fixed line for a call from a fixed line to a mobile, ie to reverse the direction of the call using ‘call back’. This could be done either on an ad hoc basis with the caller and the called party agreeing to do this spontaneously, or on a commercial basis by a company which offered automatically to reverse the direction of calls to mobiles. In this case, the substitution leads to the mobile operator losing the fixed to mobile termination charge but gaining the mobile call origination charge.

5.24 In the context of off-net mobile calling, call back would occur when the initial calling party is called back by the initial called party, so that, although the call is still an off-net mobile call, the direction of the call is reversed. Call back would result in the initial terminating operator losing the termination charge but gaining a call origination charge and the initial originating operator losing the origination charge and gaining the termination charge.

5.25 The effectiveness of call back as a constraint on call termination charges depends on the relative profitability of mobile call origination and call termination. It would also depend on the willingness and ability of consumers to make this substitution. Call back, especially on an ad hoc basis, could be restricted to particular callers and called parties (for example, family members). Oftel has been given some preliminary analysis of call back in practice by a mobile operator and Oftel is aware of the existence of commercial call back for other call types, but the question is still open as to whether they give rise to an adequate constraint on termination charges.

Countervailing buyer power

5.26 Countervailing buyer power exists when a particular purchaser (or group of purchasers) of a good or service is sufficiently important to its supplier to influence the price charged for the good or service. In order to be an effective constraint on price, the purchasers must be able to bring some pressure to bear on the supplier to prevent a price rise, for example by exerting a credible threat not to purchase. Even if buyer power exists in the retail market for calls to mobiles, those offering calls to mobiles still have to purchase that service from the MNOs. Therefore, for buyer power to have a constraining effect on call termination charges, it must exist at the wholesale level, ie in the market for call termination.

5.27 The purchasers of wholesale mobile call termination are those other operators who offer calls to mobiles. In theory, these purchasing operators could try to use their bargaining power to negotiate down the price of call termination. However, originating networks have an obligation to ensure that a call is terminated, whatever the network, meaning all networks must be able to offer termination of calls to mobiles. This greatly reduces the scope for any buyer power.

Chapter 6

Market definitions

Introduction

6.1 Oftel’s approach to market definition follows that used by the UK competition authorities and is in line with those used by European and US competition authorities. Market boundaries are determined by identifying constraints on the price-setting behaviour of firms. There are two main competitive constraints to consider: how far it is possible for customers to substitute other services for those in question (demand-side substitution), and how far suppliers could switch, or increase, production to supply the relevant products (supply-side substitution) following a price increase.

6.2 The concept of the ‘hypothetical monopolist test’ (outlined at the end of the Glossary) is a useful tool to identify close demand-side and supply-side substitutes, and Oftel uses it, as well as considering the relevant competitive conditions, to define the market. This chapter outlines possible options for the definition of the relevant market for termination of calls to mobiles, taking account of the demand-side and supply-side substitutes discussed in the previous chapters, and in the Annexes.

Possible market definitions

6.3 Three possible market definitions are discussed. Each of the possible definitions relies on a different set of characteristics, and each would have different implications for the likely existence of market power.

A market for call termination on each mobile network operator

6.4 The starting point for the first market definition considered is the lack of substitutability of calls to different mobile handsets. This would arise for several reasons. First, because of the calling party pays principle, calls to mobiles are not included in the bundle of services provided by MNOs to their subscribers, and on which they compete for those subscribers. Secondly, a call to one individual is not usually a substitute for a call to another individual. Thirdly, if a supplier of termination of calls to one individual raised its prices to an excessive level, suppliers of termination of calls to other individuals cannot easily switch into that market because to do so they would need the SIM card details of that individual from his current supplier. Further, although the supplier of that individual’s call origination could in theory easily switch, since that supplier is also the supplier of termination there is no reason why it would. On this basis then, it might seem appropriate to define the market as that for termination to each handset.

6.5 However, this analysis would only be partial. In considering the relevant market, it is not sufficient to consider supply-side and demand-side substitution alone; it is also necessary to consider the relevance of similarities and differences in market conditions. Although on the basis of demand and supply-side analysis a market for call termination on each handset is logical, in reality an inability to price discriminate between purchasers of call termination to different handsets means the MNOs charge termination to handsets at the same level across their network. On this basis, if an operator wishes to lower termination charges for calls to one subscriber, it must lower termination charges for calls to all its subscribers, effectively equalising the competitive pressures placed on all that network’s termination charges. As a result, it is sensible to define the relevant market as that for termination on each operator.

6.6 If the relevant market is that for wholesale call termination on individual MNOs, then it would seem that currently each MNO is a monopolist. However, whether each MNO has market power would still depend on the existence of any countervailing buyer power, which could still render any attempt to implement a small but significant non-transitory increase in price unprofitable. Further, there might be scope for competition to develop in the future if companies other than the particular MNO could supply termination of calls to that network at the wholesale level. However, this would depend on the necessary technological developments and on the development of contractual relations between such companies and the MNOs. Oftel is not aware of such developments.

Linked national markets for mobile services

6.7 It might be possible to conclude that the relevant market for call termination was part of a cluster of linked national markets for mobile services. This would suggest that, although the hypothetical monopolist test might generate distinct markets for different mobile services, including a national market for termination, because these services were strong complements, the markets for the different services would be linked. These links would mean that the behaviour of consumers in one of these markets was affected by the situation in the other markets.

6.8 In order for this definition to be valid, mobile subscribers must be concerned about the retail price of calling mobiles and therefore call termination charges, as a key determinant of those prices. This might be the result of their membership of a wide or narrow closed user group. It might also be the case where mobile subscribers value calls to their mobiles and that callers to mobiles are sufficiently price sensitive such that an increase in the price of calling mobiles will result in fewer/shorter calls to their mobiles to the extent that an increase in termination charges above the competitive level would be unprofitable for the MNO.

6.9 It must also be the case that MNOs provide services which are strong complements so that, although the markets for individual services would be distinct when considered using the hypothetical monopolist approach, the fact that they are used and sold together means that subscribers do not consider the price of the services individually when choosing their network but rather the price of the bundle. If this is the case an MNO would not be able to raise call termination charges, and at the same time keep the same price level of the other services in the bundle, without subscribers switching networks. However, that MNO could raise termination charges, and therefore the retail price of calls to mobiles, if at the same time it reduced prices for other services in the bundle to compensate and so retain subscribers.

6.10 In this case, the price of the overall bundle is constrained to the extent that there is competition among MNOs for subscribers. Therefore, if this market definition were to apply, and call termination were equally important to mobile subscribers as the other services in the bundle, the assessment of market power in call termination would be similar to that for the other services in the bundle, which are being considered in Oftel’s Mobile Market Review. If call termination were less important to mobile subscribers than other services in the bundle, there might be scope for a higher degree of market power in call termination than in other services.

3. A National market for call termination

6.11 A national market for call termination suggests that the suppliers of call termination (the MNOs) compete with each other on a national scale for call termination traffic, ie for the wholesale business of carrying calls to mobiles. This could happen if, for example, one MNO had access to the SIM card details of another MNO’s subscribers and could therefore offer termination of calls to those subscribers.

6.12 Such a market definition would require several conditions to be fulfilled. The first of these is that, similarly to there being a market for call termination on individual MNOs, there must be a distinct market for wholesale call termination separate from that for other mobile services. For this to be so, it must be the case that mobile termination charges are not effectively constrained by the possibility of substitution to different products on the part of (would be) callers to mobiles. Such substitution might be directly at the wholesale level or, more likely, indirectly via substitution of other retail products for those that use mobile termination.

6.13 This market definition also hinges on particular behaviour by callers to mobiles, namely whether they would substitute termination on one mobile network for termination on another mobile network. Substitution behaviour by mobile subscribers would not support this market definition, rather pointing towards the linked markets view, since call termination would be one of the services on which MNOs compete for subscribers.

6.14 This market definition implies that MNOs compete in termination charges for the customer of callers to mobiles (but not mobile subscribers themselves). For this definition to be favoured, some evidence of (or, at least, evidence of the possibility of) such competition would be needed. This might include evidence of callers to mobiles choosing the networks they call based on the call charges. It might also include fixed line operators, or other MNOs, choosing the networks on which the calls to mobiles they originate will terminate. Such evidence is not yet available and so Oftel is not currently convinced that a national market for call termination is the appropriate market definition in this instance.

Summary

6.15 The analysis in the previous chapters has concentrated on the potential of various different factors to constrain the termination charges for calls to mobiles. Different evidence would be required to demonstrate the presence of each factor and its ability effectively to constrain termination charges. The evidence obtained would ultimately determine which of the above approaches to market definition were taken. The assessment of market power is quite closely related to the view taken of market definition, because both rest upon analysis of similar factors.

6.16 Subject to closer examination of these factors, three market definitions seem possible: call termination on each operator; linked national markets for mobile services; a national market for call termination.

6.17 Further work will be undertaken to reach conclusions as to the most appropriate market definition and its implications for the existence of market power in the relevant market for call termination.

Chapter 7

Options for and scope of regulatory action

Introduction

7.1 This chapter considers some of the possible regulatory options that might be appropriate should Oftel conclude that after the expiry of the existing price controls next year there will be insufficient competitive pressures to constrain charges for the termination of voice calls to mobiles to their competitive levels, and that they are expected to remain insufficient, and to which MNOs any regulation should apply.

Options for regulatory action

7.2 Once Oftel has reached its conclusions on the definition of the relevant market for call termination and on the extent of competitive pressures and resultant market power of MNOs, it will decide – having taken into account views expressed as a result of this consultation – on the appropriate and proportionate regulatory response. If Oftel finds that the mobile call termination market is effectively competitive, no regulation would be required. In the case that Oftel finds that the mobile call termination market is not effectively competitive, Oftel has currently identified four possible regulatory options.

Option 1: Do not regulate termination charges once the current control ends

7.3 Even if Oftel were to find that there is insufficient pressure on mobile termination charges to keep those charges at competitive levels, it is possible that regulation might not be appropriate either to promote competition or to protect the consumer.

7.4 If Oftel were to have evidence that the environment in which call termination charges are set was changing sufficiently, so that competitive pressures were increasing and moving towards a level which could constrain termination charges to their competitive level, then regulatory intervention might not be appropriate.

7.5 Further, regulation might be unnecessary on the grounds that excessive termination charges did not overall operate against the public interest. It might be possible to argue that MNOs are using the relatively high revenues from mobile call termination charges to allow them to offer relatively low prices for services paid for by mobile subscribers, such as call origination, line rental, and connection and also handset subsidies. Thus, the high prices paid by callers to mobiles might allow lower prices for mobile users. Levels of mobile penetration are currently over 60%. As growth increases, the overlap between callers to mobiles and mobile subscribers grows, so that most callers from fixed lines to mobiles are also mobile owners themselves. Thus, any redistribution that takes place is largely within the same group of people.

7.6 Furthermore, it could be argued that as long as there is effective competition in the market(s) for mobile subscriber services, then any excessive profits that are earned on mobile call termination would be competed away in these other markets so that overall the MNOs do not make excessive profits. If this is indeed what is happening, then although regulation to constrain call termination might still have benefits, these benefits might be significantly less than the related costs so that overall such regulation might not be appropriate. The current extent of competition in the broad mobile sector is the subject of Oftel’s Mobile Market Review, the initial view is that the mobile sector is not effectively competitive – see Effective Competition Review: Mobile [February 2001]. If Oftel were to conclude that mobile markets other than call termination were some way from being effectively competitive, then it would be unlikely to regard the previous argument as providing a sound justification for not taking regulatory action. This is because, for the foreseeable future, it would not be guaranteed that higher termination charges would flow through into lower charges for the other mobile services.

Possible reasons for regulating and regulatory options

7.7 Even if other mobile markets were effectively competitive, there are reasons why excessive call termination charges might still be of concern. One such reason relates to distributional issues in respect of the adoption of mobile. Although penetration rates for mobiles are rising rapidly, the figures exclude the fact that many households have more than one mobile. This means more households than perhaps it first appears will not have a mobile, making the cross-over between fixed to mobile callers and mobile owners smaller than it seems. It is also possible that some of those people who call mobiles but who are not mobile owners might have taken the decision not to have a mobile because of the costs involved.

7.8 There are also issues that might still cause concern for callers to mobiles who are mobile subscribers themselves: there might be an asymmetry in their usage of fixed and mobile phones. If these callers call mobile phones from their fixed lines more than they make calls from their mobiles, they might still lose as a result of higher termination charges, even if these higher charges do fund lower prices for subscriber services. Those callers with a relatively high ratio of calls to mobiles to calls from mobiles would be effectively subsidising those with the reverse ratio. There are also potential concerns in relation to economic efficiency. If termination charges are priced excessively, and calls from mobiles are priced below cost then this sends the wrong signals to the market which will respond in a way which could result in resources being used inefficiently.

Option 2: Increase competitive constraints

7.9 There are various ways in which competitive constraints on call termination charges might develop. Even if there were no evidence that such constraints were developing in the course of market evolution, it might be possible for Oftel to intervene to encourage such developments.

7.10 Competition in mobile call termination in the most direct manner could only occur if another party were to offer termination services for calls to subscribers on a mobile network. This other party might be a personal operator, a virtual mobile network (a company providing mobile services but not owning spectrum – MVNO) or another MNO. Regardless of their identity, however, they would need to have access to the SIM card details for the subscribers’ calls to whom they wished to terminate. If this other party were not an MNO itself, it would also have to access to a mobile network on which to provide termination services. Thus, any such party would have to conclude agreements with the mobile owner’s MNO before it could offer termination of calls to them. It is possible that Oftel might be asked to intervene in the negotiations between such other party and an MNO, and in doing so Oftel could consider appropriate action.

7.11 A further, and perhaps simpler, option for the promotion of competitive pressures on call termination might be to improve consumer information regarding the price of calls to mobiles and therefore, indirectly, call termination charges. This could be done in two ways. First, one could improve the supply and clarity of information to fixed and mobile phone users concerning the price of calls to mobiles and the fact that termination charges make up approximately two thirds of those prices. This might take the form of distinct items on phone bills listing calls to mobiles, specifying not only the total price of the call but also the network called, the price per minute for that call and the appropriate per minute termination charge. Clearly, this would not solve the intrinsic problem that callers to mobiles have little choice over the networks they call, but would mean that these callers might in the future be better able to decide not to call, to keep calls short, or initiate call back. Further, it would be a relatively simple, low cost measure.

7.12 In addition, the supply of information to (potential) mobile owners on the prices of calls to mobiles could be improved. Although this would not immediately remove the associated problems of the calling party pays principle, it might contribute to increasing the awareness of the differences between the networks on the part of owners, giving those who do care about such differences greater chance to act on their preferences. Whatever the outcome of this review, Oftel plans to work further with mobile companies, consumer groups and the DTI on the issue of tariff transparency. Oftel is also currently working on ways to maximise the potential of comparative websites (perhaps with Oftel accreditation) in assisting consumer choices.

Option 3: Tie call termination charges to charges for competitive services

7.13 Even if it were impossible to increase competitive constraints on mobile call termination charges directly, there is an