Statement issued by the Director General of Telecommunications

Contents

Summary

Chapter 1 Introduction

Chapter 2 Market assessment

Chapter 3 Wholesale line rental

Chapter 4 Retail price controls

Chapter 5 Consultation details

Annex A Respondents to consultation

Annex B Proposed modifications to BT’s licence

Annex C Price control monitoring and other issues

Annex D Wholesale line rental: other issues

Annex E Wholesale line rental: starting charges

Annex F Cost benefit analysis

Summary

S.1 This statement sets out Oftel’s conclusions on its review of the fixed telephony market. The review was necessary because the current price control arrangements on BT are due to expire in July 2002. Oftel has carried out an assessment of the level of competition in the residential market and decided on the measures that are now needed to promote competition and protect consumers.

S.2 This statement sets out a radical package of measures to give consumers a greater choice of service providers while maintaining controls on BT’s prices as competition develops and continuing to protect the most vulnerable consumers from excessive charges.

Regulation in a changing market

S.3 Oftel has imposed controls on BT’s retail prices since 1984 to protect consumers from excessive prices. Price controls have been used to require BT to lower prices because there has been insufficient competition in the retail market to exert downward pressure on prices.

S.4 Since price controls were introduced, BT’s residential calls prices have fallen by over 50 per cent in real terms. The current control of RPI-4.5 per cent was introduced in 1997 for four years and extended for one year in 2001.

S.5 Oftel’s review of the fixed telephony market has found that the level of competition in the provision of fixed calls has steadily increased. Consumers in many areas now have a wide range of choice from other suppliers – cable operators, indirect access, calls and access and carrier pre-selection service providers. BT’s market share for calls is gradually being eroded, and BT’s call profits are falling (in absolute terms) over time.

S.6 Oftel welcomes both the increase in competition and the continued reduction in BT’s prices. However, the market is not yet effectively competitive. In particular, BT continues to have a large share of both lines and calls markets, and makes very high returns on calls, although these are offset to a significant degree by low returns on access (ie the basic provision of the exchange line, paid for by the telephone rental charge).

(Note that in this statement, the terms ‘line rental’ or ‘rental charge’ are used for convenience even though at present BT’s standard quarterly fixed charge also includes an allowance of ‘free calls’ (ie an inclusive call allowance)).

S.7 BT’s continuing strong market position means that immediate withdrawal from regulation would put consumers at risk. Oftel believes that, as well as some continued price regulation, new measures are needed to promote additional competition from different service providers that will lead to a greater range of choice for consumers. And as the additional competition increases commercial pressures on BT to reduce its prices, the price control regime both can and should be relaxed.

S.8 The current price control is focussed on the lowest spending 80 per cent of residential customers, for whom the rental charge makes up a large proportion of their bills. Because BT’s calls are much more profitable than lines, BT makes much higher returns from higher spending customers than from lower spending customers. Under the current price control, the significant profits made by BT on its highest spending consumers from calls have been used to offset the required price reductions on lower spending customers.

S.9 As BT’s profits on calls are increasingly eroded through competition, the price control regime also needs to be modified. In particular, change is needed because, profits from high spenders might not be available in future to continue to support the level of price reductions to low spenders required by current price controls.

Promoting competition

S.10 The main element of Oftel’s package of measures to promote competition is to require BT to provide a new wholesale line rental (WLR) product.

S.11 The review identified that a significant inhibitor of competition and innovation was the inability of alternative service providers to provide a single bill to their customers. For example, consumers who use indirect access or carrier pre-selection services receive two bills – one from BT for the line rental and one from the service provider for calls. However, both indirect access and carrier pre-selection have helped to increase competition in calls markets. But WLR might encourage larger numbers of customers to consider whether they are receiving the best deal available to them for their expenditure.

S.12 Oftel is to require BT to introduce a new line rental product to enable alternative suppliers to provide a single bill that covers both line rental and telephone calls. A single bill will give suppliers the opportunity to develop innovative tariffs such as no or low line rental with all costs recovered from calls or virtually unlimited calls paid through a monthly subscription.

S.13 The new line rental product will be available to other network operators and service providers on cost-based and non-discriminatory terms. It will be available from BT in a basic form within four months. Oftel intends to set the following prices for the following products:

• wholesale line rental (residential quality of service) – £28 per line, per quarter;
• wholesale line rental (business quality of service) – £29.87 per line, per quarter;
• transfer of service from BT to a service provider – £1.41 per line or multiples thereof; and
• connection of a new line for a service provider – £92.89 per line.

S.14 WLR will need to be developed to operate efficiently at large volumes and seamlessly with other products such as carrier pre-selection. In July, Oftel will set up industry groups comprising operators, service providers and consumer representatives to develop a product specification.

S.15 The specification will cover issues such as how orders are processed, how WLR suppliers forecast demand, how BT provides for that demand in its systems a service level agreement and will consider operational penalties for over-forecasting. It will also include a code of practice on marketing for WLR suppliers to ensure that selling practices are fair and that consumers are protected.

S.16 Developing the WLR product will require commitment and participation from all stakeholders. Oftel will lead the groups where appropriate and resolve issues that develop. With this commitment, Oftel believes it will be possible to consult on and publish a specification in autumn 2002. BT will then be in a position to develop its systems and implement an enhanced product.

Controlling prices as competition develops

S.17 As competition develops, Oftel will ensure that customers continue to be protected through a price control. This will be an ‘RPI-RPI’ control focussed on the expenditure patterns of the bottom 80 per cent of residential customers by expenditure. This means that the lower spending 80 per cent of residential customers will face no increase in their phone bills. The price control will ensure BT does not exploit its market power in the residential telephony market.

S.18 Full introduction of the wholesale line rental product, however, will lead to a significant increase in competitive pressures on BT. This could make the RPI-RPI control on the lowest spending 80 per cent of residential customers unduly tight, as the return BT makes on this group of customers is fairly small.

S.19 In the light of this concern, and in order to give an additional incentive for BT to introduce the WLR product as quickly and efficiently as possible, Oftel is ready to modify the RPI-RPI control to RPI+0 per cent. This will happen once a commercially viable WLR product has been fully implemented by BT in line with the determined product specification and is being taken up by service providers.

Protecting low users

S.20 In parallel, with the further opening of the market, Oftel will introduce additional measures to protect those customers who do not make many calls and for whom the line rental makes up a significant proportion of their bill. BT’s Light User Scheme, which currently provides protection for the most vulnerable 20 per cent of customers in the form of a rebate on the line rental and there are provisions to extend it to cover the lowest 30 per cent of customers by spend.

S.21 There will also be a ceiling on BT’s line rental charge to ensure that it does not rise above cost for all of BT’s residential customers. The geographic averaging of BT’s prices, which ensures that basic telephony charges are the same throughout the country, will continue.

Review process

S.22 The price controls set out in this statement will be set for four years. Oftel will review the retail market in 2004. The review will consider the effectiveness of competition at that time, including the operation of WLR, and the appropriateness of the continuing controls and consumer protection measures. The approach set out in this statement may then be modified as a result of this review.

Consultation

S.23 This statement includes draft modifications to BT’s licence that will implement those measures. Comments on these are required by 19 July 2002. Unless BT objects to the proposed modifications, they will take effect from 1 August 2002. However, should BT object to the proposed modifications, Oftel will refer the issue to the Competition Commission and the existing controls on BT's retail prices, including the controls on BT's retention for calls to mobiles will continue for another year while the Commission considers the case.

Chapter 1

Introduction

Price control and market power

1.1 Oftel’s aim is to obtain the best possible deal for consumers in terms of quality, choice and value for money. Competition is most likely to provide consumers with the best deal. The need to compete in terms of price, quality and otherwise meeting customers’ needs provide the best incentives for companies to strive to be efficient and provide customers with the most attractive all-round communications package. However, in markets in which competition is not effective or there is a monopoly supplier, the incentives to increase efficiency and provide customers with the best deal are diminished. This is because there is little or no threat to the profitability of the supplier.

1.2 In telecommunications, BT has market power in the provision of access and calls. Approximately half of the UK has little choice but to get access to telecommunications networks through BT. In calls markets, BT is faced with a greater threat but continues to have high market shares whilst maintaining prices that are well in excess of the level necessary to maintain a sustainable business.

1.3 Price controls have been used to restrict BT from excessive pricing that its dominance would otherwise allow, and they have also been used to encourage BT to increase its efficiency. BT is given incentives to increase its efficiency because it is allowed to keep the benefits of cost reductions until the end of the price control period if these cost reductions are higher than those that had been anticipated when the controls were set. These controls have generally been set for four years.

The current price control and market review

1.4 BT has been subject to the current price controls since 1 August 1997. These controls were set at RPI-4.5 per cent and limited BT’s ability to increase prices for a basket of services provided to the bottom 80 per cent of residential customers. The services controlled have been as follows:

• connection (of a new service);
• take-over (of a service already installed);
• line rental;
• local geographic calls;
• national geographic calls;
• international calls; and
• operator assisted calls.

1.5 The controls were focussed on the bottom eight deciles of residential customers because Oftel believed that competition would deliver a better deal to the highest spending residential customers and business customers than would be delivered by the price controls.

1.6 Oftel has also controlled BT’s retention for calls to BTCellnet and Vodafone since 1 April 1999. These controls were introduced because competition in calls to mobiles was not strong enough to protect consumers. They were set at RPI-7 per cent for three years and were extended for four months to align them with the controls for the other retail services referred to in paragraph 1.4.

1.7 Originally, the main price controls set out in paragraph 1.4 were set to last for four years, but Oftel extended them for a further year to 31 July 2002 following Oftel’s 2001 review of competition in the provision of the price-controlled services.

1.8 Oftel extended the controls in order further to assess the growing impact of indirect access and the early impact of carrier pre-selection and local loop unbundling. In addition, Oftel noted that the extension to the control would also enable it to assess later financial data that would show whether the trends of decreases in overall profitability of the controlled services were continuing.

1.9 Oftel has considered the growing competitive threat that BT is faced with and in January 2002 published a consultation document, Protecting consumers by promoting competition: consultation on Oftel's review of the fixed telephony market. That document set out Oftel’s market analysis and sought comments on a set of proposals to promote competition and protect consumers. The responses to that consultation document are summarised throughout this statement and are available on Oftel’s website (www.oftel.gov.uk/publications/responses/2002/pcr0102/index.htm).

1.10 This statement sets out the outcome of the review and sets out Oftel’s final proposals for the future.

European legislation

1.11 Although Oftel’s review of competition in fixed markets commenced before the publication of the new Directives resulting from the European Commission’s review of communications regulation, Oftel’s market assessment is consistent with the Framework Directive (Directive 2002/21/EC). The Framework Directive stated that:

"National regulatory authorities shall…….define relevant markets appropriate to national circumstances" (Article 15(3)).

Additionally, national regulatory authorities:

"shall determine on the basis of its market analysis……whether a relevant market is effectively competitive" (Article 16(2)).

1.12 As part of the implementation of the new Directives, operators’ licence conditions will be replaced by general conditions of entitlement and, where considered necessary, individual significant market power conditions by 25 July 2003. Unless Oftel carries out a review of the retail market, beginning later in 2002, the provisions in the licence conditions that result from this statement will cease after 24 July 2003. Oftel therefore intends to conduct a review of this market later in 2002.

1.13 Oftel intends to conduct a further review of the retail market in 2004.

Consultation

1.14 At annex B, Oftel has set out the proposed modifications to BT’s licence that are required to give effect to Oftel’s proposals. Oftel has set out these proposed modifications for statutory consultation. Interested parties are given until 19 July 2002 to comment on the proposed modifications. These modifications are intended to give effect to the policies outlined in chapters 2, 3 and 4.

 Chapter 2

Market assessment

Market definition and assessment of competition

2.1 In the consultation document Protecting consumers by promoting competition, 31 January 2002, Oftel set out its views on the definition of the relevant markets in the light of responses to its July 2001 consultation document Competition in the provision of fixed telephony services. Oftel also outlined its assessment of competition in markets for basic telephony services.

Market definition

2.2 Oftel's approach to market definition is based on identifying constraints on the price-setting behaviour of firms. These constraints may arise from customers substituting other services for those in question (demand side substitution), or from suppliers switching production to supply the relevant products (supply side substitution) following a price increase. This approach is widely used by competition authorities.

2.3 Oftel has proposed the following as separate markets:

• fixed access;
• local calls;
• national calls;
• international calls in two categories, which is consistent with its review of competition in international markets; calls from fixed to mobile; and operator assisted calls.

2.4 This is identical to the list proposed in Competition in the provision of fixed telephony services, with the exception of international direct dial (IDD) calls where the definition used in the November 2001 review of competition in international markets was adopted. Oftel has also stated that it considers that these markets are national in scope and that separate markets can be defined for each of the above for business and residential customers. Oftel has also considered whether a further subdivision of residential markets by spend could be made. However, although Oftel found evidence that competitive pressure tends to increase with spend, it found no firm basis for, and does not intend to define, separate markets for lower and higher spending residential customers.

Responses to Protecting consumers by promoting competition, on market definition issues

2.5 Most respondents, who commented on the market definitions, broadly agreed with Oftel's proposals and there was general agreement that calls markets were separate from access and that all markets were national in scope.

2.6 In the previous round of consultation, most respondents who commented on the issue agreed that mobile and fixed markets were currently separate. BT, however, argued in its response that fixed mobile substitution had developed to such an extent that fixed and mobile telephony were now part of a single market and that Oftel, by regarding them as separate markets, had underestimated the extent of competitive pressure on BT. BT submitted a study by the consultants .econ suggesting that consumers would switch between fixed and mobiles in response to price changes. This was discussed further in annex C to Protecting consumers by promoting competition.

2.7 Some respondents to Protecting consumers by promoting competition, commented that fixed mobile substitution was increasing, but had not reached the point where fixed and mobile services could be regarded as being in the same market. Price differentials between fixed and mobile services, together with limitations on mobile coverage and quality of service, were mentioned as possible reasons for fixed and mobile services remaining separate markets. One respondent with particular requirements for confidentiality, privacy and reliability commented that mobiles were unsuitable for its purposes.

2.8 BT has again argued that mobile services should be regarded as part of the same market as fixed services. In support of this view, BT submitted a response by .econ to the points made by Oftel in Annex C to Competition in the provision of fixed telephony services. However, this seeks to defend .econ's earlier analysis rather than presenting new evidence. It is perhaps worth stating that Oftel, in its earlier response, did not take issue with the econometric techniques used by .econ on the grounds that different or better techniques should have been used. Rather it argued that the results of the econometric analysis did not demonstrate that fixed and mobile services now constitute a single market, still less that competition from mobiles is sufficient for measures to control or increase competitive pressure on BT's prices to be unnecessary. Oftel has noted the points made by .econ but continues to believe that fixed and mobile services should be regarded as being in separate markets.

Conclusions on market definition

2.9 In the light of the above, Oftel believes that the market definitions proposed in Protecting consumers by promoting competition are appropriate. The following separate retail markets will therefore be defined for the purposes of the price control review:

• fixed access;
• local geographic calls;
• national geographic calls;
• international calls in two categories as in the review of competition in international markets;
• calls from fixed to mobile; and
• operator assisted calls.

2.10 Oftel also confirms its proposal to define separate markets for each of the above for business and residential customers but not to make any formal subdivision of residential markets by spend and that it regards these markets as national in scope.

Assessment of competition

2.11 In Protecting consumers by promoting competition, Oftel set out its belief that access and calls markets are not effectively competitive (with the exception of the competitive business IDD markets identified in the review of competition in international markets). However, it appeared to Oftel on the basis of responses and other information that competition was increasing and that there were good prospects for effective competition in retail calls markets if the remaining barriers were addressed. Existing policies addressed these problems to some extent, although there was no policy in place to address one of the main barriers identified: the current need for indirect access (IA) and carrier pre-selection (CPS) customers to pay two bills.

Responses to Protecting consumers by promoting competition on competitiveness

2.12 Most respondents agreed that competition, at least in calls markets, is increasing but not fully effective and not yet sufficient, by itself, adequately to protect consumers. BT's dominance in access markets was felt to be rather more intractable, particularly in remote areas, as significant expansion of cable networks was considered unlikely. In addition, some argued that competition for low users was likely to remain weak because such customers had little to gain from switching and were least attractive to competing operators.

2.13 Some drew attention to price cuts and reductions in BT’s market share as evidence that competition is already well developed, particularly in business markets. However, others noted that the level of BT's market share remains above the threshold for a presumption of dominance in most calls markets, and that the profitability of calls is also very high despite the availability of indirect access.

2.14 CPS was felt to be a potential source of increased competition in calls markets in future and BT pointed out that the CPS customer base is growing at some 60 per cent a month. However, some felt that progress could still be hampered by low awareness of the availability of CPS and by the need for CPS customers to pay two bills. On the other hand, use of BT's existing calls and access product, which allows service provider customers to receive only a single bill, has fallen dramatically since 2000. Nevertheless, there was support for Oftel's proposal to require BT to provide a new wholesale line rental product so that operators could offer a total service to the customer, with a single bill. Some argued that this would also help drive growth in CPS take-up.

2.15 One respondent pointed out that the widespread use of direct debit by retail customers could also reduce the inconvenience of paying two bills. However, others referred to experience in energy markets and research supporting the view that the inability to offer a total service to the customer, with a single bill, is a factor currently preventing calls markets from being effectively competitive.

2.16 BT argued that competition was now sufficiently well established for price controls to be removed without the need for additional measures to stimulate competition. In addition to arguing that substantial competition was provided by mobile operators (see above), it also presented in support of its case an empirical analysis commissioned from OXERA which suggested that customers respond to price differentials by switching operator. The rates of switching (nine per cent of customers in cabled areas have switched fixed-line access provider in two years) and use of IA (13 per cent) found by OXERA appear, in fact, to be broadly consistent with those from Oftel's surveys (four per cent switched in the last year and 11 per cent using IA in February 2002). In an econometric analysis, OXERA found that price differentials are a significant determinant of switching. However, it does not follow from OXERA's empirical findings that switching is sufficient to constrain prices to the competitive level.

Competition indicators

2.17 A number of other sources of data relating to the competitiveness of markets have become available since January. These include results from Oftel's February 2002 international benchmarking study, Oftel's February 2002 survey of residential customers and updated market share data. BT has published its group financial results for 2001-02, but its regulatory financial statements are not available for this period (as a result, BT has been unable to extract and reanalyse the necessary data in order to update the financial information outlined in Protecting consumers by promoting competition). The new data are summarised in the following paragraphs. Where possible, Oftel has differentiated between business and residential customers.

International benchmarking

2.18 If UK fixed telephony markets are competitive, one would expect UK consumers to be getting a deal which is as good as or better than that available to customers in similar economies overseas. In order to assess whether this is the case, Oftel has undertaken a series of surveys to compare UK prices and trends with those in other comparable countries. The latest survey was conducted in February 2002.

2.19 The survey found that UK prices for residential PSTN services generally compare favourably with prices elsewhere, with only Sweden and California among the sample having lower prices. UK residential prices were lower than equivalent prices in France and Germany for all usage patterns considered, while for the US the results varied according to usage. UK prices for business PSTN services were slightly above average: roughly five to eight per cent higher than in France, California and Germany, significantly higher than in Sweden but 10 per cent lower than those in Ohio.

2.20 Prices paid by residential consumers in the UK fell by around four per cent between February 2001 and February 2002. This is similar to price falls seen in most other countries (prices in Sweden have remained stable). Prices for business consumers in the UK fell by about five per cent. This is similar to the price falls seen in Germany and Sweden while larger price falls have been seen in France and the US.

2.21 The UK's relative position is generally little changed since the 2000 and 2001 surveys. As before, the existence of a significant price gap between the UK and Sweden is consistent with the proposition that UK fixed telecommunications markets may not yet be effectively competitive. However, it is not possible to draw firm inferences in the absence of an analysis of the reasons for the good performance of the Swedish operators. Given the relatively short history of competition in France and Germany, it is perhaps to be expected that UK operators would fare better when compared with counterparts in these countries.

Customer satisfaction

2.22 Oftel's February 2002 UK survey found that, among residential customers, satisfaction remained high. Some 96 per cent of those respondents for whom the home fixed phone was the main method of telephony were satisfied with it. This compares to 97 per cent in the August and November 2001 surveys.

2.23 Oftel's first international consumer and business survey was conducted in February 2002 in UK, France, Germany, Italy, Sweden, Canada, Japan and the US states of Ohio and California. The UK was found to have significantly above average residential customer satisfaction with price and reliability of fixed service, price and reliability. Amongst UK businesses, however, overall satisfaction was about average although satisfaction with value for money was slightly below average.

Awareness and take-up of indirect access

2.24 Oftel's February 2002 survey yields updated information on consumers' awareness and use of IA. BT also provided some survey evidence of customer awareness in the note by OXERA included in its response. Table 2.1 compares the results of BT's survey with evidence from Oftel's August and November 2001 and February 2002 surveys.

Table 2.1: Survey data

2.25 Oftel's surveys suggest that there has been little change in either awareness or use of indirect access by residential customers since August 2001. OXERA's estimate of the proportion of customers using IA in Q4 2001 is very similar to Oftel's. However, there is evidence of a continuing decline in the proportion of customers using IA for all of their calls which in November 2002 was about half the level of a year ago. The survey results do not conclusively identify the cause of this.

2.26 In Oftel's February 2002 international survey, the UK was found to be significantly above average on awareness of alternatives for residential customers and about average for business customers.

Customer switching

2.27 The February 2002 survey found that four per cent of residential fixed telephone users had switched supplier in the last year. This appears to confirm the fall in switching rates identified in the November survey which was thought possibly to have been anomalous. These figures compare to eight per cent in the August survey, a figure which had changed little since March 2000.

2.28 As noted above, the rates of switching found by OXERA's study for BT appear to be broadly consistent with those from Oftel's surveys. But the headline figure quoted in the main BT response document refers to switching by customers in cabled areas only. Overall, OXERA find rates of switching to be lower than in Oftel's surveys (seven per cent in two years, 15.5 per cent ever, compared to four per cent in the last year and 22 per cent ever in Oftel's February 2002 survey, figures which have not changed significantly in recent quarters). However, OXERA has found similar reasons for switching.

2.29 In Oftel's February 2002 international survey, the UK was found to be about average on rates and ease of switching for residential customers and ease of switching for business customers, although rates of switching by business customers were below average.

Market shares – retail access

2.30 Table 2.2 shows trends in BT's market shares to December 2001. BT's share of residential lines has fallen slightly since September 2000. There appears to have been a small fall in its share of business lines but this remains nearly 90 per cent.

Table 2.2: Market shares (number of lines)

Source: Oftel Market Information

Market shares – retail calls

2.31 Table 2.3 shows trends in BT's shares of calls markets to December 2001. BT's shares in volume terms are declining at a faster rate than its share of lines. There have been significant reductions in BT's shares of residential national and international calls since September 2000 although recent data revisions suggest that this decline may have been less marked than suggested in the January document. However, BT's revenue shares are still over 50 per cent in all markets except international calls for business customers, which suggests that it is likely to be dominant in most calls markets. It should be noted that, although data are only presented here for international calls as a whole, Oftel's view is that it is appropriate to regard individual country-pair routes as separate markets, at least where these are not competitive at the wholesale level. BT's share on some routes is likely to be significantly higher than on others, and this may be part of the cause of the difference between BT's shares by volume and by revenue.

Table 2.3: Market shares (calls)

Source: Oftel Market Information. Market shares have been adjusted to allow for the fact that some operators do not provide separate data for business and residential customers. In addition, Worldcom’s submitted national minutes and revenues have been apportioned among local calls, national calls and calls to mobile. BT market shares include Concert market shares for these purposes.

Profitability

2.32 In its competition assessment in Protecting consumers by promoting competition, Oftel reported financial information showing the end-to-end profitability of individual retail basket services for 1998-99, 1999-2000 and 2000-01. This information was an extraction and reanalysis by BT of data underlying figures disclosed in the 1998-99 and 1999-2000 CCA financial statements. Comparable data on BT's profitability for 2001-02 are not yet available. BT has however published its fourth quarter and preliminary group financial results for 2001-02 and its group statutory accounts and these enable overall trends in BT profitability to be inferred.

2.33 Turnover in BT Retail for the year 2001/02 increased by 0.2 per cent compared to the previous year. However, reductions in sales and administration costs have enabled earnings before tax, interest, depreciation and amortisation (EBITDA) to increase by some 21 per cent compared to 2000-01. Calls turnover and call volumes have fallen slightly, though the rate of decline in the latter is said to have been ‘stemmed’. On the other hand, both turnover from and volumes of fixed lines have increased and this is partly attributed to the success of the BT Together packages and to customers returning to BT. The profitability of lines has improved due, according to BT, to price changes, cost reductions and volume growth. BT estimates that its share of the market for residential fixed voice calls has been stable since June 2000. Its share of business voice calls is estimated to have fallen by 3 per cent, compared to a fall of 4.5 per cent in the previous year.

2.34 It is difficult to draw firm conclusions on trends in profitability in retail price controlled services from these data. However, there does not appear to be any reason to expect there to have been a significant decline in BT's rates of return on calls, which are therefore likely to have remained extremely high.

Entry by broadband and other operators

2.35 Growth in take-up of broadband service using ADSL and cable modems has continued. Demand for LLU has continued to be much lower than originally expected. In total, there are still only just over 500,000 end users of broadband Internet access, mainly ADSL and cable modem customers. However, demand for ADSL is likely to grow as a result of recent price reductions and the introduction of self-install products.

Price of operator assisted calls (‘OA’ calls)

2.36 In Protecting consumers by promoting competition, Oftel proposed that, until competition becomes fully effective, OA prices should continue to be subject to price control. It did not however propose a separate control for OA services. In the light of responses received, Oftel confirms its intention to subject prices for OA services to the same controls as other prices.

Price of calls to mobiles

2.37 BT is currently subject to a separate control on its retail retention on calls to BTCellnet and Vodafone. The retention is subject to a cap set at RPI-7 per cent per annum. In Protecting consumers by promoting competition, Oftel proposed that, in future, BT's retail retention would be included in the retail price control basket rather than be subject to a separate control.

2.38 Oftel received a number of responses from mobile operators on this issue. Few other respondents mentioned it. Those mobile operators who responded argued that BT's retention on calls to mobiles should be subject to a separate cap as now, although those fixed line operators who commented did not share this view. The former argued that, without this, reductions in mobile termination rates would not be passed on to end users. Oftel believes, however, that it is not necessary for BT's retention on calls to mobiles to be subject to a separate cap in order for customers to benefit from reductions in termination rates. If BT's retention on calls to mobiles increases, it will need to make offsetting reductions in the prices of other services within the basket.

2.39 Oftel believes that competitive conditions in calls to mobiles are broadly similar to those for other call types. Mobile operators tended to disagree, arguing that fixed operators did not appear to be actively competing on calls to mobile prices. Oftel noted in Protecting consumers by promoting competition, that returns on calls to mobiles are lower than on other call types and that this may have discouraged some operators from offering them. However, BT's current level of returns should be sufficient to attract entry unless operators have a significant cost disadvantage to BT. BT's share of calls to mobile minutes is similar to its shares of local calls and national calls. In addition, calls to mobiles are available from CPS operators under the ‘all calls’ option. These factors suggest a similarity of competitive conditions between calls to mobiles and other call types and this is reflected in Oftel's proposals set out later in this document.

2.40 It should be noted that competitive conditions in the retail provision of calls to mobiles are intrinsically different from those in the provision of mobile call termination. The latter largely reflect the fact that, under the calling-party pays principle, there is little incentive for the called party to change his or her mobile network in response to an increase in call termination charges. Oftel's proposal for the retail control on calls to mobile prices is therefore entirely consistent with its proposals for individual controls on mobile call termination charges.

Conclusions on competitiveness

2.41 In the light of responses to Protecting consumers by promoting competition, and other new information, Oftel believes that access and calls markets are not effectively competitive (with the exception of the competitive business IDD markets identified in the review of competition in international markets). Responses suggest that Oftel's proposal for a wholesale line rental as set out in Protecting consumers by promoting competition, would address one of the main remaining barriers to competition identified: the current need for IA and CPS customers to pay two bills.

 Chapter 3

Wholesale line rental

3.1 In the January 2002 consultation document, Oftel set out its view that competition in the provision of fixed services was not effective and that BT remained dominant in the provision of access and calls.

3.2 In calls markets, BT is faced with increasing competition on a national basis from indirect access operators using short dial codes or carrier pre-selection. However, in access markets, the competition is in the main provided by the cable operators whose geographic reach extends to approximately 50 per cent of the country. Competition in access is therefore limited in its geographic scope.

3.3 One consequence of BT’s dominance in access – over 80 per cent of residential and business customers are connected to BT’s network – has been its ability to maintain call prices that are well in excess of its cost of capital (Oftel estimates that BT’s cost of capital is 13.5 per cent – see Oftel’s website at www.oftel.gov.uk/publications/pricing/pcr0101.htm). BT continues to maintain extremely high shares in most calls markets and its extremely high profitability in these markets has still to be eroded.

3.4 To increase competition in the fixed telephony market, Oftel proposed that BT should be required to provide wholesale line rental (WLR) to other operators and service providers on cost-based and non-discriminatory terms. This would allow competitors to take on the retail relationship with the customer. All interactions would be with the reseller and who could offer a ‘single bill’ to end users for all telecommunications services. This would be in contrast to IA under which the retail customer retains a contractual relationship with BT for the provision of the line.

3.5 The introduction of WLR would also provide customers in areas not served by cable operators with a choice of access providers. In addition, Oftel believes that service providers might introduce innovative tariffs that might change the ‘balance’ between line rental and call charges. It might lead to similar packages to those now available in the mobile market, such as a fixed fee charge including line rental and call charges. Alternatively service providers might choose to offer packages that include a lower fixed rental charge and higher prices for calls.

Responses to the consultation

3.6 Respondents broadly welcomed Oftel’s proposal to introduce WLR. However, opinions differed on the extent to which the supply of BT’s existing calls and access product were adequate to support WLR. Several service providers and operators argued that Oftel would have to take a proactive role in industry groups that Oftel stated that it would set up to define the product and oversee the development of appropriate supply processes.

3.7 Consumer groups in particular believed that it was essential that adequate consumer protection arrangements were established to counter possible mis-selling. Other respondents urged Oftel to consider ways in which BT could be incentivised to deliver WLR as early as possible.

Oftel’s conclusions

3.8 Oftel intends to require BT to provide WLR on cost based and non-discriminatory terms to anyone wishing to offer access to BT’s public telephone system or publicly available telephone services. Oftel is therefore consulting on modifications to BT’s licence to introduce a new condition requiring BT to provide ‘access services’. Oftel is also determining the amount BT can charge other providers for key access services. The proposed licence modifications and the charges for certain access services are described later in this chapter and in annex B (licence modifications) and E (setting the charges).

3.9 Initially, Oftel expects that WLR will be made available in a form similar to the access element of BT’s existing calls and access product, as soon as practical after 1 September 2002. However, Oftel is not simply resetting the price of the access element of calls and access. Oftel is setting prices for new products that will need to inter-work with current interconnection products, such as CPS, in order to give competitors an offering that will enable them to compete with BT Retail. In this chapter and in annex D, Oftel has set out key elements of the fully operational second stage product.

3.10 The fully operational second stage product should be made available at the earliest possible date. Oftel therefore proposes to take a lead role in designing the specification of this product. It intends to establish industry groups – comprising operators, service providers and consumer representatives – to develop a product specification for the enhanced WLR. The product specification will include:

• a product functional description;
• a process definition and manual;
• ordering handling and maintenance processes;
• a service level agreement;
• marketing guidelines;
• consumer protection measures;
• consumer guide;
• contract terms; and
• a cost determination for any enhancements if necessary.

3.11 Although Oftel proposes to lead on the design of the product specification, it intends to consult interested parties. Oftel aims to complete and publish the product specification by October 2002.

WLR: provision of access services

3.12 In Condition 69B.1 of the proposed licence modifications Oftel has described access services as follows: 

3.13 In effect, Oftel believes that by virtue of Condition 69B.1 service providers should be able to offer a basic telephony service that is equivalent to the service that BT Retail offers to its customers in terms of the technical offering. In terms of the WLR product, this means that the service provider could provide its retail customer with a line for the provision of incoming call services. It also guarantees that the line would be repaired in the event of failure and that the customer would receive phone books on a non-discriminatory basis. In addition, WLR would allow the service provider to offer outgoing calls services to its customers, although these would have to be bought separately from BT or another operator offering calls services eg a supplier of service using CPS.

3.14 The terms and conditions under which the access services are commercially made available would need to be established within BT’s contract with the service provider and within its service level agreement. However, the proposed licence modification would underpin both the contract and the service level agreement, as it includes provisions that are intended to prevent discriminatory behaviour. But the contract and service level agreements are bilateral agreements. Service providers would therefore be expected to honour their obligations. BT would not be expected to maintain service for a service provider in breach of contract.

The proposed licence modifications

3.15 The main provisions of the proposed modifications to BT’s licence are as follows:

• Condition 69B.1 requires BT to provide access services.

• Conditions 69B.3 to 69B.5 empower the Director General to resolve disputes.

• Conditions 69B.6 to 69B.8 requiring BT not to act in a discriminatory manner.

• Condition 69B.9 establishes publication requirements.

• Condition 69B.10 sets starting charges for certain access services.

• wholesale line rental (residential quality of service);
• wholesale line rental (business quality of service);
• transfer of a single line or multiples thereof; and
• installation charge per line.

• Condition 69B.11 to Condition 69B.21 set the price controls.

3.16 At Annex B, Oftel has set out the proposed new Condition 69B to give effect to the requirement to provide WLR. Oftel has set out this proposed modification to BT’s licence for statutory consultation and is therefore seeking comments on these proposed modifications by 19 July 2002. Thereafter, Oftel will remind BT that it has seven days to object to the proposed licence modifications. If it does not do so, the modifications will take effect from 1 August 2002.

WLR: Costs, charges and charge controls

3.17 Oftel is setting the following starting charges for the following services:

• wholesale line rental (residential quality of service) – £28.00 per line, per quarter;
• wholesale line rental (business quality of service – £29.87 per line, per quarter;
• transfer of a single line and multiples thereof – £1.41 per transaction or multiples thereof; and
• each newly installed line – £92.89 per line.

3.18 Oftel has set these charges on the basis of BT’s incremental costs in providing these services plus a contribution towards common costs. Oftel has set out its cost calculation in annex E.

3.19 In addition, Oftel proposes to subject these services to a basket control set at RPI-2 per cent and subject the transfer charges to a sub-cap within the basket, which will also be set at RPI-2 per cent. These controls would last for four years – if Oftel has introduced a specific condition of entitlement to give effect to these controls after 24 July 2003 – with each control set to commence on 1 September 2002.

3.20 At present, Oftel does not propose to set prices for ancillary services such as call waiting. However, Oftel expects BT to provide these services and expects prices for them to be reasonable. The Director General would consider any dispute brought to him on the reasonableness of any charges.

WLR residential and business quality of service

3.21 In paragraph 3.17, Oftel has stated that it proposes to set starting charges for two WLR services and the difference in the charges is due to the different levels of service quality in terms of fault repair. The residential quality of service product offers fault repair by the end of the next working day (Monday to Friday) if reported within normal working hours (8am to 5pm). Although BT only states that it offers similar repair services to its business customers, its actual aim is to restore service in faster for business customers. Oftel intends to monitor how quickly BT repairs services for its own customers in comparison to service providers’ customers. Service providers need not buy residential quality of service for a residential customer and nor do they have to buy business quality of service for a business customer.

Implementing WLR

3.22 As explained in paragraph 3.10, Oftel intends to set up industry groups to develop a Product Specification for enhanced WLR. The two main groups that Oftel envisages are:

• a steering group, comprising senior representatives of the operators, service providers and consumers to monitor the progress of the project and to consider significant policy or process issues which cannot be resolved in other groups; and

• an operations group, which will co-ordinate the development of the product specification.

3.23 Oftel proposes to chair both groups. Other tasks groups will be set up on an ad hoc basis to develop particular aspects of the Product Specification eg processes, systems, service level agreements and contract terms.

3.24 The task groups will deliver their output to the operations group. Oftel may appoint consultants with specialist technical expertise to assist in the development of the product specification as appropriate. However, in the first instance, Oftel intends to build on the processes designed for carrier pre-selection and calls and access.

3.25 Oftel will hold workshops in July to discuss an outline product specification and the groups and work plan needed to deliver it. Further details of the workshops will be given on Oftel’s website.

3.26 The rest of this chapter seeks to define the essential elements of the enhanced WLR product and processes to be described in the product specification.

WLR: relationship with carrier pre-selection (CPS)

3.27 WLR allows the purchaser to offer ‘access’ to an end user. It is likely that some service providers would wish to combine WLR with either the CPS functionality – purchased directly or indirectly depending upon their status – while others might prefer to buy wholesale conveyance purchased from BT. Operators with Annex II status can purchase cost based call origination services from BT and can mix this service with other interconnection services purchased from BT, other operators or services provided over their own networks in order to compete in the provision of end to end calls. Service providers without Annex II status could choose to purchase wholesale calls services from BT or other operators though these would not necessarily be available on cost-based terms.

3.28 In theory, it is not necessary for WLR and CPS to be provided simultaneously, provided that the customer experiences a single transfer to the WLR provider. The service provider could ask BT to provide the WLR and activate CPS as soon as possible thereafter. In between these times the end-user would use BT for calls services. However, in practice, it is likely that the service provider reselling WLR would wish to offer access and the means of making outgoing calls simultaneously or, if that is not possible, with little gap in the provision of both services.

WLR: indirect access

3.29 BT’s current call and access product has a facility whereby calls and access customers can override the routing selected by their service provider and choose to route calls via an indirect access operator. This facility will be present in the basic WLR product available after 1 September 2002. Indeed, some customers might prefer the ability to select other call service providers and this might make the retail offering giving such freedom an attractive proposition. However, Oftel is aware that some service providers would prefer not to allow their customers to have a choice to route calls via anyone other than themselves. They argue that they need to guarantee that they will receive the customer’s call income if they are going to be able to offer innovative tariffs, such as lower fixed elements being subsidised by higher price variable elements.

3.30 Oftel believes that the requirement to provide call origination services should be applied only to operators that have SMP in the relevant market. In the national markets for access and calls, this is BT. This principle would suggest that service providers using the WLR should not be obliged to allow their retail customers to choose to route their calls via an alternative IA or CPS operator. However, to enable service providers to bar their customers from using IA operators could require alterations to BT’s network, which might involve costs.

3.31 Oftel therefore proposes to consult on whether service providers taking WLR should be able to bar access to indirect access (including CPS) operators’ services on WLR lines. This consultation will include discussions on the relevant costs and who should pay them taking account of Oftel’s six principles of cost recovery, namely:

• cost causation – costs should be recovered from those whose actions cause the costs to be incurred at the margin;

• cost minimisation – the mechanism for cost recovery should ensure that there are strong incentives to minimise costs;

• distribution of benefits – costs should be recovered from the beneficiaries especially where there are externalities;

• effect on competition – the mechanism for cost recovery should not undermine or weaken the pressures for effective competition;

• reciprocity – where services are provided reciprocally, charges should also be reciprocal; and

• practicability – the mechanism for cost recovery needs to be practicable and relatively easy to implement.

Notification requirements

3.32 Oftel is requiring BT to provide WLR and related services because of its dominance in the provision of access. It therefore follows that competitors will need prior notification before BT is permitted to change a price for any access service. Oftel believes that it is reasonable to require BT to provide advance notification that is consistent with BT’s interconnection requirements. BT will therefore be required to give ninety days’ notification before changing the price or the structure of the price for the services subject to price controls. For other services, BT will be required to give twenty eight days’ notice.

3.33 These notification periods are intended to give competitors an opportunity to change the prices for their retail services in line with changes at the wholesale level.

Other issues

3.34 Respondents to the January 2002 consultation raised several other issues about the WLR product and processes. These are set out in annex D. Oftel’s views on these issues, also set out in that annex, will inform the content and development of the product specification. Oftel’s broad views on the essential features of the fully operational WLR product are summarised in Table 3.1. 

Table 3.1, WLR: essential features