Final statements on the Strategic Review of Telecommunications, and undertakings in lieu of a reference under the Enterprise Act 2002

Executive Summary

1.1 In April 2004, Ofcom published the Phase 1 consultation of its Strategic Review of Telecommunications (the ‘Telecoms Review’). The review was designed to set out a strategic direction for Ofcom’s activities in relation to telecoms, and to create a new settlement between the regulator, the companies we regulate, and citizens and consumers. In that Phase 1 consultation document we posed five fundamental questions for the review:

• In relation to the interests of citizen-consumers, what are the key attributes of a well-functioning telecoms market?
• Where can effective and sustainable competition be achieved in the UK telecoms market?
• Is there scope for a significant reduction in regulation, or is the market power of incumbents too entrenched?
• How can Ofcom incentivise timely and efficient investment in next generation networks?
• At varying times since 1984, the case has been made for the structural or operational separation of BT, or the delivery of full functional equivalence. Are these still relevant questions?

1.2 In this final statement, we provide our answers to these questions, and set out our strategic approach to the regulation of the sector.

1.3 Attributes of a well-functioning telecoms market. Our market research and consultation suggested that businesses and consumers want much more than basic, reliable telecoms services at low prices: they also want choice, and rapid innovation and introduction of new services. Our assessment was that the most effective way of delivering this is through competition at the deepest level of infrastructure where competition will be effective and sustainable. We also showed that the competition that had delivered benefits to consumers to date might not be sustainable going forwards, so maintaining the status quo in terms of our regulation was not an option.

1.4 Though competition may be a means to delivering the kinds of outcomes that consumers want, it cannot be effective unless customers are able to make well-informed choices, and to switch easily between suppliers. Our research showed that some groups of consumers had various difficulties in making these choices. Although the same could be said of most markets, there may be features of some telecoms markets that exacerbate these problems. Though we do not consider it appropriate to leave this problem entirely to the market, it is important that we target any activity to the particular groups of consumers who are having problems. We are making changes in a number of areas and will be looking at this issue further in the wider review of consumer policy that we are now undertaking.

1.5 Where effective and sustainable competition can be achieved. Whereas competition between rival end-to-end infrastructures has proved to be effective and sustainable in the mobile market, this has not been the case in fixed telecoms. In fixed telecoms, we concluded that there were enduring economic bottlenecks – parts of the network where effective and sustainable competition was unlikely in the short to medium term. Therefore we adopted the principle that regulation should promote competition between competing infrastructures as deep in the network as such competition was likely to be effective and sustainable. However, we noted that companies who wished to compete on this basis had to rely on BT for access to parts of the network where competition was not sustainable. We concluded that in order for competition in fixed telecoms to be effective, BT needed to make such access available on the same terms as it made it available to itself: an approach we called equality of access.

1.6 Scope for a reduction in regulation. If equality of access is introduced to bottleneck parts of the network, we expect to be able to deregulate elsewhere (for example, in some retail markets). Such deregulation could take two forms: either a lessening of Significant Market Power ( SMP) conditions where equality access is applied in upstream markets or a finding that there is no longer SMP in downstream markets. We have set out our approach to deregulation, as well as our immediate forward programme of work, in this statement.

1.7 Incentivising timely and efficient investment. As technology progresses and existing copper switched telecoms networks become due for replacement, it is particularly important that regulation does not disincentivise efficient investment. We described our approach to regulation of risky investments in our August 2005 statement on assessing the cost of capital. That statement set out a number of principles, and led us to disaggregate the equity beta that we use in calculating BT’s allowable cost of capital between BT’s lowest risk activities, and the rest of BT. However, There may be a particular challenge in incentivising efficient investment in access networks and we are starting a review of next generation access to look specifically at this issue.

1.8 Achieving equality of access in fixed telecoms. The final fundamental question for the review was whether questions about the structural or operational separation of BT remained relevant. Our preferred approach of equality of access involves both equivalence at the product level, and organisational changes by BT. In June 2005, BT offered Ofcom a set of undertakings in lieu of Ofcom making a reference to the Competition Commission under the Enterprise Act 2002. In the statement in part 2 of this document, we are accepting such undertakings from BT. We expect these undertakings to have the effect of delivering equality of access.

1.9 In our June 2005 consultation on these undertakings, many respondents emphasised how important it would be that Ofcom remains fully involved with the implementation of the undertakings, and sets out how it would measure the success of its regulatory approach. We agree, and we have set out our proposed approach in the final chapter of this statement. In particular, we consider it important to measure not only whether the undertakings are being complied with, but also more broadly whether our overall regulatory approach is delivering the kinds of outcomes for businesses and consumers that are intended of it.

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