WBA Charge Control - Charge control framework for WBA Market 1 services

20 July 2011

Executive Summary

1.1 Broadband is increasingly central to the lives of UK consumers and the success of businesses. It allows consumers to access and interact with a wide range of content and services and allows businesses to exploit new market opportunities and more efficient operating models. Competition has driven the success of the current generation of broadband services. The result has been greater choice, innovation, lower prices and high levels of broadband adoption.

1.2 In the Review of the wholesale broadband access markets - Statement on market definition, market power determination and remedies' ("the 2010 WBA Statement") (-1-) published on 3 December 2010, we found there is effective competition in areas covering almost 80% of the premises in the UK. However, in Market 1 - made up of exchange areas in which BT is currently the only provider of wholesale broadband services - we decided that BT (-2-) should be subject to a charge control. On 20 January 2011, we set out our proposals on the structure, form and level for the charge control in the WBA Market 1 areas (the "January Consultation") (-3-) and requested stakeholders' views on these.

1.3 This statement sets out our conclusions on the charge control for Wholesale Broadband Access (WBA) services in Market 1. We set out below our conclusions following consideration of the responses to the January Consultation.

1.4 We believe that the benefit of the wholesale charge reductions resulting from this charge control could deliver lower retail prices and also improve broadband users' experience in Market 1. As average demand increases as more consumers seek to use higher bandwidth services, we believe that internet service providers (ISPs) will reflect the benefits arising from the charge control in better quality of service, as this is likely to be an important focal point for broadband retail competition in Market 1 areas.

The January Consultation proposals

1.5 In our January Consultation we proposed the following:

  • An RPI-X control with a single charge control basket;
  • A value of X in the range 10.75% to 14.75% with a central estimate of 12.75%;
  • Charge control only BT's IPStream Connect Max and Max Premium products;
  • A moving anchor pricing approach to setting the control;
  • Three characteristics for the anchor product:
    • Maximum bandwidth on the end user access component up to 8 Mbit/s;
    • Average allocated bandwidth per end user of 48kbit/s in 2010/11; and
    • Annual growth rate of 23%.

Stakeholder responses

1.6 We received 17 responses to our January 2011 Consultation from a number of communication providers (CPs), and a range of other stakeholders. (-4-) A full list of respondents is included in Annex 2 of this statement, and all non-confidential responses are published on our website (-5-). As set out in this statement, responses included comments on the following:

  • Scope of the charge control the majority of stakeholders agreed with the our proposal to charge control IPStream Connect only;
  • Bandwidth growth profile Respondents were most clearly divided on this issue. BT and TalkTalk Group (TTG) considered that our estimates for bandwidth growth were too aggressive. On the other hand, Sky, Cable & Wireless Worldwide (C&WW) and another respondent considered our assumptions to be too conservative;
  • Underlying assumptions used in our cost modelling Most stakeholders agreed with our proposed assumptions, though some also suggested some variations;
  • Cost of capital Sky and TTG jointly commissioned a report from Europe Economics (EE). BT commissioned a report from Oxera; and
  • The exclusion of any deficit repair payments when assessing BT's costs of providing the WBA services.

1.7 The responses included comments from four local Councils which emphasised how broadband services are important for their rural communities. We also received six responses from individuals. Of these responses, the majority were from consumers in Market 1 areas concerned about continued slow broadband speeds, whilst the rest were generally supportive of our approach.

1.8 In the following sections, we respond to the comments made by stakeholders. These comments have informed our final decision on the design and methodology of the WBA Market 1 charge control. In reaching our decisions, we also explain how our approach meets our legal duties. Below we provide a summary of our conclusions.

Summary of our decisions

1.9 Our decision on the WBA charge control to be applied in Market 1 is as set out in this statement. This statement constitutes our impact assessment.

We are charge controlling BT's 8Mbit/s IPStream Connect product

1.10 We are imposing this charge control on the IPStream Connect 8Mbit/s (Max and Max Premium) product only. It is the maximum downstream speed currently available and the product most used by end users in Market 1. We conclude therefore that charge controlling this product directly protects most consumers in Market 1 and constrains BT from excessive charging on the other products available in Market 1.

We are implementing an RPI-X charge control, with a single charge control basket, running until March 2014

1.11 We are implementing an RPI-X charge control as we believe that it will protect users by preventing BT from exploiting its SMP to increase prices and will provide BT with incentives to adopt new technologies where it is efficient to do so and to seek efficiency savings whilst also providing benefits to consumers.

1.12 We are implementing a charge control regime up to 31 March 2014. This period of just under three years is consistent with the new procedures and timeframes introduced by the amendments to the EU regulatory framework (-6-), which was implemented in the UK on 26 May 2011. It is also consistent with the forward look period considered in the 2010 WBA Statement.

1.13 We are implementing a single control basket with a safeguard cap on certain services within the basket. Details of the charge control basket and safeguard caps are set out in Table 1.1.

Cost modelling

1.14 We have developed a cost model to design the charge control in Market 1 and the underlying cost base for the control period. Key elements of our modelling approach include the following:

  • We have decided to use Current Cost Accounting Fully Allocated Costs (CCA FAC) as the appropriate cost standard to set the control;
  • We project that demand for bandwidth per end user will increase by 30% each year; and
  • We have made a number of adjustments to BT's reported cost to ensure the base year data are relevant and reliable. These include:
    • reflecting the new market definition boundaries, as determined in the 2010 WBA Statement;
    • removing any 'one-off' costs that are outside the charge control basket;
    • attributing 'non-geographic costs' between the three markets; and
    • reflecting the ongoing economic value of some assets that would otherwise be treated as fully or nearly fully depreciated.

Cost of Capital

1.15 In deriving the value of X, our aim is to define charging constraints such that, by the end of the charge control period, BT is expected to be able to earn a level of return on the basket of services that is equal to its weighted average cost of capital ("WACC").

1.16 We have taken into account the responses we received on the cost of capital in the context of our January Consultation and have finalised BT's cost of capital figure for the purposes of setting this charge control. We have also taken account of all the responses on the cost of capital to the LLU Consultation received up to the 8 July LLU Consultation closing date to inform our LLU decision on the cost of capital. (-7-) The derivation of the cost of capital figure for the WBA charge control is described in Section 6.

1.17 In determining the cost of capital for WBA services, we have taken into account the recent Competition Commission determinations in the Leased Lines charge control appeal (the 'LL Appeal Determination'), (-8-)LLU charge control appeal (the 'LLU Appeal Determination') (-9-) and the WLR charge control appeal ('WLR Appeal Determination'), (-10-) in particular regarding whether it is reasonable for Ofcom to estimate two different costs of capital within the BT Group, one for copper access services and one for the remainder of the group's activities ('Rest of BT').

1.18 Our view is that the risk characteristics of WBA services justify the use of the 'Rest of BT' rate which we estimate to be 9.7% (pre-tax nominal). This is higher than the mid-point of our January Consultation estimate of 9.3%.

1.19 In real terms, our final estimate is 6.5%, compared to our January consultation mid-point of 6.6%.

Treatment of pension costs

1.20 We have not included costs related to the repair of BT's pension deficit. In excluding such costs, we have been consistent with our pensions review statement ('the Pensions Review') (-11-) which we published in December 2010. This contained our pensions cost guidelines ('the Pension Guidelines') which set out our general policy as to the approach we normally expect to take in relation to the treatment of BT's pension costs when assessing the efficiently incurred costs of providing relevant regulated products or services.

1.21 We explained that, while we expect the Pension Guidelines to form an important consideration in relevant cases, we intend to apply the Pension Guidelines on a case-by-case and will always act consistently with our duties and applicable legal tests under the Communications Act. Although the Pension Guidelines set out the approach that we would normally expect to take, each case will be considered on its own merits.

1.22 As specified in the Pensions Review, (-12-) if we decide to depart from the Pension Guidelines in a particular case, we will set out our reasons for doing so. As a general rule, unless we consider that there has been a material change in the circumstances and background considered as part of our review, we are not expecting to depart from the Pension Guidelines.

1.23 We do not consider that there are any factors relating to the WBA charge control in particular which would support the adoption of an approach other than expressed in our Pension Guidelines.

1.24 As BT acknowledges, the arguments it raised in response to the WBA charge control are not new. We consider that these arguments have been dealt with either in the consultations or statement of the Pensions Review. For ease of reference, we summarise our view on the points reiterated by BT as part of its response in Annex 3. However, we also refer readers to the appropriate sections of the Pensions Review for our detailed analysis. (-13-)

Value of X

1.25 We are implementing a charge control RPI-12.00% which will last until 31 March 2014. As shown in Table 1.1, the control is within the range of values published by Ofcom in our January Consultation.

1.26 In addition, we are imposing RPI-0% sub-caps for a number of services within the basket, to ensure that charges for these services do not increase in real terms over the charge control period. We are setting cease charges to zero.

Table 1.1 Summary of the charge control baskets (-14-)
Basket Services within scope Value of X Value of sub-cap
IPStream Connect IPS Connect Max and Max Premium (up to 8 Mbit/s) End User Access (EUA) connection and rental; RPI-12.00%  
  IPS Connect EU bandwidth charge per month;    
  IPS Connect contracted bandwidth per Mbit/s per node rental;   RPI-0%
  IPS Connect EUA re-grade   RPI-0%
  IPS Connect EUA migration   RPI-0%
  IPS Connect EUA cancellation   RPI-0%
  IPS Connect communication provider handover rental    
  IPS Connect 20C interconnect links 1Gbit/s and 10Gbit/s rental    

The impact of the delay

1.27 The value of X is determined as though the charge control was a three-year control in force from the 1 April 2011 to 31 March 2014. As the control comes into effect on 17 August 2011, (-15-) we make a number of modifications to the charge control SMP conditions ('the Conditions') so that they are appropriate to the shorter period for which the control will apply.

1.28 These modifications were intended to take into account any price changes BT may make between 1 April 2011 and the start of the new charge control. This is because our X is calculated with reference to the prevailing prices on 1 April 2011, and that these need to be reduced in order to bring revenues in line with costs at the end of the charge control. Therefore, if BT's prices on 17 August 2011 is higher than that assumed in our RPI-X model then, all else being equal, the value of the X would need to be increased in the first year to take this into account. The formula set out in the Conditions (see Annex 1) has been designed to achieve this objective.

1.29 BT made a number of price changes on 1 April 2011 that are relevant to this charge control. The new prices have been used to generate our value of X.

1.30 For assessing compliance, we have also modified the Conditions so that the first year covers the period from 17 August 2011 to 31 March 2012.

Footnotes:

  1.-http://stakeholders.ofcom.org.uk/binaries/consultations/wba/statement/wbastatement.pdf

  2.- Our decision on the WBA charge control is addressed to BT plc. as a whole. It should be noted that however that the charge controlled product is supplied by BT Wholesale ("BTW").

  3.-http://stakeholders.ofcom.org.uk/binaries/consultations/823069/summary/condoc.pdf

  4.- Of these, five were received from Communication Providers (CPs), four from local Councils, one from a local business and one from the Communications Workers Union (CWU), with the remaining six from individuals.

  5.-http://stakeholders.ofcom.org.uk/consultations/wba-charge-control/?showResponses=true&pageNum=2

  6.-http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2009:337:0037:0069:EN:PDF

  7.-http://stakeholders.ofcom.org.uk/consultations/wba-charge-control/update/

  8.- See the Competition Commission's determination in "The Cable & Wireless UK v Office of Communications", 30 June 2010, cases 1112/3/3/09 http://www.competition-commission.org.uk/appeals/communications_act/final_determination_excised_version_for_publication.pdf

  9.- See the Competition Commission's determination in "The Carphone Warehouse Group plc v Office of Communications", 31 August 2010, cases 1111/3/3/09 http://www.competition-commission.org.uk/appeals/communications_act/llu_determination.pdf(the "LLU Appeal Determination")

  10.- See the Competition Commission's determination in "The Carphone Warehouse Group plc v Office of Communications", 31 August 2010, cases 1149/3/3/09 (the "WLR Appeal Determination") http://www.competition-commission.org.uk/appeals/communications_act/wlr_determination.pdf.

  11.-http://stakeholders.ofcom.org.uk/binaries/consultations/btpensions/statement/statement.pdf

  12.- See Paragraphs 3.13 and 8.15 plus Annex 1.

  13.- In particular, see Sections 3, 4 and 5 of the Pensions Review (cited above).

  14.- This table refers to the services as currently being named in Part 8 (BT IPStream Connect) of BT's Service Provider Price List website (BT Price List). The description of services included in the charge control basket is in Annex 1.

  15.- 28 days after this statement date to allow price change notification period.