Strategic Review Telecommunications Phase 2 consultation documents

Consultation published: 18|11|2004
Consultation closes: 03|02|2005

Foreword

Telecommunications is an important economic sector in its own right. It also has a growing impact on our lives as individuals, on businesses in terms of efficiency and customer service and on the United Kingdom's competitiveness as a knowledge-based economy.

The telecommunications sector and the communications services we get have been heavily shaped by regulation. In mobile and wireless services, this has been achieved through the allocation of the radio spectrum on which these services depend. That has been a series of regulatory decisions. In fixed line telephony, the 20 year march from a single, state-owned, monopoly towards competitive markets has been enabled - though also sometimes unintentionally diverted - by economic regulation.

The technology behind telecommunications services is at an inflection point. Telecommunications is going from analogue to digital, just as surely as is broadcasting, and probably with even more significant consequences, though they are not as widely recognised or understood. Some of this shift is evident to residential and business consumers, with the growing deployment of broadband, ICT solutions and 3G mobile. Some is less evident, involving the transformation of back office operational support systems and the design of core networks from analogue switched voice, to digital IP-based data. The impact of these changes, on the services we are able to receive and on the economics of the sector will, however, be profound. And while these changes are underway, it will be particularly important to ensure that a safety net of universal service remains available for all.

So Ofcom has undertaken a Strategic Review of the sector with the aim of reassessing the regulatory framework to make it fit-for-purpose against this changing backdrop. In Phase 1 of our Review we posed five questions which the Review would address. These are replicated on the page opposite. We also charted the evolution of regulation and the current state of the market. This Phase 2 Ofcom report builds on that work and sets out our proposals for a future regulatory strategy.

The regulatory framework has developed in three stages since BT Group plc was privatised, as an integrated entity, in 1984. The first stage was based around retail price controls, designed to protect the consumer from monopoly pricing whilst also intended to encourage the company to make increasingly efficient use of assets as nascent competition developed. In the second stage, which followed the last strategic assessment of the sector - the duopoly review in 1991 – the emphasis shifted towards encouraging end-to-end infrastructure competition, with the roll-out of the cable networks. In more recent years, as the limits of end-to-end infrastructure competition were realised and with the emergence in other markets of service-based competition models, the regulatory framework focused increasingly on the provision of access, at the wholesale level, to BT Group plc's network and facilities. And, most recently, the system of detailed market definition and reviews, assessment of significant market power and detailed remedies, created by the series of European Communications Directives, was transposed into UK legislation.

In that 20 year period, the telecommunications sector has delivered for the residential and business consumer. No longer are there waiting lists for residential lines. UK call prices - local, national and international - are amongst the lowest in the world. Mobile telephony has been a success, developing from a standing start in 1985 to over 80% penetration now. The UK today has over 5 million broadband connections, delivered over DSL or cable networks, with five major retail providers. For businesses, the development of VPNs, LANs and WANs has created bespoke data-based options providing both improved service efficiency and significantly lower call costs.

In terms of competitive market structures, mobile is strong with five competing operators and several more virtual network operators. In almost all aspects, the mobile sector displays the hallmarks of a vigorously competitive market. Its evolution will be conditioned more by developments in wireless spectrum use and availability, which we will address separately in our forthcoming Spectrum Framework and Implementation Plan, than by this Telecommunications Review.

The fixed line market, however, remains fragmented. In terms of revenues, market capitalisation and investment, BT Group plc remains larger than most of its competitors put together. Understandably, fixed infrastructure competition has followed the margin in the system, with competition to BT Group plc (apart from in cabled areas) focused on core and backbone networks. However, the technology shift to IP-based networks requires new investment, to supply what are likely to be products with lower margin than was available in the legacy products and services. There is little appetite for new investment to compete with BT Group plc at the local access level, and in some areas even in backhaul from the Local Exchange to the core network. This is a challenge.

Past regulatory attempts to secure fair access at wholesale level to BT Group plc's networks and facilities have also led to a large and growing range of detailed regulatory interventions, and at times regulatory micro-management of BT Group plc at different points in the value chain, which can set conflicting incentives both for BT Group plc and its competitors and encourage commoditised competition on the basis of regulatory arbitrage.

Faced with the technology shift to digital, it is becoming clear that the current market and regulatory structure is unsustainable. It is that challenge that our Phase 2 proposals seek to address.

This report seeks to address the five key questions that Ofcom posed for the Review. Firstly, in terms of the characteristics of a well functioning competitive market for both residential and business customers, keen prices, wide availability and reliability of basic voice and data services - guaranteed by a choice of suppliers - remain important. But innovation, range and choice in new services are increasingly prized; and the infrastructure that will support them consequently becomes more important. Purely arbitrage-based services are likely to have a limited life-span. The objective is sustainable competition. The increasing choice of new services and tariffs will also put a premium on effective customer information and the ability to switch easily between providers.

Effective and sustainable competition can be achieved in core and backbone networks, provided careful attention is paid to ensuring a successful migration of today's interconnection regime to the very different topography that IP-based networks imply. In local access and other wholesale access products, efficient and sustainable competition is likely to require some continuing regulation to secure genuine equality of access, right through from product design to customer handover. Such regulation needs to be focused on a more limited range of wholesale products than to date - where there are real bottlenecks that are likely to endure. However, where it is focused, it also needs to be more intensive than hitherto. Such an approach, of much more tightly focused but intensive intervention to guarantee genuine equality of access through key bottlenecks, also creates real scope for a significant withdrawal from sector-specific regulation.

Regulators cannot create investment, nor are they well placed to determine when and how much. That is for the industry and the market. However, the proposals in Ofcom's new regulatory framework will, we believe, encourage investment in scale and reach by BT Group plc's competitors to the deepest possible point of connection with BT Group plc's network. This should ensure that there is an increasing range of services and supply for sustainable competition from last-mile delivery right through to retail services. For BT Group plc's own network investment, Ofcom's framework contains a range of instruments and decisions - such as the review of the Network Charge Control, the valuation of BT Group plc's local loop assets, and the question whether there should be a single weighted cost of capital - to ensure that BT Group plc is able to reap an appropriate rate of return - one which recognises the risks involved in next generation networks.

On the final question posed - whether structural or operational separation of BT Group plc, or full functional equivalence, still remained relevant issues - the answer from the Phase 1 consultation was that, yes, they were still relevant; more so perhaps than we had anticipated. However, the large majority of industry respondents expressed caution about the prolonged uncertainty and disruption to the sector that would be involved in the process which would determinatively answer the structural separation question, namely an Enterprise Act market investigation and subsequent referral to the Competition Commission. If genuine equality of access could be made to work, the overwhelming majority of responses suggested that it would be a far preferable outcome. Equally, however, they shared Ofcom's view that the status quo was unsustainable.

We are at a critical point. There is a genuine opportunity for players in this market, BT Group plc in particular, both to make progress and to benefit the consumer. But market structure and technology development make it a time-limited opportunity. The response of the key players in the market in the coming months will determine whether the sector generally can take advantage of this opportunity, for the benefit of consumers and citizens, and the UK as a whole.

This then is an important consultation. It will run until 3 February. Ofcom will publish the final statement of its regulatory strategy next spring. If responses to the consultation, and market developments between now and then, support and bear out Ofcom's currently preferred course, then a series of specific regulatory - and deregulatory - actions will follow during 2005. If, on the other hand, we must conclude that a more fundamental examination of the market structure is required, then we will consider making an Enterprise Act reference. We do urge you to let us have your views.

David Currie, Chairman
Stephen A Carter, Chief Executive