Update of Ofcoms strategic review of telecommunications

17 February 2005

Oliver Holland

To read Oliver's previous article on Ofcom’s strategic review of telecommunications, please click here.

Introduction

Ofcom is now concluding the Phase 2 consultation of its Strategic Review of Telecommunications. Following this, Ofcom will analyse the responses and publish a final report containing proposals for moving forward.

Ofcom began the first comprehensive strategic review of the UK telecommunications sector for 13 years in 2004. This review, along with reviews of public service broadcasting and spectrum trading, forms part of the “three major direction-setting reviews in 2004/5” that were outlined in Ofcom’s annual plan.

The strategic review is intended to explore the following issues:

  • the importance of the telecommunications sector to the UK economy

  • the extent to which competition and regulation has delivered the goals of quality, choice and value for money

  • UK consumers’ perspectives

  • investment and innovation trends in the industry;

  • the scope of effective competition

The review is broken down into three phases:

Phase 1 – Current position and prospects for the telecommunications sector During this phase Ofcom analysed the importance of the telecommunications sector to the UK economy. In particular, the review assesses the level of competition that currently exists in the fixed, mobile, narrowband and broadband sectors.

Phase 2 – Ofcom’s strategic approach to telecommunications regulation – Ofcom then assess the scope for effective competition at specific levels within telecommunications markets and evaluate its sustainability. Based on this, Ofcom intends to identify the correct regulatory approach to take, including the withdrawal of regulation where appropriate. This phase will involve an evidence-based analysis of the underlying economics of competition, including both national and international research.

Phase 3 - Proposals Finally, Ofcom intend to produce a detailed final report setting out a review of the key policy issues and challenges that it faces and the strategic proposals for dealing with these points. In addition, it will include an implementation plan for moving forward with the outlined proposals.

Options for reform

From the analysis of the Phase 1 consultation document, Ofcom was encouraged that the telecoms industry is delivering “relatively good products, choice and value”:

  • call prices are among the lowest prices in the world

  • over five million broadband connections

  • competition in fixed line telecoms is continuing to grow (4.2 million lines using CPS)

However, problems still remain in ensuring effective competition in the fixed line market. Ofcom explain “a continuation of the status quo is neither acceptable nor desirable” and proposes three options for change and invites responses to these options.

Option 1: Deregulation

Ofcom state that one option that has been considered is that of the withdrawal of some or all sector specific regulation and allow market forces and competition law to govern the actions of those within the industry.

Option 2: Market Investigation Reference under the Enterprise Act

Some respondents to the Phase 1 consultation claim that the regulatory problems of the telecommunications sector are so fundamental that they cannot be addressed using Ofcom’s existing powers. They state these problems stem from the underlying telecoms market structure. Section 131 of the Enterprise Act 2002 includes powers for regulators to make “market investigation” referrals to the Competition Commission when a feature or combination of features of a market distorts competition.

It has been stated by some within the industry that the vertical integration of BT is such a feature and the Competition Commission could, following a reference under the Enterprise Act, ultimately impose a form of structural separation of BT. Ofcom is of the view that the costs and difficulties of such a separation outweigh any potential benefits and moreover, such action does not guarantee that subsequent regulation would then be unnecessary. The large majority of respondents to Ofcom’s Phase 1 consultation did not think that this was a suitable option.

Option 3: Real Equality of Access

Ofcom believe that this option is the most viable. Ofcom believe that ensuring equality of access or ‘equivalence’ will achieve effective competition without the disruption and costs associated with a move towards the structural separation of BT.

Ofcom defines what it understands by the term ‘equivalence’ as constituting equality of access at the product level to:

  • the same or a similar set of regulated wholesale products as BT’s own retail activities

  • at the same prices as BT’s own retail activities

  • using the same or similar transactional processes as BT’s own retail activities

Ofcom is proposing equivalence of input (a requirement that BT’s wholesale customers would be able to use exactly the same set of regulated wholesale products, at the same prices and using the same systems and transactional processes, as BT’s own retail activities. Where it is not appropriate to enforce equivalence of input, equivalence of outcome would be required. Equivalence of outcome implies that the wholesale products that BT offers to its wholesale customers should be comparable to those that it offers to its retail activities, but that the product and processes need not be exactly the same so long as any differences are not material. This type of equivalence can be applied in varying degrees according to circumstances, for example a more rigorous version would involve wholesale products to be re-engineered to guarantee equivalence of outcome.

Ofcom explain that they propose to introduce more effective regulation, focused on ‘ending economic bottlenecks’. Following the achievement of equality for access, Ofcom believes that it would then be able to withdraw many of the layers of regulation that currently exist. This would be due to the fact that the regulation of many retail markets should become unnecessary if effective wholesale regulation is achieved. Ofcom explain that the regulated wholesale network access products which ultimately will be required will be significantly fewer in number because they will be focused on enduring economic bottlenecks, the principal products being:

  • local loop unbundling

  • DataStream

  • wholesale leased lines (traditional interface), such as partial private circuits;

  • wholesale leased lines (alternative interface) , such as wholesale LAN extension service

  • wholesale line rental

  • carrier pre-selection

  • interconnection (including interconnection circuits) and call termination

  • migration products.

Behavioural change

Ofcom explain that, in conjunction with the achievement of equivalence in line with Option 2 outlined above, certain behavioural changes in the way BT conducts its internal businesses are necessary to remove any incentives that are contrary to the principles of equality of access. Ofcom emphasise that BT currently applies significant resources to ensuring regulatory compliance. However, they believe that changes to the manner in which BT conducts its internal affairs is necessary to achieve equality in the marketplace.

Ofcom does not propose to offer any specific solution and has invited BT to develop a set of proposals that ensures that there are no incentives in its internal structure to restrict equality of access. Ofcom suggests that removing inappropriate incentives could be achieved through remedies such as:

  • changes to the location of certain functions within BT’s organisation

  • separate management groups for BT’s different businesses

  • reducing the role of group activities

  • different staff locations

  • discrete internal IT systems

Ofcom explain that they do not believe in a policy of preventing BT from collaborating which may benefit of consumers, but is keen to ensure that all BT’s wholesale customers should have the same ability to collaborate with BT as its internal organisations.

The Regulatory contract

The focus of Ofcom’s regulation will be on achieving equality of access to enduring economic bottlenecks which would allow deregulation elsewhere. Such regulation will include setting the permitted rate of return on investment for BT; this will form Ofcom’s ‘regulatory settlement’ with the telecommunications sector.

Ofcom explain that setting the regulated returns that BT is permitted to earn from wholesale access will involve a complex calculation of acceptable rates of return, likely rates of investment, and the careful identification of the parts of the business to which these calculations apply. It will involve a number of considerations including the relative importance of appropriate incentives for BT to invest in telecommunications markets.

Consumer information

Ofcom explains that the combination of effective competition in telecommunications markets combined with a consumer-wide understanding of the different services and products available is the most effective form of consumer protection.

Ofcom explains that for competition to be effective, it is essential that consumers have access to clear and reliable information which enables them to make informed choices between different suppliers. Ofcom expressed concern that their consumer research indicates that this is not always the case and proposes a number of options for improving consumer awareness:

  • leave provision of information to the market itself

  • Ofcom to provide comparable pricing information

  • Ofcom to promote the provision of basic information

  • Ofcom to encourage a responsible approach to service comparisons in advertising

  • Ofcom to restrict the range of tariff packages and structures in the market

  • Ofcom to introduce changes in the format of bills to facilitate comparisons

In addition, Ofcom also invited responses on a number of options it proposes for simplifying the process of switching suppliers including:

  • regulating retail switching costs

  • positively encouraging switching

  • encouraging migration between tariff plans

  • encouraging providers to reduce the complexity of switching processes

Ofcom emphasise that universal service regulation provides an important role in that it provides the safety net for vulnerable consumers. Ofcom acknowledge that the current mechanism where BT and Kingston both fund and provide universal services may at some point constitute an unfair burden on these operators. In the future, Ofcom envisages that it may be necessary to design new funding and provision mechanisms such as the establishment of a universal service fund.

Conclusion

While the Phase 2 document is a consultation document, and Ofcom’s proposals are, therefore, subject to their acceptance of any responses by the industry, its intention is currently the working towards the delivery of ‘real equality of access’. Therefore, it is central to Ofcom’s plans that BT be required to ensure equality of access to its wholesale services between its downstream businesses and independent operators. This raises, however, a number of complex economic issues that are not easy to resolve.

In conjunction with this, Ofcom will expect to see an alteration made to BT’s internal structure and has invited BT to submit a suitable proposal.

Ofcom Chief Executive Stephen Carter summarises the position in Ofcom’s news release following the publication of the Phase 2 proposals:

“twenty years after liberalisation, the market has made good progress. However, its foundations are unstable in parts, overly dependent on intrusive regulation and with limited sustainable competition…As the move to the next generation of telecoms brings more choice and lower prices, we need a regulatory approach that is focused and which encourages investment and innovation in the services of the future.”