Introduction
The title chosen by the conference organisers for this address is "advancing competitive practices in an evolving industry."
The scheme of the Telecommunications Act is to create a competitive environment by removing barriers to entry or expansion in telecommunications markets, and then letting the competitive process unfold through rivalry between market participants delivering greater choice, lower prices and better quality services to NZ consumers. As competition increases, the regulatory regime reduces; the greater the intensity of competition, the lesser the regulatory burden. It is through this process the Telecommunications Act enables the Commission to ensure the advancement of competitive practices in an ever changing technological environment.
I want in this address to explain the application by the Commission of these Telecommunications Act principles in mobile and fixed line telecommunications markets.
Mobile Markets
In October 2006 the Commission concluded, in its Review of Cellular Mobile Market Entry Issues, that the lack of new entry in the mobile market suggested that there may be barriers preventing or constraining entry. It noted that new entrants needed to offer nationwide coverage to compete effectively with incumbents who already provided national coverage, and while the regulated roaming and co-location services had a role to play in overcoming this barrier, they may not be fully suitable for this purpose. The Commission therefore decided there were reasonable grounds to investigate whether the terms of the national roaming service should be amended, and whether the national roaming and co-location services should be changed from specified services to designated services, which would allow the Commission to set price terms.
Co-location
In December 2007 the Commission recommended that the co-location service should remain a specified service. It noted that while co-location on existing cellular mobile transmission sites was limited (with co-location only occurring on less than 0.5% of available towers), and New Zealand's relatively high prices in retail mobile services were indicative of lower competitive pressures that in other OECD countries with lower price levels, the issues preventing effective co-location were not related to price.
It concluded that effective co-location had not occurred because incumbent operators retained control over optimal sites for co-location and had no, or limited, incentives to support co-location on reasonable terms for competing cellular networks, that non-price issues (including the lack of targets, key performance indicators, and robust implementation plans), had created significant barriers to entry, and that the 2006 amendment to the Act provided the Commission with the necessary tools in the form of the Standard Terms Determination process, to address non-price issues.
The Commission subsequently initiated a Standard Terms Determination process, and set the non-price terms for co-location in a Standard Terms Determination in December 2008.
Roaming
In March 2008 the Commission concluded that there was at that time, limited competition in the wholesale market for national roaming on both CDMA and GSM networks because of the incompatibility of the two networks; a new entrant choosing one or other technology then had no choice as to the network on which it would need to roam.
The Commission recommended a number of modifications to the terms of the national roaming service, including reducing the roll-out requirement for national coverage to 65% of the New Zealand population, and clarifying the initial coverage area requirement to comprise 100 cell-sites or coverage of not less than 10% of the population. It did not recommend the service become a designated service, noting that Vodafone and New Zealand Communications (as it then was), had entered into a commercial agreement allowing NZC to roam on Vodafone's GSM network. The terms of this commercial arrangement were such that the incremental impact of the designation of the service on entry was relatively minor, and those terms would not foreclose efficient new entry. I The Commission also noted that no other new entrant had indicated an intention to build a mobile network in New Zealand.
In June 2009, when the Commission released its draft report on mobile termination services (to which I will refer shortly), the Commission noted that the price in the commercial roaming agreement may be significantly above cost, and there were reasonable grounds to commence an investigation into whether the roaming service should be extended to include price. That investigation was deferred until the final MTAS report, because benchmark termination rates, which the Commission used as a proxy for roaming rates, were a key issue of debate.
Ultimately Vodafone and 2degrees reached a "mutually acceptable outcome" on roaming rates. 2degrees advised the Commission that "The clear and credible threat of possible regulatory intervention has facilitated the constructive attempts to reach agreement on the matter". Accordingly, in December 2010, the Commission determined that there were adequate commercial arrangements in place, and as a consequence it would not investigate whether the national mobile roaming service should become a designated service.
Mobile Termination Rates
The third area of Commission activity relates to mobile termination rates (the wholesale rate that is paid by a mobile network when it terminates a call on another mobile network). In May 2008 the Commission informed interested parties that it was considering commencing a Schedule 3 investigation into whether or not mobile-to-mobile (MTM) termination rates for voice and SMS should be subject to regulation. The Commission had previously recommended fixed-to-mobile (FTM) rates be regulated; in April 2007 the Minister had rejected that recommendation and instead accepted deeds entered into by Telecom and Vodafone.
Having considered submissions, the Commission announced in November 2008 that there were reasonable grounds to commence an investigation into whether Mobile Termination Access Services (MTAS) (including FTM) should be regulated.
After a lengthy and somewhat controversial process, the Commission recommended on 15 June 2010 that mobile termination access services be regulated. The Commission had concluded that a combination of wholesale mobile termination rates that were significantly above cost, coupled with significant on-net discounting, created a barrier that restricted the ability of a small entrant to compete in both MTM voice and SMS services. It noted at that time the percentage of on-net traffic was more that 80% of all end-to-end voice traffic and a higher proportion for SMS. It concluded that regulating MTAS was likely to promote competition in both retail mobile services market and retail FTM/tolls markets, and would produce significant long-term benefits for end users in New Zealand.
The Minister accepted the Commission's recommendation, and the Telecommunications (Mobile Termination Access Services) Order 2010 came into effect on 24 September 2010. The Standard Terms Determination process began with a scoping workshop on 6 October 2010. The Commission released a draft determination in December, a 2-day conference was held in March, and the Commission's final determination is scheduled to be released at the end of this month.
Conclusion on Mobile Markets
The Commission has focussed on the removal of barriers to entry and expansion in mobile markets. It has made co-location more assessable (although the time it took to reach this point meant there has, to date at least, meant there has been little uptake of this service). The threat of regulatory intervention has resulted in a "mutually acceptable" commercial roaming arrangement, and the Commission is close to finalising the cost based regulation of mobile termination rates to remove a significant barrier to expansion
2degrees entered the market in August 2009; in the words of one commentator it "is changing the mobile landscape in New Zealand." [1] The Commission's expectation is that once the MTAS STD is in place, the barrier to expansion will be removed, leading to effective competition for the long term benefit of consumers.
Fixed Line Markets
In the fixed line market, the adoption of the ladder of Investment philosophy coupled with the operational separation of Telecom, have provided the foundation for the removal of what had been almost insurmountable barriers to the development of effective competition in fixed line telecommunications markets prior to 2006.
The twin pillars of open access, non-discrimination and equivalence of inputs, contained in the Telecom Separation Undertakings were designed to neutralise the barriers to effective competition implicit in the vertical integrated incumbent structure of the Post Office telecommunications business when it was privatised in 1990.
The ladder of investment principle, on the other hand, was designed to incentivise competitors of the incumbent to invest in infrastructure deep within the incumbent network, generating effective and vigorous competition in downstream markets.
The Ladder of Investment
The ladder of investment was explained in the Cabinet paper which introduced the 2006 amendments as follows:
The ladder of investment drives "wholesale competitors towards investment in their own infrastructure. Commencing at lower rungs of the ladder with basic resale and intermediate wholesale services while building a customer base, this concept envisages movement via LLU to eventual investment in alternative network infrastructure investment.
The long term aim of these policies is competition on level terms among operators, and it is important to price wholesale access products so as to maintain incentives for progressive alternative infrastructure development"[2]
The rationale for the principle has been described as follows:
"The 'ladder of investment' or 'stepping stones' hypothesis concerns the development and regulation of infrastructure competition. Competitive providers challenge an incumbent by offering services that, as their market share rises, rely less and less on the incumbent's assets and more and more on their own, as they 'buy' less and 'make' more."
"By these means, competitive providers progressively build out their networks closer and closer to their customers."
"The underlying goal is to increase up to a feasible limit the level of infrastructure competition, and thus reap the benefits of product differentiation and keener rivalry it brings."
The principle is incorporated into the Act by the pricing principles attaching to each "rung" of the ladder. At the bottom rung, the price of resold local access and calling services to access seekers was set at "Telecom's standard price to end users, minus 2%." Any pre-existing monopoly rents are "locked in" by the retail minus formula, and access seekers are allowed only a 2% margin to compete with the incumbent - clearly, on its own, unsustainable.
At the next (wholesale) level, the regulated price is set at "retail price as imputed by the Commission ...minus a discount comprising avoided costs saved'. Currently the retail costs avoided, based on Commission benchmarks, is 18%. Clearly this is a more attractive option; while any pre-existing monopoly rents are still "locked in", access seekers have the prospect of making a small margin, or at least breaking even, although there is no real prospect of a vibrant competitive market developing in a retail-minus pricing regime.
The importance of local loop unbundling
That is why local loop unbundling (LLU), (referred to in the Act as the unbundled cooper local loop network, or UCLL), the next rung up the ladder, is so important.
A cost based price applies to LLU. The Act specifies a Total Service Long Run Incremental Cost (TSLRIC) Final Pricing Principle, (with an Initial Pricing Principle based on benchmarking against prices for similar services in comparable countries that use a forward looking cost-based pricing method).
The Commission set de-averaged prices for UCLL, of $19.84 in urban areas (serving more than 50% of lines in a given ESA), and $36.63 for non-urban areas. The Commission made the decision to de-average the UCLL price following a long process that included substantial economic analysis and extensive consultation with the industry.
The reasons for the decision to de-average urban and non-urban UCLL prices are set out in the UCLL STD (Decision 609)[3]; that de-averaged prices better reflect the underlying cost of the service. I should note that the ACCC has also set different urban and non-urban prices for UCLL, for the same reasons.[4]
The number of unbundled lines continues to grow as access seekers continue their investment in unbundling exchanges. Over 100 exchanges have been unbundled and close to 8% of copper lines delivering broadband services are now unbundled. This has resulted in greater choice, better quality and lower prices for New Zealand consumers, and New Zealand's position in the OECD broadband penetration rankings has improved from 22nd to 17th.
Figure 1 depicts the growth in unbundled exchanges:
Figure 1: Growth in unbundled exchanges
Figure 2 shows the growth in UCLL lines since its introduction:
Figure 2: Growth in UCLL Connections
Telecom has responded to the presence of infrastructure based competitors by reducing retail prices in certain areas of the country. In particular, Telecom's 'Total Home' packages, which bundle together landline, broadband and toll calling services, are offered at a reduced price in Auckland, Wellington and Christchurch. The standard Total Home plan includes monthly landline rental, an unlimited number of national landline calls (up to 2 hours each), and 10GB of broadband for $99 per month (in Auckland, Wellington and Christchurch)[5] and $109 per month in the rest of New Zealand.
The fact that Telecom has reduced retail prices in Auckland, Wellington and Christchurch reflects the presence of competing UCLL and cable networks in these areas. In respect of Auckland, where Telecom appears to have responded to UCLL-based competition, the majority of exchanges where the Total Home discount applies (61%) have two or more UCLL-based Competing Providers.
Although there is UCLL-based competition now developing outside of Auckland, Wellington and Christchurch, this has not yet been sufficient to prompt a pricing response from Telecom in either wholesale or retail broadband markets.
The reason for the attractiveness of LLU is clear - it is the only access product that is cost based. Access Seekers are not facing a price which is simply a discount of existing retail prices. As I have noted above, the UCLL price is $19.84 a month. The Wholesale UBA price, in round figures, is currently $18 and the price for local access and calling (Plain Old Telephone Service, or POTS) is $36 a month. A wholesale customer purchasing POTS and UBA from Telecom currently pays $54. If an access seeker can provide voice and broadband services using its own exchange based equipment at significantly lower cost that the $34 differential between UCLL and UBA/POTS pricing, it is able to offer more, charge less, and still make a respectable margin. As noted above, we have seen lower retail prices in unbundled areas as a result, and our most recent broadband quality report concluded that web browsing speeds for ISPs who had unbundled Telecom exchanges were about 20% faster than access provided using Telecom's wholesale services.
Impact of cabinetisation on local loop unbundling
Unbundling does face challenges however, and the most serious is the impact of Telecom's cabinetisation program. Telecom, as part of its Separation Undertakings, agreed to install 3660 cabinets by December of this year - it has to date installed 2600 cabinets. The impact on UCLL is that more than 50% of lines served from unbundled exchanges will have been cabinetised by the end of this year.
In 2009 the Commission issued a series of sub-loop STDs, setting the price and non-price terms for access to the sub-loop (between the home and the cabinet), co-location (in the cabinet), and backhaul (from the cabinet to Telecom's point of interconnection). These services are not economic, (and consequently there has been no access seeker take-up) because there are insufficient customers served from a cabinet to justify the investment by access seekers. On average 300 customers are served from a cabinet; by contrast, the Commission's draft UBA Review decision showed that exchanges with only one UCLL-based provider had an average of 6,228 active lines, increasing to 10,242 for exchanges with 3 UCLL-based providers.
In some cases access seekers can continue to provide voice and broadband services from the exchange after cabinetisation, but in other cases the service degradation forces them to relinquish the unbundled line, and descend the ladder of investment to take the wholesale UBA and POTs service from Telecom. The drop off in the growth of UCLL customers over the second half of 2010,in a situation where there was a considerable increase in the number of unbundled exchanges, was primarily a consequence of cabinetisation; in more recent times uncertainty over UFB has been a major factor. It remains to be seen whether unbundling regains the momentum it showed at the outset.
Figure 3 shows the comparative performance of unbundling in New Zealand compared with Switzerland and the United Kingdom:
Figure 3 Comparative performance of unbundling
Resale Decision
The ladder of investment philosophy also postulates the removal of the lower rungs of the ladder over time as competition develops:
"…it is not a policy of continuous 'easy access', but one of 'tough love' in which [Service Providers] are chivvied up the ladder by price incentives or the expectation of withdrawal of the more comprehensive access products corresponding to the lower rungs of the ladder."[6]
The Commission applied this principle in its recent Resale Services report recommending that resold broadband and data services be removed from regulation. It said that:
'the Commission considers that the deregulation of resale services is consistent with the ladder of investment theory. The availability of alternative wholesale access services which are further up the value chain enables greater service variety and innovation, and therefore is likely to lead to benefits to end-users"[7]
VDSL Decision
The approach of the Commission to extending the reach of regulation is best demonstrated by its VDSL decision.
Telecom proposed to launch a VDSL service, and wanted to know whether the service would be subject to the existing UBA regulation. We said that regulation governs services, not technology - if Telecom delivered the service described in the UBA determination using VDSL it would be subject to the STD including price; if however it delivered a service with superior specifications to those set out in the STD, then that service (whether delivered using ADSL2+ or VDSL) would not be caught. In other words, the regulated service set the basis requirements; it did not constrain the commercial release of services with higher specifications.
Some access seekers argued that the new service should be regulated. While the Commission agreed Telecom should be required to give prior notice of a new UBA variant to allow time for the Commission to assess whether the variant fell within the UBA service description (and was therefore subject to the STD), or if it did not, whether the Commission should instigate a section 30R review (to extend the UBA service description to catch the new variant), it did not agree that in this case there were grounds for such a review.
It was satisfied the VDSL service was superior to the regulated UBA service, that it was important that incentives to invest in new technologies were preserved, and given the debate about the willingness of consumers to pay for upgraded broadband services, it was appropriate that the price be set by the market.
Competition Test
A feature of the Telecommunications Act is that a number of regulated services are subject to a competition condition - that Telecom faces limited competition in the relevant market. In other words, if Telecom faces effective competition, regulation will not apply. This condition has applied to UCLL Backhaul since the amendments came into force, and to UBA Backhaul and UBA on the third anniversary of the Act coming into force which was December last year.
In relation to UCLL backhaul, the Commission has said that Telecom faces effective competition, where there are one or more backhaul providers connected to, or within 1-2 kilometres of the relevant exchange, unless there are additional factors which restrict competition in relation to a specific link. In its most recent review (its third), the Commission has concluded that Telecom faces effective competition in respect to 127 primary links (from the exchange to Telecom's POI) and 31 secondary links (from Telecom POI to Access Seeker POI).
In relation to UBA Backhaul, the Commission concluded Telecom faced limited completion over all UBA links. No competitive UBA backhaul services had developed, and (unlike UCLL) there was no appropriate commercial service that would allow alternative backhaul providers to aggregate backhaul traffic inside the exchange.
In relation to UBA, the Commission's draft decision concluded that Telecom faced effective competition where there were two alternative suppliers of broadband services (via cable or unbundled copper) in an exchange, or one UCLL service provider and the exchange was forecast to have 6500 uncabinetised lines, but did not face effective competition in the provision of cabinet based UBA services. The draft concluded Telecom faced effective competition in 51 exchanges, and regulation would not apply to lines feed from those exchanges, but would continue to apply to cabinet feed lines associated with those 51 exchanges. A final decision is expected this month.
Conclusion
In the fixed line market, as in the mobile market, the Commission's approach has been to use the available tools to create an environment where competition can take place, and to remove regulation as effective competition develops.
[1] www.buddle.com.au, 4 April 2011
[2] Cabinet Policy paper which introduced the 2006 Amendment to the Telecommunications Act 2001, para 99 and 115
[3] The cost of the UCLL service is likely to vary from one region to another, as factors such as population density vary. Where costs do vary significantly from one region to another, de-averaged prices will better reflect the underlying cost of the service, and will therefore result in more efficient outcomes.
For example, an averaged UCLL price will exceed cost in urban areas, and will therefore result in an inefficiently low level of UCLL-based entry and service provision in those areas. As a result, the level of demand by Access Seekers for the UCLL service would be lower than the level of demand that would be expected in a competitive market where prices reflect the underlying cost of provision.
The Commission notes that this reduction in demand would be in those areas where UCLL-based competition is most likely, given the characteristics of xDSL technology and the importance of density for UCLL investment.
In other areas, the averaging of the UCLL price would result in an artificially low UCLL price. However, this is unlikely to have a significant effect on the uptake of the UCLL service in these areas, due to the technical limitations of xDSL technology and the scale limitations associate with rural exchanges.
Cost-based de-averaged prices will therefore ensure that the appropriate signals for use of the UCLL service and investment in associated infrastructure such as equipment in the exchanges are provided, compared to an averaged price. The Commission considers that de-averaged UCLL pricing is likely to best give effect to section 18 of the Act." http://www.comcom.govt.nz/assets/Telecommunications/STD/UCLL/Final/Final-UCLL-Standard-Terms-Determination-Decision-609.pdf
[4] "Setting a separate Band 4 price ensures that the much higher costs of providing services in rural areas is reflected in prices. It also recognises that in Band 4, the small scale of markets, and the greater risks associated with attracting sufficient customers to recoup DSLAM investment costs, are likely to be more important to investment decisions than the ULLS/WLR price differential. This is consistent with the ACCC's argument in the September 2010 Draft Report that national averaging of ULLS prices would not promote competition in remote areas 'given that the ULLS is not technically viable for delivering high speed data services in large parts of rural areas." ACCC, "Interim access determinations for the declared fixed line services Statement of Reasons", March 2011
[5] Includes Auckland City, Wellington City and some suburbs in Christchurch.
[6] Martin Cave, Snakes and Ladders: Unbundling in a next generation world, Telecommunications Policy, 2009, p 2 and 3
[7] Final Report on whether the Resale Services should be omitted from Schedule 1 of the Telecommunications Act 2001, 16 December 2010, para 63
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