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“Adapt or die – EU policies: Richard Feasey’s view on the way forward ”

by Richard Feasey, independent consultant and associate at Frontier Economics. He has worked for a variety of global telecoms operators for 25 years. The views here are personal and attributable only to the author.

A growing chorus of discontent has been heard from the leaders of Europe’s telecoms operators since at least 2007, with criticism of the European Commission now a popular sport. This would be entertaining if it were not so serious. A sector which once regarded itself as a global leader has found itself overtaken by the rest of the world, particularly in wireless and internet services. This is a sector which has a critical role to play in the broader digital economy upon which Europe’s economic future depends. Recognising this, the new European Commission president, Jean-Claude Juncker, has made the creation of a strong digital economy in Europe a priority and has appointed two heavyweight Commissioners to oversee the task.

Neelie Kroes, the recently departed digital agenda commissioner, wrestled with the same challenges during her term. Changes were made to allow operators more freedom when setting prices for access to new fibre networks in the hope that this would stimulate new network investments. A set of new ‘Connected Continent’ legislative proposals, ostensibly to reduce barriers to a European single market for telecoms services, were tabled and may yet be adopted in part. Debate also focused on the need for mobile operators to merge, as they did in Austria, Germany and Ireland. The European Council has also asked the Commission to study the impact of competition from the new internet giants such as Google, Amazon and Facebook, following claims that current regulation places the European telecoms operators at an unfair disadvantage.

Critics say that Kroes was slow to recognise the problems after 2007 and that the response from the Commission since then has often been confused and clumsy. Many of the ideas originally proposed in the Connected Continent package had few supporters outside the Commission and were quickly abandoned. Others, such as eliminating roaming charges, look like a replay of old ideological battles of little relevance to the challenges the sector faces today. In the meantime, little progress was made on key issues such as the dysfunctional management of radio spectrum in Europe, the inability of European operators to monetise internet traffic as their US counterparts have done, or what the rise of cable might mean for future broadband regulation in Europe.

Kroes responded to her critics in typically blunt terms in the last speeches she gave as commissioner. She lamented the co-existence of ‘two Europes’: a young, adaptive, ‘digital’ generation; and ‘analogue’ incumbents refusing to change and seeking instead to use regulation to protect outmoded businesses. A couple of weeks earlier she told the members of the European Telecommunications Network Operators’ Association (ETNO) to ‘adapt or die’.

Few doubt that there has been fault on both sides. Kroes’ rhetoric sometimes seemed unnecessarily confrontational as she made the transition from enforcer to policymaker.  The decision to adopt the political equivalent of a ‘poison pill’ strategy for the Connected Continent proposals, mixing populist measures designed to appeal to the European Parliament with technocratic measures which the industry had sought, was ill-advised. However, it might be argued that the real root of the problem was that the Commission remained stubbornly wedded to the ‘single market’ for telecoms as the answer to the sector’s problems.

The single market has been an article of faith in Brussels since the 1980s and features strongly in the new Commission’s rhetoric. What it actually means for the telecoms sector is obscure. For some it means removing or lowering barriers and encouraging more competition between firms across borders in order to lower prices, as single market measures in other industries have done. But telecoms networks, and the consumption of services over them, are rooted inside member states and cannot be exported across borders like other goods (save for international roaming services, which remain a focus in Brussels but represent less than 5% of the overall market for telecoms services in Europe).

For others – including, apparently, new digital economy commissioner Oettinger – it means rationalising Europe’s currently fragmented ownership structure so as to generate fewer firms with ‘scale’ to compete in markets outside of Europe. But it remains unclear what a global market for telecoms consists of, while changing the ownership structure otherwise leaves competition inside Europe largely unchanged. For others it is shorthand for the Commission’s long-standing efforts to further harmonise the application of telecoms regulation by member states. But again it is not clear if this will drive changes in the industrial landscape or if it will follow from them.

In short, the Commission may be right to criticise Europe’s telecoms operators for being reluctant to adapt in recent years, but the Commission is itself equally at fault in failing to recognise that simply talking about a ‘single market’ as if this is a strategy cannot represent an adequate response to these challenges either.

What might a better approach look like? In the remainder of this article I consider some of the most pressing demands the new Commission is likely to face and what it might do about them. These concern the need to increase investment in telecoms infrastructure, and what to do about the impact of the internet on Europe’s network operators.

PROMOTING MORE INVESTMENT IN NETWORKS

The new Commission has said greater investment in telecoms networks is a priority. In November 2014 it presented a $300bn ‘jobs, growth and investment package’ which included proposals for both public and private investment in telecoms.

Critics (which appear to include commissioner Oettinger) say that in the past, European telecoms regulators have been too keen to promote competition and lower consumer prices to the exclusion of other objectives. As a result, investment in networks, particularly in wireless networks, has fallen in Europe as operators have reacted to declines in revenues. This has occurred despite growing demand for data services and in contrast with the actions of operators in the rest of the world, many of which have significantly increased their network investments over the past five years.

For much of this time progress has been hindered by uncertainty about how or whether new fibre-based networks would be regulated. The Commission had earlier resisted requests to apply ‘regulatory holidays’ to new networks and at one point seemed to believe that reducing the charges for accessing copper networks even further would encourage more investment. It then abruptly changed its mind and went some way towards addressing the concerns of investors by recommending, in late 2013, that charges for access to fibre-based networks should not be regulated at all until at least 2020.

Investors could be forgiven for being confused by so many twists and turns. To make matters worse, national regulators still have to follow the Commission’s lead, and some have already signalled their reluctance to do so. The European operators’ industry association claimed in the summer of 2014 that only one national regulator had implemented the policy as intended.

The new Commission already faces various calls to deregulate still further. But adding yet more twists at this stage may bring diminishing benefits at the cost of yet more uncertainty and complexity. Some simplification of the existing rules can be envisaged but, in my view, the immediate priority of the new Commission should be to anchor its existing policies more firmly and ensure that they are followed through at the national level. Rebuilding investor confidence will depend on deeds, not more words.

In the case of mobile, critics have focused on the confused attempts by some member states to promote ‘excessive competition’ by reserving spectrum for new entrants or tilting the rules once they have entered. This debate has been most acute in France, where government and regulator took determined measures to promote the entry of a fourth mobile network operator in 2012, only to seek a return to three network operators (as yet, unsuccessfully) less than two years later. The Commission itself has been criticised less for promoting entry than for preventing subsequent attempts to exit (through mergers). It has generally approved mergers, but has also demanded remedies from the merging parties, which reflects a concern to avoid any upward pressure on the prices European consumers might pay. In the past this meant that spectrum and other assets were earmarked for a putative new entrant, but in recent cases the Commission has tended to favour commitments on access for MVNOs instead.

The Commission’s decisions on mobile mergers in Germany and Ireland during 2014 involve what many regard as less onerous conditions than those it extracted in Austria in late 2012. Whether the new competition commissioner will take a different view is unknown at this stage, but assuming that mergers that reduce the number of operators from three to two are likely to remain off limits in Brussels, there remain relatively few – albeit large and important – markets in which four to three mergers remain feasible. It is also worth noting that none of the mergers yet undertaken have advanced the Commission’s aim of establishing larger, pan-European operators. Instead of the transformational mergers that Europe saw in the early 2000s, recent mergers generally represent a reduction in pan-European scale as operators divest themselves of non-core assets. Today’s mergers seem to take us no closer to a ‘single market’.

In my view, the new Commission should look beyond the narrow confines of fibre regulation and merger policy. Both are important topics, but the additional benefits Europe can extract from further changes to either are limited. Moreover, they disguise more fundamental questions that European policymakers have yet to fully grasp.

The first of these is to ask where Europe should be targeting its investments when funds, both public and private, remain scarce. The Commission has taken a ‘fibre centric’ approach to this question in the past, focusing much of its attention (and what limited funds it has at its disposal) on increasing investment in fixed networks. It is notable that, over the same period, US policymakers have devoted far more attention to ensuring that the US leads the world in wireless communications. It seems likely that this is at least part of the reason why investment by US operators in wireless networks has far exceeded that in Europe over the past decade. The Commission must ensure that its policies ensure that capital is deployed as efficiently as possible in Europe, maximising returns for the European economy as a whole. This is likely to lead to a greater focus on wireless in the near term.

The new Commission might also ask what it takes to drive more investment. Mergers are only part of the story. The underlying driver for private investors is the expectation that it will allow a firm to establish a competitive advantage over its rivals (and enjoy the benefits of doing so). Mergers may be one way a mobile operator can build such competitive advantage, but economic regulation in general, and spectrum policy in particular, are more universal, more enduring and thus more significant factors in determining how telecoms markets perform.

Regulation which tries to neutralise competitive advantages, as much of Europe’s telecoms regulation has sought to do for the past 20 years, is deliberately designed to limit the capacity for one firm to gain a lead over its rivals. This has two effects: it weakens the incentive to invest in networks to gain a lead and to differentiate services based on network-related factors like quality or speed and, as a result, it tends to result in competition that is based only or primarily on price. Europe has experienced this state of affairs for many years. The new Commission should help the industry escape it. This will mean adapting regulation to encourage competition based on investment not price, encouraging more innovation and risk taking, and creating an expectation that firms can earn and retain higher returns if they succeed.

This does not mean the Commission should plan the economy or direct operators where to invest. But it does suggest there ought to be broad alignment between policymakers and industry as to where capital will yield the best returns for both. Consider, for example, how much capital was ‘wasted’ in Europe seeking to deploy 3G services in the 2.1 GHz  band because the reuse of lower, more efficient, frequencies for 3G was prohibited by regulation.

In short, the new Commission should seek to encourage the sector to be more entrepreneurial – something which commissioner Kroes identified but did little to bring about. Measures to achieve this (in wireless markets) could include removing limits on the amount of spectrum firms can accumulate, taking a more critical view of anything that involves sharing networks and network investments (including roaming and access obligations as well as voluntary arrangements), and ensuring that merger policy allows those undertaking risky mergers to retain the competitive advantages which they hope to gain from them.12 The industry probably needs to become less collaborative as a result.

LEVELLING THE PLAYING FIELD FOR OPERATORS

Let us turn now to the other set of demands which the new Commission will confront. Again, this is already hotly debated and concerns the activities of internet players and their consequences for Europe’s telecoms operators.

When entering this debate it is useful to ask what role European telecoms companies aspire to play. For example, Europe worries about its inability to create new global internet services companies to rival Google, Facebook or Amazon. President Juncker has identified this as an ambition for the future. The main challenges here relate to Europe’s capacity to promote innovation and digital entrepreneurship and for its firms to scale services rapidly and globally. Many of the obstacles to doing this – such as the availability of venture capital or linguistic barriers in Europe – have little or nothing to do with telecoms regulation. Nor do concerns about tax arrangements or relationships with the US National Security Agency or with European law enforcement, all of which have also received attention from European policymakers in recent months.

But some European operators also claim their inability to compete effectively with the internet giants can be attributed to the fragmented nature of European regulation in areas such as copyright or privacy, or to the greater regulatory burdens associated with running a network. This prompted last year’s request from the European Council for the Commission to investigate these claims and assess the case for ‘levelling the playing field’.

I remain sceptical about the likely outcome of these efforts. Although European network operators have been unable to produce internet services to rival those offered by Google and others, their counterparts in the US and China have fared no better. This suggests that the challenge is not some defect in European regulation but something more profound. Network operators may lack the innovation culture, agility, capital or willingness to cannibalise their own services required to mount an effective challenge to the internet. Many other mature industries have faced similar challenges from disruptive technology in the past and failed. Many companies in other sectors outside telecoms face similar challenges with the internet today.

This is not to suggest that nothing can be done or that the current approach to regulating the internet in Europe is satisfactory. European consumers may be at risk today because the safeguards they enjoy (eg. privacy) when using traditional telecoms services are not extended to internet equivalents. This is and should be a legitimate concern for European policymakers, but it will not affect the competitive position of telecoms operators.

Even if they cannot compete, Europe’s operators remain important suppliers of network access and potentially of other services on which global internet companies depend. This means the debate is often not about how to compete with Google and the others, but about how to improve the conditions under which European firms seek to supply them. Here European policymakers are right to worry about the market power enjoyed by global internet companies that invariably seem to dominate their markets. This is because they may directly exploit European consumers and also because they enjoy an unfair bargaining position with suppliers and customers, including Europe’s telecoms operators. It has often been claimed, for example, that Apple’s position in the smartphone market has allowed it to unfairly dictate the terms on which its products are distributed by Europe’s operators. On this view, Apple’s commercial success is not built on any regulatory advantages over the operators but on its bargaining position with them.

Assuming it regards these concerns as legitimate, the Commission has two options, neither of which is straightforward. The first is to seek to reduce or otherwise contain the internet companies by trying to inject greater competition to dilute their market power or by using regulation to limit their ability to exploit their market position. This is what the Commission is seeking to do in its investigation of Google’s search business and what some telecoms executives urged it do when considering the recent Facebook/WhatsApp merger.  Some governments also suggest that Europe should regulate the terms under which dominant platforms deal with other parties under the guise of ‘platform neutrality’.

Alternatively, or in addition, the Commission could aim to strengthen the bargaining position of European operators when dealing with the internet firms. Mobile mergers might help to reduce the ability of the internet companies to play competing operators off against each other. Alternatively, European regulators could intervene directly in the negotiations by requiring operators to apply a common charge for access to their networks. Although these may appear extreme measures (and there is no indication the new Commission is considering them), a very similar approach was adopted by the US authorities in the 1990s when they were pursuing reductions in international accounting rates with monopoly telephone providers in other jurisdictions.

The European trade association, ETNO, promoted this approach at the ITU in Dubai 2013, but with limited success. It is perhaps not surprising that Europe’s politicians generally prefer to focus on tax and privacy matters – important, but in my view also largely peripheral to the key industrial challenges we face – when discussing the impact of global internet companies on Europe.

Commissioner Kroes was clearly right to suggest that operators must adapt to the internet era, and few in the industry would deny this. She was also right, in my view, to argue that attempts to use regulation to protect outdated business models will only delay the inevitable and impose costs on consumers in the meantime. The Commission ought to ensure that nothing hinders the capacity of telecoms operators to adapt to their environment as quickly as possible. They should aim to make adaptation as frictionless as possible.

An important test of this principle will come early for the new Commission when it considers the vexed topic of net neutrality. Although advocates present it in other terms, this is likely to include proposals which would limit the ability of operators to manage their networks, business models and revenues. A Commission that fully understood the need for the industry to adapt should be expected to strongly resist any such proposals (subject of course to prohibitions on anti-competitive behaviour). The political pressures are formidable and Commissioner Kroes’ views on this topic often appeared rather fluid.

What the new Commission will do is as yet unclear.

There are many other ways in which the Commission could reduce friction and help the operators adapt. An obvious example is for Europe to begin to take the task of retiring copper networks seriously, as the US is doing. If Europe is to invest its limited capital efficiently then it needs to spend less on maintaining yesterday’s technologies and more on building tomorrow’s networks. This will involve further disruption for Europe’s telecoms operators, unwelcome consequences for employment in the industry, and a fundamental rethink of universal service policies which have remained largely unchallenged since the 1980s.

All of this is difficult and unpleasant but, as commissioner Kroes noted, the alternative is much worse for Europe’s telecoms industry.

Source: InterMEDIA

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