by Jonathan Oxley, Group Director, Competition Ofcom
Superfast broadband is now an essential part of many people’s lives in this country. From micro-businesses selling their wares on the web to Mums and Dads working away from home, fast reliable internet connections are increasingly a ‘must-have’.
Fortunately, the UK has some of the best superfast broadband metrics of any major European market. Coverage is more than 75% and set to rise to 95% over the next couple of years, while take-up is rising fast, with BT, Virgin, TalkTalk, Sky and others offering a range of competitive retail fibre packages.
However, there is no place for complacency. If superfast broadband is the present, ultrafast broadband is the future. A number of countries are already rolling out ultrafast broadband infrastructure, including South Korea and Japan. Here at home, BT and Virgin Media have announced intentions to build out ultrafast broadband in the next few years while companies like Sky, TalkTalk and others are also investing in new infrastructure. Naturally, this prompts questions about the role of regulation in fostering these developments.
Some of the principles that underpinned the development of standard and superfast broadband may offer lessons for the regulation of ultrafast. In particular, the need to support competition at its deepest sustainable level and to focus on non-discrimination, both founded on the recognition that a successful regulatory approach should promote investment and innovation as well as competition.
By sticking to these principles, Ofcom has demonstrated that competition and investment can co-exist.
So what lessons can we garner from the history of superfast in the UK?
Ten years ago, Ofcom set out its strategic approach to regulation in the telecoms sector. This heralded a sea-change in the competitive landscape for telecoms.
Why did Ofcom embark on this review? In short, to address a lack of competition in the UK telecoms market that had persisted despite previous attempts to open it up. Local Loop Unbundling had been in place since 2000, yet few operators had entered the market to offer services; and there was only limited competition in both residential and business markets.
Ofcom’s review was designed to understand why the regulatory approach had not yet had the desired effect of promoting competition. The review established a series of regulatory principles. Underpinning these was a recognition that the regulatory approach should look to promote investment as well as competition. Ten years ago, Ofcom believed that the right regulation would encourage investment. Of particular importance were commitments to:
– Promote scale competition at the deepest sustainable level, exposing as much of the value chain as possible to competition and, therefore, promote innovation; and
– Re-focusing regulation on the risk of non-discrimination – that is, moving away from a largely price-focused approach to one that considered the ability of the regulated firm to prevent competition through non-price factors, too.
Ofcom drew upon these principles to devise an appropriate regulatory framework. This resulted, most notably, in the functional separation of BT Openreach. It gave rise to requirements for BT to provide infrastructure access to all operators (including its own retail arm) on an equal basis. With this emphasis on equality of access and deep-level competition came a renewed focus on passive access.
We wanted to make LLU, and other access remedies like Wholesale Line Rental, more effective at promoting competition and supporting new entrants. Key to this was setting wholesale price controls that, while allowing BT the opportunity to generate a fair return on its investment, also allowed scale operators to compete effectively. This both made it easier to appeal to consumers and signalled to efficient operators that they had clear scope to generate a return on investment.
2005 marked a new phase of intensified competition: a new telecoms market characterised by investment in LLU, disruptive entry and price competition. This resulted not only in wide broadband availability, but also in high take-up, expanded choice and lower prices.
As the market matured, we witnessed a period of consolidation and the emergence of “the big four” – BT, Sky, Virgin and TalkTalk – all competing vigorously for customers.
For example, TalkTalk provided a strong product offering at the value end of the market, which prompted a similar offering from BT through its PlusNet subsidiary. Sky and BT competed aggressively in each other’s core markets (Sky into broadband; BT into television). And Virgin Media competed on broadband speeds through its investment in its cable infrastructure.
The emergence of superfast broadband
By 2009, the UK had a well-established and competitive broadband market with two scale end-to-end operators and two scale operators hosted on BT’s copper access infrastructure. However, the new challenge was superfast broadband and establishing what should be our approach to regulation.
We looked to the principles set out in the Telecoms Strategic Review: how best to promote investment and competition and how to promote that competition at the deepest sustainable level. We adopted much the same approach to superfast as we had to standard broadband. With functional separation in place, we looked to ensure that other operators had equality of access to existing infrastructure through remedies such as Virtual Unbundled Local Access (VULA).
However, superfast broadband brought a new issue for us to consider. The underlying network infrastructure to support standard broadband and telephone services was already present. Superfast broadband, by contrast, required the roll out of brand new infrastructure, demanding substantially higher investment than was needed for standard broadband. BT and Virgin Media had to an extent already begun investment in this infrastructure. However, coverage, availability and take-up were still relatively low. Moreover, little retail competition existed.
Therefore, the principle of promoting investment to increase availability and retail competition formed a vital part of our regulatory approach. But the scale of investment required compared to standard broadband, gave rise to a number of issues. These included:
– The demand and cost uncertainty of superfast broadband investments;
– The potentially long payback period; and
– The risky nature of such investments.
In response, we recognised the central importance of regulatory certainty, not only for BT but for other operators, when it came to making investment decisions.
So we developed the “fair bet” principle, which had the effect of leaving BT’s retail and wholesale prices of superfast products unregulated. The ‘fair bet’ principle means that BT should be allowed the opportunity to enjoy some of the upside risk when demand for superfast turns out to be higher than planned – in other words, allowing returns higher than the cost of capital.
This balances out the fact that BT will potentially earn returns below its cost of capital if demand proves to be low. The idea is that BT should bear the commercial risk associated with its commercial rollout and, therefore, the risk and opportunity to under or over-recover its costs.
With this in mind, we did not regulate the wholesale price of BT’s superfast products. Instead, we allowed BT to set a price it considered to reflect its investment risk. BT’s ability to set excessive prices was constrained by our regulation of its legacy copper-based infrastructure. This “anchor pricing” approach meant that our regulation of standard products provided a price constraint on the superfast segment that we left unregulated. Our approach sought to balance investment and the protection of competition.
The evolution of our superfast broadband approach
Regulatory forbearance has seen BT roll out fibre-based superfast broadband on a commercial basis to two thirds of the country.
But challenges remained, notably how to bring superfast broadband to the last third of the UK that, despite regulatory encouragement, remained broadly uneconomic. The state-funded BDUK programme is helping to fill those gaps and should see superfast coverage in the UK expand to 95% by 2017.
Of course, investment and competition in superfast has yet to reach the levels we’ve seen in standard broadband. But, unlike at the time of the telecoms strategic review ten years ago, our starting position is transformed. We have at least three scale competitors in the market, ready to challenge BT.
We believe our approach remains appropriate overall, and we recently restated it in our fixed market review – with some minor changes to help spur competition. For example, we addressed demand-side switching barriers and provided more certainty over the margin on BT’s VULA fibre product through our ex ante margin regulation.
The next wave of investment in ultrafast is upon us. BT and Virgin have announced ambitious plans for deploying G.Fast and DOCSIS3 technology overlays. Both are likely to need certainty about the regulatory environment in order to secure funding.
Ofcom’s next fixed access market review will commence later this year. We said in the last review that, as the market matures, more traditional regulatory measures may be appropriate, such as charge controls on superfast. Whether or not we adopt such measures will depend on the state of competition we find at the time of the review and whether BT has had a reasonable opportunity to recoup its investments – the ‘fair bet’ principle.
One option would be to adopt the same principles that underpinned our previous approach to superfast broadband investment by combining the introduction of charge controls on wholesale Superfast broadband while leaving ultrafast broadband largely unregulated. In these circumstances the ‘fair bet’ principle would apply to any ultrafast investments while regulation of the wholesale superfast inputs would ensure competition to ultrafast from competing superfast offerings – the ‘anchor pricing’ principle – in much the same way as broadband anchors superfast broadband prices today.
Is there any reason to doubt that the same principles are not appropriate for an ultrafast future? It’s probably too soon to say. But Ofcom will need to ensure that infrastructure investment is supported, while promoting competition between retail providers to provide new services that benefit consumers and businesses.
Our recently-announced Digital Communications Review will consider how communications providers and services continue to meet the needs of consumers and businesses. It will focus on how we can:
– ensure incentives for private-sector investment, which can help to deliver availability and quality of service;
– maintain strong competition and tackle obstacles or bottlenecks that might be holding the sector back; and
– identify whether there is scope for deregulation in some areas.
The review will encompass not only broadband and landline services, but also mobile. And we will be working closely with stakeholders to understand the challenges facing the sector, to help ensure the UK continues to enjoy a strong and vibrant digital communications industry.
We want to continue supporting the development of the market by providing a clear and strategic regulatory framework.
This will be designed both to promote competition and to support continued investment and innovation that can benefit consumers and businesses in the form of coverage, choice, price and quality of service.
Whether it’s ultrafast broadband, or other new technologies, identifying investment incentives and stimulating competition will remain vital parts of Ofcom’s regulatory approach. The two are not in contradiction.