19.12 Within our charge control modelling, we have reallocated £46m of costs from the TI basket to Ethernet services. This is because we consider that TI services would attract a declining allocation of common costs as TI service volumes decline and Ethernet volumes rise. As explained in Annex 12, this change in allocation would not otherwise be captured by an approach to modelling the costs of separate baskets and so we need to make a specific adjustment.
Basket design
A single basket for TI services
The LLCC Consultation proposals
19.13 In the LLCC Consultation we proposed a single basket, the TI basket, which comprised the following groups of services :
• wholesale low bandwidth TISBO (up to and including 8Mbit/s) – connection and rental (standard maintenance and enhanced maintenance);
• wholesale medium bandwidth TISBO (above 8Mbit/s up to and including 45Mbit/s) outside the WECLA – connection and rental (standard maintenance and enhanced maintenance);
• wholesale high bandwidth TISBO (above 45Mbit/s up to and including 155Mbit/s) outside the WECLA – connection and rental (standard maintenance and
enhanced maintenance);
1442 PPC charges are available at:
https://www.btwholesale.com/pages/downloads/service_and_support/pricing_information/carrier_price_list/brows able_carrier_price_list/section_b3/B8.03.rtf
• regional trunk (all bandwidths) – rental (standard maintenance and enhanced maintenance);
• RBS backhaul, Netstream 16 Longline and SiteConnect;
• interconnection services;
• TI Equipment and Infrastructure; and
• TI ancillary services excluding ECCs.
19.14 In addition, we proposed a number of sub-baskets and sub-caps:
• a sub-basket on RBS backhaul, Netstream 16 Longline and SiteConnect;
• a sub-basket on interconnection services (i.e. Points of Handover);
• a sub-cap on ancillary services, equipment and infrastructure; and
• a cap on all other charges (i.e. those services not included in the other sub-baskets and sub-caps specified above).
19.15 We explained in the LLCC Consultation that we based these proposals on the following two considerations:
• efficient pricing – where the services being considered share substantial common costs, a single basket can be more conducive to efficient pricing and cost recovery; and
• competition – where the services being considered face different competitive conditions or BT does not use the same wholesale inputs as its rivals, placing them in the same charge control basket may give BT an incentive to set prices in a way that undermines competition.
19.16 In Section 4 of the LLCC Consultation, we also discussed the importance of efficient migration when designing charge control baskets and how including services within the same basket could allow for appropriate incentives to migrate from one service to another. As explained in the June BCMR Consultation,1443 we did not anticipate significant migration between different TI services. However, over the course of the charge control period, we expected that many customers of TI services would migrate to Ethernet services. We noted that the values of X for the TI and Ethernet baskets, respectively, would be consistent with such migration.
19.17 We considered that placing the services mentioned above together in the TI basket would be conducive to efficient pricing and cost recovery and that our proposed sub-baskets and sub-caps would be appropriate to deal with the risks associated with there being different competitive conditions among certain services.
19.18 We present below the analysis we conducted for the LLCC Consultation.
1443 See paragraphs 3.31 to 3.74 of the June BCMR Consultation.
Bandwidth breaks
19.19 We had proposed, in the June BCMR Consultation, to identify separate markets at different bandwidths for TISBO services. However, having a particular market definition does not necessarily mean that charge control baskets must be defined along the same lines. We may set SMP conditions where it appears to us, based on our market analysis, that there is a relevant risk arising from price distortion, and where doing so is appropriate to promote efficiency and sustainable competition, and to confer benefits on end users. Where it appears to us, from our market analysis, that the competitive conditions in different markets are sufficiently similar such that we can identify a risk of adverse effects arising from a price distortion that is common to those markets, we may consider it appropriate to combine products in different markets. In this case, we considered that the risks are sufficiently similar that designing a common basket cap would be appropriate.
19.20 Our analysis, set out in the June BCMR Consultation, suggested that, whilst the competitive conditions are not completely homogeneous across the defined
bandwidth breaks, BT has SMP in each relevant market for TISBO services outside the Hull and the WECLA areas.1444 In particular, we summarised in Figure 19.2 below the assessment of BT’s market share and other indicators discussed in the June BCMR Consultation.
Figure 19.2 BT market share in TI services, as at the June BCMR Consultation1445
Product market Geographic
• BT’s control of infrastructure not easily duplicated
• Existence of barriers to entry and expansion
• BT’s economies of scale and scope
• Lack of countervailing buyer power
• Lack of prospects of competition Medium bandwidth TISBO
19.21 As can be seen from that analysis, BT’s market share appeared to be persistently high in each of these wholesale markets and the competitive conditions were such that we did not believe that there was the prospect for them to become competitive over the forward-looking period covered by our review. Whilst BT’s market share for high bandwidth TI wholesale terminating segments was not as high as it was for the lower bandwidth markets, all three markets were declining and there were high barriers to entry or expansion for competitors1446. The parallels in terms of declining markets and the high barriers to entry supported our view that similar risks of adverse effects arising from price distortions arise in each market, and our proposal that it would be appropriate to design a combined basket that included services at different bandwidths.
19.22 We wanted to ensure, however, that a combined basket was appropriate in light of BT’s own consumption of services. Competitive concerns could, in particular, be raised if the wholesale services purchased by BT differed from other CPs. In such a
1444 See paragraphs 7.62 to 7.179 of the June BCMR Consultation.
1445 See Tables 48, 51 and 56 in Section 7 of the June BCMR Consultation.
1446 Also, high bandwidth TI services make up a small proportion of TI services in the basket, so lower prices on high bandwidth services would not materially alter the constraint on the other services.
circumstance, BT may face an incentive to concentrate price reductions on those inputs it purchases itself, while increasing prices for inputs which are purchased disproportionately by external customers.
19.23 In order to verify that a combined basket was appropriate, we examined the extent of any difference between the PPCs purchased internally by BT and those sold to external customers. Figure 19.3 below shows the extent to which BT and its external customers used PPCs as wholesale inputs in 2010/11. All bandwidths were used both internally and by external customers and the majority of volumes were internal at each bandwidth. Across the bandwidths up to 34/45Mbit/s, the proportion
consumed internally was largely consistent, between 60% and 85%. The
140/155Mbit/s circuits were largely purchased internally, but this accounted for less than 0.5% of the total. Any rebalancing in favour of 140/155Mbit/s circuits would not materially affect the price level of the rest of the TI basket. In addition, as the
potential for new 140/155Mbit/s circuits is limited, we did not consider that there would be a material impact on competition. We therefore did not believe that the differences we identified in internal and external consumption of TI services at different bandwidths raised any competitive concerns concerning the use of a combined basket.
Figure 19.3 BT’s PPC volumes in 2010/11
19.24 Having assessed the factors described above, we did not consider that there was a high degree of competitive concern about placing TI wholesale markets at different bandwidths in a single charge control basket. In addition, the June BCMR
Consultation identified a risk of BT engaging in excessive pricing in each of the TI markets referred to in Figure 19.2 above.1447 Consequently, it was considered that a relatively broad basket could be beneficial by allowing BT to recover costs in an efficient way, as explained further below.
19.25 TI services across different bandwidths share substantial common costs. By placing the services in a single charge control basket, we considered that BT would have the
1447 See paragraph 10.104 of the June BCMR Consultation.
0%
20%
40%
60%
80%
100%
120%
Internal External Source: BT Regulatory Financial Statements ('RFS') 2010/11
64kbit/s 2Mbit/s 34/45Mbit/s 140/155Mbit/s
incentive to set prices and recover common costs efficiently. In contrast, if we were instead to create separate baskets for each bandwidth, we would have to decide on the appropriate allocation of common costs to be recovered within each basket.
Given the complexity of these allocations and the need for BT to have a certain degree of flexibility to allow it to respond to changes in demand, we considered that it would be appropriate for BT to have some limited flexibility in how these costs should be recovered. BT is likely to be better placed than us to determine how to recover its common costs.
19.26 We also noted that our proposed sub-caps would limit the extent to which BT could rebalance its charges in favour of certain services over others.
PPC trunk and terminating segments
19.27 In the LLCC Consultation, we explained that our provisional view was that the competitive conditions in the relevant trunk and terminating segments markets were similar and we did not consider that they posed an impediment to placing trunk and terminating segments together in the TI basket.1448 For instance, the analysis in the June BCMR Consultation suggested that BT’s market share in regional TI trunk was 89% and that this market was characterised by similar competition concerns as the terminating segments, such as BT’s economies of scale and scope and the existence of barriers to entry and expansion.1449
19.28 In the June BCMR Consultation, we proposed to deregulate national trunk routes, the market for which we proposed to be effectively competitive.1450 The shorter distance routes, in relation to which we proposed in the June BCMR Consultation that BT still had SMP, faced similar competitive conditions to terminating segments. This meant that the main concerns about placing trunk and terminating segments in a single basket were now less apparent than they were for the LLCC 2009. Therefore, we proposed not to impose a separate sub-cap on terminating segments.
19.29 We considered that a combined basket would be more conducive to efficient recovery of common costs, as it would allow BT to choose prices to better reflect demand elasticities; it would also enable BT to respond to changes in demand and recover common costs efficiently. As we believed that competitive conditions were similar, we proposed to keep regional trunk segments and terminating segments in the overall TI basket.
Consultation responses
19.30 Several stakeholders commented on the structure of the proposed basket design for TI services.
19.31 BT agreed with the use of broad baskets and, where appropriate, the use of sub-caps.1451
19.32 CWW claimed that our proposed basket design was too wide given that the baskets were broader than those used in the 2009 control, when cost orientation was also imposed.1452
1448 The relevant trunk market is the proposed wholesale market for regional trunk segments in the UK.
1449 See Table 81 at page 397 of the June BCMR Consultation.
1450 See paragraphs 7.434 to 7.486 of the June BCMR Consultation.
1451 See BT non-confidential response to the LLCC Consultation, page 12.
19.33 Level 3 said that in the absence of cost orientation and accounting obligations the structure of the sub baskets should be more granular in order to deliver appropriate safeguards to CPs.1453
19.34 Telefónica UK was, in general, supportive of our charge control proposals, in particular in relation to RBS backhaul.1454
19.35 Stakeholder responses specifically relating to our proposal to remove cost orientation are summarised and considered in Section 9.
Bandwidth breaks across PPCs
19.36 The AlixPartners report commissioned by UKCTA argued that the use of broad baskets increases two types of risk to competition that the proposed basket did not, in its view, address:
• the incentive to target price increases on those services where rivals are less likely to enter; and
• the incentive to target price reductions on services used disproportionately by rivals, whether in relation to bandwidth breaks or the connection/rental structure of charges.
19.37 UKCTA expressed the view that Ofcom should carry out a more detailed cost-benefit analysis in order to examine the risks that price rebalancing could impose in terms of each of the two competitive concerns identified above.1455 It did not agree that the relative degree to which services within the baskets are used by BT and its rivals are broadly comparable. It argued that, within the TI basket, the proportion of external sales varies significantly as between the components of each bandwidth, and specifically that the proportion of external sales is currently much higher for low as opposed to high-bandwidth inputs.1456
19.38 UKCTA suggested the following options to tackle these concerns:
• narrowing the basket by separating any services which have a greater potential for horizontal competition or are used disproportionately by external operators from the main basket and including these in a separate basket. UKCTA recognised that this would require Ofcom to take a view on the appropriate proportion of common costs to be allocated to each basket, however, it argued that this would reduce uncertainty over prices over the charge control;
• increasing the number of services to which sub-caps apply such as services for which BT would otherwise face a strategic incentive to increase prices (i.e. those which are not subject to horizontal competitive pressures and those which are used disproportionately by external operators). This would ensure that the design of the sub-baskets and caps is more clearly linked to potential competition
1452 See CWW response to the LLCC Consultation, paragraph 15.13, page 68.
1453 See Level 3 non-confidential response to the LLCC Consultation, page 20.
1454 See Telefónica UK response to the LLCC Consultation, page 32, 33.
1455 See The AlixPartners report, UKCTA response to the LLCC Consultation, page 27.
1456 See The AlixPartners report, UKCTA response to the LLCC Consultation, page 22-27.
distortions while limiting the regulatory burden on Ofcom to derive specific cost allocation proposals for common costs;
• tightening of sub-basket price limits that would constrain the pricing to those services for which a sub-basket or sub-cap applies. This approach could be implemented alongside the increase of services to which sub-caps apply. UKCTA admitted that the precise limits are subject to some regulatory discretion but it thought that Ofcom should be more rigorous in estimating the degree to which price changes adopted by BT can disadvantage rival CPs and apply tighter sub-caps where the risks to competitive distortions are greatest; or/and
• retaining cost-orientation obligations for all services within the charge control as this would reduce the risk of price rebalancing to the detriment of competition.1457 PPC trunk and terminating segments
19.39 In the context of cost orientation, CWW commented that a greater proportion of trunk segments were purchased internally than for terminating segments and local ends, but did not state whether it considered that this was sufficient to justify a separate sub-basket.1458
19.40 The AlixPartners report for UKCTA raised a concern that while inclusion of both regional trunk and adjacent TISBO services within a broad basket could potentially prevent excessive pricing at the aggregate basket level, it could still allow BT to raise prices for regional trunk while reducing prices for potentially more competitive TISBO services.1459
Our response and conclusions
19.41 We have considered carefully the arguments raised about the TI basket design in the response to the LLCC Consultation. Below, we respond to each of the main issues raised by stakeholders in turn.
19.42 For the present charge control, we consider it appropriate to have a wide basket for TI services, with sub-constraints imposed where appropriate to address the risk of BT pricing these services excessively. We consider that the risk of excessive pricing can be effectively addressed by the sub-baskets and sub-caps. In our view, having an additional cost orientation obligation would be unnecessary and disproportionate.1460 19.43 As set out in Section 18, we acknowledge that there are both advantages and
disadvantages to broad baskets. Given that many of the TI services share substantial common costs, a single basket can be favourable to efficient pricing. This allows BT to determine the optimal way to recover fixed and common costs, taking into account the different demand conditions (e.g. demand elasticities), different trends in costs and where relevant, appropriate migration incentives.
19.44 Nonetheless, we are aware that, if different services are subject to different
competitive conditions, then a single basket may allow BT to comply with the control by charging higher prices on less competitive services, and lower prices where it
1457 See The AlixPartners report, UKCTA response to the LLCC Consultation, page 28-29.
1458 See CWW response to the LLCC Consultation, paragraph 4.15, page 10-11
1459 See The AlixPartners report, UKCTA response to the LLCC Consultation, page 25.
1460 See our response in Section 9.
faces more competition. Alternatively, if some products are mainly purchased by external CPs, BT may concentrate price falls on products which it purchases, while increasing prices on those purchased by its rivals, thereby placing other CPs at a competitive disadvantage. In our LLCC Consultation, we assessed these potential risks and have sought to mitigate them through targeted sub-caps and sub-baskets.
19.45 We note that some stakeholders disputed the potential benefits of pricing flexibility.
For example, they disputed whether the costs were truly common or whether BT had sufficient information on pricing elasticities to set efficient prices, or even whether information on pricing elasticities was relevant for wholesale prices. We have evaluated these concerns.
19.46 First, we note that it may be true that not all costs are common to all services.
However, even if some costs are not common, sufficient cost categories such as land and buildings, and operational costs e.g. management, power, transport, are shared between all TI products. We therefore consider that there is benefit in allowing BT some pricing flexibility to recover common costs.
19.47 Second, wholesale demand is derived from retail demand. If the retail price elasticity is high, this will also tend, all other things being equal, to a higher wholesale
elasticity. We accept that BT may not be able accurately to estimate the pricing elasticity of each product. However, we consider it likely that it would be able to estimate which tariff structures expand its output by more than others as a result of experience. We also consider that Ofcom is unlikely to be able to make a better estimate of the appropriate pricing structure.
19.48 We note that UKCTA suggested that we should undertake a cost-benefit analysis of which products have greater potential for competition and which products are used disproportionately by external operators. We undertook such an analysis for the
19.48 We note that UKCTA suggested that we should undertake a cost-benefit analysis of which products have greater potential for competition and which products are used disproportionately by external operators. We undertook such an analysis for the