Introduction
In carrying out their market analysis NRAs will need to consider:
• whether infrastructure based competition35 provides sufficient competitive pressure on fixed incumbents so as to maximise the benefits of competitive supply of mass broadband access services; and
• if not, what wholesale broadband products a fixed incumbent should supply in order to maximise sustainable and effective competition.
It is clear from Figures 2.5 and 2.6 that there is considerable variation in the
competitive supply of broadband services at the retail level and that fixed incumbents will need to supply wholesale products under ex-ante regulation in some, but not necessarily all, member states. So in this section we consider how best to resolve these two issues.
Market definitions and findings of SMP
The answer to the first question is closely linked to the market reviews in which the NRAs are currently involved and in particular the review of the wholesale unbundled access market (Market 11) and wholesale broadband access market (Market 12). It is inappropriate for us to offer any guidance on this review process. But based on our discussions with interviewees in the course of our study we note the following points. First there is considerable debate on the precise definition of sub-markets, especially within Market 12. In particular there is debate on:
• the lower limit on the downstream speed of a service before it is excluded from broadband services. Some authorities propose a lower limit of 128kbits/s; others
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i.e., they should consider the position five years from now. If they choose the incumbent now, will they effectively be opting for a monopoly in perpetuity with all the loss of dynamic efficiency that would entail?
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e.g., Section 5 on Tendering Processes
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Supplemented by the activities of local loop unbundlers which Regulation 2887/2000 enables
256kbit/s. In addition, some operators argue that broadband and narrowband services are, in certain circumstances, in the same market.
• whether symmetric and asymmetric broadband services are in the same or different markets. A number of NRAs have ruled that these two service types are in separate markets.
• whether symmetric broadband services are in the same market as the wholesale terminating segment of leased lines (Market 13 identified in the
Recommendation).
• whether broadband access36 and broadband conveyance are in the same or different markets.
• whether wholesale services for business and residential customers are in the same or in different markets.
• whether there is a single national market for the supply of wholesale products or whether the geographic areas in which CATV operators offer service are in a different market from those areas where they are absent.
Secondly the answer to the question of whether the fixed incumbent is considered to have SMP in these markets, once defined, could vary considerably across the EU.
• in some Member States, it is reasonably clear that there is a strong case for an SMP finding in relation to Market 12.
• in others37, where the fixed incumbent holds less than 50% of the retail broadband market, the case requires careful consideration. Any SMP assessment is complicated by the fact that, while CATV operators in these countries compete vigorously at the retail level, they rarely offer wholesale broadband products. There are a number of reasons put forward by the CATV operators for this lack of wholesale supply:
- it is technically more difficult for CATV operators, who run a shared access network, to supply wholesale products than it is for incumbents who operate local loops dedicated to specific customers;
- CATV operators believe that they can generate more revenue by selling broadband Internet access on a retail basis alone. Selling wholesale might lead to more customers, but it would weaken their brand and reduce opportunities for cross-selling TV and voice telephony services; and
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Defined as carriage from the end user to the local exchange or RCU.
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- CATV operators typically only cover a part of a Member State, while potential ISP customers normally offer services nationally38. This lack of national coverage means that a CATV operator would need to sell at prices below the incumbent’s wholesale offering to generate demand.
• some argue that the lack of wholesale products from CATV operators means that the incumbent has SMP, even when CATV operators supply the major part of the retail broadband market. Others argue that such a market is contestable and that CATV operators would begin to supply wholesale services if the fixed incumbent raised its price significantly. If contestability is established, the case for ex ante regulation is weaker.
• these issues are inherently tied with an assessment of the appropriate manner in which to address self-supply and captive supply in the context of the new
regulatory framework.
What products should the fixed incumbent offer?
If the fixed incumbent is found to have SMP in the wholesale broadband market(s), what services should it be required to offer? Currently incumbents offer three broad types of wholesale product39, as illustrated in Figure 2.109, namely:
• IP level wholesale DSL service in which the purchaser buys the incumbent’s
retail DSL product at a wholesale price set by the market or by the NRA on a retail minus basis. Normally, the pricing structure and the functionality of this product reflect that of the retail product. The bitstream might be delivered to the ISP via a managed or unmanaged IP network and may or may not be bundled with global Internet connectivity.
• bitstream DSL service. The incumbent still provides a DSL service and
backhaul40 to the purchaser’s point of presence. However, the purchaser is able to specify the balance between upstream and downstream speed, the contention ratio for the backhaul, and the location of the point of interconnect within the incumbent’s ATM network. Such a product enables the purchaser to differentiate its offering from that of the incumbent and to offer different retail price structures.
• unbundled local loops. The purchaser rents the local loop (or uses the high
frequency spectrum within the loop) from the incumbent and provides DSL service and backhaul itself. Such a product is currently offered by all operators with SMP in the national interconnect market, under EU Regulation 2000/2887.
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Although in some cases the length of the local loops may make DSL supply impossible.
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There are many variants on the three categories described above.
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We show ATM backhaul in Figure 2.3. But IP/MPLSand Gigabit Ethernet backhaul is also possible.
Which of these product types should an SMP operator be mandated to supply on an
ex ante basis?
Mandating IP level service
NRAs are currently deciding whether to require operators with SMP in relevant markets to supply IP level services. In so doing, they need to consider whether there are grounds, under the new framework, to mandate supply on an ex-ante basis or whether competition law offers adequate remedies to deal with any incumbent who refuses to supply or supplies at a price which creates a margin squeeze on an independent ISP which wants to purchase such a service. Such consideration is required by the guidelines set out in the European Commission’s Recommendation of February 2003. These suggest that NRAs should only introduce ex ante measures where existing competition law remedies are inadequate to deal with a market failure. If NRAs do rely on competition law remedies then it is important that any fines
imposed for breach of competition law are proportionate to the gains that the SMP operator has made as a result of the breach. Unless this is the case, competition law is unlikely to be a sufficient constraint on the operator’s behaviour.
Figure 2.10 The main wholesale broadband services
PC DSL Splitter MDF ATM Managed or unmanaged IP network ISP DSLAM DSL access Backhaul Local loop ULL Bitstream access 1 IP level wholesale Bitstream access 2
Mandating supply of unbundled local loops
Incumbents with SMP in a relevant market similar to Market 11 are currently required to supply unbundled local loops. NRAs will need to decide whether to maintain, amend or withdraw this mandate as part of the market review process. However, given the low current level of use of unbundled local loops we need to consider whether more can be done to promote take-up without distorting competition.
Our research indicates that the main reason for the poor take-up of unbundled local loops is the high up-front investment required. An unbundler will typically pay €70,000 to
€100,000 in collocation and backhaul costs before it can start to provide service to any of the customers attached to the main distribution frame in connection with which these costs are incurred. In other words it appears that the natural monopoly in the provision of local loops extends back into the incumbents network – at least from the MDF to the local exchange41. Given that:
• each MDF serves 3,000 local loops on average in the EU42;
• each DSL service might generate €500 per annum from a consumer or €3000 per annum from a small business; and
• each DSL customer might have a three year life before changing supplier, it is vital that the unbundler is able to win to a substantial share of customers if it is to recoup its initial €70,000 to €100,000 expenditure. Such investment is clearly risky and, in today’s post-dotcom climate, few investors are willing to take such risks especially for mass market roll out of broadband services. It is possible that take-up of unbundled local loops will increase if and when investor confidence in the telecommunications sector returns. However, many of those interviewed in the course of our study believe that this problem is permanent.
A few respondents, particularly the local loop unbundlers, also argue that unbundled local loop take-up is low because incumbent operators have delayed implementation and raised unbundlers’ costs unnecessarily (e.g. by insisting on secure collocation cages rather than allowing co-mingling of equipment). However, there is a general view that such problems can be, and are being, overcome as the NRAs and the operators work their way through the operational problems which entrants face when renting local loops, so as to develop workable reference offers from the incumbents.
Despite these problems, the number of unbundled local loops is growing rapidly and our research indicates that there is significant demand to rent local loops from firms wishing to supply end users with substitutes for 2 Mbit/s leased lines. At the same time there are measures which NRAs could take to reduce the upfront cost for such firms. In particular they could:
• mandate the option for the local loop unbundler to commingle its equipment with that of the incumbent rather than use secure collocation cages. According to ECTA such commingling, which can significantly reduce collocation costs, is so far mandated in only seven43 of the fifteen member states;
• require the incumbent to rent cost oriented backhaul at an appropriate level of disaggregation which matches both the unbundler’s requirements and the
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But it is very difficult for an NRA to establish the boundary of such monopoly ex ante. It will depend on a wide variety of factors and will probably change over time
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There is considerable variation in the size of main distribution frames. Many terminate less than 1,000 loops. Others terminate many tens of thousands of loops. Not all of these loops are short enough to be used for broadband service
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incumbent’s ability to supply in a cost effective quantity. Given the incumbent’s existing transmission capacity between the MDFs and the core network it is highly likely that the incumbent can supply such backhaul at a significantly lower cost than the unbundler.
This analysis prompts us to make two recommendations:
• that incumbents with SMP in Market 11 be required to offer co-mingling of equipment to local loop unbundlers.
• that incumbents with SMP in Market 11 be required to offer cost-oriented backhaul at an appropriate level of disaggregation to local loop unbundlers.
Mandating bitstream services
The possibility of mandating the provision of bitstream products44 has been a subject of considerable debate. Some operators argue that:
• mandating local loop unbundling45 is as far as regulation should go to promote competition in broadband services;
• mandating bitstream access will allow purchasers to win substantial broadband revenues whilst the incumbent takes all the investment risk. This, in turn, will reduce the incumbent’s investment incentives, slowing broadband rollout; and
• mandatory bitstream access reduces the investment incentives for operators, such as local loop unbundlers and CATV operators, who provide greater infrastructure-based competition than those who buy bitstream access. We take a different view. We believe that:
• the incumbent enjoys substantial economies of scale in providing DSL access. For example, it is able to purchase DSLAMs in bulk at prices which are 50% or more below the prices paid by its smaller rivals. Mandatory bitstream allows the purchaser to enjoy these economies of scale also;
• bitstream access reduces significantly the upfront investment which the purchaser must make, when compared with local loop unbundling, thereby removing one of the major barriers encountered in relation to local loop unbundling;
• bitstream access is significantly better at promoting competition in broadband markets than IP level wholesale services. Bitstream access enables
differentiation in terms of quality of service and price when compared to IP level wholesale service; and
• the case for bitstream-type services is likely to strengthen in the future. As incumbent operators introduce VDSLaccess and push the electronics required to provide service closer to the customer, the business case for local loop
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By incumbent operators with SMP in relevant markets.
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unbundling becomes weaker46 and the incumbent’s dominance in the access network strengthens.
Of course, the arguments about investment incentives are important ones. They disappear, however, if the bitstream product is priced so as to reward the incumbent fully for the risk it is taking. We discuss this point further in the next sub-section.
We therefore consider that it would be a reasonable and proportionate NRA response if operators with SMP in the relevant markets were required to offer bitstream DSL access products for which there is reasonable demand and in areas where the incumbent offers retail DSL access.
If these suggestions are accepted, they will, in Member States where the incumbent has SMP in the supply of wholesale broadband services, offer a migration path from service-based competition to infrastructure-based competition in which the service provider:
• buys IP level wholesale service as Step 1;
• buys bitstream service as Step 2;
• migrates to unbundled local loops as Step 3; and
• finally migrates to building its own access network facilities as Step 4. As a service provider moves from Step 1 to Step 4 along the path:
• it moves from service-based to infrastructure-based competition;
• it takes more of the investment risk itself;
• it pays less to the incumbent for its access components; and
• it is able to offer products with greater functional and price differentiation.
Supporters of this hierarchy of services argue that, by using this migration path, a service provider can reduce its investment risks substantially. It can build its customer base using Step 1 or Step 2 products and then migrate to Step 3 or Step 4 products once it has established a critical mass of customers in an area. For this approach to work, certain conditions must be met. For example, it is important that:
a) all of Steps 1 to 3 are available to service providers4748. In many Member States, this is not the case;
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As the number of points of presence required for a given level of coverage increases by an order of magnitude and the up-front cost to the local loop unbundler of reaching these points of presence increases by a similar amount
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And they are available on a long term basis.
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Service providers should be able to obtain IP level wholesale service using competition law remedies
b) charges by the incumbent for migrating the service provider’s customers from one step to another are set at the efficiently incurred cost level. Little
attention has been paid to this aspect to date;
c) incumbents are able to implement the migration between different products without leaving the end-user without service. Several of the respondents to our study have identified this as a major problem; and
d) the relative prices of the incumbent’s offerings for Steps 1 to 3 are set correctly. Pricing a lower step product too low deters migration towards infrastructure competition. Pricing it too high restricts competition unnecessarily.
To date, against the background of a poor investment climate, there is no clear picture as to how the migration path will work in practice. However, we believe that it is important that such a policy is initiated in order to promote competition over infrastructure in the broadband area.
We therefore recommend that NRAs ensure that conditions (a) to (c) set out above are met by the incumbent’s offerings. We discuss pricing further below.
The pricing of mandatory wholesale products
There is detailed work now going on at the EU and Member State level to consider the most appropriate pricing of wholesale broadband products. So again we do not offer any prescriptive guidance on this subject. But this is clearly an area of great importance to NRAs and operators of all kinds. In the course of our interviews, we spent considerable time discussing this issue. Through these discussions we
identified six constraints on the pricing of mandatory wholesale products which we set out below. It is important to note that these six factors constrain pricing; they do not determine prices.
In setting prices for mandated wholesale products, we believe that NRAs should be guided by the following six pricing constraints.
Constraint 1: the need to maintain pricing relativities. We can think of the three
wholesale product types and the corresponding end user DSL service – the four steps of the previous section - as a price and cost stack as shown in Figure 2.11. The NRA could, at least in theory, set mandatory wholesale prices for all three products on either a cost plus or retail minus basis. If it uses the cost plus approach, it will also need to decide how to allocate the common costs across the cost stack. If it uses the retail minus approach it will automatically allocate the common costs to the unbundled local loop component of the stack.
Figure 2.11 The price and cost stack for broadband products
Retail costs
IP backhaul costs
ATM backhaul costs
DSLAM and collocation costs
Local loop costs
Common costs ? ? ? ? Retail price IP level wholesale price Bitstream price ULL Price
Constraint 2: the existence of competition law remedies. Service providers can
use competition law to lower the incumbent’s wholesale prices. For example,