UPD Vodafone, TalkTalk and Sky Deliver Last Minute BT Pinata Bashing

The on-going attempts to turn BT into a pinata continue this week as both Vodafone and Sky (Sky Broadband) have taken another opportunity to prod the telecoms giant ahead of Ofcom’s Strategic Review decision, with one demanding a national Gigabit broadband network and the other attacking the operator’s excess profits.

The national telecoms regulator, Ofcom, has only just closed their Strategic Review consultation and we’re now waiting with bated breath to see whether or not they decide to split BT from control of its national UK telecoms and broadband network (Openreach).

Over the past few months the incumbent has been predictably battered by their opponents (TalkTalk, Sky Broadband and Vodafone etc.), many of which want to see BT being completely split from Openreach because it would benefit their respective positions in the market.

The latest criticisms don’t appear to add anything new to the debate, but they’re still worth highlighting. Firstly, Vodafone has updated their study of BT’s financial structure from two years ago (here) and appear to suggest that the operator is raking in an excess profit of £6.5bn more than they think is fair given Ofcom’s regulation.

Vodafone’s Statement

This analysis is based on comparing the level of profitability for BT’s regulated services, expressed as a return on capital, against Ofcom’s estimate of BT’s cost of capital. The Frontier analysis shows that over the period April 2006 to 31 March 2015:

* reported returns on BT’s regulated services overall were consistently above the rate required to compensate investors, as determined by Ofcom. More specifically, in the past 10 years BT made around £18.9 billion profit from regulated services, of this £6.5 billion was over and above the determined cost of capital, of which £770 million was for the financial year to 31 March 2015;

* there is no clear trend of a reduction in overall returns, despite a number of actions by Ofcom to constrain prices over the period; and

* there have been some changes over time in the composition of the excess returns, with the excess returns concentrated on those services used by competitors to BT.

The conclusion to the report is that BT’s returns for regulated services overall have been consistently above a benchmark rate based on Ofcom’s determinations of the return required by investors. This implies that prices overall have been set at a higher level than that required to provide investors in BT with an appropriate rate of return: in other words, prices could have been lower and BT’s investors would have still been adequately compensated. We estimate that BT’s regulated prices would have been 11% lower on average, had BT’s regulated returns been in line it the cost of capital.

The figure represents an expected increase from the £5bn reported by Vodafone two years ago, which at the time was described by BT as being “ludicrous” and containing “wildly inaccurate” figures (no examples were given). The stance from BT has not changed, although this time around Ofcom will perhaps consider Vodafone’s gripe in more detail.

Elsewhere Sky has put up another blog (here), which echoes their past concerns about Openreach’s service quality / delays and also suggests that the United Kingdom should be building a more future proof pure fibre optic (FTTP/H) network that could last for decades.

Andrew Griffith, Sky’s Group CFO & MD of Commercial Businesses, said:

“For the UK to top the global connectivity table, we must aim high. We think the industry should aim for widely available Gigabit broadband which is ten times the best available speed now or fifty times the average speed the UK customer currently gets.

Many other nations are building fibre networks direct to the home capable of delivering Gigabit broadband. The New Zealand government has accelerated roll-out of fibre-to-the-premise broadband to 80% of the population by 2022. Meanwhile in Japan and Korea, more than half the population already receives connection speeds of more than 100Mbps. However the current industry structure will not deliver the radical step change that would make the UK a future world leader.

BT itself shows little appetite to take the fundamental step of delivering Gigabit broadband. It just plans to upgrade its existing copper network. The newest technology that it is planning to deploy, “G.Fast”, still relies on existing copper lines that run into customers’ homes. Professor Peter Cochrane, BT’s former head of research and development, calls their vision “wholly inadequate”.”

We don’t disagree with Sky’s aspiration, although it’s always been easier to say these things than to actually deliver and pay for them. Sky also hails Japan and Korea for delivering speeds of 100Mbps+ to more than half the population, which perhaps forgets about Virgin Media’s 200Mbps cable network in the UK.

Never the less BT’s rivals seem adamant that they could do a better job, although it’s difficult to judge while there’s an on-going absence of hard figures for the kind of investments they’d be willing to make, over what time-scale and then precisely what they’d all agree to actually do. The grass may not necessarily be greener and having more cooks in charge could create other problems.

Meanwhile BT continues to hint that any attempt to separate them from Openreach could tie the process up in legal battles. Questions also remain over how BT’s debt / pension pile might be apportioned in the event of a split, as well as the impact on consumer prices from all of the related changes (better services cost more money).

BT gave their own response last week (here) and they’ve also managed to secure some mild support from the Government’s Digital Economy Minister, Ed Vaizey, whom last week warned that such a split would have “lots of potential to backfire” (here).

Ultimately Ofcom are the only ones who can make the decision about whether or not to refer BT to the competition authorities, which would be a prelude to their break-up. We should all find out soon enough whether or not this is the path they’ll take, although historically they’ve tended to prefer a middle road solution (e.g. force BT to relinquish some control without a complete split).

UPDATE 15th October 2015

ISP TalkTalk has just posted an executive summary of their own Ofcom submission, which can be read in full here (MS Word Document). The crux of this boils down to the following four key points.

Where is competition under threat today?

To deliver the infrastructure which underpins the UK’s digital future requires effective competition in four places where it either does not exist currently, or is under severe threat:

• A level playing field for competition in infrastructure.
Openreach’s investment and commercial decisions are primarily driven by a combination of regulation and the demands of BT Retail. Neither of these two drivers will produce sufficient incentive for Openreach to be pushed to the limits of its extensive experience and potential. Separating Openreach from BT would allow Openreach greater freedom to partner on investment with other retail providers without the fear of vertical abuse; and would simultaneously free up BT Retail to collaborate with other infrastructure builders. This level playing field is much more likely to drive innovation and investment.

• Retail competition to provide superfast and ultrafast broadband.
Ownership of Openreach has given BT retail a very substantial advantage particularly in superfast broadband, where it has manipulated its control over product design and pricing to secure a 70% share of all Openreach connections. Not only does this directly harm customers through higher prices, it also reduces competitors’ ability to develop the necessary scale to invest in their own FTTH infrastructure, which would create incentives for Openreach to invest faster. An independent Openreach has a greater incentive than BT Group does to drive higher take up across all their customers, leading to quicker payback and greater investment in future.

• Competition to offer compelling quad-play offering.
The quad-play market, combining content with fixed and mobile connections, is still nascent. However, the combination of huge increases in data demand and the development of offloading technologies like femto-cells, suggest quad play will capture a large part of the market, bringing substantial efficiency gains and quality improvements. However, for consumers to benefit from quadplay, we must have strong competition between quadplay providers. This requires a market structure which does not allow foreclosure of any one element of the package.

The current course of consolidations is therefore deeply concerning and we share Ofcom’s view that four mobile network operators are required to safeguard competition and ensure customers are treated fairly. If allowed to progress unchecked, the outcome of the currently proposed mergers will mean substantial competitive harm, both to market participants and to their customers, and will significantly reduce incentives to innovate and invest across the value chain.

Openreach separation will help, but it will be equally important to ensure that consumers have meaningful choice of fixed and mobile providers; are able to easily switch between quad play providers; and are not paying for products they do not want because they are not regular switchers. The market is increasingly promotion-led, with the result that large groups of customers who do not choose (or are unable) to switch, are in effect subsidising promotional offers for the small minority of the market which does. We fully support Ofcom’s emphasis on empowered consumers, as this is a crucial element in any competitive market to ensure providers are efficient, innovative and above all treat customers fairly.

• There are no competitive drivers for better service provision.
Consumers and businesses are experiencing unacceptably low (and in some areas worsening) levels of service quality from Openreach, due to inadequate investment and the skewed incentives of Openreach, both caused in large part by ownership of Openreach by BT. Openreach’s pledges on service in its recent ‘Charter’ amounted to little more than promises (which have been made since 2006) to meet minimum service levels. This is a poor reflection of the high degree of experience and expertise of Openreach as an organisation. As an independent organisation, Openreach would be fully focussed (both operationally and in terms of investment) on the provision of the best possible service for customers