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LSE Analyst – BT and EE Merger May Entice Ofcom to Split Openreach

Wednesday, January 20th, 2016 (9:42 am) - Score 1,309

A researcher for the London School of Economics (LSE) has warned that the recently approved £12.5bn merger between fixed line telecoms giant BT and mobile operator EE may “change the competitive balance of the UK communications landscape” and challenge Ofcom’s approach to regulation.

The merger was officially cleared last week after both Ofcom and the Competition and Markets Authority (CMA) effectively ruled that it would not negatively harm competition in the either the United Kingdom’s mobile or fixed line broadband markets.

In fairness, few expected the deal to be stopped because of the limited overlap between the two different businesses (BT is fixed line / EE is mobile). Never the less some were surprised when the final deal was waved through without any significant concessions being attached.

According to Tom Evens, Senior Researcher at the University of Ghent and Visiting Fellow at LSE, the argument made by Ofcom and the CMA that the merger will not harm competition, and therefore will not affect consumers, is “questionable“.

Evens notes that the enlarged footprint will put BT in a “very strong position in both the broadband and mobile market“, with 40% of revenues for fixed and mobile revenues sold to consumers and up to 70% of the wholesale market. This in turn may also give them a lead in the emerging market for quad-play bundles etc.

Tom Evens said:

BT is determined to conquer the market for bundled services, where households take all services – broadband, mobile, TV and phone – from a single provider, and raise revenues by selling convenient, yet more expensive, bundles to its consumers. More importantly, BT is able to pursue this bundling strategy independently and run all services over its own network.

This is a huge competitive advantage, both strategically and financially, compared to BT’s main rivals Sky, Virgin, Vodafone and TalkTalk who all depend on Spectrum and/or wholesale access from another network provider, which in most cases is BT.”

Admittedly what Ofcom actually said was that many of the concerns could be tackled through their existing regulation, not least via the as yet uncertain outcome of their on-going Strategic Review (here) and the earlier Dark Fibre proposal (here).

We believe the current and future proposed regulation that we apply to BT will limit BT’s ability to discriminate over price, quality and innovation in the provision of leased lines,” said Ofcom in last year’s submission to the CMA. The regulator also pointed specifically to their plans for regulated Dark Fibre access, which they said would, “limit any potential attempts to discriminate over product innovation in mobile backhaul.

However some analysts have recently suggested that BT’s merger with EE may also add weight to the argument for BT to be split from control of their national UK phone and broadband network (Openreach), which is currently being “seriously considered” as part of Ofcom’s review. Indeed Evens appears to agree with this.

Tom Evens added:

It is vital for the UK communications industry that other operators retain access to EE’s mobile infrastructure, based on reasonable and non-discriminatory terms, in order to promote competition in the mobile market. Not only is wholesale access crucial for bundled service competition, but mobile virtual network operators have historically been new challengers in the market, devising new business models and/or introducing competitive pricing to consumers. However, the regulator’s new approach may include structural remedies that go further than the existing wholesale remedies.

The merger might influence Ofcom’s decision about the future of BT’s Openreach, which grants broadband access to most of BT’s competitors. Now that BT becomes the only operator in the UK market that controls both fixed and mobile infrastructure, Ofcom could propose remedies that prevent BT’s competitors from becoming overly dependent on the goodwill of a dominant operator that controls the gateways to consumers and businesses.

Against this backdrop, there might be a strong argument from the regulator to separate Openreach from BT.”

The regulator is widely expected to announce its preliminary decisions next month, which may or may not reshape the current broadband and phone market. Right now the only certainty is that Ofcom won’t maintain the status quo, which means that change is inevitable.. but how much change.

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Mark Jackson
By Mark Jackson
Mark is a professional technology writer, IT consultant and computer engineer from Dorset (England), he also founded ISPreview in 1999 and enjoys analysing the latest telecoms and broadband developments. Find me on Twitter, , Facebook and Linkedin.
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28 Responses
  1. Avatar Captain_Cretin says:

    It should have been a condition of the merger; BT will once again be dominant in all sectors of communication in the UK after this merger is finalised.

    And we all know who anti-competitive BT can be.

    1. Avatar Ignition says:

      What does Openreach have to do with mobile?

      The only real concern is their using their ownership of both Openreach and EE to supply backhaul to EE masts under preferential terms.

      If any separation is to be done I’d far Openreach and Wholesale were merged and the retail arms split off.

      The evidence points to BT actually being relatively weak compared to some of their peers.

      If you want to see what dominance looks like have a look at Telefonica and their mobile arm Movistar in Spain. Or there’s Deutsche Telekom in Germany, KPN in the Netherlands, France Telecom, etc.

      I’m actually quite perplexed as to why a mobile arm being a part of BT is such an issue – not having one made BT an anomaly, their peers have had them for ages.

    2. Avatar Neil says:

      “What does Openreach have to do with mobile?”

      What part of BT will be responsible for maintaining the network?

      Whos systems in BT will generate things such as PAC codes? (with landline is it not an Openreach system that previously generated MACs?)

      What part of BT will decide where new towers etc are needed and be responsible for the physical labour?

  2. Avatar MikeW says:

    I think there are bigger things afoot with the EE purchase than just bundling.

    The Radio Access Network (RAN) deployed by EE is the mobile equivalent of the fixed access network.

    BT’s objective, in acquiring EE, may have been beyond mere “quad bundling”, but instead be a focus on converged access. In such a picture, BT will probably want to create products that allows your devices to freely roam between the fixed network, the LTE RAN, and their exiting WiFi network.

    If Ofcom took a longer-term view, they might want to start requiring BT to create a regulated wholesale product, equivalent to WBC, that gives combined access to both the fixed and radio access networks – making such converged access available to other operators.

    With such products existing, the split of Openreach may only make sense if it include the EE radio access network too. Integrating that would take time, and would make a split of Openreach /now/ a matter of significantly bad timing.

    I guess we’ll see over the next few weeks…

    1. Avatar Steve Jones says:

      I suspect Ofcom will not like the idea of combined mobile/fixed line wholesale products that can only (or more effectively) by an EE/Ofcom tie-in. They will want any of the mobile operators to be able to offer such products.

      The current OR wholesale mechanism are designed to for customer neutrality. EE wouldn’t have special access (or influence).

  3. Avatar Ignition says:

    We are certainly coming up to that time when we see if, again, the prospect of improved services are sacrificed on the altar of competition.

    Last time it cost a near-ubiquitous nationwide FTTP network in return for a group of cable companies covering ~50% of the country and dropping as new properties were built that only recently fulfilled their ‘inevitable’ destiny of become part of Liberty Global and beginning to invest and expand again.

    None of those calling for the separation have committed to stepping up to plug the inevitable gaps it’ll create. It’s telling that the one company that is putting its money where its mouth is, Liberty Global, is vehemently opposed.

    Virgin Media want an environment open to private sector investment. TalkTalk can’t afford to invest so want BT’s assets to do it for them. Sky are, well, Sky. They’ve never been fans of competition unless they’re the challenger.

    I appreciate some people think Openreach being separated will create a minor miracle with FTTP everywhere but would point out that this separation has only happened in one other place, New Zealand. FTTP is indeed being deployed with extensive taxpayer funding, £700 million, to get the fibre to 80% of premises passed, towns and cities with populations of >10,000 I might add, by 2019. Over £500 per premises passed of public subsidy.

    I’ll also mention that this comes in partnership with not just Chorus, the separated equivalent of Openreach, but 3 local electricity companies. Taking advantage of overhead infrastructure that much of the UK doesn’t have. The Republic of Ireland is seeing this happen using exclusively private funding.

    Virtually everything in the UK of this nature is covered by VDSL already, dramatically reducing the benefits of immediate overbuild, and it’d be more expensive per premises.

    Another >£200 million of public funds to deploy 5Mb+ to >86% rural areas has been mentioned and is the process of being spent. Delivered via VDSL, FTTP, wireless and 3/4G.

    Our government has shown no interest in such funding. Even if they did they almost certainly cannot due to state aid rules.

    Are Sky going to fund this? No chance. Does anyone seriously think Sky would want to fund an open-access network? Whatever they build they’ll want to keep for themselves or a consortium they’re a member of.

    Vodafone? Unlikely. In RoI they responded to a tender from the state owned electricity company and are making extensive use of their overhead infrastructure to bring costs down. No such tender is likely here and rumours have it Vodafone are still talking, quietly, with Liberty Global to try and get their hands on Virgin Media.

    TalkTalk? This is a company that’s funding dividend payments to shareholders from debt.

    Anyone think of anyone else who’d be interested in such an enterprise?

    I see absolutely no reason to think there would be any short or medium term improvement in the UK as a result of full separation of Openreach.

    I see every reason to think it would bring any CapEx on the part of Openreach above the bare minimum to an immediate halt while the mess is untangled, and after that they would then be, directly, at the whim of private sector shareholders whose primary concern will, inevitably, be to sweat the existing assets as hard and as long as possible to maximise their own returns.

    You thought Openreach were bad before…

    Before the usual suspects pop up with the usual complaints I’d recommend looking at Openreach’s peers in the UK and abroad, and if you could produce a compelling argument why I’m incorrect in my assertions above rather than claiming that Openreach would miraculously be subject to the market and would immediately improve that’d be awesome.

    Without BT Wholesale as their anchor tenant a number of unwanted results are more likely, and the competition aren’t actually much better as you’d know if you’d dealt with them at any length rather than focusing purely on a grudge with Openreach because you don’t have SFBB or the type of SFBB you think you should yet.

    1. Avatar wirelesspacman says:

      Hi Ignition,

      I think your summary is excellent. As a (very) small ISP, I for one would not want Openreach separated out – for much the same reasons as you describe.

    2. Avatar TheManStan says:

      Excellent summary, an addition is that Chorus has no equivalent of VM in NZ.
      No such situation here, at best it’ll only be 30% “absolute” monopoly for Openreach in the most investment heavy areas given VMs commitment to ~65-70% nationwide coverage.

    3. Avatar GNewton says:

      @Ignition: Thank you for summary of the situation. The Ofcom digital communications review talks about the need to improve quality of service (see e.g. option 2 or option 3 at ). How do you think could that be accomplished? What option?

  4. Avatar dragoneast says:

    Something I’m not clear about. If Ofcom propose that BT divests OpenReach, can it be forced under their existing powers or does it require new primary legislation?

    Apart from that, I think a good summary from Ignition. I’d certainly prefer some relevant evidence on the effect of divestment, rather than all this Mystic Meg speculation and divining of what’s in whoever’s mind, or mindlessly calling New Zealand in aid without considering the difference in circumstances and how that affects matters. Like Heathrow expansion, it looks like a recipe for a grand talking shop and prolonged uncertainty that helps no-one but those who want no change at all.

    1. Avatar Steve Jones says:

      Ofcom have no powers to order a separation between Openreach and the rest of BT. They can only refer to to the Competition and Market Authority (CMA) who would have to carry out an investigation. Of course, it might not get that far if Ofcom could come to BT to do this voluntarily.

      The CMA do have the required powers (for forced divestment) and it wouldn’t require primary legislation. However, the CMA (like Ofcom) can’t make an arbitrary decision and it would be open to challenge under judicial review. There is also a massive amount of detail that would have to be worked out (such as the allocation of debt, assets, historical responsibility for pension deficits, IPRs and much else). Then there are little issues over where BT Wholesale fit into this.

      When Cellnet/O2 was “demerged” from the BT group, it wasn’t too much of an issue because the company had never been a fully integrated part of the business. It had an entirely different group of employees, had been a joint venture with Securicor (who were largely a “sleeping” partner) and BT Group took on all the debt incurred by Cellnet (which was huge – not just due to capital investment, but also the licences and expensive takeovers). Technically Cellnet/O2’s debt was money it owed to the group as BT group could borrow at more advantageous rates than Cellnet/O2 (Securicor never provided much finance). Cellnet/O2 was launched debt free (as it was felt it couldn’t survive loaded with liabilities) and the BT group took it on. BT groups then went on a process of asset sales and raising further finance from shareholders via a rights issue. As this exercise was entirely “in house” and was voluntary, BT group was fairly free to allocate assets/debt as they wished (albeit the regulators would have been nervous about capital investment by the BT group).

      No such “simple” thinking is likely to be considered acceptable by the regulators as (for example) simply dumping a lot of debt onto OR could threaten its levels of investment, which might not go down too well (OR is best placed to service debt as it has good cash flow).

      The whole exercise (even if it went through on an “encouraged” voluntary basis) would be a field day for lawyers, accountants, consultants and bankers.

    2. Avatar John Miles says:

      I presume BT+Openreach must already have to service debt and make additional pension payments in a way that loads costs on to the two ‘businesses’ in a fair manner. So there must already be some nominal way of assigning these costs between the two businesses. This could surely be used as a basis for assigning outstanding debt in the event of a separation.

    3. Avatar Steve Jones says:

      That would be a misunderstanding. Whilst BT’s pension contribution for the current workforce will be taken into account (as part of operational costs) for each business division, the same is not true for deficit payments. Those are treated as exceptional group items.

      The same is true for Ofcom’s calculation on those wholesale products subject to regulator pricing. Ofcom does not allow pension deficit payments to be included in OpenReach’s cost base. (That’s not true in all the privatised utilities where pension deficit payments are included – or at least those incurred when the relevant company was in public hands).

      Note that the current pension scheme is on a much less generous basis, albeit still a “defined benefit” system – a relive rarity in the private sector. The previous terms were essentially what was inherited with the 260,000 workforce in 1984 and was basically a mirror of public sector systems.

      nb. The BT pension deficit has widened in the recent past to £7bn which is a combination of pensioners living longer and reduced returns on investments. I suspect it might yet get wider (although some of the liabilities have been hedged). The total pension liability is around the £50bn mark (and the £7bn deficit is the difference between that and what the fund is meant to be worth). Interesting to compare this with the estimated cost of a national FTTP network, reckoned to be in the region of £25-30bn.

    4. Avatar Steve Jones says:

      “relative rarity”, not “relive rarity” of course…

    5. Avatar GNewton says:

      @SteveJones: What about the crown guarantee as regards pensions?

    6. Avatar Steve Jones says:

      @GNewton

      The Crown Guarantee only comes into effect should BT go bankrupt and it certainly can’t be used to remove the liability. What might happen in the event of an enforced split, I’ve no idea. It may be that the liability will be split two ways and that in the event of either successor company going bankrupt that the state will pick up the responsibility for that part. Or it might be that both successor companies would have to pick up the responsibility for the full deficit should he other fold, and the Crown Guarantee would only come into play if both failed.

      In any event, I doubt the state will want to be exposed to the possibility as they were with the Royal Mail where the £8bn deficit was picked up by the government. That may well mean that the Treasury will take an active interest.

    7. Avatar dragoneast says:

      Thanks. I should have mentioned the CMA! So, it seems to me, Ofcom can essentially “kick the issue into touch”, leaving it to the CMA and BT, with a very uncertain result, both in terms of the outcome and the effect on end-users (as well as timescale); or review their regulation, which they will sooner or later have to do anyway.

      I do not see why an “independent” OR would need less regulation, it might need more. For instance, what would prevent them from essentially deciding to compete more aggressively with Virgin, which is where the concentration of EUs are, and leave the roll out to more difficult populated rural and suburban areas entirely to state subsidy? Differential charging related to the cost of provision, too. I suppose the latter might “encourage” competition, but not much. The benefit to EU’s, even less clear.

      Four things come to mind:
      1. Is the “real issue” the status of BT as a vertically-integrated utility? That goes far wider than “just” OpenReach.
      2. The CMA seem to have shied away from restructuring the Banks, leaving it to parliament. Another vertical integration case. Even where the effect on competition is arguably of more importance, and greater.
      3. BG seems to be a case where a utility did this sort of voluntary divestment, but where the infrastructure was a far more stable business, and could be more easily separated. As far as I can tell, when it comes to matters such as infrastructure renewal, it’s been the regulator that’s had to take the driving seat.
      4. I’m just not sure that there is this huge scope to cut costs in OR without impacting the service or major investment. It’s always the Holy Grail, and about as hard to find. Cut costs and impact the service adversely, now that’s a different matter. Is that the result that anyone wants? Who are these investors? As far as I can see they like what they know, and look for stability, not uncertainty. The three uncertainties are (1) no international market for this sort of division (the New Zealand example does not constitute an international market); (2)the impact of future regulation and (3) the impact of the developing technology.

      The commercial case for a BT divestment is an interesting one, and seems to me to have received far less attention. What is it, exactly? I think it has to be more than “avoiding an argument”. Loading up an independent Openreach with it’s “fair share of debt”, if any one will take it on, sounds superficially attractive to BT’s bottom line. For the EU’s, I am less sure. Why would BT retain the debt, to “let OR get away successfully”, voluntarily?

    8. Avatar dragoneast says:

      And yes I forgot, the biggest uncertainty of all, the pension fund. Though that’d have to be sorted out first, not afterwards!!

    9. Avatar themanstan says:

      Assuming that VM reaches 70% of the population, they are already a quad play operator (which is purpose of BT and EE merger), with a spun out OR what prevents VM from becoming the new dominant player? So instead of competition between 2 “equal” entities there is none… they´d essentially balanced their debt ratio. OFCOM apparently gving the nod that SMP won´t be applied.

      To me OFCOM appears to be unable to regulate for future issues. It can only be reactive…

    10. Avatar Steve Jones says:

      I doubt very much that the CMA will consider niceties like the split of pension liabilities or debt allocation should they have this referred to them. That will be a little thing to be picked up after a high level decision was taken. It’s a highly detailed and complex thing to sort out with the the scope to be highly contentious. The main LLU operators for sure will want the maximum liability loaded onto BT Retail with the minimum on Openreach (their interests are in keeping wholesale prices as low as possible) and handicapping BTR as much as possible as a competitor. Existing shareholders on the other hand will almost certainly want more costs loaded on OR as and reduced costs would almost certainly just end up with reduced returns due to the regulatory regime and BTR’s value would suffer enormously.

      I can’t see that the competition to BTR would allow BT a free hand in dividing this stuff up either. The winners from this lot will be lawyers, bankers, business consultants and so on. They are probably running their hands in glee at the prospect.

    11. Avatar Ignition says:

      Think as VM are only an MVNO rather than a full on network operator they aren’t considered relevant as far as mobile goes.

  5. Avatar GNewton says:

    “If Ofcom propose that BT divests OpenReach, can it be forced under their existing powers or does it require new primary legislation?”

    I think it will require a new kind of regulation which be easier to carry out, more streamlined. The remainder BT may not need as much of a regulation, if any, at all, and would have more freedoms to make business decisions without Ofcom interference. This could be of benefit for end-customers as well as shareholders.

    1. Avatar FibreFred says:

      I think you misunderstood, the question was can Ofcom force BT to split off Openreach the answer is no it cannot, see Steve Jones comment

    2. Avatar GNewton says:

      According to the Ofcom digital communications review there are 4 options:

      1) Retaining the current model, where Openreach operates as ‘functionally separate’ from BT, and using regular market reviews to address any concerns around competition;

      2) Strengthening the current model by applying new rules to BT – such as controls on its wholesale charges with stronger incentives to improve quality of service, or tougher penalties if BT falls short;

      3) Separating Openreach from BT could deliver competition or wider benefits for end users. It would remove BT’s underlying incentive to discriminate against competitors. Separation could also offer ways to simplify existing regulation. However, the process would be challenging and it may not address some concerns relating to Openreach – such as service quality, or the timing and level of investment decisions;

      4) Deregulating and promoting competition between networks. Virgin Media and a variety of smaller operators own networks, which allow them to provide phone and broadband services without using BT’s network at all. This kind of ‘end to end’ competition, which sometimes involves running fibre lines directly to premises, can help incentivise Openreach to improve its infrastructure. However, it could also lead to duplication of networks and weak competition.

      There are good reasons that something needs to be done here. The Openreach Trustpilot reviews shows a low rating of 3.9/10. The BT customer service is not sufficiently qualified to deal with Openreach issues on behalf of customers. Maybe conflict of interests within BT?

    3. Avatar TheFacts says:

      Could be worse, Vodaphone score 0.3/10.

    4. Avatar FibreFred says:

      “There are good reasons that something needs to be done here. The Openreach Trustpilot reviews shows a low rating of 3.9/10. The BT customer service is not sufficiently qualified to deal with Openreach issues on behalf of customers. Maybe conflict of interests within BT?”

      LOL, there are 8 reviews on Trustpilot for Openreach, 5 probably written by yourself, you really do come out with some crackers

      It sounded like we were talking about a sample size of tens of thousands

      8 people 😀

    5. Avatar GNewton says:

      @TheFacts: Not surprised about Vodafone. They got in a mess in other countries, too, Australia comes to my mind.

  6. Avatar GNewton says:

    @FibreFred: “8 reviews on Trustpilot for Openreach, 5 probably written by yourself,”

    In all seriousness, accusing others of writing fake reviews, or repeatedly tring to ridicule other posters on ISPReview, makes you look really silly here. If Mark Jackson doesn’t ban you from this forum, rest assured I will totally ignore your baseless posts. Go somewhere else if you want to defame posters.

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