Mobile call termination market review Ofcom. 4 June Response by Telefonica UK Ltd

Transcription

1 Mobile call termination market review Ofcom 4 June 2014 Response by Telefonica UK Ltd

2 Executive summary Telefonica UK Ltd ( Telefonica ) welcomes the opportunity to respond to Ofcom s consultation document on mobile call termination 1. Contrary to Ofcom s proposed approach, Telefonica s position is that consumers interests would be best served if MTRs were set at a level in excess of LRIC (compared to setting them at LRIC). That is because we do not believe that the competition benefits of further reductions in MTRs would be significant. In any event, we take the view that they would be outweighed by the allocative efficiency losses generated by further reductions in MTRs. In the context of choosing either the LRIC or LRIC+ cost standards to cap MTRs, we therefore believe that Ofcom s statutory duties would be better served by the adoption of the latter. However, we think that the choice between the two cost standards is a false dichotomy. The policy implications resulting from a finding that MTRs in excess of LRIC are likely to be in consumers interests are not restricted to the selection of the LRIC+ cost standard to set MTRs. For example, it seems to Telefonica that Ofcom might seek to maintain the current mark-up of MTRs above LRIC throughout the next charge control period. Alternatively, if LRIC is to be used to set MTRs, and in the context of the inherent uncertainty in forming a view about various parameters for its cost modeling work, Ofcom might adopt a risk asymmetry approach and select variables that would lead to a higher estimate of LRIC. Telefonica believes that these are credible policy options which merit careful consideration. Telefonica has commissioned an analysis of the impact of reducing MTRs by Alix Partners and we attach their report as an Annex to this response. We also have concerns about Ofcom s proposed one-off, immediate reduction of MTRs to LRIC. Ofcom s long-held policy position is that glide-paths are a more appropriate means of reducing charges, and the arguments now presented by Ofcom in favour of a one-off reduction to MTRs in this consultation do not bear scrutiny. 1 Mobile call termination market review Ofcom, 4 June

3 Finally, whilst we welcome the proposed charge control on smaller MCPs, we think that Ofcom needs to retain the flexibility to set rates lower, in the context of a dispute about the charges of asset-light providers. The approach proposed by Ofcom in the consultation document would allow such MCPs to set MTRs in excess of costs, contrary to Ofcom s policy objectives, and this would act against consumers interests. In the remainder of this response, we provide answers to selected questions set out in the consultation document. 3

4 Answers to selected questions Question 5.4: Do you agree with our proposal to impose a price transparency obligation on all MCPs with SMP? If not, please explain why. No, we do not agree with the proposal to impose a price transparency obligation on all MCPs with SMP. On the assumption that Ofcom follows through with its proposal to impose a charge control on all MCPs with SMP (and not just the largest four), then all MCPs must, by virtue of SMP regulation, charge no more than the permitted rate. Experience strongly suggests that MCPs will charge the permitted rate. Further, Ofcom proposes to continue to publish the regulated charge several months before it comes into effect 2. Therefore, an additional transparency obligation appears to Telefonica to be completely otiose. Ofcom is required to ensure that regulation is objectively justified, targeted and proportionate. It appears to Telefonica that the proposed transparency obligation would satisfy none of those criteria. Question 5.7: Do you agree that our proposal to impose a charge control on all other MCPs with SMP is also appropriate? If not, please explain why. Telefonica agrees with the proposal to impose a charge control on all other MCPs with SMP, assuming that the largest four MCPs will be subject to a charge control, for the reasons set out in paragraphs of the consultation document. However, we are concerned that the charge control approach would limit Ofcom s ability to enforce charges below the benchmark rate where MCPs, such as assetlight MCPs, have efficiently incurred costs lower than this level 3. Experience suggests that this would be likely to be exploited by some providers. For example, providers might fund international call forwarding services or some other revenue sharing arrangement from revenues that exceed costs. Originating communication providers may well react by excluding calls to such services from retail call bundles, 2 See paragraphs See paragraphs

5 and this would harm consumers interests in the way described by Ofcom in paragraph Telefonica does not agree that the imposition of charge controls on smaller SMP means that a fair and reasonable duty cannot also be imposed, as Ofcom implies in paragraph Indeed, under the current charge control regime, the four largest MCPs are subject to both a fair and reasonable obligation and a charge control 4. Our preference would be the retention of both a fair and reasonable duty on all MCPs and the imposition of a charge control on smaller MCPs (assuming that the four larger MCPs would also be subject to charge controls). This would be in consumers interests because it would prevent smaller MCPs from charging rates in excess of the charge control and provide Ofcom with sufficient flexibility to impose lower charges on asset light MCPs (in the context of resolving a dispute). Question 6.1: Do you agree that the above framework is the appropriate one? If not, please explain why. Yes. Ofcom s proposed analytical framework is essentially the same as that adopted for the previous review, which emerged intact following the subsequent Competition Commission enquiry. In the circumstances, it seems appropriate to adopt it for the current market review. Question 6.2: Do you agree with our analysis and views on allocative efficiency? If not, please explain why. No. We believe that allocative efficiency is best served by setting mobile termination rates higher than LRIC, both on theoretical grounds and given the available empirical evidence. 4 By virtue of Condition M1.2 and M1.3 5

6 In our view, from a theoretical perspective, common costs should be recovered across all services that MCPs provide, retail and wholesale 5. The available evidence suggests that the reduction in MTRs brought about by the current charge controls has had a material and negative impact on low usage pre-pay customers, whilst fixed users, particularly fixed residential customers, have not benefitted from lower prices. We would refer Ofcom to sections 3 and 5 of the accompanying Alix Partners report for a more detailed discussion of the issues. Question 6.4: Do you agree with our analysis and views on competition impacts? If not, please explain why. No. The evidence suggests that Three has been able to compete effectively against the larger MCPs even though MTRs have, by Ofcom s analysis, been above LRIC for the entire period of the current charge control. The recent reductions in MTRS do not appear to have had additional impact on Three s ability to compete that would be expected if the competitive effects identified by Ofcom were significant. We would refer Ofcom to sections 3 and 4 of the accompanying Alix Partners report for a more detailed discussion of the issues. As regards competition between MCPs and FCPs, we found Ofcom s analysis unconvincing. The fact that FCPs have managed to retain the majority of reduction in MTRs (and, in respect of residential fixed customers, effectively all of it) suggests that they are not subject to a competitive constraint in terms of calls to mobiles pricing. Accordingly, Telefonica believes that there are no significant competition impact benefits to be had by further reducing MTRs in the way that Ofcom is proposing. 5 Assuming that it is not possible for fixed and common costs to be recovered from lump sum taxes 6

7 Question 6.5: Do you agree with our analysis and views on the impact on vulnerable consumers? If not, please explain why. No. Telefonica believes that further reductions in MTRs will have a negative impact on vulnerable customers. We note the evidence presented by Ofcom reveals that low income customers and customers from lower socio-economic groups over-index in terms of pre-pay ownership. Telefonica believes lower MTRs caused usage prepay customers material detriment (see section 5 of the accompanying Alix Partners report). We also note the increasing proportion of mobile only households, and the reduction in fixed only households. Again, low income consumers and those from lower socioeconomic groups are over represented in mobile only households. We do not believe that the benefits of lower MTRs have been experienced by fixedonly customers, because residential fixed to mobile retail prices have not fallen and there is little evidence that other prices that fixed customers pay are lower than they would otherwise be. There is, instead, evidence that FCPs have used the reduction in their costs brought about by lower MTRs to fund other activities (for example, the acquisition of sports broadcasting rights 6 ). Question 6.7: Do you agree with our proposal that LRIC should continue to be the appropriate cost standard? If not, please explain why. No. Our view, in summary, is that the evidence suggests that consumer welfare would be maximised if mobile termination rates were set in excess of LRIC. We believe that there would be an unambiguous increase in allocative efficiency (compared to setting MTRs at LRIC) and that no significant benefits to competition would be gained by reducing MTRs from their current level. Indeed, in our view, it is possible that consumer welfare would be increased if charge controls were set above the current level. In the context of a choice between the LRIC and LRIC+ cost standards, we would advocate the latter. 6 See: for example 7

8 However, we think that the choice between the two cost standards is a false dichotomy. The policy implications resulting from a finding that MTRs in excess of LRIC are likely to be in consumers interests are not restricted to the selection of the LRIC+ cost standard to set MTRs. For example, it seems to Telefonica that Ofcom might seek to maintain the current mark-up of MTRs above LRIC throughout the next charge control period. Alternatively, if LRIC is to be used to set MTRs, and in the context of the inherent uncertainty in forming a view about various parameters for its cost modeling work, Ofcom might adopt a risk asymmetry approach and select variables that would lead to a higher estimate of LRIC. Telefonica believes that these are credible policy options which merit careful consideration. We would refer Ofcom to the section 6 of accompanying Alix Partners report for a more detailed discussion. Question 7.1: Do you agree with our proposed modelling approach as discussed in this section, the supporting annexes and the 2014 MCT model? If not, please discuss the specific proposals that you disagree with. Telefonica has several specific points to make on Ofcom s modelling approach: Continued inclusion of 2G and 3G technologies. Telefonica supports the approach that Ofcom proposes to take, described in paragraphs A11.40 A BT is, in our view, wrong to seek to draw an analogy with the approach taken by Ofcom in the 2013 FNMR 7, since in that review, Ofcom adopted a position about core network architecture, with no implication to the end user. Conversely, the implications for potential customers of a new entrant in the mobile market deploying 4G only, summarised by Ofcom at paragraphs A11.43 A11.45, would be significant. It will be interesting to see whether BT, which purchased a significant amount of 2.6 GHz spectrum in March 2013, seeks to launch a 4G only service, in due course. 7 See paragraph A

9 Handset migration. Ofcom sets out the approach it proposes to take on 4G handset migration in paragraphs A11.06 and A Ofcom explains that the calculation of the number of new handsets requires an assumption of the market (average) rate of subscriber churn, which Ofcom estimates as 40%. In footnote 39 of Annex 11, Ofcom states that it has used subscriber churn as a proxy for handset churn. In Telefonica s view, 40% over-estimates the extent of likely handset churn for several reasons Firstly, there is a distinction to be made between post pay churn and pre-pay churn. Telefonica s experience is that the former is far lower. For example, Telefonica s most recent reported monthly post-pay churn rate was 1% 8. That equates to an annualised rate of 12.7%. We understand that other MCPs have low post-pay churn rates. This is important, because the majority of 4G users are post-pay customers. At present, there are [ ] O2 4G post pay customers, compared to around [ ] 4G pre-pay customers. Accordingly, subscriber churn amongst customers that use 4G devices appears to be significantly lower than Ofcom s estimate of 40%. We would suggest that 12.7% (i.e. the equivalent to a monthly rate of 1%) is a better estimate. Secondly, there is evidence that customers are, on average, keeping their handsets for longer (i.e handset churn is falling): Ofcom s own research 9 shows that the proportion of SIM only deals (whereby customers use an existing handset) has increased over the last few years and, in 2013, accounted for 12.9% of all post pay agreements (i.e. 8% of all connections, of which 62% were post pay connections). This had risen from 9.6% of post pay connections only two years earlier. Telefonica s experience in the market place suggests that SIM only deals are becoming increasingly popular. Our most recent data show that [ ]% of consumer post pay contracts are for SIM only deals; 8 See the final bullet point on page 56 of Telefonica s 2013 annual report: 9 See Figure 99 in section 7 of Ofcom s recent Consumer Experience research: 9

10 The research referred to above also reveals the increasing proportion of post pay contracts which run for longer periods: GfK sales data shows (Figure 102) that two-thirds of new paymonthly mobile sales in Q had a minimum contract period of 24 months, unchanged from However, 18- month contracts, which accounted for almost three-quarters of contract sales five years ago, had all but disappeared by Q1 2013, partly due to increasing smartphone take-up (as longer contracts enable consumers to spread the cost of the handset, which can be hundreds of pounds, across more monthly payments, therefore keeping monthly rental fees down).. 10 Thirdly, the use of a standard churn rate for the entire mobile base assumes that customers have a homogenous propensity to churn handsets. This appears to Telefonica to be unrealistic; some customers are likely to churn their handset more frequently than others. The important point here is that once a customer has churned onto a 4G handset, it is irrelevant (for the purpose of Ofcom s modelling), if they subsequently churn onto another 4G handset. Ofcom is seeking to measure the extent to which non 4G-handset users migrate to 4G handsets. This evidence suggests that Ofcom s estimate of a handset churn rate of 40% is too high. Telefonica believes that Ofcom should consider this parameter again to reflect recent market data and the likelihood that customers propensity to churn handsets is heterogeneous. VoLTE enabled handsets. In paragraph A11.108, Ofcom sates that it expects the percentage of VoLTE enabled handset to increase once MCPs roll out VoLTE services. [ ]. 10 Page 96 in section 7 of Ofcom s recent Consumer Experience research: 10

11 Question 8.1: Do you agree with our proposed approach to implementing the MCT charge control? If not, please discuss the specific proposals that you disagree with. No. Telefonica does not agree with Ofcom s proposal to limit the charge control to LRIC for each and every year of the charge control 11. An immediate cut to LRIC at the outset is, in effect, a P0 adjustment. Ofcom has, in the past, shied away from making P0 adjustments and generally allowed MCPs a glidepath when regulating mobile termination rates. Indeed, in its 2012 mobile call termination determination, the Competition Commission commented: As it pointed out in the Defence, Ofcom has stated that it has a strong preference for glide paths, rather than [one-off] adjustments, to align charges to costs 12 Given this approach, and the need for Ofcom to have regard to the principles under which regulatory activities should be consistent 13, in Telefonica s view, if Ofcom wishes now to make a P0 adjustment, it needs to make a sufficiently good case in favour of it. We believe that the arguments advanced by Ofcom in the consultation document fall short of this. Ofcom s approach is to argue that rates should fall to LRIC as quickly as possible, whilst allowing providers and consumers sufficient time to adjust 14. It goes on to argue that MCT is a two-sided market and that providers are able to increase revenues from subscribers 15, the implication being that providers do not need any time to make adjustments. Telefonica does not follow this line of reasoning. It is indisputable that both the calling party and the called party benefit from any particular call and that, therefore, this is a two-sided market. However, this is nothing new; that has always been the case. This observation provides no insight as to the speed at which providers and customers can adjust to new levels of wholesale charges (indeed, the implication is that adjustment can be made instantaneously, which would be inconsistent with the approach that Ofcom has previously taken). 11 See paragraph Paragraph 5.96 of the Competition Commission s Determination, 9 February 2012, refers 13 Section 3(3)(a) of the Communications Act 2003 refers 14 See paragraph At paragraph

12 As Ofcom notes in its recent research 16, most new pay monthly connections are made for a contract period of two years. Tariffs are developed on the basis of anticipated costs and revenues, including call termination costs and revenues. Given Ofcom s stated preference for glidepaths,, MCPs are likely, reasonably, to have assumed that there would be a glidepath for the charge control commencing in April 2015 (that is, that rates would be brought down to costs from April 2017), and that there would be no P0 adjustment. Ofcom s assertion, at paragraphs 8.73 and 8.74, that the proposed reduction in MTRs is negligible suggests that the anticipated benefits from such a reduction are likely to be insignificant. However, given Ofcom s statutory duty to have regard to principles under which regulatory activities should be targeted only at cases in which action is needed 17, this cannot be the case. Accordingly, Ofcom must believe that the reductions in MTRs that it is proposing are material. Telefonica agrees; that is why their implementation must be staggered in the usual way, under a glidepath. Ofcom also comments on the risk of setting MTRs below LRIC by the use of a glidepath, at paragraphs Telefonica does not agree with Ofcom s argument in favour of a symmetric approach to one-off adjustments for two reasons: 1. It is hypothetical. The fact of the matter is that Ofcom s cost modelling suggests that the LRIC of terminating a call on a mobile network is lower than the current mobile termination rate. Telefonica cannot recall any occasion on which Ofcom s cost modelling has revealed an instance of rates being lower than costs; and 2. there is no reason to believe that a symmetric approach is desirable, Ofcom has simply assumed that to be the case. Indeed, given the possibility 18 that welfare is maximised if termination rates are set at a level in excess of LRIC and Ofcom s expressed concern at the prospect of rates being set below LRIC 19, there appears to be good reason to assume that an asymmetric approach to one-off adjustments 16 Page 96 in section 7 of Ofcom s recent Consumer Experience research: 17 Section 3(3)(a)of the Communications Act 2003 refers 18 Indeed, Telefonica believes that this is the case 19 See paragraph 8.77 of the consultation document 12

13 (i.e. rates should never be lower than LRIC) would be in consumers interests and, therefore, preferable given Ofcom s statutory duties. Accordingly, on the basis of the evidence provided, we consider that the better of the two options that Ofcom has considered, in terms of satisfying its statutory duties, is the glide path approach, described in the first bullet point in paragraph 8.66 of the consultation document. In passing, we would observe that Ofcom has set up a false dichotomy in paragraph 8.66, in suggesting that the choice is between a three year glidepath and the imposition of LRIC based charge controls for each and every year of the charge control. There is at least one other option that might merit consideration: a two year glidepath (under which, rates would be brought down to costs in the final two years of the charge control). This might be regarded as analogous to the outcome following the Competition Commission s 2012 determination (because, under the amended charge control, rates were brought down to costs in the final two years of the present charge control period). 13