Strengthening fibre investment incentives in unserved areas

Transcription

1 Strengthening fibre investment incentives in unserved areas April 2017

2 About this paper This paper ( Paper ) was prepared by Liam Colley and Matt Hunt, Managing Directors in the Economics practice at AlixPartners UK LLP ( AlixPartners ), at the request of Vodafone Group Services Ltd ( Vodafone ) exclusively for the benefit and use of Vodafone. The views expressed are those of the authors and do not necessarily reflect the views of AlixPartners UK LLP, its affiliates, or any of its or their respective other professionals. AlixPartners has agreed to the publication of this Paper on this website for general information on a strictly non-reliance basis only. AlixPartners does not accept or assume any duty or responsibility or liability to any person who accesses this Paper, or, to whom this Paper is shown. The information in this Paper reflects conditions and our views as of its date, all of which are subject to change. About Us AlixPartners economists help clients face significant antitrust, litigation, regulatory and commercial challenges. In these situations, the outcome often depends on a proper understanding of relevant economic theory and a rigorous approach to collating and assessing empirical evidence. We support companies and their counsel by providing expert evidence, testimony and advice to address the most important issues when it really matters. Our clients benefit from the responsiveness and resources of a global firm with local teams in Chicago, London, Los Angeles, New York, Tokyo, and Washington, DC. We also draw on an academic affiliate network with specialist capabilities. Credible economic analysis often also depends on robust evidence on accounting and data issues, and extensive industry knowledge. Accordingly, our economists work closely with our forensic accounting, data analytics, and industry experts to provide an integrated approach. Copyright Copyright All rights reserved. No part of this Paper may be translated, reprinted, reproduced or utilised in any material form either, in whole or in part, by any electronic or mechanical means without the prior written permission of the authors, except in accordance with permitted uses and provision of the Copyright, Designs and Patents Act

3 1. Introduction and executive summary Vodafone has asked us how commercial investment in new fibre to the premise ( FTTP ) networks can be promoted. This issue is being raised in the context of Vodafone s concern that dominant incumbent operators can undermine rival operators investment incentives and discourage network deployments that compete with the incumbents own networks. Vodafone is concerned that such behaviour can weaken the competitive pressure on incumbents to invest in their own FTTP networks, and allow them to limit the speed and extent of fibre deployment. The European Commission has set out an ambitious vision for the creation of a Gigabit society in Europe with significantly increased geographic coverage of very high capacity networks by In practice, we understand that networks that can deliver Gigabit speeds will be based on FTTP technologies. 2 At present, the coverage of FTTP networks is very limited in most Member States, particularly outside of high density urban areas, and significant investment will therefore be needed to meet the Commission s policy goals. 3 In this context, the promotion of increased investment of FTTP networks is thus an important priority. Incumbent operators of legacy copper networks will be a key source of the necessary investment as they make the transition to FTTP technologies. However, investment by cable operators, fully independent FTTP networks, and other operators that rely on passive access to existing civil infrastructure to roll out FTTP networks can also play an important role in deploying FTTP networks. These operators can provide an alternative source of capital and resources to roll out FTTP networks and act as a competitive spur to incumbents that will help drive investment. Regulation has an important role to play in ensuring dominant incumbents are not able to unfairly deter investment by rival operators in order to protect their market power. A weakening of rival operators investment incentives would undermine the competitive pressure on incumbents to deploy FTTP networks and allow them to better control the speed and extent of roll-out. The resultant chilling of investment incentives risks undermining the Commission s Gigabit society goal. We take as given that the objective is to promote widespread deployment of FTTP networks. Our purpose in this paper is two-fold. First, we explain how incumbents could 1 The Commission has set a strategic objective that by 2025 all households, both rural and urban, have access to networks that offer a download speed of at least 100 Mbps, and which can be upgraded to 1 Gigabit. See COM(2016) 587 final: Connectivity for a Competitive Digital Single Market Towards a European Gigabit Society p.8. 2 For simplicity, we refer to FTTP networks in this paper, whilst recognising that cable operators may use alternative technologies when building new networks. Such networks would also be covered by the proposed scheme outlined in this paper. 3 Networks that currently offer download speeds of 100Mbps+ are available to 25% of EU homes, with take-up of 11%. See SWD(2016) 313: Evaluation of the regulatory framework for electronic communications, p.28. 3

4 discourage rival operators FTTP network deployments by targeting their own investments so as to overbuild areas within rival operators network footprints or by announcing plans to do so but not realising them. Second, we discuss how regulators can mitigate the risk of strategic overbuilding as part of their efforts to promote FTTP investment. Our focus is on identifying the key issues that regulators need to address and setting out how these can be implemented in practice. This paper sets out a regulatory approach to promote investment that is designed to limit the risk of strategic overbuild of new FTTP networks by incumbent operators by providing a limited period of overbuild protection to the rival operators undertaking these investments. The scheme has been designed to increase the incentives for both incumbent operators and rivals to invest in FTTP networks and thus assist in achieving the European Commission s goal of a Gigabit society. It seeks to carefully balance the benefits of intervention, addressing the risks of strategic overbuild to increase the deployment of FTTP networks and services by both incumbents and their rivals, whilst minimizing the potential risks of the approach through careful implementation. The proposed approach in this paper seeks to build on the proposals in the Commission s draft European Electronic Communications Code ( the draft Code ) 4 that regulators should undertake geographical surveys of network deployments with the aim of encouraging deployment of FTTP networks. By doing this the proposed approach aims to limit the additional burdens on regulators and operators. The remainder of the paper is organised as follows: Section 2 explains the importance of rival operators as alternative investors to incumbent operators. Section 3 explains how incumbents with market power can undermine rival operators investment incentives through the threat of strategic overbuilding in order to preserve their market power and profits from their legacy copper networks. Section 4 discusses the proposed regulatory approach and explains how it can reduce the risk of strategic overbuild and how it can be implemented. Section 5 concludes. An annex considers the potential risks of this form of intervention and explains how the proposed approach has been designed to limit such risks. The paper considers commercial investment decisions i.e. those that are determined solely on the basis of the revenues earned and costs incurred by the operators making those investments with no government intervention. In particular, we do not consider investment in high cost uncommercial areas that involve government subsidy or a USO 4 COM(2016) 590 final/2, Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL establishing the European Electronic Communications Code. 4

5 scheme to support network investment. We also recognise that the Commission may need to consider whether the proposed approach is compatible with State aid legislation. 5 5 Whether or not this approach is compatible with State aid legislation is beyond the scope of the paper. 5

6 2. The role of competition in driving FTTP deployment Commercial investment in FTTP infrastructure is driven by operators assessment of whether the prospective incremental profits that result from the investment will provide an adequate return on the capital required. In practice, this means that operators must be confident of achieving a sufficient number of customers on the FTTP network so that the expected profits are large enough to allow the recovery of the significant fixed and sunk costs of network investment and make a reasonable return. At present FTTP network coverage is very limited in most Member States, and there are significant numbers of premises that currently only have access to legacy copper networks (which may have been upgraded using e.g. G.fast or vectoring technologies) but not to FTTP networks. 6 The Commission is keen for operators to deploy FTTP networks to these premises. However, the scope for commercial deployment of one or more FTTP networks in areas can vary widely between different geographies, depending on local market conditions, including the density distribution and socioeconomic characteristics of households in the coverage area, the cost of laying fibre, and the performance of the existing legacy network. 7 Conceptually, it is helpful to distinguish between three different market structures that could arise in the areas that are currently unserved by FTTP networks as follows: Competitive areas: these are areas where 2 or more competing FTTP networks are potentially commercially viable. 8 This outcome is more likely in higher density urban areas where deployment costs are lower and demand higher. Challenge areas: these are areas where entry by one FTTP network is commercially viable, but not by a second FTTP network. This outcome might occur in lower density urban and some semi-rural areas. Non-commercial areas: these are lower density (e.g. rural) areas where commercial deployment of FTTP is not economically viable. Securing the availability of FTTP networks in non-commercial areas will require government subsidy in some form to allow investors to cover the gap between the cost of deployment and the revenues earned from providing connectivity services to customers. These non-commercial areas are not considered further in this paper. However, we note that regulatory measure to support commercial investment, including measures to lower deployment costs (e.g. ducts and pole access, or reforms to planning regulations), 6 See footnote 3 above. 7 The market share which enables a rival operator to make an adequate return can be considered to the critical market share. In general, critical market shares are significantly higher if deployment involves significant expenditure on civil infrastructure given the risks of unrecovered fixed and sunk costs. Conversely, critical market shares can be reduced if existing infrastructure can be reused (e.g. where operators can make use of passive access to incumbents duct and pole infrastructure, since this reduces the fixed cost of deployment. 8 We note that there is a separate question whether the number of competing networks is sufficient to ensure effective competition in in downstream markets. 6

7 and/or increase revenue prospects (including the type of overbuilding protection discussed below), can play an important role in reducing the need for state subsidy by preserving investment incentives in challenge areas and thereby decreasing the size of non-commercial areas. The extent of these different types of areas is not absolutely fixed and will depend on operators expectations of the incremental revenues and incremental costs of FTTP investment compared to their best alternative strategies. These expectations are likely to change over time as operators expectations regarding the incremental revenues and costs develop. For example, if new services which operators can monetise on FTTP networks are developed this may expand the potential revenues. Similarly, new developments in network deployment may reduce the costs of laying new ducts or laying fibre in existing ducts or on poles. However, whilst acknowledging that the boundaries of the areas are not well defined and fixed, to analyse the impact of the proposed approach it is helpful to differentiate between competitive and challenge areas. Sustainable infrastructure-based competition is in principle feasible in competitive areas. Where there is entry by rival operators the resultant network competition will provide a spur to ongoing network investment and innovation as networks compete on the basis of speed and quality as well as price. By contrast, in challenge areas, infrastructure-based competition is not sustainable and would not be expected to emerge. There is, however, the important possibility of competition for the market in challenge areas, where rivals seek to be the first to deploy a network in order to become the single FTTP network provider. The potential entry of a rival operator deploying an FTTP network provides an important source of competitive pressure on incumbent operators that would otherwise not exist, and can create a race to invest in both competitive and challenge areas. If the incumbent delays investment (or does not invest at all), it faces the risk that a rival operator will enter with a network that outperforms the incumbent s legacy copper network in terms of speed and reliability. This can put significant competitive pressure on the incumbent and result in the loss of retail and wholesale market share to the new entrant and a significant reduction in profits. If there is no credible potential entry by a rival FTTP network the incumbent operator can take the FTTP deployment decision considering maximising its own profits in the absence of competition. In this scenario, the incumbent s investment incentive is blunted by the fact that deployment of its own FTTP network will cannibalise (or replace) the profits from its legacy network. The threat of entry by a rival intensifies the incumbent s investment incentive since its legacy profits will be reduced in any event In other words, entry by rival operators reduces the incumbent s expected legacy network profits in the counterfactual i.e. where it does not invest in its own FTTP network. Since an incumbent would assess the business case for FTTP investment against the counterfactual profits, its incentive to invest in FTTP is increased by lowering the counterfactual profits. This assumes that incumbent profits are reduced by a rival operator s entry by less if the incumbent has invested in its own FTTP 7

8 Thus potential entry ensures that the incumbent is not able unilaterally to determine the speed and extent of commercial FTTP coverage. Given the European Commission s Gigabit society goals, this is desirable from a policy perspective since it promotes faster and more extensive FTTP deployment in currently unserved areas, and particularly in challenge areas. In practice, we understand that investment by rival operators in FTTP networks in currently unserved areas is unlikely to happen if it requires significant investment in new civil infrastructure (such as ducts, trenches and poles), given the significant cost involved. This reflects the fact that replication of ducts and poles is unlikely to be economically viable outside high density urban areas. Instead, rival operators are likely to need to rely on passive access to the incumbent s ducts and poles (or potentially to other existing civil infrastructure e.g. electricity distribution networks) to reduce the cost of deployment (potentially in a co-investment arrangement with other operators). To maximise the scope for competitive entry, it is therefore important that readily usable passive access services are available to entrants. In order to focus on the issue of strategic overbuilding, for the purpose of this paper we assume that regulators have taken necessary steps to ensure the availability of suitable passive access services on a non-discriminatory basis. network compared to the no incumbent FTTP investment counterfactual (or that entry by rival operators is not profitable if the incumbent deploys FTTP). 10 Incumbents may have a competitive advantage in the retail market due to vertical integration, e.g. if they have more control over the development of new products or access to better information compared to other retail competitors. If incumbents benefit from vertical integration to a greater extent on legacy networks compared to FTTP networks, it may act as a disincentive to them investing in FTTP networks. 11 We note that the Commission has proposed amendments to access regulation aimed at improving passive access to networks of operators with Significant Market Power (see Article 70 of the draft Code). 12 Another key issue that is relevant to our proposal, but is beyond the scope of this paper, is that the process for getting planning approval from local authorities or access to land could create a significant impediment to investment. Regulators and operators may need to work with local authorities to ensure that they understand the importance of speeding up these processes. 8

9 3. Strategic behaviour by incumbents can deter competitive investment As discussed above, FTTP investment by rival operators is expected to promote investment by incumbents. However, Vodafone is concerned that incumbents can undermine the commercial viability of FTTP investment by rival operators by strategically overbuilding their networks. 13 There are two forms of strategic overbuilding that are of concern: in challenge areas where only one FTTP network is expected to be viable; and in commercial areas which, in principle, can support multiple FTTP networks. Strategic overbuilding in challenge areas In principle, one would expect to see limited overbuilding in challenge areas, since by definition there is no scope for viable infrastructure-based competition. The business case for a second mover overbuilding the network of a first mover investor is therefore unlikely to be profitable on a standalone basis (i.e. ignoring any indirect effects on the viability and profitability of the operator then making investments in other areas). This suggests that incumbents and rival operators would seek to avoid the damaging effects of direct network competition on the commercial viability of investment in challenge areas by avoiding overlaps in network coverage. This outcome would be efficient, since it avoids the duplication of networks and keeps total cost down. Moreover, if entrants and incumbents focus on roll-out in different areas consumers would benefit to the extent that this helps to maximise the overall FTTP coverage from incumbents and rival operators in challenge areas. The incumbent may, however, have a strategic incentive to make an uncommercial deployment that is targeted at an area served by a rival operator s network in order to deter competitive investments in other challenge areas. Such overbuilding will limit the rival operator s ability to gain market share and hence undermine the profitability of its network investment. Moreover, the expectation that this outcome may occur in other areas where the rival operator is considering deploying will weaken the rival operator s incentive to invest elsewhere. In this sense, the cost of the overbuild deployment is a defensive investment that is made to weaken network competition and preserve or increase the incumbent s market power. In economic terms, strategic overbuilding is a form of anti-competitive conduct aimed at foreclosing competition. 14 The economic literature identifies two different mechanisms by which incumbents may be able to foreclose network competition strategically through a strategy of overbuilding rivals networks. 13 We use the term strategic overbuilding to refer to an incumbent s attempts to limit the commercial viability of FTTP investments by rivals. 14 Strategic overbuilding is a type of non-price based anti-competitive conduct. In some circumstances, dominant firm can also use price-based strategies to foreclose competition, such as predatory pricing. 9

10 The first possibility involves the incumbent investing pre-emptively in areas targeted by rivals before they have had the opportunity to roll-out their network. 15 If rivals expect this to be the case, this will clearly reduce their appetite to commit the resources necessary to plan further investments, and hence will chill competition. The ability of incumbents to invest pre-emptively in this way depends on whether they can reliably identify rivals investment plans in advance. This may be possible on the basis of public announcements made by rivals on planned deployment areas. Alternatively, incumbents could potentially use information on rivals requests to access ducts and poles during the planning stage to redirect its own planned deployments to deploy ahead of others. 16 The second possibility does not rely on incumbents being able to invest pre-emptively before rivals. Instead, incumbents may overbuild rivals networks once they have commenced roll-out in order to signal that they will respond aggressively to such deployments in future. 17 Strategic overbuilding can benefit an incumbent in three principal ways: First, by reducing the competitive pressure on the incumbent s profits from legacy services, thus protecting the economic value of its legacy copper network. Second, by ensuring that rival operators remain dependent on access to the incumbent s network to compete for customers in downstream retail markets. This is an issue if it allows the incumbent to exercise control on key strategic issues such as network investment, product design and service quality levels, or if it inhibits rivals from developing differentiated services. Finally, by undermining rivals investment incentives the incumbent can undermine competition and better control the speed and extent of its FTTP investments. It is very unlikely that rival operators will also seek to engage in strategic overbuilding to deter FTTP investment by an incumbent operator. There are three main reasons for this: First, unlike incumbents, rival operators do not have significant legacy profits to protect. 15 See Spence, M. (1977) Entry, capacity, investment, and oligopolistic pricing, Bell Journal of Economics, vol. 8(2), pp ; and Dixit, A. (1980) The role of investment in entry deterrence, Economic Journal, vol. 90, pp Any misuse of this information by the incumbent to redirect its own planned deployments so as to overbuild the area served by the rival operator more rapidly, or even pre-empt the rival operator by deploying more quickly, can be a potentially serious breach of non-discrimination obligations. 17 See Milgrom, P. & J. Roberts (1982) Predation, reputation, and entry deterrence, Journal of Economic Theory, vol. 27(2), pp

11 Second, provided that rival operators benefit from timely regulated access to the incumbent s FTTP network in areas where the incumbent has Significant Market Power ( SMP ), they have no interest in undermining this investment. 18 Finally, it may be more costly for a rival operator to overbuild an incumbent, for example if it faces higher customer acquisition costs, or higher deployment costs. As explained above, the viability of a rival operator s business case for FTTP investment depends on its ability to achieve the necessary market share and profits to cover the substantial sunk costs of deployment and make an adequate return on investment. Overbuilding by the incumbent will make it more difficult to achieve the critical market share, and can therefore be expected to substantially reduce or eliminate the profitability of the rival operator s investment. The chilling of investment incentives can result in slower or less extensive commercial deployment of FTTP networks and services. This will have an adverse impact on consumers through the reduced availability of high speed broadband services, and may also lead to increased reliance on state subsidy to support investment in challenge areas. In practice, it is likely to be very difficult for rival operators to assess the risk of overbuild in any given area. In part, this reflects the lack of visibility of the incumbent s (and other operators ) deployment plans. Incumbents can also depart from any published deployment plan if necessary to target investment at areas where rival operators plan to deploy, or have in fact deployed. For these reasons, an additional concern is that incumbents could use uncertainty over their investment plans, or announce plans that they do not intend to deliver, so as to maintain a threat of strategic overbuilding that introduces a significant downside risk into the business case for investment by a rival operator and which will reduce, and potentially eliminate, the incentive to invest. This possibility is of particular concern in challenge areas. The reason for this is that a rival operator s business case is likely to be particularly vulnerable to the threat of being overbuilt in these areas since the commercial viability of FTTP investment may be rather marginal. It is a serious concern that incumbents can prevent or delay FTTP investments by rivals by announcing plans to build their own FTTP networks, in response to rivals announcements. Merely announcing deployment plans may be sufficient to dissuade rivals from investing. After influencing the rivals investment plans the incumbent may decide not to invest itself or to delay its investment. In such a scenario consumers are not able to benefit from any investment in FTTP networks and services, which is the worst of all outcomes from an economic policy perspective if there is sufficient demand to justify such investments. 18 If regulated access is delayed, however, there is a risk that incumbents may be able to enhance market power in the retail market. 11

12 Strategic overbuilding in competitive areas One would expect that there is less risk of harmful strategic overbuilding in competitive areas. This reflects the fact that there is scope for more than one network to be economically viable, and this will serve to make it more difficult to deter entry in these areas. Moreover, it may well be commercially viable for an incumbent to overbuild a rival operator in a competitive area, unlike in a challenge area. It should also be noted that the incumbent cannot avoid ongoing network competition in areas that are served by an existing cable or FTTP network, even if it could prevent new entry by a rival operator. 19 Notwithstanding this, incumbents may be able to exploit the uncertainty in their investment plans to reduce the incentive of a rival operator to invest in a competitive area. For example, an incumbent could bring planned investment forward in an area covered by the rival operator in order to reduce the length of time in which the rival operator can benefit from the first mover advantage of being the only FTTP network. This would make it more difficult for the rival operator to achieve scale, all else equal, and could, in theory, have a chilling effect on rival operator investment, particularly in areas where the viability of a second network is rather marginal. If the incumbent is successful and investment by rivals is undermined, potentially competitive areas may become challenge areas. Again, a significant concern is that incumbents may engage in actions to threaten to overbuild but then not actually build (or delay roll-out) if rivals have been successfully dissuaded from investing. 19 In addition, there is a question of whether it would be commercially viable for a rival operator to build a FTTP network in areas served by existing cable or FTTP operators. 12

13 4. Using regulation to promote investment in unserved areas There are two main ways that regulators can promote operators incentives to invest in FTTP networks in unserved areas. 1. The first approach is through measures that seek directly to increase dominant incumbents incentives to invest in FTTP networks by increasing the incremental profitability of making these investments (relative to the profits from existing legacy networks in the counterfactual where no FTTP investment is made). 2. The second approach is through measures that seek to protect and enhance rival operators investment incentives, both to encourage investment by these operators, and to ensure that incumbents face competitive pressure to invest in FTTP networks earlier than they otherwise would. These strategies are not mutually exclusive and regulators can therefore consider using them in tandem. Indeed, the proposal discussed in this paper is intended to do so. As an example of the first approach, a report for Vodafone has proposed a modification to copper access price regulation that is aimed at increasing incumbents incentive to invest in FTTP networks. 20 This is achieved by introducing a wedge between the price for copper access that is paid by access seekers and the price received by the incumbent, thus reducing incumbents profits from legacy copper services without undermining the profitability of FTTP investment. The aim is that, the reduction in legacy profits makes FTTP investment relatively more attractive from the incumbent s perspective and hence promotes more extensive and rapid deployment by incumbents than would otherwise be the case. 21 Whilst the copper wedge approach is designed to mitigate concerns about a lack of investment in unserved areas, it will not necessarily eliminate the scope for incumbents to undermine investment by rivals. It is therefore also important for regulators to consider measures to promote and enhance rivals investment incentives in order to maintain competition to deploy FTTP networks. The wedge approach and the proposals in this paper have similarities because they are premised on reducing an incumbent s profits if it does not make FTTP investment, either because rivals are more likely to build their own FTTP network or because legacy profits are reduced See Balancing incentives for the migration to fibre networks NERA Economic Consulting 21 Investment by incumbents could also be promoted through measures aimed at directly increasing the profitability of FTTP deployment. A drawback of this type of approach is that consumers or Government may in effect be required to subsidise FTTP deployment where this make not be necessary. 22 Care would be required if both approaches were to be implemented in parallel to ensure that intervention is appropriately calibrated to have the intended effect. 13

14 Regulatory measures to promote effective competition in FTTP deployment In this section we set out a regulatory approach that can be used by national authorities to promote competition in FTTP deployment in unserved areas. The basic concept of this scheme is that national regulatory authorities (NRAs) grant rival operators that are willing to invest in unserved areas a degree of time-limited regulatory protection against overbuilding by incumbents (we refer to this as overbuild protection ). The proposed approach is designed to limit potential harm from intervention by encouraging competition where it is feasible whilst limiting measures that restrict competition. The proposal in this paper builds on the proposals in the draft Code for NRAs to conduct a geographical survey of network deployments. 23 Under the approach envisaged in this paper incumbent operators will have to inform the national regulator about their plans for future FTTP network deployments. Thereafter, incumbents face penalties for departures from their planned future network deployments that overbuild rival operators planned deployments during the protection period. 24 The overbuild penalty serves to increase the cost to incumbents of targeting rivals with network build and thus should deter harmful overbuilding and protect rivals investment incentives. At the same time, this mechanism will increase the incentive for incumbents to set out ambitious FTTP investment plans to avoid rivals being granted overbuild protection and to reduce their potential exposure to overbuild penalties. 25 This is not a policy measure that generally prevents overbuilding by dominant incumbents. Rather, it is aimed to address strategic overbuilding which targets rivals deployment plans or incumbents announcing roll-out plans that are intended to influence rivals investments decisions but which are not delivered. The proposed scheme in this paper considers overbuild protection precluding unplanned FTTP investment by incumbents that overbuilds rival operators FTTP networks. However, incumbents could choose to target rival operators investments by deploying vectoring or G.fast technology rather than FTTP networks. Whilst these technologies do not match the speed and reliability of FTTP networks their availability could significantly affect the business case for rival operators deployment of FTTP. The implication of this is that if regulators want to prioritise FTTP deployment specifically, they may wish to extend the overbuild protection to preclude G.fast and vectoring investments by incumbents as well as FTTP deployments See Article 22 of the draft Code. 24 As discussed below, it may be appropriate to allow incumbents to modify their investment plan for limited valid reasons, subject to regulatory approval. This would give a degree of flexibility to adapt to changes in circumstances, but would also increase regulatory complexity. 25 Penalties should not be applied if the incumbent decides to extend its planned coverage to areas for which no rival operator has committed to deploy, since this would potentially prevent investment in areas that would not otherwise be served. 26 We consider this issue further in the annex. 14

15 The use of regulation to prevent strategic overbuilding by incumbent operators, whilst a novel approach in telecommunications, has some precedent. For example, the UK Competition Commission imposed a remedy on the groceries market following a market investigation. The remedy recommended that the Government apply a competition test to grocery retail planning applications which was intended to limit the ability of incumbent supermarkets 27 in highly-concentrated local areas from building new stores or materially expanding existing ones. The concern was that incumbent supermarkets would have the incentive to increase their footprint strategically in order to reduce rivals incentives and ability to enter or extend. The expected result of the competition test was that there would be fewer areas of high concentration, improved retail offers and more competitive outcomes for consumers both locally and nationally. 28 The proposal in this case is considerably less intrusive than that proposed in the grocery market investigation as incumbents ability to roll out networks is not constrained provided that they stick to their disclosed plans. The proposed approach is asymmetric because incumbent operators are required to indicate their committed plans before other operators, and are not offered any overbuild protection. This reflects the fact that the key concern about strategic overbuilding arise in relation to incumbent operators, given their established market position, rather than rival operators. The approach is particularly attractive because it has the effect of increasing the incentives of both incumbents and entrants to invest in FTTP networks in challenge areas. A key benefit of the approach is that it will promote widespread commercial deployment in challenge areas, thus reducing the need for unnecessary use of public subsidies in areas that should be able to sustain at least one commercially viable network. The approach set out below envisages that NRAs would consult on the key parameters of the scheme in each country to ensure that it achieves the desired outcome (increased FTTP investment) in a way that minimises any negative impacts, such as distortion of competition. How can regulators implement overbuild protection? A key aspect of the above scheme is that it requires regulators to determine how to assign overbuild protection to rival operators. In this section we outline a practical procedure that seeks to elicit reliable information from operators on their investment intentions with the aim of implementing the overbuild protection scheme. 27 Formally, the Competition Commission considered the supply of groceries by larger grocery stores. 28 UK Competition Commission, Groceries Market Investigation: Remittal of the Competition Test by the Competition Appeal Tribunal, Decision, 2 October

16 Our proposal envisages that regulators would collect detailed geographic information from incumbents and other operators on their existing FTTP networks and future planned deployments to identify areas that will be unserved by the end of the regulator s forecast period. A similar process is envisaged in Article 22 of the draft, but our proposal differs in the way regulators gather information. With regard to understanding the level of existing and planned future deployments of FTTP networks we suggest that regulators consider a multi stage approach as follows: In the first stage, dominant incumbents are required to provide information to the regulator on their future planned FTTP deployment in currently unserved areas over a forecast period determined by the regulator (e.g. the next 3 years). These plans should provide detailed information on the precise planned coverage (e.g. location of premises served) and the timescale for roll-out that enable regulators to accurately identify areas that will remain outside the incumbent s FTTP footprint at the end to the planning period In the second stage, regulators determine contiguous geographic areas that lie outside the incumbent s planned FTTP deployment over the relevant period and where there is no existing FTTP network. We refer to these geographic areas as unserved areas. 29 The aim of this stage is to ensure that regulators can control the process through defining suitably large unserved areas and thus avoiding excessive geographic fragmentation of networks. In the third stage, the regulator requests that rival operators provide their planned deployments in the unserved areas (identified by the regulator in the second stage). Operators can submit plans individually, or as co-investment consortia. For each unserved area rival operators would be required to set out the minimum period over which they would require protection from overbuild by the incumbent in order to make investments. In a fourth stage, the regulator would announce the areas for which it has granted overbuild protection, the length of the overbuild protection and the designated operator which benefits from overbuild protection. We suggest that the simplest approach where there are multiple bids would be to designate the operator (or consortium) that requests the lowest amount of overbuild protection. 30 To provide 29 The draft Code refers to digital exclusion areas, but defines them as areas where operators are not planning to deploy or upgrade networks to at least 100Mbps (see Article 22 paragraph 5). We do not use this terminology since in this proposal the contiguous geographic areas we have in mind differ. In this scheme the unserved areas are those for which FTTP networks have not been rolled out in the relevant forecast period. The digital exclusion areas in the Commission s proposals are defined as areas where operators are neither (i) planning to deploy FTTP networks nor (ii) planning to upgrade or extend networks to at least 100Mbps. Under (ii) networks may not be upgradeable to 1Gbps. 30 Regulators could alternatively consider running a beauty parade based on a range of considerations (e.g. quality of service, and speed of deployment) in addition to the required length of overbuild protection. This would necessarily increase complexity and administrative burden on regulators and slow implementation. 16

17 incentives for rapid roll-out operators would receive overbuild protection from the moment the regulator announces the results. If the operator relies on passive access to the incumbent s network and this is not immediately available, the duration of the overbuild protection should be extended to reflect the delay (this should also be taken into account in assessing the operator s actual roll-out). Whilst rival operators would not be restricted from entering into areas where another operator has triggered overbuild protection, it seems unlikely that such investment would occur as these areas are unlikely to sustain multiple rival FTTP networks in addition to the incumbent s legacy network. However, this can be left to market forces. In a fifth stage, a government body, presumably working closely with the national regulator, may seek to allocate public funds for the deployment of FTTP networks where they are not otherwise viable and no operators plan to service the areas in question. 31 This stage, which requires consideration of how to allocate public funds, is beyond the scope of this proposal. We summarise this approach in the diagram below. 31 This will include both non-commercial areas, and potentially some challenge areas that remain unserved. As noted earlier, public subsidy should not be required to support commercial deployment in challenge areas. In practice, however, it may be difficult for regulators to determine the precise boundary between unserved areas that are no commercially viable, and those where commercial deployment is viable but yet to occur. 17

18 Stage 1 Dominant incumbent provides future planned deployment of FTTP to NRA Stage 2 NRA determines geographic areas that lie outside the incumbent s planned FTTP deployment (unserved areas) Stage 3 Rival operators provide the NRA their proposed FTTP deployment in each unserved area including the minimum overbuild protection period required Stage 4 NRA announces the designated operator benefiting from overbuild protection in each unserved areas and the length of the overbuild protection Stage 5 Potential allocation of public funds for FTTP network deployment in otherwise unviable areas We would expect that regulators would want to require rival operators to meet minimum requirements to qualify for overbuild protection (for example in relation to the quality of service, including factors such as effective download speeds, jitter, packet loss, etc). The intention of such quality factors is to ensure that overbuild protection only applies to networks which can reasonably considered a step change in service provision over legacy copper networks. Moreover, regulators may want to ensure that there is pre-qualification to ensure that operators that benefit from overbuild protection have the financial and operational capability to deliver the desired FTTP network investment. 32 To avoid excessive fragmentation, regulators may also wish to add a minimum level of roll-out commitment for each potential bidder to quality for overbuild protection. These criteria should not deter small scale entry as they are purely aimed at ensuring that quality FTTP services are delivered quickly, supported by limited overbuild protection. A key challenge for regulators will be how to ensure that operators stated investment plans are reliable. In this regard, there is a clear risk that an incumbent may seek to game the regulator by overstating its roll-out plans in order to reduce the scope for rival operators to obtain overbuild protection. Equally, there is a risk that rival operators will 32 Note that prequalification does not introduce any barriers to entry per se because this is simply a step to benefit from overbuild protection. Non-incumbent operators remain free to enter at all times in any areas under this proposed approach. 18

19 also overstate their investment plans in order to obtain more extensive overbuild protection than is necessary. This risk can be mitigated by requiring incumbent operators and rivals operators to provide committed targets in relation to planned network deployments with regulatory penalties for non-compliance (these are in addition to the overbuild penalty that applies to incumbents). For example operators could be required to commit to percentages of their total build within defined periods of time within the forecast period. Regulators could also potentially withdraw overbuild protection as a last resort in the case of sustained non-compliance by a rival operator. Incumbents and rival operators should be required to provide information to allow regulators to monitor progress (for example, revealing the extent of build every 3 months) and impose penalties. The penalties for not achieving committed roll-out targets would need to be sufficient to ensure that operators that are incentivised to hit those targets once they have agreed to them, but are not so large that the fear of penalties disincentivises operators from committing to the roll-out targets in the first place. For incumbents, it seems likely that the risk of alternative operators being given overbuild protection will tend to increase the network deployment which they will commit to. Therefore, penalties will need to be sufficiently large to ensure that they stick to their commitments. As regulators are likely to undertake the geographical survey periodically (the Commission proposes that this is done every 3 years), it may also be possible to enhance the incentives to deliver committed roll-out by telling operators that their eligibility for overbuild protection, or State funding under stage 5, would be reduced in future if there were non-compliance with roll-out commitments. This threat would need to be made clear to operators at the time at which overbuild protection is granted. In addition, the regulator would need to include an operator s previous compliance record as a relevant criterion in the selection process in future planning rounds. 33 It may be appropriate for regulators to allow operators scope to modify committed investment plans in limited circumstances to provide a degree of flexibility to respond to unanticipated market-wide developments. As highlighted above, changes in operators expectations of revenues and costs will affect their investment incentives. Thus, incumbents may wish to vary their investment plans if their expectations change. However, it is important that the scope of permissible adjustments is limited to objective factors that are genuinely outside operators control in order to ensure that the incentive to submit credible plans is maintained. To limit the potential to abuse this flexibility, operators should be required to set out to the regulator the key assumptions they have used in determining the extent of network roll-out. Such proposals will be the benchmark against which any proposed changes will be considered. 33 For example, a non-compliant operator could be deemed ineligible in future, or this could be one of several considerations in a beauty contest. 19

20 Regulators will clearly need to revise their database of FTTP coverage to take account of actual and planned deployments as they evolve. This will allow operators to identify unserved areas on an ongoing basis and help ensure that that can develop plans to address these over time. The Commission s proposals envisage geographical survey being undertaken at least every 3 years. To reduce the administration costs, it would make sense to align the proposed approach set out here with the Commission s proposals. Determining the size of the unserved areas Regulators will need to determine the appropriate size and boundaries for each of the unserved areas against which the rival operators will bid. When determining the size and boundaries it will be important to: Avoid excessive fragmentation of areas that will increase the administrative burden of determining the overbuild protection and of implementing SMP regulation at a later point of time if the operators that benefit from overbuild protection are later determined to have SMP. Avoid including too many high cost premises in an unserved area that would make the whole area unattractive for rival operators even with overbuild protection. Ensure that the size of areas is not too large, in order to make sure that roll-out is feasible for well-resourced operators, within a defined time period such as 3 years. Regulators will need to consult on the appropriate size and boundaries of the unserved areas, to ensure that these factors have been appropriately taken into account. Principles for overbuild protection and overbuild penalties Regulators will need to consider the maximum duration of the period of overbuild protection that it is appropriate to grant to rival operators, and the penalties which should be applied to incumbents for breaching the overbuild protection. These parameters are a key choice for regulators that will jointly affect the impact and effectiveness of the proposed scheme on operators investment incentives. Maximum overbuild protection period The purpose of the overbuild protection period is to give rival operators confidence that they will have a period of time to deploy their network and build up sufficient scale to achieve commercial viability. However, it would not be appropriate to allow operators to benefit from overbuild protection for too long. There is a trade-off of the benefit of a longer period in strengthening rival operators investment incentives against the potential cost of delaying entry by the incumbent that could lead to sustainable network competition. 20