Professional Documents
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11 Views of O
11 Views of O
Contents
Page General view of the DGTs proposals..................................................................................................... 324 Legal and regulatory ............................................................................................................................... 325 Market definition .................................................................................................................................... 325 O2s view on the significance of market definition............................................................................. 325 The mobile market was dynamic and competitive.............................................................................. 326 Current Prices and Regulation ................................................................................................................ 327 Current Charges .................................................................................................................................. 327 Ramsey Pricing ................................................................................................................................... 327 Choice and tariff structures ............................................................................................................ 329 Subsidies ........................................................................................................................................ 329 Competition has led to optimal prices........................................................................................... 330 No unfair subsidy........................................................................................................................... 331 Prices cannot rise and are likely to fall ............................................................................................... 332 Contractual and institutional constraints ........................................................................................ 332 Balanced prices are the key to delivering benefits ......................................................................... 332 Competitive pressures exerted by consumers and retailers............................................................ 333 Consumers alternatives................................................................................................................. 334 Technological changes................................................................................................................... 335 Regulation is unnecessary and potentially dangerous......................................................................... 335 Distributional Issues....................................................................................................................... 336 Comments on DGTs cost model............................................................................................................ 336 Ramsey pricing ................................................................................................................................... 337 Externalities ........................................................................................................................................ 337 Response to hypothetical remedies ......................................................................................................... 338 General................................................................................................................................................ 338 Proposed form of CCs findings ............................................................................................................. 343
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Hutchison 3Gs Response to the DGTs Review of Price Controls on Calls to Mobile, paragraphs 5, 11 and 12.
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the service offered by the operators. The high-quality services and the competitiveness of the UK market had brought about very rapid growth and an exceptionally high level of penetration of mobile phones. This high penetration level provided benefits for all consumers in the UK (whether or not mobile phone owners). O2 said that the MMC had noted in its 1998 report a benefit (ie an option externality) to all consumers with either fixed and/or mobile lines arose when a new subscriber joined a mobile network.
understanding of how firms competed and how services were offered. O2 noted that the MMC had concluded in its 1998 report that [it] is not in our view useful to dwell on the question of [bottle necks, market definition and monopoly positions] 11.9. O2 believed that termination of calls should not be viewed in isolation and that operators had no ability to charge excessive prices for termination. Mobile operators competed for customers by offering a service bundle including, as a minimum, the ability to make and receive calls and to send and receive SMSs. It said that the majority of costs in providing mobile services were fixed and common. The challenge for mobile operators was therefore to design tariff packages that would encourage use of their network while ensuring (so far as possible) that overall revenues were sufficient to recover such fixed and common costs. Total system prices (including termination charges) for supplying mobile services were constrained by the competitive pressures previously described, while individual service elements (including termination charges) were constrained as a result of demand responses to particular tariff pricing strategies. It was not therefore true that termination charges could, in the absence of price regulation, be set at exploitative levels on the basis that they represented a discrete service that was paid for by a group of ill-informed and/or price-insensitive fixed and off-net callers. 11.10. O2 said that mobile operators offered a bundle of complementary and interdependent services, including subscriptions and calls, both outgoing, incoming and SMS. These were not provided in isolation but were purchased by consumers as a package. Consumers sought and purchased bundles enabling them both to make and receive calls: in fact, they sought the ability to communicate via a mobile phone. O2 believed that any attempt, along the lines put forward by the DGT, to categorize separate markets for incoming and outgoing calls was artificial, given that these were not viable independent activities. O2 gave as an illustration of this point the experience of four Telepoint operators, which had offered one-way voice communication a little over ten years previously. In 1993, all four companies had abandoned the service due to lack of demand and the absence of a commercially viable business case. 11.11. O2 said that MNOs competed to sell a handset, establish a customer relationship, subscription or prepaid, and for the revenue streams that customers would generate. It maintained that termination charges were just one factor in the framing of a competitive offer. The individual elements of the bundle were interdependent and complementary, not discrete services. Mobile operators offered bundles of services that consumers bought as a complete package, and consumers would take their business elsewhere if particular elements of the bundle were too expensive. O2 pointed to the DTI evidence on switching to support this view. As such, the MNOs risked losses not just from particular service elements, but all the incremental revenues from the subscriber. 11.12. O2 told us that the majority of costs of providing mobile phone services, incoming and outgoing calls, sending and receiving SMSs, were fixed and common. Incoming and outgoing calls shared the same technical infrastructure of MSCs, BSCs, BTSs, and HLRs as well as the transmission that linked these elements. O2 said that there was no separate network path for incoming and outgoing calls. SMSs also used the same infrastructure although in a slightly different manner. It was not possible to categorize any part of the technical infrastructure as dealing only with incoming calls.
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two operators to less than 60 per cent and the share of subscribers to 50 per cent. Orange now had more subscribers than either Vodafone or O2. 11.15. O2 said that these changes in the structure of the market had been accompanied by radical changes in the number of subscribers (increasing almost fivefold), the profile of subscribers and the type of services sought. Most of that growth had been in prepay customers, now twice as numerous as post-pay customers. Mobile telephones were now used by 90 per cent of the addressable population, leading to new demands, such as SMS, which had been scarcely an issue at the time of the previous inquiry. Today, the increase in demand for SMS services far exceeded even the increase in demand for voice services. 11.16. Nor did O2 believe that the market was yet mature. It remained in a state of flux, with constant initiatives in tariff packages and the new 2.5 and 3G technologies and services imminent. The latter offered the prospect of a greatly enhanced ability to send and receive data in various formats, but required very large investments (22,000 million in obtaining licences alone), and an immensely challenging sales effort, probably requiring costly consumer subsidies to encourage the take-up of new and untried services. There was already one new entrant in the 3G market. Over the previous four years, the market had been in constant evolution, with steadily falling prices and in the cases of Vodafone and O2, falling profit margins. The degree of competition, with the introduction of 3G, seemed certain to accelerate, with the increasing convergence of industries such as IT, broadcasting and telecommunications, bringing additional competitive pressures. Hutchison 3G, in proposing a new regulatory authority, OFCOM (Office of Communications), had recognized this change.
Current Charges
11.18. O2 believed that termination charges were set at the most efficient, optimal level, and not at a level that required regulation.
Ramsey Pricing
11.19. O2 and DotEcon submitted a number of papers containing a model for determining optimal call termination charges in the presence of network externalities. This demonstrated that todays termination charges are at or about the optimal level given any reasonable structure for externalities. 11.20. O2 told us that it believed the establishment of a benchmark optimal call termination rate to be central to our inquiry, but that previous attempts to model one had been inconsistent and contained errors. It had therefore commissioned a study of optimal call termination rates,1 a copy of which it supplied to us, which it hoped would provide a basis for a consistent, error-free framework for Ramsey
1
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pricing in the presence of network externalities. It had aimed to achieve this by systematically building up a model from the behaviour of individual consumers, using a formulation in which externalities were explicit. This, O2 believed, removed the methodological problems of many previous models. 11.21. There were three key conclusions of the study, as follows: (a) That the DGTs assertion that its original estimated externality surcharge of 2 ppm was an upper bound on the true value was incorrect. The study showed that 2 ppm must be a lower bound on a reasonable externality surcharge, even taking similar assumptions to those of the DGT. (b) The study found that the benchmark optimal call termination rate was similar to (and sometimes even above) existing rates. Even on the DGTs assumptions (which O2 believed led to a significant underestimate) the optimal mark-up, when correctly calculated, was not 2 ppm, but 2.8 ppm, 3.8 ppm and 4.5 ppm at R-G factors of 1.3, 1.5, and 1.7, respectively. This was the range considered by the DGT. (c) The study found that the DGTs assertions that Ramsey pricing approaches were impractical, as they required detailed information about demand conditions, were incorrect. The study showed that the key determinants of optimal call termination were costs and the R-G factor: the results were relatively insensitive to changes in demand elasticities. For example, the model showed that, taking a subscription LRIC of 25 a quarter, fixed costs of 73 a quarter and an R-G factor of 1.3 (which O2 believed to be conservative), socially optimal call termination surcharges would be in the range of 2.3 ppm to 3.6 ppm for a wide range of demand assumptions, compared with a central case of 2.8 ppm. 11.22. O2 said that there was universal agreement across all models that it was appropriate to consider efficient cost recovery and that the DGT had himself acknowledged that Ramsey prices were an economically efficient way of recovering fixed and common costs. O2 believed that Ramsey prices should be considered not only in the context of putting into place a particular remedy, but also when assessing whether or not there was a public interest detriment that needed to be rectified. O2 therefore believed that the CC was wrong in assuming that LRIC plus EPMU represented the competitive price with which to compare the price of individual telecommunications services. O2 believed that existing call termination prices were in line with Ramsey principles and that future prices were not likely to rise above them. 11.23. Operators needed to design a tariff structure which encouraged consumers to subscribe to their network and which ensured that they earned sufficient revenues to cover the fixed and common costs. Cost-based pricing achieved the second of these objectives, but not the first. Demand-based pricing was capable of achieving both objectives provided that operators correctly assessed what consumers wanted. O2 believed that the DGT had recognized this in theory, when it stated that demand-led pricing is an efficient way for firms to recover the fixed and common costs they incur from producing a range of different goods and/or services.1 O2 believed, and the DotEcon paper Optimal Call Termination Rates demonstrated, that there was no reason why this logic should not apply to all constituent parts of a bundle of goods and services. 11.24. O2 said that it set tariffs by reference to consumer demand and market requirements. In doing so, it had regard to the following factors: its assessment of customer lifetime values, taking into account handset subsidies, reseller payments (for example, connection bonuses), the estimated life of the customer and the likely revenues a customer would generate (the last, in particular, clearly depending on the tariffs and their anticipated effect). It also paid attention to feedback from customers, which O2 obtained in a variety of ways. In other words, in the process of seeking to establish tariff rates, it would take account at all times of the need to cover costs and the fact that competition in the sector would force it to compete away any excess profits on one service element. 11.25. O2 believed that consumers attached weight both to the value of being able to make calls and to the value of being called and would accordingly want to be sure that the price structure was such that this could happen without inhibition. O2 drew attention to the NOP survey, the BMRB market research, and the DotEcon paper on mobile customer behaviour. Different consumers would be more or less sensi1 Review of the charge control on calls to mobile, A Statement issued by the Director General of Telecommunications, 26 September 2001, Annex 5, paragraph A5.4.
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tive to different pricing components. The parent buying a phone for a child partly to be able to call the child from a fixed line to check on its whereabouts would pay more concern to the cost of incoming calls to their childs network than the elderly or highly cost-conscious person who purchased a phone to use only in an emergency or if stranded in a car. 11.26. O2 said that the majority of consumers were concerned about the cost of incoming calls, since, if termination charges were too high, those consumers would lose the utility derived from receiving calls, making the particular MNO, or even the mobile phone itself, unattractive. MNOs therefore had to set termination charges at levels that would not discourage take-up. They needed to recognize the price sensitivity of a significant number of customers (business users, parents, the cautious and cost conscious), as well as the role that retailers played in informing consumers at the point of sale. Again, O2 highlighted the support given to its views by the NOP survey, the BMRB market research and the DotEcon paper on mobile customer behaviour.
Subsidies
11.29. We asked O2 whether, if insufficient competitive restraints were being exerted on the MNOs call termination charges, the revenue from those charges was being used by the MNOs to reduce the level of prices charged by them to their customers for calls, or to subsidize handset prices or monthly subscriptions. O2 replied that there were sufficient competitive restraints, that, as its Ramsey pricing modelling demonstrated, prices, in aggregate, were not above the competitive level and that the market was not characterized by unfair price reductions or cross-subsidies. Outgoing charges could not be subsidized since they were not set at below incremental cost. 11.30. We asked O2 whether the present level of call termination charges effectively resulted in fixed-line consumers subsidizing customers of the MNOs. O2 replied that there was no evidence to suggest that customers of fixed network operators were subsidizing customers of MNOs. In any event, O2 believed that fixed users and mobile users were largely one and the same group and that a group could not reasonably be said to subsidize itself. To the extent that they were not, any possible detriment was minimal and those fixed callers who did not also have a mobile benefited from the general network externality of being able to call a mobile user on the move.
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11.31. We asked O2 whether the present level of call termination charges of the MNOs enabled them to compete unfairly with the FNOs. O2 reiterated its view that termination charges were set at a competitive level: these were not above stand-alone cost and therefore could not be said to subsidize its on-net charges so as to allow it to compete unfairly with the fixed operators through on-net charges.
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clusion that affected many parties on the basis of an analysis that was not made available to, and could not therefore be challenged by, the affected parties. 11.38. In the opinion of O2, the evidence showed clearly that the four UK network operators competed aggressively for customers who bought a bundle of mobile phone services. Competitive factors, many noted by the DGT, had ensured low prices. 11.39. O2 concluded that the UK mobile market was dynamic and displayed most of the signs that would be expected of a competitive marketa high level of innovation, shifting market shares, declining prices and reasonable profits. The various components of the mobile service (including termination services) were in reality part of a package of services where the price for the whole was constrained, as evidenced by the normal or below normal profits of the majority of the industry. 11.40. Competition in the UK mobile phone market had delivered substantial benefits to consumers, a fact O2 believed was recognized by the DGT. Prices for mobile phone services had fallen dramatically over time and in particular since we reviewed this sector in 1998. Prices in the UK for the overall bundle of services compared favourably with those in other European countries. UK consumers were offered a wide range of tariffs and packages. UK operators provided a high-quality service to their customers, and UK consumers benefited from a high level of innovation, a fact also recognized by the DGT. 11.41. It was O2s opinion that the high level of investment indicated clearly the degree of competition in innovation and the wide range of new consumer benefits being delivered, including high network quality, extensive network coverage and a high level of customer service, including recently introduced services such as location-based services enabling its customers to seek and obtain information on restaurants, banks, ATMs, petrol stations and the like on an area-by-area basis, as well as Instant Messaging and Multimedia Messaging Services. Increased customer service would follow the launch of 3G, on which operators would be investing [ ] to [ ] on top of licence fees. 3G would enable the efficient delivery of complex information and data packages. 11.42. The fact that 94 per cent of consumers reported a high level of satisfaction with the mobile phone services they received convinced O2 that the factors mentioned were clearly valued by consumers: such a figure was extraordinarily high for any consumer market. Positive consumer response at that level suggested a competitive market, and showed beyond doubt that consumers valued the service that they were receiving. All consumers, whether or not they owned a mobile phone, had the ability to communicate with the vast majority of the population at any time and in almost any place. 11.43. The attractiveness of the mobile offer, including the quality and range of services available was, O2 believed, responsible in part for the high penetration, as were, to an important degree, the pricing strategies of the operators. The strategies adopted in setting termination charges and charges for other services also played a very significant part in encouraging maximum mobile phone use, allowing operators (to the extent permitted by the existing price regulation) to price the different components of the mobile service by reference to the sensitivity of consumers to changes in pricea policy which O2 believed that the DGT accepted, in principle, could be both efficient and in the public interest. 11.44. O2 believed that an analysis of whether the strategies adopted in the UK had produced more efficient results would have shown this policy had been beneficial to consumers in practice, and that prices were set at an optimal level.
No unfair subsidy
11.45. O2 said that there was no unfair subsidy from fixed to mobile. In any event, with a mobile phone ownership penetration rate at almost 75 per cent those who received incoming calls were predominantly the same as those benefiting from lower call charges. There was therefore a close alignment of the interests of fixed/mobile customers and of mobile-only customers. The group of possible
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strong losers (ie those without a mobile but making significant calls to mobiles) was very small indeed.1 11.46. O2 did not believe that the present level of MNOs call termination charges allowed them to compete unfairly against the fixed network operators. In particular, neither the price for the bundle of services provided to consumers nor the price for outgoing calls was below incremental cost. Therefore, O2 did not believe that fixed network customers subsidized mobile customers. Neither the present level of call termination charges nor any other factor identified to O2 had allowed MNOs to compete unfairly against fixed network operators. O2 added that the latter were becoming as innovative in packaging as the MNOs had been and had their own strategies to compete.
1 This was clearly demonstrated, said O2, by the Lexecon paper Distributional effects of Oftels proposed regulation of call termination charges.
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very similar, competitive prices that responded to consumer demand. If termination charges were to fall out of line with the decline in the price for outgoing calls, it could result in a damaging shift in the balance of traffic. Incoming calls would be replaced by outgoing calls, which would have the effect of: (a) neutralizing any increased margin that an MNO would enjoy on incoming calls; and (b) reducing the benefits enjoyed by mobile subscribers as a result of receiving fewer calls, thereby discouraging mobile phone uses and reducing revenues to MNOs. 11.51. O2 said that tariffs were also constrained by the threat of arbitrage, either through call-back or through a commercial entity offering a service, already technically feasible, involving the switching of the direction of a call. Call-back services were currently available for mobile-originated international calls, exploiting the price difference between outgoing and incoming international calls. O2 said that the technical infrastructure was in place and could be deployed rapidly if incoming and outgoing call charges for UK calls were to diverge systematically and persistently. MNOs needed to maintain a balance of prices to counter these threats.
that 31 per cent of SMEs indicated that they took the cost of incoming calls into account in reaching their purchasing decisions1 and that 19 per cent of small and medium businesses with mobiles had taken steps to reduce the cost for them to call their own mobiles. Second, consumers within so-called closed user groups who were part of two or more closed user groups could not avoid call termination by joining the same network as members of both groups and so benefiting from low on-net call charges, as the DGT claimed. Since these customers were sensitive to the cost of being called (either from another mobile network or from a fixed line), they might be explicitly influenced in their network choice by termination rates. 11.56. In O2s view the DGT had underestimated the effect of the first and not even considered the second of these types of price sensitivity. 11.57. O2 also regarded repeat calling arrangements as being significant. An analysis of the calling patterns of O2 customers showed that the vast majority were in repeat-calling relationships. The DotEcon paper Mobile Customers Behaviour shows that such consumers had the abilitywhich they exercised to reverse call direction between pairs to take advantage of lower calling rates, thereby exerting pressure on all aspects of pricing, including termination rates, and survey evidence2 showed that they did so in practice. Substitution between incoming and outgoing calls suggested the existence of cross-price effects between incoming and outgoing calls, involving the timing and direction of calls according to relative charges.
Consumers alternatives
11.58. O2 demonstrated, with support from the NOP survey and BMRB market research, that consumers had a number of alternatives to making mobile calls, each of which exerted pressure on prices, as described in the following paragraphs. Although examples were given of the alternatives that might be adopted by a group of customers, O2 emphasized that each customer was free at any time to choose from among the alternatives described. 11.59. Those consumers with a fixed line and a mobile might be able to switch to an on-net or offnet call paid for as part of a package of inclusive call minutes, thereby avoiding termination charges. Onnet and off-net calls provided increasingly strong substitutes for fixed to mobile calls: many subscription packages had for some time included on-net calls so that such calls could be made without further payment. All four MNOs had introduced tariffs including off-net calls within inclusive call minutes in a number of their tariff packages. 11.60. Consumers might be able and prepared to switch from a voice call with a termination charge to an SMS from a mobile, chargeable at a low set fee (typically either 10p or 12p). One of the key changes in the mobile sector since the 1998 MMC report had been the dramatic growth of SMS. For many mobile phone users (the young in particular), data communication, in particular text messaging, was not only an easy, acceptable and cost-effective way of communication, but was regarded as fun. O2 said that the DGT had reported evidence from a MORI survey showing that over 40 per cent of mobile users used text messaging and that of these, 59 per cent sent text messages because they were cheaper than voice calls.3 O2 believed that, as with email and instant messaging, SMS was certain to grow as its convenience, cheapness and acceptability as a means of communication were recognized. O2 recognized that SMS would not be a substitute for all call types, but that was not necessary for the services to have a noticeable impact on call termination. 11.61. A further switching opportunity would be to switch from a voice call to data message in a GPRS or in a 3G environment. Moreover, O2 said that 3G technologies would be capable of providing existing services in different ways as well as completely new services. GPRS was already offering some of the new data services (which had no termination fee element attached). The fact that 3G would offer the same services as the existing 2G technology meant that consumers would perceive 3G to be a substi1 Review of the charge control on calls to mobiles: A Statement issued by the Director General of Telecommunications, 26 September 2001, paragraph 2.11. 2 NOP Survey. 3 Effective Competition Review: Mobile, Issued by the Director General of Telecommunications, February 2001, paragraph A2.35.
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tute for 2G. In addition the new data services on GPRS and 3G would increasingly come to be seen as substitutes for voice services. The introduction of the RIM Blackberry, a GPRS device, made it easier to contact a business colleague via a short email than by a voice call. For emails there was no termination charge. Also available was IM which was being developed to enable virtually real-time voice communication using voice clips. 11.62. O2 believed consumers might simply shorten their calls to mobiles, reducing their costs and operators revenues. O2 believed that fixed to mobile calls were shorter than fixed to fixed calls, and that this might in part be accounted for by the nature of the call (for example, a call checking when a guest was likely to arrive for dinner on a fixed-to-mobile telephone was likely to be shorter than a purely social call to a friend). In part, however, O2 thought that these shorter calls were likely to be accounted for by the fact that callers generally knew that calls to fixed lines were cheaper than calls to mobiles (a fact recognized by the DGT1) and by the fact that consumers with this general level of price awareness might postpone the longer call intentionally in order to save costs. The propensity was for consumers to make shorter calls in response to higher termination charges.
Technological changes
11.63. On the possibility of delivering voice calls to mobile as lower-cost data calls, O2 believed that the introduction of VoIP would effectively blur the distinction between a voice call and data message: receiving a call was the same as downloading a file. Charging systems for the two technologies were different: with VoIP the called party pays for capacity or data throughputthe calling party pays for the same but this was not related to making a particular call to a particular customer. As well as providing communication without call termination, these new services would alter the nature of competition in the market. O2 believed that VoIP provided the most promising alternative to termination on a mobile network by 2004. 11.64. On the possibility that calls to mobile might be delivered to a user-nominated fixed line, O2 said that technologies to achieve this did exist and could provide an alternative to terminating on a particular network, but that these had yet to prove popular with users and would require significant changes in billing arrangements. On the possibility of calls to mobiles being handed over to the mobile network at the BSC nearest to the receiving party, O2 believed that applications could be developed to build on existing technology which could be used to reroute calls to the nearest BSC, but that the costs would be unlikely to result in significant termination charge savings. On the possibility of converting a fixed-to-mobile call to an on-net call, O2 said that it already offered services which provided significant discounts on fixed-to-mobile calls by converting them to on-net mobile calls. As regards the use of alternative, unregulated signals to deliver calls to mobiles, O2 said that it was not familiar with systems capable of doing this, but was aware that developments were in progress. It believed that it was probable that W-LAN technology would be deployed in the UK in the following two years. O2 told us that the use of dual-SIM devices or of multiple network identities on one card was technically possible but likely to be applicable mainly in the international roaming context.
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operators by generating a downward spiral of investor confidence, making the cost of borrowing more expensive, and could have particularly deleterious consequences on prepay users, as many prepay users were only marginally profitable to the mobile operators such that losing their termination revenue was likely to make them unprofitable. Any negative impact on prepay would cause significant detriment to the most socially vulnerable. It would also put at risk the development of 3G services, which could not in practice be shielded from 2G regulation (irrespective of the DGTs intentions). This could delay or damage the development of important new broadband services. A further result would be a fall in penetration levels by putting at risk the ability to price different components of the mobile service in such a way as to maintain those levels. A fall in penetration levels would be damaging to owners of fixed and mobile phones alike, as their ability to reach others by mobile phones would be diminished. In short, price regulation was not only unnecessary and disproportionateit was likely adversely to affect the public interest.
Distributional Issues
11.67. O2 stated that there might be a concern that those people who had not acquired mobile phones or a particular subsection of the population might be considered to be adversely affected by call termination prices, despite the significant benefit to the majority of the UK population. Such concerns should give rise to a public interest issue only if a significant number of consumers were at risk. O2 did not think that this was the case, because there were very few consumers frequently calling mobile phones who did not own one, given that 73 per cent of the population (90 per cent of the addressable population), had mobile phones and a further 6 per cent lived in a household with at least one mobile phone. 11.68. O2 believed that the far more serious concern from a distributional perspective was that the proposed regulation was likely to be socially harmful in its impact on vulnerable members of society. A price control would harm, in particular, those mobile-only customers (who tended to be among the least affluent sections of society). The proposed regulation would result in one clear group of losers: those with only mobile phones. This view was based on the distributional work done by Lexecon in its paper Distributional effects of Oftels proposed regulation of call termination charges.
(a) First, the DGTs LRIC model was deeply flawed, implying that only around 5 per cent of network costs were fixed and common across the three services considered: subscriptions, incoming and outgoing calls. O2 believed that this was clearly understated, rendering meaningless the DGTs own conclusions as to the legitimacy of demand-led pricing for the recovery of fixed and common costs in a way that least discouraged take-up. (b) Second, a significant proportion of the costs incurred by operators was excluded from the DGTs model, implying that those calling mobiles should contribute only to the recovery of fixed and common network costs. This ignored the fact that callers to mobile phones obtained significant benefits from investments in boosting penetration: failure to take this into account would produce an economically inefficient result.
Ramsey pricing
11.74. A description of the merits of Ramsey pricing is set out at length above. In brief, O2 could not accept the criticism that Ramsey pricing was not fair. Only in the narrow sense that prices might not be equitably distributed across each and every consumer could this possibly be alleged: Ramsey pricing was a fair system, both socially optimal and efficient, delivering a consumer surplus and public interest benefits.
Externalities
11.75. On externalities, O2 believed that people who did not own mobile phones nevertheless gained from the optional benefit of contacting mobile phone owners. This benefit was paid for by those purchasing mobile phones, and went some way to offset any call termination charges incurred by the nonmobile-phone owner and other mobile owners who gain from an increase in penetration. 11.76. O2 therefore believed that when assessing the public interest it was entirely appropriate to consider external benefits, such as those flowing from an increase in mobile penetration, since all who made or received calls from and who made calls to mobile phones received benefits from greater mobile penetration. These benefits were external to individual decisions (ie whether to acquire a mobile) that affected penetration levels. O2 believed that there were flaws in the DGTs way of calculating optimal prices in the presence of network externalities. O2 had examined both the DGTs model and the models presented by Oftels adviser, Dr Jeffrey Rohlfs, and had concluded that there were fundamental flaws in the methodology of both. In the case of the Rohlfs model, if mobile ownership increased as a result of a decrease in the price of making calls, no network externality at all was applied. In O2s view externalities should be applied regardless of the source of a change in mobile penetration. The flaw implied that since certain externalities had been ignored optimal termination rates had been underestimated. O2 added that a further flaw in the Rohlfs model arose from the definition of net externality factor used in the model. This had the effect, if the R-G factor were sufficiently small, of producing a net externality factor of less than 1. O2 believed that, where there were only positive externalities in the model, this made no sense. O2 said that a similar flaw appeared in the DGTs model, but he had chosen to ignore the impact of crosselasticities in his model. 11.77. O2 said that both the DGTs model and the Rohlfs model largely dismissed the problem of fixed cost recovery by assuming that these amounted to only a tiny proportion of the total. O2 said that at the calibration prices and quantities supplied by the DGT and used by Rohlfs to calibrate his demand system, fixed costs amounted to only about 2.9 per cent of total costs, a proportion O2 believed to be implausibly small. Given the cost assumptions reported by Rohlfs, this would imply apparent industrywide excess profits of more than 1.2 billion a year, which was clearly not the case (as the DGT had accepted). The implication of this was that costs, especially fixed costs, were under-represented in the Rohlfs model, presumably as a result of failing to include any retail costs within either model.
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] 11.85. O2 had already given its views on many of the possible remedies, but added the following points: (a) As regards the market definition adopted by us, O2 maintained with the support of empirical evidence that the requirements set by the European Commission in the Draft Recommendation in order to consider the call termination market to be part of a bundled market were met in this instance and that we were therefore wrong to define the market narrowly in terms of call termination on each mobile operators network. Regarding each of the tests proposed by the European Commission, O2 provided evidence that: (i) technical possibilities exist as substitutes for a fixed-to-mobile call such as its Cellular Exchange line which substitutes an on-net call for a fixed-to-mobile call; consumers would readily change calling patterns to save money (O2 provided survey evidence that 34 per cent of fixed-line callers will change the time they call, 61 per cent will call a fixed line instead and 41 per cent will send a text); and
(ii)
(iii) subscribers subscribe on the basis of what it costs to be called (O2 pointed to our own survey that showed of those who have chosen or changed network to be on the same network as someone they speak to often, 88 per cent did so to save money on call charges). (b) On the question whether the relevant market included voice calls using 3G technology, O2 believed that it did and that to regulate 2G voice calls and not those using 3G technology or regulate without regard to 3G costs would be illogical, inconsistent and contrary to both our and the European Commissions findings on market definition. But to regulate 3G within a costbased price control would eliminate the switching necessary to build a new generation service and would be contrary to the European Commission recommendation that 3G should not be hindered by regulation. O2 believes that if 2G cannot be regulated without adversely affecting 3G the correct approach would be to regulate neither. (c) O2 did not believe that the market was segmented to the extent of limiting the ability of priceconscious customers to force down prices. The wide variety of tariff packages had been designed to appeal to as many types of consumers as possible, and price-conscious customers influenced the creation of new packages as MNOs responded to migration among the packages. However, there are no groups of customers that can be picked off. There was no more segmentation than in any other market where differentiated services were offered. Nor did O2 believe that there was any evidence that the variety of packages made price comparison difficult: consumers were adapting behaviour in response to price and were not making ill-informed pricing decisions. The recent introduction of off-net minutes in the bundle was an example of price conscious customers driving down prices for the market as a whole. (d) O2 did not accept that the present level of call termination charges resulted in customers of FNOs effectively subsidizing customers of the MNOs. With mobile penetration at some 75 per cent, fixed and mobile users were largely one and the same, while to the extent that there were any serious losers (ie those making significant calls to mobiles but not making calls from mobiles) the total public disbenefit was very small (an estimated 13.4 million across all users). Also, fixed customers benefited from the externality of being able to call a mobile and communicate with someone on the move. O2 believed that any distributional concern was more serious with the proposed charge caps, which would result in disproportionate losses to prepay users from lowincome groups and the older members of society. O2 identified three pieces of evidence to highlight the effect on vulnerable members of society: (i) a report by Lexecon entitled Distributional Effects of OFTELs Proposed Regulation of Call Termination Charges which showed that the largest losers from a price cap on termin-
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ation charges would be those with a mobile and no fixed line, who tend to be the poorest members of society; (ii) our survey that showed whereas 58 per cent of those in social category AB are prepay, this rises to 88 per cent in social grade E; and
(iii) omnibus survey evidence which showed that in the event that mobile operators were forced to introduce a mandatory time-expired voucher of 10 (which O2 believed would be an inevitable consequence of the proposed control), this would have the effect of increasing the monthly bill for around half of all prepay consumers, and more than doubling the bill for about one-third. (e) O2 said that an assessment of whether the present level of call termination charges allowed the MNOs to compete unfairly against the FNOs depended in part upon whether they were in the same market, which the DGT and we had provisionally decided was not the case. O2 said that our conclusion seems to imply that there is insufficient competition between fixed and mobile networks thereby preventing a finding that there is a broader market than terminating calls to a particular network. However, given that conclusion, it would be incongruous to find that there was unfair competition between the different networks (as there could only be unfair competition among parties that compete). For its part, O2 believed it implausible that if FNOs and MNOs competed for calls that did not constrain MNOs in their approach to pricing. (f) As to whether the differences between on-net and off-net call termination charges reflected the cost differences between them, O2, said that in a competitive market prices for different services did not necessarily equate to the costs of providing them and that the competitive significance of on-net rates was in any event overstated. The majority of calls took place in repeat-calling relationships, the substantial majority of which crossed network boundaries, only 24 per cent being on-net. Favourable on-net rates need to be offered alongside favourable off-net rates in view of the ease of switching between tariff packages. Tariffs were now moving in the direction of bundling free off-net minutes. (g) Finally, as to whether, if call termination charges were reduced as a result of regulatory action, MNOs were likely to increase their prices for other services, O2 believed that they would have to try to compensate for any drastic reduction in revenues. O2 did not believe that a waterbed effect was inevitable, since there was no certainty that MNOs could raise subscriptions, handset prices or outgoing call prices without damaging effects on overall revenues, the loss of customers and a generally reduced mobile phone penetration. Nor was it necessarily the case that MNOs could raise prices to the extent needed to ensure continued viability: it would be irresponsible to regulate on the assumption that they would be. 11.86. As to our hypothetical remedies, O2 believed that neither a significant RPIX nor an immediate P0 adjustment to the final level, ie no glide-path, met the legal tests that had to be satisfied before we could propose a licence modification. O2 believed that any such remedy would be both unnecessary and unlawful, since there was no evidence that O2s present termination charges operated against the public interest: they were set in a competitive environment and were likely to be at or close to the socially optimal level. Significant competitive and institutional constraints were likely to keep such charges at the socially optimal level in the future. 11.87. In O2s opinion the proposed remedy failed to meet the following legal tests: (a) that it should be consistent with our statutory duties under sections 3(1) and 3(2) of the Act; (b) that it should be proportionate, as required by European law, human rights legislation and general legal and regulatory principles. This means that any remedy must do no more than address the problem identified; (c) that it should not threaten the viability of those regulated;
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(d) that it should satisfy a cost benefit analysis; (e) that it should do no more than produce the outcome expected of competition. Specifically this means imagining a situation where termination is subject to similar competitive constraints as other parts of the service bundle purchased by mobile customers; and (f) that it should be consistent with European law. 11.88. In O2s opinion a remedy involving the absence of a glide path would be highly unusual, dangerous, disproportionate and inappropriate: it would amount to clawback of the fruits of part investment in damaging revenue receipts from existing customers already invested in, [ Details omitted. See note on page iv. ]. Analysts including Goldman Sachs share concerns over the impact of a P0 adjustment. It would also have a serious impact on prepay customers (a significant proportion of which were older and poorer members of society, and which formed two-thirds of its customer base), with the likely outcome that these customers as a group would become uneconomic for MNOs. This would impact particularly negatively on low-income users who tend to favour prepay. Finally, it would have a detrimental effect on the development of 3G since O2 would be obliged to make cuts in capital spending, [ Details omitted. See note on page iv. ]. 11.89. As to the RPIX remedy, O2 believed that this would give rise to effects similar to those of the no-glide-path scenario, dependent upon the level of X. O2 had factored a remedy of RPI12 into its business plans, as a remedy which it envisaged should not significantly damage its financial viability or significantly delay the rollout of 3G, and believed that any remedy more severe would move progressively and unacceptably towards a draconian outcome. O2 pointed out that it had not been provided with the levels of any price controls under consideration and that failure to provide such information had limited its ability to comment on remedies in any meaningful way, or on the figures that underpinned a particular level of control. It could therefore comment only generically on particular forms of remedy that might be imposed. Regardless of the level of X, RPIX as a regulatory principle is incapable of satisfying the test that any remedy must come as close as possible to the competitive outcome. The remedy is a blunt and inflexible instrument. Although it serves artificially to lower termination charges, it is not market driven. As a consequence it necessarily has a finite life. This will lead to the administrative expense and inconvenience of a further inquiry in four years time. 11.90. As to the inclusion of 3G services in any remedy, O2 drew attention to the European Commissions recommendation that 3G should not be hindered by regulation, but said that any control on 2G call termination services would amount to control of 3G voice termination since voice termination on the two services could not be separated. O2 believed, therefore, that the correct decision was to regulate neither. 11.91. As to a retail benchmarking remedy as favoured by the ACCC, O2 believed that this passed all the legal tests for an appropriate remedy, provided that it were not coupled with an immediate downward adjustment. O2 believed that the remedy would have all the benefits of CPP without its disadvantages. Contrary to objections, O2 maintained that there was no risk of distortion of outgoing services, and noted that the ACCC experience provides an example that a retail benchmarking approach was workable. 11.92. O2 submitted a proposed remedy which it believed would provide a viable alternative to a price cap. Rather than seeking to address the symptom of the perceived problem (high charges for calls to mobiles) through a price control, O2 considered that the remedy sought to address any underlying regulatory problem arising from there being insufficient competitive pressure on call termination charges because those paying termination charges had no choice but to terminate their call on a particular network; and the fact that it was the calling party that paid termination charges but the receiving party that made the phone purchasing decision. Under the remedy, callers to a mobile would be given the option to reach the mobile subscriber in the normal way and to pay termination charges or to leave a voicemail 341
message at a fixed national rate. O2 shared with us the results of an Omnibus survey to test whether the remedy would prove attractive enough to consumers to act as a significant constraint on the setting of termination charges. The survey showed that 50.7 per cent of all respondents said that they would use the option of leaving a voicemail for a mobile owner at fixed-line national rates, a figure which became 66.3 per cent among those aged 16 to 22. Of the 50.7 per cent, 60.8 per cent said that they would use it five times or more out of every ten calls, while of the 16 to 22 group 74.5 per cent said that they would use it this often. O2 pointed out that callers were familiar with the concept from BTs voice messaging service. O2 demonstrated that callers would welcome the option to pay the termination charge or request a call-back, as the Omnibus survey showed that half of respondents (rising to 62.4 per cent of the 23 to 29 group) thought that it would be a helpful if incoming callers were given the voicemail option, compared with only 13 per cent who thought it would be unhelpful. O2 highlighted what it considered a number of advantages, as follows: (a) It operated within the competitive dynamic. It introduced a system whereby callers had an option to pay a termination rate or to request call-back. This would provide a new and even stronger incentive to MNOs to ensure that incoming and outgoing retail charges were balanced and would thereby provide a new and strong incentive on MNOs to ensure that incoming and outgoing retail charges were balanced and would therefore provide an effective constraint on termination charges. (b) It could be combined with certain RPP options, so that those mobile subscribers who wanted incoming calls to be routed to them directly could pay a premium for this facility. This would achieve all the benefits of RPP in increasing pressure on termination charges. The cost of incoming calls would assume greater importance in a mobile subscribers purchasing decision, without the downside in terms of consumer hostility and encouraging mobile phone owners to switch off their phones, as the RPP option would be voluntary. (c) It would be practical, viable and sustainable. Most important, it would be relatively easy to use and to implement. (d) It would provide a proportionate and potentially permanent solution without the need to revisit the issues at the end of a four-yearly price cap, in contrast to RPIX and P0 regulation, which were, by their nature, finite. 11.93. O2 did not believe that other possible remedies would have any significant impact on competition in call termination charges. It made the following main points: (a) O2 did not consider that encouraging developments such as MVNOs would create different pricing incentives from those that already exist. (b) O2 disputed the view that there is insufficient information available to enable customers to make rational purchasing decisions, pointing to our survey which showed that only 18 per cent of respondents underestimated the price of a 2-minute call to a mobile. However, if we were concerned about price transparency O2 was prepared to work with Oftel and with retailers to develop greater transparency. (c) O2 considered that any benefits of RPP (for example, that customers could be expected to take greater account of costs of calling them when choosing a network) would be outweighed by the adverse effects in terms of customer resistance, costs of implementation and economic efficiency. It identified a significant risk that under RPP there would be detrimental effects (particularly on low-income members of society) as people would turn off their phones to avoid paying for incoming calls. (d) O2 did not consider that bilateral negotiation of interconnection agreements differed from the current institutional constraints which it believed already operated as an insurmountable bar on any operator increasing their termination charges. (e) O2 considered that a non-discrimination remedy would not address any concern about the underlying level of termination charges (which it believed were at a level consistent with the public interest). It considered that any remedy concerned with addressing the balance of charges at the
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retail level was not justified. All services were subject to the competitive constraints it had identified. Where the majority of calls cross network boundaries (only 24 per cent according to O2s evidence were on-net), it believed that operators simply could not capture consumers on to their network with the allure of cheap on-net calls. (f) O2 believed that a price-squeeze test for fixed-to-mobile services was not justified. It believed that there was a competitive market where both mobile and fixed operators compete and each offer a proposition that is attractive to consumers, reflecting their respective advantages. In any event, fixed operators were in no way disadvantaged by the current arrangements as they could offer MVPN products as service providers. (g) In response to our raising the question of excessive churn, O2 objected that the topic was not raised as a public interest issue, nor did we seek to define or analyse what level of churn was considered desirable or undesirable, nor did we present evidence as to why churn or any element of it was considered undesirable and not a sign of a competitive market. O2 said that no attempt had been made to measure how much of discretionary marketing costs were supposed to be linked to the creation of churn, and hence how much was supposedly available to fund a reduction in termination rates. O2 strongly disagreed with our assertion that it would not be fruitful to quantify what we meant by excessive, and believed that any conclusion that there was an undesirable level of churn could not be maintained in the absence of clear evidence. 11.94. O2 believed that neither the two business argument nor the allocation of costs argument in favour of excluding so-called non-network costs was valid. In the case of the first, it could not accept that a true MVNO with its own physical infrastructure would adopt any different structure of prices from an MNO, and that the MVNOs desire to stimulate network usage would ensure that incoming calls bore their fair share of the costs of attracting and retaining subscribers in much the same way as prevails in the current market environment. In the case of the second, O2 agreed that callers should bear the costs caused by the caller or those from which the caller benefited. This should, by definition, include the costs of the acquisition and retention of customers and their handsets, without which callers would have nobody to call. 11.95. O2 therefore maintained its view that even where such costs were judged to be incremental costs and not fixed costs it would still, under a wide range of assumptions, be reasonable to recover at least some of these costs from incoming calls. Similarly, O2 did not accept that customer care and billing did not benefit the caller as these were all part of the services available to mobile subscribersthe very subscribers that callers were communicating with. O2s view was that a conservative measure of topdown costs that are appropriately recovered from incoming calls should be [ ] to [ ] ppm.
(a) provide callers to mobiles with an alternative means of reaching a mobile subscriber at a fixedline price that was subject to normal competitive pressures, which would bring more pressure on termination rates the more it was used (as the wider the disparity between fixed-line rates and mobile-termination rates the more likely the caller to mobile was to use the voicemail option); (b) be practical, viable and sustainable; and (c) would provide a market-driven, proportionate and potentially permanent solution without the need to revisit the issues periodically. 11.101. O2 believed that if we were not prepared to recommend such a solution, then we should recommend a retail benchmarking remedy along the lines discussed above. This would mimic the constraints in a market considered competitive by us, would be practical as shown by experience in Australia, would not risk distortion of the competitive outgoing mobile call sector and would provide a market-driven, proportionate and potentially permanent solution. 11.102. O2 believed that we should conclude by rejecting price control on the grounds that it: (a) went beyond the level of intervention required to address the public interest detriment arising from there being insufficient competitive pressure on termination charges; (b) could at best be based on predictions of what would happen in a fast developing and uncertain market, when such predictions would be almost bound to turn out to be wide of the mark; (c) was inflexible; (d) required constant revisiting at great expense to the industry, consumers and the taxpayer; and (e) risked long-term damage to MNOs ability to finance their operations. 11.103. O2 said that if we nevertheless concluded that a price control was necessary it should: (a) include a moderate glide path of four years; (b) set the X factor at a level that did no more than deliver socially optimal changes (in this context O2 indicated that an X of 12 without a P0 adjustment would not risk serious harm to its financial viability but that anything more severe came close to a draconian outcome compromising O2s long-term future); (c) regulate all MNOs in the same manner and from the same starting point; and (d) avoid placing any reliance on the Oftel LRIC model. 11.104. Finally, O2 said that it was common ground that any licence modification adopted pursuant to the current inquiry must fall away no later than 24 July 2003 due to the implementation of the new European regime. O2 suggested therefore that, due to the complications of implementing any form of price control regulation prior to this date, the CC should express any proposed regulation as a recommendation to the DGT, to implement on or after 25 July 2002, subject to the realization of certain contingencies. These contingencies were the CCs and the European Commissions finding identical markets for call termination, and each MNO being designated as having SMP in the market defined.
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