House of Commons Trade and Industry Committee

Ofcom's Strategic Review of

Thirteenth Report of Session 2004–05

Volume II

Oral and written evidence

Ordered by The House of Commons to be printed 22 March 2005

HC 407-II Published on 4 May 2005 by authority of the House of Commons London: The Stationery Office Limited £13.00

The Trade and Industry Committee

The Trade and Industry Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of the Department of Trade and Industry.

Current membership Mr Martin O’Neill MP (Labour, Ochil) (Chairman) Mr Roger Berry MP (Labour, Kingswood) Richard Burden MP (Labour, Birmingham Northfield) Mr Michael Clapham MP (Labour, Barnsley West and Penistone) Mr Jonathan Djanogly MP (Conservative, Huntingdon) Mr Nigel Evans MP (Conservative, Ribble Valley) Mr Lindsay Hoyle MP (Labour, Chorley) Miss Julie Kirkbride MP (Conservative, Bromsgrove) Judy Mallaber MP (Labour, Amber Valley) Linda Perham MP (Labour, Ilford North) Sir Robert Smith MP (Liberal Democrat, West Aberdeenshire and Kincardine)

Powers The committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No 152. These are available on the via www.parliament.uk.

Publications The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at www.parliament.uk/t&icom.

Committee staff The current staff of the Committee is Elizabeth Flood (Clerk), David Lees (Second Clerk), Philip Larkin (Committee Specialist), Grahame Allen (Inquiry Manager), Clare Genis (Committee Assistant) and Joanne Larcombe (Secretary).

Contacts All correspondence should be addressed to the Clerks of the Trade and Industry Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 5777; the Committee’s email address is [email protected].

Witnesses

Tuesday 1 March 2005

Mr Stephen Carter, Lord Currie of Marylebone and Mr Ed Richards, Ev 1

Mr Francesco Caio, Mr Ian El-Mokadem and Mr David Rowe, UK Competitive Telecommunications Association Ev 7

Ms Mary Turner, Mr Richard Sharpe and Mr Dave Simpson, Internet Service Providers Association Ev 13

Ms Karen Thompson and Mr David Carr, AOL UK and Mr Eric Abensur and Mr Simon Persoff, Wanadoo Ev 17

Tuesday 8 March 2005

Mr John Pluthero and Mr Andy May, Energis Communications Ltd Ev 21

Mr Ben Verwaayen, Ms Anne Heal and Mr Peter McCarthy-Ward, BT Ev 27

List of written evidence

1 AOL UK Ev 34 2 Broadband Stakeholder Group Ev 36 3 BT Ev 39 4 Centrica Ev 45 5 COLT Ev 49 6 Easynet Ev 51 7 Energis Communications Ltd Ev 52 8 Internet Service Providers Association Ev 62 9 Nortel Ev 65 10 ntl Ev 70 11 Ofcom Ev 74 12 Telewest Broadband (Flextech) Ev 76 13 Tiscali Ev 78 14 UK Competitive Telecommunications Association Ev 81 15 Wanadoo Ev 82

List of unprinted written evidence

Additional papers have been received from the following and have been reported to the House but to save printing costs they have not been printed and copies have been placed in the House of Commons Library where they may be inspected by Members. Other copies are in the Record Office, House of Lords and are available to the public for inspection. Requests for inspection should be addressed to the Record Office, House of Lords, London SW1. (Tel 020 7219 3074) hours of inspection are from 9:30am to 5:00pm on Mondays to Fridays.

British Music Rights British Printing Industry Federation Connect UK Communication Workers Union Federation of Small Businesses Hutchinson 3G Internet Telephony Services Providers’ Association National Consumer Council Ofcom Consumer Panel Orange UK

Trade and Industry Committee: Evidence Ev 1 Oral evidence

Taken before the Trade and Industry Committee

on Tuesday 1 March 2005

Members present:

Mr Martin O’Neill, in the Chair

Richard Burden Mr Nigel Evans Mr Michael Clapham Sir Robert Smith

Witnesses: Mr Stephen Carter, Chief Executive, Lord Currie of Marylebone, a Member of the House of Lords, Chairman, and Mr Ed Richards, Senior Partner, Strategy & Market Development, Ofcom, examined.

Q1 Chairman: Good morning, Lord Currie. Could the heart of our strategic review. I believe the citizen you introduce your colleagues for us? and consumer are absolutely central to what we are Lord Currie of Marylebone: On my right is Stephen doing. There are other considerations which we do Carter, Ofcom’s Chief Executive, and on my left is cover in the review such as the need for better Ed Richards, Senior Partner and Board member. consumer information, so we have informed May I just start by saying that we very much consumers. On the supply side we are seeking to get welcome your interest in this area. You have many a better wholesale market which will then feed into things on your agenda, but we are here to listen to innovation, but we are very conscious of the your concerns and answer any questions as fully as need that consumers on the demand side need to be we can. As you know, we have had very major better informed and we are consulting on ways in consultation with responses from very wide parts of which we may enhance that. the industry, consumer groups, the public sector and elsewhere and we are studying those and we will be Q3 Chairman: While your review is pretty wide covering the issues in our final report in due course. ranging, there seem to be other issues which have been thrown up and which have been dealt with by Q2 Chairman: Thank you. We have had a couple of other reviews. There is the value of BT’s copper, for informal chats but we have not really taken any example, which is the subject of a separate study. evidence on the record. We took the approach that Are these studies being co-ordinated? One would it was better to let you get on with the job and then think that one would impact on another. For be called to account. I think we met you within a example, the value of copper relates to prices couple of weeks of you starting up. You have been charged by BT’s wholesale sector. Is there joined-up in place barely 13 months. We are grateful to you for regulation here? coming along. We have got some meat to chew this Mr Carter: We hope so. We planned our work plan morning. Maybe we could start with the premise for this calendar year and indeed for this financial upon which your approach is base. It has been year in the full knowledge of when the Strategic suggested that the promotion of competition, which Review Phase 2 would conclude and then there you have taken as your starting point, places would be a period between that conclusion in insuYcient attention on the needs of the consumer. February and when we would publish our final It has been put to us that perhaps the consumer outcomes, which is likely to be at the end of June. should have been put first since there are a number That would allow us to run in parallel with four or of issues which are consumer orientated as much as five other what you might call day-to-day— provider orientated. although they are certainly not day-to-day in their Lord Currie of Marylebone: This is a strategic potential consequences—market reviews and other review. Right at the heart of our concerns are the activities. One of those, for example, is looking at the interests of consumers. We are concerned absolutely valuation question of the underlying copper to promote the interests of consumers and citizens as network, but there are others. We are consulting on our primary duties under the Communications Act what is an appropriate cost of capital for BT’s require. I think our analysis is that this is a market business and whether or not that should be which has suVered from a lack of competition at the disaggregated and applied in diVerent ways in wholesale end part of the industry. We are seeking to diVerent parts of the network. There are a number of address that question and if we do, we will have a other similarly significant pieces of work going on. much more dynamic, innovative sector that will very The intention is that they are concluded at a series of much serve the interests of consumers. What points between now and the end of the summer so we customers want is real value for money, innovation, get to a regulatory settlement which provides diversity of provision. That is not something that we certainty to the incumbent and hopefully a can mandate directly. What we need is a dynamic framework of high levels of competition from innovative market that delivers that. That is right at other players. Ev 2 Trade and Industry Committee: Evidence

1 March 2005 Ofcom

Q4 Richard Burden: Broadband will soon be embarked upon the broadband journey the available to 95% of the population. Its roll-out seems consensus for quite a long period was that we would to be happening at the moment. When do you think not reach beyond 70% and actually we managed to it might reach 100%? Will that extra 5% be diYcult get very, very close to 100%. The second observation to crack? is that there are many areas that have identified local Mr Carter: Going back to the Chairman’s opening schemes sometimes with local authorities or with question, it seems to us that broadband is a good development agencies for that infill problem. One of example at the retail level of where competition has the issues that have tended to be thrown up in that delivered some significant benefits. I remember circumstance has been state aid questions. As you appearing before this Committee five years ago and reach full maturity in the market and reach the final we were a long way from that level of coverage and level which the market is likely to drive it to—and certainly a long way from the retail take-up and the 99.5 is obviously very, very high—those state aid pace of take-up that we are at now and that has been issues are likely to become less relevant and that is driven in part by some eVective competition between likely to give you more scope for the kind of local the incumbent PDSN operator and the cable authority or development agency initiatives which companies and also by some measure of wholesale have been considered. It would be government who competition, not so much as we would like. To that would need to look at a Universal Service end we are at just north of 95% likely coverage and Obligation. there are some significant local projects under way to try and infill in those geographical areas which are Q6 Richard Burden: Do you reckon the right kind of remote. We are also trying to release in another place timescale for looking at that might be about a as much wireless spectrum as it is possible to do to year’s time? encourage alternative forms of less wire bound Mr Richards: I would put it a diVerent way. You broadband technologies to be a possible infill need to have a strong sense that the evolution of the alternative, and we are continuing to push for market forces has led you to a point where you aggressive competition at the wholesale level as understand how far the market will take you. I think another driver. Whether we will get to 100% at this Y the fact that it would probably have been only 60 or stage would be di cult to predict. It is worth 70% two or three years ago makes that point. Let it recognising that 70% of those people who could get go as far as the market will take it, look at potential broadband today choose not to take it. infill activity, sometimes just groups of individuals getting together, at other times in collaboration with Q5 Richard Burden: I understand that obviously local authorities and development agencies, and everyone’s wish would be to get to 100% and there then consider the USO beyond that. It is moving at are a number of things being done on that. If an incredible pace. This is not a static market. There somebody does not want broadband then that is are 100,000 people taking up broadband every single fine, but if they are in an area where they cannot get week at the time, so the rate of growth is intense. It broadband and we are up to 98% or 99%, will that does not feel like we have reached the point of person who happens to live in that area not be able equilibrium yet. to get it because he is so close to 100%, so that extra bit of eVort will not happen, or it will not come from Q7 Richard Burden: Let us move on to the regulatory the various initiatives that you are talking about? regime. The way you are approaching this at the Would it be worthwhile at any stage considering, as moment is that there are regional variations. You we are so high now in terms of proportions, some are looking for areas of market failure about where kind of Universal Service Obligation? areas require more regulation and where things seem Mr Carter: I think our view on that is that at this to be going okay. Is there not a danger that varying stage that would be inappropriate or preemptive, the regulatory regime in a regional way would act as but we would not rule it out. It is undoubtedly the a disincentive to future investment in those areas case that provision and access to some of these new that are currently being developed on the ADSL services is unfortunately disadvantaged depending network of BT? upon your geographical locality. The reason for my Mr Carter: I think I would put it slightly diVerently. gentle history lesson of what has happened over the The history of regulation by geography in last five years is there has been significant progress telecommunications is quite long. Indeed, the period over a relatively short period of time and therefore of licensing fixed infrastructure competition to BT our view is that it is worth looking at this stage to see was done by geographical franchise, by cable what happens over the next 12 to 18 months before franchise and was limited to the largely urban and rushing to a judgment as to whether or not a denser areas. We are not pursuing a policy of Universal Service Obligation would either be geographical diVerentiation by regulation. There is legitimate or required. Again, just for clarity, the no freedom to geographically deaverage voice USO would not be ours to determine. The charges, that is a fixed average charge. There is an application of a USO on broadband would be for the emerging debate about where you are likely to see Secretary of State, it would not be for the regulator. wholesale competition really emerge in the local Mr Richards: Our current technical estimates loop and the economics would tell you that that is suggest that we may reach something like 99.5 or likely to be in the denser areas. So we have signalled 99.6%, so the residual number may be very, very that whilst in our view Datastream—which is one of small. It is worth remembering that when we the existing wholesale alternative products—is an Trade and Industry Committee: Evidence Ev 3

1 March 2005 Ofcom important part of the current regulatory framework, to consider the alternatives, but it is worth putting in we need to look at what the future relationship is this large amount of eVort both on the part of BT, between Datastream and LLU, if LLU takes oV, in Ofcom—and indeed, we hope, the rest of the those areas where you are unlikely to see investors industry—to see whether we can make this one come in to invest in unbundled exchanges. That is work. where we are as of today. Q10 Mr Clapham: Let us look at BT and the Q8 Mr Clapham: Your preferred strategy is enforcement issue. Given the lengths that they seem obviously equivalence. Are you satisfied with what to be going to in terms of a separate division with BT has done so far? separate management and separate accounts, would Lord Currie of Marylebone: It seems to me that BT a full structural separation not be simpler? has engaged constructively with the questions that Lord Currie of Marylebone: It has always been open we have put forward. They have come forward with to BT’s management to decide whether or not they proposals that I think have moved the debate on. We wished to structure voluntarily their business in a have to be satisfied that it will deliver genuine diVerent way. Obviously there would be regulatory equivalence of access. There is a lot of detail to be outcomes that would be diVerent that are a matter considered there including the questions of for the board of BT plc. My own view is that they enforcement and we are engaged with BT and with have responded to our consultation in a constructive the rest of the industry in debating those issues and way at this stage. The question is how you make it we intend those to be resolved over the next few work. months. It is too early at this point to answer your question. We are examining the question of whether we are satisfied and we will have an answer by the Q11 Mr Clapham: Would a full structural change time we produce our final report. not eliminate the need for regulation? Lord Currie of Marylebone: No, it would not. This is one of the reasons why many in the industry have Q9 Mr Clapham: Is it possible to say why there is a understandably shied away from the more radical kind of skepticism in the industry about structural solution, because it is not as if with one equivalence? Do you feel that it can become a bound you are free of regulatory option, not least reality? because in the wholesale market whatever entity was Mr Carter: I think there is a skepticism based on two left behind would still be required to be regulated reasons. The first one is historical experience on the because by definition it would be a monopoly ground and, secondly, because factually the provider of wholesale, and it is not entirely clear that incumbent holds all the network asset cards, if you even a fully separated retail entity would be wholly are seeking to compete with BT that is a challenging free of regulation either. That is for now, until the activity. Our analysis laid out some alternative market matures and develops, not a likely option. options and, as David has said, at this stage we are inclined to take the view that the best option is an option called real equality of access and that requires Q12 Chairman: Do you not think you should look at two fundamental changes from BT, one in terms of the British Gas model where you have the pipes and the products they provide to competitors who wish the need for having a natural monopoly? They had to compete with them and those products have to be them separated into three linked companies and they provided on an equivalent basis to allow a level came to the conclusion that the game was not worth playing field, but there is a second dimension, which the candle and basically they went their separate is that there needs to be organisational, structural ways. and behavioural changes within BT to come in Lord Currie of Marylebone: I think there is a very behind those products so that there is not interesting parallel there. It is worth making the obfuscation, delay, all the things that conspire to point that that was a decision by British Gas make it even harder for competitors to compete management to separate themselves, not a equally. Right now we are engaged almost on a daily regulatory regime. basis in working through the detail of whether both those products and those behavioural and structural changes are (a) deliverable and (b) legally Q13 Chairman: I remember the discussions we had enforceable. At the moment we are of a view that we with them over things like separate canteens and would like to get to a position where they are. If they diVerent golf clubs perhaps even. The Chinese walls are not, that leads the sector to the inexorable became so much of a problem that it was better, in conclusion that the only way in which you can make their view at that time, to have three separate it work is to look at a fundamentally more radical managements altogether. solution. Lord Currie of Marylebone: I think there is a parallel, Lord Currie of Marylebone: It is also worth but one has also to bear in mind that telecoms recording the responses to our previous consultation networks are technologically much more complex to this. The balance of opinion in the industry was and dynamic than pipes and wires and indeed against the alternative of going down the Enterprise technology is moving things around all the time and Act route and we were encouraged, I think rightly, to therefore the question about exactly where you see whether we can really make equivalence of access make the separation is a much harder one to address work. As Stephen said, if we do not then we will have on the telecoms area. Ev 4 Trade and Industry Committee: Evidence

1 March 2005 Ofcom

Q14 Mr Evans: Is BT playing ball with you? a workable solution that works on the ground. Mr Carter: It is a fair question, but it is not a game. However robust the regulatory regime is, it will BT is engaged in detail in answering the very specific always be after the event. questions we have asked them. The diVerence, if that is what is behind your question, is that we have been Q17 Mr Evans: Is it a workable solution with more focused on where it is we are demanding timetabling as well? If something is not happening, equivalence. We have been open to the question that will you make it happen? there may be some areas of the telecommunications Mr Carter: An essential part of the framework we market where a lighter touch or a lighter form of will need to conclude or not between now and the regulation may now be appropriate because there summer will not only be undertakings that are are some markets where there is a significant legally enforceable but that have deadlines and measure of eVective competition and therefore the timelines and measurements attached to them. need for the regulator to try and impose it or control it or structure it is not as high. The level of the detail Q18 Chairman: There is a feeling that BT’s mission of their engagement is high. statement is a bit like St Augustine’s prayer, “Make me good, God, but not yet”! That is our worry, that Q15 Mr Evans: That is basically what I am getting things might take rather longer than expected. You at. Clearly what you are asking them to do is to have said you are going to put down a timetable. Do invite competition into something where they are we take it that it will be a fairly short and rigidly unused to having competition. You are basically policed operation? saying to them you want them to give away part of Mr Carter: Within the bounds of what we are their business. You talked about behavioural and allowed to do legally. We are required to consult cultural change. It is a bit like the , over time periods. We have already had questions is it not, where some countries sign up to Directives from the Committee about Universal Service without any desire whatsoever to carry out the Obligations and 100% coverage and these things regulations, whereas other countries clearly do? I am require some degree of balance. just wondering whether you perceive that BT is being genuine when they say “Yes, we will do all Q19 Mr Evans: Is equivalence being rolled out to the your requirements” and they are smiling at you wholesale market as well? when they are saying it. Do you think they are? Mr Carter: Indeed. Lord Currie of Marylebone: The conversations I have had with the senior management at BT suggest Q20 Mr Evans: I want to look at Local Loop yes, but they face a challenge. BT is a large Unbundling. Is this recognition that then ADSL organisation. It is the top board that signs up to this. now is ‘the only game in town’? They then have to transmit that message right down Mr Carter: I am not sure the cable industry would through the organisation to the behaviour of the welcome that question. Clearly at a retail level and engineers and people working out on the field and infrastructural level there is an eVective and that is a diYcult change for BT to eVect. There may increasingly consolidating competitor. It does not perfectly well be goodwill, but there is still a have anywhere near 100% geographical reach. If one challenge for BT to deliver it through the day-to-day is looking across the reach of the country in fixed operation of their activities and that is something infrastructure, ADSL is the major player. they recognise and that is the debate about the behavioural separation issues, how to really make Q21 Mr Evans: Do you fear that with Local Loop this work on the ground so that it really does deliver Unbundling it is going to divert scarce resources real equality of access for the industry as a whole. away from our infrastructural investments? Mr Carter: I think that is a very important question Q16 Mr Evans: If other companies then start and it goes back to the Chairman’s question about complaining to you that they are not getting the timing. The judgment we took when we inherited equivalence that you require, you basically have the our responsibilities—and history will be the judge of last say, do you not, because you have got the threat whether it was right or wrong—was that if we could against BT that if they do not play ball fully and co- get the conditions for alternative investments in operate with you then you have other measures up LLU right speedily then that would facilitate other your sleeve? players investing in the network at the deepest point Mr Carter: We do, and we have significant of infrastructure, which might then lead to enforcement powers. My own view is that part of the subsequent follow-on investments in other areas. change of tone of engagement is a function of the We have never seen it as an absolute end in itself. It fact that this regulator has more significant is a means to an end, but that means you have got to enforcement powers. You will hear later today from get it right reasonably fast otherwise the market or people who are competing with BT in the market technology moves on. and I suspect they will say, and they will probably be Mr Richards: We looked very carefully in the first right, that the process of registered complaint and part of the review at whether there was, as a result then seeing real change on the ground is too slow, of technological change, other opportunities for full because anything that does not happen immediately end-to-end infrastructure competition in the model in the real world of competition is too slow. What of the cable industry but perhaps through wireless does that tell you? It tells you that you need to have mechanisms or indeed fibre to the home. The Trade and Industry Committee: Evidence Ev 5

1 March 2005 Ofcom conclusion we came to, which we tested in the country like Korea is that they have very high consultation process, was that indeed in many densities which make the economics of providing people’s view there was no long-term scope for that. fibre to a building, for example, much more As a result of that, as Stephen said, what we wanted attractive. The UK tends to have less dense to focus on was driving competition as deep into the populations. We want to make sure that we have got network as possible and we combined the a clear regulatory framework in place so that when consultation we did with some economic modelling people are ready to roll-out and when they believe and where we believe that that is possible is through the demand is there from businesses or homes, that Local Loop Unbundling at least for a significant investment can be made. We have looked at a variety part of the UK. Where that takes place within the of diVerent options which we are consulting on at the UK should have a broader beneficial eVect across moment. One is full regulatory forbearance where the UK more generally. That is the way we have been essentially we say if you want to make the next thinking about it. We spent a lot of energy and time generation access investment—and this is not BT’s looking at alternatives first because clearly if it had core network, this next generation broadband been possible to take any measures which would access—we would forebear from regulating for a have introduced full multiple infrastructure certain time period, thereby making it the most competition from end to end that would have been a attractive situation. They would be able to earn full preferable outcome, but there is no suggestion returns on it. Another option is to make the ducts anywhere that that is in the oYng. and civil infrastructure of BT available to other players who then may make an earlier investment. Q22 Mr Evans: Are we not storing up a little bit of The third option that we have looked at is what we trouble for the future with so much concentration have called open access through which we would have a regulated return on a single fibre investment, going on ADSL as well? There is a capacity problem, V is there not, with ADSL in any event? Is it 18 but a whole variety of di erent providers might have one of those fibres or share that fibre access. At home megabits a second? V Mr Richards: It is 18 to 24. It varies around the you could choose between di erent service providers world. There are all sorts of experiments and but there would essentially be monopoly regulated research and development going on in this area. We access. pretty much know now that you can do 18 to 24 per second over copper. That does have a consequence Q24 Chairman: I am not very clear here. The because it is very hungry and therefore it may aVect emphasis in the last few moments has been about the reach of the ADSL network in any particular technology, but we are talking about a market which area if you are giving very high bandwidths to people requires massive resource in order to gain even a closer to the exchange. There may be a consequence niche position. The diYculty seems to be that we that needs to be looked at carefully there. have been concentrating on the technology but not Nevertheless, it does raise the issue of the next the cost. My understanding is that outside of BT generation beyond that. There will be an upper limit. there are a number of people who are very It is remarkable how far people have been able to precariously placed at the present moment in the extend what you can put over copper. This is sense that it costs them more to sign people up than another issue that we have looked at carefully and the charges that they make. If BT just sits there and had a lot of dialogue on in the UK and plays poker long enough the other ones will leave the internationally. At the moment I think it is safe to table because they do not have the resource say that in the UK there is very little ambition to roll- regardless of the technology. What would you say to out anything beyond stretching the copper as far as that view? you can to that 18 to 24 megabits per second. That Mr Carter: It is not the most optimistic view I is not the case in other countries. In the US now have heard. there is more fibre going either to the home or to the kerb. Both SBC and Verizon have announced major Q25 Chairman: We are here to get some idea of what investments in that area. As I know you are aware, is happening. in some of the Asian countries, Singapore, Korea Mr Carter: You will hear later today from and so on there is already investment of that kind. companies who are trying to compete with BT. Whether they would describe themselves as Q23 Mr Evans: Is our industry going to be precariously placed or not, I do not know. What Ed disadvantaged compared to other countries round is describing in terms of alternative technologies the world if we do not encourage or somehow demands an investment appetite, demands incentivise proper investment into these new significant capital investments and Op-Ex technologies? investments in order to be able to make it. At this Mr Richards: I think the most important thing that stage, partly because of the structure of the market, we have thought about in this area is that we have partly because of market valuations and a variety of got a clear regulatory framework which will other things, there is no real evidence of that. In facilitate that next generation investment should another place in the telecommunications market, in there be the demand from industry or indeed people mobile, there are significant capital investments at home for that kind of capacity. It is important to being made not least in the rolling out of third make the distinction between the UK and some generation network capabilities, five of them to be other countries. The biggest diVerence with a precise. It is not that there is no investment in new Ev 6 Trade and Industry Committee: Evidence

1 March 2005 Ofcom telecommunications infrastructure. We are having a Q29 Chairman: There was an access charge of £300 conversation about fixed, but there are investments which has never been altered as I recall, is that in alternative technologies taking place. correct? Mr Richards: Those are the shared line prices. We Q26 Mr Evans: Do you see that as a case for the are consulting on the fully unbundled. defence as well sometimes and not moving as fast on fixed when they say you have always got mobile Q30 Chairman: The other thing we were a bit telephony? concerned about was the issue of regulatory Mr Carter: You mean the case for BT? uncertainty and whether this was a determined investment. Are you concerned that the length of Q27 Mr Evans: Yes. time that your reviews are taking is creating a degree Mr Carter: I am not sure, not least because of their of uncertainty which is perhaps holding back LLU position in mobile. One of the conclusions we came as well? It is not just BT who is the villain here. to in our review is that fixed to mobile convergence is Lord Currie of Marylebone: If we were to be not yet, certainly in competition terms, a meaningful proceeding without proper consultation, without reality; in other words, you still need to treat them as engaging with the industry about the issues, I think separate markets for the purposes of regulation. My we would be subject to the opposite charge, that we point really was in response to the Chairman’s point are not taking due regard of the views of the that there is a scale of investment being made but it industry. is in other areas. Q31 Chairman: You are damned if you do and Q28 Chairman: Do you think the investment could damned if you do not. go further if BT’s charges were reduced? You might Lord Currie of Marylebone: Consultation does take argue that Michael Howard could use BT as a model time, but we are very clear that the objective at the for immigration policy as far as letting people into end of this is to create a regulatory framework that the exchanges is concerned in the sense that in the gives clarity and certainty, that incentivises not just past it was almost as diYcult getting through the eye BT to invest but also other players and so we have a of the proverbial needle as getting into this place. much more healthier wholesale scene which will then That has changed but there are still charges feed through as benefits to consumers at the retail involved. Fabulous sums have been paid every week end. That is absolutely at the heart of what we are to BT for what seemed to be relatively minor trying to achieve. problems; it is £300 a throw at the moment. Have you thought about trying to get that reduced? There Q32 Chairman: How do you see the role of obviously are economies of scale coming into play Datastream contributing to wholesale competition? and some of the people wanting to get into the LLU Mr Carter: Datastream was one of the first decisions business are not being able to move at the speed they we had to face when we took over from Oftel and we would like to move because of the scale of the made the decision at the time that we should regulate charges. Do you have regulatory powers to look at the margin available between IP Stream and these prices? Datastream on a retail minus basis rather than a cost Mr Carter: We do, we have been and we will plus basis. Why did we do that? We did it because it continue to do so. We have seen significant was quicker and we thought an immediate response reductions in the wholesale charges from BT in the was what many people in the industry—some of local loop both for rental and connection, largely for whom are sitting behind me—were demanding. We shared lines rather than for fully unbundled lines. rationalized it because the trouble with doing cost We are currently consulting on the cost of the local plus calculations when you are dealing with loop. Wherever we conclude on the cost of the emerging technologies is you lock in cost bases copper—because that is a significant proportion of which may change over time. It can be inappropriate the wholesale charges—will read right across to or ineYcient. What has actually happened is that I what are, going forward, acceptable charges and I think most industry observers would say that think it would be safe to say that those charges are Datastream has not developed its scale in the way only going to go in one direction and that is that one would originally have envisaged. In a sense downwards. There is no doubt that your analysis is the development of LLU in the denser urban areas correct, that the wholesale charges in part have been calls into question the role of Datastream. Short an obstacle to the enthusiasm of those people who term our view is that Datastream has a significant wish to compete. I do believe there is now a common role and we will continue to make the necessary acceptance across the industry including BT that we regulatory interventions. Then there is the need to get a level of significant competition in the technology question. Datastream is an ATM based local loop. Is there absolute universal agreement as product and as telephone products move to IP to what the charges should be? I am not so sure, but technology we will have to look at some medium- there is common agreement on the principle. term changes there. That is really where we are in the Mr Richards: Connection charges have come down industry. from £117 to £34 in the last four months and the rental from £53 to £15.60, so there has been a big Q33 Chairman: As a consumer I get bewildered by change in the last 12 months, whereas last year the speeds and charges. Is there any move afoot to price was genuinely regarded as prohibitive. simplify that for the lay person? I know that previous Trade and Industry Committee: Evidence Ev 7

1 March 2005 Ofcom regulators have used Which? magazine as a kind of prescribe it to be presented in a rather misleading conduit for the transmission of information about way. There are a lot of options out there. It may not rates and charges. Have you thought of doing be possible to make it so simple, but that is the anything like that? People are now being somewhat question we are asking. We will listen to views. bewildered by adverts saying something is twice as fast as the one which was slowest last week and you Q35 Chairman: Are you confident that once the do not really know what it is all about, and then consultations are over, once you have got your mind there is quite extensive advertising about how you clear and the industry understands what you are can get something for next to nothing and you pay going to do, you will have the ability to enforce these for it per year. Is there not a duty on you to try and decisions on the recalcitrants? simplify this so that the lay person can get a clearer Lord Currie of Marylebone: We have extensive handle of what they are paying for? powers, but one of the questions that we are Lord Currie of Marylebone: We did lay out in the specifically addressing at this moment is the question strategic review of the last consultation a whole set of how we would enforce real equivalence of access of options in this area. We are consulting on this in a way that we ensure that BT does indeed deliver question. We are reluctant to be prescriptive about on that. There are some enforcement questions and narrowing the range of options out there in the we have diVerent options in that respect. We have to marketplace because that does reduce consumer be satisfied at the end of it that we can make it stick choice. What we ideally want to achieve is a position and if we are not confident in that then we will have where the consumer is better informed and there are to look at the alternative options that we laid out. a range of options that we laid out that may or may not achieve that. It is a question we will be coming Q36 Chairman: That has covered all the areas that to. The regulator being prescriptive about tariVs and we wanted to raise with you. There may well be products I suspect is not the way forward. issues which come up as a consequence of the evidence we get this morning and so we may get back Q34 Chairman: It is not so much being prescriptive to you. about the tariVs but how they are presented and a Lord Currie of Marylebone: If you wish to ask us question of how long you consult. further supplementary questions in writing, we Lord Currie of Marylebone: We are consulted in a would be very happy to respond. timely way. The danger with being prescriptive Chairman: We may well have to do that. Thank you about how the data is presented is that we may very much.

Witnesses: Mr Francesco Caio, Chief Executive, Cable & Wireless, Mr Ian El-Mokadem, Managing Director, Centrica Telecommunications, and Mr David Rowe, Chief Executive, Easynet, UK Competitive Telecommunications Association (UKCTA), examined.

Q37 Chairman: Good morning, Mr El-Mokadem. main brand we operate in the UK: British Gas, and Perhaps you could introduce your colleagues. perhaps less familiar with One.tel. Between One.tel Mr El-Mokadem: Could I perhaps just introduce and British Gas we have established ourselves as the our Association first and I will let my colleagues largest service-based competitor to BT in the fixed introduce themselves? line market in the UK. Mr Rowe: My name is David Rowe. I run Easynet group, which is an alternative telecoms operator in Q38 Chairman: Yes. the UK. It is probably best known for pioneering the Mr El-Mokadem: We represent UKCTA, which is local loop in the UK which we have been in for a the UK Competitive Telecoms Association. It is the couple of years now. Our footprint covers around trade association committed to establishing a 750,000 businesses and our primary roll-out was genuinely competitive landscape in the telecoms based on a return for businesses, not for the consumer market in the UK. We represent basically most of market.Havingsaidthat,asaresultofsomeofthe the major players who compete against BT and each things that Ed Richards was saying earlier, the price other and also have the privilege of buying services drops have encouraged us to move into another phase oV BT in this marketplace. Between us we are well potentially for expanding our network to include a placed to comment on the topic under investigation. more consumer orientated footprint and it depends Our primary objective is to deliver a level playing partially on the outcome of some of the reviews as to field. Our firmly held view is that that is the way in what we do. We launched a wholesale product at the which investment will be maximized in this industry end of last year which competes head-to-head with and that will ultimately be to the benefit of BT wholesale and we have had a very good response customers and the economy; that is our objective. from the industry in general. We are a little bit We have been working with Ofcom, Government worried about some of the deaveraging things that and other stakeholders as hard as we can to that end. BT are doing in terms of diVerential pricing, we There are some 23 members of our Association. I am believe they are trying to hit us slightly competitively, Ian El-Mokadem. I run Centrica’s telecoms division. but, notwithstanding that, we have been very Committee members will be very familiar with the encouraged with the local loop infrastructure so far. Ev 8 Trade and Industry Committee: Evidence

1 March 2005 UK Competitive Telecommunications Association

Mr Caio: My name is Francesco Caio, Chief Mr Rowe: If I could just answer that one. From an Executive of Cable & Wireless. We have a large UKCTA perspective then clearly for people like business in this country, about £1.6 billion in Centrica it is important to have a national pricing revenues and we have recently launched under the environment for their business plan and for their Bulldog brand a Local Loop Unbundling service to marketing purposes. From a local loop operator’s both consumers and small businesses. We are now perspective, BT are using the argument, if I am right, rolling out the network account and the first phase that in the urban areas, where perhaps returns are will be to unbundle 400 exchanges by the end of this better, those are the areas where they can lower year that will cover something like 30% of the prices diVerentially to rural areas. If one turns that population and about 35% of the businesses. As argument on its head and says the reason why they David was saying, we have been observing the are able to oVer lower prices in the urban areas is evolution of Local Loop Unbundling processes and because they are making such good money in these prices very closely and we have concerns about some areas and they are the operator who holds all the of the geographic deaveraging of BT. We have cards, as we have heard before, it is almost, and I am recently submitted a complaint to the adjudicator not going to say universal provision, but it is after having worked very eVectively with both something where you would expect their Ofcom and the adjudicator. We are committed to responsibilities to be in ensuring that they use some innovating in this space, we are committed to taking of that profit from their profitable exchanges to full advantage of infrastructure-based competition eVectively subsidise the rural exchanges and not the and we are committed to both capital and managed other way round. For us that is important because bandwidths to make sure that we oVer to consumers we as a fledgling operator who are moving into a new and businesses a quality alternative in the area of area need to reassure our investors that they are broadband. going to get a return from the investment in the local loop. Where we can see that BT see us as a threat then clearly that is going to alter the business case if Q39 Chairman: Thank you. One of the reasons we BT are oVering diVerential prices in exchanges are holding this inquiry at the moment is to try and where we are being successful. I do come back to the get a feel as to how the review has gone and I think point, agreeing with Francesco, that real, really what we would want to start oV with this sustainable, long-term competitive positioning in morning is your impressions of the review. How the telecoms industry relies on end-to-end satisfied are you? Do you think they have maybe infrastructure competition of which the local loop is taken the wrong approach, been too kind to BT or arguably the best thing we have ever seen in that too rough with them? What is your general view? regard. Have they been asking the right questions as far as Mr Caio: I would refer to specific examples of what you are concerned? we have seen in the market over the last few months. Mr El-Mokadem: I think broadly the answer is that It is not by coincidence that until this competition in we are very happy with the way the review has been the local loop arrived that the consumers in this conducted thus far. Generally all of our members country and businesses in this country have been at would say that a review of this market was long a disadvantage when it comes to speed of connection overdue and I think the years that came before compared to other European markets. Only Ofcom’s establishment were typified by regulatory recently—and I am talking based on direct uncertainty, and almost a paralysis in some cases in experience—through the launch of a four megabit terms of getting decisions made, and I think a product in the area of consumers, have we seen BT strategic review of this market was long overdue. We reacting to just one flavour of 500K, which is a very believe that Ofcom’s approach has been highly low speed, and launching a new competition and you consultative and pitched at the right level, starting to are observing now a fairly rapid upgrade of speed look at the strategic issues in Phase I and then available from BT. This is one of the clearest drilling down into a very good framework in Phase examples of proof we can point to in the area of II. All of our members are signed up to the principle infrastructure-based competition. It is of concern of equivalence as being a good basis for a regulatory that once we have committed to a roll-out of the settlement in this space. So far we are very pleased network we see those exchanges, as David was with the progress that the review has made. I guess saying, where we are making some inroads being at the end though we have been at this for a year and targeted by BT to have diVerential prices on the a bit and we now need to very quickly see some wholesale, where they could scupper the plan. I results on the ground. Whilst we do not mind the think there is a perception in this country probably review going on for another few weeks if it gets to a more than others that the internet industry has been decent, robust structural answer, at the end of the composed for years of whingeing people who really day it is the results on the ground that now matter do not know what they are talking about and and that is where we want to see Ofcom turning very quickly. therefore there has been an over-reliance on regulators to keep the incumbent honest. I think we are observing a shift in this. We are observing a Q40 Chairman: What about regional variations in number of players, for sure Cable & Wireless, which the regulatory regime; is there a danger that it acts as are now committed to implementing and delivering a disincentive in areas which are currently dependent a roll-out that has never been seen before in this on BT’s ADSL? country when it comes to the focus on exchanges for Trade and Industry Committee: Evidence Ev 9

1 March 2005 UK Competitive Telecommunications Association both businesses and consumers. We have to be industry to deliver value to the users? One needs to cognisant of the fact that we are not in the charity view the debate on equivalence in this context. business. We are acting under the strong assumption Equivalence needs to cover everything, particularly that infrastructure-based competition is the key services that rely on the famous or infamous last mile driver for the quality of life for citizens and where through the years BT, as every other competitiveness for businesses, and under that incumbent in this world, has managed to build a umbrella we need to deliver returns to shareholders. natural monopoly position. As my colleagues were So I think this matter goes well beyond the Ofcom saying before, it needs to be about input. It needs to review. I think it is at the heart of policy-making in be very practical. One of the concerns of the terms of what kind of industry in the fixed industry, and Cable & Wireless in particular, is that telecommunications sector this country is willing to there a fair degree of convergence when we talk go for. I think clarity is of the essence because of about principles but now it is time to act. What does what David was saying. This industry has been equivalence mean in specific instances? For instance, destroying value for too long, not necessarily line rental is not a service that today is fit for purpose because of the incompetence of the people running when it comes to equivalence. Ian can elaborate on the net. It is time for us as an industry—and we are his direct experience in WLR, as can we. There are very grateful for this opportunity to speak to you, 900 people per week deciding to switch because it is Chairman, and to the Committee—and for the such a complicated process to forego the monthly leadership in this country to come to terms with line rental to BT. what kind of competitive model would citizens and Mr El-Mokadem: We shall add to that. Wholesale businesses benefit from in such a central element of Line Rental—which just to clarify for Committee the competitive landscape as broadband. members is the ability basically for you to choose to have to pay me for your line as opposed to BT—is a Q41 Mr Clapham: You heard Ofcom say that their very, very basic building block of switching. preferred strategy is equivalence and I note from Comparisons in other industries like gas and your submission that you support the principle of electricity would be that today you do not switch equivalence. Is that a reflection of all your from British Gas and still end up paying us for the members’ views? pipe or wire to your house. Line rental is the Mr El-Mokadem: Yes, absolutely. A fundamental telecoms equivalent of that and certainly in the five principle of our association is we would not have years Centrica has been in this space we have been responded as UKCTA were there any material lobbying very hard just to have the ability for you to disagreement amongst our members as to what we be able to choose whether I bill you for your line or put in that document. So absolutely. We are all you continue with that relationship with BT. We signed up to equivalence being a very good basis for were very pleased to see finally that Ofcom said in a regulatory settlement. I think there is a strong the last instalment of the review that the product that preference amongst the flavours of equivalence in has been delivered by BT Wholesale is not fit for the document for input equivalence because that is purpose. I am sure Committee members will have the easiest to police and to ensure in the long term. been lobbied quite hard by BT over the last 12 There was some discussion earlier about Ofcom’s months who were telling you that it actually was. powers and ability to intervene and pursue The reality is I run a business where we have got 1.4 complaints, et cetera. We firmly believe that input million fixed customers, and I can tell you very equivalence is the one least likely to result in endless clearly that a large majority of those customers disputes into the future because basically with input would love for me to be able to bill them for their line equivalence it is very clear whether we are all buying rather than have a bill from BT and a bill from us but the same thing oV BT or not. It is black and white. the reality is that that product is not scaleable, the Without input equivalence there is a lot more of a processes are very flaky and if I were to try and requirement for measurement and a lot more transfer thousands of customers per week through judgment involved in the other flavours suggested in that product it would be very labour intensive, very the Ofcom review. In the long term that is a recipe costly to operate, and probably result in far too for more regulatory intervention and more many complaints. We have been working very hard disagreement. The closer and quicker we can get to to make progress on that very, very simple building input equivalence, the better and the more block of competition and have been very frustrated transparent this industry will be. in that process. Mr Rowe: It does beg the question that someone Q42 Mr Clapham: Given the discussions that you asked earlier; are BT playing ball? I think the bottom have had with your members, could you say what line there is they are in it to serve their shareholders you feel the equivalence principle should cover? and their bonuses depend on certain profit targets Mr Caio: It should cover everything because you are and taking away their ability to make those profits dealing with an incumbent. Let me step back. hurts them personally, it is less money in their pocket Sometimes I feel that this country loves the debate from their bonuses. So it is counter-intuitive. No- between us and BT. It is almost like you are there as one in this room would behave like that. It is not to intrigued spectators to a pretty interesting fight. The do with being good or being bad; it just is. The purpose of us is not that we wake up in the morning equivalence issue therefore goes to the heart of this and say, “How can we hurt BT today?” it is really because it hurts BT and it has to be done with a big how can we develop a sustainable position in the stick, not lots of meetings dragged out. They have all Ev 10 Trade and Industry Committee: Evidence

1 March 2005 UK Competitive Telecommunications Association the cards; remember that. If you really want to create and our concern is that we run the risk of focusing genuine competition which will in the long term on principles without looking at the practicality. benefit consumers then remember what it was like Equivalence means having the same data that is before competition and how much it cost to phone available in BT Retail to everybody else who is and America and what the service levels were willing to put money into the ground to develop like. It was not just because BT wanted to be nice innovation. suddenly. It was because competition forced them into it. Unless we get equivalence properly done and also a benign environment for loop operators to Q44 Mr Evans: Going back to your relationship with invest in, then it is not going to change. British Telecom, while Francesco may not get out of bed with the intention of wanting to kick BT every morning the fact is you want to compete with them Q43 Mr Clapham: Are you confident that Ofcom and you want to get more of their business, do you can actually achieve equivalence in the market? not? Mr El-Mokadem: I think in our view Ofcom has Mr Caio: I do not think it is their business; it is the more than enough powers to impose or to reach a consumer business and it is the company business. regulatory settlement that would work. With the combination of the Enterprise Act, the Communications Act and the Competition Act Q45 Mr Evans: But you want more of it, do you not? there is more than enough legal basis for them to Mr Caio: Sure I do. I want more of that. I want to V operate. I guess my own experience is I have dealt o er something and earn customers through with most regulators beginning with ‘Of . . . ’ over the innovation, quality of service and value for money. last eight years from Ofgas through to Ofgem in energy and then Oftel through to Ofcom in telecoms Q46 Mr Evans: They are not going to give it to you and I think a key part of this is the demeanour of the out of the goodness of their hearts so the only way it regulator, that the regulator has to be strategic from is going to happen is through the regulation of the outset. They must say, “What are the macro Ofcom, which basically gets to the heart of it. I think issues which I must sort out here?” They need to be you were all listening to the Ofcom representations forceful, clear with all parties and then they have here and you heard what they had to say. Are you more than enough powers sitting behind them to happy with Ofcom? execute. If I look back to the Oftel days, the problem Mr El-Mokadem: I think so far so good. Frankly, it with Oftel was there was no strategic context for has been a breath of fresh air compared to Oftel decision-making. None of us really quite knew what which I think had run its course. There is a good Oftel was trying to achieve at the end of the day and team in Ofcom. I think they started the process, as Oftel was typified by endless complaints and endless we said earlier, very intelligently. They are asking the investigations into this and that but without a right questions. They have got a good set of context in which to make proper, robust decisions in frameworks in the Phase II document for the basis terms of where are we trying to get to, what are the for a solution but what we are going to see over the key building blocks, how do we get there. The key next few months is a real test of their mettle. thing Ofcom needs to use this review to do is to Personally—and this is me speaking rather than establish that framework so that everybody UKCTA—I have a slight concern that we are in the understands and so there is certainty about realms of it is time for a bit of a fudge to get this thing investment, and then they can use their powers very through. I would prefer personally to see this review successfully to execute against that. I would say that going on for a few more weeks and achieving the the key to this being successful moving forward is the clarity that input equivalence provides the basis for. closer you can get to input equivalence, the less need There is a lot of work to do. In terms of the proposals there will be for endless investigations and dispute that they put forward, whilst there is no doubt it is a resolution into the future, so it is worth taking the step in the right direction—and to be fair to Ofcom pain now to see what we have seen in other markets they have brought BT to the table in that respect— which is a gradual relaxation of regulation over time there is an awful lot of detail missing, and we may go once the structure is right. on to talk about some specific areas of that. I think Mr Caio: And I think it would be useful to bear in the key thing in the response from BT was that whilst mind the practical elements of what we are talking V there were some apparent concessions around things about. At the moment we are o ering consumers the like an access services division and structural opportunity to have full local loop unbundling and remedies internally, a big chunk of their document to take telephone lines, telephone services, voice was dedicated to denying the need for that change services and fast internet on the same line. In order V and denying a lot of the Ofcom comments about for us to get that opportunity to o er this innovation BT’s behaviour in the market which we would all to consumers we need to get into what the industry recognise very clearly as being what it is like to deal recognises as address matching. We need to specify with them on a day-to-day basis. an 11-number code that is associated with a customer account and we need to spell the address as in BT’s database. If the postcode or if the database Q47 Mr Evans: It goes back to David’s point, does is wrong they do not recognise that. In any other it not, that because you want to take some of their country you give the number and the name of the business they are not going to be happy about it, are consumer and that is enough. I think my concern they? Are you getting a much better relationship Trade and Industry Committee: Evidence Ev 11

1 March 2005 UK Competitive Telecommunications Association with British Telecom than you have ever had and do context of Wholesale Line Rental, the cost is £91.99. you see any of the behavioural and character change From an engineering standpoint I have very great that was talked about by Stephen earlier on? diYculty in understanding what the diVerence is and Mr Rowe: If I could just answer your original I think it is time for the industry to have BT question first which was about Ofcom. I agree addressing these issues in an open forum and decide wholeheartedly with what has been said before, but which is the right price, and I hope the conclusion is the proof is in the pudding. There are two big issues not £168! for me. One is equivalence, and the devil is in the Mr Rowe: This comes to the equivalence of inputs detail, and the other is we need to be protective of the that we were talking about. local loop because BT really do not like that. That goes right to the heart of their future. So you need to Q51 Chairman: Are you happy with the suggestions protect it now in some way or other to help it thrive on the structural changes that are going to take to increase the investment case for it. place? This possibility of the business being split up into three elements? Q48 Mr Evans: Are you seeing a sea change in BT’s Mr El-Mokadem: I was very interested earlier in the relationship with you? comments about British Gas. I think there are some Mr Rowe: To be fair, most people in BT are ordinary very relevant parallels there. Let me try and answer people who get up, go to work, come home, and we the question in this way. We were pleased to see the have a reasonable relationship with them because we proposal for an access services division in the BT are quite civil to them. The people at the top are document. That is a significant shift in terms of scheming; that is what they are paid for. concessions that BT put on the table. However, there is an awful lot of detail missing so far in those Q49 Mr Evans: I do not want you to beat about the proposals. We do not see so far in what is contained bush! What do you really think about the people at in those proposals the very clear, transparent, stand- the top? Really? You just think they have got a alone entity within BT that is free to serve all strategy which is they send their nice people out to customers including BT Retail on an independent chat to you but there is something diVerent going arms’ length basis. There were a lot of words like on upstairs? ‘monitor’ and ‘observe’ and things like that but very Mr Rowe: If I were a shareholder of BT and I wanted little feeling that this was a true commercial arms’ to get the maximum dividend, I would hope they length entity. If I look to our own history, obviously would do whatever is necessary to get the maximum British Gas has been through this whole separation profit that they can. debate and the conversation earlier was absolutely Mr El-Mokadem: To put it another way, if we look right, when done properly the Chinese walls become at a specific example, I should be one of BT so high that arguably there is a case for separation Wholesale’s biggest customers. I have been shouting because there is no benefit ultimately in the for that product for four years. I could sell a lot of it. integrated model. We have as an industry group I have had no material senior level engagement with shied away from calling for separation because if we BT in terms of progressing Wholesale Line Rental can get within BT a properly ring-fenced transparent for months, in fact probably really for years, and entity then that will serve our purposes. It is then a even after Ofcom put in its document before matter of personal opinion as to whether the BT Christmas that the thing was clearly not fit for board would ultimately see divestment or demerger purpose (because before that BT had been saying it at that point as being the right solution, and that is was) there has still been no real serious engagement really for them. The key thing is that the access on that issue. If BT had really made a mind-set services division so far is a long way oV that clearly change that was going to take on board the spirit of transparent proposal with high Chinese walls that some of the comments in Ofcom’s proposals, then I we would like to see and there are also some things would not hesitate to say that a few of us have had missing from it. Some of the key products like a bit more engagement at a senior level on some of Wholesale Line Rental and carrier pre-selection, these real, fundamental issues. Speaking personally, which are in the current proposals on the table, are I am still waiting for the call. not going to fall within the remit of the access services decision, they are still going to be in BT Q50 Mr Evans: So you think it is that nice Ben Wholesale. Frankly, from my perspective I do not Verwaayen and his mates at the very top who have a think that is going to change. I have been trying to diVerent strategy completely and you think that they get those products out of BT Wholesale for five years are pulling the wool over Ofcom’s eyes and you are with very little success so I am not encouraged by the wanting Ofcom to take further harsher action other promise in the document which is that there against them? will be an equality of access board that will somehow Mr Caio: May I bring your attention to some facts sort all that out. because there is always the danger of double guessing what people in closed rooms think about it. Q52 Chairman: You must be taking this to Ofcom; At the moment I am observing these two interesting what do they say? points. When we have to buy access to a local loop Mr El-Mokadem: This is exactly where we are at. We line from BT to then oVer full local loop unbundling have obviously pushed back since we saw the BT to our customer, we need to pay £168. When we have proposals and UKCTA has been heavily engaged in to buy that same capacity and capability in the conversation with Ofcom. One of the key areas we Ev 12 Trade and Industry Committee: Evidence

1 March 2005 UK Competitive Telecommunications Association are pushing for is much greater transparency around case hundreds of millions of pounds—that have the access services division. I am a bit concerned that gone into that portion of the value chain. I think it is having put it on at the table they say, “Whoopee, very important that the Ofcom solution encourages BT, thank you very much,” and actually the devil, as investment at the customer end of this because I everybody keeps saying here, is in the detail and so think that is the way in which you keep the far the detail around that organisation is very technologists on it because at the end of the day if it lacking. does not have an application that the customer is Mr Rowe: I think it is also important if the access willing to buy that is where a lot of telecoms models services division does come about that the have fallen down in the past. It is important that we management of it is clearly separate and is not just see the embryonic investment at that end of the value BT management on that board. It must be industry chain which many UKCTA members are bringing: management with a remit on that board for it to people like us, and Caldwell have a chance to work. Communications. That is a very important part of this jigsaw and should not be forgotten. Q53 Mr Clapham: The review document talks of the Mr Caio: May I add one point on innovation which need to promote investment. Are you satisfied that I think is very important. Through local loop its proposals will be fulfilled? unbundling we have for the first time a serious Mr Rowe: I think it depends on what comes out of opportunity to unlock that kind of monopolistic this. Clearly the bulk of the investment, as we heard resource at a time when there is a shift in demand earlier, in this country is being focused around local from traditional narrow band services to loop investment, both at Cable & Wireless and at broadband. I do believe that there is a sense that Easynet, and there are one or two other players around incumbents are somehow the involved as well. This comes back to my point that repository of innovation and “we had better not the local loop needs to be encouraged. The review touch them because if we touch them the rest are so does not necessarily focus all of its eVorts in that area flaky that we might be left without innovation”. I by any means, but I know that Ofcom is aware of would seriously ask BT to reconsider that. There is a that and their view, broadly, is in line with that too. genuine opportunity to drive sustainable innovation through limited but very well-focused investment, as V Q54 Mr Clapham: I hear what you say about the David was saying. Both our networks o er today investment in local loop unbundling, but is there a capabilities that BT is now associating with the possibility that it may cause a distraction and notion of the 21st Century Network where they are therefore move the focus away from the need for an just somehow constrained by the lack of innovation in the last mile. At the moment two smaller improved network to allow faster speeds? V Mr Rowe: Not really. If you look at the stuV that companies than BT—us and Easynet—are o ering both Cable & Wireless and Easynet are putting in a higher speed than BT and I think this is a point I now we already have eight meg. We are waiting for really would like to emphasise. There is an the final ratification of ADSL 2 ! to oVer 18meg on opportunity to see genuine innovation coming back our network. Our network is already ready for that. into the fixed telecommunications industry for the It is not a question of holding back the investment so benefit of consumers and businesses and it would be that BT can get there. We are there already. What we a shame to see that window closing now. need to do is to get a better environment so that we Mr Rowe: Also if I could pick up on your point can roll-out to a wider area and focus on the earlier about where does the speed go to, ADSL and consumer as well as the business from our fibre to the kerb. To give you an idea, something like perspective. It is a bit of a myth that BT needs to five megabits is good enough to do TV broadcasts. recycle all this money to get the next generation. If you let free competition go, we will out-innovate BT Q57 Mr Evans: We are almost there now. every single day of the year. Mr Rowe: Once you start to go to eight or ten then you can get high definition TV-type quality. The Q55 Mr Clapham: Are you confident that that question is then what else do you want to do with it. environment is evolving, shall we say? Who knows what the possibilities are in terms of Mr Rowe: It is nascent. high definition video conferencing and stuV like that. Q56 Mr Clapham: It is nascent? Mr Rowe: Yes. Q58 Mr Evans: What do you need for video Mr El-Mokadem: I think it is also right to have sight conferencing? of other forms of investment in this industry. It is not Mr Rowe: I was going to think of another all about kit. There is a real tendency to think about application but just forgive me for a moment. Yes, telecoms and to think about exchanges and wires. all of those things in fact can be done within the Obviously that is at the heart of it but if I look at my kinds of speeds that we are talking about with business we do not invest in that stuV. We choose to ADSL. To talk about the next generation is far too partner with players like these guys to deliver that. early. That is their expertise. What we bring is an insight Mr Caio: The market is now, the demand is now, into managing mass market propositions, sales, and a lot of debate about ADSL being long term marketing, call centres, customer service. There is a sounds like that has diverted attention from what is lot of innovation and a lot of investment—in our today. If you think about analogies with the mobile Trade and Industry Committee: Evidence Ev 13

1 March 2005 UK Competitive Telecommunications Association industry and waiting for the next generation, there is cannot aVord to have another risk which is BT, or always time to wait for the next generation but if we incumbents in general, being left with the power of keep waiting nothing will happen. This is what is playing with wholesale retail prices in a way that available today and I think we can genuinely address scuppers the significant investment plans which the demand for innovative services with ADSL in a drive innovation. very eVective way. Mr Rowe: Also the first and last questions investors always ask when you come up with a new plan is, Q59 Mr Clapham: A little earlier, Francesco, you “This sounds great but what if BT do this or what if mentioned the need for more infrastructural BT do that? We heard that BT are going to do this.” competition. What do you see to be the main factor It is a big risk factor in your investment. All we need holding that up? is a clear playing field. Mr Caio: Again it is the point we were making before. There has been an abundance of Q60 Chairman: Thank you very much, gentlemen. infrastructure competition at the core of the network One last question. What do you do if BT asks to but all that innovation has been somehow wasted join you? because it has been constrained by lack of Mr Caio: UKCTA? competition in the critical last mile. Also I was saying before for years consumers in this country Q61 Chairman: Yes? Do you have a fetish doll that have been oVered “any colour they want as long as you stick pins in and it is BT? it is black” type of thing, and again analogies with Mr El-Mokadem: I think that would be an ultimate the mobile industry indicate that infrastructure- measure of the success of the review. If we get to the based competition brings innovation, new services, stage where BT Retail is a competitive telecoms declining prices and value for money. Without that candidate member because it is playing in a level innovation I do not think that situation is playing field, that will be a good measure of whether sustainable. Back to what Ian was saying before, it or not Ofcom has done a good job. is important to have certainty in the regulatory framework to isolate the commercial Q62 Chairman: I thought you might say that! entrepreneurial risk. We do not want to shy away Mr Caio: We are very open. from that risk with commercial businesses but we Chairman: Thank you very much.

Witnesses: Ms Mary Turner, Chief Executive OYcer, Tiscali UK, Mr Richard Sharpe, Managing Director, AltoHiway, and Mr Dave Simpson, Manager of Regulatory AVairs, Easynet, Internet Service Providers Association, examined.

Q63 Chairman: Good morning, Mr Sharpe. As the for about 70% of the business. The other 30% is man in the middle can you introduce your colleagues wholesale so we buy from BT and we compete with and then we will begin. BT as well. We were the first and largest Datastream Mr Sharpe: Before I do that I would like to give you provider. We have got 75% coverage of the UK and a little view of ISPA, particularly in view of your last we will cover some of the challenges and benefits of comment about BT, because they are a member of Datastream as well and we are committed to rolling ISPA. ISPA is the leading trade association for out LLU this year. companies involved in the internet space in the UK. Mr Sharpe: On my right is Dave Simpson from This year is our tenth anniversary. We have 130 Easynet. members and they range from small, medium to Mr Simpson: I am Dave Simpson. I head up large ISPs in the UK. BT, AOL and Wanadoo are all Easynet’s Regulatory Department, and as you members of the trade association. We therefore already heard Easynet is primarily a business reckon to represent about 98% of the UK internet provider. We launched a wholesale product based access market. Myself I am the managing director of on LLU just before Christmas and we are moving a small niche ISP, AltoHiway. To some extent we are into the residential area. a consumer of services in terms of we would look forward to having another supplier in the local loop arena other than BT. We are a BT customer right Q64 Chairman: Thank you. How do you as an now but at this point in time we are only seeing the organisation feel about the Ofcom review so far? emergence of some competition in that arena. We Mr Sharpe: I think the previous three guys covered are a customer of Bulldog, for example, and have pretty much our feelings about it. I think that Ofcom some experience of the trials and tribulations they have proven to be very accessible. We have had a have with the local loop which perhaps we can talk number of meetings with them and that appears to about later on this morning. To my left is Mary be an improvement over what went before. There are Turner from Tiscali. basically two challenges in this review: equivalence Ms Turner: I am Mary Turner, I am CEO of Tiscali and transparency and this behavioural change. The UK. Tiscali entered the UK market in 2001. Across things that I think is missing from the review are the Europe we are the third largest ISP. In the UK we deliverables and a timescale against those service about 1.4 million consumers which accounts deliverables. Ev 14 Trade and Industry Committee: Evidence

1 March 2005 Internet Service Providers Association

Ms Turner: I agree with that because I very briefly other operators: the speed to market, the ability to looked at the response from BT and there is a lot of innovate, the ability to provide diVerent and varying politeness in the way we describe that document as products into the market, and also to build a long- being the first step, acknowledging the reality and so term sustainable business. on and so forth. I think BT acknowledging the need Mr Simpson: We must not forget there are almost as for behavioural changes and organisational changes many diVerent business models for ISPs as there are is one thing, but that is in theory and we need to see ISPs. Not everyone is an infrastructure player, as we the substance and the clarity that follows. I also heard earlier, and in that case if you are not an believe that behavioural change is at the heart of the infrastructure player, are you even interested in matter. There is something that describes LLU? I guess the answer is yes, you would be behavioural change, and that is DNA, and that is because potentially something like Easynet oVering very diYcult to change, in fact nigh on impossible, a wholesale product puts commercial pressure on so I think we need to address this. I believe that BT to innovate on their own wholesale products. We accepting what BT has proposed as the end product have seen that with the eight meg product where, as will not lead to a satisfactory conclusion. I think we heard earlier, BT have now said, “Okay, we are Ofcom needs to take a much more involved and going to introduce higher speeds and more features monitoring and measured role in this whole process. and functionality into our own products.” In terms I think leaving it to happen and letting things roll- of LLU and the practicalities of it something that is out would be a dangerous strategy to follow. I am often pointed out is whether it is working? Certainly expecting and I am looking to Ofcom to take a much we have seen a new zest behind LLU and a focus on more direct role and to bring some of the key issues it since Ofcom started and certainly with the on the table and discuss them with the participants adjudicator scheme which they have introduced to that are aVected. I am seeing some of the changes but look at all the processes and crunchy issues about is it to our satisfaction; I would say at this stage in how you do this in practice, the adjudicator is time it is early days and it is not satisfactory. working through those. I will leave it there but in terms of the adjudicator scheme we certainly see that as achievable. Q65 Chairman: We have been talking a lot this morning—and in fact you have mentioned it already—about LLU. What is in LLU for ISPA Q66 Mr Clapham: Just looking at the number of members? ISPs in the market—and there are 300 currently in Ms Turner: If you look back at the explosive growth the market—do you feel there are too many or is the in broadband it was brought about by two factors. market suYciently large to be able to provide for One is the extent of the coverage because as soon as them all? you rolled out to 95–99% coverage people could Mr Sharpe: Consumer choice is all about having access and buy broadband, but the other key thing multiple choices of supplier. It is an interesting that brought about the real growth in broadband is statistic. I did some research on the basis of that the choice, the value for money and the removal of assumption and you are about right, there are the set-up fee, what we call the activation fee, that around 300. Nobody knows exactly because people consumers have to pay. Also in a lot of come and people go all the time, they are being circumstances ISPs have been future pricing, ie, we bought up and there are new entrants into the game. have been pricing broadband at the right level to the If you take ADSL as an example, the ADSL Guide detriment of margin, so there is a very slim or no shows 110 players in this space. Net4Nowt, another margin in the hope that when LLU is rolled out we monitor of this, shows about 182, so we guess there can get the margins back. So this is what has actually are probably between 160 and 180 ADSL players. If brought about this enormous growth in broadband. you take away the larger players, 15 or so, that is a What is it that ISPs are looking for in LLU? Exactly significant number of suppliers in this market. Right this: we are looking to build a long-term sustainable now they are all likely to be BT re-sellers or BT business, like the UKCTA members were saying, central IP Stream customers. I am sure that every and this can only be brought about if there is market one of them, as we are, is looking for some confidence, stability and improved margins, and we competition in that arena simply because we are a believe that the right deployment of LLU will give us consumer of those wholesale services and we only this. On top of that what LLU will bring is product have one choice right now. My big concern about choice through innovation, exactly what Francesco LLU, however, is, as I said, we take IP Stream and Caio and David Rowe have been talking about. It is that is a central pipe into BT’s core network and the choice, it is value for money, and it is also quality. core network very, very rarely fails. 99.9% of the Today all of this is actually controlled by BT. The problems we have are in the local loop. When you last thing that is controlled by BT is speed to market. are a business-to-business ISP (and perhaps this A very good example was that two years ago just shows in some of the statistics about those 160 before Tiscali rolled out Datastream we approached players) most of the services we provide do not just BT to roll-out a couple of new products at diVerent go to a consumer sitting in his home with a single PC, speeds. They said, “It is a very good idea but come they connect to a local area network. We have done back in 12 months’ time, we will have that product some work on the number of seats that we service as ready.” When we rolled out Datastream we brought a niche player and we reckon to service some 70,000 out that exact product in under six weeks. Speed to business seats. If you multiply that across 160 ISPs, market. So these are the things that LLU would give that is an awfully big number. By the way, we do not Trade and Industry Committee: Evidence Ev 15

1 March 2005 Internet Service Providers Association believe that Ofcom consulted with us as a group spent keeping them fed and watered and trying to when they did this review, however they are grow the business. When you go to Ofcom and you addressing that now so I do not want to make too talk to them about it they have no mechanism for much of it. I think the issue is that we are seeing an taking these inputs. You could ascribe to BT a divide awful lot of problems in the local loop and what and conquer scenario because it is only when you get concerns me as a customer of BT is if I become a to situations like this and I meet Mary and we start customer of Easynet, for example, they still have to talking about things, that we discover that we have buy the local loop from the BT infrastructure as it got common problems. I do not believe there is a currently exists. If there is a problem in the local loop mechanism for logging all of these problems so that and my business customer goes down he screams you can see first of all if there is a common thread blue murder because his business stops. If a and secondly if you are looking for a sea change in consumer goes down for a minute, for 10 minutes, BT’s attitude then how do you measure the change for half an hour it is not such a big deal (although it in the attitude? You can only measure it by seeing if may seem it to them) but to a business where e-mail there has been an improvement. stops flowing, where their website may stop Mr Simpson: One of the advantages of being a trade working, and all of the VPNs connecting various body is you have diVerent views on things. I have a oYces stop working, that is a big deal. Like I said, quite diVerent opinion on some of the things you are we are seeing significant problems in that area. The saying, with all due respect. I think a lot of the issues situation right now is that BT is my supplier. If they you have pointed to are probably more historical screw the local loop up I can stop paying them. If I issues. Certainly at Easynet we sell direct to am an Easynet customer do I have the same businesses and we compete directly against leased leverage? The answer is probably no from a legal lines which are very high reliability products point of view. So the issues about who owns the local therefore we cannot accept the kinds of things that loop, how it is funded and how it is managed are Richard was alluding to, which we do not find really important. So this access services division is a actually happens in practice. What we are using step forward but, as David Rowe said, the devil is in when we do LLU is copper in the ground and the detail and the proof is in the pudding. Our perhaps some bits of BT’s backhaul and they are bits experience to date has been that that pudding might which we have found quite reliable so we do not not be around to taste for some time. necessarily have so much trouble. The issue specifically with our wholesale products is that we Q67 Mr Clapham: So are the problems that you are secure and confident enough in our wholesale encounter relating to technology due to the lack of products that we are going to run our consumer investment that is going in? business on our own wholesale products. When we Mr Sharpe: No, I believe BT have made and talk about equivalence would it not be very sweet if continue to make investment. I cannot really have an BT built their entire 21st Century Network/Next opinion about that. If you examine the problems Generation Network based on LLU, the proof of the that you have they are all about on the ground pudding being in their own eating. We would problems so an engineer goes to a box in the road, he certainly point to that going forward. Finally, on the has not got enough twisted pair, he listens on a line, adjudicator scheme which I point back to again, that he cannot hear anything, he pulls it oV and sticks it is Ofcom’s mechanism for addressing all the somewhere else. The line is live with ADSL and my practical issues associated here. Yes, there have been customer is no longer working. When you go back issues in the past and they have been acknowledged, to BT and say “you have screwed it up”, first of all but we are getting through them. We are already they give you a wishy-washy reason so that you seeing improvements. There is a lot of automation spend three or four days trying to get to the bottom coming online from BT systems around Easter and of the problem and when you get to the bottom of we should see the real practical application of that in the problem they say “it is season re-provide, sorry, the summer. At that point we will know whether the line does not exist any more”, then you have to LLU is really a scale play. insist “put it back”, and those are the day-to-day Ms Turner: It is not all doom and gloom, I must say. practical problems you see in the local loop every If you look at the last six months there have been single day. There may be a fault on the line because significant improvements not just from Ofcom; it is of some issue over the reach you may have. There are Ofcom and inquiries such as this. If you look at three all sorts of apocryphal stories that I will not go into significant improvements we have achieved (since here but it is a practical issue and it is something that the last TISC inquiry), one is the margin squeeze needs to be addressed with this access services between IP Stream and Datastream. That has been division. addressed to satisfaction. Albeit it took some 17 months but we have got it now. If you look at Q68 Mr Clapham: Presumably, as you said earlier, migration fees which used to be 70 or 80 quid, they you have a dialogue going with Ofcom which you have come down to £11. Also the pricing on LLU did not have previously so they have been made has come down significantly. These are some of the aware of some of these problems? achievements. However, the reality today is that we Mr Sharpe: Yes but equally I, in common with the still have 95% of wholesale in the hands of BT so one 160 other MDs, have the real problem of trying to must ask why. If you look at the achievement of the run my business on a day-to-day basis as you can drop in price of LLU and the migration fee coming appreciate. We have 50 people and my whole time is down, that is a great achievement on paper but a Ev 16 Trade and Industry Committee: Evidence

1 March 2005 Internet Service Providers Association bulk migration process is still awaited by the Datastreamed which will give me control over the industry. Ofcom set the delivery of that product to quality that I provide, the innovation, the choice, and the market for October last year. That date was so on and so forth. missed and it was extended to March of this year. I Mr Simpson: I think, probably, where the debate has await that because we are in March so let us see moved on slightly is that whereas it was more about whether that is actually delivered. If you look at the how Datastream and IP Stream, these two wholesale price of LLU, that is great, however it is an products, fitted together, now the debate is more about achievement on paper today because, lo and behold, how can we make sure you can still be on LLU without as soon as the prices came down we have got the being squashed by BT and their wholesale products in destabilising factor of deaveraging, which BT areas where you can compete with LLU? Wholesale is bringing down the IP Stream prices in the busiest exchanges. These are exactly the Q70 Mr Evans: You have clearly got huge reservations exchanges that most operators will LLU first. Then about BT and how they are rolling this equivalence there is the destabilising factor that is brought about out, whether they are going to comply with it or not. by the 21st Century network. Nobody is clear about What is your biggest reservation on that? the implications of the 21st Century Network. There Ms Turner: I was disappointed by BT’s response. I do is very little clarity in terms of connectivity, not wholly go to say that they are scheming; I think compatibility, and so on and so forth so for an they are smart, rather than scheming. My investor like myself, if we are looking at rolling out disappointment is that there was a recognition and an LLU there are some fundamental questions that acknowledgement by BT that change is necessary, that need to be answered to satisfy my shareholders equivalence and input level is required but beyond that before they would invest because the payback period most of the paper was spent defending and denying on LLU exchange is two to three years and that is poor performance and attitudes. What I would like to exactly the time when the 21st Century Network is see more of is how the proposal for the access service going to be rolled out. I need to know with some division is going to work because today it is going to confidence that the amount of investment that I am be no diVerent to BT Wholesale—ie, it is going to be a placing in LLU is not going to be made redundant separate division but with the same management and and where there is some form of migration path and with the same shareholders. Operationally and whether there is a cost involved, what are the functionally, on a day-to-day basis, it reports to the compatibility issues so the 21st Century Network is same group of people. How is that going to change? still enshrined in secrecy. We need to bring those Also, there was recognition that there have to be issues to the table and debate with clarity and behavioural changes. It is an easy statement to make transparency. We are pushing Ofcom to do that. but how do you go about making those changes, and They are facilitating but the progress is slow. We when do you make those changes? How are we going need to move faster. Sure we need to be considered. to monitor those changes and measure those changes? I was listening to Ofcom earlier today and there is a One step further: is Ofcom going to enforce payoV between speed and eVectiveness or compliance? Are they going to penalise for failure? correctness, the right decision, but we need to find What is this process? How long is it going to take? Are that balance and find that balance soon. we going to participate in this process? I think there are more questions than answers in the response from BT, and that is my disappointment. However, time will tell Q69 Mr Clapham: Could I just ask about the wholesale because the process is not concluded, it is still in market and Datastream because the last time that the midstream; we are participating in that process and, as Committee looked at the industry the points that you everyone keeps saying, the proof is in the pudding. I made were in relation to the wholesale market and of say the proof is in the eating of the pudding, not the course the failure of Datastream. Is that still the main pudding in itself. issue or are there others now? Mr Simpson: The irony is, as we reach the end of the Ms Turner: We have actually rolled out Datastream. Strategic Review and the rush to finish, and this is We are now probably, other than the cable operator where the real meat is going to happen, that this is the NTL, the singular operator that has rolled out bit that is going to carry us forward over the next ten Datastream extensively. I understand from some of years, potentially, so we have really got to focus on my fellow colleagues that they decommissioned the what are the key issues? What are the actual practical Datastream network because they are finding it is not issues? BT has presented their response as a package, scaleable, it is not robust, and so on and so forth. My saying “It will do this for you, the industry, and you belief is that Datastream still has a valid role in this deregulate us elsewhere”. You cannot take that market because not all operators will go and unbundle deregulation, until you have proven the bits that we every exchange in the market, so our strategy is three- want are out there and working. fold: in the congested or highly concentrated areas where it makes sense we will LLU, in the outer regions Q71 Mr Evans: I assume, Richard, with what you we will do Datastream because it still gives us a degree said earlier on (with your catalogue of disasters, that of innovation over and above IP Stream and where every time something goes wrong it takes days to Datastream is not possible we would actually then buy find out what has gone on), you feed all this stuV into a re-sale product from BT which is IP Stream. The Ofcom, perhaps, on a daily basis, if you are not belief of most operators, certainly Tiscali, is that 80% getting answers? There must be a fear that once this of the should be either LLU-ed or whole procedure is over, once our Committee has Trade and Industry Committee: Evidence Ev 17

1 March 2005 Internet Service Providers Association

finished and made our recommendations, then Q72 Mr Evans: Are your members able to access the things may just fall back to their old ways. Is that cable network? what your greatest fear is? Mr Sharpe: The answer is yes. In fact, AOL has Mr Sharpe: I think that the issue with Ofcom is that access to the network. we are discussing with them a mechanism for getting Mr Simpson: It is kind of done on a commercial that feedback, because there actually is not one at basis, at the moment. I think, probably, our view this point. The feedback is at the macro level not the would be let us concentrate on the copper because micro level, but it is at the micro level that you work the copper goes everywhere; cable is only in certain out whether there has been a sea-change in attitude areas. We have got other members who do wireless, or not. As I said, I think we are going through that we have got all sorts of diVerent infrastructures, process with Ofcom. One of the fears I have is that access infrastructures, out there, and we think if you they have set a deadline of June for getting this focus on the copper let us not get distracted by other sorted out, and there is an awful lot to do between things. Of course, it is open to commercial now and then, and I just wonder whether that is negotiation with these other guys, but let us putting a little bit of a monkey on everybody’s back. Maybe that is what is needed, but it is a very short concentrate on the copper. timescale to get to a point where you are saying, “Well, actually, if you have not now complied, when you have not even put in measures at this point that Q73 Chairman: We had some more questions but, in can tell you whether you have complied or not, we fact, your answers have covered them. That is very are now going to report it to the Enterprise Act”, helpful. There may be further points we would like and so on. I am just a little concerned about that. to raise with you and we will be in touch, or if you Mr Simpson: The industry is fully committed to have anything else you think afterwards you should engage in that dialogue, and really it is probably have said or would like to have said, then please get going to be down to BT to respond quickly enough in touch. and to commit to binding commitments by that date. Mr Sharpe: Thank you very much.

Witnesses: Ms Karen Thomson, Chairman and Chief Executive, Mr David Carr, Vice President Broadband, AOL UK; Mr Eric Abensur, Chief Executive and Mr Simon PersoV, Head of Regulatory AVairs, Wanadoo, examined

Q74 Chairman: Good morning. Perhaps you could competition on the agenda was extraordinarily introduce yourselves and then we will get started. helpful. I am going to avoid any reference to Ms Thomson: I am Karen Thomson, I am Chief puddings or eating but it is quite clear that moving Executive and Chairman of AOL UK. Can I forward it is now all about how it is executed, how introduce, on my left, David Carr, who is my Vice competition is brought into the market, and that will President of Broadband, responsible for various ultimately be the proof of the strength of the process. broadband services in the UK? However, a good start. Mr Abensur: I am Eric Abensur, Chief Executive of V Wanadoo UK, and Simon Perso is the Director of Q76 Chairman: Obviously, we have had to look this V Regulatory A airs for the UK. morning at LLU and in a number of instances we have been discussing the price reductions and the Q75 Chairman: Thank you. Very quickly, on the access to LLU. Are you happy that things have gone question of the review to-date: this is a new body, on far enough there? Are the prices low enough? Is starting with a slightly diVerent approach from its access reasonable enough now to the LLU process? predecessor, how do you feel about them? What is Is there anything else Ofcom needs to do in that area, your view of the review at present? do you think? Mr Abensur: Very good. Extremely positive, I think. Mr Abensur: I think we said, once again, twelve We attended this Committee in December 2003 and months ago, when we started this discussion reading again your report, I think we said at that regarding Local Loop Unbundling (and this time that we were cautiously optimistic about the Committee was, really, the first to start launching new body, and I think every action they have again the Local Loop Unbundling in the UK—and undertaken so far has been extremely positive. So I we thank you for that), we made this comment, and think the consulting period they have launched and your report made this comment—I think it was in the key decisions they have taken during the first half paragraph 32—about the fact that there is some of 2004 were extremely positive and gave some very criteria to make sure that local loop can expand good messages to the industry. So, so far, we would positively. Those criteria, in my mind, are about say we are quite positive about what Ofcom has price, about processes, and the third point was delivered to the market. stability. You mentioned that stability in your report Ms Thomson: We would echo that. It has been a twelve months ago. The price we have; I think the good consultative approach. I think a lot of the price has come down quite dramatically. The issues have been put on the agenda and really opened processes: we have this Telecom Adjudicator scheme up in a way that we did not feel was happening and I think all of us agree it has created some positive before that. Getting a clear roadmap for dialogue. We are still very early in the process but it Ev 18 Trade and Industry Committee: Evidence

1 March 2005 AOL UK and Wanadoo is positive, again. The third is about stability. When quality standards rather than incrementally we have to build a business case for investing in improving standards which, frankly, we do not think Local Loop Unbundling, yes, you talk about margin will be enough to get us there. but this business case is for the next five, six or seven years, so you want to make sure that your key Q77 Mr Clapham: Ithinkyouwereallsatinwhen assumptions are likely to happen, and if over the your colleagues from ISPA said they still have some next two or three years some key assumptions have reservations about the wholesale market. Do you feel been jeopardised, yes, we may have an issue and we that Local Loop Unbundling can overcome some of may have some concern. So I think we have reached the issues with the wholesale market, or does it have the two criteria of stability, in terms of price—we are the potential to perhaps undermine it? happy about the price of Local Loop Unbundling— Ms Thomson: I think if you project forward a number and we are happy about the way the process has of years and in a situation where there are a number started. However, we have a question mark about of large players using LLU, you would potentially stability: margin stability, and the stability of the have a lot of product and service innovation. LLU regulatory framework, and a question mark about also provides the ability for smaller and perhaps more the 21st Century Network—that is the kind of regional players, more specialist players, to compete. concern and question mark we may have today. Provided we get the environment right, then I think Ms Thomson: I would certainly echo some of that: on LLU will bring a much more vibrant, competitive the pricing we are broadly happy; on the process side market. We have already seen over the last couple of I would point out we manage a customer base of well years how more competition has brought us much in excess of two million customers in the UK, most of more reach into the network; the demand has been whom will go to broadband at some point. When you higher than anybody anticipated and certainly than look at the quality of the processes to support a BT anticipated at the time. So I think it is really about migration from IP Stream—the technology we are the structure and environment that we now require to currently dependent on—across to LLU, we have to make that picture come true. So it is really about be striving for extraordinarily accurate and solid making sure that the practical aspects of allowing processes. Where we are at the moment is definitely competition into the market, to get the customers not the quality that we would require to be able to migrated, to ensure that product and service eVect a significant migration across to LLU. I innovation are running, and that is really about understand it is early days and I think the getting through the next couple of years positively Adjudicator is doing a very good job, but with the size and proactively, and seeing that the investment case of customer base that we are talking about we has really been proven. If we can get there it will be an absolutely have to nail these processes. On the extraordinary market—very dynamic and very environment side, what we absolutely have to have is colourful—and there will be lots of diVerent aspects an environment in which the investment cases can be that we have not necessarily thought of yet, but we put and in which we have some stability. The removal have to make sure that the environment is right to get of IP Stream from the regulatory framework was, us there. frankly, unhelpful and I think we have seen the result Mr Abensur: Just one additional comment to what of that in BT’s announcements on deaveraging, and Karen and David said regarding the number of lines that does impact on the business cases that we have unbundling in this country. Today it is 30,000. Every been putting together. So it is really about creating a time I use this example, which is pretty easy for me, more stable environment in which investments can be which is the French example: we have in France 1.7 calculated and then brought to market. I will pass million unbundling lines. To get to this position, over to David, because he is the person in my team probably, the best case would be, I would say, the end who is putting those business cases together and of 2006. I hope as quickly as that. But it requires doing this on a day-to-day basis. everyone, not only Ofcom and key players but BT, to Mr Carr: I would agree with what Karen says. I think be really working extremely hard to help on the the business case works very well in the early migration and on the processes. So we talk about exchanges, it is when you start trying to really push Local Loop Unbundling; we have said we were LLU out as we would like to do to some of the further extremely positive and optimistic but it is still the exchanges that, the pricing around backhaul still early stage (mentioned by Karen). Yes, it is the early requires some work; that is an area that I know the stage. Once again, in relation to stability for the next OYce of the Telecoms Adjudicator (OTA) are two or three years, it is extremely important that we looking at and needs additional work. On the have that—extremely important. In two years’ time, processes, I have just underlined the importance of when we will have 1.7 to 2 million unbundling lines in that. We are talking, currently, of about 30,000 this country, which means, probably, I hope, 20, people, from my understanding, on LLU, and over 25%—perhaps a third—of all the lines of DSL the next two years we are talking about pushing unbundled, yes, maybe we can talk about some other several million out there, and that just requires a services, some other way to improve the competition, completely diVerent infrastructure than is in place at but let us try to get there. the present time. Ms Thomson: I think that comes back to quality and Q78 Mr Clapham: As an organisation, you support quality of delivery. I think it is one of the things that the concept of equivalence but you express some we certainly have active discussions with BT on, reservations with it. Are the measures that BT are which is about benchmarking against world-class taking adequate, do you feel? Trade and Industry Committee: Evidence Ev 19

1 March 2005 AOL UK and Wanadoo

Mr PersoV: I think, on a very high level, BT has clearly, priorities: diVerent players wish diVerent agreed that the principle of equivalence is products to be at the forefront of the focus of Ofcom; appropriate, and that is positive and we support it. Wanadoo has clearly stated that LLU is its focus, The phrase “the devil is in the detail” has been although we also rely on wholesale broadband mentioned previously today. We are concerned in products, and going forward we will continue to rely terms of what they mean by “equivalence”—are they on wholesale broadband products for those areas in talking about BT retail using the same products and which LLU is not viable. We do find Ofcom to be services as their competitors do? Mr Simpson from engaging in this area. Easynet previously mentioned it would be a very good idea if BT, when implementing their 21st Q80 Mr Clapham: That is good to hear. So your Century Network, were to use the same products, concerns, really, come down to the discrimination in processes, systems and prices—ie LLU—as we the market and the feeling that Ofcom have got to be would have to if we wanted to build our 21st Century positive in dealing with that? Network. So issue number one is what they mean. Mr PersoV: Yes. Ofcom is a national competition My fear is that, in some parts of their network, authority as well as a national regulatory authority. because some of BT’s products claim that inputs In its Strategic Review it has recognised the fact that equivalence is not appropriate and, rather, there competition law has not acted as a constraint on should be this continued discriminatory access to BT’s behaviour up till now. We are part of an monopoly assets, a much more watered down international company, which has its historic version of equivalence is applied. However, it is not operator in France; it is our position that where only in terms of what type of equivalence we have to competition law acts as a competitive constraint on ascertain, it is also the issue of how is it measured? the incumbent to the extent that they are not We are totally reliant on BT to tell us “Yes we are engaged in unlawful activity, then such structural compliant with the principle of equivalence”; we do measures as are being suggested (and may even go not have access to anything more than BT’s further, according to some of our competitors) may regulatory accounts, which are not the most detailed not be necessarily appropriate. However, to the documents in the world. We feel that there is an extent that there is clear evidence that BT is not ongoing need for Ofcom to assess BT’s compliance, constrained by its competition law obligations then and that while BT might be setting up a board to equivalence is appropriate. oversee its compliance with equivalence this is not a replacement for Ofcom and the regulatory process. We feel that going forward, in order for BT to Q81 Chairman: How do you view BT’s proposals to demonstrate that they are serious about going reform themselves? Some people have welcomed forward and stopping discriminatory access to these them, some people have said “We’ll have to wait and monopoly assets, Ofcom should take a much more see how far they actually go”, and other people have interventionist approach than BT is suggesting is been telling us that they are a bit thin on the detail; appropriate. that they have the bones but not much flesh. Are you in any way concerned about this restructuring of BT or is it not something that is a great source of anxiety Q79 Mr Clapham: Are any of your concerns known to you? to Ofcom? Ms Thomson: I am quite a practical person and while Mr PersoV: The industry, as a whole, finds Ofcom I think good intentions are wonderful things, you do listening; they are looking at a range of options and, not get many points for that. I have been in the of course, not wishing to fetter their discretion, have industry a very long time and I have heard lots of expressed support for the general principles. My good intentions from BT about how they are going concern is that there might be some element of to operate as a wholesale provider, and on the matter bartering going forward between equivalence, or of equivalence that is a very good intention but what general opportunistic deals which might be done, I want to see is them operating like the best whereby for a certain product range to find a weaker wholesale type of companies that we work with in level of equivalence BT will give ground on another other sectors. The intentions and what they are issue. We think, overall, that the principle of saying are very good, but it is really about the equivalence must be looked at not only in terms of practical details, it is about saying “If you are going the regulatory environment but also in terms of to launch certain types of products then what are the competition law. It is our view that any required services, what are the support systems that discriminatory access which BT’s retail business go into that? What can we (AOL) as customers, units gain from monopoly assets is de facto unlawful; expect?” If the equivalence agenda works then we you have got to look at that context when looking at will essentially have that which mimics structural what type of equivalence is appropriate. We separation; it will be a true wholesale market for our mentioned in our response, both to Ofcom’s (BT’s) customers who do have the kind of input that Strategic Review and in our submission to the we have in other commercial situations. I have heard Committee, that we believe that BT does not BT say a lot of those things, I still have not seen an naturally have a dominant position in retail markets, overwhelming drive from the company to operate and that the only reason it has dominant positions in like that. David is the person in our business who retail markets is because of this discriminatory operates with BT on a day-to-day basis, so do you access to these enduring economic bottlenecks. We want to add anything to that, David, in terms of the are happy that Ofcom is listening. The industry has, practicalities? Ev 20 Trade and Industry Committee: Evidence

1 March 2005 AOL UK and Wanadoo

Mr Carr: Coming back to the way that Ofcom is we need is access to the infrastructure and the actual looking at the regulation, they are talking about a certainty in terms of getting out there to enable us to light-touch regulatory strategy, and that seems to us move on to diVerent services and platforms. That sometimes to support BT’s infrastructure should not be uniquely delivered by BT; BT will investments rather than rolling out the LLU process make certain decisions about reducing its operating and really driving competition. We are keen to see costs and opening up new networks that allow it to Ofcom actually get its hands dirty on some of this do that, but the innovation agenda is something that stuV and drive down into the detail. It is great that I think the whole industry can actually contribute to. they have set themselves a strategic framework, but I think there is a distortion; an assumption that BT I think now what we really need to do is to see them will bring products to the market and then we will start delivering on some of the practical stuV, and necessarily buy them; what we want is to get out that includes to force BT to put some more detail of there to have access to the infrastructure and then I what they are talking about in terms of equivalence think competition will deliver a whole range of and actually to see it working and operating and services that are really only starting to be thought of driving results. at the moment. The question is how fast can we get there, to get that competitive environment operating as broadly and as deeply in the network as possible? Q82 Chairman: Just one last question to you, on the impact of Next Generation Networks. How do you Q83 Chairman: What sort of requirements are there view this in relation to the products you will be of the regulator in relation to NGN? Is it to have providing? these what seem like endless consultation processes, Mr Abensur: If we are—and we want and we must where everybody gets first, second, third and last be—to be thinking always about the consumer, if we words, as it were, or do you have to move more talk about giving much more high speed, if we talk quickly? about developing a new form of communication in Ms Thomson: First of all, there is one thing we could services, to provide entertainment and do, which is to bring IP Stream back into the communication services to the world through regulatory framework. If you bring that in there is broadband and through DSL technology, Local more certainty and, therefore, the business cases Loop Unbundling, obviously, as we can observe that start to be built in a diVerent environment. That is across Europe, is a very good route to do that. If we the first thing we could do. The second thing, really, were talking three or four years ago about is about setting very strong service standards around developing 15 megabit speed over DSL, I think few the delivery of LLU. I think the adjudicator is doing people would have believed it was achievable, and a good job on that, and we need to push further and today we talk about 20–25 meg. It is not only about faster, because the big customer bases have not having the DSL technology enhanced every time; we migrated yet; as I referenced earlier, the thought of talk about compression, we talk about new moving in excess of two million customers is a really application and services that can be provided to the significant move. These are two things that would customer much easier. Do we need to talk about support the next stage. New Generation Network when we have today a Mr Abensur: I do not have anything to add specific copper wire which is available that can improve and to that. Stability: let us get delivery of Local Loop enhance and provide all sorts of services? We are Unbundling in this country. It is a formidable talking today about providing home watching opportunity we have; we have key players willing to through DSL technology with a WiFi connection; invest in that—Tiscali, AOL and Wanadoo—that we are talking about mobile and fixed conversions have already got 40, 50 or 60% of the market. We are through DSL, GSM, 3G network. We have all this willing to get there, we are wiling to bring those new technology available today. Make them work. Once services to our customers; it is a formidable again, we talk about Local Loop Unbundling, that opportunity to invest money in this country, and we is three letters, and as we mentioned earlier it is just want to do that. at the beginning, so let us try to use this Chairman: Thank you very much. It is very often in extraordinary network available to this country these inquiries that, when we have had a lot of other successfully and be available as much as possible to witnesses, the last witnesses seem to get a shorter everyone. time, but I think in some respects the clarity and Ms Thomson: I would add to that there is an implicit precision of your responses have been such that we assumption that innovation will come from BT’s have not taken very long, but please do not think roll-out of new network technology, whereas I think that is in any way a lower consideration of your we would agree with what Eric just said, which is evidence, because it was helpful. If there is anything that we have a network available, let us get out there else you want to let us know about then please get in and get our customers on to it. We both come from touch. We may well get back to you on one or two companies that have a history of innovation and points once we have crawled over what you have bringing new products and services to market; what said. Thank you very much. Trade and Industry Committee: Evidence Ev 21

Tuesday 8 March 2005

Members present

Mr Martin O’Neill, in the Chair

Linda Perham Sir Robert Smith

Witnesses: Mr John Pluthero, Chief Executive OYcer and Mr Andy May, Director, Regulatory and Public AVairs, Energis Communications Ltd, examined.

Q84 Chairman: Good morning Mr Pluthero. any conspiracy theories; they are prosecuting a Perhaps you could introduce your colleague and commercial agenda with vigour and talent and that yourself and we will get started. really precludes willingly gifting market share and Mr Pluthero: Good morning and thank you for opportunity to their competitors. having us today. My name is John Pluthero; I am Chief Executive of Energis. To my right is Andy Q86 Chairman: I hear what you say, but it has been May, the Director of Regulation at Energis. suggested that their opening gambit with Ofcom of separating the business and—presumably with the Q85 Chairman: From what we can see you have agreement or at the insistence of Ofcom—the changed your position somewhat on the question of construction of Chinese walls between the BT break up. As I understand it, when we last looked businesses would meet some of the challenges that at this subject this was not on your agenda and it did you are putting up to their suggestions. What would not even occur I think in the Phase I evidence that you say to that? you gave to Ofcom. What is the reason for this Mr Pluthero: I think the opportunity lies on a Damascene conversion of which we read so much in continuous spectrum; it is really how far along that the press at the weekend? spectrum you push, creating structures that try to Mr Pluthero: I think one specific event coupled with deal with that fundamental commercial conflict. My a growing realisation of some of the underlying personal belief is that if you get far enough along drivers. The specific event is consumer broadband. that spectrum to really do the job, BT is put in a very Energis had a substantial market share in diYcult position because it will end up owning narrowband internet, selling to the likes of Freeserve something which is in direct contradiction to its (and Wanadoo thereafter) and obviously we were wider group goals and ambitions and what it is very keen to maintain that position in the market saying to the market and what it is trying to deliver. and our customers were keen to buy broadband Therefore you really need to go the extra five or ten% from us. We worked very extensively with BT and and separate it out formally. I think the proposals with the regulator to see if we could achieve a that have been tabled do not sit at that end of the settlement on Datastream, the wholesale variant, spectrum at all. I think some of the governance that that would allow us both to make money and to oVer has been included in that does not look strong a suitable product to our customers. I approached enough to me to do the job. BT Wholesale during the autumn of last year to explain that that was proving very diYcult, that the Q87 Chairman: What I was really getting at was that determined margin was not enough to cover the they put down their first oVer—and we will be ongoing costs and to oVer my customers a saving, discussing that with them later on this morning— that there was great uncertainty about that product. and it does accept, at least in theory, the principle We had the port reservation charge issue which had that they are diVerent businesses and should be been left in the marketplace undetermined which has treated diVerently and should be separated. When a fundamental impact on the economics. We could we look at the analogy or the precedent of British not see a way for bulk migration and various other Gas—tubes are not wires and the technologies are procedural facts. There was a lack of willingness to perhaps not as dynamic, but they are reasonably do anything about that so we had to unpick some analogous in a regulatory competitive context— contracts we had with our customers and step out of Chinese walls were imposed but they were found to that market. That made me think about the be more bother than they were worth so it was a kind underlying drivers of what was going on and where of pragmatic process. I just wonder to what extent I got to was that there was no denying the that pragmatism that was adopted in energy might fundamental commercial conflict involved for BT. well be the route down which we go in telecoms. The task we ask them to manage is a very diYcult Would you say that that is all very well but the issue one. If they are to do what their shareholders want is one of greater urgency? Given the dynamisms of them to do then it is very diYcult for them to provide the technologies involved in telecommunications as their competitors with value for money, innovative against gas, it might be argued that the approach— products. That happens both at the macro-level and which did not take very long for gas—might still be the micro-level. And we are not going to win that relevant? battle. Those forces are very substantial, very Mr Pluthero: Yes, I agree with that and really that is powerful and the management of BT do a very good my point about if you go far enough to create the job. You do not have to assume any maliciousness, real tension in the system then I think you do bump Ev 22 Trade and Industry Committee: Evidence

8 March 2005 Energis Communications Ltd into that very practical issue of should the group be ways and means in which that happens I think you owning that particular subsidiary or operating entity throw yourself straight back into that commercial because its goals and ambitions are so conflict. We have seen it on consumer DSL, on the fundamentally diVerent from the ones that you are Datastream product. Broadband has been a product prosecuting elsewhere in the group. in the consumer marketplace for four years. We did not have a wholesale variant for the first couple of Q88 Chairman: Alternatively it is not worth a candle years and when I asked BT Wholesale why IP in the sense that it is not just a philosophical view; Stream, their retail product, had good automated the practicalities of having diVerent arrangements processes, fault fixing and all the rest of it, they said mean that it is more diYcult to operate than to have because that is where all the demand is. It is diYcult three separate businesses. for me to create a demand for Datastream when I Mr Pluthero: Yes. cannot make the product work and when there is no money in it for me. We had the customers, we had Q89 Chairman: The other point I just want to raise the money to invest in it; we had every intention but at this stage is that it has been suggested that Ofcom it was an uncertain, uneconomic and unworkable is only just finding its feet as a new body, thirteen or product. That is the heart of the matter. Maybe there fourteen months in place, and that perhaps the was a time when proposals were presented to the BT opening gambit of the break up of BT might be board that said, “You can invest £50 million on a rather premature. How do you view Ofcom in its consumer DSL product. If you do that for first 14 months of existence? Datastream you get part of the margin. If you do it Mr Pluthero: It is not a gambit. for IP Stream you get all of the margin.” IP Stream will always win that conversation; that is always V where the money will go and you get into some Q90 Chairman: They have o ered three options. ridiculous thought experiments and vicious circle Mr Pluthero: I think we welcome Ofcom, a bright where Datastream is not workable as an alternative bunch of people who understand the dynamics. I because no-one wants it but no-one wants it because thought it was the right and a brave thing to do to it is not workable. BT now has 91% market share launch the strategic review. As part of that, as one of with IP Stream consumer DSL and growing. That is the licensed operators, we were asked for our four years on from the launch of consumer DSL. I opinion. I am not sure that it would have been a think it is hard to regard that as a success from a suitable answer to say, “Oh, it’s too early”. This is regulatory point of view. our view on what is a genuinely new regulatory settlement. There is a desire amongst most of the players in the marketplace to see if there is an Q92 Linda Perham: So really Ofcom’s plans for alternative to what we have had in the past where BT equivalence you do not think will work. Your have to pick their way through an endless myriad of bottom line is that the only answer is the separation detailed regulations on individual products and the of BT. construction of them, and the regulator ends up Mr Pluthero: I think achieving true input chasing BT into shadows. It can never hope to have equivalence, if it is possible, is a decent alternative. the same degree of resources or understanding of It does raise that issue, if you have true input those issues as the incumbent themselves. To try to equivalence how do you police it, monitor it, enforce find a way where we align some of the commercial it. When you put in place a scheme that is robust forces and the way we run these businesses more enough to do that I think you end up asking directly behind the regulatory agenda so the thing is yourselves the question, “Why would BT own that more self-policing. I would like to think that there is entity?” because it is doing things that are not a version of equivalence or something like that that directly in the group’s interests. We are realistic and would do the job. The more I inspect those options pragmatic enough to realise that the separation of the more I am concerned that until you deal with BT is not going to be an answer that is announced in that fundamental commercial conflict asking BT to June but I would like to get to the bottom of it. This be both principal in the marketplace, a retailer, a is a strategic review of regulation in this industry. seller, and to be providing its competitors with the You cannot have a strategic review without right ammunition to take market share from itself, I considering all the proper options that deal with the think you are kidding yourself potentially. I think real situation. I do not think it is good enough to you will find more and more elaborate ways to try to have BT wave separation away with a hand saying manage that conflict instead of dealing with that that it is too diYcult, it is too expensive and the rest conflict and solving that conflict. of it. You cannot take their word for it. When I ask my 12-year-old daughter to tidy her room, if she tells Q91 Linda Perham: Ofcom have plans for me it is impossible I do not really buy it from her. I equivalence before taking the steps to separate BT. would like to see Ofcom and BT and maybe some Can you expand on why you think that would not capable third parties—the consultants of this world, work because in your submission you say that the not the competitors of BT—in a group bottoming “heart of the situation is lack of equality of access”? out the real issues about that so we understand that Mr Pluthero: If there is true input equivalence across once and for all. Otherwise you do not have a all the relevant products and services I think that strategic review; you have a tactical review of saying, would do a job. If you asked BT to police that system “How can we slightly amend what we do today to themselves, if you asked them to come up with the make it a little bit better?” Whatever the settlement Trade and Industry Committee: Evidence Ev 23

8 March 2005 Energis Communications Ltd is this year there have to be some metrics that say, Q95 Sir Robert Smith: When you talk about “if you “Okay, if you believe that this solution on could have true input equivalence that would equivalence, access service division or some mutant address a lot of your concerns”, BT say that a lot of of it is going to do the job”, then let us set up that the age of their infrastructure makes true input path over the next two or three years with the right equivalence not possible. From your point of view is measures in place and if you do not succeed on that that a smokescreen or is there some substance in the basis then we know that we have to go for something argument that the age of the infrastructure makes more substantial that deals with that fundamental it diYcult? commercial conflict. Mr Pluthero: I do not know; none of us know. We are not inside BT; we do not know their systems. That is why I would like someone to really bottom Q93 Linda Perham: I have some bad news for you. that out as an option. It clearly can be done. O2 was My daughters in their mid-twenties do not tidy their separated—or Cellnet, as I guess it was originally— rooms so you have a long time to wait. and knowing some of the O2 people as I do, although Mr Pluthero: BT is twenty-one, so perhaps it never I have never asked them the direct question, they ends. have always talked about it in terms of this was part of BT and splitting it oV was done for value creation reasons. They found a way to do that. I just do not know about whether the systems are diYcult. Q94 Linda Perham: If I could ask you about local Certainly in the proposal that has been tabled, BT loop unbundling, Ofcom seem to be relying on give themselves plenty of time to solve those injecting greater infrastructure and competition into problems. They talk about three or four years; they the market, but again your evidence does not think talk about “only where appropriate” are they going that that is going to be much help. You talk about to split those systems up. There is plenty of room for “no real attention to interconnection arrangements manoeuvre and that is the issue. If you come out and with network operators until a later phase in the say that we are going to do all of those things people market”. Would you like to comment on that? know that you have just knocked X% oV the value Mr Pluthero: In terms of the proposal that has been of the business because you are encouraging tabled, there is very little that comes under the competition and you are fuelling competition. These Access Service Division, just local loop and some are good businessmen we are talking about. rural broadband. The wider question of local loop is adiYcult one and most of the players in the marketplace have shied away from incremental Q96 Chairman: It could be argued, mind you, that in investment in local loop for a number of risk factors, an expanding business retaining the share is in itself of which the regulatory piece is only one. The ability enough. I am not defending them, but this is going to to create uncertainty and downstream pricing is be something that is going to continue to grow and it fundamental to that. It was the issue with could be argued that they would perhaps not grow Datastream and IP Stream because of port as fast as some people would want them to grow, but reservation and so on; it is also turning out to be the nevertheless they might not necessarily lose out on issue with local loop because BT have said IP Stream what they have at the present moment. prices in the 560-odd exchanges are going to drop. Mr Pluthero: Well, 91% of the smaller market is quite useful; 91% of an even bigger market is even Those are the exchanges that people want to more useful. At the margin there is always that unbundle so you get some diVerential pricing in the tension in the decision-making process. When I tell market now which directly attacks people who are my suppliers—as I do from time to time—that they making that investment. I think there are a few issues are not going to win that £5 million contract I in terms of the Access Services Division if that is the normally get a chief executive on the phone to me angle of your question. It does not contain enough within about an hour asking what the problem is, in terms of products and services, the wholesale what can they do. We told BT that we would not be interconnects and the rest of it. The governance I pursuing Datastream. That is a £100 million order. think is too weak to enforce the right behaviours so How long do you think it took BT Wholesale senior the Access board which has some extra people on it management to call me? It is a trick question, they I think and those extra people are going to be paid never did. That is five months ago. Now, I could be by BT. If you look at the verbs used in the personally oVended but that normally takes a little submission the job of that board is: to monitor, to more than that to do. The reason I did not get a call publish, to review, to consider. That does not sound was because it actually does not matter to Paul like a lot of teeth to me. If there is a real intent behind Reynolds; he owns the IP Stream product and that governance structure then let us give it the right Datastream would only have been a substitutional powers, let us create it in the right way, let us put of that and actually it is quite good news for him Andy Peters from Telefonica or Mary Turner from because he does not have to build a new Tiscali or Francesco Caio or someone on there. infrastructure around supporting Datastream; he Once you get that far you might as well go the whole has it all on IP Stream and it is better for the BT hog and start separating the group because its group because they keep all the margin. It is quite objectives to fulfil the regulatory agenda become so diYcult to compete in a marketplace if the supplier in conflict with those of BT group that I think that you depend on absolutely for tail circuits and for becomes untenable. wholesale infrastructure and so on, notwithstanding Ev 24 Trade and Industry Committee: Evidence

8 March 2005 Energis Communications Ltd the fact that we have eight thousand kilometres of Mr Pluthero: You could carry on on the existing our own network, really does not care— infrastructure for some time, that is true, and I think fundamentally does not care—whether you get the the timetable that has been announced is an product you need or not because it is only aggressive one as you need to have on big, hairy, substitutional to him; it is not in their commercial challenging projects like this, otherwise you take interests. forever. Clearly there is a big pay oV to BT in terms of operating cost; there is a bit of a pay oV to Energis when we do our equivalent of it. We all run multi- Q97 Sir Robert Smith: Is that them failing to read the platform, multi-system networks today. That is very future of the market properly because had they been expensive, complicated and the quality suVersasa more interested might you have been able to grow result. Moving to a single multi-layer environment is the global cake and whilst they would have got their much simpler, much cheaper and much more V share of the cake in a di erent way are they controllable and I think it is absolutely necessary damaging it by stifling what you were trying to do or going forward. From a competitive point of view it is by not responding to you? a smart thing to do. There are only two players in our Mr Pluthero: No, I think if you are a market leader industry who have big chunks of money and if that is and you can control the market then you need to the case you would tend to use that money to give behave like a market leader. All the business text yourself a competitive advantage when the people books will tell you that. Controlling the pace of roll- you are playing against are limited in their capability out; making sure you leverage and monetise your to react. rolling investments fully before you move to the next phase is absolutely par for the course, the right thing Q100 Sir Robert Smith: If you were breaking up BT to be doing. No, I suspect the equation is in favour would you be breaking it up in the right way that the of controlling that market quite tightly. chunk that will produce the 21st Century Network would still be there to drive that forward? Q98 Sir Robert Smith: How do the 21st Century Mr Pluthero: I do not really understand the argument Network proposals aVect this whole debate? Would that says if you separate out Wholesale—if you have a it be possible to build equivalence into that Network? ‘netco’, the core kind of infrastructure from local loop Mr Pluthero: That is a damn good question. It is a through the main core network, if you separate that little diYcult to see and a lot of consultation is going out from the retail activities, why does that change on around 21CN. I actually applaud BT for being the anything? The only way it could possibly change first big incumbent to move to that. It is undoubtedly things is if Retail was getting a disproportionate the future. The way it interfaces with all the existing return, a supernormal profit because of its thoughts about regulation is very challenging. In conjunction with the Wholesale arm. If it is not, then theory it is distance independent and for people like Wholesale can invest as it needs to on its core network ourselves who have a big capillary network and sell that to the market in an equivalent way to potentially we get very little return oV that in future. everyone and drive innovation, revenue and profit that way. It is one of the reasons why a number of players have not gone into local loop because the whole structure of what is the lowest level of infrastructure changes Q101 Sir Robert Smith: You do not accept the sort of through time. But it challenges the existing regulatory argument that the retail experience drives the regime and certainly now is a very appropriate innovation in the Wholesale side. moment to reconsider how that works for the future Mr Pluthero: There is no evidence for that. It has not in the light of 21CN. happened in the past by BT. That is an absurd notion. Mr May: In eVect BT is linking 21CN in the strategic review, or at least it appears to be in its response. It Q102 Chairman: Are you really saying that at the end talks about 21CN’s plans being dependent on an of the day BT has not really broken free from the acceptable regulatory settlement and this is hard to mindset of the monopolist in the sense that it is just reconcile with the degree of development of their trying to kill competition? plans. They are talking about beginning in April of Mr Pluthero: I am not sure that that is the mindset of 2006 and plans are continuing, as John says. There is a monopolist. I would like to kill my competition as immense consultation and a huge number of people well; it is what we do for a living. It is just that I am Y at BT working on this. It is hard to understand how not gifted with 91% market share so it is quite di cult that can be entirely dependent on the outcome of the for me to do that. I have to try to give customers the strategic review. They are suggesting that all that kind of service and quality that makes them always work is for nothing if they do not get the settlement choose me. they want. Q103 Chairman: Local loop unbundling is a classic example of where we could have been making money Q99 Sir Robert Smith: Is there not an argument that out of allowing competitors to come in without losing the existing infrastructure, properly driven with a great deal of market share, but making a lot of competition, would produce for consumers a lot of money out of rental charges and the like from LLU. benefits anyway and that 21st Century Network Mr Pluthero: I disagree with that. I think local loop is might be slightly premature and a slight distraction the gate to the Crown jewels. The local infrastructure, from making the current system work properly? the twisted copper pair is the fundamental kind of Trade and Industry Committee: Evidence Ev 25

8 March 2005 Energis Communications Ltd attack on BT’s cash cow, on its real profitability service is provided across all of those locations. I around residential telephony and around control of think also that some of the technologies over the next the product set to customers. It is unsurprising that five or ten years will change that. they are reluctant to move quickly in that regard and we have seen the battle started on local loop now with Q106 Chairman: You said that they would set the adjudicator being called on. There are a couple of something aside; would that be by way of a levy or ways around that. One is to walk backwards slowly would it be business largesse? and the other is to make the local loop environment, Mr Pluthero: All the licensed operators would pay it the DLE, almost redundant in a few years’ time by way almost as a kind of purchase tax through throughacombinationof21CNandthevarious Wholesale because their prices would have to be such other technologies that allow you to go out to the that they could get the right return to maintain service street cabinet and so on, but also in the meantime to standards across the country. I do not think you need undermine the economics. The people are going to to step outside of that and say that we are going to local loop because it represented a way of delivering charge someone half a million pounds a year for the consumer broadband profitably because there is not privilege; we get enough of those charges today. I an ISP selling the IP Stream product today that think then it will fall to who is successful. The more makes money on it. They are subsidising this market successful you are eVectively, the more you are like billyo. But if you drop the price of IP Stream only picking up of that cost. in those locations where local loop unbundling takes Chairman: The danger is that naturally businesses will place, you make that quite challenging for those go for the low hanging fruit first. From a public policy businesses. Local loop is important so restricting point of view we have to look at this as well. Maybe access to that and making it diYcult to the point the nettle does not have to be grasped right away, but where it is a redundant piece of infrastructure is I do think it is something we have to get across. pretty smart. Telecoms for some people can be a means to enjoy a hobby; for others it is running a business, but it is a Q104 Chairman: At the moment if you are a medium utility and as such has importance and almost life and sized to small player. death terms like you have with gas, electricity and Mr Pluthero: We are the third largest in the market. water and I think that maybe we have not looked at it suYciently closely because it has been under the umbrella of one organisation, but it is something that Q105 Chairman: Nevertheless, given the dominance Ofcom is going to have to address perhaps not in the of BT, let us say that BT is broken up and a number short term but certainly in the medium term. of people have access to customers that hitherto they have not been able to reach for whatever reason, and Q107 Sir Robert Smith: Your analysis is that it is the BT’s market share does diminish, what do we do Wholesale side that is crucial to the universal service about things like universal service obligation? Should yet would people who are not in the money pot areas it be a responsibility of all the licensees in proportion be missing out on all of the frills that might come from to their business? Or should it still be carried as a the bonuses of bringing so much competition in responsibility by the dominant market player? because people would not be competing to reach Mr Pluthero: That is quite a challenging one. those customers? Fundamentally it should sit with what I call BT Mr Pluthero: That is right. The wholesaler would get Wholesale if that is the group which owns the to charge prices to all these customers buying services fundamental network asset because that is where built oV thebackofthisnetworkinawaythatmakes access is driven from. One of my concerns about local sure they can invest in the areas that do not justify it loop from a public policy point of view is that it has from a direct commercial point of view, but actually struck me as quite similar to what happened to the this market is no diVerent from most other markets in Y post o ce. You de-regulate a bunch of high-value that regard. There are demographic segments which services like overnight parcel delivery and so on and no-one is chasing because they are not worth it. allow people to compete in those spaces. The network equivalent is allowing people to go into the most Q108 Sir Robert Smith: That is where a universal attractive exchanges and you take away a degree of service protects those people. the economic return that the incumbent gets which Mr Pluthero: That is why you would want some way makes funding the second post delivery van or the of making sure there are the funds to provide an local exchange in a rural location somewhat more appropriate level of service to those areas. diYcult so I think that does have to be reconciled. I do not see why Wholesale, which would be regulated Q109 Chairman: I think that has covered our points in a very light touch way if it were separated because with you this morning, Mr Pluthero and Mr May. If all the commercial drivers are then lined up behind a we need any further information we will get back to regulatory agenda eVectively. They would be selling you and if you want, on reflection to send us to everyone equally; they would want to do supplementary memoranda then we would be happy innovation; they would want to encourage to receive it within a reasonable space of time. Thank competition because that grows the total cake. They you very much. can set aside some part of those returns to ensure that Mr Pluthero: Thank you for your time. Ev 26 Trade and Industry Committee: Evidence

Witnesses: Mr Ben Verwaayen, Chief Executive OYcer, Ms Anne Heal, Director of Regulatory AVairs, and Mr Peter McCarthy-Ward, Director of Equivalence, BT, examined.

Q110 Chairman: Good morning Mr Verwaayen. Mr Verwaayen: I have heard many labels and Perhaps you could introduce your colleagues and labelling is part of a way for people to express then we will get started. themselves. Let me say it this way, I am not sure that Mr Verwaayen: I will be glad to do that, thank you I understand all the psychology over the last 20 very much, and thank you for having us. On my years. Report One was a clear report that was right hand is Anne Heal, Director of Regulatory tabling all the alternatives. Report Two had two AVairs; on my left hand is Peter McCarthy-Ward main streams, I would say. The first one is to get who is Director of Equivalence. twenty years of frustration oV your chest which is a very helpful activity. The need to get it oV the chest is learning for us as well. Let me be very direct about Q111 Chairman: Thank you. I think you have been it. We may not agree with the things that are said, in the room since the beginning and you have but dealing with perceptions I think the definition of probably heard and seen what we have been looking perception is reality with a time lag. Therefore it is a at. This is not an inquiry into everything relating to clear incentive for us to be bold in our proposals if the Ofcom review but really in part it is focussing on that is the assembly of feelings. I think, to be honest, some specific areas, one of which obviously is your in many cases, feelings are not always facts and if activities and your proposals. Perhaps we could start V you dispute the facts you will have on yourself also o with a general question. What is your impression the task of dealing with the feelings. of the review? Ofcom came into being fourteen months ago. It started what seems in some ways this rather methodical, rigorous process. What is your Q114 Chairman: One of the things that Ofcom feeling as an organisation about it since at the end of sought to do in their review and they have indicated the day you are the big bear whom everyone walks their desire to focus regulatory attention on what around and looks at? What is your feeling about it? they would call the enduring bottlenecks. Would Mr Verwaayen: I do not know about a bear, but I do you consider the access network to be such a know that the world is changing all around us. If you bottleneck? look to the US, for example, you will see a re- Mr Verwaayen: Let us just look at ‘bottleneck to assembly of the pieces that a decade or so ago what’. It starts at a definition of the market. You separated; it is all coming back by market force. could argue that the market is a service market so Technology is changing dramatically. The ability for whether you make a phone call over a fixed line or a people to look to new ways of increasing mobile it is still a phone call and is one market. So productivity and increasing lifestyle is dramatically you could argue that the market definition, that also changing. To be honest, if you look to employment as a result will have the bottlenecks related to the in Europe and the migration of employment going market definition. We have not taken that route, on you see a networked economy where people can although we could, because if you look to today’s be dislocated from their oYces and factories and value in a total telecom market BT’s value of the participate real time into an economic process which total market is 35 to 40% and 60% is somewhere else. brings an even bigger focus on the need to get world- We have accepted for the sake of the discussion and class telecom infrastructure into a country in order the arguments that we are in that we are not going to to compete. In that environment where everything is dispute the market definition as such of the review, changing and looking back through twenty years of although we could. If you take a fixed market, the micro-management of all kinds of details, it was, I fixed line market, it is undeniable that a bottleneck think a very good move from Ofcom to step away is a part of the network that you cannot easily from that and say, “Let’s describe the landscape, duplicate or replicate. The local loop is in that part let’s see where we are, let’s see what the inputs are of the market. You have seen in our proposals that and what the outputs are that we need”. I think what we recognise the bottleneck philosophy and Ofcom did was a very methodical—I agree with therefore have tried to come with a number of that—and a very professional job. remedies that would do two things. First of all it would solve the issues that were raised; second it would maintain what we think are the benefits for Q112 Chairman: Turning it round the other way society at large and for BT of the integrated then, when a regulator conducts a review they seek company. the views and impressions of players of all sizes. Could it be said that this has just been an opportunity—to sustain the animal metaphor—to Q115 Chairman: On the question of unbundling— poke the bear through the bars of the cage? Is it just we are going to spend a bit of time on this—the last an opportunity for the people to have a moan about time you were before us you very rigorously this dreadful organisation that you run? defended the charges you were making at that time; Mr Verwaayen: I would not say that I run a dreadful you felt they were reasonable, that the business organisation at all. required that. Since then there has been quite a turnaround in the sense that the charges have been dropped. Could you explain how that has happened? Q113 Chairman: I am merely trying to convey the Mr Verwaayen: I think we agreed last time the impression that here is a near monopolist, driving product in the UK described as local loop out competition at every turn. Do you get frustrated unbundling was basically the stapling of everybody’s at that? Is that a caricature? demands; just put a staple on it and call that a Trade and Industry Committee: Evidence Ev 27

8 March 2005 BT product. At that point in time we had an interesting organisation that deals with wholesale. Those exchange of views why that was the case. After that customers have a voice and of course every customer we went back to the market, back to Ofcom and we always asks if it could be cheaper. have, I would say in a very professional manner, described a fit for purpose product, that in a way there was a lot of burden around the product and we Q119 Chairman: Some of us argued with have made it into a very clean product available to predecessors of yours on the issue of LLU that the market. We are in the process of implementing you—your predecessors anyway—did not see that that product and the positive side of that product is there was a business opportunity in allowing competition. To the extent that there have been well described as ‘one version’. That is what it is; welcome changes, I think from our point of view we everybody can use it and therefore it is financially would derive some satisfaction having, as it were, attractive for the market to use and for us it is directed light into dark corners which perhaps has implementable. meant that some of your colleagues are taking the line that you take that it would be desirable to widen Q116 Chairman: So you have made some of the the access to LLU. However, there are still questions charges cheaper, but what about activation charges? like the activation charge which seems to be Why have they not come down? somewhat arbitrary. If it is the case that you are Mr Verwaayen: There are many charges that make saying to me that on that particular charge “we are the product so you can choose more or less how to not regulated, we have cut some things, but give us combine all those diVerent elements into a bottom a chance, we have to make some money line, that is the cost of the product. I have heard somewhere”, say so. some of the evidence today. I wish the case was that Mr Verwaayen: No, that would be the wrong BT was in the position to make all those decisions answer. themselves; we are not. These are regulated prices so if you talk about Datastream, for example, it is not Q120 Chairman: It would certainly be an BT that sits in a room and decides; it is within a uncomfortable one. framework and the framework has all kinds of Mr Verwaayen: It would be uncomfortable but it margin squeeze tests. You have to fill all those would not be the truth. I hope you will allow me to diVerences between one product and the other V explain. It is true that on local loop unbundling we product and the di erences between all those are now amongst the cheapest in Europe. The reason products have to have a margin and it is tested by the for that is not altruism. The reason for that is that we regulator. So it is not that we are totally free to do all have a much better way of getting to the market; we of those things. are a very eYcient organisation related to the rest of Europe and we are able to make prices that are Q117 Chairman: So you would be more charitable attractive. However, there are elements that we are and reduce them further if the regulator allowed not yet meeting the demands of our customers and you. you focussed on one of them. We are working on it but I am not going to make a promise that that will Mr Verwaayen: By the way, the Datastream product V just discussed is a growing product with all users be e ected tomorrow. going up. You may have been under the impression when John Pluthero was talking that it is a product Q121 Chairman: To be frank I do not think we that is leaving the market; it is a product that is would have expected you to do that, but maybe just growing. one last point on this. Do you think that the Ofcom consultation on the value of your copper network is likely to result in charges coming down even further? Q118 Chairman: We spoke about rental before and Mr Verwaayen: I do not know. Anne is a bit closer that has come down. There are a number of other to it; what do you think, Anne? elements that you do not have leeway over, but Ms Heal: Obviously when they are looking at the activation charges, are these regulated or are they cost of copper they are looking at a number of within your discretion? things, but what we have said in our submission was Mr Verwaayen: They are part of the total product that we would be intending to reduce the fully cost. You cannot separate one from the other; it is a unbundled price dependent on the cost of copper. combination of factors. Some of them have to do Obviously that is the fully unbundled one; we would with the system cost because, as you know, as a not reduce the shared price any further—that has principle we have to be cost based. I think that is a already come down by 70%, because that is not fine principle. We are looking to alternatives for related to the cost of copper as an input. There is an some of those products. We are looking to see intention, a commitment, that subject to the output whether there are better methods of usage because at of their study we would reduce further. the end of the day it may sound strange to you but it is in our interests and it is in the market’s interests to make sure that we are responsive to the market. We Q122 Chairman: Are you trying to anticipate that? are responsive because wholesale customers are Ms Heal: We need to understand what comes out of customers in the first place; they are not competitors, Ofcom’s thinking. The cost of copper is a very they are customers. That is the fundamental of an significant study which looks at the value of our Ev 28 Trade and Industry Committee: Evidence

8 March 2005 BT copper access network. The copper access is a major terms of equivalence of outcome, there are a series of input to this and other products and we need to other network services to which that would apply, understand the implications. including for example, carrier pre-selection and some other call-based services. There is a very Q123 Linda Perham: Just going back to local loop complicated list which would be boring to the unbundling, you say you are fully committed to Committee if I read out but we are happy to make it making it a success, but I just wondered what the available to the clerk. purpose is for the wholesale brand of what might be called geographical deaveraging where you reduce Q125 Linda Perham: You talk about input and the price of IP Stream in the most popular outcome, but do they together equal equality of exchanges. Is that going to undermine confidence in access because if you heard Energis’ evidence they those considering investment in LLU? said that that was at the heart of this matter. Mr Verwaayen: It would be quite fascinating if we Mr McCarthy-Ward: I see it slightly diVerently. I see would invest the amount of money we are investing the two equivalence debates as being contributory to in local loop unbundling and then start to the equality of access because the other component undermine it immediately. I think it is not the reality. of equality of access is to do with governance and First of all we have 169 ISP customers, ISP organisation and motivation. The suggestion that customers that demand from us services that they we have made of creating an Access Services can bring to their customer base. We have the most Division is the other component in delivering full vibrant internet service business in Europe, arguably equality of access. in the world. Those customers also demand from us a pricing that allows them to compete. Secondly, if Q126 Linda Perham: If equivalence is properly you look to local loop unbundling there is still a enforced, should that not mimic full structural substantial margin between the averaging pricing on separation? IP Stream and local loop unbundling. It is also true Mr Verwaayen: I do not think so. I think we are that we have said that we do not expect further price making a clear distinction between equality of access reductions in the coming twelve months under and structural separation. Let me look to the facts. certain conditions of course, but let us say in the This is the most—as I said—vibrant market in normal business sense, so there is certainty also for Europe, arguably in the world. We have broadband people to invest. I think that local loop unbundling coming in this summer to approximately the same fits certain business models. Some business models it amount of people that have running water. We are does not fit and you cannot have a market that has number one in the G8. Three years ago we were one size fits all; you need to have a market with as we nowhere, on a par with Albania; there is nothing have baptised a “portfolio of opportunities”. This is wrong with Albania but you do not want to be on a a market that has many players, many interests, not par with broadband. What is the relationship just from infrastructure players but also from service between the one and the two? It is like starting a mall players that need to be served. At the end of the day somewhere, you need an anchor tenant; you need I can assure you there is no market in Europe—and someone to take it and run with it. You need to have arguably not in the world—that has this number of it on an end-to-end basis, understood system-wise players (successful players and sometimes and risk-wise. So BT taking that position needs to be unsuccessful players because some business models maintained. In a situation where you would have work, others do not). structural separation you will drive the bottleneck into its own targets, into its own business objectives Q124 Linda Perham: Can I just move onto Ofcom’s that may or may not be linked with the network and proposals on equivalence? What do you think may or may not be linked with the end user’s services equivalence should mean in practice? What should that are being developed. What we try to do is to give it cover? full perception of equivalence. I use the word Mr Verwaayen: I have the Director of Equivalence ‘perception’ because in fact I think we have already next to me so I should probably let Peter have a go given it. I can argue until the cows come home, but at that. if people feel that it is not, I have to address that issue Mr McCarthy-Ward: We have been in discussion as well. I take your report, I take the Ofcom report, with Ofcom and with the rest of the industry as to the I take the other reports as an encouragement to say, scope of equivalence and it has a variety of diVerent “You may think you are right, but others do not; meanings. If you read the Ofcom consultation it others disagree. You have two choices, you are going talks sometimes about a concept called equivalence to fight it or you are going to accept, but don’t throw of outcome; it talks sometimes about a concept the baby away with the bath water. Make sure that called equivalence of input. I will deal with them you maintain the integrity of the system that delivers separately. The scope of equivalence of input we see the services that are needed for our market in the as being applied to a small number of enduring UK.” That is what we try to do. We try to listen to bottleneck services which are vital for future what the market says and to what you say and make competition. There is a short list of these: they sure we have an answer to that. We try to do it in a include wholesale line rental; they include way that maintains the benefits that we see and I unbundled local loops; and they include Datastream think the market will see in an output manner but at and a degree of backhaul services. These are the vital the same time ensure that we get an end to the building blocks for competition as it stands today. In debate. At the end of the day it is a debate that is Trade and Industry Committee: Evidence Ev 29

8 March 2005 BT running in circles. I would say that we are already taking the perception where it should be and the only giving full access and equivalence; other people way to do that is to take it step by step by step; there would say we are not. If you try to run round faster is no magic formula. and faster you end nowhere. So we try to break out of that circle. It goes much further—I would like to Q128 Chairman: I think it is fair to say that across stress that—than we are obliged to do. If you read Europe regulation is somewhat patchy and we were V Report Two in our response the o er we have put on one of the first in on the game because of the the table goes far beyond what we are required to do privatisation policies. You made the point about the but I think it is the right thing to do because it should US where they had geographical itemisation in stop the debate where we have been and bring it to much the same way as we had with electricity the next level. companies and in 15 years the situation has changed. However, what has been addressed at least in part in Q127 Linda Perham: Politicians always have a the UK and in other parts of regulation is the issue problem with perception as well as opposed to of vertical integration. I just make the point at this reality. However, you are saying you think you are stage. There are still misgivings that some people have. Nobody is saying that you do not comply, doing the right things on equality of access but the because if you did not comply you would be up in perception certainly from our previous interviewees court and paying massive fines. So you are damned from Energis and from others is that that does not if you do and you are damned if you do not. I accept appear to be the case. As the Chairman indicated in that. There is still, however, amongst some people his original remarks, you are seen as the big beast out unease about vertical integration and also about the there who is being unfair to all the rest of them and market. As you have hinted, you can integrate of course you do not want to have this separation vertically and still be fairly small, but when you have because you have vertical integration, you are doing vertical integration and market dominance it does very well and why should you even pay lip service to create challenges for regulators. any kind of competition from lesser players as you Mr Verwaayen: I accept that but at the same time I see them. How do you get over the perception look to the reality. This is a scale market. If you want argument where people clearly feel that you are just to invest in the UK not just in 560 exchanges but if keeping it all for yourself basically? you have business in Southampton or business in the Mr Verwaayen: First of all I think you are right that north of Scotland and want to compete on a world this is a real issue because perception is hard to fight. scale, you need to get access to world-class full Everybody in telco has a retail and a wholesale if you broadband network. That will require an investment are of any size and meaning. If you compare what of over £10 billion. You cannot help that; that is happens in the UK with what happens in other what it is. So you need scale to go and do that and at countries in Europe, my colleagues in the other the same time you need to go to the financial market countries in Europe are looking to this debate that and say, “Not only do we have a great plan for the we have here and they do not understand why we are UK, we also have a great plan for you because you having it because if you look from a regulatory point are shareholders, you bring the money, you bring the of view the UK is more or less the ideal that other risk, we have a return for you.” What happens in the markets are striving to reach in the knowledge that US today is an acknowledgement of the change in they will never get there. That does not exclude us technology and the change of scale. At the end of the from having this intense debate and I take the day they now have five players left in a country of responsibility for perception very, very seriously. that size. They will eventually maybe have three left, What we try to do is to look to two things. First of fully integrated on all spectrums, from mobility to all compliance: do what you promised to do. I can triple play, all of that. Why is that? Why do they tell you the last couple of years on compliance we regard that in the US as fully acceptable, a country have an impeccable record. If you want to know a bit that is the champion of competition? Well, because more about the record maybe we can show you some there is competition between platforms; mobile of what we produce. I do not blame anyone for not platforms compete with fixed platforms; cable going through it but I thought it would be a good platforms compete with mobile platforms and idea to give you a view of what we are producing. satellite platforms compete. The old way just to This is all public; we can all read it. We have measure how many people have access to your published a detailed record of everything that is copper going from the cabinet to your home is only going on. At the end of the day it does not do the job one way to measure the choice that people have. because we are having this debate. More of this will not help so we have to do something radically Q129 Sir Robert Smith: Would that box be a lot diVerent. On compliance we are impeccable. If it is smaller though if you did have properly enforced not compliance, how about the ability for people to equivalence that mimics structural separation? communicate with us. We have a manager Mr Verwaayen: This box is twenty years of detailed responsible for local loop unbundling, paid on their work. Sometimes I have compared it with the behaviour. We have a manager on the Wholesale Russian dolls, you know, you open up and you get line rental, only paid on their behaviour. So we have the next one, the next one and the next one. tried to get the message to the market that we take Everybody thinks that asking the next thousand you seriously; we take your input seriously; we questions will help them because regulation is also understand that we have not been successful in part of the competition. If you compete with one Ev 30 Trade and Industry Committee: Evidence

8 March 2005 BT another, regulatory rules could help you in the Mr Verwaayen: I think what we have done, if you competition. I do not think, to be honest, that all look through history, is pretty stunning. Just take those answers are anything else than our incapability five years back, three years back when I arrived and to deal with the bigger issues. That is why we try to see what our proposals are today, I think we have get rid of this and put something else in place, dealt with the issues. You and others have been very equivalence being the biggest of them. eloquent in pointing out to me what the perception of the market and the perception of the public is. I Q130 Sir Robert Smith: If Ofcom were minded to go think we have given a very robust response and I down equivalence that mimicked full structural think we would be much better oV to go and separation, is that something you would resist? implement and make sure that we do it flawlessly Mr Verwaayen: Full structural separation, I cannot without giving people the wrong impression. This is imagine that they would do it. Your last report said a monumental task; this is a truly monumental task. that it is not desirable. I think that nobody in the If people say that the systems are in place, yes, they world that I have talked to on a policy level are built over 25, 30 years. They are built piecemeal anywhere has looked at that as a solution. If they because technology comes in piecemeal. If you have would do it anyway, I think it would be a disaster. to untangle those and bring them into a state of the It would be a disaster to do the structural separation art where we are, it is a monumental task which itself not just because it would be painful, very involves a lot of eVort from a lot of people. What I costly, very slow, very cumbersome, but the end would like to do is to go on with it and demonstrate result for the UK will be very bad because you would that we can do it. structurally separate an end-to-end service into diVerent entities that may or may not be aligned and all the time they will go from here in a divergence. So Q134 Sir Robert Smith: In one of the earlier answers what you will get is the incapability to take an end- about the geographical deaveraging and the eVect on to-end decision to bring innovation where it needs investors you talked about a 12 month stability to be. period, but in a sense there are a lot of people going into local loop unbundling and it takes more than Q131 Sir Robert Smith: Do you accept though that twelve months to get a return on their investment. behavioural changes are necessary internally Mr Verwaayen: Yes, but as in every market you take within BT? decisions not just on the regulation, not just on BT. Mr Verwaayen: I accept that the perception is a If I have to make good for everybody’s business leading principle that we have to take into account. assumption I have to say to you that I am incapable We are the first company in the world that has a of doing that. Going into business is taking risk. I do Director of Equivalence and Peter has no peers not know whether the local loop unbundling plans anywhere in the world. We accept that what we have from people who have them will address the needs of to do is not only deal with the facts but deal with the their customers. I do not know because local loop perception as well. unbundling is not a magic word; it is a way to get service to people who may buy or may not buy. Q132 Sir Robert Smith: So the Access Service Division is designed to deal with perception. Mr Verwaayen: It deals with two ends. It deals with Q135 Sir Robert Smith: Is it a way of getting more the realities of a bottleneck and tries to ring fence it variety into the market? in a way that you get people focussed on diVerent Mr Verwaayen: Yes. criteria of success. As Peter was saying, what you try to do in the Access Service Division is to say that we have KPIs, we publish our KPIs, I think if I will be Q136 Sir Robert Smith: If the 169 ISPs are all buying on the board as an independent I will take it at the very end from you in a sense, there is a very extremely seriously—it will be my reputation at narrow market. stake so that will be a major driver—I will chair that Mr Verwaayen: They will not because some of them board so I do not understand when people say that are integrated companies as well. They will do ISP it is not serious. It is reputation that is at stake. At and LLU. You have heard of Wanadoo and with the the same time what I would do is make sure that the knowledge of their French parent they are very well reward system, the payment system, the bonus aware of how regulated markets may or may not system is all focussed on the equivalence factor and work and they see a fantastic opportunity in the UK. on the performance factor. Equivalence is one thing They are integrated on a diVerent level and that is but you can be equivalent and be very poor. If we are fine. I think that what you see is a market that will all very bad but we are still equivalent it is not good have diVerent models, some will be successful others enough. At the end of the day it is the demanding will not, but you cannot come to BT and say, “Here consumers, demanding customers that will drive the is Joe and he was not successful and it’s your behaviour. mistake”. That is not the way to look at it.

Q133 Sir Robert Smith: Can you see ways of making it more independent to reassure the witnesses we Q137 Sir Robert Smith: That is the problem that you have heard? Can you think of a way of reassuring are going to have to address, achieving the them? confidence. Trade and Industry Committee: Evidence Ev 31

8 March 2005 BT

Mr Verwaayen: I give that to you; that is true. I have input for competition or productivity and an input not heard anybody ever not say, “I made a mistake for lifestyle—into a new fresh start. That is my but it’s also BT”. With some we have to live with; motivation. with others we have to scratch our head and ask what we can do about it. That is true. Q142 Linda Perham: You said in the Phase II response that hindrance to full input equivalence is Q138 Chairman: You admit the point that you have the age of the infrastructure. Do you think the 21st a very big task ahead of you. Why is it such a big Century Network can remove that problem? task? Is it down to the internal workings of a former Mr Verwaayen: I think it can and I cannot describe monopoly? Or is it down to inadequate regulation in how important this is for all of us. We still have the past and they should have been nudging you 1930s equipment somewhere in the network. It was towards this or helping you clear up some of the once described as a plate of spaghetti and if you pull rubble that has accumulated? here you will never know what is happening there. If Mr Verwaayen: To be honest I think it is all of the you want to introduce a new service you have to go above and more. It is systems. You cannot change through 512 diVerent systems and they are all systems overnight and everything is related to related. From a speed perspective it is no surprise everything. It is regulation. These big books of that major telcos in the world take eighteen months details that I would not dare to say that I fully to introduce a new service because that is how long understand; it is sometimes attitude; it is sometimes it will take. I think we need a much better, much what we call culture. I think we have changed thinner layer where it is much more transparent and dramatically as a company. We understand transparency is the friend of equivalence. Today we customer needs; we put customers first. We have a have a situation that we have to go and say, well we hundred million customer contacts per month in any would like to do it but we cannot. You will not way shape or form. The slightest percentage of believe that, but it is the truth; we cannot because things going wrong means that everybody has an somewhere there is someone in the network who example where we have gone wrong. I will take it as says, get away, that particular piece of equipment a personal issue that we go after each and every one cannot be taught a new trick. So it is a very poor of them. Having said all that, the combination of situation to be in. that makes it into a big task, we will not deny that. Mr McCarthy-Ward: I think the heart of the problem for us lies with the fact that the systems that Q139 Chairman: Should we view what you are doing deliver our core outputs were built in the 1980s, state as concessions or as improvement in management of the art at the time, with 13 million lines of bespoke ambition? COBOL code at the centre of our systems. It was Mr Verwaayen: They are not concessions because a designed to deliver the outputs of a vertically concession— integrated operator. The arrival of the requirement of wholesale services came after that system had Q140 Chairman: Let us put it this way then, you have been designed. So we have a series of bolt-ons to this oVered this up because if you do not oVer up heartland contorting it to produce outputs for which something there is a possibility that a solution will be it was never originally intended. And as those imposed which you might find more uncomfortable. wholesale services multiplies so this edifice creaks Mr Verwaayen: That is the perception of the carrot even more. There is a fantastic opportunity in and the stick. replacing that, but it is a diYcult and complex task. The systems deal with 23 million customers, 160 Q141 Chairman: It is also the perception of getting million call records a day. A trivial mistake which in quickly before the others have made up their mind gives you a small percentage error is catastrophic in and perhaps influencing the debate. terms of its impact on the quality of service that we Mr Verwaayen: You asked me to tell you how I feel. deliver to everybody. So it is a change that we need I have heard many speculations of what is going on to make but we need to make it with planning, care in my mind which is always fascinating to see and and skilful execution. Telecom Italia have just read. Let me tell you what is going on in my mind. I finished this process. They have not put equivalence think this is a unique opportunity to reset the clock; into it but they have built a change out of their that is how I see it, to start afresh. As long as we try system and it took them four years. We think we can to make better what is already there we will fail do it faster than that, but it is a massive task and it because that is preset mindsets all over, from our is a limitation on our flexibility for our own retail side, from their side, from everybody’s side. I think customers and for our wholesale customers. this is a unique opportunity to clean the field and I have to say that that was the brilliant stroke from Q143 Linda Perham: Are you saying you cannot Ofcom to give that opportunity. Stephen Carter has, build in equivalence from the start because of the of course, his past, the regulatory past; I have to deal history of the 1930s equipment et cetera? with our past; the competition has to deal with their Mr Verwaayen: If you define equivalence using the past. At the end it is just the consumer who is looking same computer equipment, if you define equivalence and asking what is in it for them. The customers as getting the same level of service we can, but now demand more so resetting the field has the purpose if you say no, it is only true if I use the same of creating something very dynamic in the UK that equipment on your side—which sometimes is not will bring our infrastructure—which is like oil, an fair because a small ISP having to buy the same Ev 32 Trade and Industry Committee: Evidence

8 March 2005 BT computers as we have is ridiculous—if that is your Mr Verwaayen: From our purses. This is a business definition then we cannot do it today. We are going decision that BT takes. We are a profitable business. to build something new and if you want to have that I think we invest heavily. Our Cap-Ex is arguably as equivalence we can give it to you. one of the strongest in the business and we do that because we think to be first out of the blocks has big Q144 Linda Perham: You are saying it would be advantages for our customers and therefore for us equality of outcome, back to what you were saying but we pay it, as we pay all our Cap-Ex, out of our before. proceeds. Mr McCarthy-Ward: Yes. Equality of outcome is something we can deliver quickly and we are Q149 Chairman: Would these be proceeds that come delivering now, for example on carrier pre-selection. from this particular area of activity or would they be As for equivalence of input it will take us a little time coming from across? to deliver but we are committed to delivering it as we Mr Verwaayen: It is BT; we do not label our money. change the systems we use and can provide common interfaces for ourselves and for our competitors. Q150 Chairman: Do you not have profit centres for V Q145 Chairman: You have mentioned this variable di erent parts of your operation? age of the kit that you have across the country. Mr Verwaayen: We do and what we have are Where would you find the 1930s equipment and how business cases and the business cases have to be significant is that in your network at the present proven to be profitable business cases. Of course moment? what we do is that we look to the business case and Mr Verwaayen: If you look to how our network is see whether it can stand on its own feet and that is built, we have all started from a voice network and what you would expect from us, that is what we do. a voice network is upgraded over time. For example, in the local loop there are still passive components Q151 Sir Robert Smith: Why does the 21st Century that have been there for ages and ages and ages. Over Network require you to be in the retail business? time we went from rotary systems to analogue Mr Verwaayen: Because if I am going to produce systems to digital systems and we have made services on a wholesale level, I need to know whether generations of changes but not in every corner of the there are risk taking entities that are guaranteeing country so sometimes you still find 1960, 1970 in the me to use those services. Let me take the example of switching because that is the level of the economy broadband. When we decided to go radical on that has also been used to make sure that you have broadband we lowered our wholesale prices an end-to-end business that makes sense. The big substantially. You will remember that, three years change is now from digital—which is still ago, from being one of the highest in Europe to being switching—to IP which is non-switching. one of the lowest in Europe in one big bang. I could do that because I could see that we would make Q146 Chairman: Is the old kit more likely to be in broadband the number one that we needed to get to. remote areas? I could not do it through another organisation. Mr Verwaayen: No, you cannot say that; it is all Another organisation could say that it is not on my over. Sometimes you have upgraded by leaving the priority list so I am not going to do it or yes, I will old in but putting a computer next to it which will do it later or prove to me first that it is viable, I am take certain tasks. That is how it is done sometimes. not going to have trained people to go and sell it. There are a whole range of issues that if you do not Q147 Chairman: You start this 21st Century control end-to-end you would never take the risk Network, you move through it very quickly but such and go on to invest that. From that perspective I is the speed of the dynamic of technical change that think the anchor tenant’s role for retail is always even in a relatively short period what you are putting underestimated but it is a crucial one. in at the end is diVerent from what you started putting in. Q152 Sir Robert Smith: You described this 21st Mr Verwaayen: I think that what we are going to do Century Network as being at the heart and then on in 21CN is basically collapsing all those diVerent the edges would be the changes and the innovations. networks in one and the beauty of that is that the What are the chances of the rural areas and the more core network will be service agnostic, it will not peripheral areas of the UK being at the forefront or know whether it is voice, data or video, it will just be being engaged then in the next generation of bits and bytes. The intelligence will be at the edge of services? the network. So if you have to change that—and we Mr Verwaayen: I am very passionate about this will over time when new technology comes in—it is issue. We have a coverage of broadband in the UK much easier to do because you can go to the edge and second to none in the world because I am fully of the leave the centre in place. The centre basically is fibre opinion that the economy cannot drive businesses that sends at the speed of light the bits and bytes. The just to certain areas and leave others alone. I think it intelligence to translate it to a voice search or a video is absolutely crucial that you get the coverage. From search or a data search will be done at the edge. an economic model it is much more convenient just to look to dense areas. I think that would be a big Q148 Chairman: Where is the funding for this mistake. The same goes for 21CN. I think that 21CN change coming from? as a network is useless unless it produces services Trade and Industry Committee: Evidence Ev 33

8 March 2005 BT that are available to as many customers as possible and you have indicated that you feel that you have and we do need to get ourselves into the situation gone as far as you can realistically go in having them that we cover end-to-end. separate but equal and still integrated. The experience when, for instance British Gas did this Q153 Chairman: The opening up of equivalence, the some time ago, when it had a pipe system and a retail opening up of the market, people will come in and division and a wholesale division and I know it is not take advantage of this, your share may reduce. It quite analogous but it is to an extent analogous. might almost be obvious that that would happen. They got to the point where the separate parts of the How would you see issues such as universal service business were required to become more separate and obligations being shared amongst the players? At the Chinese walls, for want of a better expression, were moment you, with the broad shoulders you have, are introduced. Then they came to the conclusion that able to carry that. Do you think you could come to perhaps it was not worth it to carry on as an entity a situation where others might have to share it so businesses were spun oV. I know there is talk of with you? some of them perhaps coming together again but Mr Verwaayen: This is a diVerent issue. Maybe that is a diVerent issue at the moment. How do you Anne can say a few words about what we have consider that by making this pre-emptive strike—if submitted on that. I can put it that way—you might be in fact creating Ms Heal: I think what we have put forward is a something that you will not be able to control and suggestion that in time—and we would suggest you will end up having to split it into three parts? sooner rather than later—perhaps Ofcom should This Committee on its last look at this felt that as an look at how it tackles the universal service international player, as a driver of innovation and obligation. It should consider alternative ways of investment that it would be inappropriate for you to funding it, possibly even alternative ways of people be broken up because of the requirement to get tendering for it. We think that because we think the 21CN and things like that in place. We are not market has changed tremendously since it was first coming at it in some kind of Austrian school of created. If you think back to 1984 where mobile economics but do you see there is a danger that you phones did not exist, where the internet did not exist, might create three Frankensteins? where there was really only one supplier—BT—you Mr Verwaayen: I am an optimist Chairman, as I see a very diVerent picture now. You see a vibrant understand you are as well, so I think that making market with a great many people playing all the way walls and daring proposals do not encourage people across the UK and you say that perhaps we should to go into a step that would destroy the benefits of be looking at this diVerently because perhaps their proposal. Is there a danger? Life is always full consumers are wanting diVerent things and perhaps of risks; that makes it an interesting adventure. I there are more eVective ways to provide them, think we have very strong arguments, I think we perhaps with some sort of levy or some sort of have demonstrated not only intent but capability to sharing of a fund. However, we do not put solutions execute. I think that the climate is changing and forward; we think it is something that Ofcom would people do accept that even large organisations like want to consider. ours can learn a few things and accept the power of perception and the necessity to deal with that in an Q154 Chairman: We have been round the track on appropriate manner. As an optimist I would say that vertical integration and the separation of the I think in a balanced way we have put something business into entities, I am not meaning this in a forward that will be appealing enough to carry the derogatory sense but you have pre-empted what day. Time will tell. might be the outcome of the Ofcom inquiry by Chairman: We will find out in due course. Thank you setting up your model of three separate businesses very much. We appreciate your time this morning. Ev 34 Trade and Industry Committee: Evidence Written evidence

APPENDIX 1

Memorandum by AOL

1. Background to AOL in the UK 1.1 AOL is the leading online service and content provider, with more than 2.3 million members in the UK, including more than 725,000 on broadband services. Across the world, more than 29 million households subscribe to AOL. 1.2 AOL oVers a range of interactive online services, as well as in-depth content and community for all the family. In the UK, AOL members spend on average more than one hour a day online, enjoying a variety of online content, from Entertainment and News to Parenting, Shopping and Music, as well as email and the Internet. 1.3 AOL members also benefit from a range of features designed to make their Internet experience safer and more secure. These include Parental Controls, anti-virus email scanning, Spy ware Protection, free Firewall for broadband members and extensive online guidance, as well as free online and telephone advice. 1.4 At AOL UK, we believe the interactive medium is fundamentally changing the manner in which people communicate, and how they are educated and entertained, in addition to the way consumers transact for goods and services.

2. Summary of AOL’s Current Outlook on the UK Broadband and Telecoms Market 2.1 AOL UK believes that broadband uptake in the UK has made good progress, but could have been significantly more impressive with more eVective wholesale competition. The year ahead oVers the promise of regulatory measures by Ofcom designed to lead to the opening up of BT’s network to competition. If successful, these changes will create greater consumer choice. 2.2 AOL welcomes Ofcom’s consultative approach and Ofcom’s objective of to establishing clear regulatory policy guidance. Ofcom’s Strategic Review provides the appropriate means of achieving that objective. Ofcom’s approach to the Strategic Review contrasts with the approach taken in previous broadband related reviews where Ofcom have, in our view, been paternalistic. 2.3 Ofcom’s Strategic Review is proposing to put a regulatory framework around issues that have been under discussion—by industry—for some time, eg “equivalence”, and we welcome Ofcom’s work in taking this initiative forward. 2.4 If Local Loop Unbundling is not successful and BT rolls out its 21st Century Network outside of the necessary regulatory environment, the prospect for wholesale and infrastructure competition—and ultimately a competitive retail environment—will be even more limited than at present. 2.5 AOL UK believes that success or failure in delivering greater choice and innovation to consumers is in the regulatory hands of Ofcom, and it will depend on how willing Ofcom is to get its “hands dirty” or whether it chooses to opt-out with “light touch” regulation.

3. AOL’s Response to Ofcom’s Strategic Review of Telecommunications (PHASE ONE) 3.1 Structural Separation of BT: While there has been a case made by some that structural separation of BT would be the best solution to achieve a level playing field for all retail telecoms providers, at this stage it is unlikely that there is the time, resource and willpower to make this solution work. In the current dynamic market, it may be that structural separation would undermine market progress for a lengthy period of time. AOL UK believes that it will be possible to achieve an appropriate level of competition without structural separation, but with firm regulation by Ofcom. 3.2 Behavioural oriented regulatory policies will be required to solve the economic imbalance in various key telecoms markets. For example, AOL UK was pleased to see that Ofcom recognized the need to keep a tight rein on LLU and has dedicated resource in the form of the Telecommunications Adjudicator to ensure closer regulatory involvement in the process. 3.3 Price and availability of wholesale services are not the only key consideration: A basic underlying principle and pre-requisite of an eYcient and competitive telecommunications market is interoperability. The interconnection of networks, irrespective of protocols and type, will have both regulatory and competition implications. 3.4 A subset of the interoperability issue is the processes for provisioning and managing subscribers. In order for AOL UK to be able to oVer competitive and consumer-friendly services, it requires that BT’s processes for provisioning and migrating consumers are eYcient, fairly priced and available simultaneously—on equitable terms—to all retail competitors. This would include interoperability on “equivalent” terms to BT’s 21st Century Network. Trade and Industry Committee: Evidence Ev 35

4. AOL’s Response to Ofcom’s Strategic Review of Telecommunications (PHASE TWO)

4.1 The risks of “light touch” regulation: As outlined earlier, this year will see a key turning point in the development of the broadband market, with the beginning in earnest of the process of Local Loop Unbundling (LLU). 4.2 AOL is currently considering a multi-million pound investment in the UK in LLU and is prepared to take on the “normal market risk and uncertainty” such an investment requires, which of course cannot be wholly underwritten by regulation. 4.3 However, Ofcom appears minded to implement a “light touch” regulatory strategy designed more to support BT’s infrastructure investments than the LLU process. This would leave AOL and other ISPs open to a much higher level of risk based on the unpredictability of BT’s actions, and the lack of certainty around the regulatory framework of LLU. This can only significantly hinder or even derail the LLU process. 4.4 Ofcom’s proposal on “equivalence”: There has been a question mark over the equality of treatment by BT of its retail arm versus that give to other ISPs. AOL supports the development and implementation of eVective remedies to the continuing problems of inequality under the banner of “equivalence”. 4.5 In order for Ofcom’s policy on equivalence to be successful it must mimic the theoretical and logical outcome of structural separation, where all retail competitors—including all of BT’s retail operations—are treated in identical fashion with respect to commercial, interconnect and process terms of business. 4.6 Behavioural remedies: We are encouraged that Ofcom also considers behavioural remedies appropriate, but remain concerned that Ofcom does not consider it appropriate to set out proposals as to how this might be achieved. 4.7 The framework governing the behavioural changes required of BT must be accompanied by a compliance program, operational transparency and an independent audit process. It should be a matter for Ofcom, rather than for BT, to determine the correct incentives and the best means of achieving equivalence. Ofcom must be willing and able to get its hands dirty in ensuring the practice of compliance with the regulatory framework and equivalence, not just ensuring the perception of compliance. 4.8 Unregulated wholesale broadband undermines all future initiatives: BT’s recent price changes to IPStream services at the 570 most popular local exchanges was a reminder to Ofcom that as long as BT can change the dynamics of the whole broadband market at will, the process of opening up its local telephone network to competition remains fragile. 4.9 At a time when Communications Providers are set to invest significant resources in deploying national services by means of regulated BT Wholesale access solutions (LLU), the identification and delineation of separate geographic markets poses serious commercial risks.

5. AOL’s Response to Ofcom’s Consultation on Next Generation Networks (BT’s 21 CN)

5.1 BT’s 21st Century Network (21CN) proposals: The roll-out of BT’s 21CN is clearly an issue of considerable importance for the communications industry, for the progress of broadband and more broadly, the UK economy. 5.2 While we wish to support BT’s investment (and will do so by paying for access to the network, as will every other service provider), the investment needs to be considered in the context of investments being made by other players in the value chain—for example the substantial investment required to enter the LLU process, or the substantial marketing expenditure used to promote products which ultimately help build BT’s wholesale business. 5.3 Ofcom cannot opt-out of the 21CN: AOL does not subscribe to the proposition that Ofcom take a facilitative role and maintain a watching brief; the issues raised by BT’s deployment of 21 CN are fundamental, and are closely correlated with Ofcom’s statutory “brief”. Ofcom must take more than a competition authority approach to this issue. 5.4 There is no such thing as partial equivalence: It is not clear how the Ofcom proposal to take a facilitative role to 21CN marries with the work being done under the Strategic Telecoms Review on equivalence. For equivalence to work, BT cannot be able to “ring fence” some parts of its business, with equivalence only on its choice of network elements. 5.5 Two-speed network: The potential financial and economic risk to AOL—and others—cannot be overstated, and Ofcom must seek to ensure that BT’s 21 CN program does not lead to a two-speed network and market environment, with BT alone deciding how it meets its regulatory obligations, only after considering its own commercial objectives. BT’s regulatory obligations must be given primacy. Ev 36 Trade and Industry Committee: Evidence

6. Conclusion—“Hands On” not “Light Touch” 6.1 Absent of a “hands on” approach by Ofcom to all of these issues, regulatory uncertainty will undermine ISP’s business planning and investment, particularly in respect of key access solutions like LLU, which are central to the development of eVective broadband competition in the UK. 6.2 For “equivalence” to be successful Ofcom must be prepared to get its hands dirty; Ofcom’s work in this area is as much about execution as it is about designing policy. 6.3 Ofcom has taken on a lot of significant issues—co-ordination is key. In addition to the Strategic Review, Ofcom are reviewing LLU, Next Generation Networks, and other areas. Ofcom must take a holistic approach and understand that “failure” on any one of these areas may spillover into the other areas and/ or hold back the broadband industry. 6.4 Despite being a convergence regulator, Ofcom’s approach to the review suggests a silo mentality to broadband. The lack of engagement from the content sector in the process thus far is illustrative of the weakness of adopting a telecom-centric approach to broadband policy. 6.5 In summary, AOL is keen to see Ofcom continue with a consultative and open approach to what are key developments for industry, and to request that Ofcom take a more active role toward the implementation of these policies.

APPENDIX 2

Memorandum by Broadband Stakeholder Group1

1. Introduction (a) The Broadband Stakeholder Group (BSG) is Government’s key advisory group on promoting the roll-out and take-up of broadband services. It provides advice on Government strategy and seeks to identify the activities required to deliver broadband networks and services into the future (http://www.intellectuk.org). The BSG is a partnership between Government and stakeholders, cemented through the strategic policy direction of the DTI and through the secretariat support of the trade body, Intellect (Information Technology Telecommunications & Electronics Association). (b) Membership of the BSG is open to corporations and organisations throughout the broadband value chain. This includes, but is not limited to, broadband service providers, broadband product suppliers, members of the broadband content industry, central Government departments, local government and RDAs, consumers and consumer representatives, trade unions and trade associations. This allows the BSG to take a broad view of the issues related to successful operation of the broadband value chain. (c) This submission is an edited version of the BSG’s response to Ofcom’s Strategic Review of Telecoms Phase 2 consultation and is intended to address the Committee’s wish to review the interim conclusions reached in the Phase 2 consultation document, and the direction of the remainder of the Review, particularly in respect to prospects for roll out and take up of broadband in the UK. (d) The BSG’s initial reaction to the Phase 2 consultation document was good in that it considered telecommunications networks as a key component of the broadband value chain, it recognised the need to create the environment for investment and innovation in next generation networks and services and it recognised also the value of achieving infrastructure competition as deep as possible into the network. (e) However, diVerent BSG members have interpreted Ofcom’s intentions in diVerent ways, primarily because it’s related consultation programme (ie next generation access and interconnection, the valuation of BT’s copper access network, cost of capital and spectrum liberalisation) seems to conflict with the intent of the Strategic Review. (f) This Review will influence the structure of the market, investment plans and technology deployed, for the next few years. Therefore, Ofcom shouldn’t initiate a round of intervention without full consideration of the potential impact on longer term market development. The objective should be to enable a natural, market led progression from current generation to next generation networks. (g) Whilst broadband achievements to date have been encouraging, it is important to be clear about future objectives and bandwidth requirements. Some would argue that, with 99.5% coverage of a basic 512k service expected by the end of 2005, little more needs to be done. On the other hand,

1 This submission has been produced by the BSG Secretariat on the basis of inputs from a wide range of stakeholders in response to the points raised in the Consultation Document. It does not represent the views of any particular stakeholder or groups of stakeholders but aims to identify some key areas for Ofcom focus and further consideration in the next phases of this Review. Trade and Industry Committee: Evidence Ev 37

the BSG is aware of many parties that argue for significantly more; ie much wider availability of multi-megabit services. The growing exchange of video rich material, together with recent announcements from Google (of a search facility for clips from TV programmes and film), and from IBM, Toshiba and Sony (of a chip for use in home broadband content servers), highlights the dynamic nature of “broadband”. (h) The BSG sees the next generation access issue as one of the most significant that Ofcom has to resolve since, unless a balance can be achieved between the requirements of high bandwidth content and high specification consumer equipment, the broadband value chain will not operate eYciently.

2. Next Generation Access (a) Although “access” is fundamental to the successful operation of the broadband value chain, the access network represents the most problematic and, most probably, the highest risk, part of the chain in investment terms. Hence, there is less competition and, consequently, it is regarded as, potentially, an enduring economic bottleneck. This can lead to regulatory intervention to lower the cost of third party access to BT’s network which can, in turn, inhibit investment in network upgrades. (b) The impact of local access on the entire value chain is multi-faceted. On the one hand, lack of competition at the local access level may have a knock on eVect on innovation in the upper layers of the value chain. On the other hand, lack of investment in local access, and the consequent under-capacity, may have an equally detrimental impact on the value chain. There is high growth potential throughout the broadband value chain. The BSG is concerned that this growth potential may be undermined if regulatory intervention deters investments in the local access or hinders competitive entry. (c) The importance of resolving this issue is emphasised by developments in diVerent parts of the chain; eg at one end of the chain, the capabilities of consumer electronics are improving significantly, in terms of storage and processing power, as are the abilities of equipment to handle multiple services. At the other end of the chain, content and services are becoming more visual/ video rich. The challenge is to ensure that content and services are matched with consumer electronics capabilities so that consumers are not frustrated by insuYcient capacity at diVerent points in the chain or by problems of interoperability, etc. At this point in time, there is concern that local access capacity will not keeping pace with either consumer or content supplier demand. (d) Whilst the core networks, where traYc aggregation is possible, are likely to develop in line with demand, access (first/last mile and middle mile) capabilities are less likely to develop in line with all individual consumers’ demands, as these will vary widely from those that are currently content with 256Kbs or 512Kbs to those seeking 10Mbs or more. The issue is how far access networks will be able to cater for high users and significant peaks in demand, since this will be influenced by the perceived investment risk of access network upgrades. (e) Ofcom acknowledges, in the Phase 2 consultation document, the high risk attached to network investment because of this lack of clarity on probable bandwidth demand. This risk is enhanced because there is no clear understanding of what current generation access networks are capable of, or what is meant by “next generation access networks”. (f) Ofcom defines next generation access networks (NGANs) as “those that go beyond the capabilities of the existing copper, cable and wireless public networks that exist today” and states that “next generation access networks have not yet been deployed on any scale in the UK”. However, Ofcom also refers to next generation networks as those deploying fibre to the cabinet. Since this is a similar structure to today’s hybrid fibre/coax (HFC) cable networks, the BSG has asked Ofcom to be clear on how it regards today’s hybrid fibre/coax (HFC) cable networks as this could have significant implications for regulation going forward. (g) Ofcom has stated that it proposes “to continue the strategy ...ofpromotingcompetition within DSL at the deepest level of infrastructure where it will be eVective and sustainable”. The BSG believes that this adds to the confusion over policy objectives as it is could detract from technological neutrality. The BSG is of the view, previously expressed by the Committee in its Report on the UK Broadband Market (Second Report of Session 2003–04), that there is a need “to ensure that investment in the existing network is sustained and that the rollout of other, alternative means to deliver broadband is encouraged”. In support of this view, we note that OECD has highlighted the link between broadband success and the availability of alternative, competing infrastructures. This extends beyond third parties using DSL on unbundled local loops. (h) The BSG has also expressed its concern at Ofcom’s statement that there is a need “to achieve the target of operational capability for a million unbundled lines per year”. Using such a metric as a measure of success could lead to decisions by Ofcom that create market distortions and compromise technological neutrality. Ev 38 Trade and Industry Committee: Evidence

3. Alternative Access Technologies (a) In line with comments above, the BSG believes that more needs to be done to clarify the potential impact of evolving DSL technologies, wireless options and fibre closer to the customer. Each technology has its advocates and it is probable that next generation access networks will use all of these technologies in future. However, the BSG is conscious that regulatory decisions have an unavoidable impact on technology decisions and it cautions against any particular technology being seen as a panacea for universal broadband delivery. (b) Amongst BSG members, there is significant support for newer variants of DSL technology that will be able to deliver higher bit rate services. In particular, it is argued that ADSL 2! can deliver 10 to 15 Mbs to a significant proportion of the population for little incremental investment. Therefore, subject to ongoing technical analysis and standards, there is the prospect for higher bit rate service deployment at relatively low incremental cost in the current access networks. (c) However, there are those that see no option but the accelerated deployment of fibre closer to the customer (eg FTTC or fibre to the cabinet). Upgrades of ADSL to VDSL are likely to require deeper deployments of fibre, which could lead to problems for LLU implementations, ie new entrants will face problems in deploying next generation broadband services and, if BT decides to deploy VDSL, this will undermine the business models of existing LLU operators. (d) Wireless technologies (eg Wi-Max and other “4G”) also oVer a promising route to broadband service delivery within a foreseeable future but the economics are currently little diVerent to those for fixed networks, ie density is essential. Therefore, although wireless will play a role, again it is not a panacea for universal coverage. (e) Therefore, the BSG advocates further analysis of (a) the role of diVerent technologies and topologies, such as DSL evolutions, the need for fibre closer to the customer and wireless based solutions in parallel with (b) more work to clarify future bandwidth requirements.

4. Potential Bottlenecks Elsewhere in the Broadband Value Chain (a) Ofcom recognises that there may be emerging sources of market power elsewhere in the broadband value chain but “these new potential sources of market power do not necessarily require any specific regulation in addition to the normal application of competition law”. (b) Various technological and competitive bottlenecks may exist or emerge within this value chain arising, for example, from technological incompatibility related to proprietary equipment standards or, at the competitive level, the desire to protect commercial interests, which may lead to limitations imposed by, for example, network owners on third party access and content and rights owners on content distribution, etc. However, many of these bottlenecks may be transient and some may be beyond the scope of Ofcom’s powers. More analysis is required of these areas. (c) There is a sense also that Ofcom needs a better understanding of the economics of the content market, with its diVerent types of content provider (including, for example, the PSBs, independent producers, film studios, games developers, newspapers, etc) and intermediaries (such as ISPs, DRM providers, search engines, content aggregators, etc). The BSG would like to see more work on developing a good understanding of this sector’s needs for bandwidth and how consumers will interact with content providers.

5. Structural Options—Civil Infrastructure (a) The BSG has always argued that access networks must be considered in terms of their core components. These components are the passive, most capitally intensive part, which is the civil infrastructure (ie ducts, poles, masts and buildings) and the active, transmission part (ie the cables, the wireless spectrum and the associated equipment housings). In the BSG’s view, the former represents the real bottleneck and major barrier to infrastructure competition “deeper into the network”. (b) Therefore, the “access” issue also requires detailed analysis of the structural options identified in the consultation document (ie non-telco or public sector ventures; use of alternative civil infrastructures; an industry joint venture; divestment of dark fibre and duct assets by BT; and diVerent structures for new-build housing). (c) The European Commission’s view of the “broadband bottleneck” as “the last mile connection to the final user” is too simplistic. The reason for the split used by the BSG is that passive infrastructure has a much higher cost but much longer life expectancy (eg 25–30 years) than the active infrastructure (say 5–10 years) and each has a diVerent earning capability. Only by making this distinction, is it possible to more closely define the enduring economic bottleneck. (d) The BSG suggests that a better focus should be on addressing this major access bottleneck, rather than on next generation access per se, in parallel with assessing the needs of next generation services in terms of bandwidth and interoperability. A focus on next generation access in isolation could be counter to the objective of technological neutrality. It will be next generation services Trade and Industry Committee: Evidence Ev 39

that determine bandwidth requirements in access networks and the transition to higher bandwidth, next generation access networks should be a natural progression. The issue is the extent to which bandwidth can be justified ahead of the demand curve—to allow for the launch of bandwidth hungry, innovative services. 6. Summary (a) The BSG believes that the core objective of the “new regulatory settlement” must be to create an investment climate for the successful delivery of next generation networks (and services) that it is as good as those of other leading global economies. (b) The new settlement must ensure that financial returns are high enough to secure next generation access network and services investment and that existing and potential investors in next generation access networks and services will be more, rather than less, confident going forward. The BSG is not convinced currently that the outcome of the Review, and related consultations, will achieve this outcome. (c) Although the BSG recognises the diVering needs of diVerent market players, Ofcom should focus on the medium to long term and ensure that it does not succumb to any form of regulatory capture by suppliers in any part of the value chain. (d) The BSG agrees with Ofcom that its focus must be on resolving the “access” issue, but that more needs to be done (a) to clarify what “next generation access” means and (b) to understand what is required at each part of the value chain to deliver “next generation services”. (e) In summary, the BSG believes that regulation must tend towards a “visionary” philosophy (ie it must help to create the future rather than fix the problems of today) and address eYcient operation of the whole supply chain. To this end, it will be important for Ofcom to assess the longer term impact of its decisions and ensure that its decisions will allow for a natural progression to next generation broadband. 18 February 2005

APPENDIX 3 Memorandum by British Telecommunications plc Contents Paragraph Introduction 1 The Ofcom Review 3 Broadband in the UK 10 Broadband indicators 11 Broadband availability 13 Competitiveness of the broadband sector 14 Retail Broadband Prices 15 Wholesale Broadband Prices 16 Broadband speeds 21 LLU 26 Separation issues 30 Equality of Access 36 Other issues raised in the Ofcom Review 39 Mis-selling of telecommunications services 41 Universal Service 49 Introduction 1. BT is pleased to submit these comments on the Committee’s Inquiry into Ofcom’s Strategic Review of Telecommunications. BT also welcomes the opportunity to comment on the specific questions raised by the Committee concerning the Review as it relates to the extensiveness and competitiveness of the broadband sector in the UK, including local loop unbundling, and the functional separation of BT. 2. In this submission we focus only on the key issues in the Review, rather than repeating what is in our full response to Ofcom.

The Ofcom Review 3. BT’s response to Ofcom’s Phase 2 consultation document can be seen at http://www.btplc.com/ Thegroup/Regulatoryinformation/Consultativeresponses/Ofcom/2005/OSRPhase2/OSRPhase2.htm 4. Our response to Ofcom contains a comprehensive set of proposals designed to stimulate the UK telecoms industry and deliver faster and more exciting services to consumers and businesses. We believe that the proposals could form part of a regulatory settlement between BT, Ofcom and the industry. The Ev 40 Trade and Industry Committee: Evidence

proposals should provide all market participants with the confidence we all need to innovate, invest and compete, and should lead to the rolling back of regulatory red tape in a number of important areas. Central to the proposals are plans by BT to oVer other operators lower wholesale prices, faster broadband services and transparent, highly regulated access to BT’s local network. 5. BT plans to invest up to £10 billion in its 21st Century Network (21CN) over the next five years. No other European telecommunications operator is making this level of investment. This investment programme has the potential to bring substantial benefits to the UK as a whole. We believe it is the right thing to do, but the commercial case has to be there and the extent to which the regulatory environment encourages innovation and rewards successful investment across the industry as a whole will be critical. We believe that our proposals will provide the necessary framework for this to happen. 6. The key points in the proposals we have made to Ofcom are that we will: — set up an Access Services Division to provide transparent and equal access to our local network; —oVer fair access to our 21CN; — cut a range of wholesale broadband prices and introduce faster services; —reaYrm our commitment to local loop unbundling and propose a further price cut; and — increase the commercial attractiveness of Wholesale Line Rental, including by increasing the margins for companies using the product. 7. As part of this package, we are asking Ofcom to: — focus regulation on BT’s local network through this new Access Services Division; — roll back other regulation on a progressive and rapid basis; — allow successful investment in Next Generation Networks to be properly rewarded; and — allow BT to compete on a level basis with other operators in the market. 8. The Access Services division would be a new part of our organisation, containing the most heavily regulated parts of BT. It would deliver products and services based on the local access copper infrastructure—including unbundled loop services—to all customers. It would be run by a separate management board. 9. We would also establish an Equality of Access Board with two independent members chosen in consultation with Ofcom, possibly one an Ofcom Board Member, to oversee all aspects of equality of access throughout BT. This would demonstrate that every operator is treated equally, allowing regulation to be rapidly rolled back in other areas.

Broadband in the UK 10. This Review is taking place against the background of significant UK progress in broadband. The UK now has the widest availability of Digital Subscriber Line (DSL) Broadband in the G7, according to the OECD. Much of this is thanks to BT. However, we recognise that we have to maintain the momentum and that the industry needs to move forward. As part of our strategy for developing broadband, we have announced plans to trial products that will deliver faster wholesale broadband services, and cut prices for many wholesale broadband access products. Broadband service providers will have greater choice over how they deliver and diVerentiate their services. We will also make further price cuts to local loop unbundling products, subject to the conclusion of two parallel Ofcom consultations on the Cost of Copper and the Cost of Capital, as well as the outcome of the Strategic Review.

Broadband Indicators—Progress Since the Committee’s Last Report 11. The Committee’s last Broadband Report was published on 3 February 2004. It is interesting to note some key statistics on broadband market developments since then:

Data February 2004 Current % of the UK with DSL 85%! 95% broadband (availability) (20/02/2004) (04/02/2005) Number of DSL broadband lines 2.3 million 4.1 million (03/04) (12/04) Number of broadband lines in total 3.8 million 6 million ! (DSL ! cable) (03/04) (12/04) Number of BT exchanges enabled for 2,345 4,185 DSL broadband (20/02/2004) (04/02/2005) Number of unbundled local lines (LLU) 9,511 31,467 Trade and Industry Committee: Evidence Ev 41

Data February 2004 Current Number of IPStream lines 1,934,924 4,138,941 Number of DataStream lines 121,159 384,916 Price for LLU Connection £117 Connection £34.86 (shared access) Rental £53 per month Rental £15.60 per month

12. This is a fast-moving market. The table above demonstrates this. On all of the key issues, and looking at broadband overall, the UK is now very well positioned. The eVorts of the entire industry have helped bring this about and we now need to ensure that the momentum is not lost. This is why the Ofcom Review is so important. Get the regulatory framework right and the UK has every chance of maintaining and even improving its international competitiveness. Get it wrong and the momentum for which we and others have worked so hard will be lost; investment and innovation will be hampered; and the UK will run the risk of falling back down the international league of competitiveness.

Broadband Availability 13. The UK now leads the G7 group of countries in Asymmetric DSL (ADSL) broadband availability— more than 99% of the population will be able to access broadband in this way by the summer of this year. A year ago BT, along with every other ADSL operator in the world, was trying to find ways of extending the “reach” of broadband, so that more people in broadband enabled exchange areas could receive service. During the year we have found a way round this problem and can now oVer service to virtually all customers who live within an area covered by an enabled exchange.

Competitiveness of the Broadband Sector 14. The UK leads the way in competitiveness of broadband oVerings—BT has the lowest retail market share for broadband lines of any of the former incumbents in Europe, at around 25% (source: European Competitive Telecommunications Association). Why? Because of the fierce competition from around 200 Internet Service Providers vying for the attention of customers and because of the existence of an independent and strong Cable TV industry in the UK.

Retail Broadband Prices 15. Prices have continued to fall. Looking at BT’s oVerings alone, prices have come down over the last year as follows:

Service Bandwidth Cost From BT Basic Broadband 1Mb £19.99 to £17.99 24 March 05 BT Broadband 2Mb £27.00 to £24.99 17 Feb 05 BT Yahoo Broadband 2Mb £29.99 to £26.99 17 Feb 05

Wholesale Broadband Prices 16. BT is committed to retaining and developing a balanced portfolio of wholesale broadband products which will support the whole of the UK and enable service providers to deliver innovation across the country. 17. In support of this aim, BT Wholesale has announced a range of product pricing initiatives and plans to deliver higher speed broadband services throughout the UK. These changes are in response to service provider requests and to help fuel end user take up of broadband connections. 18. BT Wholesale has announced price rebates that will reduce the wholesale cost to service providers of BT IPStream (a broadband Internet Protocol (IP)-based network service that enables Service Providers to connect End Users across the country to their own host site or data centre, in order to provide broadband internet and data applications). ADSL products from April in areas where the unit costs of delivering BT Wholesale broadband services are lower. In these areas, the reduction will be around 8% on average. 19. Simultaneously, BT Wholesale has announced price cuts that will reduce costs nationally for BT DataStream (a dedicated Asynchronous Transfer Mode (ATM)—based broadband network service to Service Providers and telecoms operators to deliver broadband solutions using their own IP transport services). ADSL service providers to maintain the margin between IPStream and DataStream under the regulatory margin rule, supporting customers who choose to build their own national service. Ev 42 Trade and Industry Committee: Evidence

20. BT does not expect to make any further significant price changes to the existing ADSL IPStream rental charges over the next 12 months, other than potentially some changes to support the take-up of higher bandwidth services.

Broadband Speeds 21. “Broadband” is a word that means lots of diVerent things to diVerent people. In essence, it embraces any service that oVers speeds higher than those of “narrowband”—54Kbt/s per second. Until now, most observers have considered 512Kbt/s per second to be the basic broadband speed, and this is what BT was oVering as its mass-market broadband product until very recently. However, as we said to the Committee last year, this is a fast changing area and what is accepted as the norm today is certain to be swept away in the future by technological developments and customer demand for more bandwidth-hungry applications such as video-on-demand. 22. Faster—broader—broadband became a reality for virtually all ADSL customers with BT Retail’s announcement on 10 February that it was going to provide 1Mbit/s speeds to all its BT Broadband Basic customers and 2Mbit/s to all its other existing 512Kbit/s customers. Customers need no extra kit and it will not cost them a penny more. 23. BT Wholesale has also announced that it is to trial increasing speeds to 8Mbit/s on all lines that support 2Mbit/s. In addition, BT is to trial ADSL2! technology to support even higher speed services of up to 18Mbit/s. Technical trials are scheduled to begin in April 2005 with the aim of launching higher speed services nationally from the autumn. The trials for ADSL2! follow recent proposed changes to the Access Network Frequency Plan by Ofcom. This Plan provides the regulations underpinning the use of DSL technologies in the UK copper network. 24. These developments mean we are bringing improvements on-stream quickly to give all wholesale customers the choice of the wholesale delivery mechanism they want to use to deliver broadband; be it the end-to-end BT IPStream option; end user access via BT DataStream; or by LLU (see next section). All these developments strengthen the broadband portfolio for the full range of wholesale customers, be they LLU operators or service providers who do not wish to become full infrastructure operators. 25. Technological change continues to enable improvements to be made to a range of broadband products. In addition to those mentioned above, it is worth noting that BT has also announced details of the next 500 exchanges to be upgraded to provide symmetric broadband service. By April 2006 a total of 1,300 exchanges, covering more than two thirds of UK businesses, will be able to provide this service.

LLU 26. The Committee has had a keen interest in Local Loop Unbundling (LLU) for some time now. LLU is also a critical element of Ofcom’s strategic approach. 27. BT recognises this, and we are fully committed to making it a success. During 2004, BT made significant cuts in charges for the “line-sharing” variant of LLU, making our oVering one of the cheapest in Europe. In addition to these cuts, we are now proposing a reduction in charges for the full metallic path variant of LLU (often termed “full unbundled LLU”). These price reductions will relate to the outcome of Ofcom’s Cost of Copper and Cost of Capital studies, and will be part of an overall regulatory settlement. 28. BT is determined to deliver successfully the required operational changes to create an environment where the LLU industry can achieve high volumes of LLU to agreed delivery targets. To that end BT continues to work proactively with the LLU industry and has agreed to trial the use of the OYce of the Telecommunications Adjudicator as a way of removing customer perceived barriers to achieving this aspiration. For example, BT: — has agreed an LLU Industry Plan (encompassing 52 distinct projects) with the Adjudicator and industry which is in progress; — is committed to improving LLU operational delivery against agreed KPIs; — has appointed a Director of LLU to provide focus and steer to ensure developments are completed in a timely manner; — has deployed significant levels of additional operational resource in order to handle the expected order volumes. Many automated systems and processes are already in place and development of further automation systems is being fast-tracked for implementation during 2005; and — has introduced binding Service Level Guarantees. 29. By the end of March 2005 LLU operators will be providing service from more than 600 exchanges. Many of these will have multiple operators providing service. In many cases, the new LLU deployments will be the simpler, cheaper new range of co-mingling products launched in October 2004 and will provide the platform for operators to grow towards their forecasts of 1 million LLU lines by December 2005. BT’s commitment to LLU will continue. Trade and Industry Committee: Evidence Ev 43

Separation Issues 30. The Committee concluded last time that “The potential gains from an enforced separation between BT’s wholesale and retail activities do not justify the upheaval involved.” 31. We agree with this conclusion and believe nothing has changed to suggest that this view needs to be reconsidered. 32. We are unaware of any country in the world where separation has been introduced, save in the USA where that separation was between the local and long-distance telephony businesses—an approach now being reversed by market forces. Occasionally some suggest that the separations seen in the gas or electricity industries in the UK provide evidence that BT should also be separated. Nothing could be further from the truth, as recognised by commentators over the years. There is simply no comparison between the essentially simple, one-product industries of gas and electricity supply and the complex, fast-changing communications industry. 33. Moreover, the proposals that BT has made in respect of equivalence and equality of access render irrelevant arguments about enforced separation by whatever name. 34. There is no justification for mandated structural separation where existing regulatory conditions concerning access and interconnection, and competition rules, are properly applied. Such conditions include no undue discrimination, accounting separation procedures, cost accounting standards, eVective Service Level Agreements (SLAs), and additional transparency measures. 35. Indeed, as acknowledged by Ofcom and the large majority of industry respondents, there are clear benefits to both consumers and BT in maintaining BT as a vertically-integrated company.

Equality of Access

36. As part of the package we have proposed to Ofcom, we would create a new division within BT based around our access assets and resources. This organisation, provisionally referred to the “Access Services Division”—would be responsible for the delivery of equality of access and provide the foundation for a new framework for governance. Transparency and accountability are the most important issues, and would be secured through the creation of an Equality of Access Board. 37. The key elements of our proposals are as follows: — we would create a new organisational entity—the Access Services Division—comprising the assets and manpower associated with the access network, from the network termination point in the home or business to the Main Distribution Frame in the telephone exchange; — the Division would deliver basic access services, including unbundled loop services, to all customers; — its management team and its people would be tasked to deliver eYcient management of their business, customer satisfaction, and equality of access to its services, and incentivised solely on that basis; — the unbundled loop services it provides would be available on the basis of input equivalence as soon as systems capable of providing this are in place. 38. BT believes good governance requires separation of the roles of delivery of equality of access and that of oversight, accountability and transparency. We would therefore also propose to establish a Board to oversee delivery of equality of access. Key things to note relating to this Board are that: — it would include two Independent members, appointed in consultation with Ofcom. One independent could be an Ofcom Board member; and — it would be chaired by the BT Group CEO.

Other Issues Raised in the Ofcom Review

39. We have assumed that the Committee does not wish to consider the detailed evidence submitted by those responding to the Review. This is Ofcom’s function, of course. For this reason, we do not deal in this submission with every topic covered in our paper to Ofcom—which runs to 110 pages. We have, instead, concentrated on those issues raised by the Committee. 40. However, we would like to refer to just two other issues in order that the Committee should be aware of matters which we believe to be of real interest to consumers, as opposed to most of the other points we have covered here, which are of relevance mainly to operators and service providers in the first instance. Ev 44 Trade and Industry Committee: Evidence

Mis-selling of Telecommunications Services 41. The first issue concerns Ofcom’s question about approaches that might be adopted to reducing search and switching costs for consumers. 42. We believe that the most pressing issue for consumers is actually one of mis-selling in ways that leave them uncertain and concerned about their services. Every month, more than 10,000 BT customers— consumers and businesses—tell us that rival companies are transferring their telephone calls (or entire telephone service) without permission, using techniques such as: — “slamming”—transferring the customer’s telephone service without permission; — “selling on cancellation”—transferring customers even if they just ask for information; — pretending to be BT, or “working in association” with BT. 43. Ofcom intends to publish a Notification in March, and to require communication providers to establish individual sales and marketing codes which would comply with mandatory Ofcom guidelines within one month. Ofcom have yet to articulate the appropriate metrics to have in place to assess whether mis-selling reduces but envisage these requirements only being in place for two years. Compliance with the codes would be obligatory and Ofcom’s normal powers to take enforcement action in the event of breaches, including powers to impose financial penalties for continued non-compliance after preliminary notification, would apply. 44. On 21 January, Ofcom confirmed that the level of mis-selling is such that BT should be able to cancel an order, at the request of a customer, in certain circumstances including slamming. 45. We welcome this recognition that there is a mis-selling issue. However we have expressed disappointment at Ofcom’s failure to act to date on mis-selling by using existing enforcement tools such as the Enterprise Act. 46. BT hopes Ofcom will take proactive and public action against companies engaged in mis-selling to avoid the problems faced by the energy industry. Greater transparency of measurement and reporting by communication providers and Ofcom is needed. BT does not support the automatic two year sunset clause and believes sanctions should remain even when mis-selling reduces. BT does believe the regime should be reviewed within 12 months. 47. BT remains disappointed that Ofcom has not taken the opportunity to explore additional measures that may strengthen consumer protection in this area such as direct notification by a customer moving to WLR that they wish to terminate their existing contract and third party verification. The absence of such measures merely enhances the opportunity for mis-selling. Other countries have developed solutions. In the USA, transfers have to be “verified” by a neutral third party, and there are fines of $50,000 per customer for slamming. In Ireland, and much of Europe, the losing company can challenge the gaining company to produce evidence that the customer has agreed to transfer. 48. We do, of course, recognise that any regime of this sort would apply equally to BT and we stand ready to abide by the disciplines and penalties of such an approach.

Universal Service

49. We support the principle of universal service and appreciate our wider responsibilities in the provision of commercially unattractive services with significant social benefit. But the market we operate in is highly competitive. Over 250 companies now oVer service provision and more are entering the market. As BT’s share of the market diminishes, its capability to fund loss making services diminishes too. The challenge for the regulator is to disentangle universal service from the regulation of particular carriers. This means recognising that universal service is an industry issue. It is not appropriate to link the funding of universal service to market shares or profits in other parts of the retail market. In particular, BT should not be left in a position where it increasingly loses profitable market share to carrier pre-selection, and Wholesale Line Rental etc and be increasingly left with a USO “rump”. We believe that the universal service obligation would be better funded by the industry as a whole. 50. Whilst it is vital going forward that the Telecoms Strategic Review delivers a long-term solution for universal service that meets consumer needs, the Universal Service Obligation must change now to reflect market and technological developments, or it will become increasingly irrelevant to the needs of consumers, and more costly to maintain. There is a real risk that it will repeat on a larger scale the problems currently experienced with public payphones. Here, a service in long term commercial decline has to be sustained, at considerable expense, in order to satisfy the needs of a shrinking number of users, many of whom have access to aVordable and more eYcient substitutes such as mobile telephony. This is not an eVective use of resources. It is an example of what happens if an obligation is maintained despite changes in technology and the market. Trade and Industry Committee: Evidence Ev 45

51. The current USO lags behind the market in being focussed almost entirely on fixed networks. One of the established tests for inclusion of services into the USO is widespread take up. This means that those unable to use the service are placed at a disadvantage. Mobile services have had a very high take up for some years and there are now arguments that those without mobile phones may be socially excluded and those areas without mobile coverage may be disadvantaged. 17 February 2005

APPENDIX 4

Memorandum by Centrica

Summary — Centrica Telecommunications, part of Centrica plc, operates the One.Tel brand in the UK and also sells telecoms services to British Gas customers. With over 1.4 million active fixed-line services and a further 300,000 mobile, narrowband and broadband internet services, it is the largest service- based competitor to BT in the fixed-line market. — Centrica Telecoms welcomes the Ofcom review of telecoms as much needed and timely. While there is perhaps greater public interest in the broadband and markets, it is important that the fixed line market, which still accounts for 74% of all call volumes, is not ignored. BT may argue that the existing framework has already successfully delivered competition in many areas of the market. However Centrica firmly believes that the existing structure has not only failed to deliver the greatest benefits to consumers in the past, but is incapable of meeting the evolving needs of future citizen-consumers. — Ofcom considers three options for the future regulation of the telecoms sector and proposes the principle of equivalence of inputs as best placed to deliver eVective and sustainable competition, supported by significant organisational and behavioural change. We agree with this conclusion and it is now vital that BT delivers input equivalence across the agreed range of wholesale products. — The failure of BT to deliver a workable Wholesale Line Rental (WLR) product has been particularly disappointing and highlights the diYculties surrounding equivalence when new entrants are reliant on the services of BT Wholesale if they are to compete against BT Retail. Centrica Telecoms, and large sections of the telecoms industry, are becoming increasingly concerned that a product first proposed five years ago has still not been rolled out in an acceptable way. — We believe the incentive for BT to deliver eVectively will be the “carrot” of deregulation. However it is vital that there are no deregulatory moves until the building blocks required for a truly competitive landscape are in place, and not, as BT proposes, that they will deliver equivalence only once certain deregulatory moves have been made. — One of the most significant technological changes on the horizon is BT’s proposed new IP network, known as 21st Century Network (21CN). 21CN has the potential to deliver considerable long-term consumer benefits. Like any other commercial investment it should be appropriately rewarded. However the current lack of clarity around this development is creating uncertainty and risk for continued industry investment; regulatory certainty in this area is necessary for investment by both BT and the rest of the industry. Commitment to input equivalence for all 21CN products from the outset, is crucial, otherwise we risk repeating the same mistakes all over again. — Finally, we believe that an Enterprise Act referral must not be ruled out at this stage and must remain firmly in prospect until true equivalence coupled with significant organisational and behavioural changes have been delivered; these are essential if there is to be fair and sustainable competition. BT’s response to Ofcom’s Strategic Review fails to acknowledge or address the many issues that plague the sector at present and unless BT makes significant moves to meet the requirements of both industry and Ofcom, an Enterprise Act referral may remain Ofcom’s only option.

1. Ofcom Phase II consultation—review process to date 1.1 Ofcom’s Phase 2 proposals represent a significant shift in the regulatory approach to the UK telecoms market. Centrica applauds this decisive move and the improved prospects for a truly competitive fixed-line market that it brings. 1.2 The approach that Ofcom has taken in consulting with industry has been a refreshing change to the historic consultative process, allowing all parties to evolve their thinking on an iterative basis over the consultation period. It can be anticipated that the formal responses Ofcom received on 3 February will be better informed and more substantive than they may otherwise have been if the consultation process had Ev 46 Trade and Industry Committee: Evidence

not included the many workshops, discussions and debates that have taken place. This can only be to the good; Ofcom has enjoyed an early view of the general trend of industry thinking, industry itself has worked closer with both Ofcom and BT to understand and develop the key themes and BT has had the opportunity to expose its position to challenge and review with its key stakeholders.

2. Ofcom Phase II consultation—interim conclusions

2.1 Ofcom’s Phase 2 consultation document identifies that, whilst there has been some development of fixed-line competition, infrastructure competition has failed to materialise to the extent originally envisaged and the more recent move to service provider based competition “. . . has been frustrated by delays and inadequacies in wholesale access products”. Ofcom goes on to comment that those who rely on BT for such access have experienced 20 years of slow product development, inferior quality wholesale products, poor transactional processes and a general lack of transparency. 2.2 We agree with Ofcom’s conclusions. Having played an active role, primarily in the service provider space, over the past five years, Centrica has experienced first hand the eVects of the second-rate wholesale products we have been forced to endure and the impact this has had on the progress of competition. 2.3 BT, in its own response to Ofcom Phase 2 consultation, asserts that competition in telecoms is flourishing and that comparisons between the development of competition in the energy markets and fixed- line telecommunications are inappropriate in that the only diVerentiator (between suppliers) in energy is price, not product. However, Centrica has considerable experience in both markets (energy and telecommunications) and in our view, for the vast majority of residential consumers who depend on a “plain old telephony service”, it is primarily the same factor, ie price, that drives customer switching. On this basis, the comparisons between the two markets are entirely valid and support Ofcom’s conclusions that the telecoms market lags a long way behind energy in the development and extent of competition. 2.4 To address this, Ofcom considered three options: reliance on the Competition Act, a referral under the Enterprise Act, or a focus on “equality of access” or equivalence for key bottleneck products and services. We welcome Ofcom’s recognition that the competitive conditions are not yet right to support Ofcom’s withdrawal from ex ante regulation at this time. While an Enterprise Act referral may still be required, we believe that Ofcom’s desire to focus on delivering equality of access is the right one at this stage. 2.5 The principle of equivalence already exists in the energy markets, as a result of the separation of the supply and network businesses, and as Ofcom identifies, has resulted in a healthy and well functioning competitive market with some 40% of consumers now being supplied by someone other than their original incumbent provider. Fundamentally, equivalence is a means by which the basic premise of non- discrimination (by the dominant player) can be assured. It provides a level playing field for all competitors, ensuring that those with the right commercial model can succeed. 2.6 Ofcom describes two variants of equivalence, “equivalence of inputs” and “equivalence of outcomes”. Ofcom’s predecessor, Oftel, applied a model approaching “equivalence of outcomes” in developing a WLR product which was intended to provide competitors with the ability to oVer a fixed line voice product to compete with BT’s retail service and it is useful to consider the experience of this product. Despite over two years of planning and development, the WLR product still falls significantly short of “fit- for-purpose” and a myriad of compromises and deficiencies remain. As a result, the product is cumbersome to use, both for us and our customers, with the result that competition has failed to develop into the extent originally anticipated by Oftel. The first major release of WLR was in March 2004 and while the market has grown in the intervening time, nearly all the growth has been in the business sector. The deficiencies in the product add considerable cost, inconvenience, time resource and detriment to the customer experience to which BT Retail is not exposed, and which make it unsuitable for mass-market roll-out. Furthermore, the product requires constant scrutiny by Ofcom to ensure there is no discrimination in the provision of services between new entrants and BT Retail. 2.7 True equivalence of inputs is where the same product is provided to BT’s competitors as to BT Retail, at the same price, using the same systems and transactional processes. This overcomes all of the problems which have been encountered with equivalence of outcomes and should allow the regulator to confidently withdraw from the micro-management and dispute-focused role we have witnessed continually over the past decade. The burden—and therefore the cost—of regulation for all stakeholders can be expected to lower as a result. 2.8 Where such equivalence is applied, we would anticipate a swift and appreciable upsurge in the level of competition and greater focus on product diVerentiation and value added services to meet consumers’ needs and expectations. The ultimate winners of a regulatory environment based on equivalence must be the consumers. It is vital that true equivalence is applied to the key wholesale products in use today (primarily WLR, Carrier Pre-selection and Local Loop Unbundling), as well as those that will replace them in the future 21CN environment. Trade and Industry Committee: Evidence Ev 47

3. Direction of remainder of the Review 3.1.1 Ofcom’s Strategic Review takes as a premise that by focusing regulation on enduring economic bottlenecks, you can create the circumstances where BT and other network operators alike can build on that monopoly service, and competitive wholesale and retail markets can flourish. If this happens, Ofcom believes that major steps can be taken to reduce regulation at other points in the value chain, and they set out a timetable of market reviews to support such a programme. Ofcom’s Strategic Review refers to this as a “regulatory settlement”. 3.1.2 While we support Ofcom’s proposed strategy in principle, Sections 1 and 2 of their Phase 2 review provide ample evidence that the circumstances are not yet right for major deregulatory moves of this kind. The basic building blocks for competition have to be in place before any deregulatory action can be contemplated. These building blocks relate not only to product equivalence (eg a fit-for-purpose WLR product) but also to an organisational and behavioural framework derived from changes to BT’s structure which will address the current internal conflicts of interests and better guarantee non-discriminatory behaviour at all levels. 3.1.3 It is important to be clear on the nature of the suggested settlement. We agree with Ofcom that the requisite building blocks must first be in place so that competitors can establish sustainable businesses, confident that they are not going to be undermined by anti-competitive behaviour by BT as the incumbent (for example, by changes to wholesale prices which squeeze the margin available to competitors while protecting the interests of BT Group). Also, that industry must have confidence that they will not become embroiled in an endless series of regulatory challenge and disputes. 3.1.4 We therefore note with concern the diametrically opposed view of BT—that BT will only agree to address these critical issues when Ofcom commits (as far as it can) to a settlement which includes satisfactory resolution (in BT’s eyes) of investigations into the returns BT is permitted to make on its copper access network, and into its cost of capital and price controls going forward. We can see that these are linked in BT’s mind, but relaxation of price controls (for example) should be the result of increased competitive pressure making such price controls unnecessary, rather than a pre-condition of BT committing to the reforms which Ofcom has rightly seen as essential if an Enterprise Act referral is to be avoided.

BT’s 21st Century Network 3.2.1 Ofcom’s Strategic Review is being undertaken against the background of major network transformation by BT, as it moves to IP (Internet Protocol) technology which oVers increased services at lower cost. This initiative is generally welcomed, and introduces opportunities to “design in” competition from the outset, rather than having to bolt it on to existing monopoly products systems and processes, as BT has so often done. 3.2.2 This strategic opportunity must be grasped at a product level (input equivalence) at a service level (same IS “gateways”) and a behavioural level (BT working with industry to ensure their requirements are also met). 3.2.3 The 21CN project has, from industry perspective at least, had an uncertain start, although there are signs that BT is now responding to concerns through its Consult 21 dialogue. Ofcom’s review correctly identifies the importance of 21CN arrangements not limiting competition and have naturally made this a pre-condition for any relaxation of network charge controls. 3.2.4 Development of BT’s 21st Century Network must not be, even unwittingly, a means by which BT’s retail activity gains an unfair competitive advantage, or where competitors’ products which rely on BT’s existing network fail to be seamlessly transferred to the new infrastructure, with no adverse impact on the customer’s experience. 3.2.5 Disappointingly BT are suggesting that their commitment to equivalence through 21CN systems and access through open interfaces to appropriate wholesale services where BT has significant market power will be part of an overall regulatory settlement. We can appreciate that BT might want regulatory certainty regarding the return they can expect on such investment, and support clarity of the regulatory regime in this regard. However it is totally inappropriate for BT to be contemplating committing to a 21CN design which does not have equivalence and equality of access as cardinal principles.

Investment and Incentives 3.3.1 A key element of the proposals Ofcom sets out in its Phase 2 consultation is its first regulatory principle, of promoting competition at the deepest levels of the infrastructure where it will be eVective and sustainable. This is supported by its fourth principle, to promote a favourable climate for eYcient and timely investment and stimulate innovation, in particular by ensuring a consistent and transparent approach. 3.3.2 Centrica recognises the benefits that competition at the deepest level of the infrastructure oVers in facilitating innovation and competition at the retail end of the value chain. Where there is healthy competition in the provision of key wholesale products, this will drive both price and product benefits through the value chain to citizen-consumers. Ev 48 Trade and Industry Committee: Evidence

3.3.3 However, citizen-consumers will only benefit from competition if Service Providers also invest. Regulatory certainty is therefore equally as important to encourage investment in retail markets as it is for network investment. For Service Providers, equivalence in key wholesale products, confidence in the stability of the market going forward (eg the move to 21CN) and strong regulatory control over the retail activities of BT are all vital components for continued investment in the sector. 3.3.4 BT’s response to Phase 2 also supports the two principles identified above and comments that “. . . the scale of investment and the reality of contestability may be very sensitive to regulatory decisions” (p 27). BT goes on to assert that Ofcom’s current proposals entitled “Cost of Copper” go against these principles, as they look to change the way in which this key asset is valued. BT’s concern is largely that such a revaluation will deter investors. We believe the review of the cost of copper is timely in the context of the overall review and should be accelerated to avoid delaying the ultimate regulatory settlement. Investors in competing providers who rely on access to this asset will only be encouraged (to invest) by a reduction in the costs of this access. 3.3.5 Ofcom’s principle of encouraging investment clearly requires some further clarification. Ofcom must continue to recognise the importance of investment by Service Providers, not just network operators, and must also clarify that it is investment by alternative, competing providers that it seeks to encourage, and not just investment by the incumbent.

4. Broadband and LLU 4.1 Broadband remains at the forefront of Ofcom’s regulatory agenda and its Phase 2 consultation sought confirmation that its current proposals for the regulation of wholesale broadband access remained valid. 4.2 Centrica is fully supportive of the need for a thriving wholesale broadband market in order to deliver the range of new and exciting services that this technology can facilitate. Over time, it is anticipated that consumers will no longer have a PSTN connection as standard, but will receive a wide range of converged voice, data and entertainment services through their “broaderband” connection. It must therefore be right that Ofcom review the current regulatory framework for this sector in total, to ensure that regulation facilitates and does not constrain the prospects that broadband may bring. 4.3 However, Centrica is concerned that the competitive market is not currently thriving and the prospects for widespread LLU roll-out are uncertain. While good work is being done by the Telecoms Adjudicator in ensuring LLU processes can meet all reasonable demands, Ofcom must seek to understand and address the current issues with the wholesale broadband market that may be stifling investment in this sector. Whilst BT may be vital in delivering the building blocks necessary for broadband competition, it is the competitive market that will turn these into innovative and exciting propositions for citizen-consumers. If BT is allowed to frustrate wholesale broadband competition, this will severely impact the range and variety of retail competition that is available. Ultimately, the Government’s goal of “Broadband Britain” will be best served by competition between network operators and between service providers, rather than through policies which favour the integrated incumbent. 4.4 BT argues that Ofcom must only regulate at one point in the value chain, eg LLU, or DataStream, but not both. The reality—certainly for the short to medium-term—is that products like IPStream and DataStream, will remain important to the market even if LLU takes oV, given that uptake of LLU will be in a limited number of areas. Recent changes by BT to their IPStream prices potentially undermine the investment case for LLU in some of these areas, which further demonstrates their ability to manipulate the wholesale margins between the diVerent wholesale products. By the nature of its vertical integration, BT is uniquely placed to gain a competitive advantage in the retail market. Until robust and sustainable competition is in place in at least one point in the value chain, Ofcom must retain ex ante controls over the whole of that chain.

5. Separation of BT 5.1 Ofcom’s analysis correctly highlights that product equivalence must be backed by organisational and behavioural changes on the part of BT as the dominant provider of fixed-line telephony. Without such changes, there will always be a conflict of interest between BT as the provider of wholesale products to competitors, and the interests of the BT Group which seeks to achieve success in its retail operations through its vertical integration. 5.2 Behavioural change means that non-discrimination is rigorously applied in all areas where BT is providing products and services to itself and on wholesale basis to competitors. The diYculty of achieving this to a suYcient standard can only be overcome through organisational change, a fact recognised in the case of British Gas plc in the 1990s, when, after a review by the Monopolies and Mergers Commission, it was found necessary to introduce full internal separation between monopoly network activities and its competitive retail business. More recently, Centrica plc has introduced full separation of its Rough storage operation from the rest of its businesses, following an investigation by the Competition Commission. This entailed the creation of Centrica Storage Ltd as a wholly-owned subsidiary, with its own board, entirely separate management and a strictly applied code of conduct. We see this as a model of good compliance. Trade and Industry Committee: Evidence Ev 49

5.3 BT is proposing the formation of an Access Services Division, which represents a significant step forward. Crucially, however, the Access Services Division is not a separate subsidiary (which would have better guaranteed the independence of its operations) and it will continue to carry the same brand as the retail operation users, (which is bound to lead to many customers believing that the retail area has a preferential relationship with the operator of the monopoly access network). In addition BT does not plan to introduce “transactional transparency” ie a regime under which the Access Services Division will provide services to BT Retail and competitors on essentially identical “contracts”. As far as we can see its profitability will still be the product of arcane cost allocations from extensive common service functions, rather than resulting from a largely standalone operation with its own costs and revenue streams. 5.4 Even if these deficiencies were to be addressed, the Access Services Division is only part of what is required if there is to be a framework in which competitors will have confidence. A large part of BT’s other wholesale activities are in markets where it has significant market power (SMP), and where similar standards of non-discrimination are required. BT proposes to create an Equality of Access Board, to oversee the activities as well as those of the Access Services Division, but the practical measures necessary to ensure non- discrimination for these products have not been spelled out. 5.5 BT’s Equality of Access Board is only an enhanced version of BT’s present “top-down” compliance regime, and will always be second-best to organisational changes which create business units whose entire raison d’e´tre is to meet the needs of external and internal customers for such products equally and as far as possible identically. We believe that in addition to access services, organisational changes are necessary to address other key wholesale products where BT has SMP. 5.6 A particular aspect which Ofcom rightly attaches great importance to is “migration products”; those systems which enable customers to switch products and service providers. Leaving BT’s wholesale division to develop and manage migration products does not guarantee their eYciency or neutrality, especially where BT is so reliant on integrated group-wide systems to support its retail activities and it has met the needs of competition by add-on processes which BT Retail does not use. We are sceptical that an Equality of Access Board would be able to get involved in the detail necessary to ensure total neutrality in this increasingly important suite of systems. 5.7 It is important for the success of this review that organisational initiatives by BT are matched by cultural and behavioural changes, reflecting a fundamental shift in the way in which BT provides services to its internal and external customers. We fear that BT’s Phase 2 submission, firmly rebutting criticisms of its past behaviour and defending its compliance record, could suggest that BT has not yet wholeheartedly embraced the need for such wide-ranging reform.

Conclusion — In conclusion, it is essential that we do not lose the opportunity presented by Ofcom’s review to create a sound basis for sustainable competition in telecoms, both now and into the future. This must be based on input equivalence across the agreed range of wholesale products, with this principle being adopted as a pre-requisite for all future 21CN developments involving wholesale products where BT has SMP. — Product equivalence must be backed by wide-ranging organisational and behavioural change by BT, to overcome the inherent conflicts of interest which arise with its present structure. — A regulatory settlement based on such a framework will provide greater regulatory certainty for both BT and competitors, enabling eVective competition to emerge and a reduction in regulation, to the benefit of customers, BT and industry.

APPENDIX 5

Memorandum by COLT

Headline Message Although Ofcom’s thinking behind the review is sound, the process and execution are flawed and the end game is unclear. It would have been better for Ofcom never to have started the review, rather than for BT’s proposals in its response to the TSR2 consultation to be accepted. If that happens BT may be in an even stronger dominant position (and BT would fully exploit this) and industry may start to lose faith that a truly competitive telecoms market in the UK will ever exist. This briefing is submitted by Tower House Consulting on behalf of COLT Telecom Group plc (“COLT”). It provides a two-page summary of the background to the review, its current status and COLT’s concerns about the prospects for its success. Ev 50 Trade and Industry Committee: Evidence

Background on Colt COLT is a leading pan-European provider of high bandwidth, voice, data and advanced telecommunications solutions to businesses right across Europe. COLT operates advanced metropolitan area networks in all the major business centres in Europe, linked by its fully-owned IP network. COLT is listed on the .

Background to the Telecoms Strategic Review The need for a strategic review of telecoms regulation was clear. The market was broken and needed fixing, BT was continuing to exploit its dominant position in the UK and without eVective sanction from its regulators, and there was no prospect of change. To quote from Ofcom2: “. . . UK telecoms regulation has yet to overcome the problems of enduring economic bottlenecks combined with lack of equality of access to these parts of the [BT] network . . . Entrants . . . who rely on BT to provide such access have experienced twenty years of: slow product development; inferior quality wholesale products; poor transactional processes; and a general lack of transparency . . . While individually each issue might seem immaterial, cumulatively they make the reality of competing against a vertically-integrated player an economically unattractive proposition.” If competition was failing, then so was Ofcom—Parliament had decided that the promotion of competition was one of Ofcom’s principal duties3. While we initially supported Ofcom’s “equivalence” approach in the review, Ofcom also needs to look beyond the mechanics of putting this in place (or any alternative route it now chooses to follow—see below) and aim for a competitive market that will allow much smaller pre-profit operators to engage with and compete in practice against the complex BT internal operations and systems, and which also allows other operators (ie other than BT) to operate profitably and make appropriate returns on their investment in the sector4. Also Ofcom needs to be clear on what it thinks the competitive telecoms landscape should look like post “equivalence” ie its real, clear, ideal market goals, and on exactly what BT needs to change to make this happen. Ofcom needs to be clear on this and be more forceful in prescribing exactly what it needs BT to do. Crucially, Ofcom also needs to be clear that is has the power and authority to make this happen.

Progress of the Telecoms Strategic Review Ofcom’s initial conclusions from the review were issued in November 2004. Ofcom identified the need for serious regulatory reform to address a conflicting set of duties within BT—the first, to act to benefit BT shareholders by maximising profit, and the second, to comply with its regulatory obligations to allow other players to compete. The two are not compatible and, naturally, the desire for profit for shareholders will always prevail, completely conflicting with the requirement and duty of the UK Government to create the landscape for a fully competitive UK telecoms market. Ofcom proposed the idea of “equivalence”—a new approach which would give competitors fair access to the BT Network. Ofcom reserved its right, if it transpired that equivalence was not achievable, to revert to the alternative of an Enterprise Act investigation of BT and its activities (“EA investigation”).

BT’s Response to the TSR Phase 2Consultation BT’s proposals in response to the TSR2 consultation, which were published on 3 February, indicate that what Ofcom and industry need from BT and what BT will actually oVer to achieve full “equivalence” are poles apart. Based on this, the “equivalence” option no longer looks achievable. Ofcom needs to seriously consider whether it wants to pursue this option and what it needs to do to achieve it within the next few weeks. Otherwise it should revert to the EA investigation option. In the BT response: — BT refuses to accept there is a problem5. — BT makes a series of unreasonable demands and is eVectively trying to hold Ofcom to ransom: as a pre-condition to its proposals, BT insists on (i) an accelerated approach to deregulation of BT, (ii) that there is a favourable settlement with BT on the BT Cost of Copper and Risk and Return on Capital consultations. Further, that BT Group will not make a final decision on the launch of

2 Paragraphs 1.19 and 1.20 of Ofcom’s Consultation on the TSR, 18 November 2004. 3 Section 3(1) of the Communications Act says that one of Ofcom’s two principle duties is “to further the interests of consumers in relevant markets, where appropriate by promoting competition” and Section 4(3) records the EC requirement that Ofcom must “promote competition . . . in relation to the provision of electronic communications networks and electronic communications services”; this latter requirement is of over-riding force (section 3(6)). 4 eg in COLT’s case it has invested c.£3 billion in its networks, services and systems, yet the activities of BT in the UK and other European incumbents has hindered it moving to profitability and seeing investment returns. 5 See page 80 of BT’s response: “The allegations against BT, largely consisting as they do of assertion and speculation, not backed by supporting evidence, do not present a coherent or robust case for further or tighter regulation.” Trade and Industry Committee: Evidence Ev 51

21CN until it knows these conditions will be met and that Ofcom must give BT considerable freedom on 21CN. (See pages 10, 15 and 4 respectively of BT’s response; see also page 17 on 21CN). — BT’s internal structural and compliance proposals are grossly inadequate: the proposal for a new Access Division, in particular, is a fig-leaf. Having current Wholesale and Retail divisions within the BT Group doesn’t work, so why would adding another division within the same company help in any way? Also, the “Equal Access Board” (which BT says will police the access division) is chaired by the BT CEO. He will clearly be motivated only to act in the interests of BT shareholders, not in the interests of competitors or UK consumers. (See COLT’s proposals—page 16 of its response.) — BT’s view and industry’s view of bottleneck products are clearly at odds: BT envisages separating only hard-core local loop assets; industry requires a range of other products to be separated structurally from BT Retail (see page 17 of the COLT response). — BT asks for deregulation in many areas (including voice, broadband, re: large business customers etc). There should be no deregulation until there is a clearly competitive market place and demonstrable reduction in BT’s market share. BT also asks for de-regulation in certain specific geographic areas: this is also premature and must not be undertaken without full consultation with industry. — BT directly challenges Ofcom’s authority to act: “Ofcom’s power to impose ‘real equality of access’ on BT is very limited.” (See page 34 of BT’s response.) Clearly: — BT is not serious about the review: they do not accept that there is problem and their motivation is therefore to “game” the process for maximum commercial benefit. — Ofcom does not know what legal powers they have to make BT comply with the conclusions of the review, and BT knows that. This has led to an environment where BT holds the whip hand in negotiations with Ofcom. The prospects for the review based on “equivalence” delivering a successful outcome are therefore low and Ofcom should consider an EA investigation. The review process does not currently provide for but it is essential that (i) industry has real opportunity to comment on the BT response (only a ° day workshop is currently proposed by Ofcom), (ii) Ofcom comments on the response to industry, and on how it plans to resolve the many fundamental outstanding issues with BT and in a transparent way before deciding to continue to pursue the “equivalence” option. This must be included in the process.

Questions We propose the following issues/questions for Ofcom: 1. Ofcom’s Powers: (i) What is the extent of Ofcom’s powers to force structural changes on BT? (ii) Has Ofcom considered asking DTI for greater powers under the Communications Act? (iii) What would be the eVect of simply using Ofcom’s existing enforcement powers more aggressively? 2. Ofcom must now commit to industry on how it plans to proceed: (i) Will Ofcom simply accept the BT proposals (we hope not), or will significant changes be required before they are acceptable and how will this be achieved? (ii) What form do negotiations between Ofcom and BT take? (iii) At what stage will Ofcom conclude that its “equivalence” proposal is unworkable? Has a date been set? What will Ofcom do then? 3. What does Ofcom plan to do in the interim re: the “equivalence” workstreams and timetable? 4. How is it considering the impact of 21CN in its plans? 5. (i) Can Ofcom deliver not just theoretical regulatory fixes but also an environment where competition succeeds because alternative players can be profitable? (ii) How does it see the future landscape? 18 February 2005

APPENDIX 6

Memorandum by Easynet It gives me great please to enclose a brief summary of Easynet’s response to Ofcom’s second phase of the Strategic Review of Telecommunications. Easynet believes this to be a most important piece of work which will significantly shape the future of broadband access in the UK. Founded in 1994, Easynet is a leading pan-European broadband networking company, providing businesses across Europe with innovative, IP-based wide area network solutions. Ev 52 Trade and Industry Committee: Evidence

Easynet is the UK’s leading provider of broadband services over unbundled local loops, having unbundled over 230 exchanges. Easynet oVers broadband services directly to corporate and public sector customers. Easynet also oVers broadband at speeds up to 8Mbit/s to residential customers through its UKOnline brand. In December of 2004, Easynet launched its LLUStream wholesale product. Service providers can use Easynet’s LLUStream to roll out innovative, diVerentiated high-bandwidth services to their customers. LLUStream oVers a real choice alternative to BT’s IPStream and Datastream wholesale broadband products. As such Ofcom’s approach to all aspects of broadband regulation, through the Strategic Review and other initiatives are of great relevance to Easynet’s business. I have also attached the full version of Easynet’s response which considers the individual issues in more depth.6 I would be delighted to give discuss any of the points below in more detail. If you have any questions please do not hesitate to contact me. Dave Simpson Manager of Regulatory AVairs, Easynet

Key Points from Easynet’s Response to the Telecoms Strategic Review 1. Easynet fully supports Ofcom’s approach which is to promote competition by tightly focussing regulation on the enduring bottlenecks. 2. Easynet is pleased that Ofcom have recognised the local loop as the deepest enduring bottleneck and will continue to focus its eVorts on Local Loop Unbundling as the most appropriate place for operators to compete. Ofcom must ensure that they do not undermine LLU investments by promoting other access methods such as softLLU, MSAN access/interconnect or heavily incentivising alternative fibre access networks. 3. It is acceptable to remove regulation from non-bottleneck services, but Ofcom need to be careful they don’t remove regulation too quickly or they risk adverse consequences, particularly in immature, developing markets. 4. Easynet supports Ofcom’s concept of Equivalence. It is a good concept, but the hard work will be the implementation. Ofcom must keep the pressure on BT to make equivalence a reality. Only once equivalence has been delivered, and seen to be working in practice, should Ofcom step back from regulation. A key point to this will be setting “success criteria” for key milestones with swift and severe penalties if BT fails to comply at any point in the development process. 5. The Business Rating regime has the potential to completely undermine Ofcom’s equivalence discussions in both the core and copper access network. Ofcom must work closely with the relevant Government agencies and departments to address this issue. 6. In order to ensure BT’s commitment to equivalence and their confidence in their LLU products and processes, Easynet fully believes that BT should have to use LLU to build it’s own 21CN. Easynet has built its current 21CN based on LLU and so BT should be required to do the same. This points to an organisation split to ring fence the local loop and ensure that all operators, including BT, have access to this enduring bottleneck on the same terms. 7. Easynet believes that LLU backhaul is not competitive and therefore Dark Fibre should be made available, ring fenced for this application. In eVect these would Backhaul Extension Circuits without the associated NTEs. 8. BT’s approach to geographic pricing for its wholesale products will lead to a digital divide between rural areas and urban areas. Potentially we shall soon see a market where those living in rural areas have less choice and higher prices than those living in urban areas.

APPENDIX 7

Memorandum by Energis Communications Limited Energis is grateful to the Committee for holding a timely and important inquiry. Ofcom’s Strategic Review grapples with a paradox—that 20 years of competition has seen the need for regulation grow, not shrink. Despite some successes, customers are poorly served by the status quo, paying higher prices, seeing new services introduced later and funding wasteful regulatory fights. We can and should find a better way.

6 Not printed. Trade and Industry Committee: Evidence Ev 53

Ofcom’s conclusion is that BT’s vertically integrated structure (being both supplier and competitor to rivals) and the incentives it creates have fuelled a need for ever more intrusive and complex regulation. Ofcom consider three options to escape this trap: withdraw regulation prematurely (while competition remains unstable); create new regulation delivering “equivalence”; or address the structure of the market. We think that the structural separation of BT is the best solution, and is in the long-term interests of customers of UK telecoms. We believe that the Committee has an important opportunity to bring a fresh perspective to these questions, and to share its views with Ofcom. Energis believes that we will never truly resolve the conflict of interest between BT’s roles as competitor and supplier with more, or better, regulation. As long as BT’s commercial incentives are to undermine regulation, Ofcom will struggle to impose rules on BT that adequately contain its market power. To those who are broadly comfortable with the status quo, splitting BT seems a highly inconvenient and disruptive choice. Energis believes that it is the right answer for customers, and we are heartened by Ofcom’s boldness in laying out the options. While we see the value in equivalence as an improvement on what we have now, there is much more to play for that will reduce the need for regulation and open up the telecoms landscape to greater competition and thus more innovation. The risk we see with “true” equality of access is that it assumes that Ofcom can find a plan that achieves two near-impossible goals: to escape the pitfalls of past failure that have undermined previous regulators and resulted in 20 years of slow product development; and to ensure that BT’s future incentives to deaden the impact of equivalence won’t just drive us back to where we started. Therefore, we have asked Ofcom to move swiftly to split BT, so that no competitive business benefits from being a sister company to a monopoly. If the Enterprise Act is the quickest and easiest way to achieve that, that’s what Ofcom should do. If Ofcom and BT are able to reach agreement on a workable divestiture by consent, so much the better. The Committee has already made an important contribution to the debate around broadband competition—and broadband remains a warning sign of what’s ahead. We’re deeply frustrated that all the talking and thinking by Ofcom has failed to get things moving. We hope the Committee is frustrated as well. Broadband matters, and if we can’t get it right on broadband, we won’t get it right on next-generation network issues. After four years of trying to make regulation work, BT retains a 91% share of the wholesale DSL market. Enough is enough. We have urged Ofcom to take the best option—and lay a policy foundation that will secure the interests of consumers in delivering fair competition for the future. “Equality of access” might have been the best option, if we’d thought of it in 1984, or even 1994. But in 2005, it’s time to move on from tinkering to some real reform. We hope the Committee will agree with us that the interests of consumers demand nothing less than an unflinching willingness to face into the hard issues and do what must be done.

Ofcom’s Opportunity must be Seized, not Squandered 1. We’re pleased that the Committee has undertaken this timely inquiry. Ofcom’s Strategic Review is at a critical juncture, since: (a) Ofcom has concluded that 20 years of conduct regulation have failed to deliver truly eVective and sustainable competition in a number of vital markets, and that—without a diVerent focus—is unlikely to do so in the future. (b) Ofcom has considered a number of options—in summary, having no telecom-specific rules, having better rules or taking steps that could lead to structural reform reducing the need for rules. 2. Thus, the Strategic Review has brought Ofcom to a fork in the road. The choice is between changing the structure of the market—short-term disruption bringing real and profound change; or refining the existing regulatory model, and regulating the market as it is—keeping faith with 20 years of regulatory practice, continuing on the path laid down by Oftel. Ofcom has to decide whether this is really a chance to change the road we’re on—or whether we are just pausing briefly to re-fuel. 3. Energis believes that real change will only happen when the market structure changes. We don’t want to see BT continue as a vertically integrated competitor and supplier of network access. This view reflects our consideration of the evidence, including our first impressions of BT’s proposals (released by BT shortly before the deadline for Phase 2 submissions) and the results of having participated in months of industry dialogue. We think that anything less than structural change invites a fresh cycle of regulatory fatigue. As long as BT remains vertically integrated, Ofcom will face the task of Sisyphus, endlessly at loggerheads with BT—with the battles tilted in BT’s favour through asymmetrical information, unbalanced resources, inertia and delay. 4. In our submission to Ofcom, we welcomed Ofcom’s Phase 2 document as an improvement on previous eVorts to lay conceptual foundations for telecoms regulation, in that it clearly identifies BT’s structure (and the conflicting roles of competitor and supplier it forces on BT) as the root cause of regulatory failure. Ofcom’s choice is between steps taken to manage that problem, and steps taken to solve it. Ev 54 Trade and Industry Committee: Evidence

5. For Ofcom to embrace the bolder and more far-reaching reforms involved in structural separation will require recognition from many sources that the existing approach has not worked and is not likely to work markedly better in the future. 6. Therefore, we ask the Committee: (a) to endorse our conclusion that, based on the past performance of Oftel and Ofcom itself, structural separation of BT is more likely to further the long-term interests of the citizen- consumer than a renewal of the existing regulatory paradigm; (b) to recognise Ofcom’s need to consider the desirability of structural remedies, while recognising that Ofcom must reach its view independently. 7. We also welcome the fact that Ofcom has made clear findings of fact with respect to BT’s conduct in dealing with competitors. BT’s own businesses and BT’s access customers have never yet faced each other on a truly level playing-field. We are disappointed that BT has not spoken more openly in its own submissions. For example, BT has not acknowledged the simple and obvious truth that the existing arrangements virtually force BT to work to undermine the regulatory regime, in their shareholders’ interests. This clash between the policy goals Ofcom pursue and BT’s commercial interests is not in the long-term interests of consumers of telecoms services. 8. Therefore, we are pleased that at the core of Ofcom’s findings is the conclusion that the problem is, in summary, BT’s vertically integrated structure. This is the right conclusion. BT is able to coordinate business activity between areas where BT faces competition, and areas where competition doesn’t work. This creates incentive and opportunity to influence the outcome of downstream competition in BT’s favour—a situation that is the root cause of most of the failures of telecoms regulation Ofcom has observed. 9. Despite these encouraging findings in Phase 2, unless there is real change as a result, the lasting impact of Ofcom’s Review will be slight. We have urged Ofcom to take the ideas outlined in Phase 2 as the basis for clear and decisive action to bring regulatory certainty to the market and break BT’s market power. Understanding why this market doesn’t work properly is a precursor, not a substitute, for making things right. 10. Energis believes that Ofcom’s statutory mission to further the interests of consumers in having markets that work eVectively demands a way forward that will bring real change to the telecoms industry. The long-term interests of consumers (that is, customers) will be served by solutions that allow the forces of the market to work for, not against, them. Combined with the prospect that it brings for substantive, extensive de-regulation, structural remedies are the only remedies that truly deliver on Ofcom’s priorities and principles. 11. We said in our Phase 1 submission that structural separation of BT is a last resort, but a last resort we might get to. In Phase 2, we have said to Ofcom, with more facts and evidence now available: we’re there. 12. The balance of this submission deals with the points the Committee has indicated that it wishes to focus on: (a) First, a review of Ofcom’s fundamental conclusion that the vertical integration of BT is the root cause of the need for ongoing regulation and the primary obstacle to regulatory withdrawal in telecommunications. (b) Second, a consideration of the broadband market in the UK.

The Market Situation Remains Difficult for all Players Except BT 13. Ofcom concluded that competition in the fixed telecoms market as it stands today is unsustainable. Energis believes that, despite good progress made in the market by companies like Energis prepared to go the extra mile for customers, Ofcom is right that things cannot go on as they are. Even a cursory glance at the situation of the network operators today reveals some fairly unnerving truths. Prices to end-users have fallen, but for any other parameter such as quality of service or product diVerentiation, the picture is far bleaker. 14. Worst of all—in terms of consumers’ interest in sustainable competition—is the lack of a clear path to profitability as a competitor to BT. While individual businesses such as Energis can ensure profitability by focusing resolutely on our customers, the situation of the industry taken as a whole is less promising. Without a sustainable business model for the sector, network operators will never be able to put BT under real competitive pressure. Therefore, while Ofcom could not and should not seek to protect individual competitors, the current position of the altnets is so serious as to constitute a threat to the competitive process itself. 15. There are too many alternative network providers chasing a narrow set of opportunities in the face of uncertainty about almost every aspect of the business. Although Energis itself is pleased at the success of our business serving large corporate customers—with over £500 million of new contracts signed in the past six months—even we are not immune to these impacts. The point is not that consolidation itself is an answer; instead, the situation of BT’s competitors reflects the lack of a level playing-field. More fundamental action is required to ensure that sustainable competition—in the shape of profitable sustainable alternative providers to BT—can successfully emerge. Trade and Industry Committee: Evidence Ev 55

16. The end-result is that competitors to BT must bear disproportionately high business risks as a result of the lack of certainty in the wholesale market. These risks go far beyond what we would expect in a healthy marketplace, and include the risk that BT will unexpectedly vary terms of supply, or change crucial access services in a way that undermines competition—and the risk that when these things happen, Ofcom will be unwilling or unable to intervene quickly and eVectively. As a consequence, competitors are sometimes unable to fund the investments necessary to challenge BT eVectively. 17. Nowhere has this failure of the competitive process been more clearly illustrated than in the struggle to establish competing wholesale consumer broadband services. Energis has been at the forefront of this fight for years—and our assessment is that the eVorts of all players have, in summary, come to naught. In order for consumers to benefit from competition between providers, there needs to be sustainable market opportunity for large-scale broadband network providers to compete.

The Problem is Predictable and the Cause is Known 18. As we noted in Phase 1, and as Ofcom agreed in their Phase 2 consultation, one of the most profound disadvantages of our current approach is that BT faces a situation of conflict of interest. Vertically integrated operators controlling key upstream services have strong incentives to deny access to competitors—BT is no diVerent to any other company controlling a bottleneck resource. BT’s commercial imperative is to drive shareholder value by controlling retail markets and eliminating competitors, while regulation requires BT to undertake activities that are necessary to enable competition. BT, like any other incumbent telecoms operator around the world, therefore adopts a rational and legal strategy of complying with the formal requirements for access, while testing the limits of the regulatory regime and opposing any new access requirements. 19. Shareholders in the BT Group expect innovation and process improvements created by BT to deliver benefits to BT and not to competitors, meaning that the wholesale business has little incentive to develop services that reduce the advantages enjoyed by BT Retail. 20. The end result has been that BT, like any other dominant company, has sought to minimize the impact of change in the market, specifically by ensuring that competition does not upset the telecoms order that has BT at the apex of the “food-chain”. BT’s own attempts to manage these tensions, through (for example) the divisional boundaries between BT Wholesale and BT Retail are, at best, limited in their eVectiveness. Protestations by BT of a general commitment to “competition” lack credibility because the underlying pressures operating on BT prevent the reality from ever matching the rhetoric. Likewise, BT Wholesale’s ability to treat “competitors like customers” can be severely limited by the tensions outlined above.

The Problem is BT’s Conflicting Role as Landlord and Tenant 21. Energis is one of BT’s largest wholesale customers—an account worth hundreds of millions of pounds a year. In any other industry (or indeed, in parts of the telecoms industry that are competitive), this would empower Energis to be treated as a valued customer, and given a real voice in the development of new opportunities. 22. However despite earnest statements professing commitments to competition and willingness to treat us like a customer, the reality is that BT has systematically refused our requests for new products and fought us through the regulator’s processes as we have sought to improve the services that we pay them to provide. BT has filed statements opposing or seeking to dilute every major pro-competitive reform since 1984, including carrier pre-selection, number portability, new forms of interconnection such as ATM interconnection and flat-rate internet access call origination, and on, and on, and on. It doesn’t help matters that BT Wholesale employs a significant amount of time and money to the task of optimising the product “portfolio” to ensure that margin pressure on BT is minimised and works tirelessly to reduce the impact of the regulator’s work on BT. We pay for those eVorts in the costs recovered by BT from its wholesale customers. 23. Of course this is rational, value-enhancing behaviour for the BT Group. It is easy to see why—all other things being equal, the more successful we (and our customers) are in the market, the less revenue and margin there is for BT Group. It is not, of course, in the best interests of consumers—both because of the wasteful and ineYcient process that contested regulation inevitably becomes and because of the welfare losses associated with deadened competitive eVects as a result of BT’s market power.

Broadband is just the Latest Example of a Recurrent Pattern 24. For Energis, nowhere has this been more evident than in wholesale broadband. BT has fought vigorously to prevent competing wholesale broadband providers establishing a foothold in the market, so as to create and sustain a monopoly for its IPStream oVering. Prices have been subject to constant margin- squeezing, buttressed by a lack of support for DataStream (a product BT does not use on an equivalent basis) and a lack of transparency about future network or product developments for operators other than BT itself. So after all the investigations and all the decisions, the result is that IPStream retains over 90% of the wholesale broadband market. Ev 56 Trade and Industry Committee: Evidence

25. At the heart of this situation is the fact that BT has no incentive to deliver fit-for-purpose wholesale products in a timely manner while BT remains vertically integrated. 26. Energis is deeply frustrated by the lack of progress on wholesale broadband competition. There is no point in endorsing individual pieces of work or particular approaches by Ofcom to this problem, without confronting head-on the reality that wholesale broadband competition isn’t working. Therefore, our comments are focused on how and why wholesale broadband competition has failed to arrive, before turning to whether Ofcom’s approach is likely to improve things.

Why broadband matters 27. Broadband services occupy a unique commercial and technological position, making broadband markets the strategic territory in the campaign to secure fair competition in telecommunications. 28. Broadband matters because: (a) It is rapidly eclipsing narrowband. Very soon, nearly all internet access services will be supplied as broadband services. (b) The future of fixed voice telephony and other existing services is as services delivered over broadband. One day, all services will be oVered as “applications” over broadband-enabled networks. Therefore, market failure with respect to broadband will impact all telecommunications markets, not just markets for discrete products like access to the Internet. (c) Given the flexibility and growing market presence of broadband, it is likely that the delivery mechanism for future new services will also be current or next-generation broadband. (d) BT’s obligations in broadband have been significantly weaker than have applied to BT in relation to, say, voice telephony or narrowband internet access. In particular, BT’s wholesale broadband services have not been required to be oVered at prices set to recover BT’s costs, allowing BT to recover significantly more on capital employed in broadband. (That is, pricing of broadband has been on a “retail minus” basis, as opposed to “cost-plus” pricing used for every other access service group. This has been due to the treatment of the broadband market as “emerging”. (e) Retail broadband services are now being provided to over five million subscribers in the UK and broadband represents the largest and most significant form of revenue growth for fixed- line operators in the residential and SME market segment. 29. The combined eVect of these factors has been a steady drift of the internet access market from a contestable environment where BT faced strong pressure from a variety of competitors to the establishment of a de facto monopoly in wholesale broadband. There is currently no prospect of any competitive pressure on BT with respect to wholesale broadband from any source, outside the handful of sites where LLU makes economic sense. BT has been understandably reluctant to permit competing wholesale broadband providers to establish a foothold in this lucrative market.

BT has excluded competitors using pricing and product features 30. The centrepiece of BT’s broadband strategy has been close coordination between BT’s retail prices to residential consumers, the price of BT’s “white-label” product to ISPs for resale (IPStream) and BT’s access product to network operators (DataStream). 31. This strategy has been buttressed by a lack of support for DataStream (a product BT does not use on an equivalent basis) and a climate in which there is no transparency about future network or product developments for operators other than BT itself. The opportunity to talk to the biggest network supplier (BT) from a position of parity is only granted to one user of that network, BT Retail. All other players have had to wait as a sequence of product “innovations” have been floated, without any clarity about whether or when those innovations would be finalised. 32. Prices have been set so as to: (a) Favour retail services over IPStream—that is, to maximise BT’s retail market share by squeezing margins of ISPs who buy IPStream to compete with BT’s retail products. (b) Favour IPStream over DataStream—that is, to ensure that loss of retail customers only occurs in a controlled manner to an alternative reseller of BT’s services, rather than a competing network operator, by squeezing margins of network operators who buy DataStream and use it to compete in supplying ISPs with wholesale services. 33. In setting prices and developing access products, BT has demonstrated a clear willingness to maximise the total value of its vertically integrated business by securing as many customers at the retail level as possible and by making the ground diYcult for competitors trying to oVer alternative services using access purchased from BT. Trade and Industry Committee: Evidence Ev 57

34. BT’s pricing strategy has resulted in Oftel and Ofcom being obliged to intervene (through a variety of formal and informal mechanisms) in two distinct functional levels in the broadband value chain, as BT engaged in anti-competitive margin-squeezing between BT’s retail products and the white-label product, IPStream, and between IPStream and the ATM interconnection product, DataStream. While these price reductions are helpful, they are still too little, too late, resulting in DataStream wholesale DSL market share of under 9% compared to IPStream of 91%. 35. On product features, the story is similar. Tellingly, the impact of product uncertainty has exactly reflected the “portfolio management” by BT on broadband pricing, so that: (a) the impacts have been lightest on BT Retail (who can talk to BT Wholesale (BTW) knowing that if BTW do something to hurt their business, they have an escalation path to the BT board to resolve matters); (b) somewhat more diYcult for IPStream purchasers (who have faced shifts in pricing arrangements with, for example, the introduction of capacity-based charging); (c) Most diYcult of all for proposed purchasers of the DataStream service (where changes have been mooted across a variety of process and product issues, such as port reservation abolition, the basis for VP pricing, refusal to oVer “business-class” SLAs, and others). 36. The net eVect has been that BT’s wholesale broadband product portfolio failed to provide a level playing-field between BT’s broadband network business (that sold IPStream) and competing network providers. 37. At the heart of this situation is the lack of equality of access. The incentives on BT to deliver fit-for- purpose wholesale products in a timely manner just don’t exist while BT Wholesale and BT Retail continue to “purchase” products on diVerent terms and conditions from those oVered to rivals. Given the lack of transparency about BT’s self-supply of wholesale broadband services (what does BTW use instead of DataStream, for example?), these diVerences aren’t measurable, let alone identifiable.

BT’s behaviour has been consistent for five years—do we listen to future promises of change? 38. Competition in broadband has also suVered as BT has exploited the weaknesses of our regulatory model—one of the reasons why the lessons of broadband are so relevant to the Strategic Review. The timing of appropriate regulatory intervention as a market moves through diVerent phases from newly emerging to maturity is critical, and in the case of broadband, early “safe harbour” protection served to permit BT to build strong first-mover advantage. The sequence of events on broadband illustrates how BT’s position has become so entrenched: (a) BT launched IPStream in May 2000 primarily focussed on the reseller (ISP) market. Oftel treated this as an emerging market and, as BT was relatively late in launching DSL compared with other European countries, the focus was to ensure resale competition emerged amongst ISPs. Despite the absence of eVective rules of local loop unbundling, competition at the access layer was expected to develop through local loop unbundling and there was no real attention to interconnection arrangements with network operators until a later phase in the market. (b) In September 2000, BT launched DataStream—however without ATM/InSpan handover, DataStream was not fit-for-purpose (the ATM layer was in eVect a stranded asset). BT declined to oVer this essential form of access, and Oftel eventually was forced to require BT to do so, in resolving the dispute between BT and, Energis and Thus in June 2002. So by BT prevarication and lack of timely regulatory intervention, a wholesale product was finally available two years late. (c) BT’s margin squeezing of DataStream purchasers since its launch resulted in a period of ongoing uncertainty and reluctance by ISP customers to commit to a non-BT network operator unless that network operator bore the commercial risk that DataStream pricing would remain competitive to IPStream (a matter wholly under BT’s control). During the period to April 2003, BT’s DSL coverage increased to 90% of the population and the IPStream product features and functionality continued to improve. (d) Although IPStream and DataStream were regulated through BT’s licence condition 43, only when the wholesale broadband access market review was conducted in 2004 was there any formal regulation—and certainty—in the market. (e) Ofcom’s margin squeeze model was not in place until May 2004 (18 months after Oftel rejected Energis’ first margin squeeze complaint). (f) At this stage, LLU and Datastream served less than 5% of the wholesale DSL market. (g) BT’s delay in delivering a fit for purpose interconnect product and the parallel progress that has been made in extending the DSL footprint means that any newly competing operator would need to achieve national coverage almost from day one through a bulk migration led roll-out. The need for a robust migration path introduces yet another dependency on BT. Ev 58 Trade and Industry Committee: Evidence

39. At no stage did the exclusionary pricing or uncertainty over product features of DataStream impact in any way on BT’s own consumer broadband network business, which continued to expand the dominance of the IPStream products used by reseller ISPs and BT Retail itself. DataStream as a viable alternative wholesale access product has not emerged in meaningful timescales to meet the progression of market demands.

Wholesale choices for national ISPs still do not exist 40. Right now, DataStream still accounts for less than 10% of all DSL lines and remains, as far as Energis is aware, far outstripped by growth in IPStream so that this percentage is falling, not rising. BT’s dominance in the broadband market continues to grow with each passing day. Each customer signed up in the initial growth phase constitutes an ever-deepening barrier to future market entry (particularly given the ongoing lack of a bulk-migration process in which the industry can have confidence). 41. Energis’ view is that the failure of Oftel to intervene, firstly to mandate BT to launch an interconnection product alongside IPStream and then to bring certainty to the market in determining the margin model, set the overall direction for the broadband market. While creating a climate that enabled investment by BT (who enjoyed market power with respect to broadband pricing but regulatory protection for this “emerging” product, all other operators who sought to enter the market to rival BT have been successfully seen oV—a situation that is evidenced by the fact that BT’s SMP in wholesale broadband remains as strong as it did when Ofcom assumed its powers.

Broadband as an “emerging” market 42. The final element of the broadband story relevant to the Committee’s consideration of the Strategic Review is the ongoing status of broadband as an “emerging” product that should be exempt from forms of access regulation applied to mature products. 43. Energis agrees that new and innovative products should not be heavily regulated and that to regulate such services automatically would risk stifling innovation. Even so, this “safe harbour” should be narrowly construed, particularly where the “innovation” being introduced is an enhancement of services delivered using monopoly infrastructure. In those circumstances, it is not stifling of innovation to require that the bottleneck asset be split or separated from the “innovation”. Structural separation (or, in principle, the introduction of true input equivalence) should remove the concern by giving all parties the same opportunity to innovate on the basis of a common monopoly input. 44. However, it is also clear that a product that is new and innovative becomes more established over time, and—as it moves through the product life-cycle—eventually becomes an established part of the service that consumers expect. Under those circumstances, and where a service utilizes bottleneck assets (such as use of end-user access and backhaul that rivals cannot duplicate economically) then competition between providers using network access may become an important source of pressure to ensure that consumers get the best services at the best possible price. Ultimately, services—however new or arguably innovative—that become integral to use of the bottleneck infrastructure must be subject to some form of access regulation if the interests of consumers are not to be compromised. 45. In our submission to the Review, we urged Ofcom to clarify, as part of the Strategic Review, how it views the role of a “product life-cycle” as setting out limits on the impact of safe-harbour protection for innovative products. We support the notion of some protection for genuine innovations; we also believe that the presence of millions of broadband subscribers in the UK suggests that the time when investing in broadband equipment was significantly more risky than BT’s other network activities either has passed or is passing. At that point, the rationale for exempting BT’s wholesale broadband services from an obligation to supply wholesale services at cost-oriented rates becomes unnecessary, and the case for treating broadband (bitstream) access like other forms of access becomes clear. 46. This is not a sterile point of policy: currently all of the big success stories for consumers in fixed-line communications are the result of regulators forcing BT to supply vital inputs at cost-oriented rates (for example, in narrowband internet access, in national and international voice telephony markets, in the provision of leased lines to enable competition between managed network providers, and so on). Conversely, it is hard to identify a single instance where “retail-minus” pricing has served as a platform for vibrant competition.

Can LLU ride to the rescue? 47. Energis would be pleased to see Ofcom’s proposed approach (implementing aggressive expansion of LLU as the foundation of broadband competition) succeed, despite our frustrations and our scepticism that the territory is as rosy as some industry players suggest. We hope that LLU-based competition will be successful because we will then be less reliant on BT and can begin to have arms-length commercial relationships without the need for constant recourse to the regulator. We still believe however that while LLU is sold by an integrated division within BT Group, LLU-based competition is set to fail. Trade and Industry Committee: Evidence Ev 59

48. Even if LLU is eVective, it is clearly not going to be viable in many areas of the country. Given the need for complete UK coverage for wholesale broadband services that would compete with IPStream, a bitstream-based product oVers the only potential means to compete with BT nationwide.7 We have made clear our view that full structural separation is the only way to resolve the competitive imbalances in our industry once and for all. But pending the implementation of structural separation, it is crucial that full input equivalence is required for DataStream throughout the UK (ie not restricted to particular geographical areas). In spite of Ofcom’s welcome attempt to improve conditions in the course of 2004, the DataStream product has never been fit for purpose for competition with IPStream. Full input equivalence gives it a chance of becoming so (although the scale economies that BT’s anti-competitive behaviour has bestowed on IPStream will be very diYcult for any competitor to overcome). 49. The alternative is for Ofcom to regulate IPStream (as many competitive operators argued at the time of the last wholesale broadband market review). If DataStream cannot be made to work quickly, then BT has a de facto monopoly in the wholesale market. To leave IPStream unregulated in such circumstances would be unreasonable. 50. Ofcom’s consultation document suggests that DataStream may prove to be a legacy product because ATM will over time be replaced by IP MPLS. Whilst it is reasonable to expect that in the long term BT would want to decommission its ATM network (the MSIP network), no timescales for this have so far been proposed either in the course of normal business or as part of the 21CN project. 51. But irrespective of the underlying technology (and, again, in the absence of structural separation), it is essential that BT is required to provide a bitstream product that allows network operators to compete on an equivalent basis with BT for wholesale customers. This requires BT (with input from its industry partners) to define what these service characteristics are in a technologically agnostic manner, so that the key service features and functionality currently oVered on an ATM platform are fully supported (as appropriate) within an MPLS environment. 52. This further strengthens the case for full input equivalence because then not only will BT have the right incentives to develop fit for purpose migration products, but it will also avoid the inherent danger of BT creating one MPLS-based product for its own consumption and another (inferior) product for the wholesale market. 53. In this context, Energis would welcome the opportunity to progress discussions on future interconnect methods, and we have drawn Ofcom’s notice to recent work on the provision of psuedo-wire emulation for edge-to-edge network connectivity, most commonly being considered within the context of an MPLS environment.

Equivalence Will Only Manage,Not Solve This Fundamental Conflict of Interest 54. Compared to the concepts of “undue discrimination” and other confused regulatory prescriptions we’ve had in the past, equivalence is a simple concept. However, we suspect that it will be vastly more complicated in its implementation. In any event, we see equivalence as being the latest and most coherent version of a long-standing vision of the market where a vertically integrated competitor has a position of market power but is restrained from distorting competitive outcomes by using that market power because the regulator will identify and respond to improper conduct. 55. The problem with this argument is that it pre-supposes that any regulator can achieve a suYciently high level of compliance by the regulated firm to overcome the inherent disadvantages of informational asymmetry and inertia that mean regulation doesn’t work as eVectively as its designers hope. 56. That is not to say that we see no value in taking forward the equivalence agenda, and in our submission to Ofcom we tried to map out some improvements and thoughts on how Ofcom’s preferred option of equality of access might have maximum impact. However, we want to be clear that we believe that the structural options lead to better outcomes and lower costs in terms of regulation and monopoly for consumers over the long term. 57. While BT remains vertically integrated the conflict of interest will always be there because whatever the behavioural remedies imposed on BT, there will be a common incentive: to maximise BT Group’s shareholder value. No amount of transparency or compliance can counter-balance that profit motive. 58. We believe that Ofcom’s statements about equality of access do no more than articulate more clearly BT’s existing obligations. We support moves to implement equality of access as improvements to the existing regime, but in no way does this remove the need for more fundamental, structural reform. Whatever short- term benefits to consumers equality of access could deliver are worth securing must be balanced against the inevitability that “equality of access” (like each other form of conduct regulation) will face a steady undermining by BT, as the natural commercial eVects of BT’s incentives to test the limits of that regime play themselves out.

7 A “bitstream” product would include some variant of DataStream or another product that allowed competing network operators to supplement their own network reach with broadband network elements purchased from BT. Ev 60 Trade and Industry Committee: Evidence

BT’s Proposals Put us Closer Than Ever to Workable Structural Options 59. We have also had a chance to consider BT’s own proposals made to Phase 2 of the Strategic Review. Even on first impressions, it is clear that it would not be in the interests of consumers for Ofcom to accept these proposals without extensive modification. 60. The proposals raise a number of unanswered questions. For example, BT’s proposal is to separate an “Access Services division” from the rest of BT, managing, in essence, the local loop. This division is supposed to have equivalence as its key objective. Energis observes that there are some fundamental questions that BT’s proposal leaves unclear: (a) If the Access Division is aiming to provide equivalence of input and serve the interests of a wider group of stakeholders than BT group (in other words, it is not seeking to maximise the returns to the BT Group), what rationale will BT have to invest its shareholders’ funds in it? (b) Why should an organisation whose purpose is to achieve a public policy objective be run as part of a commercial organisation whose financial interest may conflict with that objective? (c) How will the Equality of Access Board work in practice? In particular, how would it deal with situations where BT’s interests and the Access Division’s interests diverge? (d) How will the BT Group CEO separate out his role as BT employee, accountable to the BT Board, from his role as ensuring equivalence and equality of access, as Chairman of the Equality of Access Board? (For example, when the Access Division supplies services to the BT Group, will the BT Group CEO declare a conflict of interest or participate in that decision?) (e) The formal role of the Board itself is profoundly unclear. It seems to be a Board in name, not law (since the Access Division will not be a separate corporate entity)—forming something akin to an advisory committee, and without the formal power to, for example, remove the CEO of the Access Services division. The implication is that those who sit on this “board” will not have the full panoply of director’s powers or duties including the requirement to take decisions in the best interests of the company (in this case, the Access Division itself). 61. On the other hand, we’re encouraged that, despite many years during which BT maintained that any organisational separation of its access business would be prohibitively expensive and take months or years to achieve, it took just 10 weeks for BT to establish a clear proof-of-concept that could serve as the basis for discussion. 62. While Energis will consider the proposals in detail, two modifications that would be an immediate starting point for discussion should be, in Energis’ view: (a) Make it a clean break. BT Group would divest the business or businesses that control access infrastructure, through a de-merger or stock-market floatation. (b) Deal with wholesale services to ensure a true and commercially workable division between BT the competitor, and BT the supplier. BT’s proposals appear only to deal with LLU. Of course, the vast majority of network access today is sold in the form of access services—particularly PPCs, WLR/ CPS, wholesale broadband and so on. These services would also need to be separated from BT’s own retail business. To include them in the Access Division would be one option; this would risk creating a fresh dilemma as the Access Division would then occupy two parts of the value chain. A simpler approach would be to spin oV BT Wholesale into a third entity (so that there were separate shareholders for each of BT Access, BT Wholesale and BT Retail). Any solution that is limited to LLU is a very limited prize for Ofcom, and risks simply not dealing with the big issues. It would, inevitably, be a prospective solution, the impact of which will be limited in time (as LLU takes time to be industrialised) and by area (as the impact of LLU will be limited to particular areas due to the economics of unbundling). 63. The fact that BT is prepared to go to such lengths to keep its access network within BT Group makes clear how much benefit there is for BT in being able to control access services. It provides strong implicit evidence that the value to consumers of unlocking this infrastructure from the control of any one player may be large, and the gains in terms of a more competitive and more vibrant telecoms market may be significant.

The Case for Splitting BT Grows Stronger With Each New Piece of Evidence 64. In our Phase 1 Submission, Energis said: “Energis does not believe that there is a suYcient case yet made out for moving to structurally separate BT’s business activities, without exploring alternative approaches. In particular, we think that it is worth attempting to impose full functional equivalence (discussed below) first. If [equivalence] does not appear to be a workable solution, then Energis would support structural separation of BT. We do not believe that a third decade of conduct rules and accounting separation will materially further the interests of citizen-consumers, as the Act calls on Ofcom to do. At best, the status quo might (perhaps) stop citizen-consumers from losing the modest territory that competition has won. To simply ‘do no harm’ is not an outcome worthy of Ofcom’s statutory mission and the scope and eVort put into this Review.” Trade and Industry Committee: Evidence Ev 61

65. Two important things have happened to cause us to change that view. 66. The first is our growing appreciation of how diYcult equivalence will be to implement in practice, and the extent to which BT’s existing informational advantages could be used to undermine Ofcom’s objectives on the path to true equality of access. 67. For example, it is clear that BT’s eVorts to reduce the impact of the Review is well underway, so that: (a) Opportunities to require equivalence of inputs are met with proposals for equivalence of outputs (and the suggestion that the issue of equivalence of inputs may be dealt with when the 21st century network arrives—but only for particular services or for critical services, in particular areas). (b) A call for proposals that will deliver “profound organisational and behavioural change” has resulted in expectations being managed, reflecting an institutional culture that shows little evidence of acceptance of the need for significant change. (c) There has been a focus on “confidence” as the key issue—with the implication that BT has been doing the right thing, but that a lack of transparency has prevented BT’s good deeds from being recognised. Transparency is clearly vital, but as Ofcom makes clear, the issue is not just confidence; it is about the substantive diVerences in market outcome that BT oVers to rival businesses and its own vertically integrated businesses. (d) The challenge of changing BT’s institutional culture is presented as insurmountable (or requiring years to achieve)—while BT also claims a rapid commercial response to a changing marketplace. BT’s retail customers are rarely told that their required service improvements will have to wait while the “battleship is turned”. (e) A climate develops where Ofcom feels pressured through the implied or explicit threat to downgrade BT’s network modernisation program—threats that lack credibility given the strong commercial benefits BT will realise from the 21C network. BT is already suggesting publicly that separation of the copper access network would undermine the case for investing in the 21CN (core) network. We don’t understand how this would be the case, given that the situation of BT building a core next-generation network using LLU purchased from a third party is no diVerent than, say, any other network operator buying loops from BT. No other fixed-line operator using BT’s access services demands the right to control the access network as the purchase price for investment in their core network. 68. We fear that equivalence will suVer the fate of a sequence of other policy initiatives, all of which began with clear focus and what seemed like sensible reasoning, and all of which ended up back where we began. What we’ve wrestled with is not the elegance of the proposal to achieve true equality of access but the behaviours and practices—and the fundamental need to change the motives by which BT conducts its business—on the ground, day in and day out. 69. It is clear that full regulatory withdrawal (the complete lack of ex ante obligations) could never occur where BT remains a vertically integrated entity with SMP in key markets. And we cannot conceive that where BT remains a vertically integrated entity, BT’s SMP in key markets will be suYciently eroded to sustain a competitive outcome—deregulation will remain a theoretical, rather than an achievable goal. If regulatory withdrawal is BT’s ultimate goal, then it too should see the case for structural separation. This is why ultimately structural separation has to be the best and most complete answer to the questions posed by the Strategic Review. 70. The second factor was our growing awareness that the task of separation has moved from being an insurmountable hurdle on the grounds of practicality, to being achievable. BT’s own proposals evidence this. We do not believe that separation would be too costly, when compared with the benefits—and we challenge those who claim those costs are prohibitive to make a realistic assessment of what they might be. We think that, once momentum towards a separation builds, the costs and obstacles will be less dramatic than many suspect. The benefits, on the other hand, will continue to mount as the cost of regulation falls and new forms of competitive access unleash innovation and investment across the entire communications industry.

The Way Forward 71. We have urged Ofcom to remain unmoved by BT’s campaign, and to focus on the objectives and agenda set out in the Phase 2 document. BT is right to be concerned about the costs and challenges that implementation of the Strategic Review will bring. Energis welcomes a debate that correctly balances BT’s interests in regulatory certainty against the other legitimate interests in play. BT’s better response to the Review is engagement to minimize those costs and to meet those challenges, not resist the process. Ofcom should continue its eVorts to engage with BT and to create an environment where the assurances given by BT to a general commitment to competition can be crystallised into a defined process to implement the findings of the Strategic Review. 72. We believe that Ofcom should accept institutional responsibility for turning the ideas of Phase 2 and the early momentum built since November into a program to seek reform of the telecoms market structure. We hope the Committee will agree with this view and that Ofcom must analyse all options in terms of the Ev 62 Trade and Industry Committee: Evidence

long-term interests of the citizen-consumer—even if this means a short-term eVort that is not the “path of least resistance” is required. If BT will not participate in its own reform, Ofcom must remove BT’s ability to continue to do business as a vertically integrated competitor, whether through referral under the Enterprise Act or (more straightforwardly) through SMP conditions that require organisational divisions to be drawn between parts of the business that are subject to real competition, and those that are not. The ultimate objective must be to split BT into separately owned entities to align BT’s commercial incentives and the need for fair competition. 73. We don’t have a fixed view about how a structural remedy to this market could be achieved. We think that Ofcom in its consultation document understates, to some extent, the opportunity to deliver structural separation using the existing EU framework. But if a referral under the Enterprise Act to respond to the distortions resulting from BT’s structure is what it takes, that’s what Ofcom should do. Any guidance or views the Committee may have on mechanisms Ofcom might use to achieve a structural remedy (directly or through the Competition Commission) would be helpful in this debate. 74. We—of course—would welcome any move by BT to voluntarily separate its SMP and non-SMP businesses, in some form that provided business certainty and clarity of purpose to the diVerent parts of the BT Group we deal with.

IMPORTANT NOTE This submission is oVered for the purpose of advancing policy discussions and is made without prejudice to any of Energis formal legal rights. We bring an open mind to all issues, so Energis may change its views in the future.

APPENDIX 8

Memorandum by the Internet Services Providers’ Association ISPA is pleased to contribute to the Trade and Industry Committee’s inquiry on Ofcom’s Strategic Review of Telecommunications. The Internet Services Providers’ Association (ISPA) UK is the trade association for companies involved in the provision of Internet Services in the UK. ISPA was founded in 1995, and seeks to actively represent and promote the interests of businesses involved in all aspects of the UK Internet industry. Its membership includes small, medium and large Internet service providers (ISPs), cable companies, web design and hosting companies and a variety of other organisations. ISPA currently has over 100 members, representing around 95% of the UK Internet access market by volume. A full list of members is available at: http://www.ispa.org.uk/html/about—ispa/ispa—members.html Most ISPA members are prepared to give BT the opportunity to prove that equivalence is the best solution, although ISPA believes that there should be some absolute criteria that BT have to accept to safeguard this process. ISPA would like to see a framework in palace guaranteeing equitable prices and services. ISPA Secretariat 1. On the whole, ISPA agrees with Ofcom’s proposed principles for the regulations of telecoms market. ISPA agrees with Ofcom’s coherent and forward-looking approach to telecoms regulation, and would welcome a lasting and agreeable change in the whole basis of the regulatory approach such that regulation becomes focused purely on the furthest upstream activities—with consequent de-regulation downstream. ISPA recognises that in order to change the current structure of the market in the UK, changes to BT’s processes and internal governance will be required. However, some of ISPA’s members are very skeptical that BT is capable of the cultural and organisational change necessary to change its behavior significantly in the future. 2. ISPA supports Ofcom’s role as the industry regulator, but believes that Ofcom should aim to play a minimal regulatory role in the wider telecoms value chain. However, where circumstances dictate that regulation is needed, or there are enduring economic bottlenecks, ISPA believes that Ofcom must decisively intervene with tightly targeted regulation. In arriving at any such regulatory action, Ofcom should of course take into account the wider telecoms value chain insofar as it is relevant. 3. ISPA believes that all Ofcom’s regulations should be subject to ongoing review as dictated by the competitive development of the market, paying due attention not to stifle the early development of the competitive market. 4. ISPA believes that Ofcom should be very careful in its consideration of diVerences in competitive characteristics in diVerent geographic areas because this is most likely to result in diVerent prices for consumers being charged for the same products in diVerent areas. ISPA believes that prices should be Trade and Industry Committee: Evidence Ev 63

equitable across all geographies. Currently, less cost eVective areas are in part subsidised by more competitive areas with, for example, a broadband connection in a rural area costing the same as in a more competitive urban area, despite the service in the rural area costing more to provide. 5. Customers in rural areas may also have less choice when it comes to competitive oVerings because other operators will be unlikely to oVer services in those areas because of the increased costs. As a result of geographic deaveraging, customers in rural areas face increased costs whilst having access to less competitive oVerings (compared to urban areas). 6. ISPA’s response to Ofcom’s consultation aimed to highlight the risk of delineation of geographic markets without appropriate data and thorough analysis. ISPA is concerned that the arbitrary delineation of geographic markets has the potential to turn into a postcode lottery. 7. ISPA’s response reflects the fact that ISPA believes that in line with the current European regulatory framework, ex ante regulation should be in place, ensuring appropriate regulations are put in place upfront. 8. ISPA believes it might be appropriate for Ofcom to make a reference under section 131 of the Enterprise Act if competition had been severely restricted or distorted, including if BT Retail and other parts of BT Wholesale were able to gain a clear advantage from BT Wholesale at the expense of competition of the market. 9. Some ISPA members believe reference under Section 131 of the Enterprise Act would also be appropriate in a situation where BT has showed a consistent lack of regard to the regulator in terms of the relationship between BT Retail and BT Wholesale. However, ISPA is aware that this could lead to the functional separation of BT, and ISPA does not believe that this would necessarily serve market purposes well, not least because of the long periods of uncertainty the referral would take. ISPA believes however that this is a balancing act, as Ofcom must promote consumer welfare, but not at the expense of competition. 10. ISPA believes that by all players starting from a level playing field, and thereby taking away any advantage that BT Retail might have over other players, where that advantage might not be objectively justifiable, real equality of access can begin to be achieved at the product level. 11. ISPA believes that regulation must be focused at the deepest part of the network, taking into account diVerent types of products and processes, and that product equivalence must be developed in line with process and price. 12. ISPA would like to caution that care must be taken when designing the equivalence model so that it doesn’t favor BT Retail or any future part of BT should BT be reorganised. 13. ISPA believes that equivalence of outcomes are a key means for BT to prove that they are serious about equivalence. This is because unlike inputs, outcomes are subject to competitive forces of market and consumer decisions. ISPA believes that one of the key building blocks of equivalence that should result from the strategic review is that BT Wholesale must oVer the same products to everyone, not only BT Retail and other parts of BT Wholesale, in order to prove that they are serious about equivalence. 14. ISPA’s response to Ofcom’s consultation suggested that in order to demonstrate BT is serious about equivalence it should undertake to provision it’s 21CN network using the same products and processes that competitive operators have to use for their own NGNs. BT are proposing to place MSANs in local exchange buildings in order to oVer Next Generation services, in exactly the same way that LLU operators have placed their DSLAMs in the same exchanges. It seems critical, therefore, that consideration should be given to requiring that BT should use the standard LLU and backhaul products, using exactly the same systems and forecasts processes. 15. The principles in Ofcom’s consultation document are a good starting point, but further detailed discussion between BT, Ofcom and the industry on these issues is needed. 16. Migration is key for ISPs, as it is key to consumer choice, and aiding successful competition. However, currently, there are no incentives for BT in terms of “associated products”. ISPA believes that there should be a firm regulatory obligation for BT to make sure that there is an eVective migration system in place. Until BT Retail depends on these “associated products”, particularly migration products, to win customers, in addition to losing customers, equality cannot be assumed. Currently BT Retail will potentially lose more customers than it gains, so BT has strong incentives to build an ineYcient migration product. 17. ISPA is pleased that Ofcom is addressing the fact that BT needs to undergo behavioral changes. However, ISPA recognises that while behavioral change by BT is necessary to achieve real equality of access, this change cannot happen immediately. ISPA believes that BT must oVer key deliverables and time scales for the move to equality of access. 18. ISPA recognizes the diYculties involved in separating BT, and agrees that this might not even be the best course of action, and recognises the significant practical element involved in the functional separation of BT. 19. ISPA supports Ofcom’s belief that BT’s diVerent divisions should not be prevented from collaborating to the benefit of citizens and consumers. However, ISPA does believe that BT should be held accountable in order that a real change in practice is witnessed, with measurable change that holds up to external scrutiny. Ev 64 Trade and Industry Committee: Evidence

20. It is ISPA’s opinion that BT needs to be able to demonstrate that its wholesale arms oVer products and service components on the same terms to all its customers—both within the BT Group and outside. The same terms must include access to information, features, provisioning and (where appropriate) operational systems as well as pricing. It might make sense for a start if the diVerent arms of BT operated out of diVerent physical locations and had diVerent reporting lines to the BT Board. A key example of this is the fact that BT’s field engineers operate out of BT Retail rather than BT Wholesale. ISPA believe that issues like this should be included in any review due to the fact that BT Retail, competitors in the market, are providing services to enable their competitors to gain customers. 21. ISPA agrees that it is important that regulated returns reflect the degree of risk that is faced by BT when making the investment. However, investments should not be made unless there is proof and relative certainty of their success. ISPA believes that by supporting investment made by BT, other competing network providers may be discouraged from competing, as well as upholding the need to protect consumers from excessive charging. However, a balance must be found, as BT still needs to be encouraged to invest in new innovations, and next generation access networks. 22. ISPA agrees with Ofcom’s identification of current generation broadband representing a bridge between the past telecoms environment, and the possibility of sustainable competition across many types of competition in the future, including Next Generation Networks, and New Voice Services. 23. With regards to naked DSL many ISPA members believe that Ofcom should encourage naked DSL, in order to ensure a “level playing field”—although cost recovery would require serious consideration. ISPA further encourages naked DSL as a way of removing economic bottlenecks to VoIP type services, although the specific nature of any requirement for such new wholesale services should, in the first instance, be left to the industry to define. 24. Care should be taken before Ofcom consider the possibility of diVerent regulated wholesale products for current generation broadband services in diVerent locations, as this may be to the detriment of consumers living in areas where only the incumbent was able to oVer broadband service, thereby enabling the incumbent to charge a premium rate without the challenge of competition. ISPA recognises, however, that the fundamental network costs of operating within areas with diVering population densities can vary widely. 25. In order to demonstrate that BT is serious about equivalence ISPA believes BT should undertake to provision it’s 21CN network using the same products and processes that competitive operators have to use for their own NGNs. BT are proposing to place MSANs in local exchange buildings in order to oVer Next Generation services, in exactly the same way that LLU operators have placed their DSLAMs in the same exchanges. It seems critical, therefore, that consideration should be given to requiring that BT should use the standard LLU and backhaul products, using exactly the same systems and forecasts processes. 26. ISPA is concerned that there should not be a leveraging of dominance from telephony to broadband. ISPA would like to see a level playing field for the progression of VoIP type services, and believes that equitable prices will be a key way of removing bottleneck to VoIP types services, and other future developments. 27. ISPA believes that the potential lack of evidence faced by LLU operators in a 21st Century Network environment makes this an area where BT must be held accountable. The potential lack of equivalence highlighted in Ofcom’s strategic review of telecoms with regards to 21CN is concern for ISPA, as this could turn into another area where BT holds an incumbent position. 28. Investment in 21CN is an expensive step to take, and given BT’s previous investment in this area it might be very hard for new competitors to enter the market successfully. 29. ISPA recommends a cautious approach to the deregulation of voice services, as it is diYcult to project and forecast evidence of solid competition. Before voice services are deregulated, ISPA advocates that Ofcom ensure that these services are running competitively without any hitches. 30. ISPA agrees with Ofcom that it would be appropriate to conduct a market review to see whether regulation should continue, although many ISPA members would prefer that Ofcom exercise caution in reviewing the need for such regulation. 31. With regard to the migration of PSTN services to the C21 network, as regulation should be technology neutral (a basic principle of the regime), ISPA believes the current regulatory regime should continue to apply until it is shown that there is no longer market power on the part of BT in this market. The transfer of services to a new network is therefore not a relevant consideration. 32. In terms of the increased competition for voice services provided using broadband access products, the evidence of increased competition for voice services driven by broadband access is not visible yet in terms of high volumes of user lines. However, for some ISPA members, this will become a major part of their business. 33. ISPA believes that Ofcom should ensure competition in areas where alternative platforms are not in place by separating BT’s Wholesale and Retail services, and by making sure there are no barriers to entry to this market. Trade and Industry Committee: Evidence Ev 65

34. ISPA does not believe that fixed-mobile substitution will result in a single economic market for voice call origination. Many ISPA members take the view that these services are fundamentally diVerent from the point of view of the consumer, so ISPA does not expect substitution to occur in the foreseeable future. ISPA believes that if BT provided wholesale inputs to its competitors in a similar manner to its own retail operations (replicability) then deregulation of business voice services might be appropriate. 35. ISPA fully agrees with Ofcom that if equality of access was applied to key businesses, deregulation would be appropriate. 36. ISPA believes that a wide consideration of wholesale inputs should be used to test whether BT can provide an equivalence process. This should not be taken lightly, but should be a managed process. ISPA believes that this could be used as a test bed for wider equivalence policy. 37. While BT estimate that by June 2005, 99.6% of UK homes and businesses will be connected to a broadband enabled exchange, ISPA does not believe that this statistic necessarily equates to 99.6% of UK homes being able to access the internet through a broadband enabled exchange. Even with 99.6% of consumers connected to a broadband enabled exchange, there still remain 0.4% of consumers not connected to a broadband enabled exchange and there will be some access infrastructure on enabled exchanges that will not support broadband. ISPA believes therefore that narrowband Internet access should continue to be regulated for the foreseeable future. 38. ISPA believes that the arrangements for access and interconnection to next generation networks must be available to all other operations, retail or wholesale, (including BT’s own) on the same terms, to best address Ofcom’s proposed regulatory principles. To ensure that there is equal opportunity to access the market with Next Generation Networks, Ofcom’s regulatory approach to next generation access networks should be in line with Ofcom’s key regulatory principles, particularly in terms of focusing regulation to deliver equality of access. 39. Ofcom’s regulatory approach should also focus on promoting the right kind of climate for investment. This is particularly important in the ever developing and advancing world of telecoms, so that competitors are given the opportunity to invest in NGNs. 40. ISPA believes that creating scope for market entry is particularly important in terms of making sure that BT doesn’t inherent a new incumbency position on Next Generation Networks. 41. ISPA agrees with Ofcom’s belief that there is a strong imperative that regulation should not disincentivise the timely and eYcient deployment of Next Generation Networks. 42. ISPA regards it to be highly important, in the absence of contestability, to consider all options thoroughly. 43. ISPA believes that Ofcom should regulate Next Generation access if market power were to emerge in this market, along the lines of Ofcom’s regulatory principles, including the promotion of competition. 44. ISPA agrees with Ofcom that if is right to suggest that for any of the structural options proposed it should be investigated how these options could be made attractive to BT. 45. In terms of the wholesale access services BT should be required to provide in order to promote competition in the business market, ISPA believes that every replicable service sold by any retail operation (including BT’s own) must be assembled from the same wholesale building blocks available, on the same terms, to all retailers, particularly where BT has SMP status. 46. ISPA believes that the facilitation of the migration of complex corporate services (eg VPNs) between suppliers, while complex, must be allowed to happen, and in an accountable and visible manner so any inappropriate delays in migration can be identified and remedied. Interconnection is key to the future, and therefore diVerent networks must, and will need to, work together in the future. 47. ISPA agrees that increasing competition in telecoms complicates the issue of funding the USO, and that at some point it would be appropriate to consider alternative mechanisms and funding for the USO. However, ISPA believes that it is in consumer’s best interest for such a change to occur without any disruption to the consumer and consumer’s service.

APPENDIX 9

Memorandum by Nortel 1. Introduction 1.1 Nortel welcomes the opportunity provided by the Trade and Industry Select Committee to comment on Ofcom’s Strategic Review of Telecommunications. 1.2 Nortel is a recognised leader in delivering communications capabilities that enhance the human experience, ignite and power global commerce, and secure and protect the world’s most critical information. Serving both service provider and enterprise customers, Nortel delivers innovative technology solutions encompassing end-to-end broadband, Voice over IP, multimedia services and applications, and wireless Ev 66 Trade and Industry Committee: Evidence

broadband designed to help people solve the world’s greatest challenges. Nortel does business in more than 150 countries. Nortel’s Europe, Middle East and Africa Headquarters are located in Maidenhead, Berkshire. 1.3 Communications is the vital foundation stone in a knowledge economy. The transformational nature of communications has impacted on the lives of people across the world for the better. The next transformative phase of development in communications is now upon us, the imminent deployment of so called Next Generation Networks (NGNs). These NGNs are broadband service driven. They usher in new ways of working and deliver new business opportunities combined with real options of reduced business costs and yet increased productivity. The residential consumer experience is radically impacted through innovative entertainment choices, educational support, valuable e-commerce opportunities and many yet unforeseen developments. Deployment of NGNs will revolutionise the communications environment. BT’s 21st Century Network will almost certainly be the most significant carrier class NGN deployment in the next few years. However, BT is not alone in realising the potential of such networks. Other operators are at the planning stages of their own NGNs. It is in the context of understanding the profound eVects of telecommunications, and specifically the impact of deployment of NGNs on the UK economy and society, that Nortel contributes to this inquiry and comments on Ofcom’s Telecoms Review. In this response, Nortel will also provide its perspectives on the future of broadband in the UK. Broadband access is essential for NGNs and is therefore also fundamental to the success of the UK knowledge economy in the competitive global economy.

2. Nortel View of Ofcom’s Strategic Review of Telecommunications—Summary 2.1 Nortel has applauded Ofcom on producing the Telecoms Review as a unique opportunity to assist in providing much needed stability and regulatory certainty to the sector as it moves forward and looks to create and deliver new innovative technology. The regulator has provided some real options which have focussed the debate. However, it is evident that the bulk of the Telecoms Review has been focussed on the evolutionary telecommunications regulatory environment, with in Nortel’s view insuYcient attention paid in the Review itself to the imminent deployment of NGNs. Ofcom launched the Telecoms Review in December 2003 before BT’s June 2004 announcement of the timeframe of their 21st Century Network. Nortel believes that it was not Ofcom’s intention to sideline NGNs but that the Telecoms Review has simply been a victim of the speed at which the communications sector moves. Nortel acknowledge that Ofcom published a separate Next Generation Access and Interconnection consultation over the late December 2004/early January 2005 holiday period but argue that these questions should have been part and parcel of the Review rather than as an apparent add-on consultation. The detailed NGN consultation simply did not allow suYcient time to tackle the complex 72 questions asked. With this in mind, Nortel suggests the need for Ofcom to clearly link the NGN consultation with the Telecoms Review perhaps in the form of a public consultation meeting or stakeholders meeting. 2.2 Nortel has focussed its response to the Telecoms Review on the regulation of NGNs. Nortel supports the regulatory principles described in Ofcom’s Phase Two Telecoms Review consultation document and believes that Option 3, “real equality of access”, is the only viable way forward for the regulation of NGNs. Nortel believes that simply relying on an ex-post approach to the regulation of NGNs, such as the use of the Competition Act to address problems after they have arisen or making reference under the Enterprise Act once an NGN is in place, will not be as eVective as an ex ante approach, and would also represent a missed opportunity. 2.3 Nortel would like to utilise the opportunity of this Select Committee inquiry to draw attention to the need for the regulatory framework for NGNs to be agreed with utmost urgency. It is imperative that agreement is reached on how NGNs will be regulated before they are deployed, as they are otherwise unlikely to be built with ready access to the interfaces necessary for eVective regulation, potentially leading to significant problems down stream. In a Review that is setting the regulatory framework for the next 10 years, Ofcom must give suYcient focus to the near future as well as those short term issues that take up most regulatory debate at this time.

3. Nortel Vision 3.1 Nortel’s vision is to lead the way in enhancing the human experience, powering global commerce, and securing the world’s most critical information. The way the next generation of networking is implemented will determine success or failure in eliminating technical and economic boundaries to productivity and improving the security and dependability of communication. 3.2 In the past separate networks were deployed to provide distinct communications services. Long established Public Switched Telephone Networks (PSTNs) sat alongside those that emerged to satisfy business data requirements. In the 1990s there was an explosive growth in the Internet, the powerful interconnection of distinct networks which enabled people to access servers all over the world. However, these separate networks had little in common as regards the technologies and infrastructures on which they were based. They were disparate. The only significant commonality was at the physical layer. Optical transport established itself by the mid 1980s as the technology of choice for the physical links within the Trade and Industry Committee: Evidence Ev 67

cores of all communications networks. Although the separate networks shared individual optical links, the networks nevertheless remained logically separate at the optical layer and physically separate at all other layers. 3.3 During the second half of the 1990s the concept of NGNs emerged from R&D Laboratories. Such networks have cores that convey Internet Protocol (IP) packets to provide unified connectivity to enable the delivery of all the services (voice, data, multimedia) previously provided by the disparate networks. The intelligence associated with services that was previously integrated with individual connectivity networks is unbundled and moved to servers that can be accessed by these cores. NGNs can straightforwardly oVer new broadband services because data rates are not limited by circuit switched structures. They can deliver significant capital and operational expense savings in comparison with the parallel deployment of separate, disparate networks. Nortel dedicated more than one third of the organisation to R&D initiatives in 2003. With over 12,000 engineers, designers and scientists in more than 10 countries around the world and more than 30,000 global employees, Nortel brings significant experience to participate in this inquiry.

4. Regulation of Next Generation Networks 4.1 The fundamental regulatory consideration relating to a newly deployed carrier class NGN is the extent to which it creates, perpetuates or removes economic bottlenecks. It is such bottlenecks, if they exist, that will determine where other operators will need regulated access to the network and the nature and service levels of the interconnections that will be required. Key transitional issues will arise in the move to NGNs and they must be considered. If an NGN is being deployed as a replacement for an existing network, issues will arise with respect to changes in the location and topology of such interconnection points, not least because NGNs have far less geographic dependence than legacy networks. A careful balance has to be struck between too rapid a transition to new arrangements, given the significant investments made by service providers already accessing the network being replaced, and too slow a transition requiring the NGN operator to continue with arrangements that are uneconomic and therefore preventing a fair return on the NGN investment. Rather than consider these issues at length and as many directly impacted stakeholders will devote extensive resources in this area, Nortel’s response to the Telecoms Review consultation focused on the regulatory opportunity that NGNs present to agree on a set of generic interfaces and “open” protocols which have the potential to enable a service independent approach to regulation. It is Nortel’s opinion that such an approach will lead to the withdrawal of the requirements for many of today’s regulatory products. 4.2 In Nortel’s response to the Telecoms Review it has been argued that given the imminent introduction of NGNs, the definition of a generic IP packet interface with control over Quality of Service (QoS) addressing such issues as packet loss and guaranteed data rates will be fundamental to the establishment of any new regulatory regime. It will enable the provision of leased connectivity across NGNs and provide direct IP packet access to personal and business customers. With the required ability to provide point-to- point and any-to-any connections, it will enable the implementation of all forms of voice and data networks. An IP packet interface will also enable multimedia calls to be passed from one operator to another. Access to other forms of an NGN’s intelligence, such as that addressing the “mobility”, “location”, “profile”, “presence status” and “connection characteristics” of end users, will also increasingly become central to service provision. Whether or not one operator should have regulated access to another’s knowledge in these areas is, of course, down to whether or not there is an economic bottleneck or technical barrier to entry. In this technical context we note that a service provider whose only access to a customer is via another operator’s network may well find knowledge of say, “location”, diYcult to replicate. 4.3 The requirement that protocols defined by recognised standards bodies should be used by a dominant NGN operator, whenever these are available, would ensure that connecting service providers will not be restricted in their choice of equipment supplier, and hence suVer consequential cost implications. Care must also be taken to ensure that an NGN deployed ahead of the final agreement on such “open” protocols does not disadvantage operators seeking to inter-work with it, by persisting to use proprietary pre- standardisation versions of the protocols once the “open” ones have become the established norm. In those cases were there is no alternative to deploying a proprietary protocol in the long term, it will be necessary to ensure that the necessary interconnection equipment can be multi-sourced and is readily available on the open market. It will also be important to prevent a dominant operator from seeking to gain an unfair advantage by bundling processes, thereby denying access to otherwise “open” interfaces that, whilst of marginal value if one controls the entire NGN, might disadvantage service providers wishing to inter-work utilising only a sub-set of its functionality. 4.4 The need for some legacy interconnection services will nevertheless persist with NGNs. An operator seeking to exploit another’s NGN network may find its ability to oVer some services compromised by the latter’s IP architecture. However, over time we envisage that most of these services will migrate to using a QoS controlled IP interface. 4.5 In order to protect the integrity of the networks on either side of such a QoS controlled IP interface, some form of Border Gateway functionality will be needed which incorporates an appropriate “firewall” capability. As the ultimate destination of the IP connectivity is entirely separable from its geographic Ev 68 Trade and Industry Committee: Evidence

origination, the location of the “IP peering points” incorporating this functionality will be key to whether a particular operator can utilise another’s network to gain access to remote customers cost eVectively. In an environment where one NGN operator has a dominant market position, the regulation of the location of such “IP peering points” may well prove to be a useful instrument. This is particularly so given that the location of the legacy interconnection points are not so easily separable from considerations of geographic origination, being instead dictated to a large extent by the topology of the network. There may therefore be value in some form of quid pro quo arrangement, in which the connecting operators have a major say in the location of the “IP peering points” with the dominant operator, in order to relieve existing bottlenecks and prevent the creation of new ones. 4.6 If each service provider connecting to a given peering point were to deem it necessary to deploy its own equipment to ensure network integrity, it would lead to equipment duplication, and introduce unnecessary cost. Such duplication would be redundant if all parties were confident that the peering point provided adequate protection, for example by being under the control of a trusted third party. Such issues, together with that of who bears the cost of installing and managing such peering points, will need to be carefully addressed to ensure that the introduction of NGNs does not lead to new economic bottlenecks and hence major regulatory issues in the future. 4.7 With connectivity extending all the way to end users through an access network, it matters not whether it is based on fixed, mobile or hot-spot technology. It is simply the means by which service providers gain broadband access to customers, to provide services and to enable them to communicate with one another. 4.8 Nortel would also like to draw the Committee’s attention to the fact that NGNs will remove many of today’s requirements on “who does what” and “where”. This is important as it demonstrates why telecoms regulation should be harmonised across the EU and wider if possible. NGNs enable “tunnels” to be constructed to connect an end user to any server, enabling services to be provided from anywhere in the network and anywhere in the world. A server can be connected to a portion of the network owned by a carrier or an enterprise. Indeed, the distinction between carrier and enterprise solutions becomes a question of who owns what network component and where it is located. An individual teleworking from home or hotel or on the move and using mobile or nomadic wireless access can receive service either from a carrier or from his or her own company network. Regardless of who provides the service, the server hosting it can be located in another country. In cases such as the provision of new voice services using IP (Voice over IP— VoIP) it is therefore crucial that regulation is harmonised across Europe. Country specific regulatory variants will only increase cost and hold back the benefits of a future network. Nortel firmly supports Ofcom’s participation in regulatory policy discussions held at the international level amongst National Regulatory Authorities and the European Commission not least Ofcom’s active participation in the VoIP sub-group of the European Regulators Group.

5. Broadband 5.1 Broadband has been the fastest taken-up mass-market technology in history, ahead of the CD player, video game and even mobile phone. However, even with more than six million people in the UK now connected via broadband the UK cannot aVord be complacent. The UK’s place in the global competitive economy rests on the challenge of how to build on such previous success and move to the next stage of development, tackling the demand for increasing bandwidth, the threat of a “broadband fixed access bottleneck” and the subsequent need for investment in services and infrastructure. In order to meet future demand and roll out new applications and services, deployment of fibre closer to the end user is crucial. Failure to create the right framework to realise this deployment will put at risk the UK’s position as an attractive market for future economic investment as the communications infrastructure required for a world leading economy would not be in place. 5.2 Nortel expects the take-up of broadband to continue to grow as the citizen-consumer becomes increasingly aware of the benefits to both their work and home life. As take-up increases, demand for services that require broaderband networks will emerge. NGNs have the potential to transform the operating model of enterprises. With suYcient fixed access bandwidth, multi site enterprises will be able to reduce their operating costs by centralising servers and storage. They will be able to gain the financial advantages of networks with elements placed with productivity and resilience in mind, rather than having to accept the operational costs of architectures dictated by the need to accommodate access bandwidth restrictions. To gain these advantages the fixed access networks deployed to large oYce locations must have suYcient bandwidth to eliminate the bottleneck between the networks deployed in such oYces and the core networks. It is certain that data rates will increase with time, which means that enterprise access networks must be capable of being straightforwardly upgraded to support ever increasing data rates with time. Deployment of Fibre all the way to large oYces is the only solution that can remove the “broadband bottleneck” today, let alone tomorrow. 5.3 It is Nortel’s view that broadband penetration in the home will not be limited to the PC which is already heavily utilised for entertainment, information and education in many family homes or to the increasing numbers of teleworkers, but as we have witnessed with games consoles, other home appliances will become broadband enabled. What is evident is that the Asymmetric Digital Subscriber Loop (ADSL) Trade and Industry Committee: Evidence Ev 69

and today’s generation of cable modems which deliver equivalent bandwidths, will not be able to cope with the bandwidth requirements of such innovation in the home. We are already beginning to witness a residential “broadband bottleneck” with the potential for many PCs per residence and access requirements measured in units of 10s of Megabit/sec. As services per customer are defined which work at bandwidths progressively higher than today’s copper loop, serving multiple consumers in the household will clearly require multiples of this bandwidth. Similar access rates will probably satisfy the requirements of small oYces. On this basis, it is clear that the UK is currently using network infrastructure that cannot cope with 21st century needs. In order to roll-out the anticipated applications and services, deployment of “broaderband” to the home is essential. 5.4 There are a number of next generation “broaderband” technologies that can be utilised to provide the final drop to users. These technologies include high speed variants of Digital Subscriber Loop (DSL) operating over short reach twisted pairs, wireless, co-axial cable and fibre itself. In this context the Cable (CATV) networks already deployed in many countries, such as that by NTL and Telewest in the UK, represent substantial investments in next generation access. 5.5 All next generation access deployments have one thing in common. They require a high capacity backhaul from the drop point to the network core that can only be implemented using fibre or wireless technology. As it is doubtful that there will ever be suYcient spectrum to satisfy the requirement of mass market wireless backhaul, the majority of such new access networks will be dependent on the deployment of further fibre. The deployment cost of such fibre is the gating factor in the roll-out of NGNs to enterprises and residences. More precisely, the gating factor is the cost of the civil works required to install ducting. These approach 85% of the total network installation cost as the fibre gets closer to individual residences. The very high costs of digging to deploy new fibre could make the rapid roll out of more fibre prohibitively expensive for any individual operator, particularly given the risk that an operator could at some stage be forced to open up access to that infrastructure to other competitors. Other countries are addressing this barrier either through public ownership, subsidies or regulatory incentives in order to stimulate investment ahead of the demand curve. Only in those countries where there is existing widespread Hybrid Fibre Coax (HFC) coverage for CATV is there likely to be a suYcient market driven incentive for other operators to invest in costly, and potentially risky, competitive new next generation access deployments. Given that there is no such market driven incentive in the UK, it is imperative that lateral ideas are aggressively investigated. The UK plc needs to consider the implications of international competitors being one or two generations ahead in terms of broadband deployment. It is not evident that the UK government would be willing or able to subsidise on the scale of Korea, Japan, or even and therefore a third way is required. 5.6 The Civil Infrastructure Utility (CIU) concept has been considered as the third way. By decoupling the cost of civil infrastructure from the cost of technology it may be possible to find a more eYcient way of financing the deployment of NGNs in a pro-competitive way, which could allow for their timely widespread deployment across the UK, without the public sector having to bear a significant proportion of the risk. The concept could be established as a fully private venture or a public-private partnership with the relevant public authorities. In either case, the third party is prevented from providing telecommunications services to end customers. To the contrary, it is restricted to being a “real estate owner” that leases capacity to businesses, in this case telecom operators. However, the CIU concept still presents threats and opportunities for all operators with most remaining appropriately sceptical at this stage of the case for a CIU approach, viewing it as an unwelcome intrusion in the competitive landscape. Nevertheless, a third way is still required. The CIU concept provides one potential approach to the challenge of financing the deployment of next generation broadband services in the UK. The advantages for the potential investor rely on low risk and would include a very long life cycle. In contrast the disadvantages include that it would be a very big investment with low return and a long payback period. 5.7 The fundamental background remains the same, as demand for bandwidth continues to grow, investment in the deployment of fibre closer to the home, and all the way to the large oYce is crucial. Nortel welcomes that Ofcom’s Annual Plan for 2005–06 details that Ofcom will be undertaking a review of second- generation broadband as one element of one of its priorities that of “Understanding future developments”. It is welcome that one of the elements to be looked at in this review is the business climate for investment in new networks.

6. Conclusion 6.1 The introduction of Next Generation Networks (NGNs) presents an excellent opportunity to develop a new approach to regulation. Nortel believes that since the Telecoms Review outlines the regulatory framework for the next 10 years more emphasis should have been placed on NGNs rather than today’s immediate short-term problems. Despite this criticism, Nortel recognises the innovative work carried out by Ofcom and interested stakeholders to get to the point the Review and industry positioning has reached today. Such outcomes would surely have been doubted only one year ago. Nortel also welcomes Ofcom’s understanding of the importance of the international stage and the need for more harmonised telecoms regulation across the EU. Therefore, Nortel again welcomes news that international engagement will be one of Ofcom’s seven priorities for the year 2005–06. Ev 70 Trade and Industry Committee: Evidence

6.2 The Ofcom Telecoms Review has been very welcome and has provided industry and all stakeholders with real regulatory options. The consultation process has been well handled. In addressing the options laid out in the Phase Two document, it is Nortel’s view that real “equality of access” to an NGN entails the definition of a generic IP packet interface with control of Quality of Service, together with access to other forms of an NGN’s intelligence. Such access will enable a service independent approach to regulation to be developed, and will lead to the withdrawal of the requirements for many of today’s regulatory products. Given that the deployment of NGNs is imminent, it is imperative that the nature and regulation of such interfaces are agreed without delay. Nortel would welcome the opportunity to provide the Committee with additional information on any specific points of interest.

APPENDIX 10

Memorandum by ntl

Key Recommendations 1. Ofcom must use the opportunity created by the Strategic Review to ensure that the UK telecommunications sector is amongst the most attractive places in the world to invest. 2. There isn’t a regulatory regime yet designed that provides the same incentives to innovate as a competitive market. Therefore Ofcom should not seek to use regulation to mimic competition; instead it must create an environment conducive to investment, especially in infrastructure. 3. For infrastructure competition to develop, investors require certainty, and therefore Ofcom must adopt a credible strategy that can be followed consistently for the foreseeable future. 4. Equivalence is a good solution for areas where there is no prospect of true infrastructure competition. However, if it is applied too liberally, it will damage the prospect of developing sustainable infrastructure competition. 5. Ofcom must not start to regulate on a geographic basis without first understanding the potential negative impact on the urban/rural digital divide.

ntl 6. Over the past 15 years ntl has built the largest privately funded fixed access network in the UK. This now passes 8.25 million premises, or roughly one third of the UK population. In addition, ntl has built a world class high capacity core network to connect the local franchise areas. So far, in excess of £9 billion has been invested to create this infrastructure. The network allows ntl to deliver a full complement of converged communications services, ranging from interactive digital TV and high quality telephony, to high speed data services for both residential and business consumers. 7. ntl is also very well placed to deliver the communications services of tomorrow. A key strategic objective in building the network was to take optical fibre close to the customer to enable the delivery of multi-channel interactive television. ntl is now poised to exploit this network advantage and deliver a range of innovative new services. We are currently investigating the most eYcient upgrade path to oVer much higher bandwidth services. The proximity of optical fibre to our customers (over 90% are within 1,000 metres) means that advanced services can be oVered without the need for expensive and disruptive civil engineering work. 8. ntl believe this will prove to be a repeat of the cable industry’s success during the initial roll-out of broadband services. Perhaps more than anything else, this episode has demonstrated the benefits of, and therefore the continued need for, competition between alternative and independent access networks. 9. The cable industry has used its network advantage to drive broadband growth: — ntl did not need to wait for regulation to force BT to provide an appropriate wholesale product, and was therefore able to meet customer demands quickly. — Our entry-level service set the trend for sub-£20 broadband that has helped deliver unprecedented levels of growth in the UK market. — In ntl areas the proportion of homes subscribing to broadband remains significantly higher than the national average. — ntl remains the largest individual broadband service provider in the UK with almost 1.3 million customers. Trade and Industry Committee: Evidence Ev 71

The Strategic Review of Telecommunications 10. Ofcom’s Strategic Review of Telecommunications presents the best opportunity to ensure that UK consumers and the economy as a whole benefit from the most advanced and eYcient telecoms industry in the world. This is a review of regulatory strategy—a forward looking assessment of what can be achieved in the future. In this sense Ofcom are faced with a tough investment decision: spend time and eVort now in order to achieve the greatest rewards in the future; or, focus resources to ensure delivery of immediate benefits. ntl hope that Ofcom have the courage to invest in a better future. 11. Since 1984, the liberalisation process overseen by Oftel has brought significant benefits to UK consumers. We currently enjoy amongst the lowest call charges in the world; the broadband market is now growing at one of the fastest rates in the world; the mobile market continues to oVer a wide choice of competitively priced services; and businesses face a wide selection of products from a variety of suppliers. 12. On one level, this is a time to bask in the light of the success of telecommunications regulation. But herein lies the problem: far too much of this success has been driven by detailed regulatory interventions attempting to mimic market forces. In fixed line telecommunications, we are still a long way from having well-functioning, self-sustaining, eVectively competitive markets. The market structure remains heavily concentrated around BT Group, and without continued regulatory support many competitors would soon disappear. 13. We believe that Ofcom must take this opportunity to renew the liberalisation eVort—to develop a new market structure that supports eVective and truly self-sustaining competition wherever this is possible. There isn’t a regulatory regime yet designed that provides the same incentives to innovate as a fully competitive market. Once competition is self-sustaining, the regulatory structures that currently permeate the entire industry, supporting many firms and controlling market processes, can be removed safely. 14. To ensure that the telecoms sector delivers the greatest public value Ofcom must create an environment conducive to investment. Ofcom should not use regulation to mimic the eVects of competition by continually forcing lower prices and requiring BT to develop new wholesale products. Instead Ofcom should use regulation to encourage investment in competing infrastructure, and only where such investments are not viable should Ofcom require equal access to BT’s network. 15. Increasing the bandwidth capability of the last mile will remove a binding constraint on service innovation. It is for this reason that Ofcom acknowledge the greatest need for investment lies in access networks. BT are proposing to upgrade their access infrastructure as part of their 21st Century Network plans. However, regardless of the technology employed, physical characteristics constrain the capability of the BT network. The bandwidth potential of the local loop is constrained by the length of copper. The shorter the copper, the higher the bandwidth. 16. This is where the ntl infrastructure delivers real public value; the ntl network was built for the future. In contrast to BT, ntl’s significant upfront investment means that we already have optical fibre very close to the customer. Over 90% of the premises passed by our network are less than 1km from fibre. Furthermore, the short run from street cabinet to the customer site consists of both twisted copper and coaxial cable. This gives ntl an unrivalled choice of upgrade path. 17. For example, with relatively small additional investment ntl could deliver broadband at speeds of up to 28Mbps using the twisted copper cables (that is 56 times faster than BT’s original 1/2Mbs broadband product). However, coaxial cable has a far greater inherent capability to deliver high bandwidth services. At present, we provide approximately 3,000Mbps of bandwidth into homes, most of which is used for broadcast and on-demand TV. We are currently evaluating the deployment of new technology which would enable more eYcient use of the spectrum available within our network, and allow up to 100Mbps of shared bandwidth to be used for broadband whilst still maintaining the broadcast and on-demand TV. 18. These upgrades, and others to enable Gigabit Ethernet services for businesses, could all be delivered to one third of the population in the very near future. However, ntl is a commercially driven business operating in a very competitive environment. We compete not just for new customers, but for access to funds to finance the investment. It is therefore imperative that we are able to earn a fair return on both existing and future investments. Without this, we simply will not be able to continue investing in the development of the network. 19. Any move by Ofcom to reduce the value of the existing access infrastructure will almost certainly delay the introduction of the sort of advanced communications services in the UK that cable is capable of oVering. This will clearly have a detrimental impact on consumers, and on the prospects for productivity and economic growth in the UK. Ofcom must use the opportunity created by the Strategic Review to ensure that the UK telecommunications sector is amongst the most attractive places in the world to invest.

Key Principles 20. The ntl response to Phase 2 of the Strategic Review focussed on how Ofcom can create an environment conducive to investment. Telecommunications is both capital intensive and subject to unprecedented technological change. This combination creates a very challenging environment for investment. Physical assets have traditionally been depreciated over a very long period of time, but the Ev 72 Trade and Industry Committee: Evidence

uncertainty generated by constant advances in technology eVectively reduces the expected economic life of assets. It is therefore imperative that uncertainty from other sources such as regulation is kept to a minimum. This will be achieved by having a clear regulatory strategy which is implemented consistently. 21. ntl made three proposals which we believe Ofcom should follow to ensure eYcient investment in infrastructure: (a) Ensure that regulated prices are set to encourage the development of competition. Specifically, this means that pricing must not be structured in a way that devalues existing investment in infrastructure that competes with BT. Also, the pricing should allow all operators to make a reasonable rate of return. This is necessary to create an eYcient and sustainable process whereby existing business funds future investment. (b) The adopted regulatory strategy must be credible, and remain fixed for at least as long as the payback period of the investments it is trying to encourage. That is Ofcom must adopt a set of policies that can be implemented consistently for the duration of the payback period. (c) In order to give all stakeholders a better understanding of the regulatory objectives, Ofcom should provide a clear description of the market structure they expect will support sustainable and eVective competition. Essentially, this is a description of the market structure that Ofcom is seeking to encourage through its regulatory interventions. 22. The high level regulatory principles proposed by Ofcom represent a considerable step forward. However, ntl believe that the current strategy is likely to devalue existing investment in access networks, and reduce the rate of return on current and future investment. ntl are also concerned that Ofcom will not be able to apply the strategy consistently, since practical considerations will force subjective interpretation of the regulatory principles that will vary from case to case. 23. This last criticism is extremely important. In each instance where regulatory interventions do not follow documented policy the shift may be readily justified. However, any such movement detracts from the credibility of the original strategy and policy. This makes it more diYcult for stakeholders to predict the nature of specific regulatory interventions, ie regulatory uncertainty increases. As a consequence, investment suVers.

Equivalence 24. Ofcom’s strategy is focussed on achieving “real equality of access” to the BT network. Very briefly, equivalence or equality of access raises two significant questions. First, to which parts of the BT network should competitors get equal access? Secondly, how are Ofcom going to enforce equivalence? 25. In terms of the first question, Ofcom’s regulatory principles suggest that equivalence should be applied in areas where market conditions imply eVective and sustainable competition is not possible. These areas are referred to as enduring economic bottlenecks. Unfortunately, Ofcom do not suggest a method of analysis to find these enduring economic bottlenecks. A possible reason for this omission is that the problem is simply too complex to solve accurately. 26. Understanding where competition will and will not be possible requires Ofcom to second guess industry investment decisions. They need to understand where business plans to enter a particular area of the market will be viable. Specifically, Ofcom must decide where market entry is not possible. ntl do not believe that it is appropriate for Ofcom to make such decisions. However, if they must be made, the strong negative impact on investment incentives should be taken into account: if Ofcom determine that a particular area is not suited to competition, and will therefore mandate that BT oVer cheap access to their network, it is extremely unlikely that an investor will risk capital to develop an alternative network. 27. Since it is inherently diYcult to establish the precise scope of enduring economic bottlenecks, we have recommended that Ofcom publish the criteria by which enduring economic bottlenecks are to be determined. Also, ntl believe that equivalence should only be applied to a very restricted set of assets where cost-based access to the BT network will not damage the business case for investment in competing infrastructure. A more stringent application of equivalence is likely to contravene the EU’s Access and Interconnection Directive, which states that: “The imposition by national regulatory authorities of mandated access that increases competition in the short-term should not reduce incentives for competitors to invest in alternative facilities that will secure competition in the long-term.”8 28. As for the second question, mandating equivalence would be extremely diYcult and time-consuming. Existing legal powers only allow equivalence to be enforced in piecemeal fashion, through individual market reviews and subsequent product specific remedies. Each step of the process is highly complex and relatively controversial, and therefore more likely to be subject to appeal. More fundamentally, true equivalence requires behavioural change. The well documented asymmetry of information between regulated and regulator will mean that, even if the powers to enforce equivalence did exist, the regulator is unlikely to know what to ask for.

8 Access Directive, 2002/19/EC. Trade and Industry Committee: Evidence Ev 73

29. In conclusion, issues over definition mean that a strict interpretation of the equivalence is impractical to implement. Furthermore, equivalence requires behavioural and organisational change from BT, and can therefore only be implemented as a negotiated settlement between regulator and regulated. This is the “regulatory contract” that Ofcom and BT have referred to. Confidentiality concerns mean this negotiation cannot be conducted in public. Consequently, the transparency of the overall strategy is reduced. 30. As a prescriptive strategy for future interventions, equivalence leaves too much room for interpretation and therefore cannot give industry the certainty needed to make long term investment decisions. Equivalence is extremely useful in analysing and understanding market dynamics. However, forcing BT to oVer true equality of access to its network will not always be the most appropriate regulatory intervention.

Equivalence and the Urban/Rural Digital Divide 31. The strict application of equivalence implies the need for geographically varying regulatory remedies. As such, the accommodation of geographically varying remedies is included as one of Ofcom’s core principles to guide regulation. ntl believe that this is a very serious issue with the potential to destabilise market development and to negate the achievement of many benefits that competition has brought to consumers and citizens. 32. Our greatest concern is that the policy could actively encourage a divergence of competitive conditions between urban and rural areas. Regulation that reacts to market developments will see investment in densely populated urban areas where economies of scale are greatest. Consumers in these areas are likely to benefit from lower prices and a better range of products than sparsely populated rural regions. Ofcom have a duty to work in the interests of all UK consumers, and therefore should not just accept that certain areas are less attractive for private investment. 33. It is possible that regulation which diVers between geographic areas could seek to reduce the divergence in competitive conditions and therefore attempt to reduce the competitive and digital divide. However, Ofcom do not discuss such policy issues in the Strategic Review. Ofcom should not proceed to vary regulation according to the competitive conditions in diVerent geographic areas without a comprehensive and rigorous review of the implications of doing so. Since this analysis has not yet been undertaken, it is inappropriate for Ofcom to adopt geographic variation as a guiding principle for future regulatory interventions.

Conclusions 34. Achieving real equality of access to the BT network, even through local loop unbundling, can only take the UK so far. Without doubt, the successful implementation of local loop unbundling will deliver benefits to consumers in the short term. However, there is a significant risk that concentrating on the BT network to the exclusion of encouraging investment in alternative infrastructure will actually damage the long term prospects for competition. It is also likely to hinder the development of next generation access network capabilities, and therefore delay the provision of advanced communications services to UK consumers. 35. ntl’s understanding of the current regulatory process is that Ofcom is negotiating a settlement with BT. If BT promises to improve its wholesale products and behaviour towards competitors to a greater degree than Ofcom can actually force through existing legislation, Ofcom will accelerate the withdrawal of regulation in retail and some wholesale markets. However, if BT does not cooperate with these proposals, Ofcom is making several threats. First, there is the possibility of a reference to the Competition Commission, but this will take several years to reach a conclusion, and even then there is no guarantee that the findings will concern BT. More importantly, Ofcom are conducting two consultations that will dictate the wholesale price that BT is able to charge for access to its network. One relates to the valuation of the BT access network, and the other concerns the rate of return that BT should be allowed to earn on its access network assets. 36. This approach may9 have been appropriate if the BT access network were a monopoly asset. In this case, any punitive measures applied to this set of monopoly assets would only aVect BT. However, the BT access network does not represent a monopoly. BT faces competition at the access level in varying degrees from cable and mobile operators. Cable companies have invested heavily over the last 15 years building local access networks which now cover around half the population. These networks consist of short runs of both copper and coaxial cable, supported by a deep deployment of optical fibre. Cable companies provide in excess of 4.6 million access lines for voice services representing a market share just under 14%; and over 1.9 million broadband connections representing a market share of approximately 36%.

9 Even in this hypothetical situation, reducing the returns BT is allowed to make is likely to store up trouble for the future. It would reduce BT’s incentives to invest in maintaining and upgrading their infrastructure. The UK should learn from previous failures to invest suYciently in national infrastructure, leading to poor quality of service, and ultimately to increases in retail pricing for consumers. Perhaps the most pertinent example is the rail industry. Ev 74 Trade and Industry Committee: Evidence

37. Competition may not yet be fully eVective, and significant further roll-out of primary infrastructure may be unlikely in the near future, but this does not imply that the BT access network is a monopoly. Consequently, it is highly inappropriate to consider sanctions to persuade BT to behave in a particular manner that will also aVect other owners of access infrastructure. 38. Alternative infrastructure providers need to earn a return on the significant investment that has already been made. This provides the most eYcient source of funding for the maintenance and upgrade of the existing infrastructure. Perhaps more importantly, it sends signals to attract investors worldwide to the UK telecommunications sector. 39. Although there is unlikely to be significant new build of alternative access network in the near future, some will take place. This will occur alongside substantial investment to maintain and upgrade the existing infrastructure. At the very least, Ofcom should explicitly acknowledge the eVect that the regulatory treatment of BT’s copper network will have on the incentives to invest by operators other than BT.

APPENDIX 11

Memorandum by Ofcom OYce of Communications

Two issues arose during the oral evidence session on 1 March on which we thought the Committee might welcome an additional written submission from Ofcom: issues around consumer information, searching and switching, and issues in relation to LLU pricing and roll-out.

Consumer Information and Switching The need to ensure that consumers can make eVective choices was a key part of our Phase 2 consultation of the Review. We set out a series of options for improving the flow of information and for making switching between suppliers easier. We sought views on a very wide range of possible approaches. One option, which could be argued to be consistent with our duty to act as a light touch regulator, would be to leave the issue entirely to the market. But we think in a market of the complexity of telecommunications, and where competition is not fully developed, such an approach would not serve the best interests of consumers. Indeed, it could significantly stall the development of eVective competition. At the other end of the spectrum of options, we could intervene to restrict the choice and range of products and tariVs that can be oVered by telecoms service providers—perhaps in a similar way to the regulation of some personal finance products. Again, Ofcom is minded to reject such an approach as unnecessarily heavy- handed in a market where consumers strongly value innovation and where the scale of consumer detriment which might arise from customer confusion is clearly significantly less than in the case of financial services. Therefore we think the focus should be on improving the quality and quantity of consumer information on which consumers actually base their decisions. One important element of making choices is being able to compare diVerent tariV packages on a like-for- like basis and work out what oVers the best value for money. We have consulted on whether Ofcom should itself provide comparable price information, specifically through some kind of price comparison engine on our own website. But we questioned whether this would be an eYcient way to proceed. The complexity of telecommunications makes the provision of simple but broadly accurate comparisons of the kind which, for instance, energywatch provides on its website, actually rather diYcult in telecoms. Energywatch, like Ofcom, accredits third parties to provide more accurate comparisons based on customers’ actual bills and behaviour. In our case the Ofcom PASS scheme provides accreditation for tariV comparisons sites. uSwitch.com is accredited under the scheme and produces a highly-acclaimed and popular site. We would like to strengthen the Ofcom PASS scheme to make the comparisons even more useful and accurate, and to accredit further companies under the scheme. We would also like operators themselves to produce clearer information about their tariVs and services. There are a number of measures that might be taken in this regard, including some fairly straightforward measures like using simpler language and consistent terminology. One particular area of concern is comparative advertising. One suggestion in our consultation was that we might work with the Advertising Standards Authority to produce clearer rules on comparative advertising, particularly in relation to new services such as broadband. Finally, we looked at whether switching between suppliers remains more diYcult than it should be for consumers. Research evidence included in the consultation document suggested a more basic problem—that many consumers in the fixed market are unaware of the choices that are already available to them. Ofcom therefore asked whether simply communicating to consumers that choices exist, for instance using newspapers, consumer magazines and TV and programmes, might reap important dividends. Trade and Industry Committee: Evidence Ev 75

In parallel with considering consultation responses to these options, we are initiating further research into consumer information problems. In particular we are looking at how information strategies used by other regulators have worked in practice, and whether they have had a positive eVect. Our intention is that in our Phase 3 statement in the summer we will set out a strategic approach to consumer information and switching including specific timescales and deliverables.

Local Loop Unbundling (LLU) At our oral evidence session, the Committee noted concerns that alternative operators wishing to use LLU were still encountering significant challenges in doing so. We thought it would be worth briefly addressing three areas of specific concern. LLU charges: In August 2004, Ofcom announced proposals for significant reductions in LLU charges. These followed on from earlier, voluntary reductions made by BT in May. Ofcom set final LLU connection and rental charge ceilings in December 2004. The table below sets out the wholesale connection and rental prices for LLU that applied before BT’s reductions in May (Column A); BT’s voluntary price reductions (Column B); and the final price ceilings that have applied since 1 January 2005 (Column C). The percentage reductions shown are compared with the wholesale prices prevailing before BT’s reductions in May.

LLU CONNECTION AND RENTAL PRICES

A Old B BT’s voluntary C Final % Change reductions from A to C Shared access Connection £117 £83.33 £34.86 70% Rental £53 £27.12 £15.60 71% Fully unbundled Connection (transfer) £88 £88 £34.86 60% Connection (new provide) £265 £223.33 £168.38 36% Rental £119 £105.09 TBD N/A

Ofcom will return to other pricing issues in the next phase of its work, including the prices for migration from another broadband product to LLU and the costs of co-location of apparatus at an exchange. We will also be setting the rental price ceiling for fully-unbundled loops (as opposed to shared access). To determine a fair price for this it is necessary to take a view of the cost of the underlying copper assets, because a very high proportion of the costs for this service is determined by the cost of laying and maintaining the copper loop between the Local Exchange and the home or business premises. Recognising this, Ofcom is running a separate analysis to assess copper loop costs which will address issues such as the valuation of the asset, the attribution of costs to the copper loop and the appropriate recovery approach. The initial proposals on this were published for consultation in November last year, with further proposals due to be published within the next few weeks. Once the question of underlying costs of copper are resolved, Ofcom will then determine the rental price ceiling for fully unbundled local loops. We aim to complete this process by the end of 2005. In the meantime, BT’s voluntary price reduction to £105 pa rental for such loops remains the applicable price. Process issues: Ofcom has recognised that rapidly developing “fit for purpose” and eYcient industrialised processes for delivery of unbundled lines are as important as price reductions. The lack of fit for purpose processes is one of the key reasons why potential investors were deterred from entering the market using LLU. Ofcom has created the OYce of the Telecoms Adjudicator to help to quickly deliver industrialised processes for LLU. Peter Black, the Telecoms Adjudicator, brings a wealth of practical experience over many years in the industry to these issues, and is setting product/process specifications and implementation plans, overseeing implementation, assessing the performance of operators in meeting their objectives and resolving disputes. The OTA has established Key Performance Indicators (KPIs) to measure how well BT is performing in delivering fit for purpose LLU. The OTA’s most recent report, published on 8 February, highlights good progress, but variable performance in some operational areas: — 31,000 lines had been unbundled by 31 January 2005. This number has grown from around 12,000 in May 2004. The OTA had targeted 50,000 lines by February 2005. — Performance is behind OTA Key Performance Indicator, Right First Time, which measures delivering working service in time to meet customers’ expectations. Actual delivery is variable at 50–60%, against the OTA target of 75% Right First Time by February 2005, rising to 85% in the near future. Ev 76 Trade and Industry Committee: Evidence

It is clear, therefore, that significant improvements remain. Nonetheless we believe the establishment of the OTA has been a significant success and has the support and commitment of the industry. LLU backhaul: “Backhaul” is the term used in the industry for the connections between the local exchange domain and the core network—what is sometimes described as the “middle mile”. For LLU operators, backhaul is a key requirement and pricing and process issues in relation to backhaul are therefore very important. Whilst there is scope in theory for backhaul to be provided competitively in many parts of the country, in the short term LLU operators may be reliant on a BT wholesale service. We have worked with BT to allow a more flexible wholesale backhaul product which addresses the needs of LLU operators. We will be setting charges for this service later this year alongside the other remaining LLU charges mentioned above. This will remove one concern of LLU charges that there is currently uncertainty about the future evolution of pricing for these products. Some operators have called for LLU backhaul products to be included on the list of “enduring economic bottleneck” services to which the “equality of access” provisions set out in our TSR Phase 2 consultation would apply—for instance equivalence of input, possible inclusion in the list of services provided by BT’s proposed Access Services Division. As noted above, there is theoretical scope for replication of backhaul so it is unclear that this product should be regulated as tightly as, for instance, the copper local loop itself. But Ofcom will be considering this carefully as it firms up its proposals on “real equality of access” between now and the end of the Review.

APPENDIX 12

Memorandum by Telewest Broadband (Flextech) A. Introduction 1. Telewest is the broadband communications and media group, with a high capacity network passing 4.9 million homes. It provides multi-channel television, telephone and broadband internet services to 1.72 million UK households, and voice and data telecommunications services to around 70,000 business customers. Its content division, Flextech, is the BBC’s partner in UKTV and is the largest supplier of basic channels to the UK pay-TV market. 2. Telewest supports the need for the Strategic Review of Telecommunications being carried out by Ofcom, particularly its timing and market relevance, but has concerns about the sequencing of associated consultations and believes that Ofcom is sending mixed messages about its policy intent at a critical time for the sector. 3. The most important thing to keep in mind is that the outcome of this Review, and associated consultations, is likely to dictate the pace of investment and technology deployed for up to a decade ahead. 4. In the context of the Committee’s Report on the UK Broadband Market (Second Report of Session 2003–04), the following comments on the Review address the way that we believe it relates to the development of broadband in the UK, ie whether or not the outcome of the Review will lead to next generation access network investment, including local loop unbundling.

B. Resolving the “Access Issue” 1. Ofcom has rightly identified that there is a need to resolve what is defined as the “access issue”, particularly to clarify BT’s role in providing access to its “local loop”. 2. It is generally recognised that the “local loop” is a vital component of the broadband value chain but the “access issue” needs to be considered from two perspectives; the first is whether/how investment in local access can keep pace with bandwidth demands (ie will bandwidth provision stay ahead of the demand curve; will there be adequate capacity or a capacity shortfall?). The second is how third parties can get access, on non discriminatory terms, to BT’s network for providing services via unbundled local loops. How to handle the latter without undermining the former is the key task for Ofcom. 3. The access network is the most vital component in the broadband value chain because it has to provide adequate bandwidth to allow consumers to access their preferred content and services, which are becoming increasingly bandwidth hungry. 4. Ofcom believes that the local loop, ie the final connection to the customer, might constitute an enduring economic bottleneck and, hence, this element is most appropriate for regulation. In relation to BT’s local access network, it has proposed to address this by way of equivalence or equality of access, rather than a forced functional separation of BT. 5. Because this issue is central to Ofcom’s current thinking, it is addressed in the Phase 2 consultation document as well as in associated consultations covering “access to and interconnection with next generation networks”, “valuation of BT’s copper loop” and “BT’s cost of capital”. Therefore, it is important Trade and Industry Committee: Evidence Ev 77

that the Committee considers the Strategic Review in parallel with these other Ofcom work streams and in the context of BT’s subsequent announcements in response to the Strategic Review consultation that proposes the creation of an Access Co. The outcomes of all of these consultations need to be closely aligned and consistent. 6. At this point in time, we believe that an undue regulatory push of LLU by Ofcom may become the centre of gravity of the “access” debate, to the detriment of investment in the next generation access networks, either by BT or others. We are concerned that the current approach could mean that there may be little or no incentive for new or widened market entry in access networks. 7. The relationship between investment and the regulatory regime was highlighted in the Committee’s Report on the UK Broadband Market where it stated “those looking to invest in the market need to have confidence in the robustness of the regulatory regime. It may be that the advent of Ofcom gives the opportunity to re-establish confidence in the regulatory regime where currently it is lacking”. 8. In response, the Government noted that “the Strategic Review of Telecommunications will clarify Ofcom’s approach to competition at the diVerent levels of the broadband supply chain and bolster confidence in the broadband market” and Ofcom said that “it will aim to ensure that regulation does not present a barrier to appropriate investment in such networks in the future”. 9. The Committee said also that “we would naturally support any eVort to ensure that investment in the existing network is sustained and that the rollout of other, alternative means to deliver broadband is encouraged”. 10. The Government agreed that “strong competition between broadband platforms will be important in ensuring both that broadband becomes available to all ...todelivertheincreasinglyrichandsophisticated services that businesses and consumers will require . . . and that both sustained investment in existing networks and the rollout of alternative technologies are to be encouraged”. 11. Overall, Ofcom has taken a broadly positive view of the state of UK markets. However, in terms of policy objectives, we believe that there is an unclear approach in the areas of access network competition. Ofcom appears to believe that access networks can never be completely contestable all the way to the customer, despite the coverage of cable and the potential of wireless. Consequently, it implies that the BT access network should be regulated to a far greater degree than previously, particularly in terms of economic return, without suYcient acknowledgement that such a policy could chill investment in this high risk area of the market, both by BT and access network competitors. 12. Next generation access networks carry a high level of financial risk. Therefore, it is essential that the proposed revaluation, and potentially tight regulation, of BT’s copper loop doesn’t deter investment in upgrades to next generation access networks either by BT or others. 13. Furthermore, local loop unbundling should not be seen as the panacea for the perceived structural failures in the UK access market and is unlikely to lead to the levels of access network investment that will make increasingly advanced broadband services widely available. We feel the UK market is more progressive and dynamic than Ofcom acknowledges. 14. In summary, we believe that Ofcom’s approach to the economics of access infrastructure should be cautious and balanced. In particular, Ofcom’s policy being centred on LLU, but without any consideration of LLU’s potential to jeopardise long term investment in access, is a potential danger point. Telewest recognises the innovative role that LLU-based services will play in the UK broadband market but believes Ofcom may create a false economy via unduly heavy intrusive intervention. The long-term impact of this will, potentially, lead to under capacity in the UK access infrastructure. 15. We do not believe that the access network is a natural monopoly but we do believe that more consideration should be given to some structural options (including more duct sharing) to avoid the need to replicate the most capitally intensive parts of the local network.

C. The Application of “Equivalence” 1. We support Ofcom’s decision to not currently pursue the structural separation of BT since we believe that the costs to the industry and delays from such a process would outweigh the benefits. Any such move should be a decision for BT. 2. We have reservations, however, about the definition of equivalence, and the potential outcomes of a narrow focus on equivalence. The concept of equivalence, currently proposed by Ofcom, appears to assume symmetry in the ability of BT and third party companies to innovate, invest in future products and implement them. The reality of markets is that there will always be asymmetry in these areas and Ofcom’s approach to equivalence could lead to a collective sterilisation of innovation across the industry. In essence, if Ofcom demands equivalence for a high proportion of the input components to retail services, then the market will have little room left to innovate, and those whose market success is based on innovation or service diVerentiation will be disadvantaged. 3. We believe that, at the standard interconnect level, the concept of equivalence is applicable. However, we do not feel the application of equivalence to BT for the entire retail to wholesale level is a workable concept. A variety of inputs is required by downstream telecommunications activities, many of which, as in Ev 78 Trade and Industry Committee: Evidence

BT’s case, may be provided from within the same firm. In the case of BT, with a wide range of retail products directed at many sectors of the market, these inter-relationships are likely to be complex. If full equality of inputs were to be imposed, this could lead to all downstream competitors relying on a standard set of inputs at regulated prices and on the same terms. The likely consequence would be that innovation would be discouraged and price competition would be limited to squeezing the downstream margins.

D. Summary 1. If there is eYcient and substantial investment by BT and its competitors, consumers will not be exposed to excessive pricing and healthy competition will oVer innovative services. On the contrary, if there is no investment (particularly in access infrastructure) because of Ofcom’s policies, then there will be a lack of new products and associated rigidity in pricing. If Ofcom determines the need for intervention, it must be very mindful of achieving the right economic balance, since the level of profits in new markets will dictate investment in those markets. Ofcom’s role should be to support and ensure fair competition and no undue exploitation of dominance. 18 February 2005

APPENDIX 13

Memorandum by Tiscali UK Ltd Introduction The Trade and Industry Committee investigation into and report on The Broadband Market in 2004 identified issues hindering eVective competition, innovation and the wider adoption of broadband in the UK. Key observations included: — The need for wholesale competition. — The importance of market confidence in the regulatory environment. — The need to establish a reasonable and sustainable margin between wholesale DSL products IPStream and DataStream. — The need for more competitive pricing to make LLU viable. — Recommendations to examine migration charges. Since publication of the Committee’s report on 19 May 2004, Ofcom and BT actions have addressed the three pricing issues. However, the broader aims of wholesale competition and market confidence are yet to be achieved. In addition to observations on the Ofcom Strategic Review, Tiscali intends to address in this submission ongoing issues still hindering competition and market confidence to answer the Committee’s desire to examine market “extensiveness and competitiveness”. The objectives of the Strategic Review included: — Establish the extent to which the sector benefits from competition. — Assess the extent to which competition and/or regulation has delivered lower prices, higher quality and wider choice for service providers and consumers. — Compare the UK consumer experience with that in other countries. — Look at investment and innovation trends as drivers for new opportunities. — Examine the scope for eVective and sustainable competition at all levels and for the foreseeable future. Ofcom’s current goals after Phase 2 include the need for the promotion of a more competitive environment for LLU and the creation of true equality of access to BT network assets for all competing operators. Tiscali supports the case for change and a new regulatory approach. In particular, Tiscali believes that the reliance on BT for access to the network it controls is currently not producing the level of competition needed by the UK economy. Poor wholesale products and processes and a complexity of regulation and dispute have hindered market development. One clear example of this has been the struggle to develop wholesale broadband competition. Although the margin between DataStream and IPStream has been determined and the migration charge reduced, there are still no eVective bulk or single migration processes that allow ISPs an alternative choice of wholesale supplier and consumers the opportunity to move freely and easily between DSL broadband providers. If the Phase 3 statement due in Spring 2005 produces actions and results that change the UK industry, the review process will have worked. This depends on the BT reaction to Ofcom proposals and the will and ability of Ofcom to see them through. Trade and Industry Committee: Evidence Ev 79

Summary of Tiscali’s Response to Ofcom (Phase 2) The Tiscali response to the Phase 2 consultation submitted to Ofcom is attached at Annex A.10 A summary of the main features of the response is as follows: — Tiscali supports Option 3: input equivalence and transparency to achieve equality of access. — The Enterprise Act referral solution must be pursued if Option 3 becomes unviable. — No deregulation should occur without complete satisfaction of requirements for demonstrable equivalence. — The 21st Century Network (21CN) should have built-in equivalence, which means early collaboration and consultation, but the work to create equality of access should not be postponed until 21CN begins. — A major organisational change will be necessary in BT to achieve goals, involving significant separations, behavioural changes and new models of corporate governance. — Changes made to deliver equality of access must be measurable and monitored; Ofcom must be able to enforce compliance and penalise failure.

Tiscali’s Views on the BT Response to Ofcom (Phase 2) It was critical that BT responded with real commitment to change for there to be any hope of success. The BT response has been published on the BT website and Tiscali has considered the implications it holds for the future of the Ofcom review. The outlook is not promising; BT suggests many things without meeting any demands completely. A summary of problems Tiscali has with the BT response is as follows: — Organisational change proposed is limited to the creation of an “Access Services Division” (ASD), without suYciently meaningful separation and without the clarity or detail on equivalent products and transactions needed to achieve equality of access. — No detail is provided on separations required between parts of the wholesale business and between wholesale and retail businesses. — The proposed ASD would report to BT operationally, just like any existing division, and be overseen by an “Equality of Access Board” (EAB). The BT CEO would chair the EAB. — No detail is given on SMP products not sold by ASD (such as DataStream) and how issues around lack of equivalence in systems and processes would be addressed. The assets and products to be moved into ASD do not include all eligible qualifying bottlenecks. — BT proposes to delay any significant development of equality of access until the advent of 21CN, after 2006. — The only mention of behavioural and incentives change relates to ASD, but that would be inadequately separated from BT anyway. The importance of the need for total cultural shift is not acknowledged by BT. — BT’s document is negative and defensive in tone; considerable space is given to denying poor performance and behaviour and itemising alleged unfounded accusations in Ofcom publications. The BT response is disappointing. Proposals made by BT are tailored to only partly meet demands and the overwhelming impression gained is that BT challenge Ofcom to attempt to extract more or go the way of Enterprise Act referral. There is clearly a large diVerence between the detailed and practical approach to achieving equality of access demanded by the UK industry and what BT has volunteered. BT makes much of its doubts concerning Ofcom’s ability to enforce any of the changes it seeks and BT’s generosity in going as far as it has.

Next Steps for the Review An optimist may say that BT has stated a starting point for negotiation, with more to come in the process of completing the review. Ofcom will now have to decide if that is true, or if it will now be unable to bring about the desired outcome of Option 3. Where industry members such as Tiscali were hoping to begin detailed work on helping Ofcom and BT to progress the equality of access project, they are now limited to expressing severe disappointment to Ofcom and waiting for the next instalment. Ofcom must promptly reply with a Phase 3 statement that contains its opinion of what BT has oVered and what it will do to complete the review. If it is not possible to fully achieve the objectives of equality of access, the Enterprise Act referral option should be taken immediately.

10 Not printed. Ev 80 Trade and Industry Committee: Evidence

Key Issues for Broadband

Wholesale Competition BT’s retail market share is currently 36% of DSL broadband, but BT still has a monopoly over the wholesale DSL market with a 95% share. DataStream has not been able to compete eVectively as a wholesale product (the 5% diVerence is accounted for almost completely by Tiscali’s DataStream consumer base) and LLU accounts for only 31,000 lines. The changes in LLU pricing have not made an impact yet, because significant investment and time are needed and there are many processes to iron out. New investment in LLU will be visible by mid-2005, but it will take years rather than months to reach a percentage of the market significant enough to be considered competitive with IPStream. The Tiscali DataStream network currently reaches 75% of the addressable market base.

Ongoing and Unresolved Broadband Issues

Broadband activation/connection charge Tiscali still believes that the £50 BT charge is not reasonable and is an obstruction to the growth of the UK broadband market. This activity should be priced at a level closer to the £11 charge determined by Ofcom for broadband migrations. The £50 looks even more arbitrary considering the LLU connection charge is currently £34.86. A reasonable, cost-related figure would be in the region of £20–25. This activation fee aVects all ISPs oVering DSL broadband access. Tiscali leads the consumer market with product and price oVerings, but could do much more without the hindrance of this excessive charge.

IPStream/DataStream to LLU migration charge and capability The current £34.86 charge (refer above) is actually for LLU connection. Telecoms Adjudicator (TA) work should feed into an Ofcom consultation soon, however there is little knowledge available on progress against this plan. The charge should fall to £11 (see above), because the current level of charge is a huge barrier to LLU investment and roll-out. The TA target for LLU is one million lines by mid-2006 (achieved level is 31,000 in February 2005). The target seems extremely ambitious now, but even that would not be enough to cope with reasonable demands for migration by large ISPs as they roll out LLU. More significantly, there is no reason to suppose that BT can handle connections and migrations at the required rate and questions remain regarding industry demand, as the model for unbundling will focus on the most economic exchanges with a requirement to complete migration to LLU quickly and eYciently.

Broadband Market Destabilising Factors

Geographic price deaveraging On 3 February 2005, BT announced geographically deaveraged prices for wholesale IPStream products (in the form of rebates to purchasing operators), focused on high concentration exchanges. Proportionate rebates that comply with the margin determination must apply to DataStream, however these will not be announced for some weeks. Therefore, DataStream operators are disadvantaged in comparison to IPStream operators (notably BT Retail). These wholesale broadband price reductions target exchanges most eligible for LLU (the high concentration exchanges), undermine the case for LLU and are likely to disrupt and delay investment by alternative operators.

21st Century Network and Equivalence The conclusions of Ofcom’s consultation on access and interconnection for 21CN are awaited. As LLU will not develop in every part of the country, DataStream-like access will be required and this will need to be achieved by suYciently deep-level operator access in BT exchanges. BT has been slow to agree to operator demand for this. Also, BT broadband operations should receive supply of BT wholesale broadband products in an equivalent manner to retail and wholesale competitors. This does not happen and the BT response to the Phase 2 consultation does not indicate forthcoming reductions in lack of equality.

What Ofcom Needs To Do 1. Publish the Phase 3 Strategic Review statement as soon as possible and clearly commit to an Enterprise Act referral if complete satisfaction of the requirements of Phase 2 is not feasible. 2. Complete the revision of the broadband margin model to reflect deaveraged pricing and incorporate the margin between LLU and DataStream in whatever way is appropriate, and then ensure that BT pricing is compliant with its obligations. Trade and Industry Committee: Evidence Ev 81

3. Consult on and determine LLU migration charges and processes by April 2005. 4. Answer the regulatory questions raised by 21CN regarding interconnection and access in the forthcoming statement, clarifying BT obligations and protecting the future of competition in the UK broadband market. 5. Respond constructively to future demands from industry for the review of BT wholesale broadband activation charges, seeking to ensure consistency with determinations on migration and connection charges. The problems Ofcom identifies and aims to fix with the Strategic Review seriously aZict the UK wholesale broadband market. An opportunity now exists for the instigation of major change in UK telecommunications. Belief, commitment and hard work will be required of all stakeholders to ensure this opportunity is not wasted.

APPENDIX 14

Memorandum by the UK Competitive Telecommunications Association

Please find enclosed a copy of UKCTA’s submission to Ofcom’s strategic review.11 UKCTA represents BT’s competitors in the telecoms market. It is the vehicle through which competitive network operators and service providers develop and articulate public policy and regulatory proposals whose objective is to promote eVective sustainable competition in telecommunications. UKCTA pioneered the notion of equivalence or, to use Ofcom’s terminology, equality of access. This idea and the rationale behind it are explored in detail in the attached submission. UKCTA members welcome Ofcom’s embrace of the notion and indeed its apparent determination to translate ideas into action. In UKCTA’s view, the focus now needs to be on implementation, or delivery, in particular, a rapid transformation of the telecommunications market from one characterised by the dominance of the incumbent to one that embraces full and sustainable competition. This is as necessary in broadband markets as it is in telephony. UKCTA members are concerned that BT, whilst appearing to engage with Ofcom and UKCTA on the need for change, remains an organisation characterised by resistance to competition. Ofcom in particular must act firmly, with determination and speed, to ensure BT is not an obstacle to reform. UKCTA’s concerns in this regard stem not just from our experience of dealing with BT over many years; they also derive from the fact that BT’s submission to Ofcom contains many notable omissions, especially a lack of milestones and timetables for change with respect to individual broadband products and processes, as well as a lack of detail and clarity with respect to the organisational change necessary within BT to ensure a transformation to competition. Furthermore, BT’s actions, for example in relation to its broadband product portfolio (IPStream and Datastream) as well as to unbundling the local loop, undermine the fine words in the submission. The challenge facing the industry and Ofcom is now to ensure swift change. Factors necessary for this include: — Enforceable sanctions and incentives to ensure BT does not later renege on or undermine the new “regulatory contract”. — The need for organisational change within BT, involving at least a separate monopoly division that transacts with its own competitive businesses and with competitors on equal terms. — Detailed implementation of product, price and process equivalence for key BT wholesale services. — Deregulation for BT only where full product equivalence is implemented. Senior representatives of UKCTA member companies look forward to discussing these issues with members of the Committee. These reforms are in our view absolutely necessary to promote true competition and therefore enabling the UK economy and consumers to fully benefit from broadband technology and services. David McConnell Chairman 18 February 2005

11 Not printed. Ev 82 Trade and Industry Committee: Evidence

APPENDIX 15

Memorandum by Wanadoo UK plc 1. Wanadoo is a leading Internet Service Provider (ISP) and part of the France Te´le´com group. With approximately 9.5 million Internet access customers of which approximately 4.4 million are broadband customers, Wanadoo is the largest broadband ISP in Europe. Wanadoo welcomes the opportunity to submit evidence to this Inquiry, focusing on broadband-related issues. 2. This submission covers the following themes: — Broadband Growth and Competitiveness: 2005 will see significant growth in broadband; while the UK is climbing up the G7 ranking but it is time to re-evaluate competitiveness comparators. — Broadband Speed and Definition: need for a new oYcial definition of broadband. — Product Innovation and Convergence: a multi-play broadband environment. — Local Loop Unbundling: implementation started; UK is significantly behind France, which has already unbundled 1.6 million lines. — Regulation: a step in the right direction; more work to be done — Role of Government and Ofcom: margin squeeze should be avoided; more robust application of competition law; encourage investment and provide certainty.

Broadband Growth and Competitiveness 3. At the time of the 2003 inquiry, ONS reported that some 16% of UK households had broadband services, although Wanadoo estimates put the figure at 11%. Around one household in five that was Internet-enabled had broadband. This amounted to 2.335 million subscribers as at June 2003. ADSL was available to 71% of households and cable to 45%. 4. Ofcom recently reported 5.122 million broadband subscribers (of which 1.81 million were cable) as at the end of Q3 2004, with a provisional estimate of six million by the end of the year. By September 2004 more than a third of Internet connections were broadband, projected to reach 50% in the first half of this year:

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9 Dial - up Broadband 6

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0 2001 Q42002 Q2 Q3 Q42003 Q2 Q3 Q42004 Q2 Q3 Q4* Q3 Q1 Q1 Q1 UK Internet Connections (Millions) Source: Ofcom Communications Market Quarterly Update (January 2005)

5. We anticipate that some 2.8 million broadband customers will be added during 2005, although this number is perhaps flattered by the current misleading statistical definition of broadband to include anything faster than narrowband (see below). 6. BT announced in December 2004 that 95% of the population was broadband-accessible and forecasted that 99.4% would be reached by this summer. While growth has been encouraging, there is still a significant gap between broadband availability and adoption. 7. In our 2003 submission, we considered the UK’s current and projected adoption rate alongside our G7 and European competitors. We assessed that at that time UK household penetration was matched by France, although unbundling there would shortly give it an advantage, and beaten by (24% of Internet-enabled subscribers) and Spain (25%). Jupiter Research projected that UK broadband adoption level would rise to 20% by 2005 and 29% by 2008, compared with France (18/25), Germany (20/31) and Spain (22/31). Jupiter’s forecasts placed , Belgium, Denmark, , , Spain, Sweden and ahead of the UK in 2005 and suggested that by 2008 we would have overtaken only Luxembourg but Germany would have jumped ahead of us. The UK was then in sixth place in the G7 in terms of overall broadband penetration and even the most optimistic forecasts for 2005 placed UK broadband penetration considerably behind Canada, the best performing G7 country (45%). However, we observed that international comparisons can be misleading: for example, the average German and Dutch broadband products oVered a speed of 768Kbit/s, in Canada it was 960Kbit/s, 1–2Mbit/s in the US and 12Mbit/s in Japan in comparison with the UK’s 2003 average of under 512Kbit/s. Trade and Industry Committee: Evidence Ev 83

8. At 38%, UK market growth in 2004 exceeded that of France (34%), Germany (17%), the Netherlands (23%), Spain (30%) and Sweden (13%) and was beaten among our European competitors only by Greece, Ireland, Norway, and Luxembourg (European Residential Broadband Forecast, Forrester Research) although this is as much a measure of market maturity as anything else. Jupiter’s updated forecasts, however, still suggest that the UK will lag behind, with 27% of households and 48% of Internet households having Broadband in 2005 and 38%/61% in 2008 beating Germany (18/32 2005; 31/51 2008) and Italy (16/ 37 2005; 25/50 2008) but trailing France (28/60; 37/69) Spain (27/62; 36/71) and the Netherlands (43/65; 56/ 80). Forrester projects further, to 2010, concluding that by then 42% of UK households will have broadband, ahead of France and Spain (38 each) and Italy (40) but behind Germany (44), Sweden (52) and the Netherlands (54). 9. Both Forrester and Jupiter forecast that cable development across Europe will be constrained by cash shortages, with Jupiter projecting cable’s share of UK Broadband households declining from 31% in 2005 to 25% in 2008 and 24% in 2009. 10. Government policy is to achieve the most extensive and competitive broadband market within the G7. In the past—and arguably for good reason—the factors taken into account were focused as much around broadband availability (the ability of a customer to be provisioned on a broadband line) as around broadband penetration (the actual number of broadband subscribers). Given the market is more mature (albeit growing significantly), the focus now should be on broadband penetration and competition at the underlying infrastructure layer. It is timely that the Broadband Stakeholder Group and Analysys are reassessing the criteria for extensiveness and competitiveness. 11. One of the issues limiting the take-up of Internet access is the penetration of PCs or other Internet- enabled devices. As at October 2004, 34% of adults had never used the Internet (Source: ONS). Another impediment to growth of the broadband market is the high connection fee charged by BT for its wholesale broadband products. It currently costs ISPs £50 to connect a customer to ADSL. However, the work involved is less complex than the connection for LLU, which costs approximately a third less.

Broadband Speed and Definition 12. In 2003, standard broadband—by which we mean the most popular type oVered by resellers of BT’s wholesale broadband product range—was 512Kbit/s. Now, with wholesale broadband oVering speeds up to 2Mbit/s nationwide and 8Mbit/s in metropolitan areas, the average speed is considerably higher than previously stated. Wanadoo’s LLU plans involve utilising latest technologies such as ADSL2!, which oVers speeds of up to 18Mbit/s to consumers. 13. In our 2003 evidence to the Committee, we highlighted customer confusion as to what is the definition of broadband. Oftel’s old definition (used for statistical and statutory market review purposes) was that broadband was anything faster than narrowband (56Kbit/s). We are concerned now as then that consumer expectation, especially when more bandwidth-intensive services are being oVered, is unlikely to be met. A more robust definition of broadband is needed—one that will both protect consumers from misleading advertising and further would enable a more accurate comparison with broadband elsewhere in the G7.

Product Innovation and Convergence 14. In the past, broadband and other forms of Internet access were fairly simple propositions, concentrating primarily on web-surfing and email communications. In the future, broadband will be at the heart of home entertainment activities. Broadband ISPs will evolve into Broadband Service Operators, oVering bundles of “multi-play” products. 15. The Wanadoo LiveBox is an example of a broadband home gateway through which a wide range of products and services—including fast Internet access, voice telephony over IP (VoIP), TV services (movies on demand and broadcast TV) and home security—will soon be oVered, followed by full convergence between fixed and mobile telephony. This is shown graphically below: Ev 84 Trade and Industry Committee: Evidence

From Mono-play …through Triple-play …to Home Networking and Mobile Convergence

Mail Service

Mail IM Service WiFi Service NG IM IP Mail Web Net- Livebox Service Service Livebox WiFi Service work Broadband Web IM Pipe VoIP Bluetooth Service Service BB Service ADSL Pipe VoIP Web Modem TV Service Service Service WiFi

TV New Service Service

New Service

Wanadoo Home Integrated Operator Model

16. Such a range of innovative products and services requires control of infrastructure and guaranteed quality of service, which is one of the reasons why LLU is important to operators’ strategies, in addition to the cost savings which may be gained through ownership of network assets. Such innovations are also bandwidth-intensive, which again is why average broadband speeds are set to rise considerably during 2005.

Local Loop Unbundling 17. As committed to TISC in 2003, following Ofcom’s decision to reduce prices, Wanadoo and at least two other operators announced a significant investment in LLU. We have now started this process. 18. Total investment over the next few years is likely to be in the hundreds of millions of pounds. Without Ofcom’s excellent work in this area, this investment would not have happened. However, there is concern that Ofcom’s LLU policy will be diYcult to implement due to ongoing problems with pricing, products and processes of LLU and related products such as backhaul and that these problems will constrain investment in LLU. There is still no mass-market migration product from wholesale broadband to LLU despite protracted industry negotiations. Backhaul products are still not fit-for-purpose and in addition are too expensive to make LLU a viable option for more rural areas at present. 19. Furthermore, there were fewer than 38,000 unbundled lines in the UK at the end of September 2004. This compares to over 1.6 million unbundled lines in France (as at 1 January 2005), of which over 500,000 were added during Q4 2004. In France, such growth was only achievable with the cooperation of France Te´le´com. BT will need to eVect a significant change in operational behaviour for LLU to be as successful in the UK as it is in France.

Regulation 20. The UK broadband regulatory environment significantly improved during 2004: — Ofcom reduced the price of shared LLU by approximately 70%. It also established the OYce of the Telecoms Adjudicator to resolve LLU product development and process issues. — Ofcom issued a Statement of Objections against BT for breach of UK and EU competition law in relation to its residential retail broadband pricing strategy. A final decision is expected later this year and may well involve a significant financial penalty as well as subsequent damages claims from those ISPs which have been forced to follow BT’s pricing behaviour. — Ofcom reviewed the regulatory framework for Voice over Broadband (VoB), allowing it to fulfil its potential to constrain BT’s dominance in voice telephony markets. 21. Ofcom’s strategic review of telecommunications has addressed many of the structural problems which have plagued the telecommunications market since 1984: — Ofcom acknowledged that regulation has not succeeded in constraining BT’s dominance. — It was critical of the way in which BT has given its downstream operations discriminatory access to its monopoly assets (referred to by Ofcom as “enduring economic bottlenecks”). — The principle of “equality of access” is appropriate given that reliance on competition law investigations has not constrained BT’s behaviour in the past. Trade and Industry Committee: Evidence Ev 85

22. We support Ofcom’s principle of promoting competition at the deepest levels of infrastructure where eVective and sustainable and of focusing regulation to deliver equality of access beyond those levels. History has shown us that where regulation focuses solely on promoting competition at the service-provider level (and ignoring competition at the infrastructure level), it only deals with the symptoms, not the root cause of persistent dominance and as such, does not lead to eVectively competitive markets. 23. However, a number of policy and practical issues remain unresolved, which together call into question whether the environment is conducive to attracting significant investment in LLU. The above successes, while clearly significant, must be read within this wider perspective: — Despite being served with a Statement of Objections, BT’s residential retail broadband pricing remains anti-competitive. Since receiving the Statement of Objections in early September 2004, BT has further reduced the price of its retail broadband product from £19.99 to £17.99 and again to £15.99 for the first three months of subscription. It has seen its cost base increase by (in some cases as much as) quadrupling the bandwidth given to its customers. This is clear evidence that competition law does not act as a constraint on BT’s behaviour which, it is submitted, is why the principle of equality of access is required to ensure a level playing field. — LLU implementation is slow. The market still has the impression of significant reluctance on the part of BT to make LLU a success. While BT senior management are giving signals of support, this is not always met with the same enthusiasm operationally. — Full LLU prices remain much higher than elsewhere in Europe. It is 35% higher than the expected price in France. While BT has suggested that prices may fall by 8%, this is not enough and is in any event apparently dependent upon Ofcom giving ground on other regulatory issues. A 25% reduction is required to bring the UK in line with the expected price in France. — The cost of backhaul—the BT product range needed by LLU operators to extend their network reach beyond metropolitan areas—remains high and is a major constraint to the expansion of competition in wholesale and retail broadband markets. — There is currently no margin stability for investment in LLU. BT can reduce its wholesale broadband prices so as to fundamentally undermine the business cases of LLU operators, risking stranded assets where it would be cheaper to purchase wholesale broadband than to continue using LLU assets. This is not a theoretical problem: BT recently “deaveraged” its wholesale broadband prices, but only in the 561 telephone exchanges likely to be the initial targets for LLU investment. This may delay or even reduce LLU rollout volume because it will be cheaper to take IPStream than LLU in a significant number of exchanges and it will create unnecessary postcode-based price discrimination. — BT’s recent behaviour risks creating a significant digital divide between metropolitan and more rural areas. In addition to higher pricing in rural areas, BT has recently announced to its ISP customers that it will only be oVering higher-bandwidth products (such as IPStream Max and ADSL2!) in those 561 metropolitan exchanges where it will be subject to competition from LLU operators. — BT’s 21st Century Network (21CN) project raises significant risks of BT building unreplicable and discriminatory access into its new network infrastructure. While BT seems to have acknowledged this in its response to Phase 2 of Ofcom’s strategic review, we are still concerned by the lack of clarity on this issue.

Role of Government and Ofcom 24. Both Government and Ofcom have a crucial role to play in facilitating this vision of a Broadband Service Operator. The environment in which such companies operate requires them to control the underlying network infrastructure (which can only be achieved through LLU), requires regulatory certainty and protection from abuse of dominance. 25. This is especially true given the considerable investment anticipated by the market in LLU. The primary focus of Government and Ofcom should be to encourage and protect investment in LLU as best method of stimulating eVective competition, which is in the benefit not only of the telecommunications sector but also of consumers. 26. Government and Ofcom’s duty to protect consumers dovetails with this vision. EVective competition spurs innovation: BT for example is only increasing the bandwidth of its wholesale broadband products in areas where it is subject to competition from LLU operators. By providing protection from anti-competitive activities, Government and Ofcom will be protecting the vision to provide them with next-generation broadband services. 27. We believe that a number of further actions are required to remove the remaining barriers to achieving the UK’s competitive potential and to provision of next generation broadband services to as many customers as possible: Ev 86 Trade and Industry Committee: Evidence

— Margin protection should be aVorded to LLU operators to ensure that BT cannot undermine their business plans. For areas where LLU is viable (which is larger than the 561 exchanges currently identified by BT), there should be a fixed minimum margin between LLU and wholesale broadband. For areas where LLU is not viable (and where wholesale broadband is therefore the enduring economic bottleneck), wholesale broadband pricing should be cost-orientated (also known as “cost-plus”). — The definition of broadband should be changed to one which recognises the shift towards higher speeds and one which will not disappoint or mislead our customers. — A more robust application of competition law is needed against dominant companies which repeatedly engage in anti-competitive activities. — BT should be required to reduce the connection fee for wholesale broadband, where it is found to be making excessive profits. — It may also be appropriate for Government and Ofcom to set a target of unbundled lines and set strict contractual penalties against BT should they fail to deliver this.

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