The case for dark fibre access A REPORT PREPARED FOR VODAFONE

January 2015

© Frontier Economics Ltd, London.

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The case for dark fibre access

Executive Summary 3 1 Conclusions: The introduction of dark fibre remedies is now appropriate 5 1.1 Transport networks have evolved towards mature, widely adopted standards and technologies ...... 6 1.2 Significant network upgrades and enhancements are frequently required to accommodate explosive growth in supply and demand for capacity ...... 7 1.3 CPs have the reach and capability to efficiently leverage BT’s vast fibre estate ...... 9 2 Transformation in Telecom networks 12 2.1 Traditional Interface Service-Specific Networks ...... 12 2.2 Alternative Interface Multi-Service Networks ...... 15 3 Transformation in demand for services 21 3.1 Mass market ...... 21 3.2 Corporate Market ...... 25 4 Transformation in the UK market landscape 35 4.1 The Duopoly Review and Infrastructure Competition ...... 35 4.2 Access bottlenecks and Telecom Strategic Review ...... 36

Contents ii Frontier Economics | January 2015

Figures and Tables

Figure 1: UK telecom market evolution 2000-2014: key milestones ..... 5 Figure 2: BT Network hierarchy, circa 2000 ...... 13 Figure 3: Generic Fixed Access Network ...... 16 Figure 4: Average download speed for Mobile Networks ...... 18 Figure 5: BT 21CN ...... 20 Figure 6: Volumes of Outbound Voice Traffic 2000-2013 ...... 21 Figure 7: Consumer and SME Broadband Connections 2000-2013 ... 22 Figure 8: Consumer Broadband speeds and Prices ...... 23 Figure 9: Number of Internet connected devices per Household ...... 23 Figure 10: Global Mobile Data Traffic Forecasts 2013-2018 ...... 24 Figure 11: Uptake of services amongst Business users in 2005 ...... 26 Figure 12: Spending and Volumes of Corporate data services, 2003- 2004 ...... 27 Figure 13: Business Fixed Voice Volumes 2002-2013 ...... 28 Figure 14: Volumes of Ethernet Connections 2007-2013 ...... 29 Figure 15: Volumes of PPC Connections 2007-2013 ...... 29 Figure 16: TI services volume trends 2011-2016 ...... 30 Figure 17: Volumes of Ethernet Services 2008 - 2016 ...... 31 Figure 18: Price per Mbps of Ethernet Local Access Services and PPC terminating segments ...... 32 Figure 19: Business Mobile Voice Volumes 2008-2013 ...... 34

Table 1: Per Device Usage (MB per month) ...... 25 Table 2: EAD Local Access and EAD Connections 2013 and 2014 ... 33

Tables & Figures

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Executive Summary

The UK telecommunication market has undergone a very significant transformation in terms of technology, demand and competition in the past 15 years. In the first part of this period (from approximately 2000 to 2005), access was primarily narrowband for both fixed and mobile networks. The introduction of PPC in 2000, allowed CPs to efficiently connect their networks to corporate customers through a small number of interconnection points on BT’s network. The 2004 Telecommunications Strategic Review dramatically changed the consumer fixed market, with operators using LLU to offer broadband and voice services. This led to a rapid increase in the uptake of broadband services but also led CPs to co-locate at a much larger number of BT exchanges than previously, where CPs could offer nationwide services though a small number of points of interconnection. The LLU based operators were also significant users of Ethernet services for backhaul from their equipment co-located in BT’s exchange sites. Corporate customers also began to migrate their voice and data traffic from TDM based access to converged Ethernet networks. In the last five years the growth in fixed broadband has been echoed by huge growth in mobile broadband, with the widespread adoption of smartphones. The introduction of LTE, along with the licensing of additional spectrum, should allow this growth to continue. The development of ‘carrier grade’ Ethernet has allowed operators to migrate the vast majority of traffic in the aggregation network to Ethernet networks, rather than operating dual TDM and packet switched networks. The market is now characterised by convergent transport networks using robust, flexible and cost efficient network protocols supporting a range of broadband access technologies. This has radically altered network economics, removing the need to set high end user prices for traffic in order to limit demand for core transmission. This move to ‘unmetered’ traffic has led to an explosion of demand driven by new applications. Customers now expect these applications to work seamlessly over different access networks with the evolution of fixed and mobile access networks allowing for customers to use ever increasing volumes of data. The move to unmetered transport has also changed the focus of competition to access networks, with both fixed and mobile networks competing to offer broadband connections. This has resulted in thousands of network nodes being operated by CPs throughout the UK and generating high and increasing volumes of broadband traffic: whether these are mobile base stations or network equipment sited in BT’s exchanges. However, significant residual bottlenecks exist, with network bandwidth being artificially constrained where BT has

Executive Summary

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maintained control over infrastructure which has proven difficult to replicate. These bottlenecks occur in two main areas

 In high quality connections to corporate users, in areas where there is no alternative access providers; and

 For backhaul for fixed and mobile access networks. In both these areas BT has used its market power, derived from its control over fibre infrastructure, to artificially inflate prices for higher bandwidth services1 in order to maximise profits where there is no longer sound technical or economic reasons to restrict bandwidth. The lack of competition for these services allows BT, as a dominant provider, to offer a reduced quality of service and to slow the adoption of new services and technology2, further reducing the flow of the benefits of technological improvements to customers. In many past instances, regulatory intervention at critical junctures in the development of the UK telecom industry contributed to the removal of bottlenecks and constraints to competition, most importantly with the introduction of infrastructure competition following the 1991 Duopoly Review and the introduction of passive remedies for copper access (LLU) and of Equivalence of Inputs requirements following the 2004 Telecom Strategic Review. It is our view that we are now at another critical juncture in the evolution of the UK telecoms landscape, where a regulatory intervention is warranted, in the direction of making BT’s passive fibre access inputs broadly available to CPs. Availability of dark fibre would largely remove the remaining artificial bottlenecks, allowing corporate users access to higher bandwidths, boosting productivity, and removing the bottlenecks that prevent the full exploitation of the next generation of mobile and fixed broadband networks. The absence of dark fibre or similar passive remedies allows BT to leverage its market power by restricting capacity and innovation in this part of the networks. This would act as a major hindrance for further market development as it may limit the benefits of current network standards and technology, constrain network upgrades and innovation and generate network duplication and inefficiency.

1 As Ofcom points out in the consultation document (para 2.14), in BT current offer “The bandwidth gradient (i.e. the change in price charged when moving to a higher capacity circuit) exceeds the gradient of the incremental cost in relation to bandwidth” 2 All Product Development activities are subject to Openreach “Statement of Requirements” process (http://www.openreach.co.uk/orpg/home/products/productdevelopment/)

Executive Summary

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1 Conclusions: The introduction of dark fibre remedies is now appropriate

The last 15 years have seen a radical transformation in the UK telecom market:  IP/MPLS networks exploit the capability and flexibility of optical and Ethernet transmission technologies to efficiently deliver many services and applications on converged Multi-Service Platforms (“MSPs”) at very low incremental cost in comparison with previous SDH transmission networks3;  Users access voice, data, video, social networking and entertainment services with high speed broadband connections, from both fixed and mobile terminals, feeding unprecedented growth in demand for network capacity;  Regulatory decisions on infrastructure competition and network access and industry consolidation have contributed to the establishment of a competitive landscape characterised by a number of players offering competing access networks with significant reach and capabilities

Figure 1: UK telecom market evolution 2000-2014: key milestones

3 P. 36 of this report

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It is this interworking of technology, demand and policy decisions that makes the UK market extremely dynamic, where changes occur at an increasingly accelerated pace. It is our belief that a policy decision on the availability of a dark fibre remedy is critical to ensure continued dynamism and fast paced innovation in our market.

1.1 Transport networks have evolved towards mature, widely adopted standards and technologies The remarkable evolution of telecom networks in the past decade has been mostly driven by the need to establish platforms that were fit for purpose to accommodate the huge uptake of services based on the Internet Protocol (“IP”). The popularity of Internet applications highlighted the fact that traditional circuit-switched/oriented networks were an extremely costly transmission mechanism. While TDM technologies continue to make sense for some specialist applications with typically constant and modest bit-rate (voice but for instance also industrial controls and telemetry), the great majority of applications now demanded by users around the world rely on sending and receiving information in bursts, as when using a search engine, or uploading material in a social network page, or downloading video content. These applications are best served from a capacity management perspective by IP networks that allow different applications to co-exist on shared network resources on a common infrastructure. The development of low cost Ethernet switches and IP routers and the rapid increase in their capabilities over time, reflecting ‘silicon’ economics meant the per unit transport costs of IP based networks were orders of magnitude cheaper than traditional circuit switched networks. Because the “best effort” nature of IP networks created risk of conflict or degradation for the services they carried, while IP networks became rapidly popular for consumer applications, corporate users and carriers were more cautious in their uptake for business critical applications. The emergence of Ethernet as an efficient transmission medium for IP traffic and the evolution of Ethernet standards, over a number of years, into so-called “Carrier-Grade Ethernet” meant that most of these quality and service risks were gradually addressed and tackled4.

4 For instance, different applications can be identified within a single transmission bearer (VLAN tagging), applications can be prioritised for end-to-end delivery to ensure that delay-sensitive applications do not

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These (and many other) developments have fully opened the Business and Wholesale communication market to a new network approach whereby high level of security, predictability and service levels can be delivered on “flat” and “multi- service” networks, which, by reducing the number of aggregation and multiplexing layers, use shared resources more efficiently. Ethernet is also highly interoperable and can be supported on almost any physical media, including point-to-point (“P2P”) fibre with no need for separate transmission and switching protocols. As a consequence, Ethernet has become the dominant technology for network backhaul and aggregation and for corporate access, with significant investment in further innovation and development of Ethernet standards fostered by working groups such as IEEE 802.35 and associations such as the Metro Ethernet Forum, which currently counts 134 Communication Providers worldwide amongst its members. We believe that the existence of these widely accepted standards could provide a significant spur to the competitive dynamic, and that there is minimal risk that introducing dark fibre regulation will be overtaken by technology changes or may dis-incentivise migration to a new technology. To the contrary -- and similarly to the experience of copper access regulation (Local Loop Unbundling) where passive remedies coupled with prevalence of DSL standards resulted in vastly improved availability, quality and value of broadband services6 -- fibre regulation could facilitate further competition and innovation in Ethernet services.

1.2 Significant network upgrades and enhancements are frequently required to accommodate explosive growth in supply and demand for capacity Technological and network developments have contributed to a significant change in Consumer and Business services demand patterns.

degrade (Classes of Service), specific customer traffic within a carrier network can be fully separated for privacy and security (PBB/tunnelling) and customer connections can seamlessly traverse different carrier networks (ENNI interconnects). 5 Working Group on Ethernet standards 6 p. 25 and 26 of this report

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The UK telecoms market has been thoroughly transformed from a voice-centric, narrowband fixed-access environment in 2000 to a data-centric, application rich, fixed and mobile high speed access environment in 2014. Over the past decade or so:  The number of fixed broadband connections has grown very substantially, with increasingly higher speeds available to consumer customers driving the adoption on “Over The Top” video and other interactive applications;  Mobile networks have evolved from voice-centric 2G technology to 3G/4G technology which has triggered increased popularity of data- capable wireless devices such as smartphones and tablets, driving a massive and rapid increase of data service usage;  Business connectivity is increasingly reliant on Ethernet services as access mechanism to Multi-Service platforms, with traditional SDH services as access mechanism to service-specific data networks becoming increasingly obsolete. In recent years we have witnessed an explosion in bandwidth demand by users across fixed and mobile networks there is an expectation of exponential growth in access capacity requirements. This has a significant knock-on effect on network deployments. CPs need upgrades and enhancements to their site access, backhaul7 and core routes with increasing frequency. Speed, flexibility and innovation in implementing these upgrades are critical for CPs to anticipate and respond to customer demand. In the past CPs have often moved at different speeds in adopting network enhancements in support of innovative applications. From this perspective a degree of infrastructure control is important. There is evidence that CPs enjoying control of their own infrastructure were often able to avoid dependencies on the incumbent’s offer and seize prime mover advantage. For instance in the UK COLT launched Carrier Grade Ethernet services in the London area and Virgin Media delivered Synchronised Ethernet capability in high capacity services in advance of BT. As many CPs made clear in their responses to Ofcom’s Call for Inputs on, amongst other issues, Passive Remedies in April 2014 that, from CP’s standpoint, the availability of fibre from BT would allow them to meet access and backhaul

7 Defined as link between a CP network access/aggregation point and a CP service node, as per Ofcom BCMR – Consultation on Data Analysis, October 8th, 2014, para 2.8 and 2.23

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needs, fostering innovation, improving network performance and accelerating implementation of upgrades and deployment of new networks.8

1.3 CPs have the reach and capability to efficiently leverage BT’s vast fibre estate The transformation of the UK competitive landscape has also been very significant. The market has been shaped by important regulatory interventions, in particular the Duopoly Review of 1991 which introduced infrastructure competition and the Telecommunication Strategic Review of 2004 which addressed the significant mass market access network bottlenecks at the time. In parallel technology evolution and the turmoil that followed the “dot-com bubble” of the late 1990’s has led to significant industry consolidation. Those operators that are results of mergers combined the access and interconnect assets of their constituent parts and consolidated their aggregation and core networks over time. Today’s UK market is populated by a relatively small number of players with significant network resources and technical capabilities, often operating across the fixed and mobile sector, providing services to both Consumers and Businesses. Some operators have co-located POPs in as many as 3,000 BT exchange buildings9. Vodafone currently co-locates in over {confidential} exchanges. Carrier Ethernet or Ethernet over MPLS backhaul are normally used to connect Ethernet access nodes (often co-located in BT exchanges) which function as access to Multi-Service-Platform, i.e. supporting both Broadband Gateways (for Consumer services) and PE-routers (for Business services). This means that CPs increasingly use BT Ethernet access services rather than BT “leased lines”10 . From a wholesale perspective, the transition from prevalence of leased lines products, such as Partial Private Circuits, to Ethernet products, such as Ethernet Access Direct, has meant that CPs have become markedly less reliant on BT’s network to provide aggregation and long distance transport.

8 Business Connectivity Market Review Final Statement, Section 8, Para 8.67 to 8.72 9 TalkTalk interim results presentation 11 November 2014, p.37, http://www.talktalkgroup.com/~/media/Files/T/TalkTalk-Group/pdfs/presentations/2014/h1- fy15-presentation.pdf 10 P. 33- 35 of this report

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With PPCs, any CP with Points of Handover connecting a few dozens of “Tier 1” nodes could rely on BT’s transport network to achieve national coverage and avoid “trunk segment” charges (i.e. the charges levied by BT to carry traffic across its network between Tier 1 nodes). The complexity of SDH transport networks, with logical point to point links potentially being carried over a number of fibre rings and with traffic aggregated from a number of routes on a single ring, meant that replicating BT’s backhaul network would have been complicated. In the case of Ethernet services, CPs can interconnect at thousands of locations on BT’s access network and aggregate and transport traffic on their own networks rather than BT’s. In fact, Ethernet services are increasingly purchased in their “Local Access” version, i.e. for the final connection between the local exchange, where CPs are co-located, and corporate customer sites, therefore avoiding BT “main link” charges. In these cases BT does not perform any aggregation or long distance transport activity, with the aggregation network built up from simple point to point links. The trend towards use of “Local Access” services is accelerating. For instance, in the past year alone, the % of new Ethernet Access Direct connections purchased by other CP’s from Openreach (so-called “external sales”) in their “local access” version have increased from 39% to 55%.11 Given this growing prevalence of local access services, and since access to business customer sites and radio sites is generally provided on P2P fibre, no fibre aggregation is done in the terminating segment of BT Ethernet services, i.e. effectively BT is barely providing a fibre service bundled with an active device (NTU) before handing off to other CPs at the local exchange. The use of BT active services by a CP in these instances is not efficient from a network equipment and service delivery perspective. BT active devices are effectively redundant and the provision of a stand-alone fibre link to a CP would not consume any additional fibre resources compared to an active service provided by BT to the same CP using the same fibre link in a P2P configuration. It would be more efficient if customer and CP sites could be connected with “native” Ethernet, i.e. using dedicated fibre pairs and an Ethernet demarcation device without need for active devices. The availability of dark fibre for customer connections would be a necessary but not a sufficient condition for CPs to leverage this more efficient approach to connectivity based on passive inputs. In fact, when CPs purchase Local Access versions of Ethernet services, they aggregate traffic and connect their equipment collocated at BT Local Exchanges

11 BT Regulated Financial Statements 2013/14

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to their own service nodes either by using their own infrastructure or, more frequently, by using another BT active service, such as Ethernet Backhaul Direct12. The use of BT active Backhaul products also results in an inefficient duplication of active equipment: in most instances BT installs additional active equipment to light the fibre which simply mirror CPs’ own active equipment which could also light the fibre. Allowing CPs direct access to the underlying fibre would avoid such duplication.

12 In some instances, CP may also opt to buy Ethernet Local Access services from another CP on a resale basis, i.e. using this second CP backhaul network to connect to their service nodes rather than using BT “main link” components.

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2 Transformation in Telecom networks

2.1 Traditional Interface Service-Specific Networks If we look back at the typical network architecture at the turn of this century we can see that Communication Providers relied on networks that had a high degree of separation either by service or application, were more hierarchical and more complex than modern networks.  Access was mostly provided on narrowband copper or low speed radio access. Fibre access was available to business customers but generally in support of relatively low speed (e.g. 2Mbps) services  Networks were characterised by a strict hierarchy whereby customer connections would be aggregated at various levels to make the best use of relatively expensive transmission with switching carried out at all levels except the lowest level of concentrators;  Each service (voice, private line, ATM, MPLS) was provided on its own overlay network of dedicated nodes and exchanges, with a common transmission platform  The links between hubs and concentration sites and service exchanges, and between exchanges were provided on PDH and SDH platforms,  There was a high degree of separation between Fixed and Mobile networks, save for the ability to route voice calls between each other.

2.1.1 Access Copper access was prevalent for a both voice and low speed (n x 64kbps) data applications. Fibre access was available for higher speeds (2Mbps and above), although a substantial proportion of 2Mbps lines were provided on copper interfaces. For voice services specifically, copper access lines were aggregated in Remote Concentration Units (“RCUs”). For data services, copper and fibre ‘leased line’ access was aggregated in “bandwidth hubs” (Add-Drop-Multiplexer sites), where no switching capabilities and “intelligence” resided, with the exception of “big” users circuits (e.g. STM- 1s) which tended to be connected directly to service nodes. DSL services were in their infancy with BT choosing not to invest heavily in mass market broadband. BT only started to unbundle the local loop -- i.e. disconnecting links from the Multi-Distribution Frames (“MDFs”) to local exchanges and connecting them instead to a DSL Access Multiplexer controlled by another CP – in 2001. Conditions for LLU unbundling were not particularly

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advantageous for CPs, particularly in the ability to command space in DLEs to locate DSLAM equipment. Between 2001 and 2004, only 8,000 lines were unbundled and only the regulatory intervention following 2004 Telecom Strategic Review made the service provided by BT fit for purpose for CPs. Mobile access was subject to the limitations of 2G networks, which meant that mobile services were narrowband and designed to carry primarily voice and SMS services. The first 2G data applications started to appear (in fact the first commercial UK GPRS service was launched in 2000) but large corporate mobile networks, mainly developed for utilities and emergency services, were still operated on dedicated digital Public Access Mobile Radio (“PAMR”) networks (e.g. TETRA standard).

2.1.2 Aggregation and Core In the fixed network, access lines were usually multiplexed and aggregated to PDH and SDH transmission bearers to voice and data switches which were the gateway to dedicated and separate networks: PSTN, Private Circuits Networks, ATM Networks and the first few IP Networks. BT network of the era, although hardly unique, offers a good illustration of the typical network approach at the time.

Figure 2: BT Network hierarchy, circa 2000

Source: Various BT industry presentations

BT’s PSTN network was composed by almost 7000 RCUs which aggregated traffic from a number of lines onto 2 Mbps trunks connected to 770 Digital Local Exchanges (“DLEs”).

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DLEs switched calls between subscribers where both calling and called parties were connected to the same DLE (or the RCUs connected to the DLE) in order to minimise the usage of transmission links, even though the cost of switching processors was relatively high. Calls from one DLE to another DLE were routed to the so called Tandem network which was made of 194 switches13: 76 Digital Main Switching Units (DMSUs) were dedicated to long distance calls, 16 Wide Area Tandems (WATs) to intra-region calls, 13 Digital Junction Switching Units (DJSU) dedicated to address the significant traffic volumes of the London area and 26 Advance Services Units (ASUs) for the provision of Intelligence Network services (e.g. Non-Geo). 63 Next Generation Switches (NGS) were also in service, which over time replaced many DMSUs and WATs. This structure provides a stark representation of the strictly hierarchical nature of traditional networks and its consequences: in order to address the challenge of routing high volume of traffic from DLEs reasonably close to each other without consuming resources in the long distance network (DMSUs) an entire layer of “intra-regional” tandem switches (WATs and DSJUs) was created. In order to provide slightly different services and features, such as Freephone or Non- Geographic services, a dedicated infrastructure (ASUs) had to be established at significant cost within the network. In today’s IP-centric world this would be unthinkable. BT’s data network(s) had a similar structure. Customer lines aggregated in either RCUs (for low speed n x 64kbs data services on copper lines) or bandwidth hubs were routed to ~400 Digital Private Circuit Network (“DPCN”) nodes for the provision of Private Line Services, ~100 ATM nodes for the provision of ATM, Frame Relay and VPN services and ~15 IP nodes for the provision of IP and MPLS services. These networks were meshed or configured in rings to provide resilience and nodes connected to each other via SDH transmission links. For instance, following the introduction of Partial Private Circuits in 2001 CPs could rely on a relatively small footprint of Points of Handover to BT main nodes to achieve national coverage. In most cases BT’s network was still used for the transport and aggregation of corporate access lines to the core of the network. Mobile networks replicated to some extent the structure of fixed networks relying on TDM switching and transmission. While obviously service access rely on radio transmission between customer handsets and Base Station Transmitters (“BTS”) rather than fixed lines, traffic aggregation and routing across the core of the mobile network had significant similarities with the PSTN.

13 Due to capacity constraints there were also some direct DLE to DLE switching links.

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BTSs and Base Station Controllers (“BSCs”) effectively aggregated traffic from a number of radio links and transmitted them to Mobile Switches where routing of voice traffic to the rest of the mobile network and to the PSTN is performed. It must be noted that from a functional perspective BSCs are significantly more sophisticated than fixed RCUs as they handle allocation of radio channels and control handovers from BTS to BTS, i.e. ensure that the user can enjoy the service while moving across the cellular network. However with lower traffic volumes, there was less need for complex switch hierarchies to minimise the cost of transmission. The low levels of traffic and geographic dispersion of base stations also meant that is was often cost efficient to self-provide microwave links provide backhaul links from base stations, compared to purchasing or installing fixed wireline links.

2.2 Alternative Interface Multi-Service Networks Current network structure is radically different:  A variety of access methods allow high speed broadband access from both wireline and wireless networks, from fixed locations and in mobility;  Lower levels of the network generally have a purely aggregation function, making the network flatter and less hierarchical. Remote Access Nodes are typically capable basic of Ethernet switching functions, while MPLS functionality is normally established at Service Edge nodes;  Network resources can be shared across multiple services and applications on IP/MPLS Multi-Service Platforms (MSPs) built on wide area Ethernet networks. Many carriers consolidate Service Edge functionalities for both Broadband Network Gateways (“BNGs”), i.e. network edge for DSL and FTTC networks and MPLS PE router functionality for business services.  High-capacity transport and switching of enormous amount of Ethernet traffic can be performed on secure high-speed optical links with redundancy provided by dual homing nodes rather than relying on SDH rings;  Software-controlled Service layers can be shared across fixed and mobile networks, allowing service convergence across the two domains and enabling customers to enjoy services and applications seamlessly on both fixed and mobile connections and devices.

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Figure 3: Generic Fixed Access Network

2.2.1 Access

High Speed Broadband: xDLS, FTTC and DOCSIS Currently in the UK the most usual form of high-speed broadband access, particularly orientated to Consumers and SMEs, is based on xDSL technologies. DSL standards have evolved significantly in line with development of equipment that permitted the exploitation (and demarcation in upstream and downstream bands) of frequency bands left unused by so-called Plain Old Telephone Services (“POTS”) over copper cables. Successive waves of development in equipment (ADSL, ADSL2, ADSL2+, VDSL, VDSL2) has increased the number of usable frequency bands and hence the available throughput in a copper line. The current “gold standard” for xDSL services is VDSL2. Because of the physical characteristics of copper, however, signal degradation is an important factor: VDSL2 permits the transmission of asymmetric and symmetric aggregate data rates up to 250 Mbit/s (combined downstream and upstream) in the lab, but signal deteriorates quickly resulting in data rates of 100 Mbps at 0.5km, 50 Mbps at 1 km, reaching equivalence with ADSL2+ (24Mbps) at 1.6km. For this reason, VDSL2 only became commercially available in Fibre To The Cabinet (FTTC) topology whereby copper loops only extend from customer premises to a nearby street cabinet (as opposed to local exchanges as in ADSL2+) from where signal is transported on Ethernet circuits over fibre links to Multi-Service Access Nodes (“MSANs”). Cable Networks use different technology based on DOCSIS 3.0 standards. Topology is similar to FTTC, with fibre links reaching street-side cabinets, but performance is even higher than VDSL2 (up to 1.5 Gbps in the lab) because of the use of aluminum cables from Cabinets to Customer Premises, which are less subject to signal degradation than copper cables.

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Fibre services: FTTP, GPON and Point to Point Fibre VDSL2 and DOCSIS 3.0 have become in the past few years the platform of choice for the provision of broadband services to Consumers and Small Businesses where copper or coax access lines already exist. However, most requirements from Medium and Large corporates as well as Communication Providers can only be delivered on fibre links extending customer buildings. In fact, even in the consumer space, given the recent trends in bandwidth demand, Fibre To The Premise is increasingly preferred over VDSL2 for greenfield sites and new builds. Fibre To The Premise (FTTP) services can be delivered via either Point-to-Point fibre or Gigabit Passive Optical Network (“GPON”). Point to Point fibre is the prevalent option for higher speed services and for more sophisticated and larger users, which might need frequent capacity upgrades such as corporates and carriers (for instance for backhaul links from mobile radio base stations). In this case there is no dependency on optical aggregation and fibre is routed directly from the customer to a serving exchange. GPON is the prevalent options for consumer FTTC/P services where individual fibre links from cabinets or customer sites are fed into Optical Network Terminals then are aggregated in an Optical Line Terminal (OLT) for Ethernet handover at an exchange or service node. The advantage of GPON is the optical aggregation of several connections on a single fibre to the serving exchange. However, in order to ensure very high access speeds (10Gbps) the technical roadmap for GPON is subject to the availability of new optical components and technologies. From this standpoint Fibre P2P is expected to have a smoother evolution path compared to the equivalent PON solutions14.

LTE LTE/4G is a development of GSM/UMTS standards (2G/3G) allowing to increase the capacity and speed of wireless data networks using new digital signal processing (“DSP”) techniques and modulations that were developed from 2004 onwards. The first test roll-outs to the public date back to 2009, with full commercial launches across Europe, North America and Asia over 2012 and 2013. In the UK 4G/LTE has been rapidly gathering momentum following the first commercial launch in late 2012 (EE): Ofcom reported that as of March 2014 there were already 6m LTE users in the UK, compared to just over 300k 1 year earlier.

14 “Fibre Capacity limitations in access networks”. AnalysysMason Report for Ofcom, January 13th, 2010

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4G LTE is a significant evolution from the existing UMTS architecture which combined circuit and packet switching to provide voice and data services: LTE is based on a redesigned and simplified network architecture, based all-IP flat architecture system with significantly reduced latency and much higher capacity efficiency. LTE can deliver access speeds of up to 300Mbps which means that most of current IP-based applications, including video streaming and other Over The Top (OTT) services can be delivered as effectively to a mobile terminal as to a NGA broadband line, driving exceptional mobile data service growth. According to Cisco 15 4G connections have on average download speeds 3 times as fast as 3G connections.

Figure 4: Average download speed for Mobile Networks

The combination of much higher traffic volumes resulting from a combination of much greater spectral efficiency, a considerable increase in available spectrum and continuing demand growth from consumers means that the volume of traffic that can be generated by a base station has grown be an order of magnitude. As such mobile operators are seeking to replace self-provided PDH base microwave links with high capacity Ethernet links,

15 Cisco Visual Networking Index: Global Mobile Data Traffic Forecast Update, 2013-2018, February 5th, 2014

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2.2.2 Aggregation and Core Switching The development of multiple (fixed and mobile) high speed access options and the correlated explosion of demand for capacity, coupled with the increased robustness, sophistication and reliability of Ethernet transport has transformed how Communication Provider architect their metro and core networks, with a marked trend towards a “flat” architecture and the deployment of multi-service platforms. If we look at BT network architecture today 16 (which, again, is hardly unique) we can see how these changes have manifested themselves. The access layer, made in BT’s case by ~7000 RCUs is effectively replaced by ~5000 Multi-Service Access Nodes (MSAN) that rather than being gateways to a networks dedicated to a single service (voice), have the function of aggregating and converting voice and data services to IP. While some MSANs are still dedicated to the aggregation of copper lines only (C- MSANs) most can terminate fibre links (F-MSAN). Traffic generated from MSANs is backhauled using Ethernet over fibre or WDM to ~100 Metro node locations. IP routing and Ethernet switching is done at metro node level. Metro nodes also act as combined service gateways for voice, data and media services and applications. Metro nodes are parented to a small number of Core nodes (~20) where large scale routing is carried out and platforms for Terabyte global traffic exchange (IP Transit, Peering, Content Distribution Networks) are located. This architecture eliminates a number of aggregation layers and combines different access feeds and service types at the edge of the network so that they can share multi-functional metro and core infrastructure.

16 BT 21CN industry presentations

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Figure 5: BT 21CN

Source: BT Industry presentations

2.2.3 Convergence The effect of network transformation from hierarchical and complex networks of year 2000 to the “flat” and IP-centric networks of today is very evident in the proliferation of “converged” networks. The so-called Fixed Mobile Convergence (“FMC”) has been at the forefront of operators strategies throughout the year 2000s, but its development has been somewhat hindered by the complexity the so-called IP Multimedia Subsystem (“IMS”) on which FMC was based. The IMS approach was effectively to link and “translate” in a common IP language many different existing network standards and domains (some of which already obsolete) through complex inter- operability and peering interfaces. While FMC has had some success and found a number of application especially in the corporate sector, its diffusion in the broader market has been somewhat limited. The development of high-speed access and of IP-centric Multi-service architecture across fixed and mobile network has breathed new life in the Fixed Mobile Convergence environment. Native IP applications across data, video and voice services (VoLTE) can increasingly be accessed from fixed and mobile devices, routed on converged IP networks and managed by application controls shared across fixed and mobile networks. This is making the “converged” services a simple, yet high quality experience, providing further stimulus to the recent huge increase in demand of “Unified Communications” services, particularly in the corporate sector.

Transformation in Telecom networks

January 2015 | Frontier Economics 21

3 Transformation in demand for services

3.1 Mass market In voice services, fixed-mobile substitution has been an established trend throughout the 2000’s, with outbound mobile volumes reaching equivalence with outbound fixed volumes in 2009. In the same period, however commercial Voice Over IP (“VOIP”) services started to make some significant inroads in the UK consumer market 17: increasingly, voice is becoming an application provided to consumers and corporate customers over the top of IP MPLS networks, meaning that the BT’s PSTN network role in terms of transport and aggregation is becoming increasingly obsolete, as evidenced by the declining trends in voice (fixed + mobile) volumes, which has accelerated in the last couple of years.

Figure 6: Volumes of Outbound Voice Traffic 2000-2013

Fixed and Mobile Voice Volumes 300

250

200 59 71.4 88 105 118 34 43 52 64.2 126 131 132 132 134 150

100 174 172.6 165 167 BnOutbound Minutes 163.4163.2 154 149 141 128 123 111 50 103 92

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Fixed Mobile

Source: Frontier Economics analysis of Ofcom Communication Market Reports and Market Information

17 Ofcom’s research found that 12% of adults in the UK had used VOIP services in 2009. By 2014 this had grown to 35%, with half of 16-24 olds and 25-34 years old currently using VOIP.

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22 Frontier Economics | January 2015

In year 2000 less than 100k CATV customers were using broadband services in the UK. The bulk of users were accessing the Internet through dial-up services, which reached a peak of 12m users in 2002. At the end of 2013 there were almost 23m residential and SME broadband connections in the UK, of which almost 6.7m were provided “superfast” speeds (of 30Mbps and above) on VDSL2 and DOCSIS 3.0 Next Generation Access and 9.2m through Local Loop Unbundling.

Figure 7: Consumer and SME Broadband Connections 2000-2013

BROADBAND CONNECTIONS

25.0

1.1 2.3 20.0 0.4 0.1 4.1 4.3 4.0 4.4 3.8 15.0 3.7 3.4 7.5 7.9 8.8 3.1 5.5 6.4 9.2 10.0 3.7 1.3 2.7 0.2 5.0 1.9 8.6 8.4 8.1 8.0 8.1 7.0 7.8 7.5 6.6 1.4 4.1 0.8 1.7 0.0 0.1 0.10.3 0.6

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Residential Residential and SME Broadband Connections (M) FTTC/VDSL 0.1 0.4 1.1 2.3 DOCSIS/Cable 0.1 0.3 0.8 1.4 1.9 2.7 3.1 3.4 3.7 3.8 4.0 4.1 4.3 4.4 LLU ADSL 0.2 1.3 3.7 5.5 6.4 7.5 7.9 8.8 9.2 Non-LLU ADSL 0.1 0.6 1.7 4.1 7.0 8.6 8.4 8.1 8.0 7.8 8.1 7.5 6.6

Non-LLU ADSL LLU ADSL DOCSIS/Cable FTTC/VDSL

Source: Frontier Economics analysis of Ofcom Communications Market reports

Consumers are able to access broadband services delivering increasing throughput at affordable prices. The average broadband connection can deliver speeds 6 times higher than they were 5 years ago, and over the same period the average price per Mbps of throughput has decreased 5-fold. The increasing popularity of “superfast” broadband services on VDSL2+ and DOCSIS 3.0 suggests that this trend is set to continue.

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January 2015 | Frontier Economics 23

Figure 8: Consumer Broadband speeds and Prices

BROADBAND SPEEDS AND PRICES

20 17.8 25.00

20.00 15 19.29 17.81 16.44 16.55 12 16.81 16.96 15.00 10 7.6 6.2 10.00

5 3.6 4.1 PER £ MONTH 5.36 4.34 5.00 2.65 2.18 1.40 0 0.95 0.00 2008 2009 2010 2011 2012 2013

Average Broadband Speed (Mbit/s) AVERAGE BROADBAND SPEED(Mbps) Average Price Res Bband Connection(£ Month 2013 Prices) £ per Mbit/s throughput (2013 Prices)

Higher throughputs have enabled consumers to use more and more services, including Over-The-Top Video streaming. Over 50% of users use their broadband connection to watch TV content and 2/3 of households had at least 3 internet-enabled devices in their homes.

Figure 9: Number of Internet connected devices per Household

Source: The Communications Market 2014, Ofcom The mobile world hasn’t obviously been insulated by transformation in technology and consumer habits. With the advent of smartphones, mobile handsets are increasingly used to access data services, such as internet access, VOIP applications, streaming content, including video.

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24 Frontier Economics | January 2015

If possible, the trend towards higher access speed and bandwidth consumptions has been even more accelerated than with fixed network, driving the requirement for major backhaul and core network upgrades on the part of all MNO in order to accommodate massive capacity growth. Over 60% of UK adults currently have a smartphone, a growth of 20 points in just two years. Almost 9 in 10 16-24 year olds and 25-34 year olds have smartphones and regularly use data services. Considering that LTE/4G is effectively still in its infancy, accounting for only 8% of mobile subscriptions in the UK, the expectation is that demand for data services and capacity consumption will have a further steep increase as 4G penetration grows. According to Cisco18 Global Mobile data traffic will increase at CAGR of over 60% in the next five years, delivering a 10-fold increase in total traffic in 2018 vs 2013, to almost 16 Exabytes (i.e. 16bn Gigabytes19) per month of which ~half is carried on mobile networks, with the other half “off-loaded” (through Wifi routers) on the fixed network.

Figure 10: Global Mobile Data Traffic Forecasts 2013-2018

Global Mobile Data Traffic Forecasts 1 0.9 61% 0.8

CAGR 0.7 0.6 0.5 0.4

0.3 Exabyte per Month 0.2 0.1 0 0 0 0 0 0 0 0 0 0 0 0 0

Source: Cisco Visual Networking Index In the UK specifically traffic is expected to grow from 56 Petabytes in 2013 to 5.3 Exabytes in 2018, an eight-fold increase (51% CAGR).

18 Cisco Visual Networking Index: Global Mobile Data Traffic Forecast Update, 2013-2018 19 1Terabyte= 1000 Gigabytes; 1 Petabyte = 1000 Terabytes; 1 Exabyte = 1000 Petabytes

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January 2015 | Frontier Economics 25

This significant growth in data capacity consumption will be driven by both increase of number of devices, which is expected to exceed 10bn by 2018 (of which 2bn Machine-to-Machine – “M2M” - connections) and the shift towards “smarter” devices (smartphones, tablets) capable of faster connections (4G LTE), the users of which tend to consume more data.

Table 1: Per Device Usage (MB per month)

Device Type 2013 2018 Non Smartphone 11 45

M2M Module 61 451 Wearable Device 78 345

Smartphone 529 2,672

4G Smartphone 1,984 5,371

Tablet 1,374 5,609

4G Tablet 2,410 9,183

Laptop 2,455 5,095 Source: Cisco

3.2 Corporate Market The market for corporate services has also undergone a very significant transformation in the past 15 years. Voice services provided on PSTN exchange lines and ISDN channels formed the bulk of telecom requirements for over 90% business users20. In the first half of 2000’s, data services were supported through dedicated corporate networks built on point-to-point leased lines configured by the

20 Competition to Supply Business Telecoms, Continental Research and Research in Communications report for Ofcom, September 7th, 2005

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26 Frontier Economics | January 2015

corporate user to meet its requirement in terms of capacity and resilience. ~70% of large business users used leased lines in 200521. Incumbents typically priced the leased line which corporations used to self- provide private networks at comparatively high prices reflecting a combination of corporations’ high willingness to pay but also to limit ‘bypass’ of the public network for high margin services such as long distance and international call, by corporations. The high costs associated with dedicated private line networks led to increased popularity for “managed” services such as Frame Relay, ATM and Virtual Private Networks whereby Carriers wherever possible aggregated different corporate networks on shared trunk routes, managing dedicated channels with guaranteed throughput for each customer.

Figure 11: Uptake of services amongst Business users in 2005

21 Ibidem

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January 2015 | Frontier Economics 27

Source: Competition to Supply Business Telecoms, Continental Research and Research in Communications report for Ofcom, September 7th, 2005 The underlying transmission technology for the great majority of corporate services was PDH or SDH for high capacity networks. Ethernet was still in its infancy. Customer access speeds of up to 2Mbps were prevalent, with higher capacity connections (45/155Mbps and, more rarely, 622Mbps) were generally confined to the carrier market and major users for use on main trunk routes. In the early 2000’s only ~3% of corporate data connections were provided via Ethernet access22.

Figure 12: Spending and Volumes of Corporate data services, 2003-2004

Source: The Communications Market, 2005 - Ofcom

The move towards more data-centric and wireless corporate segment had a major impact in particular on voice telephony: business voice telephony volumes in 2013 were barely 1/3 of 2002 volumes. Volumes of exchange lines and ISDN channels also fell sharply, particularly in the past few years, with increased diffusion of VOIP and Multimedia platforms which make voice just another application running on corporate data networks rather than a stand-alone product.

22 The Communications Market 2005, Ofcom Report, July 2005

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28 Frontier Economics | January 2015

Figure 13: Business Fixed Voice Volumes 2002-2013

BUSINESS FIXED VOICE VOLUMES

70.0 12.0

60.0 10.0

50.0 8.0 40.0 6.0 30.0 4.0 (excluding NTS) 20.0

10.0 2.0

BN BN Outbound of Fixed Business Minutes 0.0 0.0

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 M of Business Business M of PSTN lines andISDNChannels

Business Fixed Voice Connections Business Fixed Voice Call Minutes

Source: Frontier Economics analysis of Ofcom Communications Market reports

Data services are generally provided on multi-service IP/MPLS platforms with Ethernet access and transport, rather than on dedicated corporate network based on leased lines, VPN or other dedicated managed services such as Frame Relay and ATM carried on SDH transmission. The trend towards Ethernet services and away from TI services, as well a marked shift towards higher Ethernet connection speeds (a trend that is accelerating) is evident from data available in BT’s Regulated Financial Statements. In 2013 only ~5,000 PPC connections were provided by BT, less than a 1/5 of six years previous. Instead, over the same period, Ethernet connections increased 3-fold, to ~32,000.

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January 2015 | Frontier Economics 29

Figure 14: Volumes of Ethernet Connections 2007-2013

18,000

16,000

14,000

12,000

10,000

8,000

6,000 No. No. of connections

4,000

2,000

0 2007 2010 2013 2007 2010 2013 2007 2010 2013 WES & EAD 10Mbit/s WES & EAD 100Mbit/s WES & EAD 1000Mbit/s connections connections connections

- Internal - External Source: Frontier Economics Analysis of BT Regulated Financial Statements

Figure 15: Volumes of PPC Connections 2007-2013

25,000

20,000

15,000

10,000 No. No. of connections

5,000

0 2007 2010 2013 2007 2010 2013 2007 2010 2013 Partial and Private Partial and Private Partial and Private Circuits 64kbit/s - Circuits 2Mbit/s - Circuits 34/45Mbit/s - connections connections connections - Internal - External

Source: Frontier Economics Analysis of BT Regulated Financial Statements

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30 Frontier Economics | January 2015

Ofcom research for the last Business Connectivity Market Review23 suggests that this trend is set to continue: it forecasts that “Traditional Interface” services (i.e. those mostly based on TDM transmission platforms such as SDH) volumes will more than half by 2016 compared to 2012.

Figure 16: TI services volume trends 2011-2016

Source: Business Connectivity Market Review Final Statement, Annex 12, Ofcom, March 28th, 2013 Volumes of “Alternative Interface” services, i.e. those mostly based on Ethernet access and transport are instead expected to grow substantially.

23 Business Connectivity Market Review Final Statement, Annex 12, Ofcom, March 28th, 2013

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January 2015 | Frontier Economics 31

Figure 17: Volumes of Ethernet Services 2008 - 2016

Source: Business Connectivity Market Review Final Statement, Annex 12, Ofcom, March 28th, 2013

The transition from Traditional Interface SDH services to more efficient Ethernet services also had the effect of significantly reducing capacity unit costs, as demonstrated by (cost orientated) BT wholesale prices for PPCs and EAD/WES services, as higher connection speeds are lower price with Ethernet services compared to PPC24 (SDH) services.

24 PPC price for terminating end and “Local Access” Ethernet prices are used in this comparison

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32 Frontier Economics | January 2015

Figure 18: Price per Mbps of Ethernet Local Access Services and PPC terminating segments

1,000

900

800

700

600

500

400

Price per Mbit/s (£) 300

200

100

0 WES/EAD WES/EAD WES/EAD PPC 64Kbit/s PPC 2Mbit/s PPC Local Access Local Access Local Access 34/45Mbit/s 10Mbit/s 100Mbit/s 1000Mbit/s 2007 2010 2013

Source: Frontier Economics analysis of BT Regulated Financial Statements

As CP expand their interconnect footprint, there is also a marked trend towards preference for “Local Access” versions of BT Ethernet services, whereby a terminating connection from a local POP to customer site is purchased, with no reliance on transport across BT’s network. Over half of Ethernet services purchased by CPs today are Local Access services.

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January 2015 | Frontier Economics 33

Table 2: EAD Local Access and EAD Connections 2013 and 2014

Source: BT Regulated Financial Statements, 2013/14

Similarly to trends for business fixed services and consumer mobile market, corporate users are also significantly increasing their use of mobile data services. While mobile voice volumes haven’t seen the sharp drop experienced by fixed voice volumes, business mobile volumes are also declining 25 as “over the top” VOIP apps and Unified communication services running on corporate networks increasingly capture a share of corporate voice usage.

25 The Communications Market 2014, Ofcom Report, August 7th, 2014

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34 Frontier Economics | January 2015

Figure 19: Business Mobile Voice Volumes 2008-2013

Business Mobile Voice

35

30

25

20

15

10

5

Business Business Mobile Voice Volumes Minutes) (BN 0 2008 2009 2010 2011 2012 2013

Source: Communications Market 2014, Ofcom

Corporate users account for ~1/3 of dedicated mobile broadband connections (compared to only 12% of voice connections)26 Business mobile traffic27 accounts for ~20% of total mobile data traffic in the UK and is growing at ~50% p.a. Volumes are expected to grow to 0.8 Exabytes per month in 2018 compared to 0.1 Exabytes at the end of 2013. M2M connections are also a key growth driver. 30% of UK business mobile data traffic is expected to be generated by M2M by 2018 28

26 Ibidem 27 Cisco Visual Networking Index: Global Mobile Data Traffic Forecast Update, 2013-2018 28 Ibidem

Transformation in demand for services

January 2015 | Frontier Economics 35

4 Transformation in the UK market landscape

4.1 The Duopoly Review and Infrastructure Competition The wholesale market in year 2000 was still broadly shaped by the duopoly review of 1991, and by the infrastructure liberalisation (including the award of CATV franchises) that followed. The regulatory regime differentiated between infrastructure and non- infrastructure operators, with only the former eligible to buy regulated cost-based interconnect services from the incumbent. In the early 1990’s Mercury (subsequently rebranded Cable & Wireless and now part of Vodafone) was the only wireline operator other than BT with significant long distance infrastructure. Some of the operators that entered in the UK market following the duopoly review focused on International Direct Dial (“IDD”) services, primarily to exploit the high margins available on voice calls through the opportunities brought by the concurrent liberalisation of international voice resale in several markets. These operators established very limited infrastructure (usually a single switch) to access regulated interconnect services. However, many other operators saw infrastructure liberalisation and the interconnect advantages provided to infrastructure operators under the regulatory regime as sufficient incentive to establish significant nation-wide networks of Points of Presence often linked by fibre networks built in partnership with public utilities, which had significant duct infrastructure and wayleaves on long distance routes between the UK’s major cities. This enabled operators to offer long distance national calls services using indirect access call origination and call termination offered by BT. Example of these were Racal (now part of Global Crossing) which used British Rail’s facilities, WorldCom (now Verizon Business) which also used British Rail facilities, Energis (subsequently acquired by Cable & Wireless and now part of Vodafone) using National Grid’s infrastructure, Thus (also subsequently acquired by Cable & Wireless and now part of Vodafone) relying on Scottish Power’s facilities. CATV networks focused on last-mile infrastructure but, as the CATV market started to consolidate, they also built long distance infrastructure to connect with each other franchises located in different parts of the country. Some operators focused on business markets (e.g. Colt, Level3 and MFS, the latter subsequently acquired by WorldCom) and also deployed last-mile access networks, particularly in London.

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36 Frontier Economics | January 2015

Further two Mobile operators, Orange and One2One (part of Cable & Wireless and subsequently acquired by Deutsche Telekom and rebranded T-Mobile) were licensed in addition to BT Cellnet (now O2) and Vodafone. All four mobile operators relied almost entirely on connections leased from BT as backhaul from their radio base stations and on trunk infrastructure also provided (with few exceptions) by BT.

4.2 Access bottlenecks and Telecom Strategic Review Infrastructure competition ensured the development of a dynamic market, especially in mobile and corporate services, the latter characterised by the presence of both home-grown competitors (C&W, Energis, COLT) and significant branches of global telecom operators (MCIWorldCom, Global Crossing, Level3). However, all fixed “alternative” carriers were heavily reliant on BT for interconnection and access. The interconnect regime was developed around a tiered charging structure (local, tandem, double tandem) by and large reflecting the physical and logical hierarchy of BT’s network (as described in section 1). Direct data access was mostly available on end-to-end leased lines provided by BT on a resale basis.

In August 2000 Oftel reviewed the market for leased lines. The review identified a wholesale market for “trunk segments”, which was found not in need of regulation. On the other hand, a wholesale market for “terminating segments” (i.e. leased circuits linking BT POPs with customers’ premises) was found not competitive. Following a period of negotiation between the industry and BT, Partial Private Circuits were launched in 2001. With PPCs local-end customer links were connected to a limited number of BT service node locations via various types of points of handover (BT located, CP located, inspan) where alternative operators would establish a presence in order to “complete” the end- to-end connection on their own network. Despite Altnets having regulated cost-based access to call termination and data access, it became however apparent over the following few years that, while service competition was relatively intense, BT maintained dominance on a number of markets. For instance, even in the market for corporate services, where 7 out of 10 large users used multiple providers, only 18% of large corporates used at least one of

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January 2015 | Frontier Economics 37

the 5 main “altnets” at the time (Cable & Wireless, Energis, MCIWorldcom, Thus and COLT). BT was still supplier to 98% of the users in the same sample29. Ofcom launched therefore a Telecom Strategic Review (“TSR”) in 2004. The Review indeed found that “BT remains in a position of SMP in many of the fixed telecoms markets examined”30. The TSR led to BT accepting a number of Undertakings. These included  Equality of Inputs, whereby specific network components had to be offered to Altnets at the same price, terms and conditions they were made available to retail-facing entities of the BT Group,  Operational separation between customer facing entities within the BT Group and those functions that operated BT’s network, through the creation of Openreach;  Provision of products intended to mitigate access bottlenecks in both the corporate and consumer market. These included Ethernet access services (WES), telephone lines (WLR) and, for the first time, “passive” remedies (LLU). The TSR had a major impact on the market. Many mass market operators rushed to establish a presence in hundreds of “unbundled” exchanges with two very significant consequences, which are very relevant to the consideration of fibre passive remedies;

 In order to provide near national coverage presence of CPs in BT’s network grew from a couple of hundred of locations to several hundreds and subsequently thousands of location, which led to significant growth in demand for “backhaul” connectivity from such locations to CP’s own networks and to decreased reliance on BT for long distance transport between different locations in BT’s network.

 LLU operators had to construct their own aggregation networks to backhaul traffic from exchange, rather than BT carrying wholesale traffic over the same aggregation and transport network as its own traffic. Even where BT wholesale products were used to provide backhaul, these were generally simple point to point links logically separate from BT’s own aggregation network. Following the pioneering efforts of Bulldog (subsequently acquired by Cable & Wireless), Tiscali and AOL, major consumer brands such as Carphone Warehouse (through their TalkTalk brand) and Sky joined the fray.

29 Oftel Large Business Panel, October 2003 30 TSR 1, page 2

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38 Frontier Economics | January 2015

Operators focused on the corporate sector heavily subscribed to the newly launched Ethernet access services, also spurred by concurrent innovation in Ethernet standards, increasingly migrating corporate networks from traditional SDH transmission platforms to more efficient Ethernet transport. The LLU “land grab” and stiff competition in corporate markets stretched the resources of many operators leading to a wave of mergers and acquisitions, which resulted in the establishment of larger players, with significant reach and technical capabilities:  Cable & Wireless acquired Energis in 2006 and Thus in 2008, and was subsequently acquired by Vodafone in 2012;  CATV franchises went through a long period of consolidation, coalescing into NTL and Telewest, which eventually merged in 2006 and rebranded as Virgin Media in 2007 and established consolidated networks and operations for the provision of business and wholesale services (Virgin Media Business) as well as their core consumer business;  Carphone Warehouse acquired AOL in 2006 and Tiscali in 2009 and consolidated both under their TalkTalk brand;  Sky acquired O2’s broadband interests (Be and O2 Broadband) in 2013  Level(3) acquired Global Crossing and merged their respective UK entities in 2012;  T-Mobile and Orange merged in 2010 and rebranded as EE in 2013;  EE and “3” (which acquired a 3G license in 2000) operate a network joint venture (MBNL), which aims at sharing network infrastructure. Vodafone and O2 have established a similar partnership, and have jointly struck an agreement with Arqiva for the use of Arqiva radio masts.

Transformation in the UK market landscape

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