Talktalk Submission

Promoting investment and competition in fibre networks Wholesale Fixed Telecoms Market Review 2021-26 consultation TalkTalk submission May 2020 NON-CONFIDENTIAL 1 Summary 1.1 TalkTalk supports Ofcom’s objective of accelerating FTTP investment in the UK to meet growing and future demand for ultrafast broadband. TalkTalk is also committed to supporting these investments by rapidly migrating our customers onto FTTP to provide revenue certainty. Alongside promoting investment, Ofcom should focus, as it always has done, on making the communications market work for all consumers and businesses and regulating to constrain Openreach’s market power. Ofcom’s duties to protect consumers and businesses are becoming even more important given the economic downturn and the likely increase in inequality caused by Covid-19. 1.2 As part of the package to achieve FTTP investment, Ofcom proposes to raise legacy wholesale MPF/FTTC prices at CPI inflation, rather than regulating them at cost. This was one of the main demands of BT/Openreach. This proposal would lead to consumers’ broadband bills being about £900m higher over the charge control period compared to cost- based prices. But the additional profit from higher FTTC prices will not increase Openreach’s incentives to invest in FTTP. If anything, higher FTTC prices will likely discourage FTTP investment incentives by increasing Openreach’s profit from sweating its legacy assets. As a result, Ofcom’s proposals risk undermining the delivery of its stated policy objective. 1.3 The pricing proposal is flawed in another respect. Ofcom argues that setting wholesale MPF/FTTC prices above cost will raise the price that alternative network operators (‘altnets’) charge thereby stimulating altnet FTTP investment; which in turn will encourage Openreach investment. However, because the price rises are untargeted and subject to dilution effects, only 1% of the £900m increase in broadband bills faced by consumers and businesses will feed through to the altnets, increasing their returns by a negligible amount (0.03%). Indeed, higher wholesale FTTC prices may reduce altnet FTTP investment since higher prices will erode the non-BT ISP market share reducing the viability of altnet investment. This would further reduce Openreach’s incentives to invest. 1.4 Ofcom’s proposal could improve the incentives for Openreach to deliver additional FTTP investment if it was accompanied by conditions that ensured that additional FTTC profits directly led to FTTP investment that would otherwise not have been made. Ofcom has not proposed any such ‘commitment mechanisms’. Possible commitment mechanisms could include ring-fencing of capital, funding and price incentives controlled by the Openreach board, and penalties/enforcement of roll-out phasing. 1.5 If it is not possible for Ofcom to impose an effective and pro-competitive commitment mechanism, it should look to mitigate the harm to consumers from higher prices. This could be achieved by introducing price increases in a phased way, linked to altnet FTTP investment. This could provide the same marginal investment stimulus but reduce the potential harms from higher prices. TalkTalk has proposed a methodology called ‘adaptive regulation’ that does this. Alternatively, Ofcom could set the MPF/FTTC price index at CPI- 2% (or CPI-CPI): rather than CPI+0%. Based on Ofcom’s own modelling, a CPI-2% price index would allow altnet FTTP investments enough ‘headroom’ to make a positive return even using Ofcom’s highest cost estimate – yet it would save customers £500m over the review period. NON-CONFIDENTIAL VERSION Page 1 1.6 Ofcom’s proposals for regulation of leased line products will cause significant consumer and business harm. The proposed CPI+0% wholesale price cap will lead to end-user leased line prices being £500m above the level they would be if wholesale prices were based on cost adding hundreds of pounds to the costs for small businesses at a time of significant economic uncertainty. Further, the restriction on using Openreach dark fibre access will deny most customers the significant innovation and competition benefits dark fibre enables. Ofcom says its proposals are to stimulate network build – but Ofcom does not explain why additional leased line network build delivers material benefits, given all areas have leased line networks already, or how any potential benefit outweighs the significant and certain harm. 1.7 We propose that Ofcom undertakes a thorough review of the different incentives for Openreach and altnets to invest in FTTP and analyses the costs and benefits of different regulatory options. ["]. A cost benefit analysis would help to understand Openreach’s incentives and hold them to account. Whilst his may delay a final decision it will ultimately result in a better outcome for consumers, competition and the wider UK economy. 1.8 The existing broadband networks have performed well during the Covid-19 lockdown. However, the recession caused by Covid-19 is likely to have significant impacts on the sector – lower incomes and business activity will reduce demand and willingness to pay for premium services which, combined with reduced capital availability, is likely to slow investment. It is important that Ofcom properly assesses the implications of this for regulation. 1.9 In the rest of this summary, we highlight the key areas where we think Ofcom could reconsider its approach and suggest changes to improve the proposals. Background 1.10 TalkTalk fully supports Ofcom’s objective to accelerate FTTP investment by both altnets and Openreach as well as driving high FTTP uptake amongst consumers and businesses. FTTP investment can also play a key role stimulating growth in the current recession. ["] demonstrate TalkTalk’s commitment to FTTP and the key role ISPs have in realising this objective. 1.11 The transition to FTTP must, and can, be done in a way that protects those who rely on lower speed legacy connections – either because no FTTP is available yet or because they are less affluent and cannot afford higher priced FTTP products, particularly given the already pronounced impact of the Covid-19 pandemic on inequality in Britain. 1.12 ["]. Wholesale local access regulation 1.13 Ofcom’s proposed CPI+0% price indexation for wholesale MPF/FTTC prices in Area 2 (the 70% of the UK where there is one or more existing or planned competitor(s) to Openreach) will result in retail broadband prices being about £900m above cost across the period. This NON-CONFIDENTIAL VERSION Page 2 price indexation approach is a significant departure from previous cost-based price caps and is not the ‘price continuity’ that Ofcom claims. 1.14 The higher MPF/FTTC wholesale prices are aimed at increasing altnet FTTP investment through increasing retail FTTC prices, which will in turn increase retail and wholesale FTTP prices, increasing altnet profits and making otherwise unviable altnet investment viable. Ofcom asserts that higher wholesale prices will have a “significant and positive” impact on altnet FTTP investment. However, analysis shows that in practice very little of the increase in prices will flow through to altnets – altnet revenue will increase by only £9 million across the period which is just 1% of the £900m of additional charges paid by consumers over the period. The flow through is so low because altnet customers will represent a small proportion of all customers in Area 2 (on average across the period) and because of a number of identifiable dilution effects, such as partial wholesale to retail pass through. The impact on returns of this additional revenue up to 2026 is negligible (about a 0.03% increase in IRR) which will have a trivial impact on investment levels. Ofcom’s proposed pricing approach is a very inefficient way of stimulating altnet FTTP investment. 1.15 Higher wholesale MPF/FTTC prices will also have a negative impact on altnet revenues, since they will erode non-BT ISP market share, and undermine altnet investment returns which depend on building scale quickly. Ofcom accepts this effect but has asserted that it will not “significantly damage” altnet investment. Analysis shows that even a low level of share erosion will reduce altnet investment returns by 0.04% - a small effect, but greater than the positive impact on returns described above. Thus, higher wholesale FTTC prices will likely reduce altnet FTTP investment levels – by a small amount. It certainly will not have the “significant and positive” effect Ofcom claims. 1.16 Ofcom has suggested that Openreach will divert the excess profits from higher MPF/FTTC prices into FTTC investment. There is no economic logic for this idea since additional profit from higher FTTC prices will not alter Openreach’s incentives to invest in FTTP. If anything, higher FTTC prices will likely discourage FTTP investment incentives by increasing Openreach’s potential profits from sweating its legacy assets. Openreach will only divert excess profits into additional FTTP investment that they would otherwise would not have made if there is some form of ‘commitment device’ that forces them to do so. However, this may distort and deter competition since it could mean that Openreach was effectively subsidised, facing a lower incremental investment cost than its rivals. 1.17 Thus the overall effect of Ofcom’s policy (compared to cost-based prices) will be less altnet investment, less Openreach investment, higher retail prices and weaker competition. 1.18 A possible improvement to CPI+0% indexation would be to target the higher prices so that more of the increase flows through to altnets and market share erosion is reduced. TalkTalk has proposed an approach called adaptive regulation that is targeted in this way – wholesale prices only rise above cost if and when altnet FTTP investment occurs in a locality. This delivers the same (albeit small) positive impact on investment through slightly increasing altnet revenues, but avoids the negative effect from erosion and also, because it is better targeted, results in much lower increases in consumer prices.

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