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•••• Chapter II, Competition Act 1998 Article 102, Treaty on the Functioning of the European Union Decision of The Office of Communications CW/1103/03/13: Complaint from TalkTalk Group against BT about alleged margin squeeze in relation to superfast broadband pricing Non-confidential Issue date: 21 October 2014 Decision About this document In March 2013, Ofcom received a complaint from TalkTalk Group alleging that BT was abusing a dominant position, by operating a margin squeeze on its superfast broadband products. This document sets out Ofcom’s reasons for its decision that there are no grounds for action following its Competition Act 1998 investigation into this allegation. It explains the context of Ofcom’s decision, the facts on which Ofcom bases its decision and the legal and economic analysis that leads it to conclude that there are no grounds for action in this case. This document is a notice for the purpose of Rule 10(4) of the Competition Act 1998 (Competition and Markets Authority’s Rules) Order 2014. 1 Decision Contents Section Page 1 Executive Summary 3 2 Background 7 3 Legal framework for the investigation 27 4 BT’s position on the relevant markets 31 5 Methodology for assessment of BT’s margins 38 6 Approach to BT Sport 70 7 Results of Ofcom’s margin squeeze assessment 88 Annex Page 1 BT’s margins on superfast broadband before BT Sport 102 2 Shared costs 174 3 BT Sport ‘net costs’ 197 4 Glossary 268 2 Decision Section 1 1 Executive Summary Ofcom’s findings 1.1 This document sets out Ofcom’s reasons for its decision that there are no grounds for action in relation to its investigation of an alleged margin squeeze by BT Group plc (BT) in relation to superfast broadband (SFBB) pricing. 1.2 On 13 March 2013 Ofcom received a formal complaint (the complaint), from TalkTalk Telecom Group plc (TalkTalk) alleging that BT was abusing a dominant position contrary to the Chapter II prohibition in section 18 of the Competition Act 1998 (the Act) and Article 102 of the Treaty on the Functioning of the European Union (TFEU). 1.3 TalkTalk alleged that BT was operating an abusive margin squeeze by failing to maintain a sufficient margin between the prices it charged its competitors for wholesale SFBB access products and the prices it charged for retail SFBB products, such that an equally efficient operator would be unable to compete in the retail provision of SFBB products. 1.4 On 1 May 2013, Ofcom determined that it had reasonable grounds to suspect that BT had infringed the Chapter II prohibition and/or Article 102 by abusing a dominant position and opened an investigation into BT’s alleged margin squeeze conduct. 1.5 On 21 May 2013, TalkTalk submitted a supplementary submission (the TalkTalk supplementary submission) setting out its view that changes to BT’s retail SFBB products since the complaint had “intensified” the margin squeeze.1 The changes related to an offer made by BT in May 2013 reducing the price of one of BT’s ‘Infinity’ SFBB products and including from August 2013 ‘free’ premium television sports content (BT Sport) with its SFBB products.2 On 18 June 2013, Ofcom notified BT and TalkTalk that it considered these matters should properly be considered as part of the investigation. 1.6 Ofcom’s approach to assessing whether BT may have abused a dominant position was to analyse whether the margin between BT’s upstream and downstream prices for particular SFBB offers (the February 2013, May 2013 and January 2014 offers) was sufficient to cover its downstream costs. 1.7 As BT’s SFBB offer changed over the period of our assessment, we have presented the results separately for the periods covered by the February 2013 offer, the May 2013 offer and the January 2014 offer. In relation to the May 2013 offer and the January 2014 offer we also take into account the ‘net costs’ of providing BT Sport to BT’s SFBB customers. 1.8 In relation to all three offers, we considered BT’s margins on its entire SFBB portfolio, including all Infinity and SFBB Plusnet products, and all additional products and services included in bundles except BT Sport. First we calculated BT’s revenues and ongoing and upfront costs per customer, and the monthly margin BT would make on 1 TalkTalk supplementary submission (confidential), 21 May 2013, page 3, paragraph 8. 2 TalkTalk supplementary submission (confidential), 21 May 2013, pages 9 to 24, sections 3.2 and 3.3. 3 Decision each SFBB customer. We then determined whether BT would recover its upfront costs over a reasonable average customer lifetime. 1.9 For the February 2013 offer this resulted in an average positive monthly ‘headroom’ per SFBB customer of £[] over the customer lifetime. In other words, BT’s February 2013 offer would only fail to recover its upfront costs over an average SFBB subscriber customer lifetime if BT’s ongoing monthly margin fell by £[] per customer per month. 1.10 For the May 2013 and January 2014 offers, having assessed the available monthly headroom under our margin squeeze methodology, we calculated the total costs of BT Sport less BT’s direct revenues from BT Sport (which we termed the ‘net costs of BT Sport’) and considered how these costs should be recovered for the purposes of this investigation. We identified a number of possible approaches, which we refer to as the ‘combinatorial approach’, the ‘first allocation approach’ and the ‘second allocation approach’. 1.11 We considered that if BT passes on the first and second allocation approaches, we could be confident that it would pass on the combinatorial approach as well. We therefore focussed our assessment on the first and second allocation approaches. 1.12 We present the results of our assessment of BT’s margins on its SFBB portfolio for the May 2013 offer and the January 2014 offer using both the first and second allocation approaches. The first allocation approach resulted in a positive monthly margin for the May 2013 offer of £[] and a positive monthly margin for the January 2014 offer of £[]. The second allocation approach resulted in a positive monthly margin for the May 2013 offer of £[] and a positive monthly margin for the January 2014 offer of £[]. In view of these results, we have not carried out a combinatorial test for the purposes of this no grounds for action decision. 1.13 Table 1.1 illustrates our headline findings. Table 1.1: Summary of findings on SFBB average monthly margins per customer in relation to the February 2013, May 2013 and January 2014 offers Headroom per SFBB Net cost of BT Sport Margin after BT Sport customer before BT per SFBB customer using first and Sport using first and second allocation second allocation approaches approaches February 2013 offer £[] N/A N/A May 2013 offer £[] £[] - £[] £[] - £[] January 2014 offer £[] £[] - £[] £[] - £[] 1.14 On this basis, Ofcom considers that it does not have sufficient evidence to support a finding that BT’s conduct amounts to an abusive margin squeeze in relation to the provision of BT’s SFBB products. Given that we have found that BT has sufficient margin to cover its downstream costs (such that an EEO would be able to compete with BT), Ofcom has not made a further separate assessment of whether any margin squeeze could have had actual or potential anti-competitive effects. 4 Decision 1.15 Therefore, Ofcom concludes that it has no grounds for action under Article 102 or Chapter II of the Act in relation to BT’s alleged margin squeeze. Document structure 1.16 This document’s structure is as follows: i) Section 2 – sets out the background to the investigation, gives details of the target and the complainant, explains the retail SFBB market and BT’s product range, provides background on BT Sport, and explains technical aspects of the wholesale SFBB access market. It then gives detail of the complaint and Ofcom’s investigation. ii) Section 3 – sets out the legal framework for the investigation. iii) Section 4 – considers relevant markets and BT’s position in those markets. iv) Section 5 – sets out the methodology we have used to assess BT’s margins on its SFBB products in relation to the SFBB portfolio exclusive of BT Sport. We consider each of these aspects in turn: a) what is a margin squeeze; b) the appropriate imputation test in this case; c) the appropriate cost standard to use in this case; d) the relevant output increment for our analysis; e) the treatment of shared costs in this case; f) the wholesale products we have included in the test; g) elements of the cost and revenue stack; and h) the method we have used to assess profitability. v) Section 6 – sets out our methodology for incorporating the costs and revenues of BT Sport into our margin squeeze assessment for the May 2013 offer and the January 2014 offer. In this section we: a) set out some evidence about BT’s strategy in relation to BT Sport; b) explain why we consider the net costs approach to be an appropriate basis for calculating the costs of offering BT Sport to BT’s broadband subscribers; c) explain how we calculate the BT Sport net costs in this case; and d) explain how we have approached the recovery of the net costs of BT Sport in this case. vi) Section 7 – sets out the results of Ofcom’s margin squeeze assessment. 5 Decision vii) Annex 1 – sets out in more detail the results of our cost and revenue assessment of the SFBB portfolio without BT Sport.

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