Non-Confidential

Making communications markets work well for customers A framework for assessing fairness in broadband, mobile, home phone and pay-TV

Virgin Media welcomes the opportunity to respond to Ofcom’s thoughts on how it will consider issues of fairness in its future work. This is important. ‘Fairness’ of itself is too vague a concept to guide usefully the actions of providers. We therefore appreciate Ofcom’s work, and its acknowledgement that the issues are complex.

To make our response tangible we have used the example of the so-called ‘loyalty penalty’ to illustrate some of the issues we think Ofcom will need to unpick when it assesses fairness.

In summary:

• There is a temporal aspect to fairness that is missed in a simple static comparison of winners and losers. In broadband, competition and investment has meant that customers are much better off than they were in the past. We think that this should be weighed in any assessment of fairness. If all customers are better off than they were, but some are better off than others, this should matter.

• Ofcom might also consider whether the practice or outcome being assessed for fairness is widespread or common for other products or services throughout the economy, but not considered to be unfair in those cases. If so, surely special justification is needed to explain why it is unfair in telecommunications. We doubt whether tagging broadband as an ‘essential service’ meets this requirement.

• Ofcom should carefully explain why a practice or outcome is considered unfair; even if it requires Ofcom to move outside of “traditional economic analysis”. It also requires more than listing often expressed ‘areas of concern’. In the case of the loyalty penalty, customers who are prepared to make an investment in time and effort to haggle with their existing provider, or switch to a new one, can make a saving on their bill for the supply of identical or similar services. Why is this unfair? Competition among providers has meant that not all customers achieve the same outcome, but they are treated in the same way and no one is prevented by the provider from taking advantage of the keener prices available. Simply saying that it is widely thought to be unfair (as others have done) is insufficient, and should not drive policy. If unfairness is confined to a particular cohort of customer, for example those that experience vulnerability, then this should be made explicit along with the reasons why.

• By extension, Ofcom must explain why a different outcome, or set of prices, is fairer. In the case of the loyalty penalty, is it better that all customers pay the same price? Should new customers pay more than those that have been ‘loyal’? Why would either outcome be judged fairer than the current situation?

1 • Ofcom might consider whether its past or future actions might exacerbate perceptions of unfairness. For example, have the steep reductions in the price of Openreach’s wholesale anchor product exacerbated the gap between upfront offers and the prices paid by customers who have not engaged? Will smart data (Open Communications) have a similar effect in the future?

• Ofcom is right to consider the consequences of correcting the ‘unfairness’, particularly if this has implications for other policy objectives: getting more engaged customers and encouraging investment in fibre or 5G. We had hoped that Ofcom’s new strategic priorities might help in making these trade-offs.

• More guidance is required on how (or whether) Ofcom will decide whether firms are “exploiting behavioural biases” rather than simply accommodating how customers, in real life, make decisions.

Question 1: Do you think our characterisation of what might constitute fair and unfair practices is appropriate?

Question 2: Do you agree with the questions set out in our fairness framework? Are there any other questions that should be included? Please set these out in your response.

Question 3: What additional information or guidance, if any, would you like to see included in our fairness framework?

We set out below our thoughts on the various aspects of Ofcom’s framework.

Dynamic assessment of distributional fairness

1. Not entirely. Both procedural and distributional fairness appear to be static tests; the former is an absolute test and the latter is relative. Under procedural fairness there is a yes/no answer as to whether (say) the customer has been given the right information at any point in time. However, distributional fairness seems to be a relative test i.e., it is about “some customers gaining and others losing out” (3.16).

2. We believe that Ofcom should take a more nuanced consideration of in what sense those that are ‘losing out’ are really suffering. The static characterisation of distributional fairness ignores what has happened to customers over time. The structure of prices is an outcome of a competitive process that has played out over time (and which Ofcom laid the foundations for).

3. In brief, firms running networks with a high proportion of fixed costs compete to retain existing customers and attract new ones, often from their rivals. Market research done for Ofcom indicates that triple-play customers need a saving of around £23 per month to switch provider and £20 to persuade them to change deals

2 with their existing provider (we think of this as a negative switching cost).1 Our own research shows that a better deal / value for money attracts [] of the joiners to Virgin Media.2 The presence of these discounted deals for new customers would indicate that there are enough price sensitive customers in the market to make this worthwhile for providers to offer. Potential gains (alongside an easy switching process) are what typically encourage customers to switch; it is therefore not surprising that the structure of prices reflects this behaviour. Indeed, these discounted deals help overcome one well know behavioural trait: status quo bias – sticking with what you know unless there is some good reason to switch.

4. In an assessment of fairness, Ofcom should also ask whether under this process of competition a customer gained relative to his or her previous position rather than simply relative to others at an instant in time.

5. To get away from using too many aggregate averages we have constructed a simple example of a customer who could be thought of as the ‘victim’ of the loyalty penalty (a loser today versus someone who has acted differently). Although indicative, we believe that the numbers are a reasonable illustration. We assume:

a. The customer joined in early 2011 and pays for an 18-month introductory offer of £20 per month for broadband and fixed-line telephony.

b. After 18 months, the time limited discount ends and the amount paid per month increases to £30 per month.

c. The customer has neither a) haggled with his or her existing provider b) switched to another supplier nor c) changed package and has had a 5% per annum annual price increase (‘the price walk’).

6. The table below shows the monthly amounts paid by the illustrative customer. We also introduce two pieces of aggregate average a) average download speed and b) average data consumption. The latter are both sourced from various Ofcom publications.

1 https://www.ofcom.org.uk/__data/assets/pdf_file/0022/117076/Consumer-engagement-quantitative- research-2018-slide-pack.pdf Slide 54. 2 Confidential

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Year 2011 2012 2013 2014 2015 2016 2017 2018

Monthly 20 25 31.5 33.1 34.7 36.5 38.3 40.2 Outlay (£)

Average 17 23 30 58 97 132 190 240 monthly data consumption (GB)

Average 7.6 12 17.8 22.8 28.9 36.2 46.2 54.2 download speed (Mbps)

7. This illustrative customer pays more in absolute terms than he did in 2011 when he joined, and in 2012 when his introductory offer ended and he is likely now to pay more than customers who have haggled or switched but buy the same services (the static relative test referred to paragraph 1). However, over this period his consumption of data has risen 14-fold and the quality of service that he receives (measured by download speed) has improved significantly3. So, for this customer, unit prices have declined exponentially and the capability of his service has greatly improved.4 Looked at this way, the customer is much better off relative to his position on joining. Ofcom should weigh up whether this effect should be ignored from any assessment of fairness.

8. Note that this is experience for the customer is different from other sectors where some customers experience a price walk. In insurance, each year a customer’s premiums may rise - but the value of the insurance per pound paid (in terms of the amount that can be claimed in, say, the event of loss or damage) often does not increase; it goes down. In the energy markets the price per unit of energy has increased and the monthly bills have risen despite a reduction in consumption.5 In these examples, customers may plausibly be said to be worse off than they were in the past.6

9. The upshot is that broadband customers, even if they have stayed with the same provider and have not sought to negotiate a new deal, can be characterised as better

3 In its work on the USO, Ofcom has made the case that a download speed of 10Mbps is the minimum quality of service required for the average family engaged in a variety of activities. 4 Ofcom does allude to this in 3.4: “We also recognise that there are differences between regulated sectors which will need to be reflected in approaches to achieving fairer outcomes for customers. For example, communications markets are distinguished by rapid technological change that may extend to the underlying networks through which services are delivered. There is also more scope for network competition than in other regulated sectors.” 5 Between 2004 and 2014, in real terms (i.e., adjusting for inflation), SVTs have increased by 75% and 125% for gas and electricity respectively. 6 See for example Fairness in Retail Energy Markets? Centre for Competition Policy. “Consumer dissatisfaction with rising ENEX since 2003-04 has probably been compounded by the reduction in average household energy consumption of around a quarter in the same period,13 i.e. on average households are paying more for less energy.” Section 2.3. http://competitionpolicy.ac.uk/documents/8158338/18232983/CCP+%26+UKERC+- +Fairness+in+Retail+Energy+Markets+Report.pdf/6499c409-10c9-8f5a-73a3-0290b5ab022f

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off than they were when they joined. However, some customers are better off than others because they have either haggled with their existing provider or moved to a new one. We suggest that there is nothing inherently unfair about this outcome; the fact that today’s customers may pay more for the same service than their neighbours, does not mean that the structure of prices is unfair. In the appendix we use a different measure–the amount of the working day needed to pay for broadband –to show how the lot of customers has improved over time.

Claiming lower prices

10. Our examples show that all customers are better off than they were in the past. However, there are additional benefits (in the form of lower prices) that are available to those that are prepared to haggle with their existing provider, or switch to a new supplier. These actions involve some cost to the participating consumer.7 However, this is a generally established practice across many parts of the economy.8 This reward from effort is not generally seen as unfair: nobody thinks it outrageous that a consumer who chooses not to walk further to a supermarket to save money on his or her weekly bill is being treated unfairly. They may be annoyed that they do not have enough time to make the extended trip, but this is not considered unfair.

11. Much of Ofcom’s work (and for example the ASA’s) has focused on procedural fairness and has been devoted to widening the pool of customers who are willing to haggle or shop around by reducing the effort, inconvenience and uncertainty involved e.g., faster switching, information available to current and new customers, speed data, end of contract notifications etc. Implicit within this has been the acceptance that the structure of prices (lower prices available for new and haggling customers) is not unfair, because Ofcom has encouraged customers to seek out these prices. If this is no longer considered to be fair, Ofcom would need to explain why it has changed its mind.

7 The work by the Centre for Competition Policy at the University of East Anglia also sheds some light on the choice of customers to be inactive. In their response to Ofcom’s Call for Inputs on helping customers to engage in communications markets, Dr Deller, Professors Hviid and Waddams point out that:

“Consumer engagement should be treated as an intermediate objective rather than a final objective, in other words consumer engagement is only valuable to the extent that it delivers net benefits to consumers, for example, in terms of lower prices or high quality. Also, it is essential to recognise that consumer engagement involves an opportunity cost for consumers: by spending time engaging with a communications market they are unable to spend time pursuing other activities which might deliver greater benefits.”

“…consumers appearing to leave ‘cash on the table’ by not switching may not be acting in a sub-optimal way once various non-price factors are considered such as: uncertainty in consumption and price, the time and effort required to switch, and preferences around the characteristics of suppliers.” (our emphasis) 8 “A Google search for “first month free” provides 18.1m results”. See: Robert Kenny & Brian Williamson, The importance of differential pricing for good consumer outcomes in telecoms May 2019

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12. Indeed, as well as an implicit acceptance of the fairness of the structure of prices, Ofcom’s prior regulation – in the form of precipitous reductions in costs of Openreach’s wholesale anchor product – has exacerbated the differential between prices during the minimum contract period, and that paid out of contract.9 Put another way, providers have passed through reductions in wholesale prices (as Ofcom assumed that they would) into ‘special deals’ during the minimum contract period. We note a comment in a recent Enders report:

In broadband, Sky rebranded its new customer packages in mid-May to ready itself for the impending launch of Ultrafast (>100Mbps), while also significantly firming its pricing (albeit with service enhancements to soften the blow). This appears to have ended the broadband price war that has been raging for the past year or so (precipitated by wholesale price cuts), with its main low cost rival TalkTalk having partially followed Sky’s upward pricing move. (our emphasis)10

13. Given Ofcom’s implicit support for, and encouragement of, the competitive process that has resulted in the structure of prices that it sees today, it would need to explain why it is now considered unfair. This is difficult to do once we get past simplistic and subjective assertions that “people think it’s unfair”. 11

14. Nicholas Rescher argues that we should:

“Treat people differently only in cases where there is a difference that actually makes a difference in some contextually appropriate regard. When this condition is satisfied there is a reasonable justification for that difference in treatment. Of course, that phrase “contextually appropriate regard” takes us into the matter of the purposive context of the procedural domain at issue. A training program can, without unfairness, discriminate between those who have an aptitude for the activity at issue (talent for a sport or a musical instrument) but to discriminate on the grounds of race or sex would be inappropriate and thus unfair. The committee awarding a best actor award can – indeed should – discriminate on the basis of quality or performance but the age of those involved will – or should – be irrelevant. A scholarship being awarded to “enhance student-body diversity” can, without unfairness, take race into account, but one that is awarded “to recognise the most improved

9 Ofcom explains in 2.3 that “In some markets (for example, broadband), the extent to which customers pay different prices for an equivalent, or substantially similar, service has increased over time as providers have increased the difference between promoted and non-discounted prices. While some customers may be made better off by such practices, others may end up paying more and this can lead to concerns about fairness between customers” but does not examine the factors that have led to this competitive process. 10 Enders Analysis. Sky Q2 2019 results. 6 August 2019. 11 For example, the FCA says: “Views are divided on whether price discrimination in these instances is fair. Some may consider that more active consumers are being rewarded for shopping around and finding a good deal. Others may consider that more active consumers are getting a reward at someone else’s expense and that firms are penalising loyal customers or those who are less able to find a better alternative.” Note: the paper as a whole represents a balanced and careful analysis of the issues. https://www.fca.org.uk/publication/research/price_discrimination_in_financial_services.pdf

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student” cannot. The purposive context of a distribution represents a critical factor….”. 12

15. The purposive context for broadband is the desire to attract new, and retain existing, customers. The practice of upfront discounts or offering new and better terms to customers with itchy feet (i.e., recognising differential willingness to pay) hardly seems unfair given the context. This analytical framework, however, does allow for the possibility of thinking differently about customers who, for whatever reason, are unable to either switch or haggle. This would mean, in an assessment of fairness, distinguishing between customers who are capable of engaging and those who do not possess the wherewithal to do so.

16. The latter is the distinction that Virgin Media has drawn in its recent introduction of a package of measures designed to help customers who may be vulnerable13. In particular, we will review the packages of inactive customers who are either elderly, disabled or flagged as vulnerable–and may not possess the wherewithal either to haggle or switch–to ensure that they are on the best deal available for their needs. We have valued discussions with Ofcom about our intentions; and this strikes us as a better model for regulation: where industry participants can innovate and design their own solutions to tackle perceptions of unfairness without losing the benefits of differential pricing and the competitive process.

17. Ofcom does say “it is likely that we would be less concerned where customers paying higher prices have actively chosen to do so, for example, where they are aware that better deals are available but have decided that the amount they would save does not justify the effort of shopping around” (3.41). However, this opens up a new can of worms. How can providers know what is in the minds of each of our customers so that we can determine that they have “actively chosen” to pay a higher price than if they had shopped around or haggled? This is clearly an impossible standard. A more balanced position would be to acknowledge that differential pricing is not unfair, but ensure that customers are encouraged (or ‘nudged’) to make an ‘active choice’ through, for example, end of contract notifications and slicker switching processes. This certainly seems consistent with Ofcom’s approach to date.

Consequences

18. Ofcom is right to highlight that it would assess the consequences of any proposed action and typically that “assessing the case for intervention will require us to offset benefits to some against costs to others” (3.19). Any change in the structure of prices will create winners and losers. Unfortunately, Ofcom’s new strategic priorities provide no assistance in evaluating these trade-offs – although the evidence is clear that they exist. There are situations however, where the effect on competition is such that, eventually, all customers end up worse off.

12 Fairness: Theory and Practice of Distributive Justice. Nicholas Rescher (2002) 13 As well as our previous Talk Protected offer

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19. Wadhams and Zhu14 find that in order to encourage consumer action (i.e., switching) sector regulators and agencies need strategies: “to emphasize potential gains and reduce anticipated switching time are the most likely to increase consumer activity, but programs need to be tailored to particular markets and target groups if they are to be effective in stimulating consumer activity.” (our emphasis). Put another way, potential gains (alongside an easy process) are what encourage switching between providers.

20. If providers are unable to tempt customers to switch providers with discounts, or the discounts are reduced, the evidence would indicate that fewer customers would switch providers. The net effect of this dampening of competition is unknown. Switchers and hagglers would be unambiguously worse off (because their new prices would be higher or there would be no front book to convert to), but the fate of those who do not engage in the market is difficult to predict. New equilibrium prices are uncertain; customers could end up worse off overall.

21. The modelling of Armstrong et al could shed some light on this uncertainty15.

“An important determinant of the intensity of competition in some markets is the effort that consumers make to search out good deals and avoid bad deals……..the more that consumers know about deals in the market, the greater is the competitive pressure on firms to offer good deals. Thus there is a positive externality between consumers in that each consumer benefits when others possess better market information. In many cases consumers must incur a private cost to obtain better market information (which might simply comprise the cognitive costs of processing more information). In such circumstances, policies which act indirectly to reduce incentives to acquire information may harm consumers, even if the policies are intended to protect consumers from more direct harm. We consider two such consumer protection policies: a cap on the prices suppliers can charge, and measures which enable consumers to refuse to receive advertising. A price cap which protects consumers from bad deals may be a mixed blessing. The direct effect of the regulation is positive for consumers because high pricing is prevented. But the policy reduces price dispersion and blunts incentives to become informed about the available prices, which in turn weakens the competitive pressure on firms to offer low prices. This discussion formalizes a claim sometimes made informally, which is that imposing price controls on an oligopoly market could act to raise equilibrium prices…price controls soften competition by blunting consumers’ incentives to search for good deals. Although the direct effect of a price cap is to reduce prices, the indirect effect of reduced search

14 Empirical Evidence of Consumer Response in Regulated Markets, Journal of Competition Law & Economics 12(1) 2016. 15 Consumer Protection and the incentive to become informed (Armstrong, Vickers, and Zhou, 2009)

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lessens each firm’s demand elasticity so much that prices on average go up.” (our emphasis)16

22. In summary, price discounts are necessary to attract and retain customers. Removing front book / non-front book price differentials can harm competition in two ways. First, consumers are less inclined to seek out better deals, because the pay-off from switching is reduced or removed. Second, without price differentials, providers’ incentives to compete for front book customers are reduced because there is an additional cost to the firm: the need to lower prices for non-front book customers. This weaker competition would eventually harm ‘loyal’ customers (“prices on average go up”) as well as those who were prepared to shop around. On this view, there is no ‘loyalty penalty’. Removing front book / non-front book price differentials would also have broader consequences for investment: if firms are unable to attract new customers, or lose the incentive to do so, the case for growth and expansion falls away (for example, for initiatives such as Virgin Media’s Project Lightning, which is fundamentally dependent on attracting new customers).17 Although, to reiterate, adverse effects on competition through intervention can exist irrespective of network expansion or the introduction of a new technology. The absence of neither should not make Ofcom more inclined to intervene.

Behavioural Economics

23. Ofcom does not say much about behavioural biases so it is difficult to figure out how their influence will be evaluated in practice. It may be difficult to judge when are companies reflecting the fact that customers are not economic automatons and when is this being exploited?

24. Arguably, the whole loyalty penalty campaign exploits behavioural economics. It is possible that the vast majority of customers are happy with their broadband service (Ofcom reports that 83% of broadband customers are satisfied with their service18)

16 The FCA has thought along similar lines: “Under price discrimination, the firm could offer a low price to new customers joining from a rival firm – and offer a higher price to its existing customers. However, its rivals will also price discriminate and target the firm’s existing customers with a low price. The firm has to respond to protect its existing customers and the effect can be that when firms price discriminate, prices to both new and existing customers fall compared to competition under uniform prices. ... “It could also work the other way. There are, in theory, situations where prices to both customer groups rise, relative to competition with uniform prices. However, considering the pattern of consumer preferences driving such pricing, this appears unlikely to be a widespread phenomenon.” [emphasis in original]. FCA, Price discrimination and cross subsidy in financial services, September 2016.

17 See also the example in the Communications Chambers paper: Until 2009, energy companies expanding to new areas typically offered discounts to customers in those areas to entice them to switch. In 2009 Ofgem introduced a ‘non discrimination clause’ to block this, in part to protect vulnerable groups. However, the consequence was: “the average amount saved from switching reduced by more than 50%; and many companies withdrew from the new areas they had gone into, retreating into their home areas. This resulted in a dampening of competition, with evidence of increases in the profits of energy firms and price rises for many consumers. Ofgem subsequently declined to renew the non-discrimination clauses when they expired." SMF, Should switch, don’t switch, October 2015 18 https://www.ofcom.org.uk/about-ofcom/latest/media/media-releases/2019/best-and-worst-telecoms- customer-service-revealed

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and understand the value that they get19 and that this has improved over time (and will continue to do so). And yet, long-standing consumers, when confronted with a ‘reference price’ i.e., the amount paid by new customers, may believe this to be unfair20. Ironically, this may be exacerbated by receiving end of contract notifications. In turn, firms may be attempting to counteract this behavioural bias by describing the charges in the minimum contract period as a ‘discount’. More clarity is required on how Ofcom will think about the influence of behavioural economics.

Virgin Media August 2019

19 Doing some rough and ready calculations: 15 hours per week internet usage at home (Ofcom CMR 2018); 2.4 inhabitants over 16 per household who buy broadband; 4.3 weeks per month and £35 per month cost of broadband (https://www.ofcom.org.uk/__data/assets/pdf_file/0030/113898/pricing-report-2018.pdf) equates to around 23p per hour of consumption (equivalent to the cost of 1.5 fingers in a four finger Kit Kat). 20 See Misbehaving - The Making of Behavioural Economics by Richard H. Thaler. He distinguishes between acquisition utility and transaction utility. The former is based on standard economic theory and is equivalent to consumer surplus. The transaction utility is defined as the difference between the price actually paid and the price one would normally expect to pay – the reference price. Perhaps when long-standing customers observe the discount given to new customers for the package that they buy, this price becomes the ‘reference price’ and customer feel hard done by – even though they enjoy considerable consumer surplus from their service.

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Appendix

How long do households work to pay for broadband?

Another way to think about consumer outcomes over time is to look at actual data and think about consumption differently. Adam Smith said that “the real measure of the exchangeable value of all commodities” is in the “toil and trouble acquiring it”. In Walden (1854) Henry David Thoreau noted that “the cost of a thing is the amount of…life which is required to be exchanged for it, immediately or in the long-run”. As a simple exercise we have therefore estimated the amount of the working day (in time) that the average (median) household gives up each day to pay for broadband in 2003 (the year Ofcom began its life) and 2015.

Median Household Disposal Spend on Average Working disposable income age income per broadband download hours per group 25-29 (single working and speed month to individuals or with hour (35 telephony per pay for spouse/cohabitee/civil hours per month. broadband. partner) source week, 48 weeks per year) 2003/4 £23,585 £14.0 £58 (1) 1-2Mbps (2) 4.1 2014/15 £31,019 £18.5 £37.5 (4) 28.9Mbps (3) 2.0

Notes: (1). Oftel archived data: (https://webarchive.nationalarchives.gov.uk/20080713145858/http://www.ofcom.org.uk/static/archive/oftel/ publications/research/2003/q12fixr0403.htm) Quarterly spend on a fixed phone £74 = spend per month of 24.66 [But DSL Ofcom data £23 per monthhttps://www.ofcom.org.uk/__data/assets/pdf_file/0010/40411/internetandbroadband.pdf (2).https://webarchive.nationalarchives.gov.uk/20080712180043/http://www.ofcom.org.uk/static/archive/oft el/publications/date_order/2003_pubs.htm (3) Ofcom: Communications Market Report August 2018. (4) https://www.ofcom.org.uk/__data/assets/pdf_file/0028/98605/Pricing-report-2017.pdf

The average household worked for just in excess of four hours per month in 2003 to pay for its broadband, by 2015 this effort had reduced to two hours (equivalent to 12 and 6 minutes per day respectively). Note that the average download speed in the earlier time was insufficient to meet the Netflix recommended 3Mbps for Standard Definition programmes so the quality of service that is delivered (and the services accessible) has improved immeasurably over the period. Put simply, consumers are working less to pay for broadband, but getting more.

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