SKY’S RESPONSE TO OFCOM’S STRATEGIC REVIEW OF DIGITAL COMMUNICATIONS – DISCUSSION DOCUMENT Executive Summary 1. Sky welcomes Ofcom’s strategic review. It provides an opportunity to address a series of important issues that have implications not only for consumers of communications services in the UK, but also for the long term health of the UK economy. 2. It is critical that Ofcom approaches the review with vision, imagination and an open mind. The purpose of this strategic review should not be to confirm the merits of the status quo, or to search for potential minor adjustments in course. Ofcom should be prepared to consider options that have the potential to deliver significantly better outcomes in the communications sector over the next decade and beyond. 3. The review is an excellent opportunity to take a step back from ‘business as usual’, to consider what is working well in the sector, and what isn’t. It also provides an opportunity to consider critical questions in relation to the UK’s communications infrastructure – questions that risk falling between the gaps in Ofcom’s regular cycle of market reviews. 4. It is now apparent that there is substantial concern with a series of growing problems in the sector, shared by a wide range of communications providers (“CPs), consumers, and politicians. These include: (i) the increasing dominance of high speed broadband services by BT, which risks unwinding the benefits of years of strong competition in broadband services; (ii) the inadequate quality of service delivered by Openreach – and its significant impact, every day, on large numbers of UK consumers and businesses, and (iii) the level and type of investment in the UK’s fixed line communications infrastructure. In particular, it is evident that, at a time when fibre-to-the-premise (“FTTP”) networks are being rolled out around the world – in places like Sweden, Lithuania, New Zealand, Spain and Portugal – BT’s focus is on incremental upgrades to the old copper network. There are real questions to be addressed about whether the UK risks being left behind in terms of 21st century connectivity compared to other countries around the world. 5. BT’s vertical integration – the combination of the UK’s largest retailer of fixed line communications services, with the operator of the UK’s only ubiquitous fixed line access network – lies at the heart of these issues. 6. The fundamental question for Ofcom’s review is whether the problems that have been identified merit a reference to the Competition and Markets Authority (“CMA”) for a market investigation. The key purpose of the market investigation regime is to address situations in which markets as a whole are not working well, particularly due to structural features. The threshold for making such references is not onerous. In Sky’s view, it is clearly met in this case, and Ofcom should consult on making a market investigation reference (“MIR”) as soon as possible. It needs to act quickly because the problems NON-CONFIDENTIAL currently besetting the industry are causing harm now and are likely only to get worse. Without prompt action some of the adverse effects may be impossible to unwind. 7. Above all, Ofcom should consult on making a MIR because, if the CMA decides that there are significant problems in the sector, it has the power (which Ofcom does not) to implement structural remedies to those problems – as it has done in a number of other sectors that it has investigated – in airports, cement, and hospitals. 8. What Ofcom’s review should not become is a debate about whether or not BT should be structurally separated. While Sky is firmly of the view that there would be significant benefits from such a separation, with little attendant cost or risk, that debate should properly occur as part of a market investigation undertaken by the CMA. It would be unfortunate for Ofcom to conclude after a lengthy consideration of this issue that there is a case for separation – and only then to make a MIR. 9. Nevertheless, Sky appreciates that Ofcom will wish to consider, at least at a high level, the issues associated with a potential structural separation of BT. This could deliver a range of important benefits, including: • Deregulation; with separation, there would be little or no need for the plethora of regulation that seeks to deal with BT’s vertical integration, such as much of the Undertakings and the complex VULA margin test. Regulatory resources could be deployed to focus on other issues; • Boost to investment, including in last mile fibre-to-the-home networks by alternative operators. One of the often overlooked consequences of BT’s vertical integration is that the largest retail provider of fixed line telecoms services in the UK, BT Retail, is tied to purchasing inputs from Openreach; its business is non- contestable. The ability to compete for BT Retail’s business could incentivise alternative operators to invest in new infrastructure. This would also fundamentally alter the incentives facing a separated Openreach to make such investments – particularly in the 50% of the UK where it faces no competition from Virgin Media; and • Increased competition. The threat of losing BT Retail customers is likely to have a transformative effect on Openreach, making it far more responsive to the needs of all its customers, including, for example, in relation to new product development, opportunities for co-investment, and service quality. No amount of behavioural regulation can provide such a stimulus. 10. In Sky’s view, it is easy to envisage a world in which, with the benefit of hindsight, the question would become one of why we tried to ‘paper over’ the core structural issue in the UK communications sector via inadequate ‘behavioural regulation’ for so long. 11. Plainly, BT strongly opposes separation, and has put forward a number of assertions about why it would either result in poor outcomes, or be excessively costly to undertake. These are without merit. For example, assertions that being part of BT Group provides Openreach with access to investment capital are risible. An independent Openreach would be a major-FTSE listed company, with ready access to investment capital via the markets. And in relation to the costs and complexity of separation, such claims are overblown. Companies de-merge all the time – indeed as recently as 2002 BT spun off its mobile telecoms business (BT Cellnet) – and the recent vertical separation of Telecom New Zealand shows how relatively straightforward such demergers can be. In any event, many of the steps required for full structural separation - separated accounts, assets, employees, systems and processes - have been taken by Openreach which is already functionally separate. 2 NON-CONFIDENTIAL 12. Sky reiterates, however, that it is not necessary for Ofcom to reach a definitive view on the merits or otherwise of structural separation of BT in order to make a MIR to the CMA. 13. Even if Ofcom makes a MIR to the CMA any such inquiry would take up to two years, with a risk of subsequent legal action. Therefore there is a clear and urgent need for a strengthening via regulation of the independence of Openreach from BT, in the interests of all its major customers. For example: Openreach should have its own independent board and be free to set its own commercial strategy, customers should get a greater say in planned investment by Openreach, and Openreach assets should not carry BT branding. While such changes would not be a long term structural solution to the problems associated with BT’s vertical integration, they would represent important interim steps in the right direction, and could pave the way for more structural changes. 14. Similarly, regardless of what happens in relation to these major questions raised by the review, there will be a continuing need for effective regulation by Ofcom in a range of areas, particularly where BT retains significant market power. Sky considers that, generally, Ofcom’s overall approach is the right one. However, there is merit in Ofcom (a) giving greater attention to the promotion of alternative infrastructure investment, (b) ensuring that charge controls do not allow BT easily to earn excess profits, (c) playing a more proactive role in ensuring that Openreach improves its quality of service, and (d) not devoting unnecessary resources to ‘consumer’ issues when they could be used more productively elsewhere to empower consumers. 3 NON-CONFIDENTIAL SKY’S RESPONSE TO OFCOM’S STRATEGIC REVIEW OF DIGITAL COMMUNICATIONS – DISCUSSION DOCUMENT Introduction 1. A thriving UK communications sector is crucial for the development of the economy. In this digital age, communications services have rapidly and inextricably become woven into the fabric of the everyday lives of nearly all businesses and individuals. As commerce and society moves online, the central role that the communications sector plays in driving growth and productivity has become even more pronounced.1 2. The successful development of the sector over the last 10 years has been in part attributable to a regulatory regime that created conditions that were conducive for efficient investment and innovation and which led to effective and sustainable competition over large parts of the value chain. 3. However, the sector is at a critical juncture. Decisions that are made now – including those made by Ofcom as part of its Strategic Review of Digital Communications (“SRDC”) – are likely to have a profound, long-lasting effect on the industry and the wider economy. Degrading competitive conditions, poor service quality and concerns over the scale and the focus of investment are leading to poor outcomes for consumers, businesses and the economy. 4. Over the last decade, Sky has been at the forefront of the developments that have been so instrumental in transforming the sector.