NCCN 500
This is the non-confidential
version. Confidential information
and data have been redacted.
Redactions are indicated by []
1 August 2008
Contents
Section
1
2
Page
Glossary of terms
1
Executive summary
8
Market definition and dominance
BT’s conduct
8
9
Background
NTS
12
NTS hosting and revenue sharing
The NTS regulatory regime
NTS wholesale charging arrangements
NTS call termination
The NTS Calculator
Transit
3
4
12
14
15
16
16
17
17
NTS regulatory policy
NCCN 500
NCCN 651
The first complaint
The NTS call termination market review
18
19
20
21
21
Ofcom’s investigation
23
The complaint
The investigation
Period of investigation
Evidence gathered
Evidence gathered from BT
Evidence gathered from C&W
Evidence gathered from third parties
The draft decision
Evidence gathered following the draft decision
23
25
25
25
25
28
30
30
31
The relevant market
34
Summary
Identifying markets
34
34
Identifying the relevant product market
Identifying the relevant geographic market
Markets relevant to this investigation
Introduction
NTS markets
Downstream markets: retail NTS calls
Upstream wholesale markets
The relevant market
Introduction
Analysis of NTS call termination/hosting as a two-sided market
NTS call termination/hosting market: analysis
Termination/hosting of unmetered internet traffic and calls to directory enquiries fall
outside the relevant market
Conclusion
Relevant geographic market
Conclusion
Responses to draft decision: Ofcom’s approach to market definition
35
36
37
37
37
40
41
43
43
44
51
60
61
61
62
62
BT
C&W
CPW
Thus
Ofcom comments on responses
Application of the SSNIP test
Ofcom’s analysis of the market as a single market, rather than as two separate
markets
5
66
67
67
BT’s position in the relevant market
74
Introduction
Market shares
74
74
Volume market shares
Conclusion on BT’s market share
Barriers to entry and expansion
Barriers to entry
Barriers to expansion
Constraints on BT from competing suppliers of NTS termination/hosting
Special cases: BT-originated traffic
Special cases: traffic transited by BT
Initial conclusion: traffic originated and transited by BT
Constraints that apply in the case of BT-terminated traffic
Constraints on BT from customers
OCP responses to a price increase by BT
Absorbing increased costs
Refusing to carry BT-terminated traffic
Pass price increase on to own retail callers
Effect if price increase were passed on
Observed behaviour following termination price increases
Conclusion on pass-through
Evidence on profit effect of NCCN 500
Constraints imposed by NTS service providers
Conclusion on the constraints faced by BT
NCCN 651
6
62
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65
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77
77
77
79
80
82
83
85
85
85
85
87
88
91
92
94
96
96
97
98
99
Responses to draft decision: Ofcom’s provisional conclusions on dominance
100
The conduct
105
Introduction
Alleged margin squeeze
Alleged margin squeeze in retail markets
105
106
106
Alleged margin squeeze in retail markets: the allegation
Alleged margin squeeze in retail markets: legal and economic framework
Alleged margin squeeze in retail markets: analysis
Alleged margin squeeze in retail markets: scope of margin squeeze test
Alleged margin squeeze in retail markets: methodological issues
Conclusion on retail margin squeeze
Responses to draft decision: retail margin squeeze
BT
C&W
Thus
Ofcom comments on responses to the draft decision
Possible margin squeeze in NTS hosting
Introduction
Hosting margin squeeze in a two-sided market
Definition of the hosting margin
Range of services
Cost of capital
Cost standard
106
107
111
112
116
129
129
129
129
130
131
134
134
134
135
135
136
136
1
Relevant time period
Data and results
Revenues
Costs
Summary of results
Responses to draft decision: hosting margin squeeze
BT
C&W
Ofcom comments on responses
Alleged discrimination
Alleged discrimination: the allegation
Alleged discrimination: legal framework
Alleged discrimination: analysis
Responses to draft decision: Ofcom’s analysis of alleged discrimination
C&W
Thus
Ofcom comments on responses
Alleged excessive pricing
Alleged excessive pricing: the allegation
Alleged excessive pricing: legal and economic framework
Alleged excessive pricing: assessing BT’s prices compared to costs
FAC profitability analysis: introduction
FAC profitability analysis: source of information
FAC profitability analysis: basis of preparation
FAC profitability analysis: results
FAC profitability analysis: summary of results
Alleged excessive pricing: profitability analysis based on SAC
SAC profitability analysis: methodology
Modelling the hypothetical single product firm’s network costs
Modelling the hypothetical single product firm’s non-network costs
Results
Model input analysis
Alleged excessive pricing: conclusion
Were BT’s prices excessive compared to costs?
Were the prices notified in NCCN 500 unfair in themselves or when compared with
competing products?
Conclusion on excessive pricing
Responses to draft decision: excessive pricing
C&W
CPW
Thus
Ofcom comments on responses
Other allegations made by C&W
NCCN 500 increased C&W’s costs of providing a competing service
NCCN 500 increased BT’s market power
NCCN 500 was part of a concerted strategy to dilute competition
Responses to draft decision: impact on BT’s competitors and BT’s intentions
C&W
CPW
Thus
Virgin Media
Ofcom comments on responses
Conclusion
Margin squeeze
Discrimination
Excessive pricing
Retail calls to NTS numbers
FAC profitability analysis: cost basis for wholesale services
FAC profitability analysis: stages of analysis
2
136
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209
209
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216
236
237
FAC profitability analysis: differences between voice and data
Annex
238
Page
1
NCCN 500 ................................................................................................... 211
2
NCCN 651 ................................................................................................... 213
3
Calculation of critical elasticity for calls to 0845 numbers .................... 215
4
Related markets......................................................................................... 216
Other wholesale calls markets ................................................................................ 220
5
ROCE and ROS .......................................................................................... 224
6
The importance of capital employed in BT’s retail services.................. 226
7
Alleged margin squeeze in call origination: data sources and
calculations................................................................................................ 229
8
Alleged margin squeeze in call origination: sensitivity analysis .......... 231
NTS calls account for a larger proportion of all calls ............................................... 231
Sensitivity: business customers generate same proportion of data calls as
voice calls.................................................................................................... 232
Sensitivity: C&W time of day weights ...................................................................... 234
9
FAC profitability analysis: basis of preparation ..................................... 236
3
Glossary of terms
Act: the Competition Act 1998.
Article 82: Article 82 of the EC Treaty, which provides that “any abuse by one or
more undertakings of a dominant position within the common market or in a
substantial part of it shall be prohibited as incompatible with the common market in
so far as it may affect trade between Member States”.
Average total cost (“ATC”): average total cost is the sum of fixed costs (costs that
do not vary with changes in output) and variable costs (costs that vary with changes
in output). Average total cost is total cost divided by output.
Average variable cost (“AVC”): variable costs are costs that vary with changes in
output, e.g. materials, energy, direct labour, supervision, repair and maintenance and
royalties. Average variable cost is variable cost divided by output.
BT: BT Group plc and its subsidiary undertakings.
BT Retail: a retail business of BT providing a range of retail services to residential,
business and corporate customers.
Commission: the European Commission.
Communications provider: a person who provides an electronic communications
network or an electronic communications service, as defined in the General
Conditions of Entitlement.
CPS: carrier pre-selection, a mechanism that enables a customer to transfer some or
all of his calls to an alternative communications provider, while retaining his existing
telephone line, without having to dial additional codes or use special equipment.
CPSO: carrier pre-selection operator, a communications provider that interconnects
with BT’s network and that has put in place the necessary arrangements to allow
customers who have a BT line to subscribe to CPS services that it provides.
Chapter II Prohibition: Section 18 of the Competition Act 1998, which provides that
“any conduct on the part of one or more undertakings which amounts to the abuse of
a dominant position in a market is prohibited if it may affect trade within the United
Kingdom”.
CAT: the Competition Appeal Tribunal, which was created by Section 12 and
Schedule 2 to the Enterprise Act 2002 which came into force on 1 April 2003.
CFI: the European Court of First Instance.
Dial-up internet access: internet access that uses a dial-up connection over an
analogue or ISDN (Integrated Services Digital Network) telephone line.
DLE: digital local exchange, the telephone exchange to which customers are directly
connected, often via a remote concentrator unit.
DQ: directory enquiries.
4
Discounted cashflow (“DCF”): an approach to measuring profitability under which
future costs and revenues are expressed as a present value by applying an
appropriate discount rate.
Enterprise Act: the Enterprise Act 2002.
ECJ: the European Court of Justice.
FAC: fully allocated cost, an accounting method for attributing all the costs of the
company to defined activities such as products and services. Typically this method is
guided by the principle of cost causation.
FRIACO: flat rate internet access call origination, a wholesale product purchased by
TCPs from BT that acts as an input for retail flat-rate dial-up internet access.
Freephone: Freephone numbers are numbers starting 0800 and 0808 which are
generally free to call from BT lines.
Geographic numbers: geographic numbers are telephone numbers that relate to a
particular geographic location, indicated by a geographic area code starting 01 or 02.
ISP: internet service provider, a company that provides business and residential
customers with access to the internet and other related services.
IP: Internet Protocol, the packet data protocol used for routing and carriage of
messages across the internet and similar networks.
IP network: a network that uses IP, for example the internet.
Inter-tandem transit: an interconnection service that involves the use of two tandem
switches and one inter-tandem transmission link.
Long run incremental cost (“LRIC”): the costs caused by the provision of a defined
increment of output, taking a long run perspective, assuming that some output is
already produced. The ‘long run’ means the time horizon over which all costs
(including capital investment) are variable.
Net present value (“NPV”): the result from a DCF analysis that discounts costs and
revenues using the applicable discount rate and sums these together.
NCCN: Network Charge Change Notice, the mechanism by which BT notifies other
communications providers of changes to its charges, including charges for the
termination of calls to NTS numbers.
National Telephone Numbering Plan (“NTNP”): a document published by Ofcom
that provides details of all telephone numbers administered by Ofcom and specifies
restrictions on the adoption or use of numbers that Ofcom considers appropriate for
each range.
Non-geographic numbers: a non-geographic number means any telephone number
that is not a geographic number.
NTS: Number Translation Services, telephone services using prefixes listed in the
NTNP as “Special Services”, which start with 08 and 09.
5
NTS call origination condition: a requirement imposed on BT that requires it to
originate and retail calls to NTS numbers on behalf of other TCPs, which was
imposed by Oftel (the agency responsible for regulation of telecommunications in the
UK before the establishment of Ofcom) in 2003 after it concluded that BT had SMP in
the wholesale call origination market.
NTS call termination market review consultation: Ofcom’s consultation document
NTS call termination market review, published 22 October 2004.
NTS retail uplift: part of the cost incurred by BT in originating an NTS call is the cost
of retailing, which BT is allowed to recover under the conditions of the NTS call
origination condition.
NTS service provider: a provider of voice or data services to callers who dial NTS
numbers.
OCP: originating communications provider, the communications provider that
owns/operates the network where a call begins.
Ofcom: the Office of Communications.
OFT: the Office of Fair Trading.
POC: point of connection, the point at which another communications provider’s
network interconnects with that of BT, often at a Digital Main Switching Unit
(“DMSU”).
PRS: premium rate services, services supplied over premium rate (09) numbers,
used mainly to provide access to competitions, TV voting lines, scratchcards, adult
entertainment, chatlines and some post-sales services such as technical support.
PSTN: the public switched telephone network.
Relevant period: 1 May 2004 to 1 January 2006, the period for which the prices
notified in NCCN 500 were in force
Return on capital employed (“ROCE”): the ratio of accounting profit to capital
employed. The measure of capital employed can be either Historic Cost Accounting
(“HCA”) or Current Cost Accounting (“CCA”).
Return on sales (“ROS”): the ratio of operating profit to sales.
Service provider: a provider of electronic communications services to third parties
whether over its own network or otherwise.
SAC: standalone cost, the cost of providing a particular service, which is the sum of
the incremental cost of the service (i.e. is the cost of producing a specified additional
product, service or increment of output over a specified time period) plus all of the
costs which are common between that service and other services.
6
SMP: significant market power, as defined in Article 14(2) of the Framework
Directive, which states that: “an undertaking shall be deemed to have significant
market power if, either individually or jointly with others, it enjoys a position
equivalent to dominance, that is to say a position of economic strength affording it the
power to behave to an appreciable extent independently of competitors, customers
and ultimately consumers.”
Single transit: interconnection service that involves the use of a single tandem
switch.
TCP: terminating communications provider, the communications provider that
owns/operates the network where a call ends.
Weighted average cost of capital (“WACC”): a company's WACC measures the
rate of return that a firm needs to earn in order to reward its investors. It is an
average representing the expected return on all of its securities, including both equity
and debt.
WLR: wholesale line rental, a mechanism that enables alternative suppliers to rent
access lines on wholesale terms from BT, as mandated by Ofcom’s Review of the
fixed narrowband wholesale exchange line, call origination, conveyance and transit
markets, and to resell the access lines to end consumers.
7
Section 1
1 Executive summary
1.1
The Office of Communications (“Ofcom”) has concluded that BT Group plc (“BT”) has
not infringed section 18 (“the Chapter II prohibition”) of the Competition Act 1998
(“the Act”) or Article 82 of the EC Treaty (“Article 82”) in relation to its prices for
Number Translation Services (“NTS”) call termination between 1 May 2004 and 1
January 2006, as notified in Network Charge Change Notice 500 (“NCCN 500”)
issued on 1 April 2004.
1.2
Ofcom opened an investigation on 8 April 2005 in response to a complaint submitted
to Ofcom on 15 March 2005 by Cable & Wireless Communications plc (“C&W”)
alleging that BT was dominant in a number of relevant markets including the market
for NTS call termination, and that BT had abused its dominant position in relation to
the price increases for NTS call termination on certain number ranges, as notified in
NCCN 500.1
1.3
Ofcom reached a provisional conclusion that the available evidence did not support
the view that BT’s conduct over the relevant period infringed the Chapter II
prohibition and/or Article 82 and that there were therefore no grounds for action. On
23 July 2007 Ofcom provided a non-confidential version of its provisional decision to
BT, C&W and four other parties supporting C&W’s complaint and invited them to
submit written responses on its provisional decision.
1.4
After considering respondents’ comments on its provisional decision, Ofcom has
reached the conclusion that the available evidence does not support the view that
BT’s conduct over the relevant period infringed the Chapter II prohibition and/or
Article 82 and that there are therefore no grounds for action.
Market definition and dominance
1.5
Ofcom has concluded that the relevant market for the consideration of C&W’s
allegations is the market for the termination/hosting of NTS calls on all number
ranges, by all terminating communications providers (“TCPs”) in the UK. Ofcom’s
reasoning on the relevant market is set out at Section 4 below.
1.6
BT’s share of the NTS call termination/hosting market, based on total volumes, was
below a level that would typically be associated with a position of dominance in the
relevant market. However, Ofcom found that BT is able to act independently of other
TCPs, its competitors, its customers and ultimately of consumers due to the
particular structure and features of the market.
1.7
Ofcom found that BT was able to introduce price increases for NTS call termination
without its TCP competitors, or its originating communications provider (“OCP”) and
NTS service provider customers being able to constrain its pricing behaviour.
1
The complaint that generated this investigation was submitted by Energis Communications Ltd
(“Energis”, UK company number 02630471). On 16 August 2005, Cable & Wireless plc (“C&W”, UK
company number 00238525) announced an agreement to acquire Energis. On 25 October 2005, the
OFT announced that it would not refer the acquisition to the Competition Commission. The
complainant is referred to throughout this document as “C&W”, except where it is necessary for clarity
to make a distinction between the two entities that existed prior to C&W’s acquisition of Energis.
8
1.8
1.9
BT’s competitors and customers were unable to constrain BT’s pricing behaviour
because of:
•
BT’s position in retail markets, which meant that OCPs were reluctant to pass on
the price increase to their retail customers (which would not in any case have
undermined BT’s ability to increase its NTS call termination charges);
•
BT’s significant market power (“SMP”) in the market for call origination which,
combined with the National Telephone Numbering Plan (“NTNP”) requirements
on retail prices, prevents other TCPs from raising their gross termination charges
on BT-originated calls to NTS numbers;
•
BT’s SMP in the market for single transit, which prevents other TCPs from raising
their gross termination charges on non BT-originated calls to NTS numbers; and
•
the fact that BT would have been able to match or better any outpayment to an
NTS service provider that a competing TCP could have made.
Ofcom has therefore found that BT was dominant in the market for NTS call
termination/hosting in the UK between 1 May 2004 and 31 December 2005, the
period of the investigation. Ofcom’s reasoning on BT’s position in the relevant market
is set out at Section 5 below.
BT’s conduct
1.10
C&W alleged that the price increases notified in NCCN 500:
•
imposed a margin squeeze on C&W;
•
discriminated in favour of BT and against C&W on price;
•
were excessive;
•
increased C&W’s costs of providing a competing service or forced it to provide an
inferior service to that of BT;
•
increased BT's market power in the NTS call origination and NTS call termination
markets; and
•
formed part of a concerted strategy to dilute competition.
1.11
Before finding an infringement of Article 82 and/or the Chapter II prohibition, Ofcom
must satisfy itself on the evidence that an infringement is more likely than not to have
occurred.2 The undertaking being investigated is entitled to the presumption of
innocence and to any reasonable doubt that there may be. Ofcom must therefore
proceed on the basis of an analysis that is robust and soundly based.3
1.12
Ofcom’s analysis of BT’s conduct is set out at Section 6 below. In summary,
beginning with the question of an alleged margin squeeze, Ofcom analysed whether
an operator as efficient as BT would be able to compete in the relevant downstream
markets identified in the investigation, under the cost constraints imposed by NCCN
2
3
Napp Pharmaceutical Holdings Ltd v Director General of Fair Trading [2002] CAT 1, paragraph 109.
JJB Sports plc v OFT [2004] CAT 17.
9
500. Ofcom also considered a stricter test using the costs of a reasonably efficient
competitor and BT also passed this stricter test.4
1.13
Ofcom found that BT earned high margins across all calls (even discounting all the
returns associated with local calls), and that, had NCCN 500 applied to all calls
originated by BT, the impact on BT’s margin across the relevant product set would
have been insufficient to lead to a margin squeeze.
1.14
In addition, Ofcom carried out an analysis of whether the additional revenue that BT
gained from NCCN 500 enabled it to fund higher payments to its NTS service
providers, leading to a margin squeeze in NTS hosting. Ofcom found that BT’s
conduct did not lead to a margin squeeze in NTS hosting.
1.15
On the question of discrimination by BT, in launching this investigation Ofcom was
concerned by public statements made by BT which appeared to indicate that BT had
charged different rates to other OCPs than to BT. BT also appeared to consider
internally that it had “discriminated” in its charge to other OCPs. Ofcom investigated
BT’s regulatory costing systems to assess the actual internal transfer charge paid by
BT. There was not robust evidence of a “hard” charge to BT that was different from
the charge that applied to BT’s competitors. Ofcom considered whether BT’s charges
for NTS call termination, as notified in NCCN 500, might amount to “applying
dissimilar conditions to equivalent transactions with other trading parties, thereby
placing them at a competitive disadvantage”.5
1.16
Ofcom considers that in the circumstances of NCCN 500 the relevant test for
determining whether BT was discriminating in favour of itself in an anti-competitive
manner is whether BT would have been able to make a profit had it paid the charges
notified in NCCN 500, taking into account profits earned on all the relevant services,
i.e. whether BT’s conduct led to the operation of a margin squeeze on other OCPs.
As already noted, Ofcom found insufficient evidence to support a finding of a margin
squeeze. Notwithstanding BT’s statements on NCCN 500, given the results of the
margin squeeze tests, Ofcom did not find compelling evidence to demonstrate that
BT had discriminated between itself and other OCPs putting them at a competitive
disadvantage.
1.17
Ofcom did not find any evidence that BT’s conduct led to a distortion of competition,
and found limited evidence of any adverse effect on consumers. Ofcom concluded
that BT’s intention was to increase revenue and draw Ofcom’s attention to anomalies
in current NTS regulation, not to reduce competition.
1.18
Ofcom considered that it would have needed compelling evidence of excessive
pricing, according to the tests set out in the case law. Ofcom considered these tests,
to the extent that they were relevant in this case, offered conflicting evidence as to
whether the prices notified in NCCN 500 were excessive. Ofcom found that BT’s
prices appeared to be significantly above its fully allocated cost (“FAC”), but below
another relevant measure of cost, standalone cost (“SAC”).
4
Ofcom notes the tests set out by the Court of Appeal in Albion (Dwr Cymru Cyfyngedig and Albion
Water Limited and Water Services Regulation Authority [2008] EWCA Civ 536) and by the CFI in
Deutsche Telekom (Case T-271/03 Deutsche Telekom v Commission Judgement of CFI 10 April
2008). See paragraph 6.23 et seq below.
5
Article 82 2(c).
10
1.19
Overall, in the circumstances of this case and in light of the need for compelling
evidence, there is insufficient evidence to demonstrate to the required standard of
proof that BT’s conduct constituted an abuse of its dominant position.
11
Section 2
2 Background
NTS
2.1
NTS numbers are those number ranges listed in the NTNP as “Special Services”
numbers.6 NTS numbers start with 08 or 09.7
2.2
An NTS number does not relate to a specific geographic location, but to a particular
service. The NTS number dialled by a caller is ‘translated’ by the network to a
geographic number to deliver the call to its destination.
2.3
The NTNP lists the numbers available for allocation and also specifies such
restrictions on the adoption or use of numbers that Ofcom considers appropriate for
each range. The designations for NTS numbers are summarised in Table 1 below. In
the case of NTS numbers the designations specify retail prices for calls from BT
lines.8
2.4
NTS numbers are used to provide access to a range of voice and data services.
Research undertaken by Ofcom as part of its review of NTS regulatory policy (see
paragraph 2.34 et seq below) suggested that different NTS number ranges are, to
some extent, associated with different types of services:
6
•
Freephone numbers (0800 and 0808) are mainly used to access private sector
voice services such as sales lines and helplines; and telephony services provided
by two-stage indirect access service providers;
•
0844/0843 and 0845 numbers are used extensively for metered dial-up internet
access (predominantly using 0845 numbers), and also support a wide range of
other services, including pre- and post-sales enquiry lines, public sector services,
transaction services and information services;
•
0870 and 0871/0872/0873 numbers are mainly used to provide access to preand post-sales enquiry lines, some public sector services and international
telephony services provided by resellers; and
•
Premium Rate (09) numbers are used mainly to access competitions, TV voting
lines, scratchcards, adult entertainment, chatlines and some post-sales services
such as technical support.9
The current version of the NTNP was published on 17 June 2008 at:
http://www.ofcom.org.uk/telecoms/ioi/numbers/numplan170608.pdf.
7
NTS also includes calls to the legacy 0500 (Freephone) and 0345 (local rate) ranges, which are not
available for new allocations and are no longer listed in the NTNP. NTS does not include calls to 0844
04 numbers for Surftime internet access or calls to 0808 99 numbers for unmetered dial-up internet
access based on FRIACO (flat rate internet access call origination).
8
In the consultation Changes to 0870, published on 2 May 2008 (see
http://www.ofcom.org.uk/consult/condocs/0870calls/0870condoc.pdf) Ofcom has proposed changes
to the charges that communications providers can make for calls to 0870 numbers. The designations
set out in Table 1 below and referred to elsewhere in this document are those that applied during the
period under investigation.
9
See Number Translation Services: Options for the future, 22 October 2004, published at:
http://www.ofcom.org.uk/consult/condocs/ntsoptions/nts_future/nts_future_op.pdf.
12
2.5
0820 numbers are reserved for Schools Internet Caller, a legacy service for schools
that enables them to make free dial-up calls to the internet during school hours,
reverting to normal tariffs in the evenings and at weekends (see footnote 243).
Table 1: The NTS number ranges
Range
Designation
0800 and 0808
Free to caller (unless charges are notified to the caller at the start of the
call)
0820
Schools internet
0844/0843
Special Services basic rate: charged at up to and including 5p per minute
or per call for BT customers, set by TCP including VAT (the price charged
by other OCPs may vary)
0845
Special Services basic rate: charged (before discounts and call packages)
at BT’s Standard Local Call Retail Price for BT customers including VAT
(the price charged by other OCPs may vary)
0870
Special Services higher rate: charged (before discounts and call
packages) at BT’s Standard National Call Retail Price for BT customers
including VAT (the price charged by other OCPs may vary)
Special Services higher rate: up to and including 10p per minute or per
0871/0872/0873 call for BT customers including VAT (the price charged by other OCPs
may vary)
Special Services at a Premium Rate: charged to BT customers
090 and 091
•
Generally at more than 10p per minute, up to and including £1.50 per
minute including VAT; or
•
at more than 10p per call, up to and including £1.50 per call including
VAT.
Sexual Entertainment Services at a Premium Rate: charged to BT
customers
098
•
generally at more than 10p per minute, up to and including £1.50 per
minute including VAT; or
•
at more than 10p per call, up to and including £1.50 per call including
VAT.
Source: NTNP.
2.6
There may be several communications providers involved in conveying an NTS call
from the caller to the organisation or individual receiving the call (“the NTS service
provider”), including an OCP, on whose network the call originates, and a TCP, on
13
whose network the NTS number terminates.10 The OCP and the TCP may be the
same for some calls. A third communications provider (a “transit” provider) may carry
the call between the OCP and the TCP.
2.7
These relationships are shown in Figure 1 below:
Figure 1: Parties involved in an NTS call
retail price
OCP
Transit CP
(if used)
revenue
share
payment
termination
charge
TCP
NTS service
provider
NTS hosting and revenue sharing
2.8
The regulatory framework for NTS enables the TCP to share the revenue from calls
to NTS numbers with NTS service providers. NTS thereby acts as a micro-payment
mechanism for the various services that can be accessed via 08 and 09 numbers.
The caller pays the OCP for the call. The OCP passes on a terminating payment to
the TCP, who is then able (subject to commercial viability) to share some of this
revenue with the NTS service provider.
2.9
The TCP has two distinct roles in this arrangement. First, it provides call termination
to the OCP. Second, it provides various services to NTS service providers, which we
refer to collectively as “NTS hosting” (see also paragraph 4.28 below).
2.10
NTS hosting includes the payment of revenue shares. It also includes the provision of
a range of value added services.
2.11
NTS service providers vary hugely in their scale and in the services that they offer to
callers, and therefore have very different NTS hosting requirements. Some voice
services may consist of simple number translation and routing to a particular
geographic number (e.g. an 0845 number allocated to a small organisation or an
individual, at a single geographic number). At the other end of the scale, the
customer may be a large national organisation (for example a retailer, high street
bank or government department), receiving very large volumes of calls, with call
centres at multiple locations, and will require a wider range of call routing and call
management services.
2.12
NTS hosting may therefore include a range of value added services, including:
a) conditional call routing to one or more destination numbers based on static or
dynamic parameters such as:
o the caller’s telephone number or location;
10
For the purposes of this decision, Ofcom is using the definition of “communications provider” in
section 405 of the Communications Act 2003, which is “a person who provides an electronic
communications network or an electronic communications service”. Section 32 of the
Communications Act 2003 defines an electronic communications network as “(a) a transmission
system for the conveyance, by the use of electrical, magnetic or electro-magnetic energy, of signals of
any description; and (b) such of the following as are used, by the person providing the system and in
associated with it, for the conveyance of the signals – (i) apparatus comprised in the system; (ii)
apparatus used for the switching or routing of the signals; and (iii) software and stored data.”
14
o time or date;
o routing plans defined by the NTS service provider;
o call distribution to multiple sites based on static rules, or call centre load; or
o customer keypad selections or voice commands;
b) recorded announcements;
c) call management functionality such as live or historical traffic information and
dynamic customer control of call routing parameters.
2.13
In the case of data services, NTS hosting may consist of termination of calls on a
suitable modem, user authentication, internet protocol (“IP” – see Glossary) traffic
aggregation and management, and IP traffic conveyance.
The NTS regulatory regime
2.14
The NTS regulatory regime is based on two formal regulatory instruments, which are
described in the following paragraphs. One of these (the NTS call origination
condition) applies to BT only. The other (the NTNP) applies to all communications
providers.
2.15
The current NTS regulatory regime dates back to 1996. The framework originally put
in place by Oftel aimed to encourage the provision of services over the telephone.11 It
did this by enabling TCPs to receive the profit from calls to NTS numbers and share it
with NTS service providers, who could in turn use that revenue share to fund new
and innovative services.
2.16
This model, and the key elements of the supporting policy, were retained following
the introduction of the new regulatory regime for electronic communications networks
and services that came into force on 25 July 2003.
2.17
Under the new regime, Oftel carried out a series of market reviews, one of which
covered the wholesale market for call origination.12 As a result of this review, Oftel
concluded that BT has SMP in the wholesale call origination market and imposed a
number of SMP conditions on BT, including a requirement to originate and retail calls
to NTS numbers on behalf of other TCPs known as the “NTS call origination
condition”.13
2.18
The NTS call origination condition allows BT to deduct the costs it incurs in
originating the call, retailing the call (the “NTS Retail Uplift”) and making provision for
bad debt for Premium Rate Services (“PRS”) calls (over and above the amount
already allowed for by the NTS Retail Uplift) before passing the remainder of the
retail charge (the amount that the caller pays) on to the relevant TCP, which can use
it to fund revenue share payments to its NTS service providers. BT’s call origination
11
Oftel (the Office of Telecommunications) was the authority responsible for the regulation of
telecommunications in the UK prior to the creation of Ofcom at the end of 2003.
12
Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit
markets: Identification and analysis of markets, determination of market power and the setting of SMP
conditions. Final Explanatory Statement and Notification, 28 November 2003, published at:
www.ofcom.org.uk/consult/condocs/narrowband_mkt_rvw/nwe/.
13
Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit
markets, statement of 28 November 2003 (see footnote 12), SMP Services Condition AA11.
15
charges and NTS Retail Uplift charge are regulated by a charge control – another of
the remedies imposed by Ofcom to address BT’s SMP in the wholesale call
origination market (see previous paragraph).14 The other deductions that BT makes
are also regulated.15
2.19
The second element of the NTS regulatory regime is the NTNP. As set out in Table 1
above, the NTNP specifies what the various different NTS number ranges can be
used for. Communications providers to which Ofcom has allocated NTS numbers
assume a responsibility to ensure that those numbers are used in accordance with
the designations given in the NTNP.
NTS wholesale charging arrangements
2.20
For every end-to-end NTS call, there may be a number of transactions between the
different parties involved, as set out in Figure 1 above.
2.21
The caller is billed for the call by his OCP, which retains a proportion of the retail call
charge to cover the cost of originating the call and providing retail services (such as
billing and customer service) to the customer (although only when BT is the OCP is
the amount retained for origination explicitly cost-based). The OCP passes the
residual amount to the TCP as an NTS call termination payment. Finally, the TCP
may have a revenue sharing arrangement with the NTS service provider. Where the
call is transited by a third party, there is an additional transaction in the chain: the
transit provider retains a proportion of the retail price for the provision of the transit
service before handing the call on to the TCP for completion (see paragraph 2.31 et
seq below).
NTS call termination
2.22
BT’s charges for the termination of calls to NTS numbers are not regulated. Nor are
those of any other TCP.
2.23
Non-BT TCPs’ charges for the termination of calls to NTS numbers are, however,
determined to a large extent by regulation. As set out above, the maximum retail
price of a call by a BT customer to an NTS number is subject to the limits set out in
the designations in the NTNP. The amount in pence per minute (“ppm”) that BT can
retain out of the retail charge is limited by the NTS call origination condition and the
charge controls as discussed in paragraph 2.18 above. The amount that is passed
through to the TCP (the termination charge) is therefore equivalent to the retail
charge, minus BT’s retention, minus any payment to a transit provider. For a further
discussion of TCPs’ ability to influence the level of their charges for the termination of
NTS calls, see Section 5 below.
2.24
Similarly where a TCP other than BT terminates calls that have originated on another
OCP’s network and transited via BT, BT pays the same termination charge as if the
call originated on BT’s network. This is because BT’s wholesale billing systems are
unable to take account of other OCPs’ retail prices or originating retentions and
therefore can only pay the same termination charge for all calls to any one TCP.
14
Review of BT’s network charge controls: Explanatory Statement and Notification of decisions on
BT’s SMP status and charge controls in narrowband wholesale markets, 18 August 2005, published
at: www.ofcom.org.uk/consult/condocs/charge/statement/.
15
BT’s charges for NTS Retail Uplift and the provision for PRS bad debt are set out in Charges
between Communications Providers: Number Translation Services Retail Uplift charge control and
Premium Rate Services bad debt surcharge, 28 September 2005, published at:
www.ofcom.org.uk/consult/condocs/NTSfin/statement_nts_uplift/.
16
2.25
BT’s charges for the termination of NTS calls originated by other OCPs, on the other
hand, are not influenced by regulation in the wholesale call origination market. No
OCP other than BT is subject to regulation of charges for originating NTS calls, so
the proportion of the retail price that is passed through to BT (i.e. BT’s termination
charge) is equivalent to the unregulated retail price of the call, minus the OCP’s
retention, minus any payment to a transit provider (but see discussion at paragraph
5.56 et seq below).
2.26
Before it issued NCCN 500 (see paragraph 2.41 et seq below), BT behaved as
though its charges for NTS call termination were regulated, in that it applied the same
termination charges for OCP-to-BT calls as its competitors charged for BT-to-TCP
calls (the latter being indirectly set by the combination of the NTNP and regulation on
BT in the wholesale call origination market). NCCN 500 raised BT’s charges for
terminating OCP-to-BT calls above TCPs’ charges for terminating BT-to-TCP calls.
The NTS Calculator
2.27
In order to assist TCPs in calculating their NTS termination charges BT has made
available, on its BT Wholesale website, an online tool called the NTS Calculator.16
This is an extensive Excel spreadsheet which enables TCPs to input their own call
routing parameters and to calculate how much they can expect to receive for
terminating any 08 or 09 call. The NTS Calculator is maintained both as an up-todate tool, with the latest wholesale network charges, discounts, NTS Retail Uplift and
PRS bad debt surcharge, and as a historic tool which enables TCPs to assess how
these factors have changed over time and measure the resultant effect on their
termination charges.
2.28
Charges for the termination of calls to NTS numbers differ by number range, by time
of day, and in some cases by call length.
2.29
Calls are classed as either “Daytime”, “Evening” or “Weekend”. “Daytime” calls are
calls made by residential customers between 6am and 6pm, or by business
customers between 8am and 6pm. “Evening” calls are calls made after 6pm and
“Weekend” calls are calls made on Saturday and Sunday.
2.30
During the period under investigation, calls to some NTS number ranges (0845, its
legacy equivalent 0345, and 0820) were classed as either “short” or “long”. “Short”
calls were defined during the period under investigation as calls shorter than the call
duration corresponding to BT’s minimum call charge; “long” calls as calls equal to or
longer than the call duration corresponding to the minimum call charge.17
Transit
2.31
Payment arrangements for transit depend on number range. Where BT acts as
transit provider, the OCP pays for transit for calls to number ranges starting 0844 and
0871, whereas the TCP pays for transit for calls to number ranges starting 0845 and
0870, as shown in Figure 2 below.
16
http://www.btwholesale.com/pages/static/service_and_support/service_support_hub/online_pricing_
hub/cpl_hub/cpl_pricing_hub/number_translation_services.html.
17
As of 1 October 2006, the minimum call charge was replaced with a “call set-up fee” of 3p. As a
result the concept of “short” and “long” NTS calls no longer applies.
17
Figure 2: NTS transit arrangements
D = BT’s discounted retail price
C = BT’s retention
D-C
P
OCP
D-C
BT
T
Originator pays transit (for 0844/0871)
TCP
NTS SP
T
Terminator pays transit (for 0845/0870/PRS)
P = OCP’s retail price
T = BT’s transit charge
2.32
BT’s transit charges are, in some cases, set by regulation. Ofcom has determined
that BT has SMP in the market for single transit (see paragraphs A4.47-A4.49
below).18 As a remedy, BT’s charges for single transit are subject to a charge control.
2.33
Ofcom has determined that no communications provider has SMP in the market for
inter-tandem transit (see paragraphs A4.50-A4.53 below). Communications providers
are free to negotiate charges for inter-tandem transit. However, the incentives to do
so are limited, as explained in paragraph 5.58 et seq below.
NTS regulatory policy
2.34
Since its inception, Ofcom has conducted a major review of NTS regulatory policy
and implemented a number of changes to the NTS regulatory regime.
2.35
On 22 October 2004 Ofcom published the consultation document, Number
translation services: options for the future, which set out a number of options for
future regulation of NTS (“the NTS consultation”).19 On 28 September 2005 Ofcom
published a further consultation document, Number translation services: a way
forward which proposed a number of detailed changes to the NTS regime.20
2.36
On 19 April 2006 Ofcom published the statement Number translation services: a way
forward (“the NTS statement”) setting out a number of changes to the NTS regulatory
regime, as follows:
•
18
retail prices for calls to 0870 numbers will be linked to prices for geographic calls,
so that OCPs including BT must charge their customers no more for calls to 0870
numbers than for national calls to geographic numbers. OCPs who wish to
charge higher rates for 0870 calls will be required to make a free preannouncement at the beginning of the call, telling the caller how much the call will
cost;
Review of BT’s network charge controls, statement of 18 August 2005 (see footnote 14).
Number translation services: options for the future, 22 October 2004, published at:
http://www.ofcom.org.uk/consult/condocs/ntsoptions/#content.
20
Number translation services: a way forward, 28 September 2005, published at:
http://www.ofcom.org.uk/consult/condocs/nts_forward/nts_way_forward.pdf.
19
18
•
the NTS call origination condition (see paragraph 2.17) will no longer apply to
calls to 0870 numbers;
•
the PRS regulatory framework will be extended to 0871 calls and to all adult PRS
services, regardless of price; and
•
communications providers will be required to give their customers clearer
information about the cost of calling NTS (and PRS) numbers.21
2.37
On the same date, Ofcom published a separate statement entitled Providing citizens
and consumers with improved information about Number Translation Services and
Premium Rate Services, which notified modifications to General Condition 14
requiring communications providers to give their customers clearer information about
the cost of calling NTS and PRS numbers, in line with the last of the changes set out
in the previous paragraph.22 These new requirements came into effect on 19 August
2006.
2.38
The NTS statement explained that the changes to the regulation of the 0870 range
would be implemented 18 months after the publication of Ofcom’s separate
statement on numbering policy, which was published on 27 July 2006 and confirmed,
among other things, a number of policy decisions relating to the NTNP that were
necessary to give effect to the changes to the 0870 regulatory framework set out in
the NTS statement.23
2.39
When Ofcom introduced a requirement for pricing pre-announcements on 070
(Personal Numbers) in an unrelated policy initiative, the pre-announcements
interfered with a small number of social alarm services (typically used by the elderly
and infirm to summon assistance).24 Ofcom also became aware there were a large
number of security alarm services using 0870 numbers that might also be susceptible
to interference from pre-announcements, causing service disruption.
2.40
As a result of these discoveries, Ofcom took extra time to reconsider whether it
should require the use of pricing announcements. Instead of pre-announcements, it
has, at the time of publication, proposed that communications providers wishing to
charge more for 0870 calls than for geographic calls would be subject to new
requirements to display their 0870 charges prominently on price lists and advertising
and promotional materials. The details of Ofcom’s revised proposals are contained in
the consultation document Changes to 0870, published by Ofcom on 2 May 2008.25
NCCN 500
2.41
On 1 April 2004 BT issued NCCN 500, notifying a number of increases to its charges
to third parties (i.e. other OCPs) for the termination of calls to NTS numbers with
effect from 1 May 2004.
21
Number translation services: a way forward, 26 April 2006, published at:
http://www.ofcom.org.uk/consult/condocs/nts_forward/statement/statement.pdf.
22
Providing citizens and consumers with improved information about Number Translation Services
and Premium Rate Services, 19 April 2006, published at:
http://www.ofcom.org.uk/consult/condocs/nts_info/statement/statement.
23
Telephone Numbering: Safeguarding the future of numbers, 27 July 2006, published at:
www.ofcom.org.uk/consult/condocs/numberingreview/statement/.
24
See the Ofcom statement Removal of the requirement for pre-call announcements on 070 numbers
at http://www.ofcom.org.uk/consult/condocs/numbering03/070precall/.
25
Changes to 0870: Changes to 0870 calls and modifications to the supporting regulations, 2 May
2008, published at: http://www.ofcom.org.uk/consult/condocs/0870calls/0870condoc.pdf.
19
2.42
The scale of the price rises notified in NCCN 500 differed by number range, by call
duration and by time of day. Price rises ranged between zero (for daytime calls to
0820 numbers) and 37.8% (for long duration evening calls to 0845 numbers). The
most significant rises applied to long duration calls to 0845 numbers.
2.43
NCCN 500 is reproduced in Annex 1.26
2.44
NCCN 500 notified price rises for the termination of calls originated by OCPs. Prior to
NCCN 500, BT had set its charges for NTS call termination at the same level as
other TCPs’ charges for NTS call termination – which other TCPs had set with
reference to BT’s regulated origination and transit charges.
NCCN 651
2.45
On 2 November 2005 BT issued NCCN 651, notifying a number of changes to its
charges to third parties (i.e. other OCPs) for the termination of calls to NTS numbers
with effect from 1 January 2006.
2.46
The effect of NCCN 651 was to bring BT’s charges for NTS call termination back into
line with those of other TCPs, as they had been prior to 1 May 2004. This is shown in
Figure 3 below.
Figure 3: The effect of NCCN 500 and NCCN 651
Termination charge (ppm)
2.0
31 December 2005
1 May 2004
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
24/07/1998
06/12/1999
19/04/2001
01/09/2002
0845: terminated by other TCP
14/01/2004
28/05/2005
10/10/2006
0845: BT-terminated
Source: NCCN 500, NCCN 651, NTS Calculator
2.47
26
[].27
Ofcom has calculated NCCN 500 price rises with reference to BT’s NTS call termination charges as
at 1 April 2004 for OCP–BT calls using the NTS Calculator. Ofcom notes that BT has relied on NCCN
500 itself (as reproduced at Annex 1 below) when deriving estimated price increases, which suggests
a considerably higher price increase than that implied by the comparison of the charges notified in
NCCN 500 against NTS Calculator generated prices for the period immediately preceding the
introduction of NCCN 500. Ofcom does not consider that the charges listed as “current” in NCCN 500
are a true reflection of the charges paid by OCPs to BT immediately prior to the introduction of NCCN
500. Prior to NCCN 500, Ofcom understands that both OCPs and BT used the NTS Calculator to
determine the level of charges payable for NTS call termination.
20
2.48
The price increases that are the subject of this investigation were therefore in effect
from 1 May 2004 to 31 December 2005 – a period of 20 months.
The first complaint
2.49
On 4 May 2004 C&W submitted to Ofcom a complaint about NCCN 500 (“the first
complaint”).
2.50
In the first complaint, C&W argued that the price increases notified in NCCN 500
constituted an abuse of BT’s dominant position in the market for NTS call
termination, contrary to the Chapter II prohibition, in that they would:
•
impose a margin squeeze on C&W;
•
discriminate in favour of BT and against C&W on price;
•
increase C&W’s costs of providing a competing service or force it to provide an
inferior service to that of BT; and
•
increase BT’s market power in the NTS call origination and NTS call termination
markets.28
2.51
Ofcom considered the first complaint and reached the view that the issues raised
therein would be addressed by Ofcom’s ongoing review of the NTS regulatory regime
(which is described at paragraph 2.34 et seq above). Ofcom therefore decided to
concentrate its resources on completing its review of the NTS regulatory regime,
rather than diverting resources to running a parallel investigation. Ofcom wrote to
C&W on 25 May 2004 informing C&W of this decision.
2.52
Ofcom wrote to C&W again on 7 July 2004 indicating that it would keep the matters
raised in the first complaint under review and that it would not be precluded at some
point in the future from considering a possible breach of the Act or Article 82 from the
date that the alleged breach had occurred.
The NTS call termination market review
2.53
As discussed in the previous section, Ofcom did not open an investigation into the
first complaint, as it considered that the issues raised by C&W in that submission
would be addressed by its ongoing review of the NTS regulatory regime.
2.54
NCCN 500 prompted Ofcom to include, in its ongoing review of the NTS regulatory
regime, a detailed consideration of NTS call termination.
2.55
On 22 October 2004 (the same date that it published the first NTS consultation),
Ofcom published the consultation document NTS call termination market review (“the
NTS call termination market review consultation”).29
2.56
In the NTS call termination market review consultation, Ofcom proposed to identify a
market for NTS call termination in the UK and set out its view that BT has SMP in
that market. Ofcom considered a number of options for action, and indicated that its
27
[].
C&W submission of 4 May 2004, paragraph 1.5.
29
NTS call termination market review, 22 October 2004, published at:
http://www.ofcom.org.uk/consult/condocs/ntsctmr/.
28
21
preferred option was to impose two new SMP conditions on BT, requiring it to provide
network access, and not to exercise undue discrimination in relation to the provision
of network access, in the NTS call termination market.30
2.57
The NTS call termination market review consultation closed on 7 January 2005.
Respondents to the consultation included BT and UKCTA, the trade association of
competitive fixed line carriers in the UK, which represented a number of OCPs and
TCPs with interests in NTS call termination. Non-confidential responses to the
consultation were published on Ofcom’s website.31
2.58
As discussed in Section 3 below, on 7 April 2005 Ofcom opened an investigation into
a further complaint from C&W on 15 March 2005 relating to BT’s charges for NTS
call termination. In order to avoid duplication of analysis, Ofcom decided not to
proceed separately with the market review while the investigation was ongoing, and
has not therefore concluded on the proposals set out in the market review
consultation. Some of the respondents to the draft decision (see paragraphs 3.28 et
seq below) commented that Ofcom should not have suspended the market review
pending the completion of its investigation under the Act. However, Ofcom
considered that the market definition exercise and, to some extent, the dominance
analysis undertaken as part of this investigation would in effect have been duplicated
had Ofcom progressed with the market review and the investigation in parallel. In
Ofcom’s view, this would have represented an inefficient and inappropriate use not
only of Ofcom’s resources, but the resources of the parties to the investigation.
30
31
NTS call termination market review consultation, Section 5.
http://www.ofcom.org.uk/consult/condocs/ntsctmr/resntcctr/.
22
Section 3
3 Ofcom’s investigation
The complaint
3.1
On 15 March 2005 C&W submitted its second complaint to Ofcom about NCCN 500
(“the complaint”).
3.2
In the complaint, C&W alleged that NCCN 500 represented an abuse of BT’s
dominant position in a number of markets, including the market for NTS call
termination.
3.3
C&W submitted that the relevant markets for the purposes of the complaint were the
markets for:
“NTS call origination, NTS call termination, NTS call transit and NTS
service hosting.”32
3.4
C&W submitted that BT holds a dominant position in the market for call origination on
fixed public narrowband networks, noting that Ofcom had found BT to have SMP in
that market (see paragraph 2.17 above).
3.5
C&W submitted that;
“Call origination to NTS number ranges forms a subset of the wider
call origination market and can be distinguished from, and is not
substitutable with, geographic call origination.”33
3.6
C&W submitted in addition that BT has market power in the market for NTS call
termination to services hosted on the BT network.
3.7
C&W submitted that it agreed with Ofcom’s proposals in relation to the NTS call
termination market, as set out in the market review consultation.34
3.8
However, C&W submitted that even if BT were not dominant in the NTS call
termination market, BT’s conduct in issuing NCCN 500 would equally constitute an
abuse of BT’s dominant position in the market for wholesale call origination, since:
“It is only BT’s control over and overwhelming market share in, call
origination that renders BT’s conduct in issuing NCCN 500
profitable.”35
3.9
C&W submitted that NCCN 500 constituted an abuse of BT’s dominant position in
both the market for NTS call termination and the market for wholesale call
origination.36
3.10
C&W alleged that the price increases notified in NCCN 500:
32
C&W submission to Ofcom of 15 March 2005, paragraph 5.5.
C&W submission to Ofcom of 15 March 2005, paragraph 5.10.
34
C&W submission to Ofcom of 15 March 2005, paragraph 5.13.
35
C&W submission to Ofcom of 15 March 2005, paragraph 5.14.
36
C&W submission to Ofcom of 15 March 2005, paragraph 5.16.
33
23
3.11
•
imposed a margin squeeze on C&W;
•
discriminated in favour of BT and against C&W on price;
•
were excessive;
•
increased C&W’s costs of providing a competing service or forced it to provide an
inferior service to that of BT;
•
increased BT's market power in the NTS call origination and NTS call termination
markets; and
•
formed part of a concerted strategy to dilute competition.37
C&W requested:
•
that Ofcom adopt a decision pursuant to section 31 of the 1998 Act that the price
increases notified in NCCN 500 constitute an abuse by BT of its dominant
position;
•
that Ofcom issue directions to BT under section 33 of the 1998 Act requiring it to
take such steps as are necessary to bring those abuses to an end, in particular:
a) that NCCN 500 be withdrawn;
b) that BT be required to reimburse C&W in respect of any payments it had made to
BT based on the higher charges notified in NCCN 500; and
c) that BT be required to charge other OCPs for calls terminated on its network only
in accordance with the NTS Formula;38 and
d) that BT be required to pay a penalty under section 36 of the Act.39
3.12
3.13
37
C&W indicated that its complaint was supported by:
•
Centrica;
•
ntl; and
•
Tiscali.40
Thus also contacted Ofcom in March 2005 and asked to be considered as a
stakeholder in this case.
C&W submission to Ofcom of 15 March 2005, paragraph 5.24.
I.e. the methodology of calculating charges using the NTS Calculator (see paragraphs 2.27 et seq
above).
39
C&W submission to Ofcom of 15 March 2005, paragraph 12.2.
40
C&W submission to Ofcom of 15 March 2005, paragraph 13.1. Centrica has since been acquired by
The Carphone Warehouse Group plc (“CPW”). ntl is now part of Virgin Media. The complaint, which
was made by Energis prior to C&W’s acquisition of Energis (see footnote 1), also listed C&W as
supporting the complaint.
38
24
The investigation
3.14
On 8 April 2005 Ofcom opened an investigation into the complaint under the Act and
Article 82 and published an entry on its Competition Bulletin setting out the details of
the investigation.41
Period of investigation
3.15
This investigation relates to the period of the alleged abuse i.e. the period of time that
NCCN 500 was in place, which was 1 May 2004 to 31 December 2005, i.e. 20
months.
Evidence gathered
3.16
In order to investigate C&W’s allegations, Ofcom gathered evidence from a number
of parties, as set out in the following paragraphs.
Evidence gathered from BT
3.17
3.18
Ofcom requested information from BT in connection with its investigation in several
ways:
•
formal Notices under section 26 of the Act;
•
follow-up questions to BT’s responses to Notices under section 26 of the Act; and
•
informal requests for information.
Before reaching its provisional decision, Ofcom sent BT 14 section 26 Notices, as set
out in Table 2 below:
41
www.ofcom.org.uk/bulletins/comp_bull_index/comp_bull_ocases/open_all/cw_823/. On 7 April 2004
Ofcom wrote to the Office of Fair Trading (“OFT”), informing the OFT that it intended to exercise
prescribed functions (as defined under Regulation 2(j) of the Competition Act 1998 (Concurrency)
Regulations 2004) in relation to the complaint and asked the OFT to confirm that it agreed that Ofcom
was the competent person to exercise prescribed functions in relation to the complaint. The OFT
replied on the same date confirming that Ofcom was the competent person best placed to consider
the complaint.
25
Table 2: Details of section 26 Notices sent to BT during the course of the investigation
Date of Notice
Date of BT’s response(s)
Purpose of Notice
22 April 2005
13 May 2005
Provision of documents related to BT’s
decision to impose the price increases
notified in NCCN 500.
19 May 2005
27 May 2005
6 June 2005
Details of volumes of NTS calls
terminated by BT and revenues
received by BT in respect of those calls.
11 July 2005
Description of BT’s NTS business.
12 July 2005
Details of BT’s top 10 NTS service
provider customers.
28 June 2005
14 July 2005
21 July 2005
12 July 2005
14 July 2005
Copies of BT’s management accounts
and business cases relevant to its NTS
call termination business.
Details of volumes of NTS calls
originated by BT.
21 July 2005
9 September 2005
13 September 2005
24 August 2005
26 August 2005
Clarification of relevant transfer charges
in BT’s management accounts.
25 August 2005
9 September 2005
Details of volumes of NTS calls
originated by BT.
11 October 2005
11 October 2005
17 October 2005
Financial Information derived from BT’s
regulatory costing systems (see Section
6) required for Ofcom’s investigation of
C&W’s allegations of excessive pricing
and margin squeeze.
Information on volumes of calls transited
by BT.
21 October 2005
4 November 2005
Financial information derived from BT’s
regulatory costing systems required for
Ofcom’s investigation of C&W’s
allegations of excessive pricing.
10 November
2005
18 November 2005
Financial information derived from BT’s
regulatory costing systems information
required for Ofcom’s investigation of
C&W’s allegations of excessive pricing.
14 November
2005
2 December 2005
Provision of documents related to BT’s
decision to impose the price changes
notified in NCCN 651.
14 December 2005
26
Date of Notice
Date of BT’s response(s)
Purpose of Notice
14 December
2005
19 December 2005
Financial information derived from BT’s
regulatory costing systems required for
Ofcom’s investigation of C&W’s
allegations of excessive pricing.
24 January 2006
3 February 2006
Financial information derived from BT’s
regulatory costing systems required for
Ofcom’s investigation of C&W’s
allegations of excessive pricing.
6 February 2006
6 March 2006
10 March 2006
24 March 2006
24 April 2006
28 April 2006
3 May 2006
Financial information derived from BT’s
regulatory costing systems required for
Ofcom’s investigation of C&W’s
allegations of excessive pricing.
Provision of documents related to BT’s
contracts for the provision of NTS
hosting.
5 May 2006
3.19
Ofcom requested further information from BT by way of follow-up questions to BT’s
responses to Notices under section 26 of the Competition Act 1998 on a number of
occasions, as set out in Table 3 below:
Table 3: Follow-up information requested from BT during the course of the
investigation
Date of Ofcom’s
request
Details of Ofcom’s request
Date of BT’s
response
23 May 2005
Letter from [] (Ofcom) to [] (BT)
requesting further information on BT’s
response of 13 May 2005 to Ofcom’s Notice of
22 April 2005.
27 May 2005
13 December
2005
Letter from [] (Ofcom) to [] (BT)
requesting further information on BT’s
response of 2 December 2005 to Ofcom’s
Notice of 14 November 2005.
14 December 2005
20 December
2005
Letter from [] (Ofcom) to [] (BT) with
follow-up questions on BT’s response of 13
October to Ofcom’s Notice of 11 October, BT’s
response of 17 October to Ofcom’s Notice of
11 October; BT’s response of 4 November to
Ofcom’s Notice of 21 October and BT’s
response of 18 November to Ofcom’s Notice of
10 November.
30 December 2005
3.20
13 January 2006
20 January 2006
Ofcom requested information from BT informally on a number of occasions, as set
out in Table 4 below:
27
Table 4: Other information requested during the course of the investigation
Date of Ofcom’s
request
Details of Ofcom’s request
Date of BT’s
response
27 January 2006
Letter from [] (Ofcom) to [] (BT) inviting BT’s
comments on Ofcom’s financial analysis of BT’s voice
NTS call termination/hosting business.
16 February 2006
12 May 2006
Letter from [] (Ofcom) to [] (BT) asking BT to
clarify how it accounts within its regulatory costing
systems for the effect of non-geographic number
portability.
23 May 2006
28 July 2006
8 September 2006
3.21
3.22
BT made a number of other submissions that Ofcom took into account in its
investigation, as follows:
•
BT’s response of 7 January 2005 to the market review consultation;
•
letter from [] (BT) to [] (Ofcom) of 1 April 2005 setting out BT’s comments on
the complaint; and
•
letter from [] (BT) to [] (Ofcom) of 20 April 2006 setting out BT’s comments
on the continuing investigation, including two Annexes providing details of other
OCPs’ retention on calls to NTS numbers, differences between the charges
notified in NCCN 500 and NTS Calculator rates, and BT’s analysis of retail prices
for calls to NTS numbers.
Ofcom and BT discussed various aspects of Ofcom’s investigation, either face to
face or by telephone, on the following dates:
•
4 July 2005;
•
18 August 2005;
•
2 September 2005;
•
29 September 2005;
•
11 October 2005;
•
19 October 2005;
•
2 December 2005;
•
7 April 2006; and
•
16 June 2006.
Evidence gathered from C&W
3.23
28
In addition to C&W’s submission of 15 March, Ofcom considered evidence provided
by C&W in various different ways on a number of occasions.
3.24
3.25
3.26
Ofcom sent C&W five section 26 Notices over the course of the investigation:
•
19 May 2005 (to Energis and C&W) requesting calls volumes for the purposes of
enabling Ofcom to calculate market shares;
•
28 June 2005 (to Energis and C&W) requesting details of their respective
businesses and the impact of NCCN 500; and
•
23 March 2006 (to C&W only) requesting clarification of the impact of nongeographic number portability (“NGNP”) on the investigation (see following
paragraph).
C&W made a number of other submissions that Ofcom took into account in its
investigation:
•
an email of 22 April 2005 setting out in writing a number of comments made by
C&W in a meeting with Ofcom 6 April 2005 relating to issues raised in the
complaint;
•
a letter of 18 August 2005 setting out in writing a number of comments made by
C&W in a meeting with Ofcom 11 August 2005 relating to issues raised in the
complaint;
•
a letter of 6 September 2005 setting out C&W’s comments on the appropriate
approach to Ofcom’s analysis of the alleged margin squeeze;
•
an email of 9 December 2005 attaching C&W’s comments on the impact of
NCCN 651 on the investigation;
•
a letter of 1 March 2006 about the potential impact on the investigation of issues
relating to NGNP;
•
a further letter of 10 March 2006 about the potential impact on the investigation of
issues relating to NGNP;
•
a letter of 21 April 2006 clarifying C&W’s position with regard to issues relating to
NGNP;
•
a letter of 12 May 2006 containing a review of previous submissions made by
C&W in light of its letters to Ofcom of 1 March 2006 and 10 March 2006; and
•
a letter of 23 June 2006 commenting on the relevance of issues relating to NGNP
to Ofcom’s decision.
Ofcom and C&W met to discuss various aspects of Ofcom’s investigation on the
following dates:
•
6 April 2005;
•
11 May 2005;
•
8 June 2005;
•
11 August 2005;
29
•
29 November 2005;
•
15 March 2006;
•
12 April 2006;
•
7 June 2006; and
•
16 June 2006.
Evidence gathered from third parties
3.27
Ofcom gathered evidence from third parties as follows:
•
section 26 Notices of 19 May 2005 to COLT Telecom Ltd, Centrica
Telecommunications, Easynet Group Plc, Gamma Telecom Holdings Ltd
(“Gamma”), Global Crossing (UK) Telecommunications Ltd, Kingston
Communications Ltd, MCI Worldcom Ltd, ntl Group Limited (“ntl”), Telewest
Communications Plc (“Telewest”), Thus Plc (“Thus”), Tiscali UK Limited (“Tiscali”)
and Your Communications Ltd and section 26 Notice of 29 June 2005 to Opal
Telecom Limited, requesting volume information for the purpose of enabling
Ofcom to calculate market shares;
•
section 26 Notices of 28 June 2005 to Centrica, C&W, Energis (see footnote 1);
Gamma; Hutchison 3G UK Ltd (“3”); ntl; O2 Plc (“O2”); Orange Limited
(“Orange”); T-Mobile Limited (“T-Mobile”); Telewest; Thus; Tiscali; Vodafone Ltd
(“Vodafone”).
•
section 26 Notice of 16 May 2006 to FlexTel Ltd and section 26 Notice of 18 May
2006 to IV Response Ltd.
The draft decision
3.28
On 23 July 2007 Ofcom provided a draft decision to BT, C&W and four other parties
supporting C&W’s complaint (Carphone Warehouse (“CPW”), Thus, Tiscali, and
Virgin Media, together “the supporting parties”) for comment (the “draft decision”) and
invited written responses on its proposed findings by 10 September 2007. Following
requests for extensions from a number of the recipients, five responses were
received in the weeks commencing 8 October 2007 and 15 October 2007.
3.29
Responses were received from all the companies listed in paragraph 3.28 above
apart from Tiscali. These comments are set out in the relevant sections throughout
this document.
3.30
C&W, CPW, Thus and Virgin Media expressed concerns on the length of time taken
for this investigation.
3.31
As set out in this decision, Ofcom has undertaken an extensive amount of work and
evidence gathering on the relevant market and on the allegedly abusive conduct in
order to come to this decision. This has included additional work in response to new
30
information provided by C&W during the investigation and in response to comments
on the draft decision (see below).42
3.32
As set out above, Ofcom has sent extensive information requests, in particular to BT,
to obtain the evidence necessary to carry out its analysis. In some cases, particularly
in relation to BT’s costs, information has been unavailable, or not available in a
readily accessible or sufficiently disaggregated form. In these instances Ofcom has
engaged in an iterative process with BT to obtain the best information that it can on
which to base its decision.
Evidence gathered following the draft decision
3.33
Ofcom met C&W, CPW, Thus and Virgin Media on 11 December 2007. At the
meeting, C&W and the supporting parties commented on a number of issues that it
believed warranted further analysis by Ofcom.
3.34
In a letter to Ofcom of 14 December 2007, Thus (on behalf of itself and C&W, CPW
and Virgin Media) stated that it wished to propose an alternative to Ofcom’s
methodology for the analysis of C&W’s excessive pricing allegation, and requested
access to unredacted versions of Tables 18, 19, 20 and 22 of the draft decision
(which are also Tables 18, 19, 20 and 22 of this document) to enable them to carry
out this work. Thus also asked Ofcom for access to its case file, in order to
understand any analysis conducted by Ofcom that might not have been detailed in
the draft decision.43
3.35
In order to inform its consideration of some of the comments made by C&W and the
supporting parties, Ofcom sent BT a further section 26 Notice on 21 January 2008
requesting details of call traffic routed via the 1280 prefix (which enables CPS (carrier
pre-selection: see Glossary) customers to select BT for some of their calls on a callby-call basis) and of BT’s marketing activity over the period under investigation.
3.36
On 28 January 2008 Ofcom provided C&W, CPW, Thus and Virgin Media with copies
of a file containing a number of non-confidential documents on which it had based its
draft decision (the “non-confidential documents file”). All the documents in the nonconfidential file were documents provided by BT. The file included documents that
were non-confidential in full, and redacted versions of documents containing
confidential information.
3.37
On 30 January 2008, Ofcom met with C&W, CPW, Thus and Virgin Media to discuss
the case. Thus expressed the view, as stated in a follow up email, that it felt:
“unable to provide a robust contribution due to the amount of
redacted information both in the consultation itself and the recently
delivered case file [i.e. the non-confidential documents file].”44
3.38
In order to keep C&W and the supporting parties closely associated with the
proceedings, Ofcom considered whether it could provide further information to C&W
and the supporting parties, in particular:
42
C&W provided additional information in March 2006 relating to numbers that were ported from BT
to C&W, []. Work related to this information resulted in a delay to Ofcom’s ongoing work in order to
investigate the new information.
43
Letter from [] (Thus) to [] (Ofcom),14 December 2007.
44
email from [] (Thus) to [] (Ofcom), 31 January 2008.
31
•
whether it could share with C&W and the supporting parties BT’s reasons for
asserting confidentiality over particular information;
•
whether it could tell C&W and the supporting parties which inputs in its SAC
model were derived from BT’s regulatory accounts, which were derived from
confidential information provided by BT, and which were from other sources;
•
whether it could give C&W and the supporting parties access to a version of its
SAC model, redacted to remove confidential information; and
•
whether it could give third party economic advisors employed by C&W and the
supporting parties access to confidential information (including a full version of
the SAC model) subject to a suitable non-disclosure agreement.
3.39
Ofcom took into account its obligations under Part 9 Enterprise Act in assessing what
it was necessary to disclose to the complainants in order to keep the complainants
closely associated to assist in Ofcom carrying out its functions.45 Ofcom also had
regard to procedures set out in The Competition Act 1998 (Office of Fair Trading’s
Rules) Order 2004 (SI 2004/2751).46 Ofcom asked BT to provide further explanations
of its claims to confidentiality. BT responded to Ofcom’s requests by consenting to
certain information being disclosed and providing explanations of why other
information remained confidential. Ofcom carefully considered BT’s claims to
confidentiality to apply the considerations set out in section 244 Enterprise Act. Using
this test, Ofcom considered that disclosure of BT’s confidential information might
significantly harm BT’s legitimate business interests but did not consider that the
disclosure of this confidential information to C&W and the supporting parties was
necessary for the purpose of facilitating the exercise of Ofcom’s functions under the
Act.
3.40
In addition Ofcom considered whether it was necessary to facilitate its functions to
disclose a full version of the model, including BT confidential information, to third
party economic advisors retained by C&W and the supporting parties, under a nondisclosure agreement.47 Ofcom concluded, having regard to its obligations under Part
9 Enterprise Act, that disclosure to C&W’s third party economic advisors was not
necessary.48
3.41
On 4 March 2008 Ofcom therefore provided C&W with a version of its SAC model,
redacted to remove all confidential information supplied by BT and third parties (see
45
Ofcom notes the OFT’s guideline Involving third parties in Competition Act investigations (OFT
451), 2006, published at:
http://www.oft.gov.uk/advice_and_resources/publications/guidance/competition-act/oft_451.
46
The Competition Act 1998 (Office of Fair Trading’s Rules) Order 2004 (SI 2004/2751), published at:
http://www.opsi.gov.uk/si/si2004/20042751.htm
47
Ofcom notes that complainants may be provided with confidential information in the context of
appeals of decisions made under the Act to the CAT (usually within confidentiality rings which are
established by order of the CAT). However, Ofcom also notes that the CAT is not bound by Part 9
Enterprise Act (see section 237 (5)) and has wide powers to give directions to parties involved in
proceeding before it, including with regard to disclosure of documents (rule 19 The Competition
Appeal Tribunal’s Rules 2003 S.I. 1372/2003).
48
Ofcom notes Article 8(1) of Commission Regulation 773/2004 relating to the conduct of
proceedings by the Commission pursuant to Article 81 and 82 of the EC Treaty where in relation to
access to information for complainants, the Commission states: “the complainant may however not
have access to business secrets and other information belonging to other parties involved in the
proceedings”. Ofcom also notes the European Commission’s Access to File Notice (2005/C325/07),
paragraphs 30 to 32 and 39 to 43 and 49.
32
paragraph 3.27 above, final bullet). On the same date Ofcom wrote to C&W setting
out its decision on the other requests made by C&W and the supporting parties, as
set out in paragraph 3.38 above. The letter included an annex explaining in more
detail the derivation of the non-confidential inputs to the SAC model. Ofcom asked
C&W to submit any further comments on Ofcom’s excessive pricing methodology,
and on the contents of the non-confidential documents file, by 27 March 2008.
3.42
On 4 March 2008 Ofcom provided BT with a version of its SAC model, redacted to
remove all confidential information supplied by third parties (see paragraph 3.27
above, final bullet) and asked BT to submit any further comments on Ofcom’s
excessive pricing methodology by 27 March 2008. BT did not submit any further
comments on Ofcom’s excessive pricing methodology.
3.43
C&W wrote to Ofcom on 27 March 2008 stating that it did not intend to submit further
comments on the redacted SAC model or on the contents of the non-confidential
documents file.
33
Section 4
4 The relevant market
Summary
4.1
The Chapter II Prohibition provides that any conduct on the part of one or more
undertakings which amounts to the abuse of a dominant position in a market within
the UK is prohibited if it may affect trade within the UK.
4.2
Article 82 prohibits the abuse of a dominant position if it affects trade between
Member States.
4.3
For the purposes of the Chapter II prohibition and Article 82, dominance is assessed
within a relevant market.49 This section therefore considers the relevant market for
the purposes of assessing whether BT holds a dominant position (BT’s market
position is considered at Section 5) and whether it has abused that position (BT’s
conduct is considered at Section 6).
4.4
For the reasons set out below Ofcom concludes that in the context of its assessment
of C&W’s allegations the relevant market is a single market for the
termination/hosting of NTS calls in the UK.
4.5
In identifying the relevant market in this case Ofcom relied on some of the evidence
and findings in recent relevant market reviews where appropriate, and where Ofcom
was not aware of material changes to the findings in those reviews.50
Identifying markets
4.6
The relevant market normally has two dimensions: the relevant goods or services
(the product market) and the geographic extent of the market (the geographic
market).51
4.7
These dimensions may be broadly defined as follows:
49
•
a relevant product market comprises all those products and/or services which are
regarded as interchangeable by any reason of the products’ characteristics,
prices and intended use.52
•
the relevant geographic market is the area over which substitution takes place.
See OFT, Market Definition (OFT 403), 2004, published at:
http://www.oft.gov.uk/shared_oft/business_leaflets/ca98_guidelines/oft403.pdf and European
Commission Notice on the definition of the relevant market for the purposes of Community
competition law, OJ [1997] C372/5.
50
Ofcom notes that in Joined Cases T-125/97 etc Coca Cola v Commission [2000] ECR II 1733,
paragraph 82, the Court of First Instance (“CFI”) stated that in the course of any decision applying
Article 82 “the Commission must define the relevant market again and make a fresh analysis of the
conditions of competition which will not necessarily be based on the same considerations as those
underlying the previous finding of a dominant position.” See also paragraph 5.7 of OFT 403 and
Aberdeen Journals Ltd v DGFT (No 1) [2002] CAT 4, paragraph 139.
51
See OFT 403, paragraph 2.15.
52
Commission Notice on market definition (see footnote 49), paragraph 7.
34
Identifying the relevant product market
4.8
In Aberdeen Journals, the Competition Appeal Tribunal (“CAT”) stated that, in
assessing the relevant product market:
“The key idea is that of competitive constraint: do the other products
alleged to form part of the same market act as a competitive
constraint on the conduct of the allegedly dominant firm?” 53
4.9
The European Commission (“the Commission”) has provided guidance on how it
applies the concept of the relevant product market in practice in its Notice on market
definition, which describes the sorts of information that may be used to define
relevant product markets.54 These include product characteristics and intended use,
evidence of substitution in the recent past, the views of customers and competitors,
consumer preferences, barriers and costs associated with switching demand to
potential substitutes and different categories of customers and price discrimination.
Supply-side substitution may also be relevant to a definition of the relevant market,
where its effects are sufficient to constrain pricing behaviour within the relevant
timescale.
4.10
The “hypothetical monopolist test” is a useful tool for identifying close demand-side
and supply-side substitutes.55 A product is considered to constitute a separate
market if a hypothetical monopoly supplier could impose a small but significant, nontransitory relative price increase (in the range of 5% to 10%) above the competitive
level without losing sales to such a degree as to make this unprofitable (known as
the “SSNIP test”). If such a price rise would be unprofitable because of demand-side
or supply-side substitution, then the market definition should be expanded to include
the substitute products.
4.11
Demand-side substitution occurs if consumers would switch to other products in
response to the price increase. Supply-side substitution occurs if suppliers of other
products would begin to compete with the hypothetical monopolist in the supply of
the product under investigation in response to the price increase.
4.12
The OFT defines supply-side substitution as follows:
“If prices rise, undertakings that do not currently supply a product
might be able to supply it at short notice and without incurring
substantial sunk costs. This may prevent a hypothetical monopolist
profitably sustaining prices 5 to 10 per cent above competitive levels.
This form of substitution is carried out by suppliers and hence is
known as supply-side substitution.
Supply-side substitution can be thought of as a special case of entry
– entry that occurs quickly (e.g. less than one year), effectively (e.g.
on a scale large enough to affect prices), and without the need for
substantial sunk investments. Supply-side substitution addresses the
questions of whether, to what extent, and how quickly, undertakings
53
Aberdeen Journals Ltd v DGFT [2001] CAT 5, paragraph 97.
Commission Notice on the definition of the relevant market for the purposes of Community
competition law OJ [1997] C372/5, paragraphs 36-43.
55
Commission Notice on market definition (see footnote 49), paragraphs 15-19, OFT 403,
paragraphs 2.8-2.9 and Aberdeen Journals (see footnote 53), paragraph 99.
54
35
would start supplying a market in response to a hypothetical
monopolist attempting to sustain supra competitive prices.”56
4.13
Standard practice is first to consider whether demand-side substitution would be
sufficient to constrain the ability of a hypothetical monopolist in the supply of the
relevant good or service to sustain a SSNIP above the competitive level. Supply-side
substitution possibilities are then assessed to consider whether they provide any
additional constraints on the pricing behaviour of the hypothetical monopolist which
have not been captured in the demand-side analysis. In this assessment, supplyside substitution is considered to be a low cost form of entry which can take place
within a reasonable time frame (e.g. up to 12 months).
4.14
The key point is that, for supply-side substitution to be relevant, not only must
suppliers be able, in theory, to enter the market quickly and at low cost by virtue of
their existing position in the supply of other services or areas, but there must also be
an additional competitive constraint arising from such entry into the supply of the
service in question. Where supply side substitutes are not included within the
relevant market, their impact will be taken into account in the assessment of market
power as potential entry.
4.15
A third factor that may be an additional consideration is whether there exist common
pricing constraints across customers, services or areas, such that they should be
included within the same market. A common pricing constraint is generally used to
define the market when there are indications that there are additional constraints on
firms’ behaviour that override the absence of demand- or supply-side substitutability.
4.16
Such constraints can include, for example, transactions costs associated with
differentiating prices in different areas, or consumers’ preferences for purchasing a
bundle of services from a single supplier rather than on a service-by-service basis.
Failure to consider the existence of a common pricing constraint could lead to unduly
narrow markets being defined.
4.17
A fourth factor which may also be relevant is the homogeneity of competitive
conditions. It may be appropriate to consider two products as forming a single
market if competitive conditions in their supply are sufficiently homogeneous and
sufficiently distinct from other products potentially in the market. Homogeneity of
competitive conditions may be particularly relevant for geographic market definition.
Identifying the relevant geographic market
4.18
The geographic boundary of the relevant market is generally defined using the same
approach as the product market definition, that is, by using the hypothetical
monopolist test to inform judgments as to demand- and supply-side substitutability,
and, in the absence of demand- or supply-side substitutability, considering evidence
as to the existence of a common pricing constraint.
4.19
For geographic markets, the hypothetical monopolist test asks whether a price
increase in the narrowly defined area would encourage suppliers outside the area to
begin to offer services to customers in the area and/or whether customers could
switch to suppliers located outside the area. In certain circumstances, as discussed
in paragraph 4.15 above, the existence of a common pricing constraint can be
relevant to the consideration of relevant geographic market boundaries.
56
OFT 403, paragraphs 3.13 and 3.15.
36
4.20
In many communications markets, demand- and supply-side substitution possibilities
between different geographic areas are limited. It may be appropriate to consider the
area in which competitive conditions are homogeneous in order to determine the
geographic extent of the market. The Commission’s guidelines on SMP state:
“According to established case law, the relevant geographic market
comprises an area in which…the conditions of competition are
similar or sufficiently homogeneous and which can be distinguished
from neighbouring areas in which the prevailing conditions of
competition are appreciably different. The definition of the
geographic market does not require the conditions of competition
between traders or providers of services to be perfectly
homogeneous. It is sufficient that they are similar or sufficiently
homogeneous, and accordingly, only those areas in which the
conditions of competition are ‘heterogeneous’ may not be
considered to constitute a uniform market.”57
Markets relevant to this investigation
Introduction
4.21
4.22
For the purposes of this investigation, Ofcom has considered:
•
the relevant market in which BT may hold a dominant position and in which the
conduct in question has taken place, i.e. the market in which NTS call
termination/hosting falls (see paragraphs 4.52-4.151 below);
•
any other upstream markets, in which BT’s position may influence the extent to
which it faces competitive constraints in the relevant market (see paragraphs
4.42-4.51 below); and
•
downstream markets in which any effect of BT’s conduct in NTS call
termination/hosting may be felt (see paragraphs 4.36-4.41 below).
Ofcom will define the downstream market before considering the relevant market.
This is because the demand for upstream services is a derived demand, i.e. the level
of the demand for upstream inputs depends on the demand for downstream
services. In this case, the demand for NTS call termination/hosting is derived from
callers who want to buy services by calling NTS numbers. If the upstream input
accounts for a sufficiently large proportion of the downstream price, the range of
available substitutes at the downstream (retail) level will to some extent determine
the likely range of substitutes for the upstream (wholesale) service.58
NTS markets
4.23
The following table lists NTS number ranges and summarises the retail and
wholesale pricing arrangements applicable to each.
57
Commission guidelines on market analysis and the assessment of significant market power under
the Community regulatory framework for electronic communications networks and services (2002/C
165/03), paragraph 56.
58
Where the costs incurred in the upstream market do not form a sufficiently large proportion of the
downstream market price, distinct upstream markets may sometimes be defined on the basis that a
SSNIP for a narrower service in the upstream market would not lead to sufficient substitution to the
other upstream inputs.
37
Table 5: Wholesale payment arrangements for different NTS number ranges
Range
Retail price59
Wholesale payments
080
Generally free to caller
0844
Up to and including 5p per minute or
per call for BT customers (the price
charged by other OCPs may vary).
0845
BT’s standard local call charge for BT
customers (the price charged by other
OCPs may vary).61
0870
BT’s standard national call charge for
BT customers (the price charged by
other OCPs may vary).62
• NTS service provider makes payment to TCP
• TCP makes payment to OCP
• TCP-OCP payment is, in effect, set by
regulation for BT-originated calls
• TCP chooses a price point (for BT customers
– see Table 1 above)
• OCP makes a payment to TCP
• TCP may make a revenue share payment to
NTS service provider
• for BT-originated calls, payment to TCP is the
difference between the BT retail price and
BT’s regulated retention60
• OCP makes payment to TCP
• TCP may make a payment to NTS service
provider
• for BT-originated calls, payment to TCP is the
difference between the BT retail price and
BT’s regulated retention
Same as 0845
0871
Up to and including 10p per minute or
per call for BT customers (the price
charged by other OCPs may vary).
Same as 0844
09
PRS
Same as 0844
4.24
4.25
As discussed at paragraph 2.6 et seq above, any given NTS call will involve a
number of participants, including some or all of:
•
the retail end user (i.e. the caller);
•
an OCP (which may be BT);
•
a transit provider (which may be BT);
•
a TCP (which may be BT); and
•
an NTS service provider.
There are therefore a number of possible transactions that may take place, i.e.
between:
•
59
retail end users and OCPs;
See Table 1 for full details of call prices as specified in the NTNP.
Strictly the “Deemed Retail Price”, which is the actual retail price less discounts.
61
The requirement to charge at BT’s standard local call rate applies only to BT and derives from the
NTS call origination condition (see paragraph A9.27 of the NTS consultation).
62
The requirement to charge at BT’s national call rate applies only to BT and derives from the NTS
call origination condition (see paragraph A9.27 of the NTS consultation).
60
38
4.26
•
OCPs and transit providers;
•
transit providers and TCPs;
•
OCPs and TCPs;
•
TCPs and NTS service providers; and
•
end users and NTS service providers.
Figure 4 below provides an illustration of the most important of these transactions for
the purposes of Ofcom’s investigation. For simplicity, it does not describe the
situation in which traffic is transited via a third party transit provider. It also reflects
the more typical situation where an OCP makes a payment to the TCP who then
shares revenue with the service provider.63
Figure 4: Transactions in an NTS call – predominant case
4.27
The transaction that takes place between OCPs and TCPs is of particular relevance
to this investigation, since this was the transaction directly affected by NCCN 500.
The following discussion refers to this service as NTS call termination, where the
per-minute revenue paid to the TCP is the (gross) charge for termination (the TCP
then retains the net termination charge which is the gross termination charge less
any revenue share paid the service provider). Ofcom focuses on the predominant
case (revenue is collected by the OCP), since this is the mechanism used in the
termination of calls to the number ranges affected by NCCN 500.64
4.28
NTS hosting is the term used to describe the additional services purchased by NTS
service providers that enable them to use NTS as a micro-payment mechanism by
which they receive a share of call charges paid by callers (see paragraph 2.12).
63
Some TCPs share no revenue with NTS service providers and (in the past) NTS service providers
have made top-up payments to TCPs. Note that for 0800 the flow of money is entirely in the other
direction.
64
This is not the only payment model. For example, for 0800 numbers, payments are made by TCPs
to OCPs (but not vice versa) so that an increase in the price of termination would mean a TCP
starting to hand over smaller payments to OCPs.
39
4.29
TCPs sell NTS call termination to OCPs (and ultimately the caller) and NTS hosting
to NTS service providers. They sell call termination both directly and to resellers
which act as intermediaries to sell NTS call termination/hosting on to NTS service
providers.65 The balance of the gross termination charge not passed to the NTS
service provider or reseller (referred to as the net termination charge) is retained by
the TCP. Both TCPs and resellers may provide value added services (such as call
centre solutions) in addition to basic termination/hosting.
4.30
As shown in Figure 4 above there are three significant payments in the chain of
transactions that makes up an NTS call:
a) the retail price paid by callers to OCPs;
b) the gross termination charge paid by OCPs to TCPs; and
c) revenue share payments made by TCPs to NTS service providers.
4.31
In some cases, there is a positive revenue share payment from the TCP to the NTS
service provider. This is typically the case on the relatively expensive 087 and 09
number ranges, and for large ISP (internet service provider) customers on 084. In
other cases, the NTS service provider makes a payment to the TCP, that is, a
negative revenue share. This has often been the case for voice calls
terminated/hosted on 084 (for example the “other revenue” shown in Table 18 below,
which includes payments from NTS service providers to BT).
4.32
C&W has alleged that NCCN 500 created a margin squeeze between the gross
termination charge paid by OCPs to BT and the retail price paid by callers to OCPs
for calls to NTS numbers. NCCN 500 notified changes to BT’s gross termination
charges, BT’s revenue from which might have been used to fund the revenue share
payments BT makes to NTS service providers.
4.33
The market in which BT sells retail calls (and in which C&W has alleged a margin
squeeze has been created) is considered in the following section.
4.34
In considering the competitive pressures faced by BT and its competitors in NTS
markets, it is important to also take into account BT’s position in the markets for call
origination and transit, which are considered in paragraph 4.42 et seq below.
4.35
The market in which NTS call termination/hosting falls is defined in paragraph 4.52 et
seq below.
Downstream markets: retail NTS calls
4.36
The definition of the relevant retail market is discussed in detail in Annex 4. The
discussion follows the standard approach to market definition in which the starting
point is an analysis of the constraints imposed on prices by demand- and supplysubstitution. In addition, the existence of common pricing constraints across a
number of potentially distinct products is taken into account. On this basis, Ofcom
believes that it would be possible to define two distinct product markets for:
•
65
NTS calls made by business users; and
For example, during the course of the investigation [] and [] (both undertakings operating on
the NTS hosting side of the market) presented Ofcom with anecdotal evidence that indicated resellers
typically provide NTS call termination in addition to NTS hosting. [] and [] both provide NTS call
termination to OCPs, with [] also providing NTS hosting.
40
•
NTS calls made by residential users.
4.37
However, this definition is not necessarily the most relevant to this case. The relevant
retail market is that market (or those markets) in which competition could be affected
by BT’s conduct. Ofcom’s definition of the relevant market should therefore reflect
the way in which competition actually works. As market definition is not an end in
itself but a tool to identify and define the boundaries of competition between firms, it
is also appropriate to take account of the nature of the conduct under investigation.
4.38
Downstream retail market definitions are not material to assessing two of the abuses
alleged in this case: whether the charges notified in NCCN 500 charges were
excessive or discriminatory and aimed to exclude competitors. This means that the
key reason for defining the relevant retail market(s) is to assist with Ofcom’s
assessment of C&W’s allegation that NCCN 500 imposed a margin squeeze on
OCPs operating in retail markets.
4.39
Ofcom has therefore taken account of the fact that a number of products are supplied
together as a bundle in the definition of the relevant retail market. As described in
Annex 4, in other circumstances, for example in the context of an analysis of market
power for the purposes of imposing ex ante regulation, other market definitions might
be appropriate. Ofcom’s view is that, for the purposes of this case, the relevant
downstream market may be regarded as no narrower than the smallest bundle of
services in which retail NTS calls may be offered as a component, i.e. a bundle of
the following retail products (with distinct markets for services sold to residential and
business customers):
•
local calls;
•
calls to mobiles; and
•
NTS calls.
4.40
This bundle represents the additional services purchased as part of the CPS “all
calls” option compared to the (combined) national and international calls only options
(see paragraph 6.40et seq below).
4.41
Ofcom’s view is that it is not necessary formally to conclude on the relevant retail
market for the purposes of this decision, as it is sufficient to conclude that the
relevant market in which to assess the adequacy of the retail margin is no narrower
than this. Ofcom’s analysis across the variety of combinations of calls and access
that could form the relevant retail market is sufficient to allow it to reach the view that
NCCN 500 did not create a margin squeeze either on OCPs in retail markets or in
NTS hosting (see Section 6).
Upstream wholesale markets
4.42
BT’s position in wholesale markets other than NTS call termination/hosting plays an
important part in this investigation. In particular:
•
BT’s position of SMP in the market for wholesale call origination (see Annex 4) is
a key factor in preventing TCPs other than BT from increasing the gross
termination charges that they levy on BT when they terminate BT-originated
traffic (see paragraph 5.46 et seq below); and
41
•
BT’s role as a transit provider is, similarly, a key factor in preventing other TCPs
from increasing their gross termination charges for traffic that is transited (but not
originated or terminated) by BT (see paragraph 5.56 et seq below).
4.43
This combination of factors means that BT is uniquely in a position to increase its
gross termination charges above the level that is charged by its competitors. In the
NTS call termination/hosting market, non-BT TCPs are not in a position to
successfully negotiate over their gross termination charges either to BT or to other
OCPs (see paragraph 5.46 et seq below).
4.44
The economic markets in which these services fall, together with BT’s position within
them, are discussed at Annex 4 below.
4.45
In summary, the wholesale markets relevant to this investigation are:
•
wholesale call origination in the UK excluding the Hull area, in which Ofcom has
designated BT as having SMP;
•
single transit in the UK excluding the Hull area, in which Ofcom has designated
BT as having SMP; and
•
inter-tandem transit in the UK excluding the Hull area, in which Ofcom has
determined that BT no longer has SMP.
4.46
Ofcom analysed these markets in March 2003 and following a detailed market review
and consultation, made SMP findings in these markets in August 2003 in accordance
with the requirements of the legal framework of the EC Directives. The findings were
implemented from October 2003.66 These findings remained in place until they were
reviewed again in August 2005 following a detailed market review and consultation in
relation to network charge controls.67 BT was found to have SMP in relation to call
origination and single transit, and was made subject to network change controls for
the subsequent four-year period from October 2005 to September 2009. In relation
to inter-tandem transit, BT was found to no longer have SMP from October 2005.
4.47
In Ofcom’s August 2005 review of BT’s network charge controls, call origination and
single transit were found to have stable market conditions. BT was found to have a
share of approximately 80% of call origination and 100% of single transit and entry
barriers were high. In respect of call origination, Ofcom concluded in its “forward
look” that:
“BT’s current SMP in the market is unlikely to be eroded until such
time that other direct access networks expand their customer base
and are able to compete in a significant manner with BT. New entry
into this market is constrained by the high entry barriers in the form
66
Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit
markets: Identification and analysis of markets, determination of market power and setting of SMP
conditions: Explanatory Statement and Notification, 26 August 2003, published at:
http://www.ofcom.org.uk/static/archive/oftel/publications/eu_directives/2003/fix_narrow_retail0803.pdf,
paragraph S.12 and Chapters 4, 5 and 6; and Review of the fixed narrowband wholesale exchange
line, call origination, conveyance and transit markets: A consultation document issued by the Director
General of Telecommunications, 17 March 2003, paragraph S.6 and analysed at Chapters 5, 6 and 7,
published at:
http://www.ofcom.org.uk/static/archive/Oftel/publications/eu_directives/2003/eu_narrow/narrow0303.p
df.
67
Review of BT’s network charge controls, statement of 18 August 2005 (see footnote 14).
42
of sunk costs. Therefore Ofcom believes that BT is likely to have
SMP in wholesale call origination for the duration of the next
NCCs.”68
4.48
In respect of single transit, Ofcom concluded that:
“Ofcom is of the view that, for the foreseeable future, [other
communications providers] will continue to depend on BT for single
transit where direct interconnection is not economically viable.
Therefore, Ofcom believes that BT is likely to have SMP in single
transit for the duration of the next NCCs.”69
4.49
Ofcom believes therefore that it is not necessary to conduct a further review of BT’s
position in these markets for the purposes of this investigation, for which the relevant
time period ended in December 2005, only two months after the start of the new
controls on BT’s call origination and single transit charges.
4.50
Ofcom notes the falling away of BT’s SMP in the inter-tandem transit market two
months prior to the cessation of NCCN 500 (which ceased immediately after
December 2005). However, if conditions in this market were to change such that BT
once again had a dominant position, this would not affect Ofcom’s analysis in this
case.
4.51
In addition, Ofcom’s July 2006 review of BT’s retail price controls confirmed BT’s
market power in (certain) retail markets and the need for continuing regulation to
address BT’s market power in wholesale network services. 70
The relevant market
Introduction
4.52
As described in Table 5 above, given the link between retail prices for calls to NTS
numbers and the price of geographic calls made by BT customers for 0845 and 0870
calls, NTS service providers select the retail price to be paid by BT’s retail customers
for calls to NTS numbers, by selecting a particular number range (or, in the case of
0844, 0871, and 09 number ranges, a particular price point within a range).
4.53
NTS calls may be divided into four categories depending on the identity of the OCP
and TCP. What all four call types have in common is that the gross termination
charge levied by TCPs on OCPs is outside the control of the TCP (except where BT
is the TCP), for the reasons set out in paragraphs 4.54-4.58 below.71
4.54
First, for calls from BT to another TCP, BT’s retail price is linked to the relevant
geographic price, and other TCPs are unable to affect BT’s cost-based originator
retention (the maximum charge is set by regulation – see paragraph 2.18 above).
Further, BT’s market power in wholesale call origination means that it can resist
attempts to force it to accept a lower retention, meaning that in effect the gross
68
Review of BT’s network charge controls, statement of 18 August 2005 (see footnote 14), paragraph
A5.46.
69
Review of BT’s network charge controls, statement of 18 August 2005 (see footnote 14), paragraph
A5.68.
70
Retail Price Controls: Explanatory Statement, 19 July 2006, published at:
http://www.ofcom.org.uk/consult/condocs/retail/statement/.
71
As most calls between two communications providers other than BT are transited via BT, the case
of direct connection between communications providers other than BT is not described here.
43
termination charge is selected by the NTS service provider from a limited menu at
the time at which it obtains a number.
4.55
Second, for calls between communications providers other than BT, while other
OCPs may offer higher (or lower) retail prices than BT, the fact that most such calls
are delivered via BT as a transit provider means that other TCPs’ gross termination
charges are set as though the call were originated, as well as transited, by BT,
because BT pays the same rate for termination in either case. This arrangement
minimises the complexity of interconnection billing arrangements by allowing BT to
have a single set of transit charges and termination payments that do not vary
according to the OCP or TCP involved in each call.
4.56
The exception to the predominant case where a TCP cannot influence the level of its
gross termination charge is where the OCP is not BT, and BT is not involved in the
transit of the call. BT (as an OCP) is subject to maximum retail price regulation (as
set out in the NTNP) and BT is the only OCP found to have SMP in call origination.
Accordingly, a non-BT OCP with no SMP in the call origination market is likely to
have to accept a lower call origination retention (see paragraphs 2.22-2.26 above).
In addition, transit providers other than BT are likely to be able to bill OCPs at
different rates, thereby providing TCPs with more flexibility to vary their gross
termination charge accordingly (see paragraphs 2.24 above and 5.61 below).
However, Ofcom considers that calls made under this special case are not sufficient
in number or share to materially affect Ofcom’s findings on market definition and
dominance (see paragraphs 5.51 and 5.56 above).
4.57
Third, for BT-to-BT calls, the gross termination charge would be purely an internal
transfer charge, not necessarily directly reflected in charges to customers, and
therefore has no necessary commercial or economic significance (see Ofcom’s
analysis of alleged discrimination in Section 6).
4.58
Finally, for calls from another OCP to BT, the retail price is unregulated and BT is
able to set the termination charge subject only to any competitive constraints that
may apply. No other OCP has been found to be dominant in retail calls markets or
wholesale call origination in the UK (outside the Hull area).72
Analysis of NTS call termination/hosting as a two-sided market
4.59
In this section, Ofcom considers, first, whether NTS call termination and NTS hosting
can be regarded as a “two-sided” market and secondly whether, if so, it is
appropriate to analyse both sides of the market together, as a single whole, or as if
they were two distinct markets. The two (candidate) sides are marked “side 1” and
“side 2” in Figure 4 above. These are, respectively, NTS call termination and NTS
hosting.
Features of two-sided markets
4.60
72
Certain features are necessary for a market to be regarded as two-sided. One, in
particular, is the notion of “getting two sides on board”, i.e. acting as an intermediary
to create an indirect relationship between the two sides (for example advertisers and
readers in the case of newspapers).
Review of BT’s network charge controls, statement of 18 August 2005 (see footnote 14),and Retail
price controls – explanatory statement, 19 July 2006,
http://www.ofcom.org.uk/consult/condocs/retail/statement/.
44
4.61
For instance, as part of its market review into classified directory advertising services
(“CDAS”), the Competition Commission noted that classified directory providers
operate in a two-sided market in which success depends on their ability to attract
both users and advertisers to their directory. The Competition Commission went on
to argue that:
“This interdependence of advertiser and user demand for directories gives
rise to a network effect or ‘virtuous circle’; a directory provider that has built
up high levels of usage and advertising is more attractive to new advertisers
and users than a competitor with less usage and less advertising whose
offer, in terms of price, quality and service, may otherwise be the same.”73
4.62
In a recent merger case involving equestrian magazines, the OFT identified the
existence of a two-sided market using similar reasoning:
“Equestrian magazines operate in a two-sided market, in which readers
(who demand information of one kind or another) and advertisers (who
demand space to advertise/promote their goods and/or services) are closely
inter-linked. The willingness of advertisers to pay for advertising space in a
magazine will depend on the number and type of readers. Readers'
willingness to read a particular magazine may in certain cases depend on
the amount and type of advertising and/or editorial content within that
magazine.”74
4.63
Recently, some economists have tried to define ‘two-sidedness’ in a rigorous way.
The definition proposed by Rochet and Tirole is based on the idea that, in a twosided market, the “platform” provider’s total volume of transactions depends on the
price structure (that is the respective share of the total charge borne by each side),
as well as the level of the combined price (that is the sum of the charges to each
side).75 In single-sided markets, total revenue depends only on the latter. A number
of two-sided markets feature prices on one side of the market that do not cover costs
or are even negative.
4.64
Newspaper advertising is often regarded as an example of a two-sided market.76
Advertisers contribute to the recovery of the cost of the paper by paying for
advertising space. The most extreme form of this exists where the paper is free of
charge to end consumers (i.e. readers). The volume of total newspaper readership is
likely to be sensitive to the share of payments made between readers and
73
Competition Commission, Classified Directory Advertising Services market investigation, 21
December 2006, published at http://www.competitioncommission.org.uk/rep_pub/reports/2006/521cdas.htm, paragraph 6.2.
74
OFT, Anticipated acquisition by IPC Media Ltd of Horse Deals Ltd: The OFT's decision on reference
under section 33(1) given on 16 August 2006, 1 September 2006, published at:
http://www.oft.gov.uk/shared_oft/mergers_ea02/2006/ipc.pdf.
75
Jean-Charles Rochet and Jean Tirole, Defining Two-Sided Markets, 2004, presented at UCL twosided markets conference, May 2006.
76
For instance, the OFT has stated: “Newspapers and magazines operate in so-called ‘two-sided
markets’, i.e. markets in which there are two sets of customers, each of which benefits from the other
type of customer buying the product concerned. In this case, each title competes against other titles
to attract readers, on the one hand, and advertisers, on the other. Publishers receive revenue from
both readers (through cover prices) and advertisers. Publishers take account of the interaction
between these two customer groups when determining the pricing strategy for their titles, as
readership (circulation) is an important factor in determining advertising rates.” See Newspaper and
Magazine Distribution: Public consultation on the draft opinion of the Office of Fair Trading (OFT 851),
31 May 2006, published at: http://www.oft.gov.uk/shared_oft/reports/comp_policy/oft851.pdf.
45
advertisers. For example, if readers of a free paper were required to pay a cover
price or subscription, and the amount paid by advertisers fell by an equivalent
amount, overall circulation of the newspaper might fall.
4.65
The effect on total sales arising from a change in the structure of payments is a key
feature of two-sided markets.
NTS and the characteristics of a two-sided market
4.66
In the case of NTS calls, TCPs always provide both termination (to the OCP and
ultimately the caller) and hosting (to the NTS service provider), and so perform the
function of bringing "the two sides of the market together" which, as discussed
above, is a feature of two-sided markets. In addition, the structure of charges is
crucial to the way NTS markets operate, since a TCP’s ability to attract NTS service
providers (and generate calls from OCPs’ retail customers) depends on the level of
the payment that it can offer NTS service providers.
4.67
Callers typically pay a price for NTS calls that is high relative to the costs of providing
the underlying telecoms service, while NTS service providers pay little or receive a
revenue share payment. For the purposes of illustration, a BT retail customer may
pay up to 10ppm to make a daytime 0870/0871 call, of which only some 6.7ppm
would be retained by the provider(s) involved in the call to cover the cost of
origination, conveyance and termination.77 The remaining 3.3ppm would be passed
to the NTS service provider as a revenue share.
4.68
TCPs compete with each other to attract NTS service providers, with greater success
in doing this being rewarded by receiving an increased volume of calls, on which a
termination payment is earned. A firm that sells NTS hosting to a particular NTS
service provider always terminates traffic on behalf of that NTS service provider. The
role played by NTS service providers is key since, as noted in paragraph 4.52 above,
they select the retail price paid by callers, by choosing a particular number range (or,
in the case of 0844, 0871, and 09 number ranges, a particular price point within a
range: see Table 1 above).
4.69
On the face of it, the market has some of the characteristics of two-sided markets, in
particular the dependency of call volumes on the structure of charges (with callers
paying charges which are high relative to TCPs’ costs and NTS service providers
paying relatively little or receiving a payment, as described in paragraph 4.67
above).78
4.70
In the next two sections we consider the implications of this for the most appropriate
market definition in the circumstances of this case.
Single versus separate markets: the general case
4.71
77
Ofcom agrees that in most two-sided markets it is likely be appropriate to examine
the two sides separately, as, in effect, distinct (but inter-related) markets and is fully
aware that this approach has been followed in a number of cases which have been
examined by competition authorities. For example in assessing the market for mobile
Estimates derived from BT price list and information provided by BT on hosting contracts.
Jean-Charles Rochet and Jean Tirole, Defining Two-Sided Markets, 2004, presented at UCL twosided markets conference, May 2006, and as referred to in The Challenges of a digital World and the
need for a new regulatory paradigm, Leonard Waverman, London Business School, essay in
Communications - The next decade, a collection of essays prepared for the UK Office of
Communications, November 2006, Chapter 3, page 173.
78
46
call termination, both Ofcom and the Competition Commission defined distinct
markets for termination, on the one hand, and for retail mobile calls (that is, calls
from a mobile) and mobile access combined, on the other.79
4.72
In Aberdeen Journals the CAT upheld the OFT’s market definition which focused on
the relevant product market for advertising space in local newspapers (as opposed
to a single two-sided market also encompassing the provision of newspapers to
readers).80
4.73
In Carlton/Granada, the Competition Commission defined separate relevant product
markets for advertising and broadcasting activities.81 In the report of its investigation
of the Classified Directory Advertising Services (CDAS) market, the Competition
Commission explained its market analysis in the following terms:
“Industries such as CDAS are described as ‘two-sided markets’ –
providers of CDAS compete both for users and for advertisers. The
value of CDAS for advertisers depends on the level of usage by
consumers, which, in turn, depends on the total amount of useful
advertising they find in these publications. This creates a ‘network
effect’, by which more advertising attracts more usage which in turn
attracts more advertisers. Because users do not pay directly for the
use of CDAS, CDAS providers’ profitability will be determined by
advertiser revenues (although these, in turn, may be affected by
usage); therefore we examined the market at the advertiser level.”82
4.74
When assessing whether it is appropriate to treat the relevant market as a single
market or to define distinct markets for each of the two sides, careful consideration
must be given to the circumstances of the case.
Single versus separate markets: features of NTS hosting/termination
4.75
Ofcom believes that, in the particular circumstances of NTS call termination, it is
appropriate to consider both sides of the market simultaneously and not necessary
to analyse the two sides of the market separately, as two distinct markets (one for
NTS call termination and one for NTS hosting).83
79
See Wholesale mobile voice call termination - Preliminary consultation on future regulation, Ofcom,
June 2005, http://www.ofcom.org.uk/consult/condocs/termination/260123/ and
Competition Commission, Vodafone, O2, Orange and T-Mobile, January 2003, published at:
http://www.competition-commission.org.uk/rep_pub/reports/2003/475mobilephones.htm#full.
80
Aberdeen Journals Ltd v OFT [2003] CAT 11 at [301]-[308].
81
Competition Commission, Carlton Communications Plc and Granada Plc: a report on the proposed
merger (Cm 5953), October 2003, published at: http://www.competitioncommission.org.uk/rep_pub/reports/2003/482carlton.htm. The implications of two-sidedness do not
appear to have been explicitly considered although at paragraph 5.64 it is noted that “money [i.e.
advertising] follows viewers”.
82
Competition Commission CDAS market investigation, statement of 21 December 2006 (see
footnote 73), paragraph 5.9.
83
This seems to be the approach adopted by the Competition Commission in its November 2000
report on the merger between Regional Independent Media and others. See for example the
discussion of market share measures at paragraph 4.14, and the discussion of market power at
paragraph 4.60. The Competition Commission considers whether in a local market it is likely that “the
merged entity would wish to exploit its position, for example by raising cover prices or advertising
rates, within that market”. See http://www.competitioncommission.org.uk/rep_pub/reports/2000/447rim.htm.
47
4.76
In a two-sided market, there may be an optimum pricing structure (the balance of
charges between the two sides), which may involve prices on each side of the
market that reflect considerations in addition to the costs of serving that side in
isolation. Market power on one or other side of the market may distort the structure
away from the optimum. In such cases, it may be appropriate to analyse the two
sides of a two-sided market separately.
4.77
However, the specific features of NTS mean that the characteristics we generally
expect to find in two-sided markets are either not present or are relatively
unimportant in this case.
4.78
•
The pricing structure (the balance of charges between the two sides) is
determined by regulation on the termination side of the market, and competition
on the hosting side. This means that the market outcome is unlikely to produce a
price structure which is a long way from the optimum, and structure is not
therefore an issue in this case.
•
There is no obvious means of determining the “competitive” level of the charge
on each side of the market, which varies according to the NTS number range,
which is selected by the service provider. A variety of different price structures
therefore exist in the market (compare 0800 with 09 for example).
•
Callers to some ranges benefit from a low or negative price for hosting, that is,
the outpayment to the service provider, as this enables the NTS revenue sharing
mechanism to function as a micro-payment mechanism and encourages the
development of new services (e.g. dial-up internet access).
•
Service providers are likely to be directly concerned with the price on both sides
of the market.
These four specific features of NTS are considered in more detail in the following
paragraphs. We set out below how these features, and in particular the role of NTS
service providers in choosing the retail price, mean that it is appropriate in this case
to analyse the two sides as a single market.
Pricing structure is in effect determined by regulation
4.79
A key feature of NTS markets – the structure of prices (that is, the relative levels of
the gross termination charge and the revenue share outpayment) – is not a concern
being examined in this investigation. Ofcom is not, in this case, investigating whether
the structure of charges, with retail callers paying a relatively high charge and
service providers paying relatively little or even receiving a revenue share, is
inappropriate.84
4.80
Existing regulation (the NTNP and the NTS call origination condition) already
provides a mechanism that allows issues of pricing structure between the two sides
to be addressed to a large extent, by enabling service providers to choose from a
menu of retail NTS call prices. While it might therefore be possible to define a
separate market for each of the two sides in which an NTS terminating provider is
involved (termination and hosting), this would not illuminate the analysis of the case.
84
As noted earlier, this pattern is in fact an intentional characteristic of the NTS regime. Ofcom has
considered the range of call types which may appropriately fall within this regime elsewhere, in the
NTS consultation for example, where it also proposed measures to address concerns about the level
and transparency of certain charges.
48
Therefore, a key advantage (in general) of analysing the two sides of the market
separately, the ability to consider the balance of prices between the two sides, is not
relevant for the purpose of this investigation.
No means for accurately assessing competitive prices separately on each of the two
sides of market
4.81
Because the optimum pricing structure does not necessarily reflect the underlying
costs on either side of the market, it would be difficult to assess the “competitive
price”, and hence the right starting point for a SSNIP test, for the two sides of the
market separately. Identifying the competitive price level for the net termination
charge (where the net price is the total unit revenue retained by the TCP following its
transactions with both OCPs and NTS service providers and, where relevant, transit
providers, as opposed to the gross charge or price, which is the price that the TCP
charges to OCPs, as noted at paragraph 4.27 above) in the single-market approach
is less difficult, because it reflects the combined underlying costs of servicing both
sides of the market i.e. termination and hosting. Similar issues may arise in other
two-sided markets such as classified directories, as noted in paragraph 4.73 above.
In some cases the price for hosting is zero or negative
4.82
As noted at paragraph 4.31 above, in some cases the price of hosting is negative,
that is, the TCP pays the service provider a revenue share in return for which a
service such as a customer helpline or internet access is provided (see paragraph
2.12 above). As explained in paragraph 4.99 below, the level of the outpayment
reflects the pressure of competition to attract service providers. A range including
zero or negative prices appears therefore to be consistent with a competitive
outcome yet does not, by itself, bear any obvious relation to the costs of hosting.
This further illustrates the difficulty in analysing pricing constraints for NTS hosting
separately from pricing constraints on NTS termination.
Service providers are directly concerned with the price on both sides of the market
4.83
A number of NTS service providers operate primarily as retailers, including a
disparate range of consumer markets such as banking, white goods etc, and use
NTS numbers to deliver after-sales service. A relevant factor in the competition
between NTS service providers in these consumer markets may be the levels and
balance between the price for making NTS calls and the price for the primary
consumer service (banking, white goods etc). This means that the NTS service
provider will be concerned directly with the price on both sides of the market,
including the charge to the caller. An implication of these features is that it is not
necessary to analyse the two sides of the market separately.
4.84
There is a parallel between the service provider’s ability, in this case, to choose from
a menu of retail NTS call prices, and the role of “side payments” in two-sided
markets.85 As pointed out by Rochet and Tirole, side payments can enable the
externality between customers on the two sides to be internalised.86 This means that,
85
Side payments are payments directly between the parties. Callers and called parties (NTS service
providers) are generally unable to make such side-payments among themselves.
86
Op cit, page 11. Rochet and Tirole refer to “side transfers” and “side contracting”. One source of
externality in this case is that the called party benefits from a call being made but the caller will not (in
general) take this into account when deciding to make the call. Another externality may arise because
the cost that a party on one side (of the two sided market) is willing to bear depends in turn on the
number of customers on the other side of the market (and vice versa).
49
where side payments enable the optimum price structure to be achieved, there is no
need to analyse the two sides separately, and the market may be analysed as if it
were a single market (for NTS call termination/hosting). We consider that a service
provider's ability to choose from a menu of NTS call prices can approximate to a
side-payment mechanism, albeit imperfectly.
4.85
For example, suppose a service provider on an 0870 number decides that the
desired structure in fact entails it paying for the call in order to encourage calling
(because of a positive externality). If explicit side-payments were possible, the
service provider could agree with the caller for a side payment of the requisite
amount to be paid to the caller (which could vary by caller). Such payments are not
feasible but, within the NTS regime, there is another option open to the service
provider. It can choose a different number range which does feature the desired
structure – in the example above, 0800 would be more appropriate. In this sense, the
service provider's ability to choose from a number of different price points for the call
appears to have a similar role to the side-payment, in enabling the externality
between the caller and called party to be internalised, and in allowing a relatively
efficient price structure to be achieved by the market.
4.86
In the light of the above discussion, we believe it may be helpful to identify three
different cases for the purposes of market definition in this decision. We set
out below the terminology that we have used to describe these cases in this section.
Terminology of course is not in itself important except insofar as it aids
understanding. But with this in mind, and with the caveat that it is proposed for the
purposes of this case only, we propose the following typology of markets:
i)
a single-sided market is one in which there are no interdependencies. This
would include “standard” cases, such as vegetables purchased from a market
stall;
ii) a two-sided market is one in which there are interdependencies between the
two sides. The sort of interdependency which is relevant here is found for
example in the classified directories, newspapers and other markets described in
paragraphs 4.60-4.65above. The key feature of such markets is that total sales
depend on the structure of charges, not just their level, and in particular on the
balance of charges between the two sides (for example, on the fact that a
particular newspaper may be free to the reader, with costs being covered by
charges made to advertisers). It is possible in such cases that market power on
one side of the market leads to a distortion in the price structure and therefore it
is generally appropriate to analyse the two sides of the market separately; and
iii) a special case of ii) in which the interdependencies are internalised, for example,
by means of a side payment mechanism. It might be helpful to think of such
markets as “single(-sided) platform” markets. For the reasons set out above,
notably the ability of service providers to choose the retail call price from within a
range subject to regulation, NTS call termination/hosting is an example of this
kind of market. In these cases, it may be appropriate to analyse the two sides of
the market together, because the side payment or equivalent mechanism means
that a reasonably efficient price structure can be achieved by the market.
Questions of market power, or alleged abusive behaviour can then be analysed
by looking at the market as a whole.
50
NTS call termination/hosting market: analysis
4.87
In the discussion of market definition that follows, Ofcom considers the constraints
that apply to NTS call termination and NTS hosting jointly, based primarily on the
net, rather than gross, price of termination.87
4.88
Where the TCP makes revenue share payments to NTS service providers in order to
attract them to its network, the net charge is lower than the gross charge. For some
calls, such as 0845 voice, the service provider may make a payment to the TCP
rather than receiving a revenue share. In such cases, the net termination charge is
higher than the gross charge.
4.89
The market in question is referred to as NTS call termination/hosting. In the analysis
that follows, Ofcom therefore applies the hypothetical monopolist test based on the
net price of NTS call termination/hosting. In other words, it considers the response of
customers following a 5-10% increase in the net price of NTS call termination.
4.90
In the following section (paragraphs 4.92-4.151), the hypothetical monopolist test is
used to define the boundaries of the market for NTS call termination/hosting. To this
end, the effect of a SSNIP in the net termination charge is considered in order to
test, in turn, each of the following propositions:
a) the relevant market encompasses NTS call termination/hosting services sold by
all TCPs (see paragraphs 4.92-4.99);
b) the relevant market spans all NTS number ranges (see paragraphs 4.100-4.107);
c) the relevant market includes both voice and data termination (see paragraphs
4.108-4.141); and
d) other non-geographic call types fall outside the relevant market (see paragraphs
4.142-4.150).
4.91
The geographic extent of the market is considered from paragraph 4.152 et seq.
The relevant market encompasses NTS call termination/hosting services sold by all
TCPs
4.92
The net termination charge levied by TCPs varies by number range and by customer.
For example, considerably larger amounts of money are available for revenue
sharing on the more expensive number ranges (087 and 09), while, on a given
number range and other things being equal, NTS service providers that receive
greater volumes of incoming traffic tend to receive higher per minute revenue share
payments.
87
Similarly, in the OFT consultation Newspaper and Magazine Distribution: Public consultation on the
draft opinion of the Office of Fair Trading (OFT 851), 31 May 2006, published at:
http://www.oft.gov.uk/shared_oft/reports/comp_policy/oft851.pdf, footnote 203, the OFT states:
“Consider a publisher which increases prices to one side of the market, for example by demanding a
higher share of the cover price (thereby reducing wholesalers’ and retailers’ margins and possibly
leading to an increase in [carriage service charges]). This will result in: (i) fewer copies being sold to
final consumers (for example, because some retailers exit the market leading to reduced availability
and thus fewer sales); and (ii) higher profits on the copies that are still sold. Analogously to a firm in a
one-sided market, the publisher would balance effect (i) against effect (ii). The difference in a twosided market is that effect (i), as well as including the lost revenue on foregone sales, is reinforced by
a fall in advertising revenue (resulting from the fall in circulation)”.
51
4.93
Following a 5-10% increase in the net termination charge levied on a particular NTS
service provider by a TCP (i.e. a fall in revenue share payments), it would be
relatively straightforward (subject to any contractual obligations that may apply, for
example) for the NTS service provider to switch to another TCP for NTS call
termination.
4.94
This is based on Ofcom’s understanding that investments that need to be undertaken
to supply additional NTS number ranges are small (see paragraph 5.31 below).88
4.95
Different TCPs also compete with each other to provide NTS call termination at the
stage when NTS service providers entering the market are deciding which TCP to
use to enable them to provide services to callers. Ofcom considers that substitution
by service providers between TCPs is likely to be sufficiently large to make the
SSNIP unprofitable. Therefore all TCPs should be included in the relevant market.
4.96
There are a number of precedents for markets for call termination services being
defined on a network specific basis.89 In such markets, the calling party pays
arrangement means that a SSNIP in the price of call termination is borne by the
caller, who is unable or does not have the incentive to influence the choice of TCP
and therefore does not respond to the SSNIP by choosing an alternative TCP (as
this choice is made by the called party).
4.97
This is sometimes referred to as the “calling party pays externality” (because the cost
or benefit arising from the choice of terminating operator falls on parties who do not
participate in it). This tends to lead to network-specific call termination markets.
4.98
In general, the calling party pays externality does not play a key part in determining
the competitiveness of NTS call termination. However, as explained in paragraph
5.46 et seq below, non-BT TCPs are not able to exert an influence on gross
termination charges or retail prices (except to the extent that they select the retail
price point for calls to 0844 and 0871 numbers) – whereas BT is.
4.99
The key source of competitive pressure therefore comes from NTS service providers,
who have an incentive to choose the TCP that offers them the highest revenue share
(i.e. imposes the lowest net termination charge at the desired retail price point). As
noted above in paragraph 4.83 above, in some cases this price point may reflect
competitive pressure in final goods markets in which NTS service providers operate
and, unlike fixed geographic and mobile calls, the called party (in the case of NTS,
the NTS service provider) has a role in setting the retail price. NTS service providers
therefore provide a competitive constraint across all TCPs (see paragraph 4.66 et
seq above).90
The relevant market spans all NTS number ranges
4.100 There are a number of limitations to demand-side substitution between different
number ranges.
4.101 Consumer research undertaken by Ofcom shows that consumers’ perceptions
regarding the relative cost to them of calling NTS numbers depends on the number
range. These perceptions reflect real differences in the prices of calls to different
88
NTS call termination market review consultation, paragraph 4.17 et seq.
See footnote 79.
90
Some indication of the importance of the revenue share outpayment, though in a different context,
was collected for Ofcom’s review of NTS: see for example the NTS statement, paragraph 3.56.
89
52
NTS number ranges and the types of services that tend to be offered (see Table 1
and paragraph 2.4 above).91
4.102 This means that, facing a 5-10% increase in net NTS call termination charges, NTS
service providers offering services terminated on a particular number range might be
reluctant to switch to another number range (whether or not they switch to another
TCP at the same time) as this could have an impact on call volumes. The extent of
this reluctance is difficult for Ofcom to determine. However, Ofcom’s view is that it is
not necessary to examine this issue in detail given the scope for supply-side
substitution between the provision of termination/hosting services using different
number ranges, which, as will be argued below, is significant in this market, and the
homogeneity of competitive conditions.
4.103 If a hypothetical monopolist supplier of NTS call termination/hosting on (for example)
the 084 range increased the net charge levied for its services, TCPs providing NTS
call termination/hosting on the 080, 087, and 09 ranges would be able to switch
quickly into supplying the same service on 084 (subject to allocation of numbers by
Ofcom and compliance with the NTNP) without having to make substantial additional
investments (see paragraph 5.31 below). Once a TCP has established the network
platform needed to terminate NTS calls, the platform can be used equally for all
types of NTS voice calls. In addition, the marketing and distribution arrangements for
the various types of NTS are very similar.
4.104 Supply-side substitution between number ranges (for example by terminators of 0870
calls into the termination of 0845 calls) will, however, only place additional
constraints on TCPs beyond those already captured by demand-side analysis to the
extent that there are additional players not already materially present in the supply of
0845 terminations. Such a situation is likely to exist in the case of NTS call
termination/hosting, since, to some extent, some TCPs specialise in the termination
of a certain type of traffic (e.g. only 0845 traffic). This is demonstrated in Figure 5
below, which shows that, currently, TCPs terminate quite different mixes of each
traffic type. Figure 5 shows the percentage split, by number range, of total
terminated minutes of the six largest terminators of NTS traffic based on 2004/05
data.
4.105 It is clear from Figure 5 below that different TCPs terminate significantly different
mixes of traffic, and in particular that there are a number of terminators of 0845 traffic
that do not terminate significant volumes of the other traffic types. Given that, for the
reasons set out in paragraph 4.103 above, little additional cost need be incurred to
terminate calls on additional number ranges (at least in the case of voice calls – see
paragraph 5.33 below), a monopoly supplier of termination/hosting on the 09 or 087
ranges could be additionally constrained by supply-side substitution from
communications providers currently providing termination on 0845 number ranges.92
91
Ofcom commissioned residential and business consumer research in July 2004 among GB adults
and Oftel residential consumer research carried out in August 2003 among UK adults. The research
was intended to examine awareness and perceptions of the cost of calling 084 and 087 numbers,
perceptions of the cost of ‘local rate’ and ‘national rate’ calls why SME’s use NTS numbers and
reactions to changing price structure. See Annex 7 of the NTS consultation, e.g. paragraph A.7.3.
92
The figures in the table below are all rounded to the nearest whole percentage point, meaning that
in cases where less than 0.5% of a TCP’s total traffic is to a particular number range the figure is
listed as 0% (and also that, in some cases, the row entries in a particular column do not sum to
100%). However, some TCPs generate negligible amounts of traffic on certain ranges, and do not
therefore exert a significant competitive constraint.
53
Figure 5: Traffic mixes of different TCPs, 2004/0593
[]
Source: Responses to section 26 Notices of 19 May 2006 (see paragraph 3.27).
4.106 In the above discussion, we provided the example of TCPs who specialised in 0845
and could additionally constrain the 09 and 087 number ranges, since the supplier
could easily provide termination services in these number ranges given the small
investments needed. It is also the case that some TCPs who specialise in
termination in 0845 are also present in the provision of NTS termination in 09 and
087 number ranges, albeit as small players. The potential for expansion by suppliers
with a small but material presence in more than one number range (as set out in
Figure 5), is suggestive of a degree of homogeneity of competitive conditions not
necessarily reflected in market shares.
4.107 Given this scope for supply-side substitution and homogeneity of competitive
conditions, Ofcom considers that the services affected by NCCN 500 form a single
product market, namely that for NTS call termination/hosting, which covers all NTS
number ranges.
The relevant market includes both voice and data termination
4.108 Ofcom has considered whether termination of voice and data calls to NTS numbers
are both part of the relevant market.94 There are a number of considerations which
have informed Ofcom’s view that a broader market including both data and voice
exists. These are:
•
the NTS regulatory framework;
•
common pricing constraints; and
•
supply-side substitution.
The NTS regulatory framework;
4.109 The key regulations governing the pricing of NTS call termination include:
•
the NTS call origination condition; and
•
retail pricing arrangements for NTS calls.
4.110 Ofcom does not consider that these regulations constrain BT (or other TCPs) to set
the same gross termination charge for both NTS voice and data calls, or to charge
other OCPs for termination at the same rate as they pay to other TCPs. Importantly,
these regulations do not constrain the net termination charge retained by the TCP
which will also reflect any variations in the (unregulated) outpayment to service
providers.
93
[] supplies mostly 084x for data NTS calls related to its dial-up ISP business. C&W also provides
084x data NTS calls for other ISP services.
94
Data calls to NTS numbers are mainly for dial-up internet access.
54
4.111 Under the first regulation (the NTS call origination condition) BT is only permitted to
make cost-related charges for originating and retailing NTS calls and must pass the
remaining revenues over to the TCP.
4.112 Under the second (the NTNP), the various NTS number ranges have different
designations for use, some of which relate to retail pricing (others relate to content,
for example 098 which is reserved for sexual entertainment services). For example,
the 080 range is designated as a range where no charges are made to customers
unless those charges are notified to the customer at the beginning of the call. In
selecting a particular NTS number block, a TCP takes on an obligation to use the
numbers in accordance with the designations given in the NTNP. In this sense, the
TCP is restricted in its use of NTS numbers.
4.113 Ofcom notes that NTS calls on the number ranges 0870/0871 are primarily voice
calls (although not exclusively), whereas NTS calls to 0845/0844 include both voice
and data calls.
4.114 Neither of the above regulations require TCPs to price voice and data call termination
at the same rate.
Common pricing constraint
4.115 Ofcom considers that for the period under investigation, data and voice NTS call
termination/hosting were subject to a common pricing constraint, thereby placing
them both in the relevant NTS call termination/hosting market for the reasons set out
below. In particular:
•
technical constraints make it unfeasible for BT to introduce different gross
termination charges for voice and data traffic without disproportionate cost and
disruption;
•
other TCPs are in any case not able to vary their gross termination charges
because of the combined effects of the regulation of retail NTS prices and BT’s
market power in call origination and (single) transit, as set out in paragraph 5.46
et seq below. The amount BT pays other TCPs does not differentiate between
voice and data traffic due to retail price regulation and BT’s market power in call
origination and the call origination condition that applies to BT as a remedy to this
market power (see paragraph 4.54 above);
•
differences in average (gross and net) termination charges for voice and data
which are apparent in BT’s accounting data reflect different patterns of usage at
different times of day (and therefore volume weights applied to the same
parameter gross termination charges).95 In addition, differences in average net
termination charges for voice and data service providers also reflect a tendency
for larger service providers to receive higher outpayments (for example because
of economies of scale and negotiating strength).
4.116 Ofcom considers that there are two aspects to this constraint:
•
whether or not TCPs can distinguish between data and voice calls; and
95
The reason for differences in average termination charges between voice and data arises from
different patterns of usage at different times of day, and therefore volume weights applied to the same
parameter prices (BT responses of 4 November 2005 and 16 December 2005 in response to Ofcom
section 26 Notices of 21 October 2005 and 14 December 2005, respectively.
55
•
whether or not TCPs can impose different charges for different types of calls.
4.117 Ofcom considers that it could be technically feasible for a telecoms network to
distinguish between voice and data calls by identifying data calls. At least two
methods could potentially be used. For example:
•
TCPs could identify a data call once the call is established. This could be
accomplished by monitoring the call for the set-up tones that are exchanged
between modems; or
•
A TCP might be able to distinguish data calls if it can tell (from the destination
number, or another routing parameter) which calls are destined for its IP network,
which is used to terminate only data calls.
4.118 In respect of the first option, Ofcom understands from BT that such technology is not
currently incorporated in BT’s network. BT stated:
“BT does not have a way of splitting long and short calls between
voice and data.”96
4.119 In either case, in order to establish differential charging, the information identifying
data calls would need to be passed to the interconnection billing systems, for
example via the Call Detail Records.
4.120 For interconnection purposes, charges for calls to 0844 and 0871 numbers are set
for each block of 100,000 numbers. Ofcom generally allocates numbers to
communications providers in blocks of 10,000.97 This means that communications
providers must specify the price point they require when they apply for numbers so
that Ofcom can allocate a block within a group of 100,000 that has the required price
point. Calls to 0800, 0845 and 0870 numbers each have a single price point for
interconnection purposes.
4.121 Since voice and data services have historically been mixed up within 08 number
blocks (in other words 0845 and 0844 are both used to provide voice and data NTS
call termination), BT would need to depart from established interconnection billing
arrangements in order to bill voice and data services differently. Differential billing for
voice and data services therefore implies greater tariffing granularity unless a
significant effort is made to separate voice and data services onto separate number
blocks.
4.122 A TCP could adopt several strategies to introduce differential termination charges for
08 calls without greater billing granularity:
96
•
it could introduce new number blocks, reserved for voice or data services and
apply differential price points; or
•
it could modify its NTS call termination charges for existing number blocks that
are predominantly used for data services – for example the 0844 09XX blocks
that are designated for metered internet services in the NTNP.
BT response to Ofcom section 26 Notice, 18 November 2005.
Certain non-geographic ranges are allocated in blocks of 1,000, e.g. 0800 Freephone numbers and
some Internet-only ranges.
97
56
4.123 The first approach would be the least disruptive but would of course only work for
new allocations unless the TCP is able to persuade its customers to move to the new
ranges.
4.124 The second approach is possible, but in practice most NTS data calls are terminated
on numbers in ranges that contain a mix of voice and data services, so that this
approach is not practical, and Ofcom is not aware of any providers that have applied
this approach.98
4.125 Ofcom considers that it would be feasible for a TCP to depart from the current
interconnection tariffing convention and start applying tariffs to smaller number
blocks, or even individual numbers. However, increasing tariff granularity increases
both the complexity and load on billing systems both for the TCP and other OCPs,
and the TCP might therefore need to establish multilateral agreement with OCPs in
order to introduce such a solution (although it might also attempt to introduce
differential changes on a unilateral basis). In practice, TCPs other than BT have
limited ability to negotiate with OCPs in any case.99
4.126 In conclusion Ofcom considers that there are currently technical constraints
preventing TCPs from introducing differential termination charges for voice and data
NTS calls that would involve significant cost to overcome. Moreover, Ofcom
considers that the potential need to migrate existing, as well as new, customers onto
different number blocks would be disruptive as well as costly for customers.
Accordingly, Ofcom considers that, in practice, communications providers have
limited incentives to price separately for voice and data customers (as evidenced by
the fact that no TCP attempted to do so over the period under investigation). Ofcom
concludes from this that TCPs’ charges for voice and data NTS call termination are
subject to a common pricing constraint.
4.127 There are however differences in the average net termination charges for voice and
data calls. As noted above, these reflect different patterns of usage at different times
of day (and therefore volume weights applied to the same parameter gross
termination charges). In addition, average revenue share payments for data calls
may tend to be higher for a given gross termination charge and this could result in a
lower net charge for termination. This may reflect economies of scale in serving
larger service providers, and their negotiating strength. However, net termination
charges for data and voice calls will tend to move together in response to any
change in the gross termination charge for the reasons given above.
98
In the NTS call termination market review consultation, the following question was put to NTS call
operators “Do stakeholders agree with Ofcom’s initial view that the termination of all NTS call types
(0845/0870, etc, also voice and data calls) should be included within the same market? In response,
several suppliers made statements that supported Ofcom’s view that there was no evidence of NTS
data and voice calls being charged at different rates. For instance, BT stated that “BT agrees that
substitutability patterns and pricing constraints suggest a single NTS call termination market covering
all of the NTS number ranges and including voice and data traffic.” BT’s response to Ofcom’s
Consultation Documents Translation Services: Options and Translation Services Call Termination, 7
January 2005, Annex C, page 48. Centrica stated that “Centrica is not aware of any pricing
implications for differentiating between voice and data calls; therefore we also agree that it is
acceptable for voice and data calls to be included within the single market for NTS call termination.”,
NTS Call Termination Market Review: A response by Centrica, 5 January 2005, page 7. Stakeholder
Reponses to the NTS call termination market review consultation are published at:
http://www.ofcom.org.uk/consult/condocs/ntsctmr/resntcctr/.
99
This argument is explored further in paragraph 4.43, i.e. due to a combination of BT’s position of
SMP in call origination, and the relationship between BT’s retail NTS prices and geographic call
prices.
57
Supply-side substitution
4.128 As described above, supply-side substitution is relevant where suppliers that are not
currently supplying data (voice) NTS call termination/hosting to a material extent, but
are supplying voice (data) NTS call termination/hosting, would enter the supply of
data (voice) within one year and without incurring significant cost in response to a
SSNIP, and where a sufficient number of customers would switch to those new
suppliers to make that SSNIP unprofitable.100
4.129 First, this section examines the competitive structures (including entry barriers)
related to the provision of voice and data. Second we consider the ability of firms
present in either voice or data to enter the ‘reciprocal’ segments of the market (i.e. if
providing data the ease of supplying voice NTS call termination and vice versa).
Third, this section assesses whether entry would be additional to that already
considered as part of the demand side analysis (i.e. would there be new entry by
firms not already present in the market).
4.130 Ofcom obtained anecdotal qualitative evidence during meetings with providers of
NTS call termination that suggests the structure of the two segments differs
materially. For example, Ofcom met with two small voice call termination businesses,
[] and [], but it appeared from the discussions that there were few small
businesses offering data NTS call termination.101 A discussion with [], an ISP (and
one of C&W’s customers) suggested to Ofcom that it was more often larger providers
such as BT and C&W who provide data NTS call termination, due to the fact they
provide IP network and routing.102
4.131 Ofcom therefore understands that data NTS call termination is now typically provided
by larger TCPs (including, for example, BT and C&W) that own an IP network, and
that there are relatively few (if any) TCPs that provide data NTS call
termination/hosting by interconnection to larger providers’ IP networks. This appears
to be because a number of operators have constructed such networks primarily for
the provision of unmetered termination. Given the continued demand for metered
termination as well, the most efficient way to provide it is for operators with IP
networks to use this infrastructure, enabling NTS data traffic to be taken off the
PSTN at the earliest possible point.
4.132 This contrasts with the voice segment of the market, where entry requires potentially
less investment and fewer points of interconnection. For example, there appears to
be a proliferation of operators that interconnect with larger networks, and in some
cases at only a few points of interconnection (“POCs”).103
4.133 This qualitative analysis suggests that it may be more difficult to expand from voice
into data than from data into voice. In the case of a supplier of NTS data termination,
it is likely that this operator could commence supplying NTS voice call termination
relatively quickly in response to a 10% increase in voice termination charges, since
the entrant could start off at a small scale (e.g. one POC) and could scale its
investment over time as their market share grew. Therefore, on the basis of the
100
To conduct a SSNIP test, we set aside the assumption of a common pricing constraint to enable us
to raise the prices of NTS data and voice call prices independently for the purpose of undertaking the
test.
101
[].
102
Teleconference with [], 23 May 2006.
103
Teleconference with [], 12 April 2006 and meeting with [], 15 May 2006.
58
evidence presented above, the entrant would only need to interconnect with an
existing network operator’s PSTN network, and this could be done at very few POCs.
4.134 However, it is likely to be more difficult for providers of NTS voice call termination, in
response to a 10% increase in NTS data call net termination charges, to supply NTS
data call termination. For instance, entry would require investment in IP networks.
These network investments are likely to be substantial since digital local exchange
(“DLE”) interconnection is required and would suggest entry within a year would be
unlikely. Even if entry within a year were possible, suppliers operating in voice that
are not operating in data tend to be small-scale, and the likelihood of such operators
placing an effective constraint on existing operators in data therefore appears low.
4.135 Accordingly, Ofcom considers that there is likely to be an asymmetry between likely
entry from data to voice, with possible barriers for those operating in voice, who seek
to supply data termination but not vice versa.
4.136 Ofcom has given consideration to whether the likely entry from data to voice, in
response to a hypothetical 10% SSNIP increase in the net price of voice represents
an additional supply side constraint. One way of considering whether supply side
substitution will provide additional constraints on voice is to consider whether firm
shares differ between the two segments in order to identify suppliers of data
terminations not materially present in the supply of voice terminations who could
switch to the provision of the latter.
4.137 From the market share data available to Ofcom (see Figure 5 above), it appears that
a firm (such as []) that was primarily a terminator of metered data traffic could
impose an additional constraint on the pricing decisions of a hypothetical monopolist
of the termination/hosting of NTS voice traffic.104 As [] is, in the UK, an ISP, it is
reasonable to assume that reported TCP terminated traffic in the 084x range in
Figure 5 relates to data. On this basis Ofcom considers that [], which is not
significantly active in voice call termination, would provide an additional constraint
were it to enter the voice segment.
4.138 Although there are some suppliers (such as BT) who are already significantly present
in both voice and data, and therefore could not be expected to impose a material
additional constraint on the behaviour of providers of voice NTS call termination,
Ofcom considers that other suppliers (such as []) who are present in NTS data call
termination could be expected to enter the NTS voice call termination segment in
response to a hypothetical 10% increase in the net price of voice termination
charges (i.e. asymmetric supply side substitution from data to voice call termination
for calls to NTS numbers).
4.139 Ofcom acknowledges that, given the asymmetry in supply-side substitution and low
likelihood of entry from providers of voice NTS call termination, there might be a
case for regarding data NTS call termination as a separate market, if the alleged
behaviour related to the provision of termination of data calls alone. However, given
the common pricing constraint described above, Ofcom considers that the relevant
market in this case spans both voice and data.
4.140 In conclusion, Ofcom has considered evidence of common pricing constraints and
constraints arising from supply-side substitution. Ofcom finds that there is evidence
that over the period of the investigation, termination of voice and data calls to NTS
numbers were subject to a common pricing constraint. Although there may be scope
104
[] response to Ofcom section 26 Notice of 19 May 2005.
59
for BT to introduce separate prices for voice and data (through migrating existing
customers and allocating new customers to new number blocks) BT did not attempt
to do so during the period under investigation.
4.141 Ofcom also considers that the possibility of asymmetric supply-side substitution from
data to voice combined with the evidence on common pricing constraints suggests
that voice and data NTS call termination can be regarded as part of a single market
for the purposes of analysing the conduct alleged in this case.105
Termination/hosting of unmetered internet traffic and calls to directory
enquiries fall outside the relevant market
4.142 Ofcom does not consider that the market should be broadened to include
termination/hosting of unmetered internet traffic or directory enquiries (“DQ”)
services. Ofcom has considered the possibility of demand- and supply-side
substitution and the homogeneity of competitive conditions in each case.
Termination/hosting of unmetered internet traffic
4.143 Demand for unmetered (internet) termination is derived from the demand for retail
internet access. There are separate markets for metered and unmetered internet
access at the retail level because of the different characteristics of metered and
unmetered access and the different needs of customers that use them.
4.144 Ofcom considers that there is limited demand side substitution between dial-up (i.e.
metered) and unmetered internet access services. Facing a 5-10% increase in retail
dial-up internet charges, Ofcom considers it unlikely that customers will switch to
take up unmetered internet access in sufficient numbers to make the dial-up price
increase unprofitable.
4.145 Metered services suit light users and those wanting flexible payments, whereas
unmetered services are suited to heavier users (who are therefore likely to have a
higher willingness to pay) and those wanting fixed monthly payments. Ofcom notes
that dial-up customers are less likely to have this higher willingness to pay and
therefore are less likely to be attracted to the flat rate price structure.106
4.146 On the supply side, there are significant differences between the requirements for
networks supporting metered and unmetered traffic with the implication that there will
be significant costs for metered suppliers wishing to start supplying unmetered
services, even in the presence of regulated products such as FRIACO (flat rate
internet access call origination).107 For instance entry barriers arise from the need for
entrants to build out their networks to a high proportion of BT’s DLEs in order to
supply unmetered termination economically (i.e. based on FRIACO) although, as
noted earlier, such a network could also be used to provide metered terminations.
4.147 As far as Ofcom is aware, there are no suppliers of unmetered data NTS call
termination that are not already active in the NTS call termination/hosting market.
105
106
See also footnote 98.
Review of the wholesale unmetered narrowband Internet termination market, consultation, 17 March
2003, paragraphs 2.8 to 2.13, and Wholesale unmetered narrowband Internet termination services –
UK excluding Hull area market November 2003, paragraphs C.14-C24, both published at:
http://www.ofcom.org.uk/static/archive/Oftel/publications/eu_directives/index.htm.
107
FRIACO is a wholesale product purchased by TCPs from BT that acts as an input for retail flat-rate
dial-up internet access.
60
Broadening the definition of the relevant market from NTS call termination to one for
both NTS and unmetered termination/ hosting would therefore not necessarily
identify any additional constraints beyond those already captured by the NTS-wide
market definition.
Calls to DQ services
4.148 Similarly, Ofcom’s view is that the relevant market should not be broadened to
encompass the termination/hosting of DQ services.
4.149 Facing a 5-10% increase in net termination charges, NTS call customers would be
unlikely to switch to calling numbers in the 118 range, which is reserved for DQ
services. The different nature of the services offered by NTS and directory enquiry
service providers makes such demand-side substitution between them unlikely.
4.150 Facing a 5-10% increase in net termination charges, it is unlikely that NTS service
providers would switch to supplying services offered on the 118 number range, as
118 is reserved for the provision of DQ services only. While there may be services
operating on other number ranges that would meet the criteria for the allocation of a
118 code, this does not apply to the majority of services currently offered on other
NTS ranges so switching would not be an option.
Conclusion
4.151 Ofcom concludes that in the context of its assessment of C&W’s allegations the
relevant product market is a single two-sided market for the termination/hosting of
NTS calls on all ranges, by all TCPs.
Relevant geographic market
4.152 A key feature of the NTS call termination/hosting market is that the relationships NTS
service providers have with TCPs are not based on geographic considerations (see
Annex 4).
4.153 An NTS service provider that is physically located in any area of the UK, including
Hull, is able to buy services from any TCP, and is not restricted to TCPs located in
the same area. Similarly, callers in any part of the UK, including the Hull area, can
reach service providers wherever they are located. From the service provider’s point
of view therefore, termination/hosting services provided anywhere in the UK are
likely to be seen as demand-side substitutes. This substitutability may also be
expected to be reflected in relative homogeneity of competitive conditions throughout
the UK.
4.154 For some types of telecoms service, separate geographic markets have been defined
for the Hull area (in which BT does not operate and Kingston Communications is the
legacy incumbent) and the rest of the UK. However, service providers and callers in
the Hull area are in a comparable position (as far as NTS call termination is
concerned) to service providers and callers in other parts of the UK.
4.155 The implication of the above factors is that termination/hosting on Kingston’s network
is substitutable for termination on the network of any other TCP. Ofcom therefore
61
concludes that the geographic area of the NTS terminations/hosting market is the
UK.108
Conclusion
4.156 Ofcom concludes that in the context of its assessment of C&W’s allegations the
relevant market is the market for NTS call termination/hosting in the UK.
Responses to draft decision: Ofcom’s approach to market definition
4.157 Four respondents to Ofcom’s draft decision commented on Ofcom’s approach to
market definition.
BT
4.158 BT states that:
“Generally BT concurs with the approach that Ofcom took to defining
the market but differs from Ofcom in its conclusions.”109
4.159 BT considers that, rather than a single two-sided market, there are two separate
markets:
“(i) for NTS call terminations in the UK, and (ii) NTS hosting in the
UK.”110
4.160 BT argues that:
“There are significant differences between the structure of a true
two-sided market as exemplified by the Newspaper/publishing
industry and the structure of the market for NTS calls.”111
4.161 Specifically:
“In a true two-sided market there is a direct correlation between the
behaviour of the purchasers of the products (i.e. a published
periodical and the advertising space within that newspaper) forming
the two sides of the market.”112
4.162 According to BT, this means that the price charged to purchasers impacts on
circulation (an increase in price leads to a decline in circulation and vice versa).
However, in the case of NTS, if BT were to offer higher revenue shares in the NTS
hosting market, it does not follow that it would then be able to charge more for NTS
call termination.113
108
Because the geographic market definition does not materially affect the dominance assessment or
conduct analysis, Ofcom does not undertake a detailed analysis of it here (for further detail see Annex
4, particularly A4.26).
109
BT’s comments on the draft decision, paragraph 2.4.
110
Ibid.
111
BT’s comments on the draft decision, paragraph 2.2.
112
BT’s comments on the draft decision, paragraph 2.3.
113
BT’s comments on the draft decision, paragraph 2.4.
62
4.163 BT argues a SSNIP analysis would suggest that NTS service providers will be
inclined to switch to the TCP that pays the highest revenue shares (as indeed Ofcom
suggests at paragraph 4.79 of its draft decision) and concludes that:
“This suggests that the market for NTS hosting should be as wide as
all TCPs providing NTS hosting to NTS service providers.”114
4.164 However, according to BT, a SSNIP analysis of NTS call termination shows that
substitutability for a particular NTS number is limited, which suggests that:
“the market for NTS call termination is only as wide as calls that may
be terminated on an individual TCP’s network.”115
4.165 BT concludes that:
“As the product market for NTS hosting encompasses all TCPs
providing NTS hosting and the market for NTS call termination is
limited to individual TCPs networks then this suggests that there are
two separate markets as opposed to a two-sided market.”116
4.166 BT argues that in fact there may be a number of narrower (network-specific or rangespecific) markets for NTS call termination. BT notes that the termination charge for a
particular NTS number (unlike revenue share outpayments):
“does not vary depending on the NTS service provider customer and
is fixed to the number range in question or in the case of 0844, 0871
and 090 the price point chosen by the NTS service provider.”117
4.167 In particular BT notes, in its introductory remarks on market definition, that it may not
be appropriate to include 0845 and 0870 in the same market as other NTS ranges:
“as the effect of the NTS call origination [condition] may be such as
to lead to the conclusion that substitutability and competitive
constraints differed for these number ranges when contrasted with
other number ranges.”118
4.168 Nevertheless, BT does not consider that it is necessary, for the purposes of reaching
a view on C&W’s complaint, to conclude whether there is a single two-sided market
or two separate markets, or whether the relevant market definition for NTS call
termination is narrower than that proposed by Ofcom:
“the main purpose of the market definition is to identify the
competitive constraints that BT faced…BT is of the view that these
constraints would be the same whether the relevant market for BT’s
NTS call termination products and hosting products is one two-sided
market or two markets each consisting of one side of the doublesided market as defined by Ofcom.”119
114
BT’s comments on the draft decision, paragraph 2.32.
BT’s comments on the draft decision, paragraph 2.36.
116
BT’s comments on the draft decision, paragraph 2.37.
117
BT’s comments on the draft decision, paragraph 2.39.
118
BT’s comments on the draft decision, paragraph 2.7.
119
BT’s comments on the draft decision, paragraph 2.6.
115
63
C&W
4.169 C&W states that Ofcom’s approach to market definition departs from standard
practice in two key respects:
“According to the OFT’s Market Definition Guidelines an analysis of
the relevant market starts with the product or products relevant to
the complaint, expanding the market depending on demand and
supply side substitutability – Ofcom does not follow this approach.
Ofcom’s approach to market definition in two-sided markets does not
appear to be supported by case law and appears generally
inconsistent with the standard economic views on how the market
definition exercise should be conducted in relation to two-sided
markets.”120
4.170 C&W submits that Ofcom’s approach to market definition “results in serious errors in
the subsequent analysis of BT’s conduct thereby raising questions as to the validity
of that analysis”.121
4.171 C&W submits that Ofcom should have analysed the two sides of the two-sided
market separately (which is the approach taken in the case law quoted in the draft
decision), and that Ofcom does not adequately explain why it examined them
simultaneously. C&W cites, in support of its view, an article by David S Evans on the
analysis of two-sided markets and a presentation by Amelia Fletcher, the OFT’s
Chief Economist.122
4.172 C&W submits that Ofcom’s approach to market definition has implications for its
subsequent analysis of its excessive pricing allegation. The market definition
adopted, according to C&W:
“does not allow an identification of the customer who suffers the
excessive price, i.e. whether they are hosting or termination
customers.”123
4.173 C&W believes that this:
“leads towards an analysis based on profitability, rather than an
analysis of pricing. This produces a one-dimensional assessment of
excessive pricing, rather than viewing it in the round.”124
4.174 C&W further submits that Ofcom’s approach to market definition has implications for
its analysis of C&W’s margin squeeze allegation.125
4.175 On the retail side of the market, C&W argues, a different approach to market
definition (i.e. the application of the SSNIP test as set out in the OFT’s guidelines)
“would have identified the products relevant to the margin squeeze allegation, i.e.
NTS calls subject to NCCN 500”.126 In other words, C&W seems to be arguing that
120
C&W’s comments on the draft decision, page 10.
Ibid.
122
C&W’s comments on the draft decision, page 12-13.
123
C&W’s comments on the draft decision, page 14.
124
Ibid.
125
C&W’s comments on the draft decision, page 15.
126
Ibid.
121
64
Ofcom’s failure to properly conduct a SSNIP test led it to apply the retail margin
squeeze test on the wrong product set.
4.176 C&W states that, “with regards to the hosting market the errors in market definition
may be even more marked”. C&W submits that Ofcom’s market definition exercise
fails to take into account:
a) “The competitive nature of the hosting side of the market;
b) How service providers choose which TCP to use for hosting purposes; and
c) Whether the market may be further segmented by type of NTS number, or by
type of customer”.127
4.177 The impact of this, C&W argues, is that Ofcom has applied the hosting margin
squeeze on the wrong product set. C&W argues in relation to this point that Ofcom’s
analysis of the hosting side of the market fails to recognise that BT’s product mix
may be very different to that of its competitors.128
CPW
4.178 CPW contends that Ofcom has “departed from the conventional method of defining
the relevant product market leading to a fundamental flaw in the provisional
conclusions”.129
4.179 CPW “does not believe that current case-law supports Ofcom’s approach in
analysing this market as one single two-sided market”, and submits that the standard
approach to two-sided markets is to conduct a SSNIP test on each side of the
market separately and to examine the “dynamic linkages” between the two to help
explain how one side may constrain the other. CPW cites a number of cases in
which the two sides of a two-sided market are analysed separately.130
4.180 CPW believes that Ofcom’s approach “leads to an over-emphasis on BT’s overall
profitability” in its analysis of C&W’s excessive pricing allegation, and that it “does
not allow an identification of the customer who suffers the excessive price, i.e.
whether they are hosting or termination customers.”131
Thus
4.181 Thus submits that:
”Despite apparently setting out the correct approach to follow, Ofcom
does not appear to have followed the suggested logic through and
as a result has […] failed to define the market correctly.”132
4.182 Thus submits that Ofcom should have analysed the two sides of the market
separately, and that:
127
C&W’s comments on the draft decision, page 16.
Ibid.
129
CPW’s comments on the draft decision, page 1.
130
CPW’s comments on the draft decision, page 2.
131
CPW’s comments on the draft decision, page 3.
132
Thus’s comments on the draft decision, page 7.
128
65
“had the analysis been conducted in this way it would have been
clear to Ofcom that there is no demand side substitution, because
originating providers are not in a position to switch to another
provider (i.e. NTS termination on the relevant number ranges is a
bottleneck service, similar to geographic call termination, which is
subject to an SMP condition).”133
4.183 Thus submits that NCCN 500 may have had an effect on call volumes and that this
may have imposed an indirect pricing constraint on certain NTS calls, which “could
have an impact on the relative attractiveness of individual communications providers’
retail offerings”.134
4.184 Thus also believes that Ofcom should apply the same principles to non-geographic
call termination as it has to its analysis of geographic call termination, i.e. that each
TCP’s own network constitutes a separate market.
4.185 In addition, Thus states that Ofcom has dealt exclusively with the retail market and
has ignored the primary (wholesale) market where the price change was notified.135
4.186 Thus contends that Ofcom’s analysis of the hosting market was also deficient, and
failed to go into sufficient detail.136
4.187 In its comments on Ofcom’s margin squeeze analysis, Thus mentions the 1280
prefix, which enables CPS customers to revert to BT on a call-by-call basis and
would, in theory, enable them to use BT only for calls to 0845 and 0870 numbers.
Thus contends that:
“Whether or not this happened in practice, this undoubtedly acted as
a competitive constraint on OCPs’ behaviour and, as such,
demonstrates that the market is not as broadly bundled as Ofcom
suggests.”137
4.188 Thus cites, as evidence for the relevance of 1280 to Ofcom’s analysis, online advice
for consumers explaining how they can use 1280 on a call-by-call basis, and the
wording of the letter sent by BT to customers who had switched from BT Retail to a
CPSO at the time that NCCN was in force, which invited them to “check which calls
are cheaper with BT”.138
Ofcom comments on responses
4.189 The respondents’ main concerns with Ofcom’s approach to market definition are that:
133
•
although it describes the SSNIP test approach to market definition, Ofcom does
not in fact carry out a SSNIP test;
•
Ofcom should have analysed the two sides of the market separately and then
examined the “dynamic linkages” between them;
•
Ofcom’s analysis of the market on the hosting side is insufficiently detailed;
Ibid.
Ibid.
135
Ibid.
136
Thus’s comments on the draft decision, page 8.
137
Ibid.
138
Thus’s comments on the draft decision, page 8-9.
134
66
•
Ofcom’s approach to market definition leads to flaws in its analysis of (and
conclusions on) excessive pricing; and
•
Ofcom’s approach to market definition leads to flaws in its analysis of (and
conclusions on) retail and hosting margin squeeze.
Application of the SSNIP test
4.190 Ofcom’s approach to market definition reflects the approach set out in the OFT
guidelines by:
a) starting with the product or products relevant to the complaint, and
b) expanding the market depending on demand and supply side substitutability.
4.191 C&W’s complaint relates to the increased prices for NTS call termination notified in
NCCN 500 (see Annex 1). Ofcom therefore starts its analysis by considering the
narrowest possible set of NTS call termination products, including NTS call
termination provided on the network of a single TCP, termination of calls to a single
NTS number range, voice NTS calls only and data NTS calls only, and exclusive of
other non-geographic calls.
4.192 Ofcom has explicitly applied the SSNIP methodology to assessing the product
dimensions of the relevant market. Specifically, Ofcom has adhered to the OFT
guidelines when assessing market definition by considering the likely demand and,
where appropriate, additional supply side substitution response to a 5%-10% SSNIP
by a hypothetical monopolist. Ofcom has then interpreted whether the likely demand
or supply side substitution would make the SSNIP profitable, thereby enabling it to
assess whether the nearest substitute(s) fall within the relevant market or not. For
instance, Ofcom has applied SSNIP tests to determine whether the relevant market:
•
encompasses NTS call termination/hosting services sold by all TCPs (see
paragraphs 4.92-4.99 above);
•
spans all number ranges (see paragraphs 4.100-4.107 above);
•
includes both voice and data termination (see paragraphs 4.108-4.141 above);
and
•
includes other non-geographic calls (see 4.142-4.150).
4.193 Ofcom also notes that in respect of Ofcom’s margin squeeze test, the relevant
market for the purpose of applying the test is determined by the scope of retail
competition, including an analysis of the product bundles across which competition
takes place (see paragraph 6.40 et seq below).
Ofcom’s analysis of the market as a single market, rather than as two separate
markets
4.194 Ofcom sets out its reasoning for why the NTS termination/hosting market can be both
defined and analysed as a single market at paragraphs 4.66-4.85 above. Ofcom
believes that this analysis remains appropriate and has expanded on the arguments
set out in the draft decision to address respondents’ comments.
67
4.195 C&W cites an article by David S Evans in support of its view that the two sides
should be analysed separately in this case. However, it is clear that the point of
Evans’s warning not to ignore interdependencies is precisely to avoid the error that
might result if the market were defined in the way proposed by C&W and analysed
without taking account of the interdependencies identified by Evans.
4.196 For example, in a more recent article than that quoted by C&W, Evans writes:
“Price equals marginal cost (or average variable cost) on a particular
side is not a relevant economic benchmark for two-sided platforms
for evaluating either market power, claims of predatory pricing, or
excessive pricing under EC law…thus it is incorrect to conclude, as
a matter of economics, that deviations between price and marginal
cost on one side provide any indication of pricing to exploit market
power or to drive out competition.”139
4.197 C&W also cites the view of the OFT’s Chief Economist, Amelia Fletcher, in support of
its view. However, it is clear that the presentation C&W refers to in its submission
(made by Amelia Fletcher in a personal capacity) refers to two-sided markets in
general. Ofcom acknowledges that it is appropriate to analyse the two sides of the
market separately in most cases, but not in this one, and does not believe that
Amelia Fletcher’s intention was to rule out in all cases the approach that we have
taken here.
4.198 As set out at paragraphs 4.77-4.85 above, Ofcom considers that it is appropriate in
this case to assess the two sides of the market together. In particular, the “dynamic
linkages” referred to by some respondents are reflected in the price structure in a
relatively efficient way by means of the ability of NTS service providers to choose the
retail price, subject to the NTS regulatory regime. Moreover, adopting the alternative
market definition proposed by respondents would not, in any case, affect Ofcom’s
conclusions on BT’s position on the relevant market or on BT’s conduct (see
paragraphs 4.204-4.209 below).
4.199 The literature on two-sided markets appears to acknowledge that the same
conclusions may be reached whether a two-sided market is analysed as a single
market or as two separate single-sided markets. For example, Evans and
Schmalensee argue that the importance of two-sidedness will vary from case to
case:
“the constraints on market power that result from interlinked demand
also affect market definition. Market definition assists in
understanding constraints on business behaviour and assessing the
contours of competition that are relevant for evaluating a practice. In
some cases the fact that a business can be thought of as two-sided
may be irrelevant. That could happen either because the indirect
network effects…are small or because nothing in the analysis of the
practices really hinges on the linkages…In other cases, the fact that
a business is two-sided will prove important both by identifying the
real dimensions of competition and focusing on sources of
constraints.” 140
139
David Evans and Richard Schmalensee, The Industrial Organization of Markets with Two-Sided
Platforms, Competition Policy International Spring 2007), p.174.
140
Op cit.
68
4.200 Moreover, as Tommaso Valletti says:
“For an economist this second approach [i.e. analysis as a single
platform] is bound to give the same answer...as the first approach
[defining two separate markets].”141
4.201 This is not to say that other approaches would necessarily lead to incorrect
conclusions. As Valletti has said, it should be possible to reach the same
conclusions with other market definitions provided constraints are correctly identified
– but in this case, the analysis of the two-sided market as a single market facilitates
the identification and analysis of these constraints.
4.202 Ofcom has considered whether analysis of the two sides of the market separately
would affect any of its conclusions on BT’s position in the relevant market or on
whether BT’s conduct constituted an abuse, and has concluded that it would not (see
paragraphs 4.204-4.209 below).
4.203 Ofcom does not therefore accept C&W’s contention that, had Ofcom adopted C&W’s
proposed market definition (i.e. two single-sided markets, one for NTS call
termination and one for NTS hosting), it would have reached different conclusions in
its analysis of BT’s position on the relevant market. Nor does Ofcom accept BT’s
contention that it is not dominant whichever of the two approaches to market
definition we adopt.
Analysing the two sides separately would not affect Ofcom’s conclusion that BT is
dominant in a relevant market
4.204 BT does not agree with Ofcom’s provisional conclusion that it is dominant in a
relevant market. BT was the only respondent to disagree with this element of
Ofcom’s analysis. Ofcom’s analysis on dominance is set out at Section 5 below. The
following paragraphs consider, for completeness, whether a different approach to
market definition would have led to different conclusions on dominance.
4.205 Ofcom’s finding that BT is dominant in the market for NTS call termination/hosting
would apply equally if the market were more narrowly defined, to consist of
termination only, or if additionally restricted to termination only on BT’s network.
4.206 At paragraph 5.67 below Ofcom states that:
“the focus…is on the constraints faced by BT as a TCP when it
increases its net charges via an increase in gross termination
charges [that is, the price on the termination side of the market],
because this analysis goes directly to answering the question as to
why BT can act independently with respect to price.”
4.207 In other words, Ofcom has considered whether there are any constraints on BT’s
ability to increase its termination charges – exactly as would be necessary if the
market were defined to include only termination on BT’s network.
4.208 The analysis of the responses available to OCPs and their ability to undermine an
increase in BT’s gross termination charge set out in paragraph 5.68 et seq below
would apply unchanged, as would the conclusion in paragraph 5.134 below that
141
Tommaso Valletti, Mobile call termination: a tale of two-sided markets published in
Communications and Strategies, Q1 2006.
69
“possible strategies of OCP…customers are not capable of
constraining the pricing behaviour of BT as a TCP.”
4.209 Ofcom has also considered possible constraints from service providers and other
TCPs. As it has found that these do not, in practice, constrain BT’s ability to increase
charges, and that BT is therefore dominant in the wider market, it follows that it
would also be dominant in the more narrowly defined market. The fact that BT would,
by definition have a 100% share of this market would lend further weight to the
finding of dominance in this case.
Other comments on Ofcom’s approach to market definition
4.210 THUS comments that “NCCN 500 may have impacted on call volumes and this could
have led to an indirect pricing constraint”.
4.211 Ofcom notes that if NCCN 500 rates had been passed on in retail prices then there
could have been an effect on retail NTS call volumes. However, the evidence
indicates that, in general, NCCN 500 was not passed on to retail customers
(although see paragraphs 5.114-5.115 below for details of []’s response to NCCN
500), and therefore it would be unlikely that there would be an impact on call
volumes (see paragraph 5.45). Ofcom has also considered the explanation for why
OCPs did not pass on the price increase, including the possibility that this would
make their retail offerings less attractive, which we consider in our analysis of BT’s
dominance (see paragraphs 5.95-5.111 below).
A different approach to market definition would not have led to different conclusions
on alleged excessive pricing
4.212 C&W and CPW submit that Ofcom’s approach to market analysis has led it to
concentrate its analysis of C&W’s excessive pricing allegation on BT’s profitability,
whereas it should have considered alleged excessive pricing “in the round” and, in
particular, identified which consumers might be affected by the alleged excessive
price (see paragraphs 4.172 and 4.180 above).
4.213 Ofcom’s approach to the excessive pricing allegation is set out in full in Section 6.
Ofcom agrees that excessive pricing should be considered “in the round”, and that it
is normally appropriate to consider excessive pricing from a number of different
angles (as suggested by case law, notably Napp).
4.214 Ofcom notes C&W’s concern that Ofcom has not conducted its test of excessive
pricing based on the gross termination charge: “it is of course the [price to OCPs]
that is of concern to C&W in terms of all the allegations it has made i.e. that
the…charge paid by C&W to BT is excessive, discriminatory, and causes a margin
squeeze”.
4.215 It is also clear from C&W’s reference to Evans that it does not believe that the gross
termination charge should necessarily be related to costs on the termination side of
the market only, even if these could be identified. As noted at paragraph 4.79 et seq
above there is no obvious means of determining the “competitive” level of the charge
on each side of the market. This varies according to the NTS number range and is
selected by the service provider. A variety of different price structures therefore exist
in the market, with a wide range of “competitive” gross termination charges (compare
0800 with 09 for example), and the service provider is able to select the one
appropriate for its business model. This does not of course mean that excessive
pricing cannot occur in the NTS call termination/hosting market, only that it is
70
appropriate to consider it taking into account costs on both sides of the market
including the level of any outpayment to service providers or, if higher termination
charges are passed on in higher outpayments, by means of the hosting margin
squeeze test.
4.216 In any case, Ofcom has considered whether prices were excessive for calls to 0845
and 0870 number ranges separately. Table 23 shows that prices for 0845
termination (alone) were not excessive and table 24 shows that this is also true of
0845 and 0870 calls together. Paragraph 6.428 below explains that the latter result is
more marginal than the former largely because of economies of scale (SAC could be
significantly higher for a business specialising in 0870 calls).
4.217 Ofcom does not consider that a different market definition would have led it to
approach the excessive pricing allegation in a different way, and does not therefore
believe that its approach to market analysis has led to flaws in its analysis of BT’s
conduct, as the respondents suggest.
A different approach to market definition would not have led to different conclusions
on alleged margin squeeze
4.218 Insofar as the two margin squeeze tests are concerned, Ofcom has, in effect, carried
out the “single sided” analysis apparently advocated by C&W. On the retail
origination side of the market, it has assessed whether BT’s retail margin would have
been adequate to cover relevant costs including gross NTS termination charges at
the rates levied to OCPs under NCCN 500, while on the hosting side, it has
considered whether other TCPs could have matched BT’s outpayments to service
providers given the level of gross termination charges paid by BT to those other
TCPs. This latter would be equivalent to a test of leverage of dominance into the
hosting side of the market from a separate termination side.
4.219 The respondents’ concerns appear to focus on the range of products across which
the margin squeeze analyses are carried out. These however do not depend on the
analysis of the wholesale market as a single market or two separate markets.
4.220 In fact, the tests that Ofcom has carried out in order to establish the existence or
otherwise of a margin squeeze on the hosting side of the market and excessive
pricing are the same as those that would be conducted if a narrower definition of the
market were adopted. As is clear from Tables 15–17 below and the discussion in
subsequent paragraphs, there was no margin squeeze in NTS hosting for any of the
relevant service increments. These include 0844/0845 alone, 0844/0845 and
0870/0871 and all number ranges. In each of these cases, the tests were carried out
for voice and data separately.
4.221 Ofcom believes its approach to have been reasonable given the competitiveness of
NTS hosting (C&W agrees that “there may well be considerable movement between
TCPs and/or certain number ranges if there were a SSNIP” and that hosting is
“potentially very dynamic”) and the absence of evidence that the product mix
changed during the 20 months of NCCN 500.142
4.222 On the retail side, C&W argues (and other respondents also suggest) that the
relevant market is “NTS calls subject to NCCN 500”.143 However, the scope of the
retail-side margin squeeze test is determined by the scope of competition at the retail
142
143
C&W’s comments on the draft decision, page 16.
C&W’s comments on the draft decision, page 15.
71
level, not the definition of the wholesale (NTS) market, and no retail competitor offers
just this bundle of services
4.223 Ofcom has carried out the retail margin squeeze test on a number of possible service
bundles, and found there to be no margin squeeze on even the narrowest relevant
market definition.
4.224 In its guideline on market definition the OFT states that:
“In some cases the relevant product market may consist of 'bundles'
of what are otherwise distinct products…Whether this is appropriate
depends on the investigation…The perspective of customers will be
important in assessing the appropriate frame of reference.”144
4.225 In its guideline on assessment of conduct, the OFT states that:
“If there is evidence that a vertically integrated dominant undertaking
has applied a margin squeeze and that it harmed (or was likely to
harm) competition, this is likely to constitute an abuse of that
dominant position.”145
4.226 In light of the OFT’s comments as set out in the two preceding paragraphs (in
particular, the need for a margin squeeze to be at least capable of harming
competition for it to be an abuse) Ofcom believes that its treatment of the retail
market is appropriate to the investigation.
4.227 Thus argues that CPS customers’ ability to use 1280 to divert some calls to BT
demonstrates that the market (and the relevant bundle for conducting a margin
squeeze test) is narrower than Ofcom suggests (see paragraphs 4.187-4.188
above).
4.228 However, if the 1280 function had, as Thus contends, been a significant competitive
constraint it would presumably have resulted in pressure to bring retail NTS prices
into line in advance of NCCN 500. The fact that some competitors apparently
maintained retail NTS call prices at levels above BT’s (see paragraphs 5.115 and
5.119 below suggests that competition did not take place solely for these calls, but at
the level of a larger bundle, as set out in the preceding paragraphs and considered
more fully in Section 5 below.
4.229 Ofcom has not been able to find any evidence that 1280 is widely used, to the extent
that it would represent the kind of competitive constraint Thus suggests. As noted at
paragraph 3.35 above, Ofcom sent BT a further section 26 Notice requiring it to
provide information about the use of 1280 during the period that NCCN 500 was in
force. BT was unable to extract data from its systems that would have provided an
accurate estimate of the extent to which 1280 was used over the period.
4.230 However, Ofcom does not believe that it would have been possible, by means of
NCCN 500, for BT to have established a dominant position in the retail supply of
calls to NTS numbers by encouraging use of 1280. Given that CPS operators (and
cable operators to which 1280 is not relevant) could remain in the market, a fact
confirmed by Ofcom’s margin squeeze tests, it would be easy for customers to cease
using 1280 if BT subsequently raised retail prices (which it is prevented from doing in
144
145
72
OFT 403, paragraph 5.11.
OFT, Assessment of conduct (OFT 414), paragraph 6.5.
any case by the NTNP). This suggests that BT would not have been able to establish
a position of dominance by this means.
4.231 Ofcom does not therefore agree that the availability of the 1280 function affects the
relevant market definition or its analysis of margin squeeze.
73
Section 5
5 BT’s position in the relevant market
Introduction
5.1
The European Court of Justice (“ECJ”) has defined a dominant position as:
“a position of economic strength enjoyed by an undertaking which
enables it to prevent effective competition being maintained on the
relevant market by giving it the power to behave to an appreciable
extent independently of its competitors, customers and ultimately of
consumers.”146
5.2
For the reasons set out below, Ofcom has concluded that BT was dominant in the
market for NTS call termination/hosting in the UK over the relevant period, given the
particular features and structure of that market.
5.3
The key element of Ofcom’s dominance assessment is a detailed assessment of the
competitive constraints faced by BT during the period that NCCN 500 was in force.
This assessment directly considers the extent to which BT was able, over the
relevant period, to act independently of its competitors, customers and ultimately of
consumers.
5.4
The assessment is based on:
5.5
•
an analysis of the incentives of BT’s customers and competitors following an
increase in BT’s prices for NTS call termination/hosting (see paragraphs 5.665.94 below);
•
survey evidence which assesses the likely reaction of end users following
different strategies that might be adopted by OCPs other than BT in the event of
such a price increase (see paragraphs 5.95-5.111 below); and
•
a description of what actually happened following the price increases notified in
NCCN 500 (see paragraph 5.112-5.124 below).
In addition, Ofcom has considered other factors which might impose constraints on
an undertaking’s ability to behave independently. The following section therefore
begins with a consideration of two other widely used indicators of market power:
market shares (see paragraphs 5.6-5.26 below) and barriers to entry (see
paragraphs 5.27-5.34 below) and expansion (see paragraph 5.35-5.49 below).
Market shares
5.6
An analysis of dominance often begins with an assessment of the market share of
the allegedly dominant company.
5.7
In its guideline Assessment of Market Power, the OFT states that:
“There are no market share thresholds for defining dominance under
Article 82 or the Chapter II prohibition. An undertaking’s market
146
74
Case 27/76 United Brands v Commission [1978] ECR 207, paragraph 65.
share is an important factor in assessing dominance but does not
determine on its own whether an undertaking is dominant. For
example, it is also necessary to consider the position of other
undertakings operating in the same market, and how market shares
have changed over time.”147
5.8
The guidelines also emphasise the importance of other competitive constraints
including existing competitors, the scope for new entry, buyer power, economic
regulation, firm behaviour and financial performance.148
5.9
In Hoffmann-La Roche, the ECJ stated that:
“…although the importance of the market shares may vary from one
market to another the view may legitimately be taken that very large
market shares are in themselves, and save in exceptional
circumstances, evidence of the existence of a dominant position. An
undertaking which has a very large market share and holds it for
some time… is by virtue of that share in a position of strength.”149
5.10
The OFT has stated that it considers it unlikely that an individual undertaking would
be dominant with a market share of below 40% but it acknowledges that, if other
factors are present such as the weak position of competitors in that market,
dominance could be established at market shares below 40%.150
5.11
In Virgin/British Airways, the Commission found that British Airways was dominant in
the UK air travel agency services market with a market share of 39.7%.151 This was
upheld by the Court of First Instance (“CFI”) on appeal.
5.12
The presumptions that have developed in the case law to assist in assessing the
degree of market power held by an undertaking from its market share reflect the
(conventional) relationship between market shares and market power which is
considered to exist when the effect of competing products is felt directly and the
market is relatively stable and mature.
Volume market shares
5.13
Figure 6 below shows how total NTS call termination/hosting volumes, and BT’s
share of this market have evolved over the three full financial years to 2005.
Figure 6: BT’s volume market share, 2002/03 to 2004/05
[]
Source: BT response to section 26 Notice of 25 August 2005.
5.14
Figure 6 shows that, over this three-year period, the total size of the market declined
from over [] minutes to under [] minutes. Over the same period, BT’s share
remained broadly constant ([]% in 2002/2003 and []% in both 2003/04 and
2004/05). BT had the largest market share in 2002/2003.
147
OFT, Assessment of Market Power (OFT 415), 2004, published at:
http://www.oft.gov.uk/shared_oft/business_leaflets/ca98_guidelines/oft415.pdf, paragraph 2.11.
148
OFT 415, paragraphs 3.3-3.6.
149
Case 85/76, [1979] ECR 461, [1979] 3 CMLR 211, paragraph 41.
150
OFT 415, paragraph 2.12.
151
OJ [2000] L 30/1, [2000] 4 CMLR 999 Commission Decision BA/Virgin and Case T-219/99 [2003]
ECR II-5917 British Airways v Commission
75
5.15
For the period under investigation, BT’s market share by volume was [ (below
31%)].
5.16
Ofcom does not consider that, in the particular circumstances of the market under
investigation in this case, market shares are a reliable indicator of whether or not BT
can act independently of its competitors and customers. This is because BT has a
unique position in this market among competing suppliers of NTS
termination/hosting, as a consequence of the NTS regime and BT’s SMP in
wholesale call origination and transit arrangements (as identified at paragraphs 2.142.26 above and summarised in paragraphs 5.46-5.47 below). This unique position
does not arise by virtue of BT’s share of the NTS call termination/hosting market.
Accordingly, the market shares illustrated above are not particularly informative as to
whether BT has a dominant position in the market.
5.17
It is worth noting, however, that in 2004/05, BT was in fact the largest NTS call
terminator (by volume) with a []% share of all NTS call terminated traffic
(see Figure 7 below). Energis and C&W (prior to their announced merger on 16
August 2005) had []% and []% of the market, respectively. For the period of the
investigation prior to the merger of Energis and C&W, BT was the largest NTS call
terminator in the market.
Figure 7: TCP shares of all terminated traffic, 2004/2005
[]
Source: TCP responses to section 26 Notices in May and August 2005.
5.18
Ofcom does not consider that BT’s position in the termination market has been
reflected in a higher market share because until NCCN 500, BT had set the same
gross termination rates as it paid to other TCPs and so had not chosen to use its
position of market power (for example, by raising termination charges and
outpayments in order to attract service providers). This changed when BT decided to
unilaterally raise its gross termination charge in May 2004. Ofcom considers the lack
of competitive constraints on BT’s ability to raise its gross and hence net termination
charges (i.e. the inability of competing TCPs and service provider customers to
respond to BT raising its gross and hence net termination charges) to be more
relevant to its assessment of BT’s position in the relevant market, as set out at
paragraph 5.24 et seq below.
5.19
For completeness, Ofcom also considered possible differences between volume- and
revenue-based market shares.
5.20
According to the Commission’s Notice on market definition:
“As a rule of thumb, both volume sales and value sales provide
useful information. In cases of differentiated products, sales in value
and their associated market share will usually be considered to
better reflect the relative position and strength of each supplier.”152
5.21
152
76
Calculating revenue shares for NTS call termination/hosting is a potentially difficult
exercise, and figures calculated in this way must be interpreted with care. As
explained in paragraph4.99 above, the chief mechanism by which competitive
pressure is exerted on TCPs is via the actions of NTS service providers. This means
that, for revenue market shares to provide a better reflection of the competitive
Commission Notice on market definition (see footnote 49), paragraph 54.
position of a TCP than volume market shares, they would have to be based on the
net revenues earned by TCPs, i.e. the sum of all gross charges less revenue share
payments.
5.22
Comparisons between the gross revenues earned by different TCPs might be
misleading, for a number of reasons. First, different TCPs have different time of day
profiles (i.e. the balance between the proportion of daytime, evening and weekend
calls that they terminate). As daytime charges for termination are higher than
charges for termination at other times, operators with a relatively high proportion of
daytime calls will inevitably tend to have a revenue share above their volume share,
irrespective of market power. Over the period of the conduct in question, NCCN 500
had a particularly significant effect on the gross revenues earned on daytime calls:
BT’s gross termination charges for daytime weekday traffic were over [] times
higher than for the next highest category, weekend traffic (see Annex 1). Second,
different TCPs terminate different proportions of calls to each NTS number range,
and both gross termination charges and average revenue share payments vary
significantly by number range.
5.23
On this basis, Ofcom has decided that, given the particular circumstances of NTS call
termination/hosting, in which gross termination charges provide limited information
about the extent of competitive pressures faced by TCPs, it would not be appropriate
for Ofcom to solely base its dominance assessment on volume or revenue market
shares.153 This is consistent with Ofcom’s approach to assessing BT’s position within
the relevant market, which, as set out at paragraph 5.66 et seq below, is a detailed
assessment of the constraints faced by BT.
Conclusion on BT’s market share
5.24
BT’s share of the NTS call termination/hosting market, based on total volumes, is
below a level that would typically be associated with a position of dominance in the
relevant market.154
5.25
However, for the reasons set out at paragraph 5.16 above the market shares above
are not particularly informative as to whether BT has a dominant position in the
market. Rather, it is necessary to analyse the competitive constraints faced by BT in
making its increase in the gross termination charge.
5.26
Therefore, as explained in the following section, a detailed assessment of the
constraints faced by BT forms the central part of Ofcom’s assessment of BT’s
position within the market.
Barriers to entry and expansion
Barriers to entry
5.27
The threat of competitors entering a market may prevent firms from raising prices
above the competitive level. However, if there are significant barriers to entry, this
threat is likely to be weak or absent. A dominant firm may then be able to raise
153
[].
DG Competition in Discussion paper on the application of Article 82 of the Treaty to exclusionary
abuses: Public Consultation, Brussels (2005), paragraph 31, page 11, and as quoted in John Vickers,
Market Power in Competition Cases, European Competition Journal Vol.2 special issue, p 13, seems
to countenance a single dominance finding with a share as low as 25%.
154
77
prices sustainably without attracting additional competition that would compel it to
lower its prices.
5.28
In its guideline Assessment of Market Power, the OFT states that:
“Entry barriers are important in the assessment of potential competition. The
lower are entry barriers, the more likely it is that potential competition will
prevent undertakings already within a market from profitably sustaining
prices above competitive levels… An undertaking even with a large market
share in a market with very low entry barriers would be unlikely to have
market power. However, an undertaking with a large market share in a
market protected by significant entry barriers is likely to have market
power.”155
5.29
5.30
In these guidelines, the OFT states that “it is useful to distinguish between the
following factors which, depending on the circumstances, can contribute to barriers
to entry:
•
sunk costs;
•
poor access to key inputs and distribution outlets;
•
regulation;
•
economies of scale;
•
network effects; and
•
exclusionary behaviour.”156
In a footnote, the OFT adds:
“Exclusionary behaviour does not refer only to behaviour that raises entry
barriers. Exclusionary behaviour also refers to practices that make it harder
for existing competitors to become more forceful competitors…”157
5.31
155
Most of the types of barrier to entry listed above are relatively low in this market. A
firm wishing to enter this market and sell NTS hosting to NTS service providers (and
NTS call termination to OCPs), in competition with those sold by TCPs already in the
market must:
•
invest in obtaining access to the necessary network infrastructure, including
switching equipment;
•
obtain NTS number ranges from Ofcom;
•
invest in any additional hardware and software needed to support particular types
of NTS services;
•
interconnect with other communications network providers, notably BT; and
OFT 415, paragraph 5.7.
OFT 415, paragraphs 5.6-5.28.
157
OFT 415, footnote 24.
156
78
•
market its hosting services to NTS service providers.158
5.32
Ofcom considers that the sunk entry costs and economies of scale associated with
these activities are unlikely to be prohibitive. As set out in the market review
consultation, the technology used to offer NTS is well established and is available in
entry-level PC based switches.159 TCPs do not therefore need to build networks out
to a large number of end users in order to enter this market, and typically
interconnect only with BT.160
5.33
In practice, NTS service providers employing the technology described in the
preceding paragraph appear to specialise in the provision of NTS call
termination/hosting for voice calls only.161 Termination of metered data calls appears
to be provided largely by TCPs with more extensive networks (this is necessarily the
case for unmetered data call termination, which does not form part of the relevant
market) and this may indicate that somewhat greater sunk costs have to be incurred
in order to offer data NTS call termination.
5.34
However, even notwithstanding that entry barriers in the wider NTS call
termination/hosting market appear to be low this does not mean that BT faced
significant extra constraints from competitors as a result of NCCN 500. This is
because of the significant barriers to expansion faced by other TCPs with respect to
the NTS traffic terminated by BT, which are discussed in the following sections.
Barriers to expansion
5.35
According to the OFT:
“New entry is not simply about introducing a new product to the
market. To be an effective competitive constraint, a new entrant
must be able to attain a large enough scale to have a competitive
impact on undertakings already in the market. This may entail entry
on a small scale, followed by growth. Barriers to entry are closely
related to barriers to expansion and can be analysed in a similar
way. Many of the factors discussed above that may make entry
harder might also make it harder for undertakings that have recently
entered the market to expand their market shares and hence their
competitive impact.”162
5.36
Ofcom believes that service providers are likely to be price sensitive and willing to
switch TCP in response to price differentials. As with barriers to entry, most potential
barriers to expansion appear low. However, the cost of establishing extensive
interconnection with BT may represent a barrier to expansion from the perspective of
very small players. More importantly, as discussed below, BT’s ability to offer prices
which other TCPs cannot match represents the key barrier to expansion in the NTS
call termination/hosting market.
158
NTS call termination market review consultation, paragraph 4.19.
NTS call termination market review consultation, paragraph 4.17 et seq.
160
NTS call termination market review consultation, paragraph 4.20.
161
Ofcom approached several NTS call providers who indicated that typically smaller operators
tended to supply voice rather then NTS data call services. Operators approached by Ofcom included
[] (telephone meeting of 23 May 2006), [] (telephone meeting of 12 May 2006) and [] (meeting
of 15 May 2006).
162
OFT 415, paragraph 5.37.
159
79
Constraints on BT from competing suppliers of NTS termination/hosting
5.37
In its complaint, C&W suggested that the price increases notified in NCCN 500
constituted prima facie evidence that BT has market power in setting its own NTS
call termination rates, unconstrained by competitive pressures from any source.163 In
a competitive market, it would be unusual for an undertaking to be able to profitably
increase its charges to a level that was over 20% (in the case of 0845 calls) above
that of its competitors where it was providing a similar service. The remainder of this
section therefore considers this suggestion made by C&W in its complaint in more
detail.
5.38
The following discussion first identifies how, in the absence of the regulatory and
other economic factors present in this market, TCPs could, in principle, constrain
BT’s price increase (paragraphs 5.39-5.40 below). The subsequent paragraphs then
go on to explain why in practice, this mechanism is not available to TCPs, and that
TCPs are therefore unable to constrain BT’s prices, due to the presence of
regulation and other economic factors (see paragraphs 5.42-5.49 below).
5.39
A profitable increase in the gross (and net) termination charge by BT would, in
principle, attract entry (or expansion) by other TCPs who could match the increase
and pay slightly more to service providers who would then switch to the new TCP
entrant in response. This mechanism would return the net termination charge to the
competitive level and therefore TCPs could undermine BT’s attempt to raise gross
(and net) termination charges.
5.40
Importantly, the ability to fund higher outpayments to service provider customers
(who select the terminating network) arises initially from the TCP raising its gross
termination charge to OCP customers (on the termination side of the market). In the
absence of factors such as SMP in call origination (see paragraph 2.23 above), the
higher gross termination charge leaves OCPs with a lower call origination payment
(i.e. lower retention) unless the OCP raises its retail prices (which would make it less
competitive compared to other OCPs). As illustrated at Figure 9 below, and as
discussed at paragraph 5.77 et seq below, the OCP will not switch to another TCP
unless the service providers were also to switch, since call origination revenues
could be at risk.
5.41
The following paragraphs consider whether in practice non-BT TCPs can influence
the level of the gross termination charge.
5.42
NCCN 500 resulted in an increase of up to about 25% in BT’s gross NTS call
termination charges to non-BT OCPs (see Figure 3 above), with corresponding
increases in the net termination charge (except to the extent that it was offset by
increases in payments to NTS service providers). However, as will be seen at the
conclusion of this section, this did not cause BT to lose market share. In other words,
despite the apparent absence of barriers to entry in this market, new entrants were
not able to discipline BT by capturing some of its share of the market, i.e. they faced
barriers to expansion.
5.43
When BT increased its NTS call termination charges to OCPs via NCCN 500, this
increase did not appear to provide BT’s NTS service provider customers with an
incentive to switch away from BT’s NTS hosting services to those of other firms (see
paragraph 5.77 et seq below).
163
80
C&W submission to Ofcom of 15 March 2005, paragraph 7.23.
5.44
The main immediate impact of the price increases notified in NCCN 500 was on
OCPs (as it took the form of an increase in the gross termination charge), rather than
on NTS service providers (who select the terminating network). Therefore in this
section we consider possible responses by OCPs first, before going on to consider
responses on the other side of the market.
5.45
Ofcom does not consider, based on evidence gathered from BT’s competitors (see
Section 3), that any OCP passed on the increase in a way that would encourage
substitution into calls to competing NTS service providers.164 Given this, it is highly
likely that, relative to a counterfactual in which BT had not increased its charges for
NTS call termination, NTS service providers continued to receive the same volume of
traffic and the same per minute revenue for this traffic (or possibly more, to the
extent that BT passed on some of the higher termination charge in higher revenue
share payments).
5.46
In addition, other TCPs were unable to match BT’s increase in the gross termination
charge. As discussed at paragraph 2.14 et seq above, this is because of the
interaction of BT’s dominance in call origination and the fixed relationship between
BT’s retail NTS prices and geographic call prices. The maximum retail price of a call
by a BT customer to an NTS number is determined by the NTNP, which fixes the
relationship between BT’s retail NTS prices and geographic call prices. The
maximum amount that BT, as OCP, can then retain out of the retail charge is limited
by the NTS call origination condition (i.e. BT’s retention must be cost-based) and,
given BT’s dominance in origination, it is able to charge (no less than) this amount.
The amount that is passed through to the TCP is therefore equivalent to the retail
charge minus BT’s retention, minus any payments to a transit provider, all of which
are outside the control of the TCP.
5.47
In the absence of these factors, a profitable increase in the gross (and net)
termination charge by BT would attract entry (or expansion) by other TCPs who
could match the increase and pay slightly more to service providers, who would then
switch to the new entrant in response. This mechanism would return the net
termination charge to the competitive level. However, because competing TCPs
can’t match BT’s higher gross termination charge in practice, and therefore cannot
fund a strategy of offering higher outpayments in a competitive market, TCPs will not
be able to attract service providers away from BT without incurring losses.165
5.48
The absence of barriers to entry to the NTS call termination/hosting market would be
a relevant factor if it enabled new entrants to capture market share from BT, i.e. by
reducing the volumes of NTS traffic that BT terminates.
164
ntl response to section 26 Notice of 28 June 2005; BT Response of 25 May 2005 to Ofcom section
26 information request of 19 May 2005; “BT interconnect change 20040608.ppt”, PowerPoint
presentation forming part of ntl response to section 26 Notice of 28 June 2005; C&W response to
section 26 Notice of 28 June 2005; Centrica response to section 26 Notice of 28 June 2005; Energis
response to section 26 Notice of 28 June 2005; Telewest response to section 26 Notice of 28 June
2005.
165
As set out at paragraph 4.29, NTS call termination/hosting is sold directly by TCPs to NTS service
providers, and via resellers that act as intermediaries between TCPs and NTS service providers.
Resellers therefore both compete with TCPs in the NTS call termination/hosting market, and provide
them with a channel to market. As with TCPs, resellers’ prices for NTS hosting services are
constrained by the possibility of switching by NTS service providers. Since resellers are dependent on
the TCP to supply NTS call termination/hosting, the extent of any competitive pressure they are able
to apply to TCP charges is limited, perhaps similar to that of large NTS service providers, discussed at
paragraphs 5.129-5.132.
81
5.49
In practice, for the reasons given above, BT’s competitors face significant barriers to
expansion in this market. The demand faced by BT as a TCP with regard to its
termination charges was therefore very inelastic.
5.50
The following section now considers some specific cases that are relevant to the
questions as to whether TCPs can influence the level of their gross termination
charges. These include:
a) BT-originated traffic; and
b) traffic transited by BT.
Special cases: BT-originated traffic
5.51
BT originates a high proportion ([]) of calls to NTS numbers.166 Ofcom has
designated BT as having SMP in the wholesale call origination market.167 Since
1996, BT and other communications providers have been subject to a regulatory
regime for NTS which is designed to encourage innovation in the provision of value
added services despite BT’s position of dominance in wholesale call origination (see
Section 2).
5.52
TCPs other than BT are unable to set their own termination charges for NTS calls
originating on BT’s network, because of a combination of the weakness of their
bargaining position vis-à-vis BT (which is a result of BT’s dominant position in call
origination) and the relationship between BT’s retail NTS prices and geographic call
prices.168 In order for other TCPs’ termination charges to increase, BT would have to
accept less for call origination than is permitted by the relevant charge control
condition. BT’s dominance in call origination allows it to refuse any such proposals
(and BT has actually done so where requested by TCPs).169
5.53
The relevant conditions are that:
166
•
BT’s retail prices for calls to 0845 and 0870 numbers are linked to its standard
local and national call charges, which are both part of the basket of retail services
that was subject to the Retail Charge Control while NCCN 500 was in force; and
•
the NTS call origination condition (see paragraph 2.17 above) requires that BT’s
origination retention is cost-based and allows BT to charge up to a limit set by the
relevant Network Charge Control.170
BT response of 9 September to Ofcom Notice of 25 August 2005.
Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit
markets, statement of 26 August 2003 (see footnote 66), as summarised at paragraph S.12 and
analysed at Chapters 4, 5 and 6 and most recently, Review of BT’s network charge controls,
statement of 18 August 2005 (see footnote 14).
168
It might be argued that 0844 and 0871 calls, where TCPs can choose from a range of different
retail price points, are a partial exception to this. But it remains the case that, for a given retail price
point, non-BT TCPs are unable to replicate BT’s NCCN 500 behaviour, i.e. increasing termination
charges for a given retail price.
169
See email from [] (Easynet) to [] (BT) of 2 April 2004 and subsequent correspondence,
supplied by BT in response to Ofcom section 26 Notice of 22 April 2005, numbered CA172, and email
from [] (Telewest) to [] (BT) of 13 April 2004 and subsequent correspondence, supplied by BT in
response to the same Notice, numbered CA183.
170
The charge control for certain retail services is set out in SMP Condition D1, Review of Fixed
Narrowband Retail Services Markets published by Oftel, 28 November 2003.
167
82
5.54
In the absence of the NTS call origination condition, BT could use its position of SMP
in wholesale call origination to raise its charges for originating NTS calls, and with
retail prices remaining linked to geographic call prices, TCPs’ receipts would be
squeezed.
5.55
In summary, other TCPs cannot increase their current termination charges on traffic
originated by BT (either directly in terms of the gross termination charge, or in terms
of the net charge through lowering outpayment levels to service providers).
Special cases: traffic transited by BT
5.56
Ofcom understands that close to 100% of NTS traffic that is both originated and
terminated by communications providers other than BT is transited via BT.171 This is
because few communications providers other than BT interconnect directly with each
other. Traffic that is originated by an OCP other than BT and terminated by a TCP
other than BT is therefore generally passed by the OCP to BT, which then passes it
to the TCP. Such traffic is said to ‘transit’ BT’s network.
5.57
Where both the OCP and the TCP are connected to the same BT switch, the service
provided by BT is referred to as ‘single transit’. Where the OCP and TCP are
connected at different BT switches and conveyance over BT’s network is required,
the service is referred to as ‘inter-tandem transit’.
5.58
In theory, competing network operators could interconnect directly with each other
instead of using BT as a transit provider. However, there is a fixed cost associated
with interconnecting at each interconnection point, which means it is generally
uneconomic for competing network operators to establish direct interconnection on a
large scale for the relatively small volumes of traffic involved (given that BT has by
far the largest share of the wholesale call origination market). This is a contributory
factor to BT’s position in the market for single transit where Ofcom has designated
BT as having SMP, for the reasons set out in Annex 4 (these reasons include BT’s
ubiquitous access network and BT as the only provider that provides single transit to
any notable extent, meaning that its share of the market is close to 100%). As a
result of BT’s SMP in the market for single transit, BT is required to offer single
transit to other communications providers at regulated charges.
5.59
In contrast to single tandem transit, inter-tandem transit is the service a
communications provider supplies to others to enable them to convey calls between
its tandem exchanges when a call originates and terminates on networks other than
its own. In August 2005, Ofcom set out the view that there is a single market for
inter-tandem conveyance and inter-tandem transit on fixed public narrowband
networks in the UK excluding the Hull area and that this market is effectively
competitive (see Annex 4).172 This finding arose because the number of providers
with a high level of connectivity to BT’s tandem exchanges means that there are
hardly any routes where fewer than three communications providers are present and
allows single transit to replace inter-tandem transit to a significant extent as many
providers are connected to BT at the same tandem exchange.
5.60
TCPs are unable to set differential gross termination charges for:
171
NTS calls that are transited by BT between non- BT OCPs and TCPs account for around []% of
all NTS call traffic.
172
See Review of BT’s network charge controls, statement of 18 August 2005 (see footnote 14).
83
5.61
•
calls to 0845 and 0870 numbers that are transited (but neither originated nor
terminated) by BT; and
•
calls originated by BT and terminated by another TCP.
This is because BT bills other OCPs at the same rate irrespective of the identity of
the TCP and pays other TCPs at the same rate irrespective of the identity of the
OCP. Figure 2 above (repeated as Figure 8 below) shows that (excepting NCCN
500), when BT functions as a transit provider, OCPs pay the same amount to BT as
BT does to TCPs when it originates a call. It subsequently bills separately for transit.
Payment arrangements for transit depend on number range. The OCP pays for
transit for calls to number ranges starting 0844 and 0871, whereas the TCP pays for
transit for calls to number ranges starting 0845 and 0870.173
Figure 8: NTS transit arrangements
D = BT’s discounted retail price
C = BT’s retention
D-C
P
OCP
D-C
BT
T
Originator pays transit (for 0844/0871)
TCP
NTS SP
T
Terminator pays transit (for 0845/0870/PRS)
P = OCP’s retail price
T = BT’s transit charge
5.62
The existence of this arrangement, together with low levels of direct interconnection
between communications providers other than BT, makes it difficult for competing
network providers to broker bilateral agreements for gross termination charges.174 In
most cases, either the TCP or the OCP will lose out by not transiting traffic via BT.
When providing service to OCPs other than BT, TCPs need to make these OCPs an
offer that is at least as attractive as the one that the OCP can get if it uses BT as a
transit provider, i.e. an amount that is no more than the OCP would have to pay to
BT as a transit provider ((D-C) in the diagram above). This is also the amount that
BT will pay the TCP if the OCP chose to route the calls to BT for onward transit to
the TCP. The margin that the TCP can earn over and above the payment that BT will
make to it is therefore restricted to being equal in size to the transit payment.
5.63
This means that transiting via BT is the norm for NTS calls neither originated nor
terminated by BT (close to 100%). Of NTS traffic transited via BT, in 2004/05 []%
was conveyed via single transit and []% by “double tandem” (i.e. inter-tandem)
transit.175 While Ofcom has determined that BT no longer has SMP in the market for
inter-tandem transit, BT continues, at the time of writing, to provide this service at the
regulated charges that applied while it was designated as having SMP, which gives
173
These payment arrangements are as set by Ofcom in paragraphs 3.52–3.56 of the NTS
consultation.
174
See Review of BT’s network charge controls, statement of 18 August 2005 (see footnote 14).,
Annex 5.
175
Source: BT response of 13 October 2005 to Ofcom section 26 Notice of 11 October 2005.
84
OCPs and TCPs the incentive to transit traffic via BT. Single transit, in which BT has
SMP, is also available at controlled charges.
Initial conclusion: traffic originated and transited by BT
5.64
TCPs other than BT are constrained in the gross charges they can levy on OCPs for
NTS call termination, as a result of BT’s dominance in the market for call origination,
commercial incentives (that do not support the establishment of direct
interconnection between altnets), and the way in which non-BT TCPs bill BT for calls
that transit via BT’s network (which does not identify the OCP). TCPs other than BT
are therefore in effect unable to increase gross charges above their current level.
This has implications for the constraints that BT faces in terminating traffic that is
originated by other OCPs (see paragraph 5.40 et seq above).
Constraints that apply in the case of BT-terminated traffic
5.65
On balance, Ofcom’s conclusion is that BT’s ability to increase prices, such as its
NCCN 500 charge increases, was not constrained by competition between TCPs for
NTS service providers.
Constraints on BT from customers
5.66
This section sets out Ofcom’s analysis of the likely sources of competitive pressure
on TCPs (including BT) from customers on both sides of the market for NTS call
termination/hosting in the UK, i.e. OCPs and NTS service providers.
5.67
The focus of this section is on the constraints faced by BT as a TCP when it
increases its net charges via an increase in gross termination charges, because this
analysis goes directly to answering the question as to why BT can act independently
with respect to price. Since, however, the demand for NTS call termination/hosting is
two-sided, Ofcom’s analysis considers constraints from both sides of the market, i.e.
both on OCPs/callers and on NTS service providers.
OCP responses to a price increase by BT
5.68
The responses potentially available to OCPs following NCCN 500 were:
•
to refuse to originate calls destined for BT-terminated NTS numbers;
•
to pass the price increase on to their own retail customers; and
•
to absorb the increased cost.
5.69
These strategies are summarised in Figure 9 below and then considered in turn in
the following paragraphs.
5.70
The starting position for this analysis is that BT, in its capacity as a TCP, increases
its gross termination charge to other OCPs. The responses available to OCPs and
the consequent net impact on BT may be contingent on the OCP’s status as a TCP,
or BT’s status as an OCP. This means that, for each of the rows in Figure 9
corresponding to the options available to the OCP (which may be a vertically
integrated provider operating both in origination and termination), the impact on both
BT and the other communications provider (as both an OCP and a TCP) is
considered.
85
5.71
86
The arrows in Figure 9 indicate the direction in which the available revenue per
minute earned from NTS traffic (net of gross termination payments to BT in the case
of the OCP), and volumes, would move, relative to a counterfactual in which BT had
not increased its termination prices. A question mark indicates a degree of
uncertainty as to the consequences of the response in question.
Figure 9: Options available to OCP following a termination price increase by BT
Impact
OCPs
action
Altnet (A) (OCP)
Altnet (A) (TCP)
BT (OCP)
Traffic
volume
Traffic
volume
Traffic
volume
ppm
margin
ppm
margin
BT (TCP)
ppm
margin
Traffic
volume
Impact
ppm
margin
(a)
absorb
increased
cost
(b)
Refuse to
carry
traffic
(?)
(c) Pass
price
increase
on to own
retail
callers
(?)
(?)
(d)
Increase
own
terminatio
n rates
(i) Altnet (A)
(OCP) is
worse off (ii)
BT (TCP) is
better off
(i) Altnet (A)
(OCP) is
worse off (ii)
BT (OCP)
may gain
(iii) BT
(TCP) is
worse off
(i) Altnet (A)
(OCP) may
lose (ii) BT
(OCP) may
gain (iii) BT
(TCP) may
gain or lose
This
response is
not feasible
for the
reasons
given in
paragraph
5.64.
5.72
Each of the above options, which are available to other communications providers
following an increase in BT’s charges for NTS call termination/hosting, are examined
in further detail in the following sections.
5.73
The purpose of this analysis is to identify the constraints faced by BT when it raises
its NTS call termination/hosting charges. Given the factors described in paragraphs
5.64 et seq above, the fourth option – TCPs increase their own NTS call
termination/hosting charges – is not feasible and so is not discussed in any detail.
5.74
Each of the options available to BT’s competitors is examined to see whether the
pursuit of that option would have placed a constraint on BT (i.e. would make its price
increase unprofitable), and whether it would be in the commercial interests of the
communications provider in question. Ofcom’s conclusions are reported at
paragraphs 5.132-5.135 below.
Absorbing increased costs
5.75
Under this strategy OCPs do not change their retail prices from the levels that
prevailed prior to BT’s NTS call termination price increase.
5.76
This strategy, while it may be optimal for OCPs under certain circumstances (i.e.
where increasing prices or refusing to connect calls is not a commercially viable
87
strategy) will not serve to constrain BT’s activities under any circumstances, because
it gives neither callers nor service providers an incentive to switch to alternatives and
so would not reduce the volume of calls received by BT. Therefore BT’s charge
increase will be profitable.
Refusing to carry BT-terminated traffic
5.77
Under this strategy, OCPs facing BT’s increased NTS call termination charges,
refuse to connect calls from its retail customers to NTS service providers that use BT
as a TCP. In other words, if its customers dial an NTS number that is terminated on
BT’s network, they will not be able to get through (and will hear an appropriate tone
or network message).
5.78
BT, as a TCP, would experience a loss of revenue from terminating traffic by OCPs
adopting this strategy.
5.79
OCPs (as pure OCPs, that is, before any changes to revenues which the operator
may obtain as a TCP, which are considered below) will lose revenue relative to the
scenario under which they absorb BT’s increased NTS call termination charges –
assuming that there remains a positive margin available on originating such calls –
because they will forego the revenue that they would otherwise have earned from
their retail customers calling BT-hosted NTS numbers.
5.80
In addition, the basket of services sold to customers by the OCP becomes less
attractive to customers. This is because customers are no longer able to access
certain services that may form an important proportion of the overall basket of calls
and access services that they demand. Based on a simple calculation (dividing total
minutes by total lines) Ofcom has calculated that in 2004/05 the average BT
customer (business and residential combined) spent just below £5 per quarter on
calls to 0845 and 0870 numbers.176 The market share data set out above suggests
that around one-third of these calls would be to BT-hosted numbers.
5.81
Customers can react to this development in one of the following ways:
5.82
176
•
stay with the same OCP and no longer make calls to BT-hosted NTS numbers;
•
stay with the same OCP and switch to calling NTS numbers offered by other NTS
service providers that do not use BT as a TCP (some of which may be terminated
by the OCP); or
•
switch to another OCP that allows them to call BT-hosted NTS numbers – note
that the more OCPs adopt the strategy of blocking access to BT-hosted NTS
numbers, the more likely it is that callers will switch to BT as an OCP, since
connectivity to BT-hosted NTS numbers will be increasingly unavailable
elsewhere.
The attractiveness for OCPs other than BT of the ‘refuse to connect’ strategy
therefore depends on how consumers are likely to respond. Under the third of the
customer scenarios listed in the previous paragraph, the OCP is clearly in a worse
position, and, potentially, BT gains as an OCP. The greater the proportion of
customers selecting this strategy, the less likely the ‘refuse to connect’ response
would be to constrain BT’s behaviour. The ‘refuse to connect’ response is more likely
Source: BT Wholesale; Ofcom estimate based on Communications Report 2006, para 3.4.2. £5
represents 2.5% of residential telecoms users’ quarterly spend (i.e. £183 a quarter).
88
to place a constraint on BT’s pricing in the first two customer scenarios identified in
the preceding paragraph. However, from the perspective of the OCP, this response
is unlikely to be optimal. BT will lose revenue, but the OCP’s immediate focus will be
on its own profitability, which would tend to be reduced as a result of following this
strategy unless, in the second scenario, it can expect to make offsetting gains as a
TCP. This possibility is discussed further below.
5.83
Unless and until customers have reacted (in one of the three ways listed in
paragraph 5.81 above) to the OCP’s refusal to connect calls to BT-hosted NTS
numbers, the OCP will always earn higher profits under the “absorb price increase”
option. In fact some customers may not react at all, particularly for calls where there
are no immediate substitutes or where the cost of dialling NTS numbers is not
material to the overall service package (see paragraph 5.85 below). Then, it will be
more profitable to absorb the price increase because, as long as the margin earned
on calls to BT-hosted NTS numbers remains positive (that is, the retail price remains
above cost), it will be more profitable to carry a positive volume of such calls than a
zero volume. This will continue to be the case unless BT’s loss of revenue as a TCP
resulting from refusal of other OCPs to connect calls, and pressure applied by BT’s
NTS service providers as a consequence, causes it to reverse its price increase.
5.84
Ofcom’s view is that OCPs are unlikely to pursue the ‘refuse to connect’ strategy. It
may be optimal for them to do so if a refusal to carry traffic were to persuade BT to
reverse its gross price increase. This may happen if the OCP does not lose a
significant number of customers as a result of refusing to connect to BT’s NTS
numbers (and BT does not therefore gain at the origination level). OCPs will lose
fewer customers where calls to NTS numbers that BT terminates are not a vital part
of their retail offering to customers. This will be the case where the OCP’s customers
are willing to switch to calling NTS numbers terminated by TCPs other than BT.
5.85
The extent to which customers will be willing to switch to calling numbers terminated
by TCPs other than BT will be determined by a range of factors. In particular,
customers might not be willing to switch to other NTS numbers in cases where:
5.86
•
calls relate to NTS services for which the customer has no immediate substitute,
for example after-sales services where the customer has already purchased the
primary product, such as telephone banking; and
•
the choice of service provider (this might, for example, be the caller’s bank) is
based largely on aspects of the overall service package other than those relating
to NTS calls.177
Ofcom refers to calls where there is no immediate substitute for dialling a particular
number and for which responsiveness to changes in relative prices is likely to be low
as ‘locked in’, Ofcom’s survey data suggests that the proportion of callers which are
‘locked in’ to calling a particular number range is as follows:
•
on 0845 numbers: 7% of minutes; and
•
on 0870 numbers: 50% of minutes.178
177
Although note that, to the extent that they are visible and form a material part of the lifetime cost
associated with the product, customers may take such call prices into account when making initial
purchasing decisions.
89
5.87
A service that did not enable an OCP’s customers to call around 30% of NTS
numbers (i.e. BT’s share of the NTS call termination/hosting market), including
‘locked in’ numbers, would not be attractive to callers. Any OCP that adopted this
strategy would therefore lose market share relative to a counterfactual in which it
continued to offer a service that enabled customers to call these numbers.
5.88
Consumer research carried out by Ofcom in 2005 can be seen to give weight to the
view that OCPs are unlikely to adopt the strategy of refusing to connect customers
following a price increase by BT. Seventy-five percent of those with a landline
claimed to use ever use 0845 or 0870 numbers, and some 37% of those who ever
used 0845/0870 numbers claimed they thought they would change their landline
company if they were no longer able to make calls to some 0845 and 0870 numbers.
Given the significant margins that are available on selling other call types and access
services (see Ofcom's analysis of the margin squeeze allegation in Section 6), this
strategy would clearly not be optimal for a communications provider that wanted to
maximise profits in either the short or longer term, given the potential for losing
existing customers.179
5.89
Ofcom therefore considers it very unlikely that this strategy would be adopted by any
OCP in response to an increase in BT’s NTS call termination/hosting prices. This has
been borne out by the actual behaviour of OCPs following NCCN 500, with such a
strategy not having been adopted by any of BT’s competitors, as far as Ofcom is
aware.
5.90
An example of a situation in which OCPs refused to carry calls to a particular number
range (where none of their customers were tied in to calling these ranges) is
provided by DQ liberalisation in 2003. In its response to the market review
consultation, BT used this case to illustrate its argument that OCPs can refuse to
connect calls terminated by a particular TCP.180
5.91
The legacy 192 DQ number, which had been controlled by all of the direct access
fixed and mobile originators on their own networks, was replaced by a range of
178
These figures are consistent with the classification of “locked-in” services set out in Annex 15 of
the NTS statement.
179
Number Translation Services: 0870 & 0845. Consumer responses to possible changes in pricing or
availability of services, August 2005. Unpublished research report (carried out for the NTS call
termination market review which as noted at paragraph 2.58 was suspended pending completion of
this investigation) based on face-to-face interviews carried out by BMRB as part of an omnibus
survey. The report is based on interviews with 921 UK adults (aged 15+) with access to a landline
phone that could make and receive calls, weighted to ensure a nationally representative picture (the
weighted base is therefore 933 respondents). Respondents who ever used 0845 or 0870 numbers
were asked:
“Imagine that your landline company told you that you would no longer be able to make calls to some
0845 or 0870 numbers. This would mean you might not be able to call your bank, your credit card
company, gas supplier, electricity supplier and some shops from your landline at home. If this
happened, realistically, which of these things do you think you would do?:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
I would change my landline company
I would change my bank and/or other suppliers that I couldn't call from home any more
I would call these numbers from a mobile phone instead
I would call these numbers from another landline (e.g. at work or at a friend's)
None of these, I just wouldn't call these numbers any more
Other (specify)
Don't Know”
180
See BT’s response of 7 January 2005 to the NTS market review consultation.
90
competitively provided 118 XXX numbers. Following liberalisation, some OCPs did
not allow their end users to access some of the new DQ numbers, for example BT’s
new 118 500 DQ service.
5.92
However, in this situation, all callers had to start dialling new numbers to access
DQs, and (to varying extents, depending on which network they were calling from)
had a wide range of near-identical alternative products to choose from, so that, in
effect, none of the new 118 DQ NTS service providers had any ”locked-in”
customers.
5.93
Ofcom’s view is that this unique situation means that the DQ liberalisation experience
does not provide a useful guide as to whether OCPs would pursue the “refuse to
connect” strategy in the context of NTS calls. Notably, calls to many BT-terminated
NTS numbers are received by organisations such as retail banks, the customers of
which would not view calls to a competitor as being an acceptable substitute once
they have decided to bank with a particular company.
5.94
Ofcom concludes that refusing to connect customers to BT-hosted NTS numbers is
not an optimal strategy for OCPs, and that refusal to connect would therefore be very
unlikely to provide a constraint on BT’s gross NTS call termination charges.
Pass price increase on to own retail callers
5.95
Under this strategy, OCPs other than BT increase their retail prices for calls to NTS
numbers to reflect the increased input costs that they incur as a result of BT’s
increased charges for NTS call termination.
5.96
Since the marginal cost of inputs, including termination payments to BT, will influence
OCPs’ retail pricing decisions, a response of this type might be expected from OCPs,
absent any other considerations. Although competing retail OCPs typically charge
somewhat higher prices than BT for NTS calls (e.g. a comparison of BT’s rates for
0845 at the time of NCCN 500 being issued with those of the two cable companies
plus two of the largest indirect access operators shows that the prices of BT’s
competitors were at least as high as those of BT, even before BT’s discounts), they
compete with BT on retail price in terms of the entire basket of services sold to end
users.181
5.97
Under NCCN 500, BT increased its gross termination charges for termination of
some NTS calls by up to about 38% depending on number range, call duration, and
time of day (see paragraph 2.42 above) The weighted average NCCN 500 increase
was 25%.
5.98
There are two different ways in which OCPs could pass increases in gross
termination charges on to end users. First, OCPs could pass on the extra cost
across a narrow set of calls – for example, if BT increases its termination charge for
0845 and 0870 calls, passing on the price increase across BT-terminated 0845 and
0870 calls only. Alternatively, they could pass on the price increases across a
broader set of services, e.g.
•
all calls to NTS numbers, regardless of whether or not they are terminated by BT;
•
all calls (including geographic calls and calls to mobiles); or
181
See, for example, BT’s analysis of retail prices for calls to NTS numbers provided with the letter
from [] (BT) to [] (Ofcom) of 20 April 2006.
91
•
5.99
a broader set of services, e.g. a mixture of calls and access.
For passing on increases in BT’s gross charge for NTS call termination to act as a
constraint on BT, it must be the case that OCPs will have the incentive and are
technically able to pass on price increases specifically on the affected NTS calls and
that, following such increases being passed on, callers will react in such a way that
there is a sufficiently large fall in call volumes to make BT’s initial price increase
unprofitable. In the next section Ofcom considers what the effects would be if the
price increase were passed through.
Effect if price increase were passed on
5.100 Facing an increase in the marginal cost of supplying calls to BT-terminated NTS
numbers, Ofcom would expect at least some OCPs, if they were acting rationally, to
pass on BT’s price increases, since marginal cost (together with marginal revenue) is
an important determinant of the optimal price set by firms.
5.101 However, OCPs are not only customers of BT’s TCP business, but also compete with
BT at the retail level (i.e. as retail access providers). They might, as a result, be
reluctant to pass on BT’s NTS call termination price increases because of a concern
that this would undermine their price competitiveness vis-à-vis BT, which has SMP in
certain retail markets and whose input costs were not affected by NCCN 500.182
5.102 To assess the reaction of consumers following retail price increases, Ofcom has
carried out an analysis that examines the likely switching behaviour of callers
following an increase in BT’s NTS call termination prices being passed on. The aim
of the analysis was to estimate, based on BT’s NCCN 500 price increase and
assuming that an OCP customer changed its retail prices in such a way as to pass
on the entire price increase, how price elastic the demand for the OCP’s calls would
need to be in order for BT’s price increase not to be profitable.183
5.103 This analysis, which is set out at Annex 3, does not take account of the tendency of
retail customers to switch to BT for the whole bundle of retail services if the price of
this bundle, when supplied by competing OCPs, goes up. In other words, Ofcom’s
analysis looks at the possible effect on call volumes, assuming no customers switch.
It is therefore conservative since, if the magnitude of the call-price elasticities alone
suggests that BT’s price increase would be profitable, this result could only be
strengthened by consideration of such switching. In addition, the analysis should
ideally be carried out based on prices at the competitive level (since market power is
measured by the ability to raise price above this level). However, to the extent that
actual prices are already above the competitive level, the apparent substitutability of
other services is likely to be increased (a phenomenon sometimes known as the
“cellophane fallacy”, so again a finding that BT’s price increase was likely to have
been profitable may be regarded as conservative.184
5.104 As set out in Annex 3, Ofcom has calculated critical values of the price elasticity
(above which the price increase would not be profitable in the absence of switching
182
See for example Retail Price Controls: Explanatory Statement, 19 July 2006, published at:
http://www.ofcom.org.uk/consult/condocs/retail/statement/.
183
The own price elasticity of demand for a product is a measure of the responsiveness of the
demand for that product to changes in its price. The more elastic the demand, the higher (in absolute
terms) its responsiveness to price changes, and vice versa. More formally, the own price elasticity is
defined as the ratio of the percentage change in quantity demanded to the percentage change in
price.
184
OFT 403, paragraph 5.5.
92
to BT for the retail bundle) based on two assumptions for the proportion of the
termination charge increase passed on in the retail price, namely:
•
a “base case”, under which a value of 30% was assigned to this proportion; and
•
a conservative case, based on a value of 100%.
5.105 Ofcom considers the former case to be the more likely, based on information from
other communications providers. The 30% assumption approximates to BT’s share
of termination of non-BT originated NTS calls. The OCP is assumed to increase the
price of all 0845 calls, but by only 30% of the amount of the increase.
5.106 The critical elasticity in each case was, respectively (the ranges expressed below
being derived from the use of different assumptions regarding the demand curve for
retail calls):
•
for the base case, between -5.6 and -6.8; and
•
for the conservative case, between -1.6 and -2.1.
5.107 The magnitudes of both of these elasticity estimates are fairly high relevant to likely
estimates for the own price market elasticity of demand for retail NTS calls.185 The
true value of this parameter is likely to be lower in magnitude than -1.0, given the
relatively small proportion of callers’ budget accounted for by retail NTS calls (see
paragraph 5.80 above). The market elasticity of NTS calls is most relevant if all nonBT OCPs pass on the increase across NTS calls as a whole since the price of calls
to BT relative to those to other TCPs then does not change. The relative price of
calls to BT then does not change. Given the elasticity estimates, BT would be likely
to benefit from NCCN 500 in this case. Moreover, BT will gain an additional benefit to
the extent that the total price of the retail bundle supplied by other OCPs rises and
induces switching to BT.
5.108 If OCPs were able to pass the increase on the price of calls terminating on BT’s
network alone, then the responsiveness of demand to differences in relative prices
between TCPs would be more relevant. But estimates of firm-level elasticities of this
sort, which reflect customer switching between providers, are not widely available.
This makes it difficult for Ofcom to assess whether such estimates are realistic or
not. One indicator that is available is the proportion of locked in calls (see paragraph
5.86 above), for which responsiveness to changes in relative prices is likely to be
low.
5.109 In practice, other OCPs have been unwilling to pass on price increases on BTterminated calls alone, for reasons discussed further below. For instance, [] (the
only OCP to adjust retail prices at all) advised that increasing retail prices in relation
to BT terminated traffic only would not be an attractive option due to difficulty
communicating changes to customers, confusion (leading to higher call centre costs)
and inability to distinguish BT number ranges from other TCPs. This suggests that
both for commercial and technical reasons, OCPs would not pass through increases
to BT terminated traffic only (see paragraph 5.114 below).
185
Market elasticity, as opposed to own price elasticity (see footnote183) is the change in total market
demand in response to a change in price by all firms in the market. This may be contrasted to firmlevel elasticity, i.e. that faced by a particular firm in response to a change in its price alone, which
would also reflect switching to competing providers.
93
5.110 Ofcom has considered BT’s position in the wholesale call origination market as well
as its position as a TCP. Another important point to note is that, if an OCP had
passed on TCP (e.g. BT’s NCCN 500) price increases to its retail customers, leading
to increased prices for retail calls to NTS numbers, the OCP’s overall package would
have become less attractive to customers relative to BT, and BT may have gained
market share and revenue in retail markets and in the wholesale call origination
market.
5.111 This suggests that, following an increase in BT’s NTS call termination charges, if all
other OCPs pass the increase on to their customers (and, as is argued above, there
is no other way in which BT’s conduct as a TCP can be constrained at the origination
level), BT’s price competitiveness as a retail operator will have improved vis-à-vis
that of its rivals. This is because, as outlined above, other TCPs are unable to
respond with termination price increases of their own that could reduce the
competitiveness of BT’s overall package of calls and access. So, even if other OCPs
are able to lower BT’s revenues as a TCP by passing on price increases to end
users, BT’s revenues at the retail level are likely to increase, compensating it to
some extent for any losses that it incurs at the TCP level. This further strengthens
the finding outlined above, namely that it is unlikely that BT’s behaviour as a TCP will
be constrained.
Observed behaviour following termination price increases
5.112 The actual response of BT’s competitors to NCCN 500 may not be a reliable guide as
to their optimal responses, absent the threat of regulatory intervention, since, while
NCCN 500 was in force, BT’s competitors may have been waiting for a response
from Ofcom following its commitment to examine the competitive implications of this
issue (both in this investigation and in the NTS call termination market review), and
did not therefore pass on BT’s price increases. Notwithstanding considerations of
this sort, the extent to which BT’s competitors did pass on price increases is
discussed in the following paragraphs.
5.113 Ofcom required thirteen communications providers (see Section 3) to provide details
of any changes that they had made to their prices for calls to NTS numbers as a
result of the price changes notified in NCCN 500.
5.114 Of the thirteen communications providers from whom Ofcom sought information, only
[] said that it had changed its prices for calls to some NTS numbers as a result of
NCCN 500. [] told Ofcom that following NCCN 500 it had increased its retail prices
for all 0845 and 0870 calls i.e. it had not just increased its prices for BT-terminated
calls. [] told Ofcom that increasing its retail prices only in relation to BT-terminated
traffic would not have been an attractive option, and that it had rejected such a
move. Its internal documentation following NCCN 500 made the following comments
on such a change:
•
“Difficult to communicate to customers;
•
Confusion will drive calls into the call centres; and
•
System implications - new charge band for BT number range & maintenance.”186
5.115 Ofcom notes that, as reported in confidential internal [] documents, [] considered
a range of possible retail pricing actions in response to NCCN 500.187 Ofcom notes
186
94
[].
that [] could have chosen to absorb the NCCN 500 price increase like BT’s other
competitors, although this would have resulted in an estimated £[] reduction in
[]’s margins. Ofcom also notes that []’s action to raise retail 0845 and 0870 call
prices for all traffic (terminated by both BT and other TCPs) had the effect of raising
[]’s 0845 retail prices from []% above BT’s prices to []% above BT’s prices,
and in doing so raising []’s margins. This could indicate []’s pricing action was
aimed at increasing both revenues and margins, and hence went further than the
recovery of NCCN 500 prices.
5.116 None of the other communications providers from whom Ofcom sought information
said that they had changed their prices for retail calls to NTS numbers as a result of
NCCN 500.188
5.117 A number of them commented on their decisions not to change retail pricing, as set
out in the following paragraphs.
5.118 [] stated that:
“It was decided… that retail call prices to the affected number ranges
would not be amended. This was due to BT’s dominant position in
the retail calls market.”189
5.119
[] stated that:
“As [] currently charge in excess of BT’s rates it was intuitively felt
that there was no scope to increase existing charges so as to protect
margins.”190
5.120 [] explained that:
“[] does change its retail prices regularly and undertakes a price
review process called []. However, this process is essentially
market-driven; almost invariably, [] shows that it is necessary to
change our prices to meet the market’s requirements. Only very
occasionally are cost considerations brought into play. This is
because []’s position in the market is essentially that of a price
follower.”191
5.121 [] stated that it had not adjusted its retail pricing in response to NCCN 500:
“in order to maintain our competitive position.”192
5.122 These accounts show that no OCPs – except for [] – passed on BT’s NTS call
termination price increases. In the case of [], it was not able to pass on the
increase to customers solely in relation to the 0845 and 0870 numbers hosted by BT,
but rather passed on the increase to all NTS end customers. A key motivation behind
OCPs not passing through the increase to customers appears to have been a desire
to maintain a competitive position vis-à-vis other OCPs including BT.
187
Ibid.
[] confirmed in its response that it does not have any retail customers and that the question was
not therefore applicable.
189
[] response to section 26 Notice of 28 June 2005.
190
[] response to section 26 Notice of 28 June 2005.
191
[] response to section 26 Notice of 28 June 2005.
192
[] response to section 26 Notice of 28 June 2005.
188
95
Conclusion on pass-through
5.123 The preceding discussion shows that:
•
only one of BT’s OCP customers passed on BT’s termination price increases to
end users; and that
•
even if all OCPs had passed on BT’s termination price increases, it is unlikely
that this would have made BT’s termination price increase unprofitable.
5.124 On this basis, Ofcom’s view is that OCPs passing on BT’s termination price
increases would not impose a competitive constraint on BT.
Evidence on profit effect of NCCN 500
5.125 Ofcom has not been able to compare what happened to BT’s traffic volumes, (and its
revenues and profits) following NCCN 500 with a counterfactual in which BT did not
issue NCCN 500. However, given the arguments outlined above, and the fact that
BT did not lose market share between 2003/04 and 2004/05, Ofcom does not
consider that BT suffered any loss of volumes of ([]-originated) traffic that came
close to making NCCN 500 anything other than a profitable strategy for BT.
5.126 Changes in some key operational and financial measures for BT are summarised in
the tables below. All figures focus only on the traffic type that was affected by NCCN
500, i.e. calls from other OCPs to BT.
Table 6: OCP-to-BT 0845 NTS call volumes (millions of minutes)*
2003/04
2004/05
% change
848
908
7%
Voice
1,667
1,598
-4%
Data
2,515
2,506
-0%
Total
*Numbers are not rounded and therefore figures may not total exactly
Source: Ofcom calculations using volume information supplied by BT used in Ofcom FAC profitability
analysis (see Section 6).
Table 7: BT's gross NTS call termination charges* for 0845 OCP-originated calls
(average ppm)**
2003/04
2004/05
% change
2.16
2.58
19%
Voice
1.12
1.38
23%
Data
1.47
1.82
23%
Weighted averag
* Excludes hosting revenues
**Numbers are rounded and therefore figures may not calculate exactly
Source: Ofcom calculations using volume information supplied by BT used in Ofcom FAC profitability
analysis
96
Table 8: BT's gross NTS call termination revenues for 0845 OCP-originated calls*
(£m)**
2003/04
2004/05
% change
18.35
23.40
28%
Voice
18.75
22.12
18%
Data
37.10
45.52
23%
Total
* Excludes hosting revenues
**Numbers are rounded and therefore figures may not total exactly
Source: Ofcom calculations using volume information supplied by BT used in Ofcom FAC profitability
analysis
Table 9: BT's net 0845 termination charges for 0845 OCP* (average ppm)**
2003/04
2004/05
% change
3.98
3.49
-12%
Voice
0.70
0.91
30%
Data
1.81
1.85
2%
Weighted averag
* Excludes hosting revenues
**Numbers are rounded and therefore figures may not total exactly
Source: Ofcom calculations using volume information supplied by BT used in Ofcom FAC profitability
analysis
5.127 The figures above show that, following NCCN 500;
•
BT’s gross NTS call termination charges increased. BT’s net charge increased
overall (although it fell for voice call termination, possibly reflecting reduced
payments from NTS service providers); and
•
while there was some decline in BT’s volumes for data, this was more than offset
by the increase in BT’s NTS call termination charges. Moreover, given that no
OCP passed the increase in termination charges on in higher retail prices for BTterminated calls (in one case – [] – retail prices were increased, but
irrespective of the identity of the terminating network), it seems likely that the
reduction in data volumes reflected general market trends.
5.128 In addition, internal BT documents suggest that it believed that NCCN 500 would be
profitable for it. It appears to have estimated the likely increase in profit from NCCN
500 as approximately £[] (see paragraph 6.556 below for more details).193
Constraints imposed by NTS service providers
5.129 Ofcom has also considered the possibility that competition to attract NTS service
providers might constrain BT’s ability to increase its charges for NTS call
termination/hosting by forcing it to pass on a higher share of the (gross) termination
revenues earned by BT as a TCP. This is an important consideration in this market,
since, if, following an increase in gross charges, BT’s net charges (i.e. the amount
retained by BT) were constrained by competition to attract NTS service providers,
this might be interpreted as suggesting that BT did not hold a dominant position.
5.130 Ofcom considers that competition to attract NTS service providers is unlikely to
constrain BT’s ability to set prices above the competitive level. If BT as a TCP were
to increase its termination prices and OCPs were to absorb this price increase, then:
193
Briefing paper about the first complaint, 12 May 2004, provided by BT in response to section 26
Notice of 22 April 2005 numbered 1.11.
97
•
NTS service providers would be receiving the same volume of minutes as had
previously been the case; and
•
the inability of other TCPs to respond by increasing their gross NTS call
termination charges would mean that NTS service providers would not be able to
get a better deal elsewhere, and hence would not be able to constrain BT.
5.131 If BT as a TCP were to increase its gross NTS call termination charges, and this
price increase was passed on by other OCPs (causing BT to lose volumes as a
TCP), then, if NTS service providers were to receive the same per-minute payment
from BT, they would be worse off than was previously the case. In such a case, they
might consider establishing relationships with other TCPs that would charge lower
termination prices to OCPs, thereby guaranteeing larger volumes and revenues for
the NTS service provider. However, provided that BT’s price increase led to higher
gross termination revenues, BT would be able to offer the NTS service provider a
larger absolute amount of revenue (even if volumes declined) and retain more
revenue for itself.194
Conclusion on the constraints faced by BT
5.132 Following a gross price increase by BT, a number of strategies were available to its
competitors (i.e. other TCPs providing termination/hosting) and OCP and NTS
service provider customers.
5.133 Ofcom’s conclusion is that BT’s ability to increase prices, such as its NCCN 500
charge increases, was not constrained by competition between TCPs for NTS
service providers. Ofcom found that BT is in a different position to other TCPs in the
market because, as discussed in paragraph 5.46 et seq above, other TCPs cannot
increase their gross charges for NTS call termination since:
194
•
their charges to BT for BT-originated calls to NTS are effectively fixed because of
a combination of BT’s dominance in the wholesale call origination market and the
fixed relationship between BT’s retail NTS prices and geographic call prices. In
the absence of these factors, a profitable increase in the gross (and net)
termination charge by BT would attract entry (or expansion) by other TCPs who
could match the increase and pay slightly more to service providers, who would
then switch to the new entrant in response. This mechanism would return the net
termination charge to the competitive level. However, competing TCPs cannot
match BT’s higher gross termination charge in practice, and therefore cannot
fund a strategy of offering higher outpayments in a competitive market. Therefore
competing TCPs will not be able to attract service providers/customers away from
BT without incurring losses;
•
the lack of direct interconnection between communications providers other than
BT and BT’s position as an NTS transit provider prevents other TCPs from
applying selective increases in termination charges which depend on the identity
of the OCP; and
•
a price increase by BT at the termination level may, uniquely, lead to benefits to
BT at the origination level, mitigating any reduction in volumes incurred at the
termination level. There is no similar mechanism in place for other TCPs.
Note that the critical loss calculation (Annex 3) does not allow for the reduction in volumes to lead
to cost savings for BT, other than savings from reduced revenue share payments.
98
5.134 Ofcom’s view is that possible strategies of OCP and service provider customers are
not capable of constraining the pricing behaviour of BT as a TCP, and that BT will
therefore be able to set a price for NTS call termination that is above the competitive
level. In summary:
•
absorbing termination price increases will not constrain BT’s pricing behaviour (or
that of any other TCP);
•
a refusal to carry BT-terminated NTS traffic is unlikely to be a viable strategy for
other OCPs, and as such did not impose a competitive constraint on BT; and
•
where OCPs passed the increases to end users, there was no material effect. In
any case, given the implications for their position in retail calls and access
markets, this would not have been seen by most OCPs as a viable strategy. This
response did not therefore constrain BT.
5.135 Additionally, the actions of NTS service providers would not constrain BT’s
behaviour, since if BT as a TCP were to increase its termination prices and OCPs
were to absorb this price increase, then:
•
NTS service providers would be receiving the same volume of minutes as had
previously been the case; and
•
the inability of other TCPs to respond by increasing their gross NTS call
termination charges would mean that NTS service providers would not be able to
get a better deal elsewhere, and hence would not be able to constrain BT.
5.136 As discussed further at paragraph 6.545 et seq below, BT appears to have had two
aims in increasing its changes for NTS call termination: to generate additional
revenue, and to raise awareness of features of the current NTS regulatory
framework that BT considered should be changed:
“This proposal will help to add force to BT’s view that the regime
needs to be overhauled by demonstrating that BT can use the
current structure to its advantage, just as other operators have used
it to their advantage in the past. The price change will also
emphasise that the regime is highly uncertain and is difficult to plan
for.”195
5.137 This suggests that BT did not see itself as facing any competitive constraints on its
ability to set charges for NTS call termination.
NCCN 651
5.138 As set out at paragraph 2.45 et seq above, on 2 November 2005 BT issued NCCN
651, effective 1 January 2006, in which it reduced its gross NTS call
termination/hosting charges, bringing them back into line with the charges of the
other TCPs. It is clear that this change did not result from competitive pressures felt
by BT, since:
•
as described above, analytical reasoning indicates that NCCN 500 was a
profitable strategy for BT and, to the extent that it has been possible to assess,
195
See paper to BT Wholesale Pricing Authorisation Group of 18 March 2004, supplied by BT in
response to Ofcom section 26 Notice of 22 April 2005, volume 1, tab 8.
99
this has been borne out by the profitability analysis constructed by Ofcom from
information drawn from BT’s regulatory costing systems;
•
BT has explained that the decision to issue NCCN 651 was taken in part to
improve relations between BT and its customers and between BT and Ofcom,
offering the following explanation in a paper of September 2005 to BT’s
Operations Committee recommending that the price increases notified in NCCN
500 should in effect be reversed:
[];196
•
the price increase was maintained for 20 months supporting the case that BT’s
prices remained in force for a period of time consistent with an undertaking
holding a dominant position in a market.197
Responses to draft decision: Ofcom’s provisional conclusions on dominance
5.139 C&W and Virgin Media both state that they support Ofcom’s provisional conclusion
that BT is dominant.198
5.140 BT was the only respondent to provide detailed comments on Ofcom’s provisional
conclusion that BT was dominant in the market for NTS call termination/hosting for
the period under investigation.
5.141 BT states that:
“BT’s share of the NTS hosting market, based on total volumes, or
between []% and []% for the relevant period, is significantly
below a level that would typically be associated with a position of
dominance on the relevant market and despite discussion to the
contrary [i.e. Ofcom’s arguments at paragraph 5.24 of the draft
decision] would generally not be sufficient to be associated with a
position of dominance.”199
5.142 BT further notes that its market share did not increase during the period under
investigation:
“which whilst not conclusive, is indicative of an absence of
dominance particularly when BT’s low market share is taken into
account.”200
5.143 BT states that it is one of a number of vertically integrated providers capable of using
use retail revenues to fund revenue share outpayments in NTS hosting (although it
states that there is no evidence the additional revenues it received when NCCN 500
was in force were put to that purpose), and that:
196
Annex 1, BT response to section 26 Notice of 14 November 2005.
Note that the SSNIP test used for market definition purposes considers whether a hypothetical
monopolist could sustain a price increase of some 5%-10% above the competitive level for a period
typically of 12 months. Arguably pricing behaviour that suggested BT could act independently of its
competitors and customers in respect of NTS call termination could, by extension, also be taken to
imply BT’s pricing behaviour of 20 months could also support a dominance finding.
198
C&W’s comments on the draft decision, page 1 and Virgin Media’s comments on the draft
decision, page 1.
199
BT’s comments on the draft decision, paragraph 3.3.
200
BT’s comments on the draft decision, paragraph 3.7.
197
100
“there is no evidence that BT’s competitors on the market for NTS
hosting were not able to match BT’s “prices” indeed during the
relevant period BT lost or failed to win a number of significant
accounts.”201
5.144 BT states that:
“in the absence of the regulatory factors present in this market,
competing TCPs would in principle constrain BT from raising its
prices for call termination above the competitive level.”202
5.145 BT argues that:
“TCPs were unable to match BT’s increase in the gross termination
charge because of regulation, specifically the NTS call origination
condition, and the removal of this condition would allow competing
TCPs to match and therefore constrain BT’s behaviour.”203
5.146 BT argues that, contrary to Ofcom’s assertion (see paragraph 5.52 above), that TCPs
are unable to set their own termination charges because of their relatively weak
bargaining position vis-à-vis BT:
“the reason that TCPs are not able to set their own termination
charges is the NTS call origination condition.”204
5.147 BT argues that:
“innovation in the provision of value added services has flourished
and, for the relevant period, there was (and is) effective competition
for the provision of NTS hosting.”205
5.148 BT states that in the absence of the NTS call origination condition BT would not, as
Ofcom claims, be able to exploit its position of SMP in wholesale call origination to
raise charges for originating NTS calls, in fact it would have been “obliged to
negotiate with TCPs and ultimately to purchase [NTS] termination” at prices set by
those other TCPs.206
5.149 BT argues that Ofcom is wrong to conclude that the reason most traffic not originated
or terminated by BT is transited by BT was that few communications providers other
than BT interconnect directly with each other. BT states that the real reason most
traffic transits BT’s network is that:
“OCPs were able to use the transit of calls over BT’s network
combined with the effect of the NTS call origination condition to
avoid having to negotiate and agree termination charges directly with
TCPs which may have been significantly more than the termination
charge charged to BT.”207
201
BT’s comments on the draft decision, paragraph 3.8.
BT’s comments on the draft decision, paragraph 3.11.
203
BT’s comments on the draft decision, paragraph 3.14.
204
BT’s comments on the draft decision, paragraph 3.17.
205
BT’s comments on the draft decision, paragraph 3.5.
206
BT’s comments on the draft decision, paragraph 3.20.
207
BT’s comments on the draft decision, paragraph 3.25.
202
101
5.150 BT argues that:
“the NTS call origination condition together with the nature of BT’s
and other communication providers’ networks, was such as to
provide an absolute constraint on the pricing behaviour of all TCPs,
including BT during the relevant period.”208
5.151 BT argues that, contrary to Ofcom’s assumption,
“An OCP may […] discipline BT and constrain BT’s pricing behaviour
for NTS call termination by selectively refusing to connect calls to
only those NTS numbers terminated by BT for which there is a ready
substitute NTS not terminated by BT.”209
5.152 BT argues that this is precisely what happened following the proliferation of DQ
services after the 118 range was made available.210 BT states that Ofcom has relied
on OCPs’ comments for its assertion that refusing to connect calls would not be a
viable strategy.
5.153 BT argues that Ofcom is incorrect when it concludes that even if OCPs had passed
on BT’s termination charge increases, this would have been unlikely to make this an
unprofitable strategy for BT. BT argues that:
“BT’s pricing for the relevant period was explicitly designed to avoid
retail price changes by OCPs…BT deliberately set the relevant
charges to avoid OCPs having to pass through (either in part or in
full) the increased termination charge by increasing their retail
prices.”211
5.154 BT argues that it would not have been in its interests for other OCPs to raise their
retail prices in response, as this would have had a negative impact on the business
of NTS service providers. BT states that:
“The fact that BT carefully and diligently considered and balanced
these issues in setting the charge for the relevant period is clear
evidence that BT felt and was constrained in fixing the termination
charge…”212
5.155 BT states that it set the charges notified in NCCN 500 at a level such that its
competitors would not be placed at a competitive disadvantage in absorbing the
increase:
“BT took explicit account of the commercial drivers of OCPs, setting
the charges at a level that would not cause them either to cease
buying NTS termination from BT, or that would require OCPs to
increase their retail prices…such that there would be a consequent
impact on BT’s volumes”.213
208
BT’s comments on the draft decision, paragraph 3.28.
BT’s comments on the draft decision, paragraph 3.33.
210
BT’s comments on the draft decision, paragraph 3.34.
211
BT’s comments on the draft decision, paragraph 3.43.
212
BT’s comments on the draft decision, paragraph 3.48.
213
BT’s comments on the draft decision, paragraph 3.53.
209
102
Ofcom’s response
5.156 Ofcom acknowledges that BT’s market share is “significantly below a level that would
typically be associated with a position of dominance” (see paragraph 5.24 above).
However, market share, for the reasons discussed at paragraphs 5.16 et seq above,
is not a reliable indicator of dominance in this case. Ofcom has therefore based its
analysis on the strategies available to BT’s competitors following NCCN 500, and
concluded on this basis that that suggests that BT has the ability to behave
independently of its customers, competitors and ultimately of consumers.
5.157 Ofcom considers that the fact that BT’s market share did not increase during the
period under investigation is consistent with Ofcom’s conclusion that BT’s conduct
did not constitute an abuse of its dominant position. Rather, BT used its dominant
position to set its prices above those of its competitors, which enabled BT to make
additional profits, but did not impose a margin squeeze on its competitors. Ofcom
notes that the fact that BT's market share did not decline, despite BT pricing
significantly above other operators, is consistent with dominance.
5.158 BT suggests that those of its competitors that are vertically integrated could have
used their retail revenues to fund revenue share outpayments in NTS hosting.
However, not all BT’s competitors are vertically integrated. Moreover, of those that
are, it seems likely that most of the NTS calls they originate will terminate on either
BT or another TCP and be transited via BT, incurring the higher termination charges
that applied under NCCN 500.
5.159 Ofcom agrees that the NTS call origination condition is to some extent relevant to its
consideration of competitive constraints in the NTS call termination and hosting
market, in that it requires BT to supply NTS call origination to all TCPs. The NTS
charge control (as referred to at paragraph 2.18 above) does not, in itself, prevent
BT’s competitors from raising their NTS call termination charges, but places a ceiling
on BT's charges for call origination – there is nothing to stop other OCPs demanding
to pay less, other than BT's market power in call origination.
5.160 However, it is not relevant in this case (where Ofcom is considering BT’s actual past
conduct) to speculate about what market conditions might prevail in the absence of
the NTS call origination condition or other regulation. The consideration of BT’s
position in the market for NTS call termination/hosting, for the purposes of this
investigation, has to be assessed in the light of the regulatory conditions prevailing at
the time, i.e. the NTS call origination condition. To that extent, speculation as to what
market conditions might have been in the absence of such regulation is not relevant
in determining the question of dominance in this matter.
5.161 BT submits that there is “effective competition” in the provision of NTS hosting.
Ofcom acknowledges that, as shown by the results of its evidence gathering (see
paragraphs 6.568 et seq below) there is competition for NTS hosting contracts.
However, as set out at paragraphs 5.132-5.137 above, the behaviour of NTS service
providers does not act as a constraint on BT’s ability to behave independently of its
competitors.
5.162 BT submits that refusal by OCPs to connect NTS calls to BT would be a viable
strategy, as evidenced by OCPs’ conduct following the introduction of the 118 range.
Ofcom addresses the relevance of the DQ case to this case at paragraphs 5.90-5.94
above.
103
5.163 BT argues that the charges notified in NCCN 500 were set at such a level that BT’s
competitors would not have been placed at a competitive disadvantage were they to
have absorbed the additional cost imposed by NCCN 500. As set out in Section 6
below, the appropriate way to assess whether there is a margin squeeze is by
reference to the retail prices of the firm allegedly conducting the margin squeeze, not
those of its rivals. C&W’s allegation of a margin squeeze in call origination was
assessed using BT's retail prices, rather than those of its competitors. Ofcom
considers that the appropriate scope for the retail margin squeeze test is a broader
product bundle than calls to NTS numbers alone.
Conclusion on BT’s position in the relevant market
5.164 Ofcom concludes that BT was dominant in the market for NTS call
termination/hosting in the UK between 1 May 2004 and 31 December 2005, the
period over which the investigation has taken place.
5.165 BT’s ability to act independently of other TCPs reflects BT’s dominance: (a) in the
market for call origination which, combined with the NTNP requirements on retail
prices, prevents other TCPs from raising their gross termination charges on BT
originated calls to NTS numbers; and (b) in the market for single transit which
prevents other TCPs from raising their gross termination charges on non-BT
originated calls to NTS numbers
5.166 Based on the evidence set out above, Ofcom’s has found that the particular
circumstances of this market means that there are minimal constraints on BT’s ability
to act independently of its customers and competitors.
104
Section 6
6 The conduct
Introduction
6.1
Having concluded that BT was dominant in a relevant market over the period that
NCCN 500 was in force, Ofcom assessed whether BT’s conduct in imposing the
prices notified in NCCN 500 amounted to an abuse of BT’s dominant position, in
breach of the Chapter II prohibition and Article 82.
6.2
Whether a particular type of conduct constitutes an abuse will be a question of fact
for every case, as explained by the ECJ:
“The concept of abuse is an objective concept relating to the
behaviour of an undertaking in a dominant position which is such as
to influence the structure of a market where, as a result of the very
presence of the undertaking in question, the degree of competition is
weakened and which, through recourse to methods different from
those which condition normal competition in products or services on
the basis of the transactions of commercial operators, has the effect
of hindering the maintenance of the degree of competition still
existing in the market or the growth of that competition.”214
6.3
A dominant firm is subject to a “special responsibility not to allow its conduct to impair
genuine undistorted competition”.215 The “special responsibility” will be increased
where a firm is super-dominant or near monopoly, although the scope of the special
responsibility depends on the specific circumstances of each case.216 Superdominance is not relevant in this case.
6.4
Ofcom’s analysis proceeded according to C&W’s allegations and focused on C&W’s
three principal allegations which were:
•
that NCCN 500 constituted anti-competitive price discrimination by BT;
•
that NCCN 500 led to a margin squeeze on competing originating providers; and
•
that the prices notified in NCCN 500 were excessive.
6.5
In addition to the alleged margin squeeze in call origination, Ofcom considered
whether NCCN 500 imposed a margin squeeze on BT’s competitors in the provision
of NTS hosting, in that the additional cost imposed by NCCN 500 prevented them
from competing with BT in the provision of NTS hosting services.
6.6
Ofcom also considered C&W’s further allegations that NCCN 500 constituted an
abuse of BT’s dominant position in that it:
•
increased competing operators’ costs or constrained them to offer an inferior
service;
214
Case 85/76 Hoffman-La Roche v Commission [1979] ECR 46, paragraph 91.
Case 322/81 Michelin v Commission [1983] ECR 3451, paragraph 57
216
Cases C-395 and 396/96P Compagnie Maritime Belge Transports v Commission [2000] ECR I1365, paragraph 114.
215
105
6.7
•
increased BT’s market power in NTS call origination and call termination; and
•
formed part of a concerted strategy to influence the commercial conduct of BT’s
competitors and dilute competition.
Ofcom’s analysis of C&W’s allegations is set out in this section.
Alleged margin squeeze
6.8
Ofcom’s analysis and assessment of C&W’s margin squeeze allegations are
considered in the following section.
6.9
As described at paragraph 6.220 et seq below, Ofcom’s margin squeeze analysis in
effect addresses C&W’s allegation of price discrimination, as well as the margin
squeeze allegation itself. Both Tests 1 and 2 as set out by C&W (see paragraph
6.222 below) are addressed by Ofcom’s margin squeeze analysis, by the hosting
margin squeeze test and the retail origination margin squeeze test respectively.
Alleged margin squeeze in retail markets
6.10
This section addresses whether NCCN 500 constituted an abuse of BT’s dominant
position in NTS call termination/hosting by imposing a margin squeeze on OCPs
other than BT, as C&W has alleged. Such a margin squeeze could have the effect of
restricting or distorting competition in the relevant retail calls market(s).
Alleged margin squeeze in retail markets: the allegation
6.11
C&W submitted that the price increases notified in NCCN 500 constituted an abuse
of BT’s dominant position in that they imposed a margin squeeze on OCPs other
than BT.
6.12
C&W’s arguments on margin squeeze are set out at paragraphs 8.6-8.15 of its
submission to Ofcom of 15 March 2005 and in a letter to the case team of 16
September 2005.
6.13
C&W argued that:
“Since an end-to-end NTS service cannot be provided without call
origination, call origination is a key input of the kind described in
[Oftel’s] Guidelines.”217
6.14
C&W submitted that the effect of NCCN 500 is to impose a margin squeeze on C&W
at the origination level.218
6.15
C&W submitted that:
“even with the fewest number of possible network elements
deployed, BT would not be able to cover its costs of origination.”219
217
C&W’s submission to Ofcom of 15 March 2005, paragraph 8.6-8.7, referring to The Competition
Act 1998, The Application in the Telecommunications Sector (OFT 417), published at:
http://www.oft.gov.uk/shared_oft/business_leaflets/ca98_guidelines/oft417.pdf.
218
C&W’s submission to Ofcom of 15 March 2005, paragraph 8.8.
219
C&W’s submission to Ofcom of 15 March 2005, paragraph 8.12. See also paragraph 2.27 et seq
above.
106
6.16
C&W provided details of BT’s costs (taken from publicly available sources),
submitting that this analysis suggested BT was failing to cover its end-to-end costs of
carrying NTS calls.220
6.17
Considering the appropriate scope of the margin squeeze test, C&W submitted that:
“the margin squeeze test should be applied to the products in
respect of which a margin squeeze is alleged.”221
6.18
C&W argued that:
“To take an analogous case, if a dominant undertaking were to
engage in margin squeeze selectively against particular competitors,
that would clearly still be abusive; and, yet, there would be no
margin squeeze across the whole market. By extension, it would be
illogical to say that a dominant undertaking may engage in margin
squeeze in relation to certain products in a market in which it is
dominant. It must be right that the margin squeeze test should be
applied only to the products which are the subject of the margin
squeeze.”222
6.19
C&W concluded, citing British Sugar, that:
“the margin squeeze analysis should necessarily be restricted at
most to calls which form the subject of NCCN 500”.223
6.20
Commenting on the relationship between market definition and the appropriate scope
of the margin squeeze test, C&W submitted that:
“there would be no need to consider the scope of the application of
the margin squeeze test if the relevant upstream and downstream
markets were defined more tightly.”
Although it went on to say that:
“Having said that, there are clearly some arguments for a more
granular market approach to market definition in this case.”224
6.21
Ofcom considers C&W’s arguments in the following section.
Alleged margin squeeze in retail markets: legal and economic framework
6.22
A margin squeeze occurs where an undertaking that is active on two vertically related
markets and that enjoys upstream dominance fails to maintain a sufficient margin
between its prices in the upstream and downstream markets, thereby restricting
competition in the downstream market.
220
Table 1 and Table 2 of C&W’s submission to Ofcom of 15 March 2005.
Letter from [] (C&W) to [] (Ofcom) of 16 September 2005.
222
Ibid.
223
Commission decision 88/158 (Case No IV/30.178 Napier Brown-British Sugar), OJ L284
19/10/1998 which, according to C&W “makes clear that the margin squeeze test must be applied to
the dominant provider’s products, as opposed to any competing upstream inputs”. Letter from []
(C&W) to [] (Ofcom) of 16 September 2005.
224
Letter from [] (C&W) to [] (Ofcom) of 16 September 2005.
221
107
6.23
The EC and the UK competition authorities have long accepted margin squeeze as
conduct that can amount to an abuse of a dominant position abuse in contravention
of Article 82/Chapter II. The most recent case law on margin squeeze is the 2008
judgment of the CFI in Deutsche Telekom (see paragraphs 6.26 and 6.31 below) and
the 2008 judgment of the Court of Appeal in Albion (see paragraph 6.32 below).225
6.24
In National Carbonising Company, the Commission, while rejecting the complaint that
was made, accepted that margin squeeze could amount to an abuse:226
“an undertaking which is in a dominant position as regards the
production of a raw material…and therefore able to control its price
to independent manufacturers of derivatives… and which is itself
producing the same derivatives in competition with these
manufacturers, may abuse its dominant position if it acts in such a
way as to eliminate the competition from these manufacturers in the
market for derivatives. From this general principle the…Commission
deduced that [the dominant undertaking] may have an obligation to
arrange its prices so as to allow a reasonably efficient manufacturer
of the derivatives a margin sufficient to enable it to survive in the
long term.”227
6.25
The first Commission decision to find margin squeeze as an abuse was Napier
Brown.228 The Commission found that British Sugar was dominant in both the
upstream (industrial sugar) and downstream (retail sugar) markets, and that the
margin between the prices British Sugar charged for industrial sugar and retail sugar
was not enough to enable a reasonably efficient competitor to remain in the
downstream retail sugar market, since the margin did not cover British Sugar's own
repackaging and selling costs. The Commission found that:
“The maintaining, by a dominant company, which is dominant in the
markets for both a raw material and a corresponding derived
product, of a margin between the price which it charges for a raw
material to the companies which compete with the dominant
company in the production of the derived product and the price
which it charges for the derived product, which is insufficient to
reflect that dominant company’s own costs of transformation … with
the result that competition in the derived product is restricted, is an
abuse of a dominant position.”229
6.26
225
In Deutsche Telekom, the Commission concluded that Deutsche Telekom had
abused its dominant position in the fixed telecommunications network market by
structuring its pricing so that its wholesale customers were charged higher rates for
access to the local loop than its retail customers, thereby leaving no margin for its
wholesale customers to compete in the downstream retail market. The Commission
Case T-271/03 Deutsche Telekom v Commission Judgment of CFI 10 April 2008 and Judgment of
the Court of Appeal 22 May 2008 Dwr Cymru Cyfyngedig and Albion Water Limited and Water
Services Regulation Authority [2008] EWCA Civ 536.
226
OJ [1976] L36/6.
227
Ibid, paragraph 14. In this case, the Commission had rejected National Carbonising's original
complaint. National Carbonising applied to the ECJ for a review of that decision and applied for
interim measures. The courts directed the Commission to adopt interim measures while the case was
pending before the court which the Commission did. National Carbonising withdrew its application to
the ECJ in 1977.
228
OJ 1988 L284/1.
229
Napier Brown, paragraph 66.
108
said that this was a margin squeeze because competitors could never compete for
customers in the downstream retail market. The Commission was of the view that the
margin squeeze abuse continued even after Deutsche Telekom took action to
ensure that prices for wholesale services were lower than retail prices as the
difference was still not sufficient to cover Deutsche Telekom’s own costs for the
supply of retail services.230
6.27
The Commission’s Telecommunications Access Notice states that a margin squeeze
can be demonstrated by showing that the dominant company's own downstream
operations could not trade profitably on the basis of the upstream price charged to its
competitors by its upstream operating arm or, in appropriate circumstances, by
showing that the margin between the price charged to competitors in the
downstream market (including the dominant company's own downstream operations,
if any) for access and the price which the network operator charges in the
downstream market is insufficient to allow a reasonably efficient service provider in
the downstream market to obtain a normal profit (unless the dominant company can
show that its downstream operation is exceptionally efficient).231
6.28
In the UK, Oftel’s guideline The application of the Competition Act in the
telecommunications sector is consistent with the Commission’s Telecommunications
Access Notice, stating that:
“Where a vertically integrated undertaking is dominant in an
upstream market and supplies a key input to undertakings that
compete with it in a downstream market, there is scope for it to
abuse its dominance in the upstream market. The vertically
integrated undertaking could subject its competitors in the
downstream market to a price or a margin squeeze by raising the
cost of the key inputs and/or by lowering its prices in the
downstream market. The integrated undertaking’s total revenue may
remain unchanged. The effect would be to reduce the gross margin
available to its competitors, which might well make them
unprofitable. In considering whether an undertaking is engaging in
price squeezing in breach of the Competition Act, the Director
General will consider whether the dominant undertaking would be
profitable in the relevant downstream market if it had to pay the
same input prices as its competitors.”232
6.29
The OFT's draft competition law guideline Assessment of Conduct states:
“A margin squeeze may occur in an industry where a vertically
integrated undertaking is dominant in the supply of an important
input for a downstream market in which it also operates. The
vertically integrated undertaking could then harm competition by
setting such a low margin between its input price (e.g. the wholesale
price) and the price it sets in the downstream market (e.g. retail
price) that an efficient downstream competitor is forced to exit the
market or its unable to compete effectively”.233
230
OJ 2003 L 263/9.
Commission Notice on the Application of Competition Rules to Access Agreements in the
Telecommunications Sector, OJ [1998] C265/2, paragraphs 117 and 118.
232
OFT 417, paragraph 7.26.
233
OFT, Assessment of conduct: draft guideline for consultation (OFT414a), April 2004, published at:
http://www.oft.gov.uk/shared_oft/business_leaflets/competition_law/oft414a.pdf, paragraph 6.1.
231
109
6.30
In Genzyme, the OFT investigated Genzyme, which manufactured and supplied
Cerezyme, the most effective drug for the treatment of Gaucher’s disease. Genzyme
sold Cerezyme to the NHS at a price that included the provision of the separate
service of homecare administration of the drug. Genzyme’s price to its own
subsidiary was lower.234 The alleged margin squeeze consisted of supplying
Cerezyme to third party delivery/homecare services providers of Cerezyme at the
NHS list price. Genzyme left no margin for alternative providers to compete with it in
the downstream market for homecare services. The OFT concluded that a margin
squeeze had occurred in this case. This finding was upheld on appeal by the CAT.235
6.31
The CFI in Deutsche Telekom confirmed that the test for margin squeeze should be
based on the dominant undertaking’s own charges and costs or those of an “equally
efficient” competitor rather, than a “reasonably efficient” competitor test, as follows:
“it is necessary to consider whether [Deutsche Telekom] itself or an
undertaking just as efficient as [Deutsche Telekom] would have been
in a position to offer retail services otherwise than at a loss if it had
first been obliged to pay wholesale access charges as an internal
transfer price […]”236
6.32
There are some features that are common to the test for margin squeeze as
formulated in the case law. In Albion the Court of Appeal summarised those features:
a) vertical integration: the undertaking alleged to be operating the margin squeeze
must be vertically integrated, i.e. it must operate in related upstream and
downstream markets, its upstream operations supplying an input to its
competitors and to its own operations in the downstream market;
b) dominance in the upstream market: the undertaking alleged to be operating
the margin squeeze must enjoy a position of dominance in the upstream market
(with a need for access to an input from the upstream market in order to operate
in the downstream market). Such upstream dominance has been a feature of all
of the EC and UK cases in which a margin squeeze has been found;237
c) significantly active in the downstream market: the abusive undertaking must
be active downstream on a sufficient scale that its pricing decisions are capable
of influencing the conditions of competition in the downstream market;
d) insufficient margin between downstream and upstream price to cover
costs: the undertaking must maintain an insufficient margin between its
upstream and its downstream prices, thereby restricting competition in the
downstream market; and
e) no objective justification for the margin squeeze: it will be a defence for a
dominant company to show an objective justification for a margin squeeze
established under (a) to (d) above.238
6.33
234
Ofcom considers that criteria (a) – (c) are satisfied in this case as follows:
OFT decision 27 March 2003, No CA98/3/03.
Case No 1016/1/1/03 [2004] CAT 4
236
Case T-271/03 Deutsche Telekom, paragraph 194. See also paragraphs 188 to 192.
237
See National Carbonising Company, Napier Brown/British Sugar, Deutsche Telekom and
Genzyme cases discussed above.
238
Dwr Cymru Cyfyngedig and Albion Water Limited and Water Services Regulation Authority [2008]
EWCA Civ 536, paragraphs 87 to 110.
235
110
a) BT is vertically integrated between the ‘upstream’ market of NTS call
termination/hosting and the ‘downstream’ market(s) for retail calls.
b) BT was dominant in the market for NTS call termination/hosting in the UK over
the relevant period. Competitors wishing to be active in NTS call
termination/hosting need to purchase termination of calls to BT-hosted NTS
numbers from BT (see Section 5 above).
c) BT’s activity in the downstream market of retail calls is well documented, e.g.
Ofcom’s Retail Price Controls, Explanatory Statement, 19 July 2006.239
6.34
In order to determine whether criterion (d) is met in this case, Ofcom considers that
the correct approach, consistent with the case law set out above, is to determine
whether an undertaking as efficient as BT’s downstream business could trade
profitably in the downstream market when paying the wholesale prices charged by
BT upstream; and that this should be tested by reference to BT’s own downstream
costs. This is the test applied by the OFT in Genzyme.
6.35
In telecommunications and other network industries, a test based on the costs of a
reasonably efficient operator (as opposed to the costs of an operator as efficient as
the dominant undertaking’s downstream operations) has been considered to be
appropriate either where the incumbent has costs advantages deriving from its
status as “first-mover” in the relevant market or from its legacy position as historic
incumbent; or where specific sectoral powers are being used in order to promote
competition.240 However, as set out above, the CFI confirmed in Deutsche Telekom
that the appropriate test for margin squeeze is the “as efficient” competitor test rather
than a “reasonably efficient” competitor test. This was also confirmed by the Court of
Appeal in Albion.241
6.36
In any event, Ofcom considered whether there were significant cost advantages
enjoyed by BT in a relevant market (see paragraph 6.109 et seq below) but found
that any such advantages were not material to its conclusions.
Alleged margin squeeze in retail markets: analysis
6.37
Ofcom’s analysis followed the approach set out in the previous section, which
conducts the margin squeeze test on the basis of the incumbent’s costs, thereby
testing whether an equally efficient operator would be able to compete in the relevant
downstream markets.
6.38
Ofcom has concluded that the prices notified in NCCN 500 do not impose a margin
squeeze on C&W and BT’s other downstream competitors.
6.39
The remainder of this section sets out:
•
the range of products that should be included within the margin squeeze test (see
paragraphs 6.40-6.59 below);
•
other methodological issues (see paragraphs 6.60-6.86 below);
239
Retail Price Controls: Explanatory Statement, statement of 19 July 2006 (see footnote 70).
Commission Notice on the Application of Competition Rules to Access Agreements in the
Telecommunications Sector, OJ [1998] C265/2, paragraphs 117 and 118.
241
Dwr Cymru Cyfyngedig and Albion Water Limited and Water Services Regulation Authority [2008]
EWCA Civ 536, paragraph 105.
240
111
•
details of the data sources and calculations used by Ofcom (see paragraphs
6.87-6.93 below); and
•
results and conclusions (see paragraphs 6.94-6.123 below).
Alleged margin squeeze in retail markets: scope of margin squeeze test
6.40
As discussed in Section 5 above, Ofcom has concluded that BT was dominant in the
market for NTS call termination/hosting in the UK over the relevant period. NCCN
500 notified increases to BT’s prices for NTS call termination on certain NTS number
ranges.
6.41
The purpose of carrying out a margin squeeze analysis is to assess whether such a
price increase is capable of having an impact on competition between firms at a
downstream level. This means that the set of services across which the margin
squeeze test should be applied depends on the range of services across which firms
compete at the downstream level.
6.42
Table 10 summarises the key price changes notified in NCCN 500 (see Annex 1 for
further details).
Table 10: NTS termination prices pre and post NCCN 500242
0845 – long duration
0845 – short duration
0870
D
E
W
D
E
W
D
E
W
Pre-NCCN 500
2.07
0.36
0.44
5.04
2.00
2.12
5.85
3.11
0.98
Post-NCCN 500
2.57
0.49
0.56
6.95
1.83
1.90
6.05
3.21
1.02
Difference (ppm)
0.49
0.12
0.13
1.91
(0.17)
(0.21)
0.19
0.10
0.04
Difference (%)
24%
34%
28%
38%
(9%)
(10%)
3%
3%
4%
Source: NCCN 500. Key: D = daytime, E = evening, W = weekend
6.43
242
As Table 10 shows, the price increases notified in NCCN 500 price differed in both
percentage and absolute terms by number range, call duration and time of day, with:
•
significant increases on 0845 calls (particularly on all long duration, and daytime
short duration, calls);
•
significantly smaller increases on 0870 calls; and
•
no material increases on other relevant number ranges.243
Prices for the pre-NCCN 500 period are taken from prices derived using the NTS Calculator as at
1 April 2004. Prices for the period during which NCCN 500 was in force are taken from NCCN 500
itself, as reproduced at Annex 1.
243
Ofcom’s analysis has not considered the potential impact of the changes to BT’s NTS call
termination charges for 0820 in any depth. BT terminates a very small volume of calls to 0820
numbers on behalf of other OCPs, the total having fallen by an average of 88% per year over the last
two years. In 2004/05, BT terminated about []minutes on 0820 on behalf of other OCPs, i.e. about
[]% of the corresponding total for 0845 calls and about []% of the corresponding total for 0870
calls. This means that even a proportionately very significant charge increase by BT, such as an
112
6.44
6.45
6.46
6.47
6.48
The companies that had their costs increased by BT’s NCCN 500 price increase can
be divided into two categories:
•
communications providers that do not compete with BT in the relevant markets at
the downstream level; and
•
communications providers that compete with BT at the downstream level.
Communications providers that do not compete with BT in the relevant markets at the
downstream level, and that would not therefore be affected by a margin squeeze,
include:
•
the mobile network operators (O2, Vodafone, T-Mobile, Orange, and H3G), which
sell calls services but operate in different product markets to BT (i.e. the market
for mobile calls and access); and
•
Kingston Communications, which sells NTS calls but, as discussed in Section 4,
operates in a different geographic market to BT.
Communications providers that compete with BT at the downstream level, and which
might therefore feel the impact of an anti-competitive margin squeeze, include:
•
Virgin Media (or, during the period under investigation, ntl Telewest);
•
other access providers that primarily focus on business customers (e.g. C&W);
•
indirect access providers, i.e. CPS and WLR (wholesale line rental – see
Glossary) service providers such as TalkTalk.
None of the types of providers listed in the previous paragraph offer a bundle
consisting only of calls to 0845 and 0870 numbers, or calls to all NTS numbers.
What they offer to consumers is one of the following:
•
a full range of services comprising both calls to all number ranges and access
(i.e. line rental) and, in some cases, other products such as broadband internet
access and digital television; or
•
a CPS service offering calls to all numbers (CPS Option 3); or
•
a CPS service offering calls to some numbers (CPS Option 1 and/or Option 2).
Customers who are with BT for line rental can choose from a number of CPS options
for their calls:
•
Option 1 (international calls only);
•
Option 2 (national calls only);
•
Option 1 and Option 2 together; and
average of 1ppm, would have cost OCPs other than BT a combined total of £300 per year. It is clear
that such a sum would be very unlikely to have an impact on competition and Ofcom’s analysis
therefore generally excludes any consideration of 0820.
113
•
6.49
Option 3 (“all calls“ – international, national, local, mobile, non-geographic
(including calls to NTS numbers), personal, paging and directory enquiries.244
Ofcom’s analysis therefore considered the impact of NCCN 500 on the margin
earned by BT across:
•
a combination of all calls and access (relevant to competition with other retail
OCPs, i.e. Virgin Media – or, during the period under investigation, ntl Telewest);
•
all call types but not access (relevant to competition with CPS service providers);
and
•
the “CPS Option 3 incremental product bundle”, i.e. calls that are provided as part
of a CPS Option 3 package but not as part of CPS Option 1 and Option 2
packages combined (local calls, calls to mobiles, calls to non-geographic
numbers including NTS, personal, paging and director enquiries). If such a test
were failed, NCCN 500 could have a negative impact on the level of competition
by making the CPS “all calls” option unattractive to both prospective entrants and
players currently in the market.
6.50
As noted above, C&W contends that “the margin squeeze test should be applied only
to the products which are the subject of the margin squeeze“. Ofcom rejects this
formulation as it does not accurately capture the basis on which other providers
compete with BT, and cannot therefore enable Ofcom to assess whether BT’s
conduct is anti-competitive. Ofcom notes that when observing margins for individual
call and access products, (on 0845 and 0870) BT incurs negative margins on NTS
call termination, where revenues are insufficient to recover product costs as derived
on an FAC basis (see Figure 10 and Figure 11 below). However, as outlined below,
a finding of a negative margin in relation to a particular range or across all retail NTS
calls would be insufficient to demonstrate a margin squeeze likely to lead to an
adverse effect on competition, since competition arises across a far broader set of
retail call products.
6.51
Other things being equal, in cases where the upstream product(s) in question form a
small proportion of the total costs of supplying the relevant downstream products, it
is less likely that upstream price increases will lead to a margin squeeze. Retailers
typically sell a bundle consisting of a number of different retail products, not all of
which require the input in question. Margins on the relevant bundle of retail products
may therefore remain adequate even when the price of the upstream product is
increased. Upstream price increases may have an impact on competition if they lead
to negative margins across the narrowest bundle of services across which any of the
downstream firms competes.
6.52
As noted above, the set of services across which the margin squeeze test should be
applied depends on the range of services across which firms compete at the
downstream level. The smallest set of services over which it is appropriate to assess
the margin is therefore the narrowest set of services sold by competitors in the NTS
calls market that includes calls to 0845 and 0870 numbers. If this test indicates that
there is no margin squeeze, it may not be necessary to carry out tests on a larger
bundle as we would assume that margins on broader groupings of services would be
profitable. For completeness, Ofcom also conducted these tests.
244
See Addressing the local call Disadvantage, 30 July 2004, published at:
http://www.ofcom.org.uk/consult/condocs/cps_option/cps_statement/cps_stmnt.pdf
114
6.53
Some of BT’s competitors in the retail market focus on a particular group of
customers, particularly business customers. It could therefore be the case that
NCCN 500 had an impact on competition between suppliers of calls and access
services to a particular customer segment. Ofcom therefore analysed services sold
to residential and business customers separately.
6.54
We said above that the set of services across which the margin squeeze test should
be applied depends on the range of services across which firms compete at the
downstream level. As set out in the preceding paragraphs, the set of services across
which firms compete, and the consumers they are targeting, vary. Ofcom therefore
carried out six separate tests, each of which is based on the range of services
offered by a particular type of competitor. These tests are set out in Table 11.
Table 11: Parameters of tests for assessing alleged margin squeeze in call origination
Customer type
Product bundle
Test 1
Residential customers
all retail calls plus access
Test 2
Residential customers
all retail calls but not access (CPS Option 3)
Test 3
Residential customers
CPS Option 3 incremental product bundle
(see paragraph 6.49 above)
Test 4
Business customers
all retail calls plus access
Test 5
Business customers
all retail calls but not access (CPS Option 3)
Test 6
Business customers
CPS Option 3 incremental product bundle
6.55
Rather than conducting a separate test for each of BT’s different retail offerings (e.g.
the different BT Together options), Ofcom conducted the tests set out in Table 11 at
a broader level, aggregated across all of the tariffs that BT offers to residential and
business customers. Ofcom took this approach because the conduct under
investigation applied equally to all of BT’s retail packages, and although NCCN 500
applied only to calls originated by competing OCPs, the test is constructed on the
hypothesis that NCCN 500 had applied to calls made by BT’s retail customers. In
any case, as discussed below, the impact of NCCN 500 on BT’s margins is not
material whichever of the six test specifications we adopt.
6.56
Ofcom is not aware that the business of any of BT’s competitors in the NTS calls
markets is tightly focused solely on the call types that were most affected by NCCN
500 to the extent that varying the proportions in which BT terminates traffic on the
different NTS number ranges would affect the result. Ofcom therefore based its
analysis on call charges averaged across time of day, calculated using the relevant
proportions for BT-to-BT traffic in 2004/05 (“BT’s own time of day weights”).245
6.57
For completeness, Ofcom carried out two further tests focusing on downstream
prices:
•
at a particular time of day; and
245
Source: BT letter to Ofcom dated 9 September 2005 and email response of 11 September 2005 to
Ofcom Notice of 25 August 2005.
115
•
for a hypothetical competitor supplying only business customers.
6.58
Such tests might represent the relevant scope if any of BT’s competitors in the
origination market generated disproportionately high volumes of, for example, 0845
long duration evening and/or 0845 short duration daytime calls, since BT’s prices for
these call types attracted the highest price increases. Business customers, for
example, would generate higher volumes of daytime calls than residential
consumers (in particular, 0845 short duration calls, for which the highest
proportionate charge increases were levied).
6.59
Ofcom therefore conducted a sensitivity analysis by repeating its analysis using time
of day weights based on the proportions in which one of BT’s competitors at the
retail level, which supplies only business customers, originates calls to such call
types. The results of this sensitivity analysis are set out in Annex 8.
Alleged margin squeeze in retail markets: methodological issues
Forward-looking or historical analysis
6.60
An issue to be considered is the methodology by which estimates of the margin will
be made. In principle, there are two possible bases that we could use to calculate
the margin:
•
an assessment of historical financial accounting data; and
•
a forward-looking net present value (“NPV”) analysis over a number of years.246
6.61
Generally speaking, where relevant historical accounting information is available for a
meaningful amount of time, a historical accounting approach to profit calculation is
likely to provide the more robust measure of profits. This is because it relies primarily
on costs and revenues reflecting the actual transactions entered into. Furthermore
such information is capable of being subjected to independent audit.
6.62
For the accounting approach, the most reliable source of data is the audited financial
statements that cover a 12-month period. More detailed information can usually be
obtained from an undertaking’s internal management accounts which are typically
produced on a monthly basis and may contain an analysis of the profitability of
individual products.247
6.63
BT is required to prepare regulatory accounting information on a current cost basis
for certain economic markets in which it is designated as having SMP. This basis
seeks to address in particular the use of asset valuations and depreciation charges
based on possibly significantly out-of-date historical asset purchase cost. Current
cost depreciation charges and asset valuations typically based on current
replacement cost should reflect much more closely the opportunity cost of using
assets during the period in question. Ofcom has therefore used information drawn
from BT’s regulatory costing systems as the source for the financial inputs into its
margin squeeze analysis.
246
Ofcom notes that an historical financial accounting approach should be distinguished from historic
cost accounting. The former refers to the use of actual data which may include historic cost
accounting figures (i.e. HCA) but equally could include current cost accounting (i.e. CCA) figures.
247
Certain regulated businesses, such as BT, are also required to produce detailed, audited accounts
to a much greater level of detail than statutory annual accounts.
116
6.64
UK regulators and the Commission concur that the historical accounting approach is
most appropriate where it provides a meaningful and reliable measure of the
profitability of pricing and investment decisions in the period being considered and
the BSkyB and Wanadoo cases provide examples of the explicit preference for a
historical accounting approach over a forward-looking NPV approach.
6.65
In BSkyB, the OFT recognised the potential for historical accounting approaches to
suffer from accounting distortions, but concluded:
“The Director considers that the historical approach is the
appropriate way of assessing margin squeeze in this case. The
Director does not consider that a positive NPV for DisCo would
necessarily imply that BSkyB has not margin squeezed. An historical
approach that recognises and treats investment expenditures
appropriately is therefore the best option available.”248
6.66
The OFT did not favour the use of a NPV approach where historic data was available
in order to avoid the major (and well-known) problem that NPV approaches introduce
– the potential that positive NPV results reflect the outcome of the anti-competitive
behaviour.249 That is, sacrifices in short-run profits might lead to higher long-run
profits, not due to any natural development in the market, but due to the elimination
or exclusion of competitors. A margin squeeze, for example, will be profit-enhancing
over time (the dominant undertaking incurs initial losses which will be more than
offset in the future through higher prices or greater market share in the future), so
that if the profitability of the dominant firm is assessed over a sufficiently long period,
there would be no losses unless suitable adjustments are made.
6.67
The Commission in Wanadoo concluded that:
“the Commission finds that only the adjusted [historical] costs
approach allows any valid conclusions to be drawn; the others can
help to throw further light on the matter, but no more.”250
6.68
The use of NPV analysis may be appropriate where accounting data do not
accurately reflect economic costs, for example, because the margin squeeze is
alleged to be occurring in a new market, where it is often reasonable to expect an
undertaking to incur losses initially.251
6.69
However, to the extent that the NPV approach relies on forward-looking business
plans, it will be based on assumptions regarding future revenues and costs.
Assessing the validity of the assumptions in the business plan is not straightforward
and inevitably involves a level of judgment.
6.70
In Ofcom’s view, consistent with the cases quoted above, the historical accounting
approach is the most appropriate, in the current circumstances, to determine
248
OFT decision CA98/20/2002, BSkyB investigation: alleged infringement of the Chapter II
prohibition, 17 December 2002, paragraph 390 http://www.oft.gov.uk/NR/exeres/E5019794-B2A848EF-B420-F96F8A2BAD7F.htm.
249
OFT BSkyB decision (see footnote 248), paragraph 389.
250
Commission decision of 16 July 2003 relating to a proceeding under Article 82 of the EC Treaty
(COMP/38.233/Wanadoo Interactive). References in this document are to the English version of the
decision available at http://ec.europa.eu/comm/competition/antitrust/cases/decisions/38233/en.pdf.
Wanadoo Interactive appealed the Commission decision to the CFI on 2 October 2003 (OJ (2003)
C289/46) and the CFI upheld the Commission’s decision on 30 January 2007 (CaseT-340/03).
251
OFT 417, paragraph 7.23.
117
whether or not the prices notified in NCCN 500 led to a margin squeeze during the
period that they were in force.
6.71
NCCN 500 was applied in a mature market (the total volume of 0845 calls terminated
by all TCPs, for example, declined by an average of 15% p.a. between 2002/03 and
2004/05), and was reversed after a relatively short period of time.252 This means that
the drawbacks to the use of historical accounting data identified above are not
material to this case. In assessing whether the prices notified in NCCN 500 led to a
margin squeeze, the key question to be investigated is whether BT’s retail calls and
access business remained profitable while those prices were in force.253
6.72
Ofcom therefore based its analysis in this case on a historical accounting approach.
Appropriate basis for estimating costs
6.73
252
253
Another key issue to be considered in carrying out a margin squeeze test is the
definition of cost. A number of different concepts of cost are defined in Table 12
below.
Source: Responses from TCPs to S26 information request of May 2005
The results given in Figure 16 and Figure 17 answer this question.
118
Table 12: Relevant cost standards for Ofcom’s analysis
Incremental cost is the cost of producing a specified additional product, service or
increment of output over a specified time period. In many cases, the relevant increment
may be the entire output of a particular service or group of services. The incremental costs
of a service are then those costs which are directly caused by the provision of that service
in addition to the other services which the firm also produces. Another way of expressing
this is that the incremental costs of a service are the difference between the total costs in a
situation where the service is provided and the costs in another situation where the service
is not provided.
Incremental cost can be contrasted with the standalone cost (“SAC”) of a service which
is the cost of providing that particular service on its own, and with common costs.
Common costs are those which arise from the provision of a group of services but which
are not incremental to the provision of any individual service. Common costs may be
identified in the following way: if the incremental costs of each service are removed from
the total cost of providing all services, what are left are the common costs (i.e. those costs
which are shared). Where there are no common costs, incremental cost and SAC are the
same. Where there are common costs, the SAC of a service is the sum of the incremental
cost of the service plus all of the costs which are common between that service and other
services. In this case there are said to be economies of scope, that is, total costs are
reduced by producing a number of services together, because common costs then have to
be incurred only once.
Variable costs are costs that vary with an undertaking’s output over a specified time
period. By contrast, fixed costs are costs that do not vary with output over the specified
period. Total costs are the sum of variable and fixed costs.
Fully allocated cost (“FAC”) is an accounting concept by which all the costs of a multiproduct firm are attributed to its various activities, primarily on the basis of cost causation.
Average FAC is the nearest equivalent of average total cost (“ATC”) in a multi-product
firm. Long-run average incremental cost (“LRIC”) is equivalent to long-run average
variable cost for a given output increment (e.g. the service in question) and time period.
6.74
Whether costs can be considered as variable, fixed, incremental or common depends
on both the size of the output increment and the time horizon over which the variable
or incremental nature of costs is being assessed. Variable and incremental costs are
the same if the same output increment and time horizon is used.
6.75
The time horizon may not coincide with the period of investigation – it may be shorter
or longer depending on the specific nature of the conduct and the life of the assets
involved.
6.76
Ofcom believes that among two relevant factors in the decision on the relevant time
horizon are (a) the period over which the alleged margin squeeze prevailed; and (b)
whether the margin was temporarily low and expected to rise in the future. Further
factors are the asset lives of key investments and the nature of the behaviour under
investigation.
6.77
The period over which the charges were in force is significant because it provides a
minimum time horizon. For example, if a price was a special offer for a single week
or month, it may be appropriate to consider only costs that were variable within that
119
week or month. However, if prices had been sustained (without rising) for a period of
over two years, it is reasonable to expect that prices should cover the costs that
were variable with output over the two-year period. Otherwise, there would be a risk
of concluding that BT could reasonably fail to recover costs that could have been
avoided (i.e. were incremental) in that period.
6.78
It could also be argued that a longer timeframe could be appropriate if the conduct
had ceased solely due to the commencement of enforcement proceedings. However,
this is not a critical issue in this case because, as described below, the findings
relating to margin squeeze are not sensitive to the time period over which variability
is assessed.
6.79
It is necessary to compare BT’s revenues in the downstream market with its relevant
costs in order to determine whether the margin between its upstream and
downstream prices was sufficient to enable its relevant downstream operations to
cover their costs during the period covered by the investigation. Profitability is used
as the measure of whether revenues are sufficient to recover (downstream) costs,
and the measure of whether prices are sufficient to recover unit costs. As the OFT
states:
“To test for margin squeeze, it is usual to determine whether an
efficient downstream competitor would earn (at least) a normal profit
when paying input prices set by the vertically integrated
undertaking.”254
6.80
In assessing a potential margin squeeze, there are a number of cost standards that
might be applied.
6.81
In AKZO, the ECJ determined that a price or margin below average variable cost
(“AVC”) charged by a dominant firm is presumed to be anticompetitive. This is
because, if a price is less than AVC, the firm would be better off ceasing production
entirely, and such conduct is therefore (generally) only rational if there is an anticompetitive motive. Thus:
“Prices below average variable costs (that is to say, those which
vary depending on the quantities produced) by means of which a
dominant undertaking seeks to eliminate a competitor must be
regarded as abusive. A dominant undertaking has no interest in
applying such prices except that of eliminating competitors so as to
enable it subsequently to raise its prices by taking advantage of its
monopolistic position, since each sale generates a loss, namely the
total amount of the fixed costs (that is to say, those which remain
constant regardless of the quantities produced) and, at least, part of
the variable costs relating to the unit produced.”255
6.82
The ECJ went on to say that a price or margin between the average variable cost of
offering a service and the average total cost (“ATC”) may be anticompetitive if it can
be shown that there is intent to exclude and that:
“Moreover, prices below average total costs, that is to say, fixed
costs plus variable costs, but above average variable costs, must be
regarded as abusive if they are determined as part of a plan for
254
255
OFT 414a.
Case C-62/86 AKZO Chemie v Commission [1991] ECR I-3359, paragraph 71.
120
eliminating a competitor. Such prices can drive from the market
undertakings which are perhaps as efficient as the dominant
undertaking but which, because of their smaller financial resources,
are incapable of withstanding the competition waged against
them.”256
6.83
A price or margin above ATC is presumed not to be anticompetitive. In his Opinion
([2000] ECR I-1365) on Cewal’s appeal to the ECJ, Advocate General Fennelly
stated:
“I would, on the other hand, accept that, normally, non-discriminatory
price cuts by a dominant undertaking which do not entail below-cost
sales should not be regarded as being anti-competitive. In the first
place, even if they are only short lived, they benefit consumers and,
secondly, if the dominant undertaking’s competitors are equally or
more efficient, they should be able to compete on the same terms.”
257
6.84
Ofcom’s analysis was primarily based on an analysis of FAC, which is the nearest
equivalent to ATC in a multi-product firm (see Table 12). A test that is passed based
on an analysis of FAC, provided the attribution is reasonable, is usually taken as
strong evidence that there is no margin squeeze. It is therefore only in cases where
such a test is failed that it is important to undertake an analysis based on variable or
incremental costs.
6.85
Ofcom’s tests were based on BT’s retail margin for various products, calculated by
subtracting the sum of retail costs and internal transfer charges from retail revenues.
Transfer charges between different parts of BT’s business and interconnection
charges from other fixed and mobile communications providers form a significant
proportion (80% or higher) of the cost of providing the retail calls and access
services that form the basis of this margin squeeze test.
6.86
This means that estimates of variable/incremental cost and FAC measured across
these services are relatively close together (because the transfer and
interconnection charges are a component of both FAC and incremental cost).
Because Ofcom’s margin squeeze tests were passed on a FAC basis, it has not
been necessary to reach a conclusion to carry out a detailed analysis based on
estimates of variable or incremental costs.
Data supplied by BT
6.87
Ofcom required BT to provide cost, revenue and volume data from its regulatory
costing systems for its various PSTN retail products (see Table 2 above), which
include the various retail products considered in the various bundle options.
6.88
Ofcom required BT to provide data for both the 2003/04 and 2004/05 financial years.
As NCCN 500 came into effect on 1 May 2004, Ofcom did not consider previous
financial years in the context of this piece of its analysis. Nor did Ofcom use forecast
data in its analysis for a number of reasons. First, accounting data was not available
256
Case C-62/86 AKZO Chemie v Commission [1991] ECR I-3359, paragraph 72. On the issue of
intent in this case, see paragraph 6.545 et seq below.
257
Opinion of Advocate General Fennelly on Cewal’s appeal to the Court of Justice, Cases C-395,
paragraph 132, and 396/96P Compagnie Maritime Belge v Commission [2000] ECR I-1365
(“Compagnie Maritime Belge”). This case involved an exception to this general presumption.
121
for the full 2005/06 financial year when Ofcom carried out its analysis. Second, traffic
affected by NCCN 500 (notably calls to 0845 numbers) is declining as a proportion of
all traffic (from []% to []% from 03/04 to 04/05), which means that it is
increasingly unlikely that BT’s conduct in raising its charges could have led to a
margin squeeze in future, with the affected calls accounting for a declining proportion
of downstream revenues.258 In any case, the prices notified in NCCN 500 ceased to
have effect on 1 January 2006, making an analysis of forecast data from beyond this
point inappropriate.
6.89
BT was unable to provide origination volumes for 0845 and 0844 separately, or for
0870 and 0871 separately.
6.90
In its analysis Ofcom therefore assumed that NCCN 500 applied to all BT-to-BT 084X
and 087X calls. Other things being equal, this would have overstated the impact of
NCCN 500. BT-to-BT 0844 and 0871 calls account for a [] proportion of BT-to-BT
NTS traffic, with 0844 volumes accounting for less than []% of all such 084X
traffic, and 0871 volumes accounting for less than []% of all such 087X volumes in
2004/05.
6.91
The data supplied by BT did not consistently analyse services sold to business and
residential customers separately across all its services, and did not separately record
information on BT-to-BT traffic. To control for these factors, Ofcom made a number
of adjustments to the data supplied by BT before conducting its analysis. These
adjustments are set out at Annex 9, which provides a full list of the data sources and
calculations used in Ofcom’s analysis.
Measure of profitability
6.92
In order for a margin to be considered adequate, it must be sufficient to allow the firm
to earn its required minimum rate of return on capital.
6.93
In this case, Ofcom considers that the appropriate measure of the minimum required
return on investment is BT’s Return on Sales (“ROS”), for the reasons set out in
Annex 5.
Results
6.94
On a FAC basis, in 2004/05, [ (some of BT’s services were loss-making)].259
6.95
[]. However, Ofcom considers that the additional losses caused by NCCN 500
would have been insufficient to lead to a margin squeeze when considering BT’s
margin across all relevant call types, as set out in the following tables.
Table 13: BT’s margin (all business products), 2004/05 (£m)
Connections
From BT regulatory accounting
information
NCCN 500's impact
Line
rental
Local
calls
Business FAC Returns
Nat
It'l calls CTM
FF
calls
084x
087x
[]
Numbers are rounded and therefore total figures may not total exactly
258
259
BT response dated 9 September 2005 to Ofcom’s section 26 Notice of 19 August 2005
[].
122
09x
Total
Table 14: BT’s margin (all residential products), 2004/05 (£m)
Connections
From BT regulatory accounting
information
NCCN 500's impact
-107
0
Line
rental
Local
calls
-256
0
407
0
Residential FAC Returns
Nat
It'l calls CTM
FF
calls
80
0
93
0
117
0
084x
087x
09x
Total
[]
Numbers are rounded and therefore total figures may not total exactly
6.96
As Table 13 and Table 14 above show, if BT, as an OCP, had faced NCCN 500, the
impact on its profits would have been relatively small.
6.97
As set out at paragraph 6.46 above, at a downstream level, BT competes with
companies with a variety of different business models. There are therefore a number
of possible constructions for the margin squeeze test, which are listed in Table 11.
The following discussion considers BT’s margins on these different service
increments, which, to recap, are (for residential and business customers separately):
•
all retail calls plus access;
•
all retail calls but not access (CPS all calls); and
•
CPS Option 3 incremental product bundle.
All retail calls plus access (tests 1 and 4)
6.98
The first pair of tests measures BT’s margin across all call types plus access, in order
to ascertain whether NCCN 500 created a margin squeeze on ntl Telewest (now
Virgin Media) and other direct access providers that compete with BT.
6.99
To the extent that BT’s competitors are able to rely on their own networks (instead of
buying wholesale inputs from BT), these tests may overstate the likelihood of a
margin squeeze to the extent that BT’s wholesale charges are greater than its
competitors’ incremental costs.
6.100 Figure 10 and Figure 11 set out estimates of BT’s margin expressed as ROS for all of
BT’s retail services, both before and (assuming that BT faced the price increases
notified in NCCN 500) after NCCN 500. The “total” figure in the final column
measures BT’s margin across all of the services shown in the Figures, i.e. all call
types plus access. In Figure 10 and Figure 11, “CTM” means calls to mobiles and
“FF” means calls to freephone (or free to caller, i.e. 0800) numbers. Note that the
margin on NTS call types alone is not a relevant test, as set out in paragraphs 6.406.59 above.
123
Figure 10: BT’s margin, all calls and access (business) 2004/05
Figure 11: BT’s margin, all calls and access (residential) 2004/05
6.101 Figure 10 and Figure 11 show that BT earned:
•
a significant negative margin on access services (with the exception of business
line rentals);
•
a significant positive margin on geographic call types; and
•
a negative margin on 084X, 087X and 09X calls, which would have been
exacerbated by NCCN 500 had it applied to BT-to-BT calls.
6.102 The impact of NCCN 500 on BT’s margin, measured across all of the services listed
in Figure 10 and Figure 11, was relatively small. For services provided to business
customers, the impact of NCCN 500 would have been to reduce BT’s ROS,
measured across all the relevant retail services, from []% to []%. For services
provided to residential customers, the impact of NCCN 500 would have been to
reduce BT’s ROS, measured across all the relevant retail services, from []% to
[]%.
6.103 Figure 10 above shows that the impact of NCCN 500 on BT’s profitability, when
measured across all business calls and access services, was relatively small. This is
because of the relatively small number of calls to the relevant number ranges
124
originated by business customers (primarily because businesses do not, as a rule,
use dial-up internet access).
6.104 Figure 11 shows that the impact of NCCN 500 on BT’s margin on residential calls
and access would have been somewhat greater, but still small, i.e. it would tend to
lower BT’s ROS, measured across all services, from []% to []%.
6.105 Ofcom’s view is that the relative magnitudes of the pre- and post-NCCN 500
profitability levels shown in Figure 10 and Figure 11 provide useful additional
evidence in assessing whether NCCN 500 introduced a margin squeeze against
BT’s downstream competitors. However, as is apparent from Figure 10 and Figure
11, BT’s ROS for all calls and access combined suggests that BT earned a positive
margin on these services.
6.106 Ofcom concludes, on the basis of these results which show that the margin was
sufficient to allow competitors to earn an adequate return (as compared to the
benchmarks referred to in Annex 6), and the relatively small impact of NCCN 500 on
profitability, that NCCN 500 did not lead to a margin squeeze when measured across
all call and access services. Therefore Ofcom concludes that NCCN 500 did not
distort downstream competition between BT and other direct access providers, i.e.
Virgin Media (formerly ntl Telewest).
All retail calls but not access (Tests 2 and 5)
6.107 The second pair of tests that Ofcom conducted measured BT’s profitability across all
retail calls but not access in order to ascertain the impact of NCCN 500 on
competition between BT and CPS providers.
6.108 []. It follows from this that, absent any other adjustments, it is easier for BT to pass
a margin squeeze test on the basis of calls only than it is to pass a test based on
both calls and access. The results set out in Figure 12 and Figure 13 show that, for
both residential and business services:
•
[]
•
[].
Figure 12: BT’s margin, calls only (residential)
Turnover (£m)
Residential customers
ROS (%)
Return (£m)
pre-NCCN500
post-NCCN500
pre-NCCN500 post-NCCN500
Test 1 (all calls + access)
Test 2 (calls only)
[]
Figure 13: BT’s margin, calls only (business)
Turnover (£m)
Test 4 (all calls + access)
Test 5 (calls only)
Business customers
ROS (%)
Return (£m)
pre-NCCN500
post-NCCN500
pre-NCCN500 post-NCCN500
[]
125
6.109 Ofcom considered whether it was appropriate to make additional adjustments to
carry out this version of the test to control for the so-called “local call disadvantage”.
6.110 Even where CPSOs (carrier pre-select operators) interconnect at all of BT’s local
exchanges, they still face higher costs than BT. This is because for a local call
between two customers that are connected to the PSTN using a BT access line (i.e.
customers of BT Retail or CPSOs/WLR service providers), there are often additional
switching stages when an interconnecting operator is used to carry the call.
6.111 The calls for which this is an issue are those between customers connected to the
same local exchange, and those between customers connected to adjacent local
exchanges. BT routes these calls entirely on its own network, so that they do not
pass via a transit exchange. However, CPSOs must take these calls off at BT’s DLE
(digital local exchange), route them up to their own switch and then send them back
to the same DLE, incurring additional costs in the process. This effect is referred to
as the “local call disadvantage.”260
6.112 While the impact of the local call disadvantage is difficult to quantify precisely, BT’s
margins, measured across all calls, are sufficiently large that, even if returns on local
calls earned by BT were reduced or removed from Ofcom’s analysis, BT would still
make a positive margin. This is because of the substantial margins earned on
national and international calls and on calls to mobiles, as shown in Figure 14 and
Figure 15 below.
Figure 14: BT’s margin, all calls except local calls (business), 2004/05
260
See Investigation against BT about potential anti-competitive exclusionary behaviour: Decision of
the Office of Communications, 12 July 2004, published at:
http://www.ofcom.org.uk/bulletins/comp_bull_index/comp_bull_ccases/closed_all/cw007/cw_760_dec/
cw_760_dec.pdf.
126
Figure 15: BT’s margin, all calls except local calls (residential), 2004/05
6.113 BT’s margin (measured as ROS) on sales to business customers across all calls
excluding local calls (assuming that BT had faced NCCN 500) was []% (versus
[]% without NCCN 500). For sales to residential customers, BT’s ROS across all
calls excluding local calls was []% (versus []% when BT did not face NCCN
500).
6.114 These results are qualitatively very similar to those shown in Figure 12 and Figure 13
above, showing that BT earned high margins across all calls even discounting all the
returns associated with local calls, and that, had NCCN 500 applied to NTS calls
originated by BT, the impact on BT’s margin would have been insufficient to lead to a
margin squeeze.
6.115 Ofcom therefore concludes that NCCN 500 did not impose a margin squeeze on BT’s
downstream competitors that offer calls only, i.e. CPSOs.
CPS Option 3 incremental product bundle (Tests 3 and 6)
6.116 Finally, Ofcom conducted a margin squeeze test on the CPS Option 3 incremental
product bundle, i.e. calls that are provided as part of a CPS Option 3 package but
not as part of CPS Option 1 and Option 2 combined, in order to ascertain whether
NCCN 500 created a margin squeeze on CPS operators wishing to provide the “all
calls” option.
6.117 The results of this pair of tests are shown in Figure 16 and Figure 17 below.
Figure 16: The impact of NCCN 500 on Tests 1, 2 and 3 (services sold to residential
customers)
Turnover (£m)
[a]
[b]
[c]
[d]
[e]
Test 1 (all calls + access)
Test 2 (calls only)
CPS all calls
CPS national and international
Test 3 (margin of [c] over [d])
Residential customers
ROS (%)
Return (£m)
pre-NCCN500 post-NCCN500 pre-NCCN500 post-NCCN500
[]
Source: BT data
127
Figure 17: The impact of NCCN 500 on Tests 4, 5 and 6 (services sold to business
customers)
Turnover (£m)
[a]
[b]
[c]
[d]
[e]
Test 4 (all calls + access)
Test 5 (calls only)
CPS all calls
CPS national and international
Test 6 (margin of [c] over [d])
Business customers
ROS (%)
Return (£m)
pre-NCCN500 post-NCCN500 pre-NCCN500 post-NCCN500
[]
Source: BT data
6.118 It is clear from Figure 16 and Figure 17 above that there is a significant margin
between CPS all calls and the other CPS options and that NCCN 500 had a very
limited impact on this margin.
6.119 [].
Figure 18: BT’s margin, local calls, calls to mobiles, and NTS calls (residential)
Figure 19: BT’s margin, local calls, calls to mobiles, and NTS calls (business)
128
6.120 In order to control for the local call disadvantage (see paragraph 6.111), Ofcom
calculated the margin between CPS Option 3 and the other CPS options, but
subtracted from this margin the returns associated with local calls. [].
6.121 BT’s margin on CPS Option 3 excluding local calls and the other CPS options,
measured as ROS, was []% for business customers ([]% assuming that BT had
faced NCCN 500) and []% for residential customers ([]% assuming that BT had
faced NCCN 500).
6.122 Based on these factors, and given that removing all of the returns associated with
local calls is an extreme assumption, Ofcom concluded that NCCN 500 did not lead
to a margin squeeze on competitors offering CPS Option 3 (all calls) as opposed to
other CPS options.
Conclusion on retail margin squeeze
6.123 Based on the analysis set out above, Ofcom has concluded that NCCN 500 did not
lead to an anti-competitive margin squeeze between BT’s upstream wholesale NTS
call termination charges and the retail prices that it charged in the downstream retail
calls and access markets.
Responses to draft decision: retail margin squeeze
6.124 Ofcom received three responses which questioned Ofcom’s retail margin squeeze
analysis, from BT, C&W and Thus.
BT
6.125 BT states that it would not have conducted the margin squeeze test in the same way
as Ofcom, but that it nevertheless supports the conclusions reached:
“Generally BT would not necessarily have applied the [retail margin
squeeze] test or the analysis in the same [way] that Ofcom has
done. However that Ofcom did apply the test in the way that it has
done clearly demonstrates that BT’s behaviour in fixing the charges
for the relevant period, even if BT were dominant on the relevant
markets, was not abusive…”
C&W
6.126 C&W notes that there are two possible cost bases for assessing an alleged margin
squeeze: “the costs of a reasonably efficient operator on one hand and the dominant
operator’s own costs on the other”.261 C&W notes that Ofcom has concluded that in
this case it is appropriate to base its tests on BT’s own costs, and submits that
Ofcom “provides no conclusive authority to justify this view”, and that “at the very
least [Ofcom] has simply chosen to apply the test most favourable to BT”.262
6.127 Having selected this cost base, C&W submits, Ofcom has failed to adjust costs for
any scale efficiencies apart from the local call disadvantage (see paragraphs 6.109
et seq above). C&W submits that Ofcom is wrong not to adjust costs and that the
implication of this is that the costs used in the test are too low, and the test is
therefore too easy to pass. C&W submits that, as a result of the call origination
261
262
C&W’s response to the draft decision, page 31.
C&W’s response to the draft decision, page 32-33.
129
condition, “if BT had to pay the NCCN 500 price then […] it may not have been able
to cover its cost”.263
6.128 C&W submits that in identifying the narrowest set of products across which
companies compete in order to conduct its test, Ofcom has:
“…expand[ed] the margin squeeze test across several products that
are not directly derived from the upstream product. Ofcom cites no
precedent for this expansion, and indeed case law does not support
it.”264
6.129 C&W submits that Ofcom has departed from established case law, in which “the
analysis of margin squeeze has been confined to the relevant product market”.265
6.130 C&W submits that Ofcom has not examined the impact of NCCN 500 on “those
CPS[Os] that only provide calls to some numbers, e.g. CPS Option 1 and/or Option
2”.266
6.131 C&W submits that Ofcom:
“has not seriously considered whether end-users buy different kinds
of calls from different providers on a “least cost routing” basis, or
whether different kinds of calls are bought and sold separately on
wholesale markets.”267
6.132 C&W contends that the effect of applying the margin squeeze test to the wrong
product set is that the effect of NCCN 500 is “diluted”, such that:
“Ofcom fails to take into account the fact that BT was making a loss
on retail calls subject to NCCN 500.”268
Thus
6.133 Thus considers believes that:
“Ofcom’s margin squeeze conclusions are invalid because it has
performed the analysis on the wrong downstream market.”269
6.134 Thus concludes that “Ofcom should re-do its margin squeeze test focusing on the
narrower retail market comprising calls to numbers covered by NCCN 500”.270
6.135 Thus argues that “Ofcom has ignored BT’s significant and inherent cost advantages”
in constructing its margin squeeze test.271
6.136 Thus is concerned that:
263
C&W’s response to the draft decision, page 34.
C&W’s response to the draft decision, page 35.
265
Ibid.
266
C&W’s response to the draft decision, page 36.
267
Ibid.
268
C&W’s response to the draft decision, page 40.
269
Thus’s response to the draft decision, page 8.
270
Thus’s response to the draft decision, page 9.
271
Ibid.
264
130
“Ofcom has ignored the fact that consumers can and do use the
‘1280’ prefix to over-ride routing to their CPS provider and divert
calls selectively back to BT….(T)he availability of the CPS prefix was
widely recognised in the market, and acted as a mechanism to
disaggregate competition to a lower level than has been assumed by
Ofcom in its analysis.”272
6.137 Thus submits that the availability of 1280 leads to “competition on a number range by
number range basis” between BT and CPSOs, and offers, as evidence of this, online
advice for consumers explaining how they can use 1280 on a call-by-call basis, and
the wording of the letter sent by BT to customers who had switched from BT Retail to
a CPSO at the time that NCCN was in force, which invited them to “check which calls
are cheaper with BT”.273
Ofcom comments on responses to the draft decision
6.138 In addition to respondents’ comments on Ofcom’s margin squeeze analysis, which
are considered in the following paragraphs, respondents raised a number of issues
with Ofcom’s approach to margin squeeze in the context of Ofcom’s proposed
market definition and analysis of C&W’s discrimination allegation. We deal with these
at paragraphs 4.218-4.231 above and 6.263-6.291 below respectively.
6.139 C&W argues that the margin squeeze test should be based on its own (higher) costs
rather than BT’s (i.e. a reasonably efficient operator approach). C&W also argues
that in its analysis of the BT Together case (see paragraph 6.141) Ofcom took
account of the scale disadvantages of BT’s competitors.
6.140 Ofcom has considered both the equally efficient operator (“EEO”) test and the
reasonably efficient operator (“REO”) approaches. As set out above, Ofcom notes
the judgment of the CFI in Deutsche Telekom and of the Court of Appeal in Albion in
relation to the appropriate test, i.e. the EEO.
6.141 In the BT Together decision, Ofcom conducted an EEO test, an REO test and a
hybrid test (combining the EEO and REO approaches) to allow for the local call
disadvantage.274 However, Ofcom rejected the full REO approach, on the grounds
that it did not accept that the scope of the REO should be extended to take account
of matters going beyond unavoidable disadvantages (i.e. unavoidable structural
costs).
6.142 In the Gamma Telecom decision, Ofcom applied a hybrid test that allowed for only
unavoidable additional costs (as in the BT Together decision).275
6.143 In the Freeserve 2 decision, the primary test was an EEO test based on the dominant
undertaking’s costs.276 In this case, BT’s legacy advantages were not relevant, and
therefore only the EEO test was conducted.
272
Thus’s response to the draft decision, page 8-9.
Ibid.
274
See footnote 260.
275
Complaint from Gamma Telecom against British Telecommunications Group plc (“BT”) about
reduced rates for Wholesale Calls from 1 December 2004: Decision of the Office of Communications,
13 June 2005, published at:
http://www.ofcom.org.uk/bulletins/comp_bull_index/comp_bull_ccases/closed_all/cw_802/262194/
276
Investigation by the Director General of Telecommunications (the ‘Director’) into alleged
anticompetitive practices by British Telecommunications plc (‘BT’) in relation to BTOpenworld’s
273
131
6.144 As set out at paragraph 6.35 above, where BT has an inherent incumbency
advantage Ofcom could consider applying the REO test (either in part or in full,
depending on the extent of the advantages). Ofcom notes the tests set out by the
Court of Appeal in Albion (see paragraph 6.32 above) and by the CFI in Deutsche
Telekom (see paragraph 6.31 above). In any event, in this case Ofcom considered
the presence of the so-called local call disadvantage, and has also applied a hybrid
or adjusted EEO test.
6.145 As set out at paragraph 6.109 et seq above, the local call disadvantage arises in
relation to calls where two customers are connected to the same local exchange via
a BT PSTN access line. Whereas BT routes these calls internally, without the need
for transit via an exchange, a CPSO (e.g. C&W) must take these calls off BT’s
network, route them using its own switch and then carry that traffic back to the same
DLE, thereby incurring additional costs.
6.146 Ofcom has, in respect of tests 2,3,5 and 6 (see Table 11 above), acknowledged the
higher interconnection circuit costs of a CPSO (i.e. for a reasonably efficient
operator) when assessing margin squeeze and interpreting the results.
6.147 Accordingly, scale disadvantages were taken into account by means of the local call
disadvantage, an adjustment which Ofcom also made in the BT Together case, as
C&W acknowledges. Ofcom states, in the final decision in that case:
“Ofcom believes it may be reasonable to take account of structural
cost disadvantages in a margin squeeze test and in this investigation
Ofcom has considered the effects of structural cost disadvantages
faced by CPS Providers at the upstream network input level in terms
of the local calls disadvantage. Ofcom does not believe, however, it
is reasonable in this case to extend the scope of the ‘reasonably
efficient new entrant’ margin squeeze test to take account of matters
going beyond such unavoidable disadvantages.”277
6.148 As stated at paragraph 6.52 above:
“the set of services across which the margin squeeze test should be
applied depends on the range of services across which firms
compete at the downstream level.”
6.149 Ofcom considers that retail providers do not compete for the provision of 0845 and/or
0870 calls only. Rather, such calls are offered as part of a broader bundle including
various different call types and, in some cases, access. Accordingly, Ofcom does not
accept C&W’s argument that the margin squeeze test should be conducted on NTS
calls only. Even where NTS calls are not offered as part of call packages by some
operators, Ofcom does not consider that this would alter Ofcom’s test.
6.150 C&W suggests that Ofcom’s approach may be inconsistent with case law in that the
products included in the relevant product set are “not directly derived from the
upstream product” (see paragraph 6.128 above). As discussed at paragraph 4.222
and paragraphs 6.50-6.54 above, however, it is necessary to broaden the product
set (beyond products “directly derived from the upstream product”) in order to
capture accurately the basis on which other providers compete with BT. Ofcom notes
(‘BTOW’) consumer broadband products, 20 November 2003, published at:
http://www.ofcom.org.uk/bulletins/comp_bull_index/comp_bull_ccases/closed_all/cw_613/cw_613.pdf
277
Gamma Telecom (see footnote 275), paragraph 120.
132
that C&W appears, indirectly, to support this premise in its comments on excessive
pricing, where it suggests that it would be unrealistic for any competitor of BT to
provide only NTS services and not to provide any other calling products.278
6.151 Ofcom has carefully considered competition between retail call providers and retail
call packages, and has given particular attention to the offerings of CPS providers. In
doing so, Ofcom has based its margin squeeze tests on a range of different product
groupings, including CPS options available in the retail market over the period of the
investigation (including CPS all calls and CPS Option 3 – see paragraph 6.97 et seq
above). Ofcom understands that there are no CPS providers that offer calls to NTS
numbers only. [] is therefore irrelevant for the purpose of assessing the alleged
retail margin squeeze and its impact on other OCPs.
6.152 Ofcom has considered Thus’s claim that CPS customers’ ability to use 1280 to divert
some calls to BT demonstrates that the market (and the relevant bundle for
conducting a margin squeeze test) is narrower than Ofcom suggests (see
paragraphs 4.227-4.231 above).
6.153 As discussed at paragraph 4.229 above, Ofcom sought further evidence for Thus’s
claim but has not been able to find any evidence that 1280 was widely used over the
period under investigation, to the extent that it would represent the kind of
competitive constraint Thus suggests. In any case, it seems unlikely that it would
have been possible, by means of NCCN 500, for BT to have established a dominant
position in the retail supply of calls to NTS numbers by encouraging use of 1280.
Ofcom does not therefore agree that that the availability of the 1280 function affects
the relevant market definition or its analysis of margin squeeze.
6.154 As discussed at paragraph 3.35 above Ofcom also required BT to provide details of
marketing and advertising undertaken over the period that mentioned the cost of
calling NTS numbers. While the material supplied by BT refers to differences
between BT’s prices for NTS numbers and those of its competitors, Ofcom does not
believe that this material suggests, as Thus claims, that BT “was trying to present the
0845 and 0870 calls market as distinct” – as the intention appears to have been to
market BT’s BT Together inclusive packages. Ofcom notes that the advertising
campaign mentioned by Thus does not appear to mention the cost of calling NTS
numbers.279
6.155 C&W asserts that Ofcom has not considered whether the availability of least cost
routing products may affect its proposed retail margin squeeze analysis (see
paragraph 6.131 above).
6.156 Ofcom understands least cost routing to be a product offered to business customers,
which uses software to route calls made by those customers according to the
cheapest route that the provider has identified for a particular call type. Least cost
routing providers do not supply calls over their own networks, and buy calls from a
number of different providers. Since their customers do not call only NTS numbers,
least cost routing products will therefore route calls to providers that provide both
NTS and non-NTS calls. Accordingly, Ofcom does not accept that NTS calls
(bundled with non-NTS calls) provided through a least cost routing package, are
suggestive of a different product bundle upon which to apply Ofcom’s retail margin
squeeze test.
278
279
C&W’s response to the draft decision, page 46.
See “BT battles against low-cost competitors”, Guardian, 11 June 2004.
133
Possible margin squeeze in NTS hosting
Introduction
6.157 In the previous section, Ofcom considered whether BT’s margins on services sold to
retail residential and business customers would have been squeezed as a result of
the increases in NTS call termination charges notified in NCCN 500. Ofcom found
that BT’s retail margins were sufficient for an equally efficient downstream operator
to cover its retail costs. Accordingly, Ofcom concluded that there was no retail
margin squeeze.
6.158 For completeness, Ofcom also considered whether additional revenues earned by
BT from the higher charges that applied under NCCN 500 could have been used to
increase payments to NTS service providers to a level that other communication
providers could not match without being forced to incur losses. Ofcom has termed
this possible abuse a “hosting margin squeeze”.
6.159 This analysis also addresses C&W’s allegation that, as a result of NCCN 500:
“BT will be able to leverage its dominance into the “downstream”
market of NTS call termination since it will be in a position to use the
additional revenues generated relative to its competitors to offer
more lucrative fee share arrangements to NTS service providers.”280
Hosting margin squeeze in a two-sided market
6.160 Before NCCN 500, prices for NTS call termination were uniform across the industry
(see paragraph 2.26 above), with BT charging the same as other TCPs for
terminating calls on its network. Under NCCN 500, however, the gross termination
charge payable to BT by other OCPs was more than other TCPs could charge for
terminating calls whether originated by BT or other OCPs (unless no transit via BT
was involved).
6.161 The TCP can pay out part of the revenues it receives in gross termination charges to
its NTS service provider customers. The level of payments to NTS service providers
is one of the main ways that TCPs compete against each other. The residual (the net
termination charge), represents the TCP’s margin, out of which it must cover the
costs of NTS call termination and hosting, including any value added services
provided to the extent not charged for separately.
6.162 The higher gross termination charge received by BT under NCCN 500 could have
allowed it to impose a hosting margin squeeze as follows. If, as a result of increased
revenues from NCCN 500, BT was in a position to increase the revenue share paid
out to NTS service providers (reduce its net charges to them for hosting) to a level
that other TCPs could not profitably match, this may have given it an unfair
advantage over competing TCPs.
6.163 This would constitute a “hosting margin squeeze” because the margin available to
competing TCPs would have been insufficient to cover their costs. BT’s ability to
impose a hosting margin squeeze would be possible only as a result of its
dominance in NTS call termination, which gives it the ability to raise the gross
termination charge above the level other TCPs can charge. By raising payments to a
280
C&W’s submission to Ofcom of 15 March 2005, paragraph 8.29.
134
level other TCPs could not match, BT would then be able to increase its share of
NTS hosting and possibly force other TCPs to exit the market.
Definition of the hosting margin
6.164 The hosting margin is defined as the difference between the gross termination
charge received by other TCPs and BT’s revenue share payments to NTS service
providers. If this hosting margin is less than BT’s costs of providing NTS call
termination and hosting, this would suggest that NCCN 500 led to a hosting margin
squeeze.
6.165 Essentially, the test asks whether, given the level of the gross termination charge that
competing TCPs receive and the level of BT’s revenue share payments, an equally
efficient operator could match BT’s payments and cover its costs in the
termination/hosting market. That is, there is a hosting margin squeeze if:
Gross termination charge received by other TCPs – BT payment
– BT termination/hosting costs < 0
6.166 The use, in the test, of the gross termination charge received by non-BT TCPs
(rather than that received by BT) reflects the position that the dominant undertaking’s
profitability should be assessed on the assumption that it receives the same gross
termination charges as its competitors.
Range of services
6.167 Ofcom argues that supply side factors support the aggregation of the set of services
across which firms compete to undertake a margin squeeze test (see paragraph 6.52
et seq above).
6.168 Accordingly the test takes into consideration the possibility that NTS service
providers could run a business offering 0845 voice or data service only, or a bundle
of number ranges (on voice or data), or on all number ranges (on voice or data).
6.169 Ofcom therefore carried out the test on a number of different service increments, to
reflect these different possible entry models:
•
0845 (voice);
•
0845 (data);
•
0845 and 0870 (voice);
•
0845 and 0870 (data);
•
0845, 0870 and 0800 (voice); and
•
0845, 0870 and 0800 (data).281
6.170 However, even if some TCPs specialise in a narrow range of services, it would also
be relevant to consider whether there were any barriers preventing TCPs from
281
Data obtained from BT operational system for terminating data NTS calls indicate a small volume
of traffic minutes were terminated on the 0870 data range. Ofcom includes 0800 to reflect possible
supply as part of a broader group of number ranges.
135
offering a wider range of services, if there appeared to be a “margin squeeze” on a
narrower set of services (see paragraphs 4.128-4.140 above).
Cost of capital
6.171 Ofcom has taken into account the cost of capital at both the network and retail level.
At the network level, Ofcom has taken BT’s transfer charges which reflect a return on
capital employed estimate for network assets. Ofcom has also considered Mean
Capital Employed (“MCE”) in relation to assets at the retail level. Ofcom notes that
the retail MCEs were either immaterial or negative (see relevant MCE statements in
Annex 9).
6.172 Accordingly, Ofcom has not included these numbers within its estimate of costs (in
the first instance where the numbers are immaterial, the numbers are considered de
minimis for the purpose of the analysis and where they are negative, they are not
considered meaningful for inclusion in the analysis).
6.173 The profit measure Ofcom is using is a current cost return figure for the relevant
regulatory product groups’ profit and loss accounts extracted from BT’s regulatory
accounting systems. This profit measure can be thought of as having the elements of
an EBIT measure. The figure reflects the financial position of BT in respect of these
services before interest and tax (the cost of capital of 12.5% is a pre-tax measure).282
In addition, depreciation allowances are included which is more reflective of an EBIT
measure (as opposed to an EBITDA measure).
Cost standard
6.174 For the reasons discussed at paragraph 6.60 et seq above, Ofcom used historical
accounting data, rather than a forward looking DCF (discounted cashflow) analysis,
to conduct its assessment.
6.175 The relevant cost standard for this analysis was (as for Ofcom’s analysis of the
alleged margin squeeze on OCPs), FAC, for the reasons set out at paragraph 6.84
above. In practice, if it were found that BT failed the hosting margin squeeze on an
FAC basis, it would be appropriate to consider tests relative to incremental or
variable costs.
Relevant time period
6.176 NCCN 500 was in force from 1 May 2004 to 31 December 2005 inclusive (20
months). However, the relevant period in which the hosting margin squeeze may
have taken place (and therefore the period over which the test should apply) relates
more closely to the period in which additional receipts earned from NCCN 500 could
have influenced the level of payments made to NTS service providers. Many of the
hosting contracts that were renegotiated subsequent to the introduction of NCCN
500, and which provided for higher payments, were of considerably longer duration
than the period during which NCCN 500 was in force.283
6.177 Ofcom has also had regard to the availability of information from BT’s regulatory
accounting systems, in particularly regulatory product group information for P346
282
The figure of 12.5% reflects the cost of capital incorporated into BT’s regulatory accounts for the
period in question.
283
Some contracts have a minimum period of [], [] the period over which NCCN 500 rates were
applied.
136
(data) and P056 (voice).284 Ofcom analysed revenues and costs for financial years
2004/05 and 2005/06 in relation to these product groups. At the time that Ofcom
conducted its analysis, actual cost and revenue data were not available for the
entirety of all relevant contracts (which in some cases ran until at least March 2007).
There is additional complexity given that contract start dates differ, as do the length
of the contracts.
6.178 Ofcom’s analysis was conducted for the period April 2004 to March 2005, on the
grounds that this period captures the first 12 months in which payment levels would
have risen reflecting the application of increased receipts from NCCN 500. Ofcom
would not expect costs (with the possible exception of payments) and revenues to
differ significantly between March 2005 and December 2005, and therefore
considers the test over this 12-month period to be representative of the 20-month
period under investigation.
6.179 Clearly, additional contracts are likely to have been renegotiated in the rest of the
period. Ofcom has allowed for this in the margin squeeze test by assuming, as a
sensitivity, that the NCCN 500 payments applied to all contracts (which represents a
more stringent version of the test).
6.180 Ofcom notes that the shorter the period, the less likely costs are to be variable.
However, if the hosting margin squeeze test is passed on the basis of FAC, it is not
necessary also to carry out the test on the basis of a subset of costs that are variable
over the period of one or two years.
Data and results
6.181 To apply the hosting margin squeeze test, Ofcom used BT’s cost and revenue data
for NTS voice and data call termination/hosting, as reflected in BT’s regulatory
product groups P056 (voice) and P346 (data).285 The costs reflected in these
regulatory product groups are derived using the principle of cost causation, which
should ensure the attribution of all incremental costs and some common costs to
these product groups. Using the information supplied by BT, Ofcom sought to
establish the profitability of the principal number ranges on an FAC basis. This
process included attributing shared costs, weighted by traffic volumes, between
number ranges, and in the case of data, attributing shared costs between metered
and unmetered narrowband internet access.
6.182 Ofcom attributed shared costs within each product group to number ranges by
volume (e.g. shared network costs). Ofcom initially carried out the test based on FAC
because, if this test is passed, this is sufficient to establish the absence of a margin
squeeze (given that the FAC methodology is reasonable). If the FAC test is failed, it
will be necessary to carry out an additional test based on AVC.
Revenues
6.183 The gross termination charge received by BT’s competitors for NTS call termination
services reflects the equally efficient operator test as discussed at paragraph 6.37 et
seq above. The charges have been estimated by taking monthly prices generated by
the NTS Calculator (see paragraph 2.27 et seq above) and then averaged to
generate average annual termination revenue for the period 2004/05.
284
285
For further explanation of these product groups, see paragraph 6.347.
The process is more fully described in paragraph 6.338 et seq.
137
6.184 In addition to NTS call termination and NTS hosting, BT provides a number of value
added services to NTS service providers and receives additional revenue from
these.
Costs
6.185 BT’s NTS call termination and hosting costs have been used to reflect the costs that
an equally efficient competitor would need to cover using its hosting margin and
other revenue sources referred to above.
6.186 Termination costs are based on those costs reflected by BT, on a current cost
accounting (“CCA”) basis, within its regulatory product groups P056 (voice) and
P346 (data).
6.187 Ofcom required BT to provide information from its regulatory costing systems to
enable it to determine the (cost-based) prices at which BT would potentially have
charged a new entrant hosting business seeking to buy in IP network services
(instead of having to invest in an end-to-end network which would be uneconomic if
only NTS call termination services are offered).
6.188 As discussed below (in relation to Ofcom’s analysis of C&W’s allegation of
discrimination) Ofcom considers that internal transfer prices derived from BT’s
regulatory costing systems are ‘soft’ charges, in that they do not in themselves
represent a cost to BT. Such ‘soft’ charges may approximate to the cost to BT of
self-providing network services, to the extent that they are used for internal
management accounting purposes and so are intended to provide signals for
decision-making within BT. However, this in itself means that they may therefore be
influenced by other factors underlying BT’s internal accounting policies and do not
therefore necessarily accurately reflect the true cost to BT of self-providing network
services.
6.189 However, Ofcom considers that for the purpose of conducting the hosting margin
squeeze test, the cost of buying in IP network services is a necessary element of the
cost stack and that internal transfer prices represent the best estimate of costs that
were available during Ofcom’s investigation. Ofcom understands that use of the IP
network is transfer charged into downstream product groups on the basis of that
network component’s CCA cost for the corresponding year. This cost base includes
a return on the component’s mean capital employed using its regulatory cost of
capital.
6.190 Once the number translation has been performed, the call will be routed to a
geographic number for termination. Ofcom has estimated the costs of onward
conveyance by assuming that the equally efficient hosting business could buy in the
necessary network services at the relevant BT tariff rather than being required to
invest in its own network.
6.191 Ofcom has estimated hosting costs by considering BT’s hosting costs. As discussed
at paragraph 6.183 above, the test applies to an equally efficient operator – in this
case, one that is providing the same quality of hosting service – otherwise the test
could be either unnecessarily restrictive or potentially too easy to pass. For example,
an estimate of hosting costs based on a new entrant offering a basic hosting service
could understate the costs of providing BT’s quality of service and hence fail to
detect a margin squeeze. Accordingly, the equally efficient operator costs should
reflect BT’s hosting costs.
138
6.192 Ofcom estimated payments to NTS service providers in two ways.
6.193 First, Ofcom took actual payments recorded in BT’s profit and loss accounts for the
regulatory product groups P056 and P346. Ofcom considers that this approach
provides a lower bound estimate for the payments competitors would need to match
in the market, since this figure is a weighted average of payment levels negotiated
before NCCN 500 and those negotiated after NCCN 500. This variant of the test is
referred to as Model A in the subsequent discussion.
6.194 Second, Ofcom considered BT’s contracts with its largest NTS service provider
customers which were renegotiated after NCCN 500 came into effect.286 Ofcom took
a sample of BT’s largest contracts with NTS service providers (by revenue) and
calculated the weighted average level of payments made under these contracts and
applied them to all contracts as if they had also been renegotiated at the higher
(average) payment level. Ofcom estimated this average for 0844/0845, 0870/0871
and for all number ranges. This estimate could be interpreted as the upper bound of
higher payment levels associated with NCCN 500. This variant of the test is referred
to as Model B in the subsequent discussion.
6.195 The results of the hosting margin squeeze test are as follows:
Table 15: Hosting margin squeeze results for 2004/05 (voice), Model A
Model A (outpayments from BT FAC P+Ls)
Revenues
Gross termination charge
Advanced stat packs revenues
SP revenues (top up payments)
0845/0844
0845/0844 &
0870/0871
All number
ranges
£ million
[]
Costs
Termination and hosting costs
Retail costs
Outpayment
Profit/loss
Table 16: Hosting margin squeeze results for 2004/05 (voice), Model B
Model B (outpayments from BT hosting
contracts)
Revenues
Gross termination charge (BT to OCP)
Advanced stat packs revenues
SP revenues (top up payments)
0845/0844
0845/0844 &
0870/0871
All number
ranges
£ million
[]
Costs
Termination and hosting costs
Retail costs
Outpayment
Profit/loss
6.196 Ofcom has applied relevant FAC costs. These include: network transfer charges (at
tariff), network transfer charges (at cost) (both including a cost of capital item), and
retail costs (although fixed assets are relatively small in this category and hence a
286
Source: BT’s response to section 26 Notice of 24 April 2006.
139
cost of capital is not included in the cost stack), as reported by BT in its profit and
loss account for regulatory product group P056. The results of the Model A test
indicated that an equally efficient operator, receiving gross termination charges from
BT and paying out the same payment levels as BT, receives a hosting margin that
exceeds the termination and hosting costs of service provision in respect of key
service increments (the most relevant combinations of number ranges).
6.197 Ofcom notes similar results apply when Ofcom uses payment levels taken from BT
contracts (Model B). However, as expected, BT’s margins on Model B are lower,
reflecting the fact that payments (taken from a sample of hosting contracts
renegotiated since NCCN 500) all reflect higher payment rates and therefore
represent an upper bound on the level of payments that would need to be met by a
hosting competitor in this market.
6.198 Ofcom also applied the test to data NTS call termination. As described above, when
it was looking at BT’s voice business, Ofcom applied sensitivities in its analysis of
costs by considering an upper and lower bound estimate, which we refer to as Model
A and Model B respectively. However, Ofcom could not apply the same approach in
data, as the information provided by BT on revenue share payments was insufficient
to enable Ofcom to conduct an equivalent Model B analysis, that is to say a lower
bound estimate based on a sample of contracts (as opposed to actual revenues
derived from financial data provided by BT).287
Table 17: Hosting margin squeeze results for 2004/05 (data)
Model A (outpayments from BT FAC P+Ls)
Revenues
Gross termination charge
Port rentals
internal
external (includes internal)
0845/0844
0845/0844 &
0870/0871
All number
ranges
£ million
[]
Costs
Termination and hosting costs (transfer
charges at tariff and interconnect
IP platform (allocated between unmetered
and metered
Retail costs (allocated between unmetered
and metered)
Outpayment
Profit/loss
6.199 Ofcom has applied relevant FAC costs (including payments, cost of capital and port
rental revenues) reported by BT in its profit and loss account for regulatory product
group P346, and adjusted to reflect FAC. Ofcom considers that an equally efficient
operator would be able to compete and earn a hosting margin that covers the costs
of data call termination and hosting for key service increments.
6.200 BT passes the test for 0845, 0845 and 0870 and all number ranges service
increments. The profit from 0845 exceeds the profit from 0870, for the joint
287
In its section 26 Notice of 24 April 2006, Ofcom required BT to provide internal documentation
relating to the top 10 NTS hosting agreements, by value, which BT entered into during the period that
NCCN 500 was in force. Ofcom did not ask BT to provide information separately for voice and data
customers. None of the agreements in respect of which BT provided documentation related to the
provision of data NTS call termination, e.g. to an ISP.
140
0845/0844 and 0870/0871 service increment due to significant differences in traffic
volumes (5.43 billion traffic minutes compared to 8 million traffic minutes). [].
Summary of results
6.201 The results of the hosting margin squeeze test indicate that an equally efficient
operator providing voice or data call termination and hosting services could earn a
hosting margin that covers the costs of termination and hosting for the 0845, 0845
and 0870 and all number range service increments during 2004/05.
6.202 The cost standard applied to the termination and hosting costs is FAC, which, for the
multi-product firm, approximates ATC. Accordingly, the fact that the test shows that
revenues exceed ATC is good evidence that no margin squeeze has taken place.288
6.203 Ofcom also considered the test at three different levels of service increment to
determine whether the test results differed according to scope of entry.
6.204 In conclusion, Ofcom considers that the prices notified in NCCN 500 did not lead to a
hosting margin squeeze and concluded that all three levels are profitable.
Responses to draft decision: hosting margin squeeze
6.205 BT and C&W commented on this element of Ofcom’s analysis.
BT
6.206 BT argues that Ofcom’s hosting margin squeeze analysis fails to take into account:
“the ability of other vertically integrated communications providers
[…] to use the additional revenue earned by them from the higher
retail charges that applied to their subscribers during the relevant
period to increase revenue share payments to NTS service
providers.”289
6.207 BT goes on to say that:
“This retail revenue clearly available to those other vertically
integrated communications providers was not available to BT during
the relevant period.”290
6.208 Other than its comments on the hosting margin squeeze, BT did not comment on
Ofcom’s analysis of its conduct as set out in Section 6 of the draft decision.
C&W
6.209 Referring back to its comments on market definition, C&W reiterates its view that
Ofcom’s analysis of the hosting (side of the) market is insufficiently developed.291
288
This is because as noted at paragraph 6.84, a test that is passed based on an analysis of FAC,
provided the attribution is reasonable, is usually taken as strong evidence that there is no margin
squeeze. It is therefore only in cases where such a test is failed that it is important to undertake an
analysis based on variable or incremental costs.
289
BT’s response to the draft decision, paragraph 4.4.
290
BT’s response to the draft decision, paragraph 4.5.
291
C&W’s response to the draft decision, page 38.
141
6.210 C&W states that it understands the purpose of Ofcom’s “Model A” is “to provide the
lower bound estimate that is the very least payment that a competitor would need to
make to compete”. C&W submits that there are several problems with this model:
•
it uses a weighted average price for the 2004/05 financial year, thereby diluting
the impact of NCCN 500, which was in force only for 11 months of this period;
•
it does not capture changes in revenue shares over the year; and
•
it does not capture changes in individual contracts “to determine where margins
altered on particular contracts”.292
6.211 C&W states that it understands the purpose of Ofcom’s Model B is to provide a
higher bound estimate, but that “the point of this test is not made clear by Ofcom”
and that Ofcom should have used the highest payments that BT made to a service
provider, to ensure that “the margin squeeze was not being undertaken on any
particular contract”.293
6.212 C&W states that Ofcom’s approach to assessing a possible margin squeeze in data
hosting is unclear and that if, as it appears, Ofcom has used only the higher bound
estimate, Ofcom “seems to have bent over backwards to be favourable to BT”. C&W
further submits that if it did not have the data to construct a full model for data NTS
call termination, Ofcom should have required BT to provide it.294
Ofcom comments on responses
6.213 In addition to its specific comments on Ofcom’s hosting margin squeeze analysis,
which are considered in the following paragraphs, C&W raised a number of issues
with Ofcom’s approach to the hosting margin squeeze in the context of Ofcom’s
proposed market definition. We deal with these at paragraphs 4.218-4.231 above.
6.214 Ofcom considers that taking weighted average prices for the 2004/05 financial year
(rather than for the 11-month period of May 2004-April 2005) would not materially
alter Ofcom’s finding that BT’s conduct did not lead to a margin squeeze in NTS
hosting. This is based on the fact that BT passed the hosting margin squeeze test by
a sizeable margin over the 12-month period over which the analysis was undertaken.
Ofcom notes that operational costs (i.e. efficiencies) are unlikely to have differed
materially between April 2004 (when NCCN 500 was not in effect), and the
remaining 11 months of the 2004/05 financial year (which lies within the period in
which NCCN 500 was in effect). Ofcom considers that on a weighted average basis,
over the 12 month period within the financial year 2004/05, the analysis and findings
are robust. Even if the weighted average price (as opposed to the weighted average
cost) was found to be different from the NCCN 500 price (i.e. the price for the 11
months when NCCN 500 was in force, as opposed to the weighted average for the
whole year), the margin by which the test was passed was sufficiently large for the
result to be robust.
6.215 Ofcom notes that when the NCCN 500 price increase is applied to all contracts for
the entire period (the strict Model B test), BT passes the test. As set out at paragraph
6.194 above, Ofcom took a sample of BT’s largest contracts with NTS service
providers that were renegotiated after NCCN 500 came into effect (by revenue) and
292
Ibid.
Ibid.
294
C&W’s response to the draft decision, page 39.
293
142
calculated the weighted average level of payments made under these contracts and
applied them to all contracts as if all contracts had also been renegotiated at the
higher (average) payment level. Accordingly the strict Model B test could be
interpreted as the upper bound of higher payment levels associated with NCCN 500.
Model B therefore explicitly assumes that a weighted average level of payments
made under these contracts was passed on to all contracts in each of the twelve
months for the 2004/05 financial year. This provides strong evidence that the
measurement of the weighted average price in Model A is not material to the finding
of no margin squeeze.
6.216 Ofcom considers that it is correct to assess a hosting margin squeeze over a group
of hosting contracts, and not, as suggested by C&W, on individual contracts,
because providers of NTS termination and hosting were competing with each other
for more than one contract over the period under investigation. In practice,
competing NTS termination and hosting businesses do not compete solely for a
specific contract, but will be in the market to contract with as many service providers
as possible. Ofcom considers that a narrow test based on individual contracts as
proposed by C&W would therefore be inappropriate.
6.217 C&W believes that Ofcom has “bent over backwards” to construct a test favourable to
BT for data call termination. This is not the case. In order to obtain the information it
needed to carry out the hosting margin squeeze tests, Ofcom required BT to provide
details of its top 10 hosting contracts, by value. None of these contracts was for the
provision of data termination. Given the relative sizes of the voice and data
businesses, and the results set out in Tables 15–17 above, Ofcom considers that it is
reasonable to conclude that there was no hosting margin squeeze in data call
termination. Requiring BT to provide additional information to construct a full model
for data would not, therefore, have led to a different outcome. Ofcom does not
accept the claim made by C&W that Ofcom has not sought the relevant information
to complete its analysis of a hosting margin squeeze on BT.
6.218 Ofcom notes that the strict test would allow for a significantly higher outpayment
level. The higher bound test is based on pass-through of a weighted average level of
payments in response to NCCN 500 and applied as if the weighted average payment
was paid in respect of all contracts with service providers (and not just paid in
respect of the sample of contracts from which the weighted average payment was
derived – see paragraphs 6.194 and 6.215 above). Ofcom therefore considers that
even if some data NTS termination/hosting contracts had fallen within the top 10, it
would not have reached a different conclusion. Specifically, Ofcom notes that
outpayments would need to have increased by an amount roughly equivalent to a
third of BT’s gross termination revenues in order for BT to fail the strict test. Given
this order of magnitude by which BT passes the lower bound test, Ofcom is satisfied
that BT passes the hosting margin squeeze tests jointly and separately for voice and
data.
6.219 BT has claimed that other communications providers could fund higher outpayment
levels from higher retail prices. Ofcom does not consider that this is relevant to its
hosting margin squeeze test which, as set out at paragraph 6.162 et seq above, is
concerned with whether higher NCCN 500 (wholesale) prices have been passed
through in the form of higher outpayments in such a way as to force an equally
efficient operator seeking to match BT’s higher outpayments to no longer cover the
efficient operator’s (i.e. BT’s) cost of NTS termination and hosting. Ofcom notes that,
were competing non-BT vertically integrated businesses to raise their retail prices,
this would make it more difficult for them to compete with BT, which has SMP in call
143
origination. Accordingly, Ofcom does not consider that this is a relevant
consideration for the application of the equally efficient hosting margin squeeze test.
Alleged discrimination
Alleged discrimination: the allegation
6.220 In its complaint, C&W submitted that the price paid by BT (as an OCP to itself as a
TCP) for NTS call termination under NCCN 500 was less than the charge that it
levied on C&W when it provided identical services to C&W, and was therefore
discriminatory.
6.221 C&W’s arguments on discrimination are set out at paragraphs 8.16-8.59 of its
submission to Ofcom of 15 March 2005.
6.222 C&W submitted that there were two possible tests for determining whether NCCN
500 constituted discrimination:
“Test 1: […] the charge paid to [C&W] where [C&W] terminates the
call must equal the internal transfer charge within BT where BT itself
terminates the call”; and
“Test 2: […] the charge BT proposes to impose under NCCN 500 for
terminating the call must equal the internal transfer charge paid by
BT itself for terminating its own calls.”295
6.223 C&W submitted that
“if either of these tests reveals a difference in the price charged or
paid between BT and [C&W], BT will be engaging in discriminatory
pricing”;296
and that:
“as a matter of logic, BT must fail one of these tests.”297
6.224 C&W submitted that the nature of the abuse would be determined by whichever of
the two tests BT were to fail:
“a failure of Test 1 would indicate that BT is abusing its dominance in
NTS call origination by paying a competing operator (C&W) less
than it pays itself for the equivalent call termination service”;298
since:
“price discrimination is only legitimate if it reflects differing costs.”299
6.225 Were BT to fail Test 2, on the other hand, this:
295
C&W submission to Ofcom of 15 March 2005, paragraph 8.21.
C&W submission to Ofcom of 15 March 2005, paragraph 8.22.
297
C&W submission to Ofcom of 15 March 2005, paragraph 8.23.
298
C&W submission to Ofcom of 15 March 2005, paragraph 8.25.
299
C&W submission to Ofcom of 15 March 2005, paragraph 8.27.
296
144
“[suggests that BT was] abusing its market power in call termination
[…] by charging different termination rates to different originating
operators (C&W and itself) with no underlying difference in cost.”300
6.226 The result of BT’s conduct would also depend on which of the tests was failed. The
implication of a failure of Test 1 would be that:
“BT will be able to leverage its dominance into the “downstream”
market of NTS call termination since it will be in a position to use the
additional revenues generated relative to its competitors to offer
more lucrative fee share arrangements to NTS service providers;”
whereas if Test 2 were found to be the relevant standard:
“The effect of this abuse would be to entrench BT’s market position
in NTS call termination at the expense of its competitors.”301
6.227 C&W concluded that:
“Regardless of whether BT failed Test 1 or Test 2, the outcome of
BT’s discriminatory pricing would be a reduction of competition in
NTS call termination.”302
Alleged discrimination: legal framework
6.228 Article 82(c) of the EC Treaty identifies discrimination as conduct that may constitute
an abuse of a dominant position in the following terms:
“applying dissimilar conditions to equivalent transactions with other
trading parties, thereby placing them at a competitive
disadvantage.”303
6.229 In its draft guideline on conduct, the OFT states that the most direct form of
discrimination occurs through the prices charged to different sets of customers and
cites two basic forms of discrimination that might fall within the scope of Article 82
and section 18:
(i) “an undertaking might charge different prices to different
customers, or categories of customers, for the same product –
where the differences in prices do not reflect any differences in
relative cost, quantity, quality or any other characteristics of the
products supplied;” or
(ii) “an undertaking might charge different customers, or categories
of customers, the same price even though the costs of supplying the
product are in fact very different. A policy of uniform delivered prices
throughout the country, for example, could be discriminatory if
differences in transport costs were significant.”304
300
C&W submission to Ofcom of 15 March 2005, paragraph 8.31.
C&W submission to Ofcom of 15 March 2005, paragraph 8.32.
302
C&W submission to Ofcom of 15 March 2005, paragraph 8.33.
303
Section 18(2) (c) Competition Act uses identical wording.
304
OFT 414a,paragraph 3.1.
301
145
6.230 In Alpha Flight Services/Aeroports de Paris the CFI and the ECJ upheld the
Commission’s decision that the operator of the two Paris airports had abused its
dominant position by imposing different fees on ground handlers for the provision of
the same services, without justification.305
6.231 In British Airways v Commission the CFI found (and its judgement was upheld by the
ECJ) that the performance reward scheme operated by British Airways (“BA”)
resulted in some cases in different rates of commission being applied to an identical
amount of revenue generated by the sale of BA tickets by two travel agents.306 The
CFI held that:
“In those circumstances, the Commission was right to hold that BA’s
performance reward schemes constituted an abuse of BA’s
dominant position…….in that they produced discriminatory effects
within the network of travel agents established in the United
Kingdom, thereby inflicting on some of them a competitive
disadvantage within the meaning of subparagraph (c) of the second
paragraph of Article 82 EC.”307
6.232 In its draft guideline on conduct, the OFT indicates that discrimination may be an
abuse where it is exclusionary, for example where a dominant undertaking uses a
discriminatory pricing structure to set predatory prices and/or to set discounts which
have the effect (or likely effect) of foreclosing all, or a substantial part, of a market;
alternatively where a vertically integrated undertaking is dominant in an upstream
market and a competitor in a related downstream market and it uses discriminatory
pricing to apply a margin squeeze that distorts competition in the downstream
market.308
6.233 The OFT also states that price discrimination may be abusive where it is exploitative,
in particular allowing an undertaking to exploit market power by charging excessively
high prices to certain customers.309
6.234 The OFT notes that:
“when considering whether price discrimination is an abuse, it is
often relevant to consider whether the pricing structure in question
allows the efficient recovery of fixed costs and expands demand
substantially or opens up new market segments.”310
6.235 The OFT guideline The application of the Competition Act in the telecommunications
sector suggests a similar effects-based approach to discrimination:
“Where discounts are offered to certain customers that do not reflect
underlying cost differences they represent a form of price
discrimination. There may be legitimate reasons for offering such
discounts, even where they do not reflect underlying cost
305
Case T-128/98 [2000]ECR II-3929, Case C-82/01 P [2002] ECR I-9297
Case T-219/99
307
Ibid, paragraph 240.
308
OFT 414a.
309
OFT 414a, paragraphs 3.4 and 3.5
310
OFT 414a, paragraph 3.6
306
146
differences. They may, for example, represent an efficient way of
recovering fixed or common costs.”311
6.236 Oftel followed this approach in BT broadband promotion in conjunction with
BSkyB.312 In this case, while Oftel found that there was prima facie discrimination by
BT in relation to the joint promotion in favour of those of its customers who were also
BSkyB subscribers, there was no effect on competition. Oftel cited the OFT’s
guidelines on conduct and on competition law in the telecommunications sector,
finding that :
“It is therefore not an abuse in itself for BT to price discriminate
between its customers. However, it would be abusive if it were
shown that this discrimination had an effect on competition in the
relevant market(s).”
6.237 In the BHB case, the Court of Appeal took the view that while ATR and Phumelela
were paying considerably different amounts for similar transactions, it did not
necessarily follow that this placed ATR at a competitive disadvantage distorting
competition:
“Certainly it made ATR’s operation less profitable than it would have
otherwise been, but ATR’s ability to compete with Phumelela (or, so
far as material, with others) remained intact. Although they impact on
each other, profitability and competitiveness are two different
things…”313
6.238 In the Court of Appeal’s view, there needs to be proof that a pricing differential
actually or potentially distorts competition between the parties subject to that
differential.314
Alleged discrimination: analysis
6.239 As set out above, C&W submits that BT engaged in price discrimination in one of two
possible ways, both of them constituting anti-competitive price discrimination leading
to a reduction of competition in NTS call termination.
6.240 Both of the tests set out by C&W propose a comparison with “BT’s internal transfer
charge”. Test 1 compares BT’s internal transfer charge with the charge paid to C&W
where C&W terminates the call; Test 2 compares BT’s internal transfer charge with
the prices notified in NCCN 500.
6.241 In the analysis set out below Ofcom addresses the following issues:
a) establishing the facts about the level of the transfer charges,
311
OFT 417, paragraph 7.30.
Decision of the Director General of Telecommunications 15 May 2003 Complaint submitted under
the Competition Act 1998 (The Act) by NTL Group Ltd (NTL) alleging an infringement of the
prohibitions imposed by Section 2(1) and 18(1) of the Act by British Telecommunications Plc (BT).
313
Judgment of the Court of Appeal 2 February 2007 Case A3/2006/0126 (1) Attheraces Limited (2)
Attheraces (UK) Limited v (1) The British Horseracing Board Limited (2) BHB Enterprises Plc EWCA
Civ 38, paragraph 270.
314
Case A3/2006/0126, EWCA, Civ 38, paragraphs 277-278.
312
147
b) considering the significance of comparisons between transfer charges and prices
in NCCN 500, and whether this constitutes a separate possible abuse of a
dominant position under the Act and Article 82.
6.242 In the course of its investigation, Ofcom requested a variety of information which was
extracted by BT from its regulatory costing systems (including unaudited downstream
financial information).315 In addition, Ofcom required BT to provide copies of its
management accounts reporting on NTS call termination.316
6.243 Ofcom found that the relevant BT downstream regulatory product group financial
statements did not reflect any internal transfer charge revenues for NTS call
termination in respect of BT-to-BT NTS calls, i.e. a specific charge from one part of
BT to another in respect of a service equivalent to the services for which price
increases were notified in NCCN 500. This resulted from BT’s accounting policy of
reflecting the full value of retail turnover for BT-to-BT NTS calls in the relevant
downstream regulatory product groups.
6.244 BT is not required to report transfer charges given that Ofcom has not previously
made an ex ante finding that BT has SMP in the NTS call termination/hosting
markets. The following discussion explains why the transfer charge, or absence of
one, in any event, is not determinative in the context of this investigation.
6.245 BT’s management accounts appeared to reflect internal transfer charge revenues in
respect of some of the services for which price increases were notified in NCCN 500.
BT argued in its response to Ofcom’s section 26 Notice of 24 August 2005 that these
internal transfer charges were not the relevant basis for Ofcom’s analysis. In
response to the question:
“Explain what prices BT charges to itself for each of the call types
notified in NCCN 500, i.e. the internal transfer charge for NTS call
termination where BT is both the terminating and originating provider
of the call. Provide information on the relevant charges for each of
the relevant call types for the period:
•
before 1 May 2004;
•
immediately after 1 May 2004;
•
following any further changes to BT’s prices since NCCN
500 became effective”.
BT explained that:
“The relevant internal transfer charges in answer to this question are
the internal charges set out in BT's regulatory (”AS”) accounts. We
have provided this information below under the heading ‘AS
accounts – internal transfer charge.’
BT does not consider the internal transfer charges in the
management accounts to be the relevant transfer charge for any
purpose other than internal accounting. BT has, however, also
provided information on the internal charges in BT's management
315
316
See Table 2 above.
Ofcom section 26 Notice of 28 June 2005.
148
accounts to address questions raised by Ofcom on the 18 August
conference call on management account information.
For the avoidance of doubt, the only internal charge that we believe
is relevant to the Competition Act investigation is the internal charge
set out in the AS accounts.”317
6.246 Ofcom has considered the sense in which BT may be said to have discriminated in
the charges it set for NTS call termination while NCCN 500 was in force.
6.247 The transfer charge recorded in BT’s management accounts for the provision of NTS
call termination to itself is different from the charge levied on other OCPs for the
same service.
6.248 It is of concern to Ofcom that BT itself may have believed that it has “discriminated”
in this sense:
[]318
6.249 This was also indicated in a statement made by BT shortly after NCCN 500 was
issued:
“Colin Annette said that BT had issued NCCN 500, which increased
termination payments for access to its 0845 and 0870 services from
the 1st of May 2004. These rates are only applicable to non-BT
originated minutes and BT Retail would continue to pay pre-May '04
rates.”319
6.250 Internal documentation supplied by BT confirms that BT’s understanding was that the
charges notified in NCCN 500 would apply only to other OCPs:
“We are only changing OLO [“Other Licensed Operator”, i.e. OCPs
other than BT] originated 0845/0870/0820 call. The manner in which
BT accounts for BT-BT calls remains unchanged.”
“This does not include traffic from BT’s own customers, as this is
strictly controlled by the NTS regulatory pricing structure.”320
6.251 Ofcom therefore investigated carefully BT’s regulatory costing systems to assess the
actual internal transfer charge paid by BT as explained above. Ofcom notes BT’s
response in relation to the actual internal transfer charge as set out at paragraph
6.245 above. Ofcom agrees that any transfer charge recorded in BT’s management
accounts for the provision of NTS call termination is inevitably a ‘soft’ charge, and
does not represent the true cost to BT of purchasing NTS call termination from itself.
This is because it is simply an amount recorded in the internal accounts of a vertically
integrated firm (BT).
317
Annex A to BT response of 26 August 2005 to Ofcom Notice of 24 August 2005.
[].
319
NTS Focus Group meeting notes and actions, 20 April 2004, published at:
http://www.ofcom.org.uk/telecoms/groups/nts_focus/notes/nts20040420.
320
email from [] to [], 5 April 2004, numbered DK450 and briefing paper dated 10 June 2004,
volume 1 tab 13, BT response of 13 May 2005 to Ofcom section 26 Notice of 22 April 2005 – see
Table 2 above.
318
149
6.252 The recording of such a charge might be likened to the transfer of coins from one
pocket to another – it cannot affect the overall value of the company unless the level
of the transfer charge affects pricing or other commercial decisions by BT in its role
as an OCP, TCP or NTS service provider. It may be contrasted with a ‘hard’ charge,
such as that paid by other OCPs to BT for NTS call termination, which is a real cost
to those businesses (see also paragraph 6.188 et seq above), and so affects their
commercial decisions.
6.253 Therefore, and crucially, the fact that such a charge may exist in BT’s management
accounts does not tell us whether or not other OCPs could have been placed at a
competitive disadvantage by paying a charge different from that ‘soft’ charge. There
was not robust evidence of a “hard” charge to BT that was different from the charge
that applied to BT’s competitors.
6.254 Ofcom considered whether other OCPs would have been placed at a competitive
disadvantage by NCCN 500, i.e. whether there is discrimination leading to a
competitive disadvantage which is of an exclusionary nature.
6.255 Cases involving internal transfers have traditionally been looked at from the point of
determining whether a margin squeeze is occurring which is foreclosing the relevant
market to competitors.
6.256 In Genzyme, the CAT upheld the OFT’s finding of an abuse of Genzyme’s dominant
position in the upstream market for “effective treatments for Gaucher’s disease”
based on a margin squeeze abuse of pricing its Cerezyme drug to its competitors at
a price higher than it priced to its downstream subsidiary, thereby reserving the
downstream market to itself.321
6.257 On the facts of this case, in order to address the question of competitive
disadvantage that could arise from a difference in charges that applied between BT
and other OCPs, Ofcom has first sought to identify the maximum charge for NTS call
termination that BT could have charged itself while covering the costs of originating,
conveying and terminating an NTS call on its network, given the retail price of that
call.
6.258 If this maximum is below the charge which BT made to other OCPs for NTS call
termination then, if BT had faced the same ‘hard’ charge for NTS call termination as
other OCPs, it would have made a loss on these calls. It can then be inferred that the
implicit charge that BT made to itself for NTS call termination, consistent with
covering the end-to-end costs of the call on this basis, must have been below the
charge made to other OCPs for the same service.
6.259 However, in considering whether there has been discrimination leading to a
competitive disadvantage or, equivalently, an anti-competitive margin squeeze, it is
necessary to consider carefully the range of services over which the test should be
conducted. This may be broader than just the single service in which there is a
difference in pricing.
6.260 Therefore, in determining whether BT’s charges for NTS call termination, as notified
in NCCN 500, might amount to “applying dissimilar conditions to equivalent
321
[2004] CAT 4, 11/3/2004. The OFT’s decision was also based on a finding of anti-competitive
bundling (Genzyme’s practice of including Homecare Services in the NHS List price for Cerezyme)
but this aspect of the OFT’s decision was not upheld by the CAT. However, the CAT found that
Genzyme’s bundling practice facilitated the margin squeeze abuse. See for example paragraph 654
of the judgment.
150
transactions with other trading parties, thereby placing them at a competitive
disadvantage”, Ofcom considers that the relevant test is whether BT would have
been able to make a profit had it paid the charges notified in NCCN 500, taking into
account profits earned on all the relevant services i.e. whether BT’s conduct led to
the operation of a margin squeeze on other OCPs. As set out above, Ofcom has
assessed whether the prices notified in NCCN 500 led to a margin squeeze on
OCPs, and has concluded that they did not.
6.261 Notwithstanding BT’s statements on NCCN 500, given the results of the margin
squeeze tests, Ofcom did not find compelling evidence to demonstrate that BT had
discriminated between itself and other OCPs putting them at a competitive
disadvantage.
6.262 Ofcom has also considered whether the application of NCCN amounted to excessive
pricing (see paragraphs 6.292-6.477 below).
Responses to draft decision: Ofcom’s analysis of alleged discrimination
6.263 Two respondents, C&W and Thus, commented on Ofcom’s analysis of alleged anticompetitive price discrimination. BT did not comment on Ofcom’s assessment of
C&W’s allegation of anti-competitive price discrimination.
C&W
6.264 C&W submits that, despite evidence that BT was not paying the same rates as other
providers for “exactly the same transactions”, Ofcom “fail[s] to carry out a robust
analysis” to establish precisely what BT was charging itself.322
6.265 C&W submits that Ofcom could have used information from BT’s regulatory accounts
and/or from BT’s management accounts to establish a transfer charge as a relevant
point of comparison for an analysis of discrimination.323
6.266 C&W submits that Ofcom gives no consideration to whether the charge increases
imposed by BT were “objectively justified”, and submits that they could not have been
so if their stated purpose was to increase revenue.324
6.267 C&W states that Ofcom:
“seems to have taken the view that the dissimilar conditions [i.e.
alleged price discrimination] must have an exclusionary effect in
order to constitute abuse of a dominant position.”325
6.268 C&W submits that Ofcom has erroneously based its opinion on the OFT’s draft
guidelines. C&W believes that:
“the OFT says that discrimination which is exclusionary, and it gives
margin squeeze as an example, is likely to breach the prohibition.
But this is not a maximum test, it is merely an example.”326
322
C&W’s response to the draft decision, page 22.
C&W’s response to the draft decision, page 25.
324
C&W’s response to the draft decision, page 26.
325
C&W’s response to the draft decision, page 27.
326
Ibid.
323
151
6.269 C&W states that the relevant test is not the approach suggested by the OFT, but the
wording of Article 82(c), which refers to “competitive disadvantage” rather than
exclusionary effect. C&W notes that the courts have found discrimination to be an
abuse without demonstrating any exclusionary effect.327
6.270 In any case, C&W submits that, had Ofcom properly conducted an analysis of the
alleged discrimination, “it would have proceeded to demonstrate the resulting impact
on competition”, and submits that the revenue lost by BT’s competitors as a result of
NCCN 500 would have led, “over time”, to exclusion, as:
“we would not have been able to sustain that level of loss in the long
run without having to make commercial decisions about our
continued ability to stay in the market.”328
6.271 C&W concludes that:
“Ofcom errs as a matter of law by failing to apply the discrimination
test mandated in the Ch 2 prohibition and Article 82, together with
relevant case law, properly or at all;
Ofcom errs in its finding of fact when it says that it is unclear whether
BT has as a matter of fact discriminated;
Ofcom errs as a matter of law by relying solely on a margin squeeze
test in attempting to assess the effect of discrimination.”329
Thus
6.272 Thus has concerns that:
“Ofcom has been unable to make a clear statement about the
discriminatory nature of the prices offered for access to BT’s 0845
and 0870 services to BT downstream retail business and altnets.”330
6.273 Thus states that Ofcom places “too much emphasis on what is and isn’t included
within BT’s management accounts”, which Thus believes are irrelevant as “BT’s call
origination, discount deductions and NTS retailing cost are well-understood regulated
elements”.331
6.274 Thus states that:
“Neither BT’s management nor regulatory accounts were designed
to record this type of detailed internal charging, since no cost
accounting or accounting separation obligations applied in respect of
NTS termination. Hence it is unsurprising that Ofcom have failed to
find what was never there in the first place; the problem is that
Ofcom looked in the wrong place.”332
327
Ibid.
C&W’s response to the draft decision, page 29.
329
C&W’s response to the draft decision, page 30.
330
Thus’s response to the draft decision, page 5.
331
Ibid.
332
Ibid.
328
152
6.275 Thus considers that it would have been possible for Ofcom to have based its analysis
on “recognised cost elements on a per call basis”.333
6.276 In Thus’s view:
“it would be unsafe…to reach a decision…. without first calculating
the BT Group revenue and termination costs for on-net 0845 and
0870 calls using known cost elements from regulatory accounts.”334
6.277 Thus states that:
“No objective justification has been put forward for the price rise and
BT’s competitors were undoubtedly placed at a disadvantage.”335
Ofcom comments on responses
6.278 C&W argues that, because NCCN 500 only applied to non-BT OCPs, BT was paying
the same amount to itself, as TCP, as it was before NCCN 500, which was less than
it was charging other OCPs “for exactly the same transactions”.
6.279 Ofcom has considered the sense in which BT may be said to have discriminated in
its charges to other TCPs for NTS call termination while NCCN 500 was in force.
6.280 Ofcom notes that there was what might be termed “apparent discrimination”, insofar
as the transfer charge recorded in BT’s management accounts for the provision of
NTS call termination services to itself is different from the charge made to other
OCPs for the same service. Ofcom is concerned that BT internally appeared to
consider that it had discriminated in this sense (see paragraph 6.248 above).
6.281 However, more detailed investigation by Ofcom, as set out at paragraphs 6.2516.252 above, found that any transfer charge recorded in BT’s management accounts
for the provision of NTS call termination services is inevitably a ‘soft’ charge, not a
“hard” charge, such as that paid by other OCPs to BT for NTS call termination, which
is a real cost to those businesses. Ofcom notes BT’s response to Ofcom’s section 26
Notice of 24 August 2005 (see paragraph 6.245 above).
6.282 Moreover, Ofcom notes that the reference to the EC Access Notice quoted by C&W
in fact describes the weaknesses of transfer charges for use in competition cases.336
It is precisely because transfer charges “could be used as a mechanism for
disguising excessive pricing, predatory pricing or a price squeeze” that they should
not be relied on in competition cases. A test for margin squeeze, for example, should
therefore be based on the charges levied by the dominant firm to its downstream
competitors rather than the transfer charges shown in its accounts.
6.283 C&W and Thus contend that Ofcom could have calculated an exact charge for
comparison purposes on the basis of “BT’s regulatory accounts and/or from BT’s
management accounts” (C&W) or “recognised cost elements” (Thus).
6.284 Ofcom notes that C&W’s alternative proposal, of inferring the transfer charge from
the retail price of an NTS call less charges for call origination, relies on an
333
Ibid.
Ibid.
335
Ibid.
336
C&W’s response to the draft decision, page 23, referring to paragraphs 120-127 of the
Commission’s Access Notice (see footnote 231).
334
153
assumption that the retail price should be equal to cost. The existence of
discrimination in the sense that the retail price is below cost including the charge that
BT made to other OCPs for NTS terminations is not, however, sufficient to establish
that such “discrimination” would impact on competition. In this regard, it may be
noted that this test for discrimination is equivalent to the test for the existence of a
positive margin on the service in question. However, in considering whether there
has been a margin squeeze, it is necessary to consider carefully the range of
services over which the test should be conducted.
6.285 Therefore, Ofcom considers that the relevant test is whether BT would have been
able to make a profit had it paid the charges notified in NCCN 500, taking into
account profits earned on all the relevant services i.e. whether BT’s conduct led to
the operation of a margin squeeze on other OCPs.
6.286 The test that Ofcom outlined for discrimination was to assess whether the conduct
lead to a competitive disadvantage that was of an exclusionary nature (see
paragraph 6.255 above). Ofcom further explained that this meant whether the
conduct distorted competition in the relevant downstream market.
6.287 Therefore, Ofcom’s test did not state that discrimination must have an exclusionary
effect, but rather included a requirement that there should be an actual or likely effect
on, or distortion of, competition.
6.288 Ofcom’s test is not inconsistent with the Chapter II prohibition or Article 82 and is
consistent with case law, most notably the decision of the Court of Appeal in BHB
(see paragraphs 6.237 et seq above).337
6.289 Ofcom did take into account existing case law when assessing the allegation of
discrimination in this case and formed the view that as C&W’s allegation is based on
BT’s internal transfer charge for NTS call termination, Ofcom would need to make an
accurate determination of the actual hard internal charge (rather than soft inferred
charge) in order to progress the analysis of discrimination in a traditional sense.
6.290 As set out in paragraph 6.252 et seq above, Ofcom has not been able to determine a
“hard” charge representing the price actually paid by BT to itself. Ofcom has also
rejected the proposal of inferring an internal transfer charge from the retail price of an
NTS call less charges for call origination, relying on the assumption that the retail
price should be equal to cost. In the absence of a ’hard’ charge, Ofcom applied the
retail margin squeeze test as set out above to determine the actual or likely effect on
competition had BT faced the NCCN 500 increased charge itself.
6.291 C&W and Thus suggest that Ofcom should have given greater consideration to
whether BT’s charges were objectively justified. Since Ofcom did not find that BT’s
charges constituted abusive discrimination (or margin squeeze), Ofcom did not need
to go on to consider objective justification which could have been a defence for BT in
an allegation of abuse. Ofcom is not of the view that any increase in prices without an
objective justification, in itself, demonstrates that conduct would lead to a competitive
disadvantage/distortion of competition.
337
Case A3/2006/0126, EWCA Civ 38, paragraphs 265-278.
154
Alleged excessive pricing
Alleged excessive pricing: the allegation
6.292 In its complaint, C&W submitted that the prices notified in NCCN 500 were
excessive.
6.293 C&W’s detailed arguments on excessive pricing are set out at paragraphs 8.34-8.39
of its submission to Ofcom of 15 March 2005.
6.294 C&W submitted that, “as a matter of logic”, BT must either be pricing call origination
below cost, or over-recovering its call origination costs, and that the prices notified in
NCCN 500 must therefore be excessive on the basis of the tests set out in Napp
Pharmaceutical Holdings Ltd v Director General of Fair Trading (“Napp”).338
6.295 C&W further submitted that:
“the prices set out in NCCN 500 are likely also to be excessive on
other relevant measures, since, inter alia:
•
the price charged by BT to itself is less when terminating calls which
originate on its own network. In the absence of objective justification
for this difference in treatment, the clear inference must be that the
higher price (i.e. the price charged to C&W) is excessive;
•
the price charged by C&W to BT (under the NTS Formula) for call
termination services is less than that charged by BT.”339
Alleged excessive pricing: legal and economic framework
6.296 All firms that try to make profits have an incentive to raise price above cost if they
can. In competitive markets, the ability to do so is constrained by the actions of rival
firms attempting to undercut each other to gain market share.
6.297 A dominant undertaking may be able to raise prices above the competitive level,
increasing its profits at the expense of its customers, who are worse off as a result.
However, the dominant undertaking’s gain will be smaller than customers’ losses,
except in the case of completely inelastic demand, as demand from some customers
who would be willing to pay more than the cost of producing the service (and would
do so if prices were at the competitive level) is choked off by the high prices. This
means that excessive prices in retail markets would make society as a whole worse
off, even if the firms’ profits and benefits to consumers were to be given equal weight.
This is one reason giving rise to concern about excessive prices.
6.298 Excessive prices in wholesale markets may raise other concerns. In particular, an
excessive wholesale price charged by a vertically integrated dominant undertaking to
customers which are also its competitors in retail markets may have an exclusionary
effect and so allow leverage of dominance from the upstream to the downstream
market. Ofcom has examined possible distortion of competition in retail calls or NTS
hosting in previous sections.
338
339
C&W complaint of 15 March 2005, paragraphs 8.37-8.38.
C&W complaint of 15 March 2005, paragraph 8.39.
155
6.299 The ultimate concern about excessive pricing is an exploitative or exclusionary effect
(see paragraph 6.297-6.298 above). As set out above, Ofcom has concluded that
there is an absence of compelling evidence of adverse effects on competition. As
regards any adverse effect on consumers, Ofcom notes that most of BT’s
competitors did not increase NTS call prices following the introduction of NCCN 500
– although Ofcom notes that BT’s competitors may have been waiting for the
outcome of Ofcom’s investigation and market review before taking any decision on
changing their prices. Of the 13 communications providers who were required to
provide Ofcom with details of retail prices over the period of NCCN 500, only one
([]) indicated that it had increased retail NTS call prices (see paragraph 5.113 et
seq above).340
6.300 Ofcom notes that in response to NCCN 500, [] could have chosen to absorb the
NCCN 500 price increase (as did BT’s other competitors) which would have resulted
in a reduced margin.341 Ofcom notes that [] chose to raise its retail 0845 and 0870
call prices (which were already above BT’s retail prices – [] in the case of 0845)
and in doing so raise its margins. Accordingly, Ofcom considers that although
consumers were impacted by []’s decision to raise retail 0845 and 0870 call prices
(by []ppm and []ppm respectively), the price increases implemented by []
appear to have been at least partly related to a commercial strategy by [] to raise
its own margins and retail revenues (see paragraph 5.115 above). Most
communications providers, however, did not raise their retail call prices for reasons
including: maintaining their competitive position in the market (compared with BT and
other OCPs), their stated position in the market as a price follower, and their own
retail charges exceeding those of BT prior to NCCN 500 (paragraphs 5.118-5.121
above).
6.301 Ofcom has conducted the United Brands/Napp/Albion tests, as set out in paragraphs
6.305 et seq below. But, in light of the absence of compelling evidence of adverse
effects on competition and limited evidence of adverse effect on consumers, Ofcom
considers that compelling evidence of excessive pricing would be needed under
these tests to support an infringement finding.
6.302 A price apparently above cost is not necessarily excessive. Even in competitive
markets, prices may be high relative to cost at times, for example due to short-term
fluctuations in demand or supply, or because the firm has developed an innovative
product or process (and may for example be protected by intellectual property rights).
6.303 Excessive pricing by a dominant undertaking may be an abuse of a dominant
position contrary to Article 82 of the EC Treaty and section 18(2) of the Act.
6.304 Section 18(2) of the Act provides that conduct by a dominant undertaking may
constitute an abuse, in breach of section 18(1), as follows:
“Conduct may, in particular, constitute such an abuse if it consists in
•
directly or indirectly imposing unfair…selling prices…”
6.305 In United Brands, the ECJ stated that:
340
Ofcom notes that the 13 communications providers from whom Ofcom requested pricing
information accounted for a large proportion of the non-BT share of retail customers.
341
[].
156
“…charging a price which is excessive because it has no reasonable
relation to the economic value of the product supplied would be…an
abuse.”342
6.306 The ECJ then set out a two-step process for identifying excessive pricing, stating that
the questions to be determined were:
“whether the difference between the costs actually incurred and the
price actually charged is excessive, and, if the answer to this
question is in the affirmative, whether a price has been imposed
which is either unfair in itself or when compared with competing
products.”343
6.307 In Scandlines Sverige AB v Port of Helsingborg (“Scandlines”), the Commission
applied the tests established in United Brands, assessing the costs actually incurred
in providing the services supplied and making a comparison with the price actually
charged for those services. 344
6.308 The Commission noted that even if it were assumed that the profit margin of the Port
of Helsingborg was high or “excessive”, this would not be sufficient to conclude that
the price charged bore no reasonable relation to the economic value of the services
provided:
“the mere fact that revenues may exceed costs actually incurred is
not sufficient to conclude that the difference is ”excessive“ in the
meaning of the first question posed by the Court in paragraph 252 of
the United Brands judgment. In any event, the Commission
considered that even if it were to be assumed that the difference is
”excessive“, the Commission would have to proceed to the next
question as laid down in United Brands in the same paragraph, in
order to determine whether the prices charged to the ferry-operators
are unfair, either in themselves or when compared to other ports.”345
6.309 To determine whether the prices were unfair, the Commission first looked at a
comparison of the port fees charged to ferry operators and the port fees charged to
cargo vessels at the port and found that as the overall services provided to ferry
operators and cargo vessels were not equivalent, it was not possible to draw a
comparison between these prices. When the Commission looked at the ship fees
component of the port fees charged, it found that Scandlines paid less per unit than
other vessels.
6.310 The Commission then looked at the port charges paid by Scandlines at another port
in an attempt to draw a comparison of the contested price to prices of comparable
products offered by other companies on different markets. However the Commission:
•
could not find evidence that the services provided at the two ports were
equivalent;
•
could not find evidence that the conditions of supply would be equivalent; and
342
Case 27/76 [1978] ECR 207 paragraph 250.
Paragraph 252 (the ECJ went on to point out in the following paragraph that there were other ways
“of selecting the rules for determining whether the price of a product is unfair”).
344
Case COMP/A.36.568/D3, 23 July 2004.
345
Case COMP/A.36.568/D3, 23 July 2004, paragraph 142, reiterated at paragraph 216.
343
157
•
was not convinced that the regulated prices at the comparator port would be
applicable to Helsingborg as the principles of the regulation were unknown.
6.311 The Commission then looked at the port fees charged by other ports even though it
was of the view that it could not be considered that all ports provide and charge for
the same basic services. There was no evidence that the prices charged to ferry
operators at Helsingborg stood out in comparison to the other ports the Commission
looked at.
6.312 In Corinne Bodson v Pompes Funèbres des regions libérées (“Bodson v Pompes
funèbres”), the ECJ referred to a comparison between prices charged where there
was competition, and those charged where there was a local monopoly, as one way
of determining whether the price for a product is excessive.346
6.313 In the UK, the OFT has suggested a number of possible comparisons for assessing
whether prices are excessive. Evidence of excessive pricing could be based on
comparisons of prices with those of the same products in other markets or at other
times, and with underlying costs, as well as evidence of excessive profits. Profits may
be excessive when they are significantly and persistently in excess of the level which
would be expected in a competitive market.347
6.314 This was the test applied by the OFT in its investigation into excessive pricing
allegations in Napp. In its decision, the OFT was of the view that:
“a price is excessive and an abuse if it is above that which would
exist in a competitive market and where it is clear that high profits
will not stimulate successful new entry within a reasonable period.
Therefore, to show that prices are excessive, it must be
demonstrated that (i) prices are higher than would be expected in a
competitive market, and (ii) there is no effective competitive pressure
to bring them down to competitive levels, nor is there likely to be.”348
6.315 On appeal, the CAT endorsed the OFT’s approach, stating that:
“while there may well be other ways of approaching the issue of
unfair prices under section 18(2)(a) of the Act, the Director’s starting
point…..seems to us to be soundly based in the circumstances of
the present case.”349
6.316 The CAT also endorsed the approach taken by the OFT in using the following
comparators to determine whether a price is above the level that would exist in a
competitive market:
a) Napp’s prices with Napp’s costs;
b) Napp’s prices with the costs of its next most profitable competitor;
c) Napp’s prices with those of its competitors; and
346
Case 30/87, [1988] ECR 2479, paragraph 31.
OFT 414a, paragraph 2.7.
348
CA98/2/2001, 30 March 2001.
349
Napp Pharmaceutical Holdings Ltd v Director General of Fair Trading [2002] CAT 1, paragraph
391.
347
158
d) Napp’s prices with prices charged by Napp in other markets.350
6.317 In Albion Water Limited v Water Service Regulation Authority (formerly Director
General of Water Services) (“Albion”), the CAT stated:
“…..where the issue is one of abuse, it is desirable that the question
whether the price is “unfair” is to be assessed on the basis of a fully
informed calculation of costs. In particular, the extent to which a
price is unrelated to costs is relevant to the question whether that
price is “unfair”.”351
6.318 The CAT also noted that to treat a class of customers the same as another class of
customers where the costs are significantly different, would, in the absence of
objective justification, be discriminatory and that, in those circumstances, the issue of
whether the price in question was unfair should continue to focus primarily on the
comparative situation of customers on the facts of that case (in that case customers
for potable and non-potable water respectively).352
6.319 The United Brands two-stage test was recently applied by the Court of Appeal in the
BHB case, where the Court of Appeal made a number of points on the test:
a) First, the Court of Appeal noted that the ECJ judgment poses two questions:
“The first is whether the difference between the costs actually
incurred and the price actually charged is excessive. The second
question is whether, if the first question is answered affirmatively, a
price has been imposed which is either unfair in itself or when
compared to competing products.”353
b) Second, the Court of Appeal noted that:
“the central concept in abuse of dominant position by excessive and
unfair pricing is not identified as the cost of producing the product or
the profit made in selling it, but as the “economic value of the
product supplied”. The selling price of a product is excessive and an
abuse “if it has no reasonable relation to its economic value.”
c) Third:
“the court did not say that the economic value of a product is always
ascertained by reference to the cost of producing it plus a
reasonable profit cost (cost +), or that a higher price than cost + is
necessarily an excessive price and an abuse of a dominant position.
The court as indicating that one possible way (inter alia) of
objectively determining whether the price is excessive and an abuse
is to determine, if the calculation was possible, the profit margin by
reference to the selling price and the cost of production.”354
350
Napp Pharmaceutical Holdings Ltd v Director General of Fair Trading [2002] CAT 1, paragraph
392.
351
[2006] CAT 36, paragraph 247.
352
Albion Water Limited v Water Services Regulation Authority (formerly Director General of Water
Services) [2006] CAT 36, paragraphs 251 and 252.
353
Case No: A3/2006/0126 [2007] EWCA Civ 38, paragraph 116.
354
Case No: A3/2006/0126 [2007] EWCA Civ 38, paragraphs 117-118.
159
d) Finally the Court of Appeal noted that:
“the law on abuse of dominant position is about distortion of
competition and safeguarding the interests of consumers in the
relevant market. It is not a law against suppliers making “excessive
profits” by selling their products to other producers at prices yielding
more than a reasonable return on the cost of production, i.e. at more
than what the judge described as the “competitive price level”. Still
less is it a law under which the courts can regulate prices by fixing
the fair price for a product on the application of the producer who
complains that he is being overcharged […]”355
6.320 In summary, the Court of Appeal noted that “exceeding cost + is a necessary, but in
no way sufficient, test of abuse of a dominant position.”356 In that case, the Court of
Appeal found that the judgment at first instance had based the economic value of the
product supplied by the British Horseracing Board (UK pre-race data) on ‘cost +’
which did not take sufficient account of the value of that pre-race data to Attheraces
(the complainant) and tied the costs allowable in ‘cost +’ too closely to the costs of
producing that data.
6.321 Ofcom began its analysis of the excessive pricing allegation with an assessment of
BT’s prices compared to measures of cost.
Alleged excessive pricing: assessing BT’s prices compared to costs
6.322 Ofcom notes the Court of Appeal’s comments in BHB and the ECJ’s test in United
Brands. In particular, the ECJ set out two tests as highlighted by the Court of Appeal:
•
whether the difference between the costs actually incurred and the price actually
charged is excessive. This test is analogous to comparator a) identified in Napp
as set out in paragraph 6.316 above.
•
whether, if the difference is excessive, whether the price under investigation is
unfair in itself or when compared with competing products. This test is analogous
to comparators b) to d) in Napp.
6.323 The aim of Ofcom’s initial analysis in line with the first test was to determine whether
the difference between the costs incurred by BT in supplying NTS call termination to
other OCPs and the price it charged could be considered excessive.
6.324 In this analysis, Ofcom considered two different measures of profitability (return on
capital employed, or ROCE, and return on sales, ROS), two different measures of
cost (FAC and SAC), and made comparisons with rates of return earned by
comparable undertakings.
6.325 As discussed at Annex 5, there are various reasons for using either ROCE and ROS.
Ofcom calculated BT’s profitability on both a ROCE and ROS basis.
6.326 Ofcom’s initial analysis of BT’s profitability used FAC data from BT’s regulatory
accounting systems. As noted in Table 12 above, FAC is an accounting concept
which ensures that all BT’s costs are attributed to its activities. In a multi-product firm
like BT, it is analogous to the concept of average total cost in a single product firm.
355
356
Case No: A3/2006/0126 [2007] EWCA Civ 38, paragraph 119.
Case No: A3/2006/0126 [2007] EWCA Civ 38, paragraph 209.
160
Ofcom’s analysis, as set out below, concluded that BT’s returns, calculated on a FAC
basis, were high in relation to its costs.
6.327 However, this does not of itself demonstrate that the prices notified in NCCN 500
were excessive. This is because of the existence of significant common costs
between BT’s activities. BT’s FAC is one method of attributing these common costs,
but it is not unique. Other attribution methodologies may also be reasonable, and
could produce quite different views of BT’s rate of return. In the absence of a
definitive view on the maximum proportion of these common costs that it is
reasonable for BT to recover from NTS termination it is informative to consider the
further cost measure of SAC, which includes all (relevant) common costs.
6.328 The OFT states that:
“Where a dominant undertaking does not generate supra-normal
profits overall, this does not rule out the possibility that it charges
excessive prices on a particular line of business”;
and that:
“To assess the profitability of a line of business it may be necessary
to allocate common costs to the particular activities identified…In
some circumstances the standalone cost of the line of business may
be relevant…Where an activity generates revenues that persistently
and significantly exceed its standalone costs…this would be good
evidence of excessive profits being earned on that activity.357
6.329 Ofcom has therefore estimated the SAC of NTS call termination and compared the
prices notified in NCCN 500 with those costs.
6.330 The SAC of a product is defined as the cost that an efficient firm producing only the
service in question would incur. Such a firm would not benefit from economies of
scope and common costs which might, in a multi-product firm, be recovered from a
number of services, but, in the case of a single-product firm, will need to be incurred
for and recovered from the single product.
6.331 The concept of SAC has its origins in the theory of contestable markets.358 A
contestable market is one in which the complete absence of barriers to entry means
that incumbent firms, even monopolists, are constrained to price no higher than
average costs by the threat of entry. In the multi-product case, the incumbent also
makes only normal profits overall. The price of each product must be above its
incremental costs (otherwise the firm could increase profits by ceasing to produce
that product, or would be vulnerable to an entrant producing all products except that
one).
6.332 The highest price that a multi-product firm could charge for any individual good or
service in a contestable market is given by the efficient SAC of that good or service.
This is because a price above this level would attract entry by a single product firm
which would compete the price down to this level. It is therefore the maximum price
consistent with equilibrium in a contestable market and the absence of entry barriers.
357
OFT 414a, paragraphs 2.12-2.13.
See Baumol, W., Panzar, J. and Willig, R. Contestable Markets and the Theory of Industry
Structure, (1982), New York, Harcourt Brace Jovanovich.
358
161
In the multi-product context, a price (significantly and persistently) above SAC might
therefore be regarded as excessive.
6.333 Ofcom considered two methods of measuring the SAC of NTS call termination. One
method would be to use data derived from BT’s regulatory costing systems. These
allow the production of measures of the incremental cost and SAC of BT network
services for use as ‘first-order’ tests of anti-competitive (i.e. exclusionary or
predatory) and excessive pricing respectively. However, there are only two
increments in the BT incremental cost model which is used to calculate them – the
whole of BT’s network conveyance services and the whole of its local access
network.359
6.334 This means that intra-network common costs (costs that are common to more than
one core network service but incremental to the core network as a whole) are
included in the incremental costs of the various network services. The resulting
measures of incremental cost and SAC, known as “distributed” incremental cost and
“distributed” SAC, will therefore normally be respectively above and below the “true”
incremental cost and SAC measures based on defining each service as the relevant
increment.360 A finding that a price was above distributed SAC (“DSAC”) would not
therefore be sufficient for a finding that a price is excessive, as such a price could still
be below (true) SAC.
6.335 In Albion the CAT rejected estimates of SAC produced by Dwr Cymru and the
regulatory authority which had been produced “on a ’new build’ basis even though it
was accepted, quite rightly, in evidence that those calculations did not, and could not,
form any basis for charging”. The CAT also noted that:
“the proper approach to ‘stand-alone’ costs depends on the context
and circumstances. None of the above [OFT] definitions were given
in the context of an access charge for common carriage, which is the
present context”.361
6.336 Ofcom's view is that the OFT definition of SAC, which is similar to that given at
paragraph 6.330 above, is appropriate to the present case, which is not concerned
with setting charges for common carriage.362 Moreover, Ofcom's estimates of SAC do
not rely on an assumption of new build financed on a venture capital basis.
6.337 Ofcom therefore constructed a model to estimate, on a “bottom-up” basis, the costs
that a hypothetical single product firm would incur in providing NTS call
termination/hosting on a standalone basis, that is (true) SAC. This analysis is set out
at paragraph 6.363 et seq.
359
For further explanation of the method used to calculate incremental and standalone costs for BT’s
network services, see Guidelines on the Operation of the Network Charge Controls from October
2001, published by Oftel, December 2001,
http://www.ofcom.org.uk/static/archive/oftel/publications/ind_guidelines/pcr1201.htm, especially at
Annex B.
360
Ibid.
361
[2006] CAT 23, paragraph 575.
362
OFT 414a refers to SAC as “those costs that would be incurred if the company undertook only the
line of business in question”. A discussion paper by Oxera, an economic consultancy, published as
OFT 657 in July 2003, defines “stand-alone” cost as: “The costs of an activity or line of business that
would be incurred if the company undertook that activity only. All common costs are attributed to the
activity in question.” See http://www.oft.gov.uk/advice_and_resources/publications/reports/Economicresearch/oft657.
162
FAC profitability analysis: introduction
6.338 NCCN 500 came into effect on 1 May 2004, one month after the beginning of BT’s
2004/05 financial period. To assess the impact of NCCN 500, Ofcom therefore
compared BT’s profitability in 2004/05 with its profitability in the previous financial
year.
6.339 Changes in reported profitability between financial periods could be due to a number
of factors, for example, changes in network costs or revenue share payments. To
isolate the impact of NCCN 500 from other factors, Ofcom sought to distinguish the
profitability of calls originated by other OCPs and terminated by BT (which were
subject to the price increases notified in NCCN 500), and the profitability of BT-to-BT
calls (which were not).
6.340 The only item which was treated in the analysis differently depending on whether it
related to calls originated by other OCPs or calls originated by BT was NTS call
termination revenues. Otherwise Ofcom’s approach to the attribution of costs and
revenues did not differ according to whether calls were OCP-originated or BToriginated, meaning that any differences in profitability between the two call types
would be solely attributable to NCCN 500.
6.341 As discussed in Section 4 above, NTS call termination/hosting is in a two-sided
market. NTS call termination is always provided in conjunction with NTS hosting
(whether it is provided by a TCP or a reseller). It was therefore only relevant to
Ofcom’s analysis to determine the profitability of NTS call termination/hosting
combined.
6.342 Ofcom also compared BT’s profitability for different number ranges and for different
types of NTS call termination/hosting (voice and data).
6.343 The two number ranges most impacted by NCCN 500 were 0845 and 0870 (see
Annex 1). Ofcom analysed the profitability for these ranges separately for two
reasons:
•
the price increases notified in NCCN 500 were significantly higher on 0845 than
on 0870 (~23% versus ~4% on a weighted average basis); and
•
BT’s competitors may supply services predominantly or exclusively using either
0845 or 0870.
6.344 While the prices notified in NCCN 500 applied equally to all NTS calls to the relevant
number ranges, BT offers two different retail services (voice calls to NTS numbers
and metered dial-up internet access) for which NTS call termination is a source of
revenue. These services are based on different underlying costs, and receive
additional revenue from different sources. Reflecting this situation BT prepares
separate management and regulatory financial information for its voice and data
termination/hosting businesses. Ofcom therefore analysed BT’s profitability for voice
and data separately.
6.345 The profitability analysis for 0845 was split between voice and data, because this
number range was material in both, but 0870 profitability analysis only related to
voice, since 0870 data calls were negligible.
163
FAC profitability analysis: source of information
6.346 The information Ofcom used in its analysis was initially sourced from BT’s regulatory
reporting systems. For the services Ofcom was considering, BT can prepare
regulatory product group financial statements as a by-product of the processes it
undertakes to prepare its audited published regulatory financial statements.363 These
particular regulatory product group statements are themselves not audited.
6.347 Two regulatory product groups were relevant. These include all the activities under
investigation as well some others which were not:
•
P056: BT Linkline: captures all NTS voice calls terminated by BT, both those
originated by other OCPs, which generate NTS call termination revenue for BT,
and those originated by BT, which are reflected at their retail value to BT.364
P056 includes call termination as well as the hosting activities and related
account management support required to serve BT’s voice NTS service provider
customers. It also includes the retail and call origination activities in respect of
BT-to-BT calls.
•
P346: Dial IP: captures all non-geographic data calls terminated by BT, both
those originated by other OCPs, which generate NTS call termination revenue for
BT, and those originated by BT, which are reflected at their retail value to BT.
P346 also captures unmetered data calls terminated by BT at their wholesale
values.
P346 includes call termination and conveyance to the internet provided over BT’s
IP network for both metered and unmetered calls, and related account
management support for BT’s external ISP customers. P346 also reflects the
revenue generated from “port rentals” (the basis on which BT charges for
wholesale metered and unmetered data call termination) both in relation to ISPs
and BT’s own downstream retail ISP operations. It also includes the retail and call
origination activities in respect of BT-to-BT calls.
6.348 The regulatory product group financial statements did not provide the necessary
degree of granularity (e.g. revenue analyses split by number range and by OCP) for
Ofcom’s analysis. Ofcom therefore required BT to provide further information (see
Table 2) consisting of more granular analysis of the costs, revenues and volumes
used to prepare the relevant regulatory product group financial statements, and
additional information consistent with these statements.
FAC profitability analysis: basis of preparation
6.349 The basis of preparation of the profitability financial analysis including the way in
which Ofcom processed the information provided by BT is set out in Annex 9.
363
BT is required to produce annual Current Cost Financial Statements, the purpose of which is for
BT to demonstrate compliance with its ex ante obligations of cost orientation and non-discrimination
for certain products and services. These statements, which separate out BT’s operations between
wholesale and retail activities, are prepared under various SMP conditions imposed following market
reviews. BT’s regulatory reporting obligations for 2004/05 were set out in The regulatory financial
reporting obligations on BT and Kingston Communications: Final Statement, published on 22 July
2004 (www.ofcom.org.uk/consult/condocs/fin_reporting/fin_report_statement/finance_report.pdf).
364
With the exception of calls to Premium Rate (09) numbers, which are captured in a different
regulatory product group
164
FAC profitability analysis: results
6.350 The stages of analysis followed in Ofcom’s profitability analysis are set out in Annex
9. In the tables below a distinction is drawn between profitability arising from BT-toBT traffic and OCP-to-BT traffic. In practice when negotiating hosting contracts with
service providers BT will take into account the NTS termination revenues it will
receive both from its own customers and from OCP customers (subject to NCCN
500) in determining the revenue it proposes to share with the provider.
6.351 It is therefore arguable that it is only meaningful to look at NTS termination/hosting
profitability combining both types of calls. This could still be the case even if (as
Ofcom understands and as reflected in the following profitability analysis) BT has no
way of knowing once the contract has been negotiated whether a call terminated in
respect of an individual service provider originated on an operator’s network subject
to NCCN 500. The comparison drawn between BT-to-BT and OCP-to-BT traffic may
however still be helpful in understanding the incremental impact on profitability
arising from the introduction of NCCN 500.
6.352 The results of the analysis are set out (on an end-to-end basis) in Table 18-Table 20
below.
165
Table 18: BT’s profitability: 0845 voice
0845 Voice
2003/04
2004/05
BT to BT OCP to BT
£m
a
Revenue
NTS call termination
Other
Total
% point
premium
£m
b
BT to BT OCP to BT
£m
a
b-a
£m
b
% point
premium
b-a
x
Costs (profit & loss)
Revenue share outpayments
Network costs
Retail costs
Total
[]
Profit
y
Mean capital employed (MCE)
z
Volumes (millions of minutes)
Performance measures
Return on capital employed (ROCE)
y/z%
Return on sales (ROS)
y/x%
Note: numbers are not rounded and therefore figures may not total exactly.
Table 19: BT’s profitability: 0870 voice
0870 voice
2003/04
BT to BT OCP to BT
£m
£m
a
Revenue
NTS call termination
Other revenues
Total
% point
premium
b-a
x
Costs (profit & loss)
Revenue share outpayments
Network costs
Retail costs
Total
[]
Profit
y
Mean capital employed (MCE)
z
Volumes (millions of minutes)
Performance measures
Return on capital employed (ROCE)
y/z%
Return on sales (ROS)
y/x%
Note: numbers are not rounded and therefore figures may not total exactly.
166
b
2004/05
BT to BT OCP to BT
£m
£m
a
b
% point
premium
b-a
Table 20: BT’s profitability: 0845 data
2003/04
0845 data
Revenue
NTS call termination
Other revenues
Total
2004/05
BT-to-BT
£m
OCP-to-BT
£m
% point
premium
BT-to-BT
£m
OCP-to-BT
£m
% point
premium
a
b
b-a
a
b
b-a
x
Costs (profit & loss)
Revenue share outpayments
Network costs
Retail costs
Total
[]
Profit
y
Mean capital employed (MCE)
z
Volumes (millions of minutes)
Performance measures
Return on capital employed (ROCE) y/z%
Return on sales (ROS)
y/x%
Note: numbers are not rounded and therefore figures may not total exactly.
6.353 Several factors, some of which are listed below, mean that great care needs to be
taken when interpreting the financial information in Table 18-Table 20 above.
•
The costs reflected in the regulatory product groups (i.e. P056 and P346) are
themselves the result of an extensive and multi-level cost attribution process
undertaken by BT to prepare its regulatory financial statements. In the context of
a multi-product firm like BT this means that the source data for Ofcom’s
profitability analysis has already been highly processed by BT.
•
In order to ascertain the impact of NCCN 500 on BT’s profitability Ofcom needed
to focus on relatively narrowly defined services (e.g. 0845 voice termination
hosting for OCP-to-BT calls). The absolute cost and revenue figures for these
services finally obtained are small, both in absolute terms and in relation to the
entirety of BT’s activities. Profitability measures based on such small figures will
be inherently very sensitive to the accounting policies and attribution
methodologies adopted, both by BT and Ofcom, in the preparation of the
information shown in the tables.
•
Ofcom selected volumes (millions of minutes across all times of day) as the cost
driver to apportion shared costs to individual number ranges. This single cost
driver is necessarily an overall proxy for the underlying cost driver for each
individual activity supporting NTS termination/hosting services.
•
It was necessary to request volume information from BT above and beyond that
required by BT to prepare financial statements for P056 and P346. This
additional information was sourced from BT’s operational systems supporting its
NTS voice and data termination activities and was not always transparently
consistent with information extracted from BT’s regulatory accounting systems.
167
6.354 Collectively these factors mean that the figures in these tables are not completely
precise, but should be regarded as subject to a margin of error. In addition, as part of
its consideration of the other tests for excessive pricing set out at paragraph 6.316 et
seq above, Ofcom also took account of the premium of the returns obtained by BT
from OCP-to-BT calls (subject to NCCN 500) over and above the returns on BT-toBT calls (not subject to NCCN 500), and on trend information obtainable by
comparing 2004/05 with 2003/04. These may also be less subject to some of the
factors set out above.
6.355 From BT’s voice activities (Table 18 and Table 19 above) it is evident that BT’s
revenue share payments to NTS service providers have become increasingly
significant over time against a background of an overall modest increase in call
volumes. Consistent with this theme, payments from NTS service providers to BT
(reflected in “other revenues”) for 0845 voice have fallen over time. These are the
principal drivers behind reduced profitability in BT’s voice activities before taking into
account the impact of NCCN 500 on OCP-to-BT calls.
6.356 Within BT’s data activities the dominant theme was the significantly reduced volumes
between 2003/04 and 2004/05. BT’s revenue share payments to NTS service
providers fell slightly on a unit basis.
6.357 The results of Ofcom’s profitability analysis have been brought together in the
following summary table.
FAC profitability analysis: summary of results
Table 21: BT’s profitability: summary
2003/04
BT-to-BTOCP-to-BT
a
b
2004/05
% point
premium
b-a
BT-to-BTOCP-to-BT
a
b
% point
premium
b-a
Return on capital employed
(ROCE)
Voice
0845
0870
Data
0845
[]
Return on sales (ROS)
Voice
0845
0870
Data
0845
6.358 For both 0845 voice and 0845 data the significant positive impact on BT’s profitability
resulting from NCCN 500 is reflected in OCP-to-BT calls. The incremental impact on
Ofcom’s profitability measures is shown in the “% point premium” column for
2004/05.
6.359 This premium is wholly attributable to the difference between the charges notified in
NCCN 500 and NTS Calculator rates, as all other costs and revenues have been
apportioned between BT-to-BT and OCP-to-BT calls on an equivalent basis. This
premium is much more modest for 0870 voice, which is in keeping with the smaller
price increase on this range.
168
6.360 A number of points can be drawn from this financial analysis:
•
NCCN 500 increased BT’s profitability on NTS voice and data calls originated by
other OCPs, significantly so in the case of the 0845 number range;
•
[];
•
voice profitability (as measured by ROCE and ROS) is higher than data
profitability; and
•
profitability (again measured by ROCE and ROS) is falling for voice and data
before the impact of NCCN 500 is taken into account.
6.361 Ofcom also calculated the combined returns earned by BT from its voice and data
NTS call termination/hosting businesses. Ofcom calculated separate values for 0845
voice and data and for all 0845 and 0870 activities combined. The OCP-to-BT returns
for 2004/05 reflect the profits that BT earned as a result of NCCN 500.
Table 22: BT’s profitability: weighted average returns
2003/04
2004/05
BT-to-BT OCP-to-BT
BT-to-BT OCP-to-BT
Return on capital employed (ROCE)
0845 voice and data
All
[]
Return on sales (ROS)
0845 voice and data
All
6.362 The proportion of total calls represented by OCP-to-BT calls differs by range and by
call type. The weighted average returns in Table 22 are not therefore the same for
OCP-to-BT calls as they are for BT-to-BT calls in 2003/04. With this caveat in mind,
these combined figures demonstrate that profitability fell between the years 2003/4
and 2004/5, before the impact of NCCN 500 is taken into account.
Alleged excessive pricing: profitability analysis based on SAC
SAC profitability analysis: methodology
6.363 As part of its assessment of BT’s profitability (see paragraph 6.322 et seq above),
Ofcom modelled the SAC faced by a hypothetical single-product firm providing NTS
call termination/hosting and compared it with the revenues that BT received under
NCCN 500 for the provision of the same service. If, at the prices charged by BT, it
could earn a positive return compared to SAC significantly above its cost of capital,
this might suggest that the prices charged by BT for NTS call termination when
NCCN 500 was in force were excessive.
6.364 Ofcom first analysed BT’s profitability on the 0845 range, which was subject to the
highest price increases under NCCN 500 (see Annex 1) before expanding its
analysis to incorporate 0870.
169
6.365 Ofcom adopted a hybrid approach to modelling the SAC of the hypothetical single
product firm, using a detailed bottom-up modelling exercise to establish the
hypothetical single product firm’s likely network costs and estimating all the other
costs of its business on the basis of BT’s costs.
6.366 This was because the retail costs of other NTS providers from whom Ofcom obtained
cost information (see paragraph 3.27 above, final bullet) would not have reflected the
retail costs faced by the hypothetical single product firm.
6.367 Ofcom has assumed that the hypothetical single product firm operates on the same
scale as BT. It would therefore face retail costs associated with managing large
contracts (for example those provided by BT in response to Ofcom’s section 26
Notice of 24 April 2006). By contrast, the smaller providers from whom Ofcom
obtained information faced minimal retail costs, and in some cases none at all. For
example, one way of doing business at a small scale is to enable customers to
manage their own accounts online, so that there is no face-to-face customer
relationship management and therefore no significant ongoing retail costs.
6.368 The purpose of Ofcom’s analysis was to assess whether BT’s charges notified in
NCCN 500 were excessive in relation to the underlying costs. It followed that the firm
should be able to provide the same services at the same scale as BT, and thus be
capable of theoretically satisfying all of BT’s present demand. Ofcom therefore
assumed that the hypothetical single product firm would receive the same volumes of
NTS traffic as BT and would follow the same time of day profile.
Modelling the hypothetical single product firm’s network costs
6.369 The hypothetical single product firm’s network costs include both capital expenditure
and operational expenditure, notably:
•
switching;
•
other hardware and site costs;
•
staff;
•
software and other resources required to run the network; and
•
payments to BT for geographic call termination.
6.370 To estimate these costs, Ofcom first determined the size of the network that the
hypothetical single product firm would need to be able to provide a volume and
quality of service equivalent to that of BT. The scale of the hypothetical single
product firm’s network was determined with reference to the volume of minutes
terminated by BT in 2004/05.
6.371 The hypothetical single product firm’s network as modelled is shown in Figure 20
below:
170
Figure 20: Network model for hypothetical single product firm
Load balanced 1/3 traffic
Site 3
Network
monitoring
centre
1,886 E1’s
Switch
1,886 E1’s
BT DMSU
1,886 E1’s
Switch
Site 1
Site 2
SCP
SC
SCP
1,886 E1’s
Switch
1,886 E1’s
1,886 E1’s
Switch
Load balanced- 1/3
Load
trafficbalanced
+ 17% 1/3 traffic
redundanc
OSS
OSS
BSS
BSS
1,886 E1’s
Switch
1,886 E1’s
1,886 E1’s
Switch
Load balanced- 1/3
Load
balanced
traffic
+ 17% 1/3 traffic
redundanc
Network costs: key assumptions
6.372 The hypothetical single product firm’s network infrastructure, as modelled, operates
under one principal constraint, which is that it is not modelled as having a national
network fully interconnected with that of BT. The rationale for this is that such a level
of infrastructure is possessed only by communications providers offering a broad
range of services over their networks (e.g. BT and C&W). It is highly unlikely that a
firm offering only NTS call termination/hosting, even at BT’s scale, would find it
economic to build and maintain its own national network.
6.373 Ofcom’s analysis therefore assumes that the hypothetical single product firm has a
minimal network and buys from BT such network conveyance services as it requires
(for example geographic call termination).
6.374 A hypothetical single product firm interconnecting with BT at a single point would be
vulnerable to service outages resulting from localised problems on BT’s network.
BT’s larger NTS service provider customers, for whom continuity of service is likely to
be a crucial requirement, would be unlikely to consider an alternative provider whose
network was less robust.
6.375 To partially compensate for this, the hypothetical single product firm is modelled as
having three interconnections to one single BT Digital Main Switching Unit (“DMSU”),
of which any two are of a sufficient size to carry all traffic. If one of the three routes
into BT’s network was to become unavailable (for example, because of problems in
171
the ducting which contains the data cables) the hypothetical single product firm would
be able to carry the same total volume of traffic via the remaining two routes.
6.376 Ofcom believes that voice NTS providers with a single point of interconnection with
BT are relatively common (although they may not have the same provision for
continuity of service in the event of network outages, discussed in the preceding
paragraph, as our hypothetical single product firm).
6.377 Ofcom does not, however, believe that there is an equivalent business model for
providers of data NTS call termination. It appears to be much larger multi-product
firms such as BT and C&W that provide data NTS call termination/hosting. These
firms have achieved economies of scale and scope essentially by taking on the
functions of ISPs themselves. Both BT and C&W possess large modem banks and
thus convert their traffic into IP at the earliest opportunity, which represents a more
cost-effective means of conveying data calls than the PSTN.
6.378 Ofcom has not however modelled an IP network provider because firms such as
C&W and others with large IP networks are not single product firms, and so their
costs would not be appropriate as an estimate of our hypothetical firm’s SAC. The
fact that single product providers of data NTS call termination/hosting may not be
observed in practice does not vitiate the use of this model for the SAC test. Indeed, in
most markets where there are significant economies of scope, single product firms
would not generally be expected to be able to operate profitably.
6.379 However, there is no theoretical reason why a hypothetical single product firm could
not offer data NTS call termination/hosting without investing in its own IP network.
For a standalone operator it would not be economical to invest in an IP network – all
the operators that provide an IP network are multi-product firms. A standalone
provider could receive NTS data calls and send them over the PSTN to a geographic
number hosted by an ISP with its own modems. In this way, the hypothetical single
product firm would not be differentiating between voice and data calls. Ofcom has
therefore considered such a business model in its analysis.
6.380 Even a hypothetical single product firm with a single point of interconnect with BT
would still require significant network infrastructure to process the large volume of
traffic implied by this test. The principal determinant of the scale of a single product
firm’s network, and thus the appropriate equipment to use, is the peak volume of
traffic that this network would have to process.
6.381 The proportion of calls in the busy hour was assumed by Ofcom for the purposes of
modelling to be 20%. This is significantly larger than the figure BT uses for its own
planning purposes, which we understand to be around 10-15%. BT may not pass the
test with a lower figure. However, Ofcom considers that the hypothetical single
product firm is likely to need more capacity than this for two reasons. Firstly, it is
handling NTS calls exclusively, and NTS service providers tend to generate
significant peaks in the demand for access to their numbers. Secondly, the
hypothetical single product firm has to offer a level of service equivalent to BT, and
would need to reassure large customers that it had enough network capacity to
satisfactorily process all the incoming calls received. Therefore, even Ofcom’s
assumption of a 20% ratio may be seen as conservative.
6.382 Based on these assumptions, Ofcom estimated the likely capacity that the
hypothetical single product firm would need to provide an equivalent service to that
offered by BT at the busiest time of the day.
172
6.383 In order to handle such volumes, Ofcom’s model is based on “carrier class” switches,
i.e. the type of switch that would be used by large communications providers such as
BT or C&W. Although smaller providers of NTS call termination/hosting may use
inexpensive PC-based switches, these components would not reliably be able to
provide services at the scale being considered, both because of the volumes handled
and the quality of service provided by large dedicated switches (which would be
demanded by large NTS service provider customers for whom, as discussed above,
continuity of service is likely to be business critical).
6.384 Ofcom determined that four suitably configured Ericsson AXE 10 switches would be
required to service the volume of traffic expected at the busiest periods. To provide a
degree of resilience, the three-site configuration detailed above was modelled with
two such switches at each site. This configuration provides a capacity of 50% more
than the busy hour requirement, enabling the network to cope with the failure of a
single switch or of an entire site (i.e. six switches in total).
6.385 Ofcom has derived total switch costs for the single product hypothetical entrant by
multiplying the number of required switches (as set out above in paragraphs 6.3836.384 above) by the relevant running cost (i.e. operational expenditure (Opex)) and
up-front cost (i.e. capital expenditure (Capex)) estimates for the switches (as set out
below in Table 23). Note Ofcom annuitises the Capex estimate (over five years at a
weighted average cost of capital (“WACC”) of 11.4%) to arrive at its annuity Capex
estimate.
Table 23: Switch costs and capacity parameters
Carrier class switch
Ericsson AXE 10
Initial cost (Capex)
£2,000,000
Running cost (Opex)
Expected lifetime (years)
£200,000
5
Source: Ofcom estimates
6.386 The interconnection cost for the single product hypothetical entrant from its three
sites to BT’s network is set out in Table 24 below. Connection costs were annuitised
(over five years at a WACC of 11.4%) to arrive at an annuity Capex estimate. Fixed
rental costs are multiplied by the estimated number of interconnection circuits. Per
kilometre rental costs were multiplied by the estimated number of interconnection
circuits and the distance between the entrant’s site premises and BT’s network (21
kilometres). Total interconnection costs (including an annuitised connection, fixed
rental and per kilometre rental costs) were then added together. The total estimated
interconnection cost was then expressed in pence per minute (“ppm”) by dividing
through by traffic minutes in the 0845 voice and data product group and for the 0845
and 0870 voice and data product group – see Table 29 and Table 30 below).
173
Table 24: Interconnection costs
Average cost over period of NCCN 500
Connection
£1,292
Rental – fixed (notes 2 & 5)365
£1,777
Rental – per km (notes 1, 2, 4 & 5)366
Period of recovery
£24
5
Source: Ofcom, BT carrier price list
6.387 Ofcom’s model also included the control software and hardware elements needed to
provide NTS call termination/hosting. These include a service control platform
(“SCP”), which directs the translation of NTS calls into geographic calls and provides
some hosting services, such as automated voice response and intelligent routing.
Ofcom has estimated these costs in Table 25 below.
Table 25: Interactive Service Platform
IN SCP cost per hundred367
IN SCP operational costs per hundred
Period of recovery
£2,000,000
£200,000
5
Source: Ofcom estimates
6.388 Ofcom derived total annual SCP platform costs by summing SCP Opex and an
annuitised SCP Capex estimate (over five years at a WACC of 11.4%). These
estimates were then expressed in ppm by dividing though by traffic minutes in the
0845 voice and data product group and for the 0845 and 0870 voice and data
product group – see Table 29 and Table 30 below).
6.389 The model also included an interconnection billing system which records details
about the ingress and egress of all calls and is used to verify payments from BT to
the hypothetical single product firm for NTS call termination/hosting and the
payments made by the hypothetical single product firm to BT for geographic call
termination. These primary systems are located at one site with backups at another
in case of site failure.
365
Refers to notes to BT’s carrier price list (see btwholesale.co.uk).
Refer to notes to BT’s carrier price list (see btwholesale.co.uk).
367
Refers to capacity of 100 transactions per second (“TPS”). Note Ofcom converts this number into a
“call arrival per second” metric ([] for all NTS calls) and multiplied by two to obtain a “transactions
per second” metric ([] for all NTS calls). The “number of hundreds” required by the hypothetical
entrant can be derived by dividing this estimate by [] (approximately [] “hundreds”, hence total
SCP costs for hypothetical entrant is £[]or £[] annuitised over 5 years at a AWACC of []%).).
366
174
Table 26: Operations Systems Software (OSS) & Billing Systems Software (BSS) costs
System
CAPEX (£)
OPEX (£)
Replacement
period
BSS/OSS Hardware (Active)
1,000,000
100,000
5
273,298
BSS/OSS Hardware (Standby)
1,000,000
100,000
5
273,298
WIA/billing & mediation
(Software and licensing)
1,500,000
150,000
5
409,947
CRM (software & licensing)
2,000,000
200,000
5
546,596
Source:
Annuity
required
Ofcom estimates
6.390 Ofcom added Opex and annuitised Capex (annuitised over five years at a WACC of
11.4%) estimates to derive a total OSS and BSS cost. These estimates were then
expressed in ppm by dividing though by traffic minutes in the 0845 voice and data
product group and for the 0845 and 0870 voice and data product group – see Table
29 and Table 30 below.
6.391 Another element of the costs included in the model was the staff that would be
needed to maintain, operate and develop the hypothetical single product firm’s
business. Provision was made for a dedicated team at each site, a central
management team responsible for monitoring the hypothetical single product firm’s
network 24 hours a day, a team responsible for implementing technical projects and
maintaining the core systems, and developers responsible for bespoke software
projects (either to maintain and improve the SCP and associated software or to
develop bespoke systems which customers may require).
6.392 Table 27 below sets out these costs in detail.
175
Table 27: Network staff costs
Per site employees
FTE required
Salary (£)
Data build engineers
2
50,000
O&M engineers
3
50,000
1.3
50,000
Switch manager
1
60,000
Cabling resource
1
45,000
Data centre manager
1
45,000
IN support
1,400,000368
Total salary cost
Network management centre employees
NMC manager
1
60,000
Network surveillance
12
30,000
Technical support managers
1
60,000
Technical support
6
45,000
Database administrators
6
50,000
Service delivery
12
50,000
Reporting
2
45,000
Total salary cost
1,740,000
Technical project management team
Business analyst
4
40,000
Technical analyst
4
50,000
Release manager
1
50,000
Technical project manager
2
60,000
Testers
4
40,000
Architecture and design
1
60,000
Total salary cost
750,000
Development team
368
Note that per site salary costs are multiplied by 3 to obtain a sub-total cost of £1,400,000 which
reflects total per site employee costs across the three sites.
176
Per site employees
FTE required
Salary (£)
Developers
8
70,000
Development manager
1
75,000
Total salary cost
635,000
Senior network management
Head of development
1
80,000
Head of service delivery
1
80,000
Head of databases
1
80,000
Head of project management
1
80,000
Network Director
1
150,000
Total salary cost
470,000
Source: Ofcom estimates
6.393 The staff costs reported in Table 27 above represent salary costs only. To adjust to
reflect the additional non-salary costs of employing and retaining staff (such as
National Insurance, training etc) Ofcom applies a costing factor of 2.5 to reflect the
total salary and non-salary related costs for the entrant.369 These total costs were
then divided through by traffic minutes to derive a ppm estimate of the staff costs for
the 0845 voice and data product group and for the 0845 and 0870 voice and data
product group – see Table 29 and Table 30 below.
6.394 Ofcom also considered site costs for the single product hypothetical firm (see Table
28 below). These total costs were also apportioned on the basis of traffic minutes to
derive a ppm estimate of the site costs for the 0845 voice and data product group
and for 0845 and 0870 voice and data product group – see Table 29 and Table 30
below.
369
Ofcom estimate.
177
Table 28: Site costs (operations and resource)
Equipment
Up-front costs (£)
Switch
100,000
Up-front Annuity
required (£)
27,330
Replacement
Period
5
OPEX (£)
UPS
150,000
40,995
5
15,000
Air conditioning
300,000
81,989
5
50,000
Fire suppression (e.g.
FM200)370
60,000
16,398
5
20,000
Cabling, DDF,
jumpers
40,000
10,932
5
Generator
300,000
81,989
5
10,000
20,000
Electricity
25,000
Property rental
100,000
Support and
maintenance
costs per site
100,000
Sum of OPEX and
annuitised
CAPEX per
site per
annum
599,633
Source: Ofcom estimates
6.395 In order to determine the payments the hypothetical single product firm would make
to BT for geographic call termination, Ofcom undertook a geographic analysis of the
size of the population that would be covered by each of BT’s DMSUs at singletandem rates. It then assumed that the hypothetical single product firm was
interconnected to the DMSU that provides the highest population coverage, 13%. For
the remaining double tandem termination payments to BT Ofcom used data provided
by [] to estimate the proportions of short, medium and long double tandem
termination. Ofcom used BT’s carrier price list to identify for relevant conveyance
services and prices (in ppm). Total geographic call termination costs were
apportioned on the basis of traffic minutes to derive a ppm estimate of the costs for
the 0845 voice and data product group and for the 0845 and 0870 voice and data
product group – see Table 29 and Table 30 below.
6.396 A cost of capital of 11.4% in pre-tax nominal terms was used to annuitise all the
capital expenditure. This is the cost of capital that BT faces for regulatory purposes
outside its copper access network (for which the rate is 10%), which is used as a
reasonable assumption in the absence of evidence of the cost of capital reflecting the
370
Brand of fire suppression system.
178
specific characteristics of the NTS termination/hosting business.371 However, BT is a
large multi-product business, with many income streams, and such favourable
access to capital may not therefore be available to a smaller single-product firm.372
Modelling the hypothetical single product firm’s non-network costs
6.397 The non-network costs faced by the hypothetical single product firm cover all the
other functions of the hypothetical single product firm’s business, including :
•
sales and marketing;
•
customer support;
•
business support (finance, HR);and
•
general administration.
6.398 For the reasons set out above, Ofcom did not perform bottom-up modelling to derive
costs for these functions, but instead derived its own estimate of the SAC derived
from the total retail cost attributed by BT to the regulatory product groups analysed
by Ofcom for the purposes of its FAC profitability analysis.373
6.399 BT classifies non-network costs related to the provision of NTS call
termination/hosting within ”retail costs” within its regulatory financial information. The
relevant regulatory product groups for this analysis are (as set out at paragraph
6.347 above) P056 and P346.
6.400 The total retail costs within these groups (after elimination of the costs which relate to
the retailing by BT of NTS calls to its own subscribers) include costs for number
ranges other than 0845 and 0870 and so the first step to estimating the hypothetical
single product firm’s costs was to apportion these costs between the relevant number
ranges.
6.401 Ofcom did not consider that apportioning these costs to the services in question
based on call volumes (which was the approach used in Ofcom’s FAC profitability
analysis) was the most appropriate approach when deriving a measure of the
relevant SAC. This was most clearly the case in P346, where an apportionment on
the basis of call volumes would lead to unmetered data calls picking up []% of
retailing costs but generating []% of revenues. In P056, an allocation based on call
volumes would assign most of the costs of retailing to 0845 calls, as these account
for a greater proportion of total volumes. However, this overlooks the fact that 0870
calls contribute twice the revenue of 0845 calls, as they provide more revenue per
minute.
6.402 To account for the relative value of the call types in question, Ofcom decided on an
approach which would allocate the retail costs based on net revenue (excluding
revenue share payments to NTS service providers). This is consistent with the
371
See Ofcom’s approach to risk in the assessment of the cost of capital: Final Statement, 18 August
2005, published at: http://www.ofcom.org.uk/consult/condocs/cost_capital2/statement/final.pdf.
372
Had Ofcom’s analysis indicated that the charges notified in NCCN 500 were excessive based on
BT’s cost of capital, it might have been appropriate to conduct a sensitivity analysis using different
rates. Since the analysis did not lead Ofcom to this conclusion, it was not necessary to carry out this
sensitivity.
373
In this context retail costs excludes revenue share outpayments, which are treated separately in
the standalone cost analysis.
179
approach Ofcom adopted in respect of marketing expenditure in setting the NTS
retail uplift.374
6.403 This methodology enabled Ofcom to estimate BT’s non-network costs for the
products under consideration.
6.404 However, the retail cost information drawn from BT’s regulatory accounting system is
prepared on an FAC basis, which means that further adjustments are required to
prepare an estimate of SAC for the purposes of this modelling exercise.
6.405 One approach to estimating the SAC would be to estimate a ratio of SAC to FAC
based on an appropriate comparator. One that is readily available is the ratio of
DSAC to FAC ratios based on BT network services in the relevant regulatory product
groups, P056 and P346, which yields ratios in the region of 2.4 to 2.8. These
comparators are not ideal in the present context, for two reasons; first, they relate to
network rather than non-network costs, and second, they are based on DSAC not
SAC.
6.406 In relation to the first of these points, economies of scale and scope may be greater
for network services than for retail services, and the derived DSAC to FAC ratios
could therefore overestimate the true DSAC to FAC ratio for non-network costs.
Having said that, economies of scale and scope in non-network functions are not
negligible. For example, in the modelling used to inform the setting of BT's retail price
controls in 2002 and in the NTS Retail Uplift in 2005 Ofcom used a cost-volume
elasticity (the ratio of the percentage change in costs to the percentage change in
output causing it) of 0.25 for retail costs (apart from bad debt which varies directly
with revenue) while in other cases Ofcom has used a cost volume elasticity (“CVE”)
of around 0.45 for indirect costs.375 These CVEs reflect significant economies of
scale in these activities (or, equivalently economies of scope in the services which
the functions support).
6.407 In relation to the second point, on the other hand, it is likely that DSAC is below the
true SAC for any given service, for the reasons set out above (see paragraph 6.334
et seq above), namely that intra-business common costs are distributed among all
the services to which they are common (rather than added to the incremental costs of
just the service in question, as required for a true SAC). As a result, the DSAC:FAC
ratios referred to above could lead to an underestimate of SAC for non-network
expenditure.
6.408 Taking these factors into consideration, Ofcom derived SAC estimates for nonnetwork expenditure by applying a factor of 2 to the FAC estimates. Ofcom regards
374
See paragraphs A2.22 - A2.29 of the September 2005 statement Charges between
Communications Providers: Number Translation Services Retail Uplift charge control and Premium
Rate Services bad debt surcharge. The analysis on which this decision was based deals mainly with
marketing expenditure. The underlying logic is that "it is the profit earned supplying products to its
customers that provide the motivation to advertise". It would be consistent that sales and marketing
effort, and thereby cost, would be concentrated upon those areas which earn the highest margins.
375
CVE is defined as the percentage by which costs increase for a 1% increase in volume. See
Protecting consumers by promoting competition: Oftel's conclusions, 20 June 2002, published at:
http://www.ofcom.org.uk/static/archive/Oftel/publications/whole_line/2002/pcr0602.htm and, for
example, Determination of fixed portability costs and charges and statutory consultation on proposed
modifications to BT's Licence to give effect to charge controls for portability, 31 May 2002, published
at http://www.ofcom.org.uk/static/archive/oftel/ind_info/licensing/mods/2002/galvin31502.htm or
Wholesale Line Rental: Reviewing and setting charge ceilings for WLR services, 9 November 2005,
published at: http://www.ofcom.org.uk/consult/condocs/wlrcharge/wlr.pdf
180
this as a reasonably conservative assumption, in the sense that it may tend to
understate the costs of the hypothetical single product firm.
6.409 In addition, there is some corroboration for the level of non-network costs implied by
the ratio of 2 being conservative, which in the case of the modelling for the
hypothetical single product firm supplying both 0845 and 0870 NTS call
termination/hosting comes to an SAC of £63m. Ofcom’s analysis shows that BT's
total retail costs for the two regulatory product groups, on an FAC basis, are around
£[]. Ofcom has adjusted this figure downwards to exclude BT’s costs of retailing
calls to its retail customers (about £[]), leaving a total £63 million, which would
need to be increased by an appropriate factor to give an SAC figure.
6.410 The model does not include hardware elements such as leased lines and any other
software that may also be required to provide such services since as discussed,
these are bespoke services in addition to NTS call termination/hosting. Modelling
these on a bottom-up basis could not be achieved without detailed information on the
types and specifications of the services and to whom and in what quantity they are
offered. However, as the results do not suggest that the charges notified in NCCN
500 were excessive (see below), Ofcom does not consider that it is necessary to
factor in this additional cost.
6.411 The model also includes revenue share payments to NTS service providers. These
are taken from a breakdown provided by BT for the purposes of the FAC profitability
analysis of its 2004/05 retail costs which Ofcom has expressed on a pence per
minute basis based on the total volumes terminated by BT on the number ranges in
question.
BT’s revenues
6.412 BT’s gross revenues in the NTS termination/hosting market come from two sources:
revenues for the provision of NTS call termination/hosting and payments received
from NTS service providers. The net revenue is the sum of these two elements less
any revenue share payments to NTS service providers.
6.413 The main source of is payments from OCPs for NTS call termination/hosting. These
revenues have been calculated as the product of the charges notified in NCCN 500
(see Annex 1) and the volume of calls terminated (i.e. the actual volume of calls
terminated by BT, as set out at paragraph 6.370 above).
6.414 BT also derives revenue from payments from NTS service providers for some NTS
hosting services. BT does not (and is not required to) publish separate charges for
these services. Ofcom therefore derived a ppm figure for the average income from
these services for each number range from the regulatory product group information
provided by BT (i.e. from P056). Note that Ofcom has excluded port rental revenues
received from data service providers in this analysis. In addition, the network cost
element of the model includes a cost for software developers responsible for creating
and maintaining bespoke services.
Results
0845 only
6.415 The results for the combined SAC analysis of 0845 voice and data calls are set out in
Table 29 below.
181
Table 29: BT’s loss on ppm basis based on the SAC of the hypothetical single product
firm (0845 voice and data combined)
Item
0845 voice and
data combined
Termination revenue
Other revenues
[]
[]
Total revenues
[]
Payments to NTS service providers
[]
Net revenue
[]
Switch
Site costs
OSS & BSS:
Interconnection
Interactive services platform
Operations and resources
Geographic termination payments
Total network costs
[]
[]
[]
[]
[]
[]
[]
[]
Non-network costs
[]
Total costs
[]
BT’s loss
-0.368
6.416 These results indicate that BT’s prices for termination of 0845 calls when NCCN 500
was in force did not exceed the estimated SAC of the hypothetical single product firm
providing NTS call termination/hosting at BT’s scale for the whole of the 0845
number range and there was a loss of 0.368 ppm.
6.417 This evidence does not support the view that BT’s prices for the termination of calls
to 0845 numbers, as notified in NCCN 500, were excessive.
0845 and 0870
6.418 Ofcom also considered a hypothetical single product firm providing NTS call
termination/hosting on both 0845 and 0870.
6.419 Call volumes for 0870 are smaller than for 0845 ([] terminated minutes as opposed
to [] for 0845 in 2004/05). However, the higher revenues associated with 0870
mean that it is as significant to BT as 0845 in revenue terms.
6.420 The hypothetical single product firm providing NTS call termination/hosting on both
0845 and 0870 is modelled by Ofcom in much the same way as the 0845-only single
product firm.
6.421 However, there are some important differences in costs and some significant
economies of scale. The area where the costs for 0870 differ significantly from those
for 0845 is in the level of payments made to NTS service providers. The average
payment made by BT for an 0870 call is [] ppm, compared to [] ppm for an 0845
call. This higher revenue share payment reflects the higher ppm NTS call
termination/hosting revenues BT receives from 0870.
182
6.422 The other major difference is that, in this model, payments from NTS service
providers to BT tend to be higher for 0870 calls, as 0870 calls tend to be voice calls
and 0845 data calls do not attract any of these additional payments.
6.423 The hypothetical single product firm providing NTS call termination/hosting on both
0845 and 0870 is able to benefit from some significant economies of scale. The
network configuration outlined above is still judged to be the most suitable setup for
the combined operator. Some of the modelled costs increase in proportion to the
increase in traffic (notably the number of interconnects with BT and the quality of
SCP required).
6.424 However, all of the network costs decrease on a ppm basis due to economies of
scale, apart from payments to BT for geographic call termination. This is due to the
different time of day profile of 0870 calls as a whole as a whole compared to 0845
calls. The volume of data NTS calls terminated on 0870 is negligible, meaning that
0870 calls are generally speaking voice calls, which are more likely to be made
during the day and therefore attract higher geographic termination charges.
6.425 Non-network costs for the hypothetical single product firm are also higher than when
it is terminating 0845 calls This is due mainly to the methodology Ofcom has used to
derive the ppm non-network costs whereby 0870 calls, due to their higher net
revenues, attract more of the total “retail costs” attributed to the relevant regulatory
product groups .
6.426 The results for the single product firm proving NTS call termination/hosting for both
0845 and 0870 is given at Table 30 below.
183
Table 30: BT’s loss on a ppm basis based on the SAC of the hypothetical single
product firm (0845 and 0870)
Item
Value (ppm)
Termination revenue
Other revenues
[]
[]
Total revenues
[]
Payments to NTS service providers
[]
Net revenue
[]
Switch
Site costs
Operating and billing systems:
Interconnection
Intelligent networking platform
Operations and resources
Geographic termination payments
Total network costs
[]
[]
[]
[]
[]
[]
[]
[]
Non-network costs
[]
Total costs
[]
BT’s loss
-0.013
6.427 These results indicate that BT’s prices for 0845 and 0870, taken together, when
NCCN 500 was in force, did not exceed the SAC of a hypothetical single product firm
providing NTS call termination/hosting at BT’s scale. This evidence does not support
the view that BT’s prices for the termination of calls to 0845 and 0870 numbers, as
notified in NCCN 500, were excessive.
6.428 This result is more marginal than the 0845-only results presented in Table 29 above,
which appears to be largely because of the higher net revenues associated with 0870
(and economies of scale from the volumes of 0845 and 0870 taken together).
Model input analysis
6.429 Ofcom undertook sensitivity analysis to determine which inputs in the modelling
process had the greatest bearing on the outcomes as reported in the tables above.
6.430 The two factors which had the largest impact on the hypothetical single product firm’s
costs were the uplift that was applied to BT’s FAC costs of retailing to arrive at a SAC
estimate, and the proportion of calls that were deemed to fall within the ‘busy hour’.
6.431 Since the network used by the hypothetical single product firm was modelled in
detail, network costs can be estimated to a relatively high degree of accuracy so that
likely variations in individual constituent costs such as the cost of switching
equipment and the pay rates of employees had an immaterial effect on the outcomes
reported.
6.432 As already discussed above Ofcom applied a factor of 2 to BT’s attributed FAC nonnetwork costs for 0845 and 0870 calls in order to derive an estimate of these costs
184
on an SAC basis. Ofcom believes that this is a relatively conservative assumption
and that there might be a justification for using a higher ratio. However, as Ofcom’s
analysis does not indicate that the charges notified in NCCN 500 were in excess of
SAC, it is not necessary to subject this assumption to a sensitivity analysis of the
effect of using a higher ratio.
6.433 As regards the busy hour proportion, as discussed above there are features of NTS
traffic that may generate spikes in demand, that is very high short-term peaks in
traffic volumes. For an operator attempting to supply NTS at BT’s quality of service,
including coping with these peaks in demand, the assumption made in Ofcom’s cost
analysis may be something of an underestimate. If this is a significant factor, the true
SAC may be somewhat above Ofcom’s estimate. However, as Ofcom is able to
reject a finding of excessive pricing in any case it is not necessary to further allow for
this factor.
6.434 A further important variable is the level of payments made by BT to NTS service
providers. For voice calls, Ofcom considers that using the actual value of payments
made by BT is appropriate, as a hypothetical single product firm would need to offer
equivalent payments to win business from BT. However, in the data business the
payments reflected within regulatory product group P346 also take account of
additional services that BT provides, such as converting PSTN traffic to IP which are
not provided by Ofcom’s modelled operator. Therefore, it may be the case that the
hypothetical single product firm using the configuration detailed above would have to
offer significantly higher payments than BT to win BT’s business (or invest in its
network to offer the same services as BT). Either scenario would result in reduced
profitability for the hypothetical single product firm and would therefore make a
finding of excessive pricing against BT less likely. Ofcom has not therefore
conducted a sensitivity analysis on this cost, as it is able to reject a finding of
excessive pricing without doing so.
Alleged excessive pricing: conclusion
6.435 Before finding an infringement of Article 82 and/or the Chapter II prohibition, Ofcom
must satisfy itself on the evidence that an infringement is more likely than not to have
occurred.376 The undertaking being investigated is entitled to the presumption of
innocence and to any reasonable doubt that there may be. Ofcom must therefore
proceed on the basis of an analysis that is robust and soundly based.377
6.436 As discussed at paragraphs 6.305-6.321,above, the case law presents a number of
possible tests and comparators that can assist in determining whether an
undertaking’s prices are “excessive”, i.e. whether they are higher than would be
expected in a competitive market.
6.437 In United Brands, the ECJ set out a two-step process for identifying excessive
pricing, stating that the questions to be determined were:
“whether the difference between the costs actually incurred and the
price actually charged is excessive, and, if the answer to this
question is in the affirmative, whether a price has been imposed
376
Napp Pharmaceutical Holdings Ltd v Director General of Fair Trading [2002] CAT1, paragraph
109.
377
JJB Sports plc and Allsports Limited v Office of Fair Trading [2004] CAT 17, paragraphs 191-199.
185
which is either unfair in itself or when compared with competing
products.”378
6.438 There are therefore two broad areas for consideration in determining whether the
prices notified in NCCN 500 were excessive. First, whether BT’s prices were
excessive compared to costs (i.e. “the difference between the costs actually incurred
and the price actually charged”); and second, if this were found to be the case,
whether the prices notified in NCCN 500 were “unfair in [themselves] or when
compared with competing products.” It is Ofcom’s view that, in the absence of
compelling evidence of adverse effects on competition and limited evidence of an
adverse effect on consumers, Ofcom would need cogent evidence that BT’s pricing
was excessive under such tests.
6.439 The absence of likely or actual harm to competition appears to have been a key
consideration in BHB (see paragraph 6.601 et seq below) and Ofcom looked at
whether any actual harm occurred to competition in this case, or whether it was likely
that any harm to competition would have occurred as a result of the price changes
notified in NCCN 500.
6.440 Ofcom considers that, had the prices notified in NCCN 500 been excessive, this
might have led to two possible types of harm. First, BT’s competitors would have
been harmed by having to pay the higher charges, reducing their ability to compete
with BT in the origination segment and in NTS hosting. This type of harm was
assessed by the retail and hosting margin squeeze analysis, which concluded that
BT’s competitors did not suffer a margin squeeze either in origination or in NTS
hosting as a result of BT’s conduct. Analysis of market shares over the period that
NCCN 500 was in force (and since) suggest no relevant change in market share for
BT in the relevant market during this period.
6.441 Second, had BT’s competitors passed the higher charges through to their retail
customers, this might have led to consumer detriment in the form of higher retail
prices. As set out at paragraphs 5.114-5.115 above, Ofcom is only aware of one
instance where a competitor to BT ([]) passed the higher prices through to their
customers, and notes that this price rise appeared to go beyond what was required to
cover the additional cost imposed by NCCN 500. However, Ofcom notes that BT’s
competitors may have been waiting for the outcome of Ofcom’s investigation and
market review before taking any decision on changing their prices (see paragraph
5.112 above).
Were BT’s prices excessive compared to costs?
6.442 To consider whether BT’s prices were excessive compared to its costs, Ofcom
undertook an analysis of BT’s profitability on two different measures: FAC and SAC.
6.443 The results set out at paragraph 6.346 et seq above showed that BT’s profitability on
an FAC basis increased as a direct result of NCCN 500. For the reasons set out
above (at paragraph 6.353 above), the resultant profitability indicators are subject to
some possible margin of error. In addition, there seemed to be some differences
between the profitability of BT’s voice and data businesses. Nevertheless, overall,
378
Case 27/76 United Brands v Commission [1978] ECR 207, paragraph 252 (the ECJ went on to
point out in the following paragraph that there were other ways “of selecting the rules for
determining whether the price of a product is unfair”).
186
the results of Ofcom’s FAC analysis suggest that BT’s NCCN 500 prices were
comfortably above costs on an FAC basis.
6.444 However, the FAC measure of costs depends on the particular allocation of costs
reflected in BT's accounts, which is not necessarily the maximum which could
reasonably be recovered from NTS call termination. While the FAC analysis
suggested that BT’s prices were comfortably above cost, in the circumstances of this
case, Ofcom’s view is that this in itself was not sufficient to conclude that the prices
notified in NCCN 500 were excessive compared to BT’s costs, in relation to the first
test set out in United Brands.
6.445 Ofcom therefore conducted a further analysis that compared BT’s prices to the SAC
faced by a hypothetical single product firm. As noted above (at paragraph 6.331
above), in principle SAC represents the highest price that could be sustained in a
contestable market.
6.446 As one would expect, the SAC of a hypothetical single product firm was higher than
the costs generated by the FAC analysis, because the latter only reflect a proportion
of the (potentially significant) common costs between the services under investigation
(NTS call termination/hosting, primarily on the 0845 and 0870 number ranges) and
the wide range of other services that BT supplies in conjunction with NTS
termination/hosting.
6.447 The results of Ofcom’s SAC analysis (as set out at paragraph 6.415 et seq above)
suggest that the prices notified in NCCN 500 were below SAC.
6.448 Ofcom considers that the comparison of BT’s prices and costs offered by each of the
FAC and SAC analyses provides relevant but conflicting evidence. The inference to
be drawn from the comparison of prices and costs therefore depends on the strength
of the evidence overall. In the circumstances of this case, Ofcom’s judgement is that
the evidence of excessive pricing provided by the FAC analysis is insufficient on its
own, because it reflects one particular way in which common costs could be
recovered, but it is not clear that this is more reasonable than many other ways of
recovering common costs. The different results in the analysis of SAC, which
represents an upper bound on prices sustainable in a contestable market,
demonstrate the importance of the common cost recovery issue in this case.
6.449 The United Brands test is a two-step test. Even if Ofcom had concluded, on the basis
of its FAC analysis alone, that the prices notified in NCCN 500 were excessive
compared to BT’s costs, it would then have needed to conduct the second test set
out by the ECJ in United Brands, as applied by the Court of Appeal in BHB, i.e.
whether the prices notified in NCCN 500 were “unfair in [themselves] or when
compared with competing products.” This analysis is set out in the next section.
Were the prices notified in NCCN 500 unfair in themselves or when compared
with competing products?
6.450 As discussed above, the case law offers a number of possible comparators that may
help Ofcom scope a test for determining whether, in terms of the United Brands test,
the prices notified in NCCN 500 were unfair when compared with competing
products.
6.451 In Napp, for example, in considering whether the second test set out in United
Brands was passed, the OFT considered the following possible comparators (in
addition to a comparison of the target’s prices and its underlying costs):
187
•
Napp’s prices with the costs of its most profitable competitor;
•
Napp’s prices with those of its competitors; and
•
Napp’s prices with prices charged by Napp in other markets.
6.452 In the main Albion judgment, the CAT did not employ all of the tests suggested in
Napp. In relation to the first comparison (between the dominant undertaking’s prices
and its costs – i.e. the profitability analysis discussed in the preceding section) the
CAT referred to the fact that the existence of supply contracts to other non-potable
water users was not a valid comparator for determining whether excessive pricing
had occurred in that case as there was no evidence that such contracts were cost
related.379
6.453 In its December 2006 Albion decision, the CAT cited paragraph 252 of United
Brands, where the ECJ refers to a price being either unfair in itself or when
compared to competing products and the CAT noted that the latter was difficult to
apply in Albion as “there is no substitute for the service of the transportation and
partial treatment of water here in question”.380 In those circumstances, the CAT
decided to focus on the comparison of supply costs to prices to customers for
potable and non-potable water.381
6.454 In this case, as in Albion, not all of the comparisons suggested in Napp are relevant.
The nature of the NTS call termination/hosting market and the services supplied by
BT mean that there is limited scope for replicating the tests applied in Napp in order
to determine whether BT’s prices were “unfair in themselves or when compared to
competing products.”
6.455 Ofcom considered the possibility of comparing BT’s prices with the costs of its next
most profitable competitor. In order to undertake such a comparison, Ofcom would
have had to assess the profitability of a number of other TCPs to identify BT’s most
profitable competitor. Other TCPs do not produce regulatory financial statements
(the accounting system for which was primary source of data for Ofcom’s
assessment of BT’s profitability), and discussions with C&W suggested to Ofcom that
other TCPs do not produce financial information at a level of granularity that would
have enabled Ofcom to conduct an equivalent assessment of their profitability in
relation to the relevant services.
6.456 In section 26 Notices dated 28 June 2005, Ofcom asked a number of providers to:
“Provide an estimate of your costs (other than revenue share
outpayments) of NTS call termination for 2004/05, at as granular a
level as possible, setting out in detail your method of preparation of
assumptions (particularly in relation to allocation of common costs)
and clear descriptions of each cost category you have identified.”382
6.457 None of the respondents were able to provide any level of detail regarding these
costs that would have assisted Ofcom.
379
[2006] CAT 23, paragraph 753-757.
[2006] CAT 36, paragraph 250.
381
December 2006 decision of the CAT in Albion (see footnote 380), paragraph 252.
382
This question was included in section 26 Notices sent to C&W, Centrica, Energis, Gamma, ntl,
Telewest, Thus and Tiscali.
380
188
6.458 C&W stated in its response of 10 July 2005 that “network costs are not attributed at
this level”. Energis, in a subsequent exchange of emails about the feasibility of
providing more granular cost data, stated that it would welcome clarification of how, if
it were able to provide this data, Ofcom would adjust it to ensure a fair comparison
with BT’s costs, and went on to say that:
“We don't want to lessen the importance of Ofcom's analysis of
excessive pricing but given the limitations that we discussed we
would be concerned about attempting a meaningful assessment of
BT's profitability using Energis’ costs as we do not have a high
degree of confidence that even if all the relevant costs were readily
obtainable that they are directly comparable with BT’s.”383
6.459 Since Ofcom had concluded that the first test set out in United Brands was not clearly
passed, it concluded that the complexity and scale of such an exercise would have
outweighed the value that it would have brought to Ofcom’s conclusion, in particular
given the comments made by C&W about the reliability of their own data as a
suitable basis for comparison. Ofcom has not therefore compared BT’s prices with
the costs of its most profitable competitor. Ofcom has, however, compared BT’s
prices with the costs of a hypothetical single product firm, as set out above. That
analysis concluded that BT’s prices were not in excess of the costs of the
hypothetical competitor.
6.460 As discussed at paragraph 2.26, prior to NCCN 500, prices for NTS call termination
were uniform, with BT charging the same rate as other TCPs. NCCN 500 increased
BT’s charges for NTS call termination price by up to 37.8% on some ranges, with a
weighted average price increase on 0845 of approximately 26% and on 0870 of
approximately 3% (on a weighted average basis).
6.461 Moving to a comparison between the prices notified in NCCN 500 and the prices
charged by BT in other markets (following the final test adopted in Napp), Ofcom
noted that NTS call termination is supplied only in the NTS call termination/hosting
market. Ofcom does not consider that BT offers any comparable products in other
markets that would offer a relevant benchmark for assessing whether BT’s prices for
NTS call termination, as notified in NCCN 500, were unfair when compared to
competing products.
6.462 Ofcom notes that there is little guidance in case law to assist in determining how a
price may be unfair in itself. For example, in United Brands, while stating that
“charging a price which is excessive because it has no reasonable relation to the
economic value of the product supplied” would amount to excessive pricing, the ECJ
offered little guidance on how to determine the “economic” value of the product or
service provided.384
6.463 In dealing with this question of whether the price was “unfair in itself” in Albion, the
CAT noted that in its view there was a certain ambiguity in the test set out in United
Brands as to whether there is a distinction between a price which is excessive and a
price which is unfair and stated:
“At present, we are not persuaded that, in a case such as the
present, there is necessarily a distinction between a price that is
383
384
email from [] (Energis) to [] (Ofcom), 19 September 2005.
Case 27/76, [1978] ECR 207, paragraph 250.
189
“excessive”, as distinct from a price which is “unfair”, or that
“economic value” is intrinsically difficult to ascertain.”385
6.464 The CAT went on to say:
“…this case does not concern the establishment of some justum
pretium (just price) in the abstract sense, but the much more prosaic
question of whether the costs of the “distribution” of non-potable
water are the same as the costs for the “distribution” of potable
water.”386
6.465 In Scandlines, the Commission was of the view that, in determining whether a price
might be unfair in itself, the economic value of the product/service should also take
account of other non-cost related factors, especially as regards the demand-side
aspects of the product/service concerned.387
6.466 In view of the recent case law in excessive pricing that questions whether there is
any real distinction between whether a price is excessive when analysed in relation
to costs or unfair in itself or compared with competing products and Ofcom’s
assessment that there was insufficient evidence to conclude that the NCCN500
prices were excessive compared to BT’s costs, Ofcom does not believe there is
sufficient evidence to conclude that these prices were unfair in relation to costs.
Conclusion on excessive pricing
6.467 As set out in the previous two sections, Ofcom has considered whether, based on the
balance of probabilities, the two-step test to determine whether excessive pricing has
occurred – as set out in United Brands and followed by the CAT in Napp and Albion,
the Court of Appeal in BHB, and the Commission in Scandlines – is passed in this
case.388
6.468 The United Brands test is sequential, relying first on a determination of whether a
price can be considered excessive and, if it can, then assessing whether that price is
unfair in itself or when compared with relevant benchmarks.
6.469 As set out above, the Court of Appeal made it clear in BHB that it is also important to
assess in relation to allegations of excessive pricing whether there is evidence of
competition in the market being distorted by the pricing.389
6.470 Ofcom has considered whether the available evidence, using comparisons with BT’s
FAC and the SAC of a hypothetical single product firm, would support a finding of
infringement.
6.471 Ofcom has considered whether it has sufficient evidence to satisfy the standard of
proof.390 As stated by the CAT in Napp:
“…..the standard of proof in proceedings under the Act involving
penalties is the civil standard of proof, but that standard is to be
applied bearing in mind that infringements of the Act are serious
385
[2006] CAT 36, paragraph 250.
[2006] CAT 36, paragraph 251.
387
Case COMP/A.36.568/D3, 23 July 2004, paragraph 226.
388
JJB Sports plc & Allsports Limited v Office of Fair Trading [2004] CAT 17, paragraph 191-196.
389
Case No A3/2006/0126 EWCA Civ 38, paragraphs 215-218.
390
The Racecourse Association v Office of Fair Trading [2005] CAT 29, paragraph 131.
386
190
matters attracting severe financial penalties. It is for the Director to
satisfy us in each case, on the basis of strong and compelling
evidence, taking account of the seriousness of what is alleged, that
the infringement is duly proved, the undertaking being entitled to the
presumption of innocence, and to any reasonable doubt there may
be.”391
6.472 The CAT has subsequently endorsed this approach in JJB Sports plc & Allsports
Limited v Office of Fair Trading.392
6.473 Ofcom also notes the view expressed by the Commission in Scandlines that it bears
the burden of proof based on cogent evidence to establish the existence of the
abuse.393
6.474 In the circumstances of this case, Ofcom does not believe that the evidence meets
the standard of proof set out in the case law to establish that the prices notified in
NCCN 500 were excessive.
6.475 While there is no doubt that NCCN 500 did have the effect of increasing BT’s
revenue at the expense of its competitors (see paragraph 6.555-6.556 below),
without a justification based on BT’s underlying costs, Ofcom does not consider that
this in itself is sufficient to draw a conclusion that BT’s prices were excessive.
6.476 As noted above, Ofcom is mindful of the Court of Appeal’s decision in the BHB case
that abuse of a dominant position is about distortion of competition and safeguarding
the interests of consumers, and is not a law against suppliers making excessive
profits by selling their products to other suppliers at prices yielding more than
reasonable returns on the cost of production.394 Ofcom did not find any evidence that
BT’s conduct in this case led to a distortion of competition or that it led to an adverse
effect on consumers generally, as only one of BT’s competitors raised its prices in
response to NCCN 500.
6.477 Therefore Ofcom concludes that there is insufficient evidence to support C&W’s
allegation that the prices notified in NCCN 500 were excessive and that BT’s conduct
thereby constituted an abuse of BT’s dominant position within the meaning of the
Chapter II prohibition and Article 82.
Responses to draft decision: excessive pricing
6.478 C&W, CPW and Thus comment on Ofcom’s excessive pricing analysis. BT does not
comment on Ofcom’s assessment of C&W’s allegation of excessive pricing.
C&W
6.479 C&W submits that:
“[Ofcom’s] approach [to its analysis of alleged excessive pricing] is
simplistic and based on an inappropriate approach to cost allocation.
Ofcom is overly-reliant on a simple analysis using the United Brands
approach and thus looks strictly at cost issues; in fact the case law
391
[2002] CAT 1, paragraph 109.
[2005] CAT 29, paragraph 197-200.
393
Case COMP/A.36.568/D3, 23 July 2004, Scandlines Sverige AB v Port of Helsingborg, paragraph
244
394
Case No A3/2006/0126 [2007] EWCA Civ 38, paragraph 119.
392
191
since United Brands makes it clear that excessive pricing cannot be
analysed simply on the basis of cost considerations.”395
6.480 C&W states that Ofcom has “rejected” its own analysis of BT’s profitability on an FAC
basis:
“because it argues there are different ways in which common costs
could be allocated, and the methodology used in BT’s FAC is only
one way.”396
6.481 C&W submits that:
“if Ofcom had doubts about FAC then it could have considered a
range of allocation methodologies rather than disregarding
altogether the appropriateness of taking into account that in a multiproduct firm with common costs like BT, the “competitive” price level
is below the standalone cost.”397
6.482 C&W proposes a number of alternative approaches to cost allocation which it
believes Ofcom should have considered, namely:
•
equi-proportional mark-ups (EPMU);
•
Ramsey pricing; and
•
Efficient Component Pricing Rule (ECPR).398
6.483 In C&W’s view, “Ofcom should have investigated use of these cost allocation
methodologies rather than relying just on a SAC model to assess excessive
pricing.”399 C&W submits that Ofcom could, and should have used LRIC estimates,
rather than SAC, as the basis of its excessive pricing comparison.
6.484 Turning to Ofcom’s SAC analysis, C&W has a number of concerns with Ofcom’s
approach.
6.485 C&W contends that the use of SAC as a cost base is inappropriate as:
“It is unrealistic to expect any competitor to provide only NTS
services and not to provide any other calling products…..Ofcom has
taken account of this to a limited extent by assuming that a network
built out for NTS termination would not include conveyance assets,
however this is unlikely to fully capture this issue.
[…] new entry in the NTS termination market is likely to occur at a
price which is lower than SAC and therefore this lower price should
be considered in the test.”400
6.486 C&W submits that Ofcom is wrong to rely on Albion as a relevant precedent, and to
rely on the OFT’s guidelines.401
395
C&W’s response to the draft decision, page 41.
C&W’s response to the draft decision, page 42.
397
Ibid.
398
C&W’s response to the draft decision, page 43.
399
Ibid.
400
C&W’s response to the draft decision, page 46.
396
192
6.487 C&W submits that:
“Precedent shows that a finding of excessive pricing not only
requires consideration of costs, but should include other tests so that
the evidence can be considered in the round.”402
6.488 C&W submits that “the fact that prices cannot be shown to be above SAC is not
sufficient to rule out that prices might be excessive” and suggests, in relation to the
four tests set out in Napp, that:
•
“Comparison of BT price with BT’s cost: [...] SAC may be inappropriate for
this market and thus more emphasis should have been placed on other cost
standards;
•
Comparison of BT’s costs with cost of the next most profitable competitor:
Ofcom did not test this on the basis that it could not identify the next most
profitable competitor and did not believe that cost data was available. These
arguments are weak given that Ofcom could have compared price against all
competitors and could have requested additional information [...]
•
Comparison of BT’s price with those of its competitors: This was not tested
by Ofcom. However the price charged by BT was above those of its competitors.
Moreover, the prices charged by BT’s competitors were set by the NTS
origination retention.”403
6.489 C&W acknowledges that the fourth test in Napp, comparing prices with those
charged in other markets, may not be appropriate here.404
6.490 C&W cites the more recent decision in BHB which suggests that assessment of a
customer’s willingness to pay, rather than an undertaking’s costs, may be an
appropriate way to assess alleged excessive pricing.405
6.491 C&W submits that Ofcom has not properly considered the second strand of the test
set out in United Brands, i.e. whether the price charged is unfair in itself or when
compared to competing products.406
6.492 C&W suggests that Ofcom has “fail[ed] to complete its analysis [i.e. to carry out
additional tests] because of lack of evidence”.407
CPW
6.493 CPW does not believe that Ofcom has carried out a “sufficiently sophisticated”
analysis of the excessive pricing allegation.408
6.494 CPW submits that:
401
C&W’s response to the draft decision, page 44.
Ibid.
403
C&W’s response to the draft decision, page 45.
404
Ibid.
405
C&W’s response to the draft decision, page 46.
406
C&W’s response to the draft decision, page 47.
407
C&W’s response to the draft decision, page 48.
408
CPW’s response to the draft decision, page 3.
402
193
“…the fact that prices cannot be shown to exceed SAC is not
sufficient to rule out that prices might be excessive. In other words, if
Ofcom would have found that prices were above SAC, this would
have been sufficient to conclude that they were excessive.”409
6.495 CPW states that Ofcom should have carried out a variety of tests for excessive
pricing, in line with the general approach in case law. C&W notes that Ofcom
“strangely dismisses” three of the four tests identified by the OFT in Napp, and notes
that in BHB “willingness to pay” is used as a further benchmark.410
6.496 Further, CPW notes, citing Naloo, that:
“more recent case law even suggests that one need to consider
whether the excessive pricing is applied in a discriminatory
fashion.”411
6.497 When looking at Ofcom’s SAC analysis, CPW has concerns that Ofcom’s model
contains unrealistic assumptions, since “no new entrant would decide to enter the
UK communications market with a view to supply only NTS services.” Ofcom’s
removal of conveyance assets from the model does not, in CPW’s view, fully
address this issue.412
6.498 CPW is also:
“concerned that Ofcom appears to dismiss the findings using FAC
because it argues that there are different ways in which common
costs could be allocated, and the methodology used in BT’s FAC
model is only one way….Ofcom should consider a range of
allocation methodologies rather than disregarding altogether the
appropriateness of taking into account that in a multi-product firm
with common costs like BT, the “competitive” price level will be
below SAC.”413
6.499 CPW believes that:
“If Ofcom believes it is not possible to employ different allocation
methodologies in BT’s FAC model Ofcom should take BT’s top-down
LRIC cost and add the fixed and common cost mark-up which can
be done using a range of alternative approaches.”414
Thus
6.500 Thus states that it:
“has grave concerns that Ofcom has made the decision that BT’s
pricing was not excessive based on the output from a very simplistic
stand alone cost model….(t)he reality is that BT is a complex
business supplying multiple products over a shared platform. We
have serious concerns for the future of our sector if Ofcom make an
409
Ibid.
CPW’s response to the draft decision, page 5.
411
Ibid.
412
Ibid.
413
Ibid.
414
Ibid.
410
194
excessive pricing finding dependant on exceeding Stand Alone
Costs. In our sector we can think of very few examples where SAC
modelling would accurately reflect market conditions.”415
6.501 Thus believes that Ofcom should have developed a model based on a LRIC + EPMU
approach.416
6.502 It also states that:
“in considering the issue of excessive pricing it is our belief that
Ofcom should have conducted a wider enquiry into the allegation
and not one (that) was focused solely on cost modelling alone.”417
Ofcom comments on responses
Ofcom’s approach and legal precedents
6.503 The respondents raise a number of issues about Ofcom’s approach to the excessive
pricing allegation in the context of the case law.
6.504 C&W’s assertion that Ofcom “relies on Albion Water as authority for its approach” is
inaccurate. The use of SAC was rejected as a basis for setting prices in Albion.
However, the different circumstances of this case make it the appropriate basis for
Ofcom’s analysis here.
6.505 C&W submits that Ofcom has placed too much emphasis on a footnote in the OFT’s
draft guideline Assessment of Conduct as support for applying SAC in this matter. 418
6.506 Ofcom notes that the OFT’s discussion of allocation of costs in this section of the
guideline is of a general nature:
“To assess the profitability of a line of business it may be necessary
to allocate common costs to the particular activities identified.
Whether and how this should be carried out will depend on the
circumstances of the case.”419
6.507 The footnote qualifies the previous statement by stating that “in some circumstances
the standalone cost of a line of business may be relevant”. Ofcom has provided its
reasons for believing that it is appropriate to consider SAC in this case (see
paragraph 6.330 et seq above).
6.508 The respondents submit that Ofcom has focused only on BT’s profitability and failed
to consider the allegation “in the round” or to take into account other tests suggested
by the case law. This is clearly not the case. As discussed above, the other
comparisons specified in Napp (see paragraph 6.316 above) were taken into
account to the extent that they were meaningful.
6.509 The respondents suggest that Ofcom should also have considered willingness to pay
as a relevant benchmark, as discussed in the recent BHB judgement.
415
Thus’s response to the draft decision, page 10.
Ibid.
417
Ibid.
418
OFT 414a.
419
OFT 414a, paragraph 2.13.
416
195
6.510 Ofcom notes that BHB related to an intellectual property service, for which sole focus
on the cost of production might not be appropriate. It is unclear to Ofcom the extent
to which an analysis of willingness to pay is relevant to the very different type of
services that are covered by NCCN 500. However, even if relevant, Ofcom notes
that a standard for excessiveness based on willingness to pay is a tougher threshold
to cross even than SAC, since customers may well be willing to pay in excess of this
level, particularly if in practice, customers have shown themselves willing to pay the
prices charged, as in this case.
Alternatives to SAC as basis of comparison
6.511 C&W proposes three alternatives to the use of FAC and SAC as a benchmark for
excessive pricing. These are LRIC+EPMU (long run incremental cost plus equiproportional mark-up), Ramsey pricing, and the ECPR (efficient component pricing
rule). Ofcom did not consider any of these alternatives in its analysis, as none is
relevant to this case.
6.512 LRIC+EPMU is an approach in which the share of all relevant common costs
allocated to each service is equal to the ratio of the incremental costs of providing
that service to the sum of all incremental costs for the multi-product firm. If all
charges are set at LRIC+EPMU, full recovery of common costs will be achieved, with
no supernormal profit. It is likely that LRIC+EPMU will be similar to FAC, which also
involves allocating all relevant common costs among all of the services. Therefore,
an analysis of LRIC+EPMU may add little to the evidence already provided by the
FAC analysis. In addition, there are other methods of allocating common costs and
there is nothing intrinsically correct in a proportionate allocation of common costs in
assessing excessive pricing. Accordingly, the evidence provided by such an
approach is likely vulnerable to the same limitations as the FAC approach discussed
above at paragraph 6.327 above and there are potentially a number of other
reasonable allocation methods that could be used. Some services would then
receive an allocation of common costs greater than that implied by strict
proportionality to the incremental costs of that service. The range of reasonable
allocations could include some in which all common costs are recovered more than
proportionately from one or a small number of services.
6.513 In Ofcom’s view it would not necessarily be unreasonable for BT to set the charge for
the services covered by NCCN 500 to recover a share of common costs greater than
that implied by an allocation in proportion to the incremental costs of that activity,
particularly given that these are a few of many services across which competition
occurs. First, other charges may be set at less than LRIC+EPMU and thus be
making a smaller contribution to common cost recovery. It would then be necessary
for some charges to be above LRIC+EPMU to ensure full cost recovery. Second,
even in competitive markets it is not the case that overall revenues, taking all
products together, are at all times just equal to cost including a rate of return equal to
the cost of capital.420 Third, as discussed as paragraph 6.301 above, cogent
evidence of excessive pricing would be needed under these tests to support an
infringement finding.
6.514 Ramsey pricing is a means of calculating the price which optimally recovers fixed
costs subject to an overall zero (supernormal) profit constraint. Specifically, it
requires the price of each service to be equal to the marginal cost of that service plus
a mark-up which is inversely proportional to the (market) elasticity of demand for that
service. It therefore relies on elasticity information which, in practice, is not likely to
420
OFT 414a, paragraphs 2.16-2.20.
196
be available. Moreover, a rational firm will set prices taking account of firm level
elasticities which may differ from the market elasticities required for efficient Ramsey
prices to be set.
6.515 Even if demand elasticity information were available, Ofcom notes that, while
Ramsey pricing represents an efficient cost recovery rule for fixed or common costs
(and hence represents one interpretation of FAC for a multi-product firm), it is not
necessarily unreasonable for the charge for a service to recover a share of fixed or
common costs in excess of that implied by the Ramsey pricing rule for that service.
First, as with LRIC+EPMU charges, the Ramsey rule cannot be applied to one
service in isolation. If other charges are set at less than the level implied by the
Ramsey pricing rule and are thus making a smaller contribution to common cost
recovery, it would be necessary for some charges to be above the Ramsey price to
ensure full cost recovery. Second, even in competitive markets it is not the case that
overall revenues, taking all products together, are at all times just equal to cost
including a rate of return equal to the cost of capital.421
6.516 In its recent judgment in the BHB case the Court of Appeal came to the view that, in
deciding whether a price is excessive, in the sense of bearing “no reasonable
relation to economic value”, customer willingness to pay should be taken into
account.422 A Ramsey price could be said to be consistent with this principle since,
by being based on elasticities of demand, it is related to willingness to pay.
6.517 However, a Ramsey price is not the only price that might be said to reflect willingness
to pay, and there is no suggestion in the BHB judgment that the Court of Appeal
intended to suggest this. Indeed, it is clear that originators of NTS traffic continued in
practice to (be willing to) pay NCCN 500 prices. In any case, as discussed further
below, the BHB case is different in crucial respects to the present case.
6.518 The ECPR is an access pricing rule which is intended to prevent statically inefficient
entry by pricing access at retail price minus costs saved by supplying a wholesale
competitor rather than the retail market. The ECPR price is therefore derived from
and dependent on the retail price and does not bear any necessary relation to the
“costs actually incurred” in the provision of the wholesale service. It is therefore
unlikely to be appropriate as a test for excessive pricing. It is rather a rule which
specifies the margin between a retail and a wholesale price and so is, in effect a
form of the margin squeeze test on a narrowly defined market, which Ofcom has in
any case rejected as inappropriate (see paragraphs 6.148 et seq above).
6.519 C&W has suggested that LRIC may be the appropriate cost standard in this case. To
suggest that any price above LRIC should be considered excessive is incorrect as, if
all prices were set at or below LRIC, recovery of common costs would be impossible.
This would be unsustainable.
Ofcom’s SAC model
6.520 C&W objects to SAC on the basis that it does not allow the firm to “benefit from
economies of scale and common costs”. C&W is incorrect on the first point, since
Ofcom allows for economies of scale by modelling a firm supplying a volume of calls
equivalent to BT’s. While it is true that the single product firm modelled by Ofcom
does not benefit from economies of scope, this is by design and is appropriate to the
test, since SAC by definition assumes a single-product firm.
421
422
Ibid.
Case No A3/2006/0126 [2007] EWCA Civ 38, paragraphs 212-218.
197
6.521 The validity of the SAC test does not depend on the actual existence of singleproduct firms. Indeed, in competitive markets where economies of scope are
significant, competition would place pressure on such companies to diversify in order
to lower costs, or leave the market.
6.522 C&W appears to understate the ability of small firms without significant network to
operate in NTS termination/hosting, though of course this may to some extent be
dependent on the availability of some network services at regulated charges, which
mitigates “the natural monopoly characteristics of a telecoms access network [and]
the extent of shared infrastructure between calling products” described by C&W.423
6.523 Ofcom notes in passing that the actual existence of some single-product operators in
NTS call termination/hosting (e.g. operators providing voice NTS call termination
services) does not imply BT’s NTS call termination/hosting prices are excessive. The
evidence suggests that these providers are based on a different business model to
that set out in the SAC model. In the SAC model, the single-product firm was
modelled to provide the same quality of service to a similar size of customer base to
BT, but to have only a few points of interconnection with BT’s network. Accordingly,
actual single-product providers of NTS call termination/hosting are likely to provide a
lower level of service than the firm modelled for the purpose of the SAC model, and
therefore have lower unit costs (e.g. customers managing their accounts themselves
online for an actual single-product firm, compared to dedicated customer account
managers for our modelled firm).
Other comments
6.524 CPW argues that Ofcom should have investigated a range of FAC approaches.
Ofcom did undertake a range of FAC based tests (see paragraphs 6.338 et seq
above) which provide evidence relevant to assessing excessive pricing. While, in
these tests, Ofcom found BT was pricing above the FAC for relevant NTS number
ranges while NCCN 500 was in force, the evidence provided by the analysis of FAC
was not conclusive evidence in itself, given that BT passed the test based on SAC
and in the absence of compelling evidence of adverse effects on competition and
limited evidence of an adverse effect on consumers (see paragraph 6.299).
6.525 CPW has concerns that Ofcom’s model contains unrealistic assumptions, since “no
new entrant would decide to enter the UK communications market with a view to
supply only NTS services.” Ofcom’s removal of conveyance assets from the model
does not fully capture this issue, in CPW’s view.
6.526 Ofcom has already addressed respondents’ concerns that the “unrealistic”
assumptions invalidate the application of a SAC approach (see paragraph 6.521 et
seq above). In response to CPW’s second point, the reason for modelling a
“network-less” provider buying in geographic termination services from BT is to
ensure a model which is both tractable and transparent, and where relevant
information was available to populate the model. Moreover, such an approach
provides for a conservative assessment of SAC, since by not requiring significant
investments in fixed network assets, a pass of this test by BT at this SAC level will
necessarily imply a pass in an SAC approach which seeks to model significant
network costs.
6.527 In considering prices relative to costs (i.e. assessing BT’s profitability) on both an
FAC and SAC basis and, in respect of each approach, assessing profitability for
423
C&W’s response to the draft decision, page 46.
198
various number ranges and product groupings, as well as assessing the fairness of
the prices (including whether there existed relevant comparisons), Ofcom has
considered the allegation of excessive pricing in the round.
Other allegations made by C&W
6.528 In addition to the three principal allegations considered above, C&W’s submission
argued that BT’s conduct constituted an abuse of BT’s dominant position in that it:
•
increased C&W’s costs of providing a competing service (or forced it to offer a
service inferior to that provided by BT, e.g. a call origination service which does
not include calls to particular numbers);
•
increased BT’s market power in NTS call origination and NTS call termination,
which for a dominant undertaking such as BT constitutes an abuse in itself; and
•
formed part of a concerted strategy to dilute competition.
6.529 These further allegations are addressed below.
NCCN 500 increased C&W’s costs of providing a competing service
6.530 C&W submitted, at paragraphs 8.40-8.46 of its submission to Ofcom of 15 March
2005, that NCCN 500 constituted an abuse of BT’s dominant position in that it
increased C&W’s costs of providing a competing service, or forced them to offer an
inferior service.
6.531 C&W set out three possible courses of action that BT’s competitors might take in
response to the price increase notified in NCCN 500:
“absorb the price increase and become less profitable in providing
retail access services and potentially less profitable compared with
service providers whose calls originate with BT;
increase prices to their end user customers; or
offer a more limited service that does not provide access to BT’s
hosted numbers.”424
6.532 Ofcom considers that were a price increase to make BT’s competitors “less
profitable”, this would not constitute an abuse of BT’s dominant position unless it
could be demonstrated that the impact on BT’s competitors’ profits was sufficient to
lead to a margin squeeze.
6.533 As set out above, Ofcom has considered whether the prices notified in NCCN 500 led
to a margin squeeze in either retail calls and access provision or NTS hosting.
Ofcom concluded that NCCN 500 did not lead to a margin squeeze in either market.
6.534 It follows from this that BT’s competitors, if at least as efficient as BT, could remain
profitable (even if they were less profitable than previously) without having recourse
to either of the other two possible courses of action suggested by C&W.
424
C&W submission of 15 March 2005, paragraph 8.41.
199
6.535 Ofcom therefore concludes that the charges notified in NCCN 500 do not constitute
an abuse of BT’s dominant position on the basis that they increased C&W’s costs of
providing a competing service.
NCCN 500 increased BT’s market power
6.536 C&W submitted, at paragraphs 8.47-8.59 of its submission, that NCCN 500
constituted an abuse of BT’s dominant position in that it increased BT’s market
power in NTS call origination and NTS call termination, which for a dominant
undertaking such as BT constitutes an abuse in itself.
6.537 C&W submitted that there were a number of case law precedents for such a finding
including Tetra Pak International v Commission and Compagnie Maritime Belge
Transports v Commission.425
6.538 Ofcom notes that both cases refer to the “special responsibility” of a dominant
undertaking and come to the view that:
“the actual scope of the special responsibility imposed on a
dominant undertaking must be considered in the light of the specific
circumstances of each case which show that competition has been
weakened.”426
6.539 Ofcom also notes that both cases involved dominant undertakings with a very high
market share, and that in Compagnie Maritime Belge Transports v Commission there
were only two competitors in the relevant market.
6.540 Ofcom does not hold the view that NCCN 500 increased BT’s market power in the
markets for wholesale call origination or NTS call termination/hosting as explained
below.
6.541 As set out in Section 5 above, BT’s market power derives mainly from the restricted
ability of its competitors to respond to any increase in BT’s charges for NTS call
termination. This is essentially a result of features of the relevant market and its
relationships with other markets (for example the fact that other TCPs’ charges for
NTS call termination are, in effect, regulated via regulation in the wholesale and retail
call origination markets, and the limited incentives for BT’s competitors to establish
bilateral agreements for NTS transit rather than using BT). Ofcom does not consider
that a position of dominance relying on such factors will be either strengthened or
weakened by a change in BT’s charges for NTS call termination.
6.542 While BT’s market share is not a determining factor in its position of dominance in the
market for NTS call termination/hosting, an increase in BT’s market share
attributable to NCCN 500 might offer evidence that BT’s position of dominance had
been further strengthened as a result of NCCN 500. However, as discussed in
Section 5 above, Ofcom did not observe any increase in BT’s share of the relevant
market over the period in question.
6.543 Finally, Ofcom’s analysis of BT’s conduct does not support C&W’s allegation. Had
Ofcom concluded, for example, that BT’s conduct had led to a margin squeeze on its
competitors (in either call origination or NTS hosting) this might provide evidence
425
Case C-333/94, Tetra Pak International v Commission, judgement of 14 November 1996 and case
C-395/96, Compagnie Maritime Belge Transports v Commission, judgement of 16 March 2000.
426
Case C-333/94, paragraph 114.
200
that their competitive position vis-à-vis BT had deteriorated as a result of NCCN 500
and that conversely BT’s market power had increased. However, Ofcom concluded
that NCCN 500 did not lead to a margin squeeze on BT’s competitors.
6.544 Ofcom therefore concludes that the charges notified in NCCN 500 do not constitute
an abuse of BT’s dominant position on the basis that they increased BT’s market
power in a relevant market.
NCCN 500 was part of a concerted strategy to dilute competition
6.545 C&W submitted, at paragraphs 8.60-8.66 of its submission, that NCCN 500
constituted an abuse of BT’s dominant position in that it formed part of a strategy to
influence the commercial conduct of BT’s competitors in the relevant market.
6.546 In support of this allegation, C&W quoted BT’s response to Ofcom’s NTS call
termination market review:
“BT took explicit account of the commercial drivers of OCPs, setting
pricing that would not cause them either to cease buying BT’s NTS
services or to increase retail pricing … the result was pricing that set
call origination charges on a broadly reciprocal basis between
OCPs, while leaving all parties a reasonable rate of return for an
efficient operator … NCCN 500 was aimed at bringing retail OCP
retentions closer into line [with the rates Ofcom permitted BT to
retain].”427
6.547 C&W submits that on the basis of this statement:
“It is clear that NCCN 500 is designed, and was designed from the
outset, to control the commercial behaviour of competitors, thereby
relieving competitive pressure on BT in related markets such as the
NTS services hosting market and NTS retail services markets.”428
6.548 Ofcom considers that BT’s intentions in increasing its prices for NTS call termination
via NCCN 500 might be relevant to its decision in this case.
6.549 In particular, had Ofcom concluded that BT’s conduct constituted an abuse of its
dominant position, evidence as to BT’s intentions would have been relevant in
calculating any appropriate penalty that could be imposed.
6.550 The CAT in Napp stated that an infringement is committed “intentionally” if the
undertaking must have been aware that its conduct was of such a nature as to
encourage a restriction or distortion of competition.429
6.551 However, on the basis of the analysis set out above, Ofcom has concluded that BT’s
conduct did not constitute an abuse of its dominant position in NTS call
termination/hosting in the UK.
6.552 Nonetheless, as part of the investigation, Ofcom considered BT’s intentions in
relation to the NCCN 500 price increase and found no evidence of exclusionary
intent.
427
C&W submission of 15 March 2005, paragraph 8.61, quoting BT’s response to the market review
consultation, pages 33 and 35 (original emphasis).
428
C&W submission of 15 March 2005, paragraph 8.63.
429
[2002] CAT 1, paragraph 456.
201
6.553 In particular, as part of its investigation, Ofcom required BT to provide internal
documents relevant to its strategy in issuing both NCCN 500 and NCCN 651, as well
as documents relating to the largest hosting contracts that it bid for during the period
that NCCN 500 was in force (in order to assess how NCCN 500 affected BT’s
competitiveness). This information was requested in section 26 Notices of 26 April
2005, 14 November 2005 and 24 April 2006.
6.554 Ofcom’s analysis of BT’s responses does not support C&W’s allegation that NCCN
500 formed part of a concerted strategy to dilute competition. NCCN 500 appears to
have had two aims:
•
to increase BT Group revenues; and
•
to encourage Ofcom to reconsider the NTS regulatory regime.
Evidence of intention to increase BT Group Revenues
6.555 An internal briefing note on the first complaint stated that:
“The driver for this pricing decision was that BT felt there was up to
£[] of incremental revenue that could be generated without directly
triggering a pricing impact for dialling consumers.”430
6.556 The source of this additional revenue was the disparity between BT’s retail charges
and those of its competitors: BT offers retail discounts for calls to 0845/0870
numbers, whereas other originating providers do not. The original intention was “to
reduce the ‘average discounts’ value in other operators’ NTS formula calculations”,
until it was pointed out that:
“the same outcome could be achieved simply by raising BT’s
termination prices for these services, as BT had no ex ante pricing
constraints on these services.”431
Evidence of intention to encourage Ofcom to reconsider the NTS regulatory
framework
6.557 In addition, NCCN 500 was seen as having a longer term strategic value. It was
commented that the proposal:
“fully seeks to exploit current regulation inconsistencies.”432
and that it:
“closed what could be called a ‘regulatory loophole’ the altnets were
exploiting.”433
6.558 BT appears to have seen NCCN 500 as a “bargaining chip”, which BT was prepared
to give up in return for concessions from its competitors:
430
Briefing paper about the first complaint, 12 May 2004, provided by BT in response to section 26
Notice of 22 April 2005 numbered 1.11.
431
Ibid.
432
BT response to Ofcom section 26 Notice of 22 April 2005, item numbered DK241.
433
BT response to Ofcom section 26 Notice of 22 April 2005, item numbered KE674.
202
"I am expecting that, if we manage to agree a new NTS arrangement
with the industry, there will be a contractual piece that makes the
charges reciprocal in some way. This would ostensibly foreclose
NCCN 500 and similar efforts. However, that does not mean we
would lose the VALUE of NCCN 500 (etc.), as these would be live
pieces of cash that would be in the melting pot for discussion (e.g.
we would want to see something like that £[] per annum in our
pockets, but perhaps in a different form such as improved retail
margins). This would represent a giveaway of what we consider to
be our commercial freedom, so it is a valuable bargaining chip…I
have never made a secret of the view that I believe NCCN 500 gives
us the only valuable bargaining chip in the game, when dealing with
other operators.”434
6.559 NCCN 500 was also viewed as a way of putting pressure on Ofcom to review the
broader NTS regime:
“This proposal will help to add force to BT’s view that the regime
needs to be overhauled by demonstrating that BT can use the
current structure to its advantage, just as other operators have used
it to their advantage in the past. The price change will also
emphasise that the regime is highly uncertain and is difficult to plan
for.”435
Conclusions on BT’s intent
6.560 Ofcom’s conclusion, on the basis of the documents supplied by BT, was that BT’s
intentions in issuing NCCN 500 were to generate additional revenue for BT Group
and to draw attention to anomalies in current regulation that meant that BT was free
to raise its charges for NTS call termination, since BT believed that the framework
gave its competitors freedoms from which BT did not benefit.
6.561 BT’s decision to withdraw the price increases notified in NCCN 500 appears to have
been motivated by factors other than attempting to end conduct that BT knew to be
anti-competitive (see paragraph 5.138 above, second bullet), including improving
relationships with both Ofcom and wholesale customers.
6.562 [].
6.563 Therefore, the withdrawal of NCCN 500 was seen as:
[]
6.564 In a paper to the BT Operating Committee (“OC”) of 19 September 2005, the view is
set out that:
[]
6.565 In the face of a likely forced withdrawal of NCCN 500, BT believed that its best option
was to voluntarily withdraw it in order to improve relationships with Ofcom and
wholesale customers:
434
435
BT response to Ofcom section 26 Notice of 22 April 2005, item numbered CA255.
BT response to Ofcom section 26 Notice of 22 April 2005, items numbered 1.8 and DK929.
203
[]
6.566 []
6.567 Ofcom believes that BT’s intention in the setting of NCCN 500 was not to reduce
competition, but to generate additional income while also highlighting a regulatory
‘loophole’ that its competitors were exploiting. The decision to withdraw the price
changes in NCCN 651 was made when senior management weighed up the benefits
of increased revenue against the costs of provoking Ofcom and wholesale
competitors/customers.
Evidence on hosting contracts
6.568 Ofcom also requested information into the top ten hosting contracts bid for by BT
during the period NCCN 500 was in place, in order to ascertain whether NCCN 500
had the effect of enabling BT to win more business.
6.569 The information received from BT served to highlight the highly competitive nature of
the market, both in price and non-price competition, but did not suggest that BT was
better placed to win new business than it had been before NCCN 500.
6.570 When discussing a particular contract in internal emails, one of BT Wholesale’s Sales
team members states that:
“This particular customer will trawl the marketplace for an 0845
provider offering zero ppm. We need to have a zero on 0845 to
ensure that we keep the business and that [customer x] don’t go off
to Opal/C&W who would jump at offering zero for this amount of
business (approx 60 million minutes per year).”
6.571 Ofcom also noted from the information received from BT that it has stringent
regulatory controls in place for approving new bids, and in certain circumstances this
can prove a hindrance to winning new business, as a member of the Sales team
notes:
“Having to receive sign off levels from Legal, Finance, Business
Operations and a Bid Manager for every single bid is not an effective
use of time considering we only win 30% of the business we bid for
and in most cases the net revenue is well under £500k.”
6.572 Ofcom therefore concludes that the charges notified in NCCN 500 do not constitute
an abuse of BT’s dominant position on the basis that they were part of a concerted
strategy on the part of BT to reduce competition.
Responses to draft decision: impact on BT’s competitors and BT’s intentions
6.573 Four respondents commented on the impact of NCCN 500 on BT’s competitors and
on BT’s intention when it issued NCCN 500.
C&W
6.574 C&W stresses that “we do not necessarily accept that it is necessary to show effect
or intention for BT’s conduct to be abusive”. Nevertheless, C&W believes that BT’s
204
competitors were adversely impacted by NCCN 500 and that BT was aware that this
would be the outcome.436
6.575 C&W argues that Ofcom has not fully analysed the impact that BT’s conduct had on
competitors. It states that:
“(w)hile Ofcom appears to acknowledge the lack of competitive
constraints facing BT and therefore its ability to raise its prices in the
manner that it did, Ofcom appears to actually fall short of
acknowledging the damage that this caused to BT’s competitors.”437
6.576 C&W submits that the inability of BT’s competitors to respond to the price change
“must have negatively impacted BT’s competitors’ ability to effectively compete
against BT”. C&W submits that Ofcom has failed to take this into account “other than
for concluding that BT held a position of dominance on the market”.438
6.577 C&W notes that, as set out in its original submission, it lost £[] “as a direct result of
NCCN 500” and that “other [communications providers] made losses as a direct
result of NCCN 500”.439
6.578 C&W submits that Ofcom has been “less robust” than it should have been in
assessing the impact of NCCN 500 because the price rises were in effect reversed
with NCCN 651, and that Ofcom should have made an assessment of the likely
impact of NCCN 500 “over time”. C&W claims that:
“we would have been unable to sustain that level of loss in the long
run without having to make commercial decisions about our
continued ability to stay in the market.”440
6.579 The fact that BT claims it was “exploiting a regulatory loophole” is, C&W argues, no
defence for its behaviour “if [BT] understood that to exploit it would be damaging to
competition”.441
6.580 C&W states that, as Ofcom acknowledges, BT’s competitors’ responses to NCCN
500 may have been influenced by the knowledge that Ofcom was investigating, and
that BT’s competitors may therefore have decided to absorb the additional cost
imposed by NCCN 500 even though such a strategy would not have been viable in
the long term:
“BT knew that any increase in revenue [from NCCN 500] would be a
direct result of losses that its competitors would face. We fail to see
how this could not equate with an intention to harm competition. It
must have been foreseeable by BT that if its competitors would lose
revenue in direct proportion to the increase in BT’s revenue, that this
would not be sustainable over time and could lead to its competitors
exiting the market for the provision of NTS services. This in itself
must be an intention to distort competition.”442
436
C&W’s response to the draft decision, page 20.
C&W’s response to the draft decision, page 18.
438
C&W’s response to the draft decision, page 19.
439
C&W’s response to the draft decision, page 29.
440
Ibid.
441
C&W’s response to the draft decision, page 51.
442
C&W’s response to the draft decision, page 50.
437
205
6.581 C&W also states that:
“while there is no need to demonstrate intention, BT’s stated reasons
for NCCN 500 do not constitute defences for its behaviour. If
anything they exacerbate it.”443
6.582 C&W submits that it is “implausible” that the fact BT was aware that its competitors
would be limited in their ability to retaliate “cannot be considered as anti-competitive”
per se. C&W mentions that the CAT, in Napp, held that an infringement may be
considered “intentional” if the undertaking knew its behaviour was likely to distort
competition.444
CPW
6.583 CPW states that NCCN 500:
“represented a substantial transfer of revenue from CPW to BT,
which has had a negative overall impact on CPW’s ability to
compete...CPW believes that BT introduced NCCN 500 to harm its
competitors for the simple reason it had discovered a flaw in the
NTS regulatory framework that allowed it to do so.”445
Thus
6.584 Thus claims that it:
“experienced a significant adverse financial impact as a result of
BT’s decision to raise prices through NCCN 500.”446
6.585 Thus has said that “BT knew from the outset that its competitors were likely to make
a pence per minute loss on each call originated to a BT NTS number.” In addition,
BT “picked pricing that was uplifted enough to damage their competitors and provide
them with a healthy unregulated revenue stream”.447
6.586 Thus believes that Ofcom should undertake further analysis to establish precisely
what BT’s intentions were. Thus states that it finds it “surprising” that the information
supplied to Ofcom by BT did not appear to contain any internal assessment of BT’s
competitors’ likely reactions to the price change, or any internal debate over
precisely where prices should be set.448
6.587 Thus states that
“we would urge Ofcom to request again details of all BT Group
deliberations over BT’s decision to issue NCCN 500 and the level at
which to set the pricing…If no further written documentation is
forthcoming we believe gathering oral evidence would be
appropriate in this instance. This would help to substantiate our view
that this was a deliberate and carefully thought out scheme designed
443
C&W’s response to the draft decision, page 51.
C&W’s response to the draft decision, page 20.
445
CPW’s response to the draft decision, page 1.
446
Thus’s response to the draft decision, page 1.
447
Thus’s response to the draft decision, page 3.
448
Thus’s response to the draft decision, page 4.
444
206
to inflict damage on competitors, and hence a more serious breach
than would otherwise have been the case.”449
6.588 In addition, Thus believes that “it was probably no coincidence that at the same time
as NCCN 500 was announced BT Retail embarked on a heavy consumer marketing
campaign…..[which] focused on highlighting the pricing differences between BT and
their competitors over the pricing of 0870 and 0845 calls. Thus urges “Ofcom to
request that BT supply documentation relating to the planning and timing of these
specific marketing initiatives and explore any linkage between the campaigns
themselves at the advent of NCCN 500.”450
Virgin Media
6.589 Virgin Media states that it “had very limited options to respond” to the price increases
notified in NCCN 500. Virgin Media states that suffered a material incremental
increase in costs during the period that NCCN 500 was in place, and questions “how
such a scale of impact cannot be regarded as competitively damaging”.
Ofcom comments on responses
6.590 Ofcom has not expressed a view that it is necessary to demonstrate intent in order
for BT’s conduct to be considered an abuse. Rather, Ofcom considered that any
intention on BT’s part to distort competition would have been a relevant supporting
factor in assessing evidence of an actual or likely effect on competition.
6.591 Ofcom does not dispute that there is no need to show an actual effect on competition
in order for an abuse under Article 82 or Chapter II to occur, and agrees that it is
sufficient to show that conduct likely to lead to a (detrimental) effect on competition is
sufficient to support a finding of abuse.
6.592 Ofcom’s conclusions under each allegation of abuse are that the conduct did not lead
to an actual or likely (detrimental) effect on competition. In this case, the conduct
complained about was in place for a period of 20 months – a time in which any
anticompetitive effects of the conduct might have been expected to have become
evident.
6.593 The respondents suggest that the inability of BT’s competitors to respond to NCCN
500 is evidence that they could not compete effectively with BT, and that BT’s
conduct is therefore abusive.
6.594 Ofcom did come to the conclusion that BT’s competitors did not have the ability to
constrain the pricing behaviour of BT (see paragraphs 5.132-5.135 above). However,
while that conclusion means that BT has the ability to set a price that is above a
competitive level, it does not necessarily follow that BT did so in this case. Ofcom’s
assessment of BT’s conduct shows that it did not have any actual or likely effect on
competition.
6.595 C&W suggest that the fact BT was aware that its competitors would be limited in their
ability to respond to the price increase was, in itself, “anti-competitive”.
6.596 Ofcom is of the view that even if BT was aware its competitors had limited ability to
respond to the price increase notified by NCCN 500, that is not equivalent to being
449
450
Ibid.
Ibid.
207
aware that conduct is of such a nature as to encourage a restriction or distortion of
competition. Ofcom considers that such an awareness is more relevant to the intent
of the conduct. Ofcom’s assessment of the conduct and the actual evidence of what
occurred in the relevant market did not show any effect on competition.
6.597 Thus suggests that there must have been extensive debate within BT about the likely
response of its competitors to the price increase and the level at which to set prices,
and suggests that Ofcom ask BT for this information again.
6.598 Ofcom has no evidence that BT has failed to comply with Ofcom’s original request for
information. The internal correspondence supplied by BT in response to Ofcom’s
section 26 Notice of 22 April 2005 included discussions of the appropriate level of
prices, in that it referred to BT’s decision to set the level of the price change with
reference to discounts offered by other OCPs (see paragraph 6.556 above). It also
included some analysis of competitors likely reactions, although this was not referred
to in Ofcom’s draft decision.451 Ofcom notes that a number of extracts from BT’s
internal correspondence were redacted from the draft decision provided to
complainants as they contained information that was commercially confidential to
BT.
6.599 The respondents state that they were adversely impacted financially by NCCN 500.
C&W claims that, although competitors absorbed the additional cost imposed by
NCCN 500 in the short term, this would not have been a viable long-term strategy
and, had NCCN 500 remained in place, market exit may have occurred.
6.600 The intent of Article 82 and Chapter II is to prevent the distortion of competition. This
has been expressly stated in previous cases including Bronner v Media Print:
“.. it is important not to lose sight of the fact that the principal
purpose of Article [82] is to prevent distortion of competition – and in
particular to safeguard the interests of consumers – rather than to
protect the position of particular competitors.”452
6.601 This position was also endorsed in the BHB case:
“As Jacobs A-G said in Bronner (cited above), the principal of Article
82 of the Treaty is the protection of consumers, […] not of business
competitors. In our judgment this is correct, even if it is the
competitors and not the consumers who are alleging abuse of
dominant position. We need to look at ATR’s immediate interests to
the market served by ATR. There is little, if any, evidence that
competition in the market is being distorted by the demands made
by BHB upon ATR.”453
6.602 In Ofcom’s view, an adverse financial impact on a competitor does not necessarily
equate to distortion of the market and our analysis of the conduct did not show that
NCCN 500 would have made BT’s competitors unprofitable, thereby leading to a
distortion of competition or, in the limit, market exit (see in particular Ofcom’s
analysis of C&W’s allegation of margin squeeze at paragraphs 6.37 et seq above).
451
See, for example, items DK16, DK207 (OCPs increasing retail prices), CA435, CA196 (OCPs
raising termination charges, DK165 (OCPs refusing to connect calls to BT), BT’s response of 13 May
2005 to Ofcom section 26 Notice of 22 April 2005.
452
[1998] ECR 1-17791 at 7811, paragraph 58.
453
Case No: A3/2006/0126 [2007] EWCA Civ 38, paragraph 215.
208
Conclusion
6.603 The following paragraphs summarise Ofcom’s analysis of BT’s conduct and
conclusions on C&W’s various allegations.
6.604 C&W’s three principal allegations were that the price increases notified in NCCN 500:
•
imposed a margin squeeze on C&W;
•
discriminated in favour of BT and against C&W on price; and
•
were excessive.
6.605 Before finding an infringement of Article 82 and/or the Chapter II prohibition, Ofcom
must satisfy itself on the evidence that an infringement is more likely than not to have
occurred.454 The undertaking being investigated is entitled to the presumption of
innocence and to any reasonable doubt that there may be. Ofcom must therefore
proceed on the basis of an analysis that is robust and soundly based.455
Margin squeeze
6.606 Beginning with the question of an alleged margin squeeze, Ofcom considered
whether an operator as efficient as BT would be able to compete in the relevant
downstream markets identified in the investigation, had it faced the additional cost
imposed by NCCN 500.
6.607 Communications providers supply calls to NTS numbers as part of a bundle of
services including different types of calls (e.g. calls to geographic numbers and
mobile numbers) and in some cases access – they do not compete to supply NTS
calls only. Ofcom therefore concluded that it was appropriate to conduct its margin
squeeze analysis across these service bundles and not, as the respondents to its
draft decision suggested, across only the call types affected by NCCN 500. Ofcom
carried out a number of different variations of its retail margin squeeze test to
capture the different types of communications providers competing with BT in the
retail origination and calls markets.
6.608 Ofcom found that, across the relevant service bundles, BT earned high margins, with
higher margins on some call types (for example, national and international calls and
calls to mobiles) compensating for losses on other services, including those call
types affected by NCCN 500. This was true even when Ofcom discounted all the
returns associated with local calls.
6.609 Ofcom concluded that, had NCCN 500 applied to all calls originated by BT, the
impact on BT’s margin across the relevant product set would have been insufficient
to lead to a margin squeeze.
6.610 In addition to its assessment of the margin squeeze allegation outlined by C&W,
Ofcom carried out an analysis of whether the additional revenue that BT gained from
NCCN 500 could have enabled it to fund higher payments to its NTS service
providers that its competitors were unable to match, leading to a margin squeeze in
NTS hosting (see paragraphs 6.158 et seq above). As in the retail margin squeeze
454
Napp Pharmaceutical Holdings Limited v Director General of Fair Trading [2002] CAT 1, paragraph
109.
455
JJB Sports plc and Allsports Limited v Office of Fair Trading [2004] CAT 17, paragraphs 191-199.
209
analysis, Ofcom considered different variants to capture the different bases on which
other communications providers compete with BT; in this case whether they are
providing NTS hosting in voice or data.
6.611 Ofcom found that BT’s conduct did not lead to a margin squeeze in NTS hosting.
Discrimination
6.612 On the question of discrimination by BT, Ofcom considered whether BT’s charges for
NTS call termination, as notified in NCCN 500, might amount to anti-competitive
price discrimination.
6.613 As set out at paragraph 6.249 et seq above, BT appears to have acknowledged
internally that NCCN 500 imposed a charge on its competitors that was different from
the charge paid by its downstream business. This was of concern to Ofcom
However, Ofcom’s detailed analysis of financial data supplied by BT showed that
there was no “hard” charge in BT’s account that might provide a relevant comparator
for the charges that BT’s competitors were required to pay while NCCN 500 was in
force. There was not robust evidence of a “hard” charge to BT that was different from
the charge that applied to BT’s competitors.
6.614 Ofcom therefore concluded that, in the circumstances the relevant test for
determining whether BT was discriminating in favour of itself in an anti-competitive
manner is whether BT would have been able to make a profit had it paid the charges
notified in NCCN 500, taking into account profits earned on all the relevant services,
i.e. whether BT’s conduct led to the operation of a margin squeeze on other
communications providers. As set out above, Ofcom concluded that NCCN 500 did
not lead to a margin squeeze on BT’s competitors in retail access and calls markets.
Excessive pricing
6.615 As set out at paragraphs 6.323 et seq above, Ofcom considered the tests for
excessive pricing, to the extent that they were relevant in this case.
6.616 As noted at paragraph Error! Reference source not found. above, Ofcom is
mindful of the Court of Appeal’s decision in the BHB case. Ofcom did not find any
evidence that BT’s conduct in this case led to a distortion of competition or that it led
to an adverse effect on consumers generally.
6.617 The excessive pricing tests offered conflicting evidence as to whether the prices
notified in NCCN 500 were excessive. Ofcom found that BT’s prices appeared to be
significantly above its FAC, but below SAC.
6.618 Overall, in the circumstances of this case and the need for compelling evidence,
Ofcom concluded that there was insufficient evidence to demonstrate to the required
standard of proof that the prices notified in NCCN 500 were excessive and thereby
constituted an abuse of BT’s dominant position.
6.619 Having investigated each aspect of C&W’s complaint, applied appropriate tests and
examined the relevant case law, Ofcom has concluded that there are no grounds for
action in this case.
210
Annex 1
1 NCCN 500
NETWORK CHARGE CHANGE NOTICE
For Number Translation Services
NCCN NUMBER:
500
SERVICE:
BT LoCall Services
BT NationalCall Services
BT Schools 0820 Service
EFFECTIVE DATE:
1st May 2004
Associated Terms and Conditions are in Schedules 105, 106, 111, 116 and 168 of Annex C of
the Network Charge Control Standard Interconnect Agreement dated 1st October 1997
SUBMITTED TO OFTEL ON: 1st April 2004
BY: Michael Barford
ROLE: Manager, Regulatory Pricing
BT Wholesale
SIGNED: Michael Barford
1 City Place
Gatwick
West Sussex
RH6 0PA
Tel 01977 593648
211
Network
Time of Day
Gradient
Retail Time
of Day
Gradient
Current
Charge
P/Min
Proposed
Charge
P/Min @
01/05/2004
Percentage
Change %
BT LoCallTM Short Duration Calls 0345 &
0845
Daytime
Evening
Weekend
1.459
0.668
0.526
1.491
0.605
0.513
5.0674
1.2953
1.3724
6.9482
1.8274
1.9046
37.1%
41.1%
38.8%
BT LoCallTM Long Duration Calls 0345 &
0845 [NOTE 2]
Daytime
Evening
Weekend
1.459
0.668
0.526
1.491
0.605
0.513
1.7517
0.2809
0.3580
2.5682
0.4874
0.5646
46.6%
73.5%
57.7%
BT NationalCallTM Calls 0990 & 0870
[NOTE 1]
Daytime
Evening
Weekend
1.459
0.668
0.526
1.491
0.605
0.513
5.8137
3.0929
0.9723
6.0462
3.2144
1.0166
4.0%
3.9%
4.6%
BT 0820 Internet Caller Long Duration
Calls (covers Schools Internet, Primary
Schools Internet, Public Institutions
Internet)
Daytime
Evening
Weekend
1.459
0.668
0.526
1.491
0.605
0.513
0.0000
0.2809
0.3580
0.0000
0.4874
0.5646
0.00%
73.5%
57.7%
BT 0820 Internet Caller Short Duration
Calls (covers Schools Internet, Primary
Schools Internet, Public Institutions
Internet)
Daytime
Evening
Weekend
1.459
0.668
0.526
1.491
0.605
0.513
0.0000
1.2953
1.3724
0.0000
1.8274
1.9046
0.00%
41.1%
38.8%
BT Number Translation Services
Notes:
1.
2.
These charges shall also apply to BT International Incoming Calls to the service and number ranges
specified.
These charges shall also apply to BT International Incoming Calls to the Short and Long duration services
and number ranges specified.
212
Annex 2
2 NCCN 651
NETWORK CHARGE CHANGE NOTICE
For Number Translation Services
NCCN NUMBER:
651
SERVICE:
BT LoCall Services
BT NationalCall Services
BT Schools 0820 Service
EFFECTIVE DATE:
1st January 2006
Associated Terms and Conditions are in Schedules 105, 106, 111, 116 and 168 of Annex C of
the Network Charge Control Standard Interconnect Agreement dated 1st October 1997
SUBMITTED TO OFTEL ON: 2nd November 2005
BY:
Zack Thompson
ROLE:
Regulatory Pricing
BT Wholesale
SIGNED:
Zack Thompson
PP W2.157E
BT Brentwood
One London Road
Brentwood, Essex
CM14 4QP
Tel 01277 323461
213
Network
Time of
Day
Gradient
Retail Time
of Day
Gradient
Current
Charge
P/Min
Proposed
Charge
P/Min @
01/01/2006
Percentage
Change %
BT LoCallTM Short Duration Calls 0345
& 0845
Daytime
Evening
Weekend
1.459
0.668
0.526
1.536
0.549
0.498
6.9482
1.8274
1.9046
5.0185
1.9947
2.1018
-27.8%
9.2%
10.4%
BT LoCallTM Long Duration Calls 0345
& 0845
Daytime
Evening
Weekend
1.459
0.668
0.526
1.536
0.549
0.498
2.5682
0.4874
0.5646
2.1076
0.4535
0.4574
-17.9%
-7.0%
-19.0%
BT NationalCallTM Calls 0870
Daytime
Evening
Weekend
1.459
0.668
0.526
1.536
0.549
0.498
6.0462
3.2144
1.0166
5.8119
3.0862
0.9867
-3.9%
-4.0%
-2.9%
BT 0820 Internet Caller Long Duration
Calls
Daytime
Evening
Weekend
1.459
0.668
0.526
1.536
0.549
0.498
0.0000
0.4874
0.5646
0.0000
0.3888
0.4574
0.00%
-20.2%
-19.0%
BT 0820 Internet Caller Short Duration
Calls
Daytime
Evening
Weekend
1.459
0.668
0.526
1.536
0.549
0.498
0.0000
1.8274
1.9046
0.0000
1.9947
2.1018
0.00%
9.2%
10.4%
BT Number Translation Services
214
Annex 3
3 Calculation of critical elasticity for calls to
0845 numbers
A3.1
Ofcom calculated what value of retail price elasticity would be required for NCCN 500
to be unprofitable for BT with respect to 0845 calls. Ofcom has termed this value the
“critical elasticity”. This depends partly on whether the price increase is assumed to
be passed on at its full ppm value on all 0845 calls, or “diluted” to reflect the fact that
it only applied to BT terminated calls which are some []% of the total. A key
variable in this calculation is therefore the dilution parameter.
A3.2
The calculation is based on 0845 calls since this is where BT applied the biggest
proportionate price increases in NCCN 500.
A3.3
The following are the key variables in the calculation:
•
E = the retail own price elasticity of demand for 0845 calls
•
X = the proportion of the termination charge increase under NCCN 500 assumed
to be passed on in the retail price.
•
W1 = BT’s average gross termination charge for 0845 calls immediately before
NCCN 500 based on BT’s price list
•
W2 = BT’s average gross termination charge for 0845 calls immediately after
NCCN 500 based on BT’s price list
•
P1, = the pre-NCCN 500 average retail price for 0845 of a major OCP, ntl,
assuming BT’s average time of day profile and an average call duration of one
hour. It is necessary to assume an average call duration in order to calculate an
average call set-up charge per minute. This unrealistically long average call
duration would tend to understate the pre-NCCN 500 retail price and
consequently also the extent to which a BT price increase would be profitable
•
P2 = P1 + (W2 -W1 )*X, the retail price that would be charged following NCCN
500
•
Q1 = the volume of 0845 calls at price P1
•
Q2 = Q1 * (1+ E * (P2 - P1)/P1), the volume of 0845 calls at price P2,
A3.4
Ofcom then calculated values of E such that profits are unchanged for values of X
equal to 1) []% and 2) 100%.
A3.5
Note that, because this does not allow for the reduction in volumes to lead to cost
savings for BT, other than savings from reduced revenue share payments, this
calculation would tend to understate the extent to which a BT price increase would be
profitable and produce a lower bound for the critical value of elasticity.
215
Annex 4
4 Related markets
A4.1
For the purposes of this investigation, Ofcom has considered:
•
the relevant market in which BT may hold a dominant position and in which the
conduct in question has taken place, i.e. the market in which NTS call
termination/hosting falls;
•
any other upstream markets, in which BT’s position may influence the extent to
which it faces competitive constraints in the relevant market; and
•
downstream markets in which any effect of BT’s conduct in NTS call
termination/hosting may be felt.
Retail calls to NTS numbers
A4.2
This section discusses the downstream market(s) in which the effect of BT’s conduct
in this case might be felt.
A4.3
C&W alleged that NCCN 500 would have the effect of creating a margin squeeze
between BT’s wholesale charges and its retail call prices, since it increased the costs
incurred by OCPs other than BT in providing retail calls to 0845 and 0870 NTS
numbers.456 These services, referred to in the following discussion as “retail NTS
calls” are downstream of NTS call termination/hosting because NTS call termination
is a necessary input to a retail end-to-end NTS call.
Product market
A4.4
In 2005 Ofcom carried out an analysis that briefly considered the relevant market for
retail NTS calls (“the August 2005 review”).457
A4.5
In the August 2005 review, Ofcom outlined its view that calls to NTS numbers are
part of a product market that is distinct from the markets for other call types.
A4.6
Ofcom argued in the August 2005 review that fixed and mobile calls are in separate
markets, because:
A4.7
456
•
demand-side substitution between the two call types is restricted by differences in
price and functionality; and
•
barriers to entry prevent constraints between the two call types being imposed by
means of supply-side substitution.
Ofcom argued that calls to non-geographic numbers are not in the same market as
calls to geographic numbers, because:
With only BT-terminated calls affected by NCCN 500.
Review of BT’s network charge controls, statement of 18 August 2005 (see footnote 14),
paragraph A5.20 et seq. This analysis was based on a summary of the narrowband market reviews
carried out by Oftel in 2003 (see http://www.ofcom.org.uk/consult/condocs/narrowband_mkt_rvw/).
457
216
A4.8
A4.9
•
the two call types are not substitutable from a demand-side perspective because
they are used for different purposes, e.g. it would not be possible, using a nongeographic number, to reach the same called party as could be obtained on a
geographic number (and vice versa); and
•
there is no scope for supply-side substitution between the two call types to
provide further constraints because all suppliers of retail non-geographic calls are
already supplying geographic calls.
Ofcom argued that calls to different types of non-geographic numbers (e.g. DQ, PRS,
other NTS ranges) are in different markets since:
•
these different call types are not substitutable from a demand-side perspective,
since they are used for different purposes (in a manner analogous to geographic
and non-geographic calls); and
•
there is no scope for supply-side substitution between different types to provide
further constraints, because all suppliers of non-geographic calls are already
supplying all non-geographic call types.
However, the issue of whether there might be distinct markets within the broader
category of calls to NTS numbers was not considered.
A4.10 Ofcom also concluded that residential and business calls are in separate markets,
since:
•
there is limited scope for demand-side substitution between the two call types,
given that suppliers are able to identify residential and business customers, and
charge different tariffs; and
•
there is limited scope for supply-side substitution between the two because of the
tendency of residential and business customers to be located in distinct
geographic areas.458
A4.11 Taken together, the arguments set out in the August 2005 review suggest that there
are two distinct product markets for:
•
NTS calls made by business users; and
•
NTS calls made by residential users.
A4.12 It is, however, important to consider two further issues, namely:
i)
whether narrower definitions might be appropriate, i.e. whether there is a distinct
product market for retail calls to 0845 numbers, and so on; and
ii) what implications, if any, the buying patterns of these services have for market
definition.
A4.13 When carrying out a SSNIP test analysis for calls from fixed lines, the appropriate
starting point, as outlined in Ofcom’s most recent full review of retail markets, is for
458
Paragraph A5.28 et seq. of the August 2005 review.
217
calls between a pair of individuals, i.e. a call from person X to person Y.459 Such a
market definition will typically not be broadened to encompass calls to other
individuals by demand-side substitution, but might be broadened by supply-side
substitution to the extent that cost-based termination is available, and it does appear
that suppliers of retail calls face a common pricing constraint across all recipients in
setting call prices within a call type (e.g. local calls, calls to mobiles, and so on).
A4.14 Taken in isolation, this factor might arguably suggest that there is a distinct economic
market for every call type across which a common pricing constraint applies, i.e. one
market for local calls, another for calls to mobiles, another for calls to 0845 numbers,
and so on.
A4.15 However, in relation to point ii), it is important to note that calls to NTS numbers are
only ever bought as part of a package of services. This suggests that competition
tends to take place within a market that includes a larger variety of products and
service than calls to NTS numbers alone (a fact arguably supported by the widely
differing prices for these calls on different networks), with providers competing
against each other to supply a bundle of services.
A4.16 There are therefore compelling reasons to think that defining narrow calls markets for
these call types would be inappropriate. For example, when considering one of the
key determinants of market power, namely the scope for market entry, it would not be
the case that entry would only take place in relation to 0845 calls following an
increase in the price of this type of calls.
A4.17 As discussed in Section 6, communications providers use a number of different
business models in order to sell retail calls services to end users, namely:
•
all retail calls plus access;
•
all retail calls but not access (CPS all calls); and
•
some retail calls but not access (CPS national and/or international calls).
A4.18 The smallest bundle of services within which retail NTS calls are provided therefore
includes a number of other call types, in particular local calls and calls to mobiles.
A4.19 Downstream retail market definitions are not material to assessing whether the
charges notified in NCCN 500 charges were excessive or discriminatory. This is
because the key reason for defining the relevant retail market(s) definition is to assist
with Ofcom’s assessment of C&W’s allegation that NCCN 500 imposed a margin
squeeze on OCPs other than BT.
A4.20 As explained in Section 6, Ofcom’s view is that the appropriate breadth of a test to
ascertain whether BT’s conduct led to a margin squeeze in wholesale call origination
is not solely determined by the scope of the economic market(s) in which any margin
squeeze would be felt. Having analysed BT’s costs and revenues for 2004/05, Ofcom
concluded that NCCN 500 did not create a margin squeeze.
459
Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit
markets, statement of 26 August 2003 (see footnote 66)Fixed Narrowband Retail Services Market Identification and analysis of markets, Determination of market power and Setting of SMP conditions Explanatory statement and Notification, 26 August 2003,
http://www.ofcom.org.uk/static/archive/oftel/publications/eu_directives/2003/fix_narrow_retail0803.pdf
218
A4.21 On this basis, Ofcom’s view is that it is not necessary to formally conclude on the
relevant retail market definition for the purpose of this decision, beyond the fact that
calls to NTS numbers are always supplied as part of a bundle of services. Given that
NCCN 500 did not create a margin squeeze, Ofcom’s view is that there are separate
downstream markets for services sold to residential and business customers, and
that those markets should be further delineated on the basis of a bundle that is no
narrower than the minimum bundle of services in which retail NTS calls may be
offered as a component, principally the following retail products within the UK:
•
local calls;
•
calls to mobiles; and
•
calls to NTS numbers.
A4.22 It is also worth noting that some (voice) NTS calls are originated on one of the five
mobile networks. Ofcom has considered whether it is necessary to carry out a market
definition exercise for such calls and concluded that it is not, for the following
reasons. First, Ofcom’s upstream market definition encompasses the termination of
calls originated on both fixed and mobile networks callers, meaning that considering
the market definition for mobile calls would not have any further impact on the
upstream market definition. Second, it has not been suggested that NCCN 500 could
have an impact on competition in calls markets that include calls made by mobile
customers.
Geographic market
A4.23 As noted in Section 4, the SSNIP test is relevant for defining the geographic market
as well as the product market. In this context, the SSNIP test assesses whether a
hypothetical monopolist in one geographic area would be constrained by consumers
switching to other suppliers in other areas, or by other suppliers switching to the area
in which the hypothetical monopolist supplies.
A4.24 Demand-side substitution between different geographic areas tends not to be
feasible for any call type (e.g. customers wanting to make a call from Town X to
Town Y do not view a call to the same destination but made from Town Z as a
substitute). Supply-side substitution may, however, be feasible, depending on the
availability of wholesale inputs on reasonable terms. The identification of a common
pricing constraint is therefore often an important factor to consider in defining the
relevant geographic market.
A4.25 For all retail call types, including NTS calls, BT currently charges a uniform price to
callers throughout the country. This means that any response by BT to competition in
a given area in the form of lower prices would apply throughout the UK (excluding the
Hull area), and therefore that the geographical extent of the relevant markets should
be regarded as the whole of the UK (excluding the Hull area), and the Hull area. This
means that the extent of the geographical market is the whole of the UK, excluding
the Hull area where a uniform constraint holds.
A4.26 For the purposes of this investigation, Ofcom has not considered this definition in any
great depth, since the geographic scope of downstream markets does not have any
key implications for the market definition for termination/hosting, with TCPs
terminating traffic on behalf of communications providers based throughout the UK,
or indeed on the scope of the relevant margin squeeze test, since Ofcom’s analysis
219
has considered the impact of NCCN 500 on competition between BT and all the
types of competing providers which operate on a mostly national basis.
Other wholesale calls markets
Wholesale narrowband call origination
The relevant product market
A4.27 Wholesale call origination is a key input into all of the retail call types described in the
previous section.
A4.28 Ofcom’s view is that there is a single market for narrowband call origination (which is
used as an input into all of these call types), and that BT has SMP in that market.
This view was set out in Ofcom’s 28 November 2003 statement Review of the fixed
narrowband wholesale exchange line, call origination, conveyance and transit
markets and confirmed in Ofcom’s 18 August 2005 statement Review of BT’s
network charge controls.460
A4.29 The delineations discussed in the previous section, based on different call types (e.g.
national, international) and customer types (business/residential) do not apply to the
corresponding wholesale call origination product, as call origination is a uniform
product and does not differ according to the ultimate destination (e.g. a fixed
geographic number or a mobile number) of the call. While the charge for NTS call
origination differs from that for other types of calls in that it includes an explicit
contribution to retail cost recovery, it is part of a cluster of origination services bought
by suppliers of retail calls from suppliers of origination.
A4.30 OCPs compete to provide a range of services over a single access line, rather than
limited services across many access lines. Such competition means that customers
choose the provider that can provide the range of services at the lowest price. The
fact that retail call origination is always purchased as part of a bundle provides further
support for the view that all call origination services should be treated as forming part
of a single product market.
A4.31 Finally, a common pricing constraint applies to the call origination services that are
supplied as an input into all retail call types, including services sold to both residential
and business customers.
A4.32 Ofcom’s conclusion is that there is a single market for wholesale call origination,
used as an input into all call types sold to both residential and business customers.
The relevant geographic market
A4.33 The application of the SSNIP test to wholesale call origination (and also to transit as
discussed below) implies a potentially very narrow geographic market definition. This
is because the price of call origination provided by a hypothetical monopolist at, for
example, at a particular exchange:
460
Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit
markets, statement of 28 November 2003 (see footnote 12) and Review of BT’s network charge
controls, statement of 18 August 2005 (see footnote 14).
220
•
would not be constrained by demand-side substitution to call origination in other
areas, since customers are only interested in obtaining call origination from a
particular location; and
•
would not be constrained by supply-side substitution by suppliers from other
areas, because of the significant time and expense that would be required for
supply-side substitution to take place from other areas.
A4.34 Ofcom’s view is that the market for call origination (outside the Hull area, where BT
does not operate) is national in scope. The key aspect of BT’s position in the market
for call origination in the context of NCCN 500 is its regulatory requirement to supply
origination for NTS calls at cost-based charges. This remedy has been applied by
Ofcom on a uniform basis in all geographic areas. It is not the case that a TCP in any
one area in the country is more or less able to negotiate with BT when setting its
gross termination charges. The analysis that follows therefore assumes a single
national market for call origination (outside the Hull area).
Conclusion
A4.35 The relevant market is call origination in the UK excluding the Hull area.
BT’s position on the relevant market
A4.36 Ofcom has designated BT has having SMP in the market for wholesale call
origination in the UK excluding Hull.
A4.37 The primary source of this position of dominance is BT’s position as the incumbent
communications provider, and the only undertaking with a ubiquitous access
network. No other provider has so far found it commercially attractive to attempt to
replicate this network reach.
A4.38 BT’s market share of call origination has fluctuated between about 70% and 80% for
a number of years.461
A4.39 No other provider is in a position of countervailing buyer power, since they all
compete with BT at the downstream level, and BT’s own retail business is by some
distance the biggest buyer of call origination
A4.40 Ofcom imposed the NTS call origination condition on BT in order to promote
competition in NTS, given BT’s SMP in the market for wholesale call origination.
Single transit
The relevant product market
A4.41 Single transit is a service provided by a transit provider in respect of calls originating
and terminating on networks other than its own, where the OCP and TCP are directly
connected to the same transit provider’s tandem exchange. The call is therefore
transited through a single tandem exchange.
A4.42 Single transit is in an economic market which is distinct from that for other wholesale
calls services such as inter tandem transit (“ITT”) (see below). Since Ofcom has
461
See for example Review of BT’s network charge controls, statement of 18 August 2005 (see
footnote 14), paragraph A5.45.
221
determined that no provider has SMP in the market for ITT, Ofcom’s analysis of
single transit focuses on constraints imposed on single transit by ITT.
A4.43 A hypothetical monopolist of single transit:
•
would not be constrained by demand-side substitution into ITT. Use of ITT would
involve a transmission element, involving higher costs, which may not be required
if the operator purchased single transit; and
•
would not be constrained by supply-side substitution from suppliers of ITT, since
such firms would require a much higher level of connectivity with other providers
to be able to offer single transit services. This would require significant
investment and build to a large number of other providers’ tandem exchanges. It
is therefore very unlikely that a provider of ITT would be able to supply in a way
that constrained the prices of a hypothetical monopolist of single transit.
A4.44 Based on these considerations, Ofcom’s view is that there is a distinct product
market for single transit.
The relevant geographic market
A4.45 BT is the only supplier of single transit services. On this basis, Ofcom considers that
BT would have a dominant position in supply of single transit services throughout the
UK, regardless of whether the UK was viewed as being a single geographic market
or encompassing more than one geographic market. For the purposes of this
investigation, Ofcom regards the market for single transit as national (excluding the
Hull area), based on the uniformity of competitive conditions throughout the UK
(excluding the Hull area).
Conclusion
A4.46 The relevant market is single transit in the UK excluding the Hull area.
BT’s position on the relevant market
A4.47 Ofcom has designated BT has having SMP in the market for single transit in the UK
excluding Hull.
A4.48 The primary source of this position of dominance is BT’s position as the incumbent
communications provider, and the only company with a ubiquitous access network.
A4.49 BT is the only provider that provides single transit to any notable extent, meaning that
its share of the market is close to 100%. While some communications providers are
now interconnected to BT’s tandem switches, at current volume levels the business
case for interconnection between competing providers is commercially unattractive.
Inter tandem transit
The relevant market and BT’s position within the relevant market
A4.50 ITT is the service a communications provider supplies to others to enable them to
convey calls between its tandem exchanges when a call originates and terminates on
networks other than its own.
222
A4.51 In the August 2005 review, Ofcom set out the view that there is a single market for
inter-tandem conveyance and ITT on fixed public narrowband networks in the UK
excluding the Hull area and that this market is effectively competitive. This
represented a change from Oftel’s previous consideration of the market (the
November 2003 market review referred to above), which concluded that BT had SMP
in the markets for inter-tandem conveyance and transit on fixed public narrowband
networks; and single transit on fixed public narrowband networks in the UK excluding
the Hull area.462
A4.52 Ofcom’s assessment that this market was competitive was based on:
•
increasing interconnection to BT exchanges by competing infrastructure
providers; and
•
BT’s declining share of ITT (BT’s share of ITT has been consistently below 40%
since Q3 2002/03).
A4.53 Since BT’s position in ITT does not form a key part of this investigation, Ofcom does
not consider it necessary to reconsider this market definition or assessment for the
purpose of assessing the impact of NCCN 500 on competition.
462
Review of the fixed narrowband wholesale exchange line, call origination, conveyance and transit
markets, statement of 28 November 2003 (see footnote 12).
223
Annex 5
5 ROCE and ROS
A5.1
In order for a margin to be considered adequate, it must be sufficient to allow the firm
to earn its required minimum rate of return on capital.
A5.2
When using historical accounting information to assess profitability, a commonly
used measure of the rate of return actually earned is return on capital employed
(“ROCE”). Using this measure, an activity is considered not to be profitable if the
ROCE that it earns falls below the level that would be required by investors in order
to compensate them for any risk incurred by investing in the activity, i.e. below the
activity’s weighted average cost of capital (“WACC”).463
A5.3
The use of ROCE as a measure of profitability is not, however, appropriate in all
circumstances, particularly in the case of activities that inherently require relatively
little physical or working capital. This applies strongly to BT’s retail calls and access
activities, since outpayments to TCPs, including its own wholesale business, account
for a high proportion of the total underlying cost base (see Annex 7). Most of BT’s
fixed capital is included in its wholesale business, with the required return included in
the outpayment from BT Retail. At the retail level therefore, capital employed is
typically small relative to turnover or even negative.
A5.4
A frequently-used alternative in such circumstances is Return on Sales (“ROS”).464
ROCE is generally considered to have greater economic significance than ROS,
which has the disadvantage that there is no theoretical benchmark with which to
compare it. This means that the “required” return on sales will vary directly with the
capital intensity of the firm and its cost of capital. It is therefore necessary to
benchmark the return on sales with that earned by other firms of similar capital
intensity and risk.
A5.5
Competition authorities have provided indications of an appropriate return on sales
where capital intensity is low. In the 1999 report by the then Monopolies and Mergers
Commission (“MMC”) on BT, instead of using return on capital employed, the MMC
based its assessment of the profitability of BT’s calls business on return on turnover
(“ROT”). 465 The MMC considered that the reason this approach could be applied to
BT’s call business was the “very high proportion of turnover accounted for by boughtin services”’.466 The MMC took the view that a return on turnover of 1.5% would be
463
See, for example, Ofcom’s approach to risk in the assessment of the cost of capital, 18 August
2005 (see footnote 371), and OFT414a.
464
Also referred to (as in BSkyB) as Return on Turnover, RoT.
465
British Telecommunications Plc: A report on a reference under section 13 of the
Telecommunications Act 1984 on the charges made by British Telecommunications Plc for calls from
its subscribers to phones connected to the networks Cellnet and Vodafone. MMC, 21 January 1999.
The MMC concluded (paragraph 2.113) that calculating a return on net assets employed was an
unreliable basis for setting a reasonable return as the mean net assets employed in call activities are
not only relatively small but they consisted for the most part of working capital items which could
fluctuate considerably from year to year.
466
Paragraph 2.116. In the case of BT, ‘over 80% of the retail price to consumers represents the cost
of bought in services’ (Paragraph 2.112).
224
appropriate for BT’s calls-to-mobiles activity. In contrast, in its report on Scottish
Hydro-Electric plc a return of 0.5% was adopted.467 The MMC considered that
“the potential for competition from new operators and the speed with
which it could impact on BT are factors which we believe
differentiate BT’s calls to mobile activity from the circumstances of
Scottish Hydro-Electric.”468
A5.6
For these reasons, in the historical accounting analysis set out in Section 6, Ofcom
uses ROS as a reasonable measure of the minimum required return on investment,
and has used as a benchmark a rate consistent with the MMC’s analysis.469
A5.7
The figures in the following Annex show the importance of payments and the low
capital employed in supplying retail services to residential, business and all
customers respectively. These tables show that most, if not all, of the BT retail
services in question will have ROCEs that do not lend themselves to meaningful
comparison with company cost of capital estimates: negative capital employed
means that high returns lead to negative ROCE; whereas low (positive) capital
employed leads to services having triple-digit ROCE. The usefulness of ROCE as a
measure of profitability in this case is therefore significantly reduced.
467
Scottish-Hydro-Electric plc, A Report on a reference under section 12 of the Electricity Act 1989,
MMC, June 1995, paragraph 2.85.
468
Scottish-Hydro-Electric plc, A Report on a reference under section 12 of the Electricity Act 1989
(see footnote 467), paragraph 2.117
469
OFT 657, paragraphs 1.24-1.27.
225
Annex 6
6 The importance of capital employed in
BT’s retail services
A6.1
Shaded cells indicate inputs supplied by BT, with unshaded cells describing
calculations carried out by Ofcom.
Table 31: Payments and capital employed – BT retail products (products sold to
residential customers), 2004/05
Charges
from BT
Wholesale
Markets
£m
Payments
Total CCA
Operating
Costs
Charges from
Mean
BT Wholesale
capital
& payments employed
% of TC
£m
£m
%
£m
Products:
P501,P502,P503,P504 2,170
(IDD Residential)
-
2,360
[]
[]
P241 Inland Calls BT
to Mobile Residential
21
373
466
[]
[]
P317 PSTN Local
calls: Residential
137
17
253
[]
[]
P319 PSTN National
calls: Residential
86
10
142
[]
[]
P455 PSTN Res
Connections (Std)
115
-
139
[]
[]
P461 Residential
Telephone Line
Rentals
2,170
-
2,360
[]
[]
TOTAL
4,699
400
5,718
[]
[]
Source: BT
226
Table 32: Payments and capital employed – BT retail products (products sold to
business customers), 2004/05
Payments
Total CCA
Operating
Costs
Charges from
BT
Wholesale &
payments - %
of TC
Mean capital
employed
£m
£m
£m
%
£m
P014 IDD Calls
to Overseas
Fixed Business
[]
[]
[]
[]
[]
P240 Inland
Calls BT to
Mobile
Business
[]
[]
[]
[]
[]
P316 PSTN
Local calls:
Business
[]
[]
[]
[]
[]
P318 PSTN
National calls:
Business
[]
[]
[]
[]
[]
P454 PSTN
Bus
Connections
(Std)
[]
[]
[]
[]
[]
P460 Business
Telephone Line
Rentals
[]
[]
[]
[]
[]
TOTAL
[]
[]
[]
[]
[]
Charges
from BT
Wholesale
Markets
Source: BT
227
Table 33: Payments and capital employed – BT retail products (products sold to both
customer types), 2004/05
Payments
Total CCA
Operating
Costs
Charges from
BT Wholesale
& payments % of TC
Mean capital
employed
£m
£m
£m
%
£m
P056 BT
LinkLine
[]
[]
[]
[]
[]
P059 BT
ValueCall
[]
[]
[]
[]
[]
P171 Freephone
BT to OLO
[]
[]
[]
[]
[]
P313 BT to OLO
Lo-call
[]
[]
[]
[]
[]
P314 BT to OLO
Nationalcall
[]
[]
[]
[]
[]
P315 BT to OLO
Valuecall
[]
[]
[]
[]
[]
P346 BTnet
Services - Dial
Access
[]
[]
[]
[]
[]
TOTAL
[]
[]
[]
[]
[]
Source: BT
228
Charges
from BT
Wholesale
Markets
Annex 7
7 Alleged margin squeeze in call origination:
data sources and calculations
A7.1
Shaded cells indicate inputs supplied by BT, with unshaded cells describing
calculations carried out by Ofcom. Note that BT accounts for BT-to-BT and BT-toTCP NTS calls separately.
Table 34: alleged margin squeeze in call origination: data sources and calculations
Data series
Source/notes
(a)
FAC business and residential financial
statements, i.e. profit and loss accounts and
statements of capital employed, for various
geographic call types.
BT response to section 26 Notice of
11 October 2005.
(b)
FAC business and residential financial
statements for access products, i.e.
connections and rentals.
BT response to section 26 Notice of
11 October 2005.
(c)
FAC financial statements for BT-OCP NTS
calls – combined business and residential:
P171 (Freephone); P313 (Lo-call); P314
(Nationalcall); P315 (Valuecall i.e. PRS).
BT response to section 26 Notice of
11 October 2005.
(d)
Total volume (both data and voice traffic) data
for BT originated traffic – split by BT-OCP and
BT-to-BT by NTS number range.
BT response to section 26 Notice of
11 October 2005.
(e)
Ofcom-derived FAC financial statements for
retailing of all NTS calls by number range (i.e.
both BT-to-BT and BT-to-TCP calls, rather
than just BT-to-TCP, as in the data supplied
by BT. These statements were constructed by
multiplying all of the key financial measures
provided in (c), i.e. costs and revenues, by a
multiplier equal to the ratio of the sum of BTto-BT and BT-to-TCP call volumes divided by
BT-to-TCP call volumes.
(c); (d)
(f)
Information on the split between traffic
(minutes) originated by business and
residential customers in the case of
geographic calls (local and national).
BT response to section 26 Notice of
11 October 2005.
Also voice-data split for all BT-to-BT 084x
calls (15%-85%).
229
(g)
(k)
Data series
Source/notes
Ofcom-derived business and residential
financial statements for each NTS number
range, calculated by splitting all figures (e.g.
turnover, opex, payments) in (e) on the basis
of (f).
For 084X, Ofcom assumed that all
data traffic (and associated
revenue/costs) was residential.
The financial impact of NCCN 500 split by
business and residential if higher rates were
faced on all BT-to-BT traffic.
C&W submission of 15 March 2005.
For all other NTS number ranges,
including 084X voice, Ofcom
assumed the same businessresidential proportions as per the
average of BT-originated local and
national geographic calls.
BT response to section 26 Notice of
11 October 2005.
Based on:
230
(i) total volumes of BT-to-BT calls;
BT response to section 26 Notice of
25 August 2005.
(ii) a time of day split for the above; and
NTS Calculator.
(iii) the differential between BT and altnet
termination prices.
Volume splits implied in (f), (g).
Annex 8
8 Alleged margin squeeze in call origination:
sensitivity analysis
A8.1
As discussed in Section 6, NCCN 500 did not lead to a margin squeeze across a
relevant set of services. This is because the set of calls that NCCN 500 applied to
represents a small proportion of the retail calls and access services sold by BT to its
residential and, especially, its business customers.
A8.2
This Annex sets out the sensitivity analysis carried out by Ofcom to test this result,
which consists of three further tests:
•
NTS calls assumed to account for a significantly larger proportion of calls
originated by BT;
•
business customers assumed to generate as many data calls to NTS numbers as
they do voice calls;
•
traffic is originated by BT according to the same time of day profile as another
OCP.
NTS calls account for a larger proportion of all calls
A8.3
Ofcom calculated what the impact of NCCN 500 would have been if NTS calls had
accounted for a significantly larger proportion of the calls originated by (and hence of
the value of) the services sold by BT.
A8.4
This analysis assessed the extent to which NCCN 500 might have had an impact on
any competitor generating a particularly large proportion of NTS calls. Ofcom has no
reason to think that any of BT’s competitors actually operates such a business
model.
A8.5
The results below are calculated on a fully allocated cost basis, and calculated
across all call types plus access.
231
Table 35: BT’s ROS, business
multiplier Pre-NCCN 500Post-NCCN 500
1
2
3
4
[]
5
6
7
8
9
10
Table 36: BT’s ROS, residential
multiplier Pre-NCCN 500Post-NCCN 500
1.00
1.25
1.50
[]
1.75
2.00
2.25
2.50
2.75
3.00
3.25
A8.6
The results set out in the tables above show that, for services sold to business
customers, BT would need to generate over five times as many NTS calls as it
actually does in order to create margins of an order that might be suggestive of
NCCN 500 imposing a margin squeeze across all calls and access. For services sold
to residential customers, BT would need to generate roughly twice as many NTS
calls in order to create margins of an order that might be suggestive of NCCN 500
imposing a margin squeeze across all calls and access.
A8.7
As, in practice, none of BT’s competitors have an output mix resembling those
described in the tables above and, moreover, this test is based on FAC rather than
incremental cost, these results suggest that Ofcom’s findings are robust.
Sensitivity: business customers generate same proportion of data calls as
voice calls
A8.8
Ofcom assumed in its analysis that business customers do not generate any data
traffic to NTS numbers affected by NCCN 500 – i.e. that businesses do not use dialup internet access.
A8.9
In fact, they do generate some: Ofcom’s SME tracking research (which looks at
businesses in the UK with between 1 and 250 employees with £50K turnover or
232
more) found from October-December 2005 that a number of businesses of this size
do still use dial-up internet:
•
85% claimed to be connected or in the process of connecting to the internet
(unweighted base size = 896); and
•
among those connected to the internet, 19% claim to be using 'dial-up/ordinary
phone line' (unweighted base size = 839).
A8.10 The survey did not record what proportion of this was metered traffic, i.e. calls
affected by NCCN 500.
A8.11 Ofcom therefore assumed for this sensitivity analysis that business customers
account for the same share of NTS data calls as they do of voice traffic, which is
likely to be an overestimate and therefore a conservative assumption for these
purposes.
Table 37: Results (base)
Turnover
[a]
[b]
[c]
[d]
[e]
[f]
[g]
[h]
[i]
Base case (all calls + access)
Calls only
CPS all calls
CPS national calls
Margin of [c] over [d]
CPS international calls
Margin of [c] over {[d]+[f]}
CPS all calls except local
Margin [g] excl. local calls
[]
Turnover
[a] Base case (all calls + access)
[b] Calls only
[c] CPS all calls
[d] CPS national calls
[e] Margin of [c] over [d]
[f] CPS international calls
[g] Margin of [c] over {[d]+[f]}
[h] CPS all calls except local
[i] Margin [g] excl. local calls
Residential customers
Return
ROS
pre-NCCN500 post-NCCN500 pre-NCCN500
post-NCCN500
Business customers
Return
ROS
pre-NCCN500 post-NCCN500 pre-NCCN500
post-NCCN500
[]
233
Table 38: Results – assume that some business NTS data traffic
Turnover
[a]
[b]
[c]
[d]
[e]
[f]
[g]
[h]
[i]
Base case (all calls + access)
Calls only
CPS all calls
CPS national calls
Margin of [c] over [d]
CPS international calls
Margin of [c] over {[d]+[f]}
CPS all calls except local
Margin [g] excl. local calls
[]
Turnover
[a]
[b]
[c]
[d]
[e]
[f]
[g]
[h]
[i]
Residential customers
ROS
Return
pre-NCCN500 post-NCCN500 pre-NCCN500
post-NCCN500
Business customers
Return
ROS
pre-NCCN500 post-NCCN500 pre-NCCN500
post-NCCN500
Base case (all calls + access)
Calls only
CPS all calls
CPS national calls
Margin of [c] over [d]
CPS international calls
Margin of [c] over {[d]+[f]}
CPS all calls except local
Margin [g] excl. local calls
[]
A8.12 This sensitivity tends to increase the apparent profitability of BT’s sales to the less
profitable residential sector, and to reduce the profitability of sales to business
customers. However in both cases, margins are significantly above the relevant
benchmark, even on an FAC basis.
Sensitivity: C&W time of day weights
A8.13 In its analysis, Ofcom calculated the impact of NCCN 500 on BT’s profitability using
actual time of day weights for BT-to-BT traffic. As a sensitivity, Ofcom replaced these
with time of day weights supplied by C&W relating to traffic that it originates.
Table 39: Results – assume same T.O.D profile as C&W
Turnover
[a]
[b]
[c]
[d]
[e]
[f]
[g]
[h]
[i]
Base case (all calls + access)
Calls only
CPS all calls
CPS national calls
Margin of [c] over [d]
CPS international calls
Margin of [c] over {[d]+[f]}
CPS all calls except local
Margin [g] excl. local calls
[]
Turnover
[a]
[b]
[c]
[d]
[e]
[f]
[g]
[h]
[i]
234
Base case (all calls + access)
Calls only
CPS all calls
CPS national calls
Margin of [c] over [d]
CPS international calls
Margin of [c] over {[d]+[f]}
CPS all calls except local
Margin [g] excl. local calls
Residential customers
Return
ROS
pre-NCCN500 post-NCCN500 pre-NCCN500
post-NCCN500
Business customers
Return
ROS
pre-NCCN500 post-NCCN500 pre-NCCN500
post-NCCN500
[]
A8.14 Applying C&W’s time of day weights reduces the ROS for residential customers
somewhat, although it would remain above benchmark levels even on an FAC basis.
Moreover, C&W customers are mostly businesses, suggesting that the business
analysis is more relevant, which is unaffected by the change of weights.
235
Annex 9
9
FAC profitability analysis: basis of
preparation
A9.1
BT’s regulatory product groups P056 and P346 reflect all the non-geographic
number ranges used by BT to provide the voice and data services described in the
previous section, not just those NTS number ranges affected by NCCN 500. In
order to ascertain the costs associated with the prices notified in NCCN 500, it was
therefore necessary to attribute shared costs between number ranges. Ofcom also
attributed the revenues associated with other services provided in conjunction with
NTS call termination e.g. advanced voice call management or data port rentals (on
the hosting side of the two-sided market) between the different number ranges
reflected within P056 and P346.
A9.2
BT’s regulatory product group financial statements are prepared on a current cost
basis. When assessing profitability, asset values should, where possible, reflect
their current cost of acquisition rather than past acquisition costs. This approach
means that when assessing whether prices are high in relation to the costs of
supply, up-to-date measures of the cost of supply are taken into account.
FAC profitability analysis: cost basis for wholesale services
A9.3
BT’s regulatory product group financial statements reflect the costs of wholesale
services, e.g. geographic call termination or use of BT’s intelligent network (“IN”)
incurred in servicing purchasers of NTS call termination and NTS service providers,
not at underlying cost, but at either published tariff where it exists (e.g. geographic
call termination) or at CCA cost including its regulated return on capital employed
(e.g. intelligent network).470 This is referred to in the following discussion as the
“transfer charge basis”.471
A9.4
Ofcom however wished to establish the costs actually incurred by BT on an “endto-end basis”, reflecting the full profitability that it as a vertically integrated
undertaking with its own network derived from its NTS call termination/hosting
operations on a fully attributed basis. Ofcom therefore sought to use BT’s actually
incurred costs consistently throughout its analysis of its profitability.
A9.5
As an intermediate step Ofcom also produced cost analyses based on the “transfer
charge basis” which was used to conduct the hosting margin squeeze test and as a
comparator in the SAC analysis set out below, where the “transfer charge basis”
470
A technology used in conjunction with traditional telephone networks to enable them to support
value-added services such as NTS and personal numbering. The core functions of switching, call
progress tones/announcements and dialled digit recognition continue to be supplied by the network,
but call control for value added services is provided by a service layer that interacts with the network
layer. Services are defined entirely in software, enabling services to be defined without the need to
modify the network switches. Intelligent Network architecture and standards are defined in ITU-T
Q.1200 series recommendations.
471
In BT’s regulatory financial statements, “transfer charges” are notional charges made to an activity
for the use of a service from another activity within the same vertically integrated entity. The activities
making or receiving the charges are generally defined in line with normal business value chains, with
notional charges recorded between each activity stage.
236
better simulated the costs faced by the hypothetical competitor modelled (which in
each case did not operate its own network).
FAC profitability analysis: stages of analysis
A9.6
The following discussion applies equally to termination of voice and data NTS calls.
There were, however, some differences between BT’s voice and data NTS call
termination businesses, which led Ofcom to treat certain cost and revenue items
within these businesses in a specific way.
Stage 1: substitution of OCP-to-BT NTS call termination/hosting revenues with
Ofcom’s own calculation
A9.7
The wholesale call revenue figures supplied by BT in relation to OCP-to-BT calls in
response to Ofcom’s information requests (see Table 2) did not generate the
relationships Ofcom would have expected, based on a weighted-average
comparison with pre- and post-NCCN 500 published tariffs. Using volume data
supplied by BT and multiplying it by the relevant unit prices, Ofcom calculated
weighted average unit prices pre- and post-NCCN 500 to arrive at an overall
percentage price increase attributable to NCCN 500. This differed significantly from
the equivalent weighted average unit price rise derivable using the revenue and
volume figures BT supplied to Ofcom for the purposes of its financial analysis.
A9.8
It appeared to Ofcom that this resulted primarily from BT’s inability to account
precisely for the impact of non-geographic number portability, both in terms of
numbers ported from BT to other TCPs (i.e. where BT was the donor operator) and
to BT from other TCPs (i.e. where BT was the recipient operator) and to attribute
call revenues accurately between voice and data services, since BT does not
capture at source whether a call is voice or data.472
A9.9
In order to reliably isolate the change in profitability attributable to NCCN 500,
Ofcom therefore substituted the call revenue figures supplied by BT for OCP-to-BT
revenues with its own calculations using the volume of data calls provided by BT
originated on other networks.
A9.10 This approach ensured that the percentage revenue increases reflected published
charges. Ofcom took into account the relevant time of day profiles for voice and
data calls separately, and factored in Ofcom’s estimate of the split of total volumes
by voice and data for short 0845 calls terminated by BT in each period.473
A9.11 The methodology used to calculate these wholesale revenues was the same used
to calculate wholesale call revenues for BT-to-BT calls (stage 2), except that it
used the charges notified in NCCN 500, rather than the NTS Calculator rates for
2004/05.
Stage 2: elimination of call retailing and origination activities
A9.12 Ofcom eliminated retail call revenues and related costs (i.e. transfer charges for
call origination and an estimate of BT’s retail costs, based on the NTS retail
472
For a further discussion of non-geographic number portability and the process for porting numbers
between “donor” and “recipient” operators, see:
http://www.ofcom.org.uk/telecoms/ioi/numbers/num_port_info/non_geogr_num_portab/.
473
Volumes were split 50:50 between voice and data as their time of day profile lay in between the
two.
237
uplift474) from the data provided by BT, and replaced retail revenues from BT-to-BT
calls with revenues calculated using the relevant average NTS Calculator rates.
Stage 3: number ranges analysed
A9.13 Ofcom separated out BT’s NTS call termination/hosting activities between the
principal number ranges it operated under, and in the case of data, unmetered
internet access (which for the purposes of the analysis were treated as a distinct
NTS number range). Ofcom’s analysis of the number ranges impacted by NCCN
500 was further split between BT-to-BT calls and OCP-to-BT calls.
A9.14 Ofcom first allocated costs and revenues to those number ranges where, using the
cost causation principle, the costs or revenues could unambiguously be assigned
to a single identified number range.475 Ofcom then apportioned all other remaining
costs and revenues based on relevant call volumes (see tables 36 and 37 for the
various call proportions used.
A9.15 At this stage of the analysis Ofcom had constructed cost, revenue and volume
information for BT’s NTS call termination/hosting activities, for each number range
reflected in the relevant regulatory product groups, prepared on a CCA FAC basis
with wholesale services reflected not at cost but at their transfer charge values.
Stage 4: substitution of transfer charges with underlying costs
A9.16 Ofcom then constructed cost, revenue and volume information for each relevant
number range on the “end-to-end basis” for the wholesale services. It did this by
substituting transfer charge values relating to network activities with the underlying
cost and MCE information supplied by BT (see tables 36 and 37 for an indication of
the amounts involved). This information was also on a CCA FAC basis.
Stage 5: calculation of profitability measures
A9.17 Using this information, Ofcom then calculated ROCE and ROS for the number
ranges affected by NCCN 500.
FAC profitability analysis: differences between voice and data
A9.18 The preceding section sets out an overview of the stages of the analysis in a way
that applies equally to voice and data. Specifics relating to Ofcom’s analysis of
BT’s voice and data services are set out in tables 34 and 35.
474
See Charges between Communications Providers: Number Translation Services Retail Uplift
charge control and Premium Rate Services bad debt surcharge, September 2005,
http://www.ofcom.org.uk/consult/condocs/NTSfin/statement_nts_uplift/
475
The cost causation principle, as set out in BT’s Regulatory Accounting Principles document, is that
revenue (including appropriate transfer charges), costs (including appropriate transfer charges),
assets and liabilities shall be attributed to network components, wholesale services and retail
products in accordance with the activities which cause the revenues to be earned or costs to be
incurred or the assets to be acquired or liabilities to be incurred.
238
Table 40: Methodological issues for FAC analysis (voice)
Stage of analysis
Specifics
Notes
Source information
Sub-analysis of product group P056:
BT Linkline
1. Substitution of OCP-toBT NTS call termination
revenues with Ofcom’s
own calculation
Equivalent inputs and same approach
taken for voice and data
2. Elimination of call
retailing and origination
activities
Equivalent inputs and same approach
taken for voice and data
3. Number ranges
analysed
Number ranges identified
The principal ranges were:
•
0800;
•
0845 (split between BT-to-BT and
OCP-to-BT); and
•
0870 (split between BT-to-BT and
OCP-to-BT).
For the purposes of this analysis 0844
was aggregated with 0845, and 0871
with 0870, as BT did not account
separately for revenues and costs
associated with these number ranges.
In both financial years analysed, 0844
and 0871 volumes were an immaterial
proportion of total 0845 and 0870
volumes (e.g. 0.1% and 1.5%
respectively in 2004/05).
Cost and revenue allocations
Cost and revenue
apportionments
The principal items allocated between
number ranges were:
•
BT-to-BT and OCP-to-BT NTS call
termination revenues for the
relevant number ranges (0845 and
0870); and
•
public payphone supplementary
call conveyance charges
(PPSCCC) – allocated to
Freephone calls.
The principal items apportioned
between number ranges were:
•
other revenues from NTS service
providers not directly related to call
volumes;
•
call conveyance transfer charges;
•
intelligent and other network
239
Stage of analysis
Specifics
Notes
transfer charges;
•
remaining retail costs;
•
mean capital employed.
The principal items apportioned
between originating operator (i.e.
between BT-to-BT and OCP-to-BT
calls) were:
•
revenues from NTS service
providers relating to 0845 calls;
•
other revenues (as above); and
•
revenue share payments.
The % split of volumes between
number ranges, and therefore the
basis of the above cost
apportionments, is given at table 36.
4. Substitution of transfer
charges with underlying
costs
Wholesale services reflected on a
transfer charge basis were substituted
with their corresponding underlying
(i.e. network component) costs
provided by BT as relating to P056 as
follows:
•
an adjustment was made to call
conveyance network component
costs to eliminate the origination
element. The origination element
was assumed to be the same
proportion that origination transfer
charges (see stage 2 above) was
to total call conveyance transfer
charges.
•
for other network costs elements,
no further adjustments were
necessary
Once these cost substitutions had
been made, the cost and revenue
apportionments (immediate step
above) were recalculated to reflect
these changes.
5. Calculation of
profitability measures
240
Both ROS and ROCE were calculated
in the same way for voice and data.
Table 41: Methodological issues for FAC analysis (data)
Stage of analysis
Specifics
Notes
Source information
Sub-analysis of product group P346:
Dial IP
1. Substitution of OCP-toBT NTS termination
revenues with Ofcom’s
bottom up calculation
Equivalent inputs and same approach
taken for voice and data
2. Elimination of call
retailing and origination
activities
Equivalent inputs and same approach
taken for voice and data
3. Number ranges
analysed
Number ranges identified
Cost and revenue allocations
Cost and revenue
apportionments
The principal ranges were:
•
0800;
•
0845 (split between BT-to-BT and
OCP-to-BT); and
•
unmetered.
The principal items allocated between
number ranges were:
•
BT-to-BT and OCP-to-BT NTS call
termination revenues for the
relevant number ranges (i.e. for
0845 only);
•
revenues for unmetered ports; and
•
charges for unmetered wholesale
services (e.g. flat rate internet
access call origination (FRIACO)
and product management, policy
and planning (PPP) for FRIACO.
The principal items apportioned
between number ranges were:
•
other revenues from NTS service
providers not directly related to call
volumes (primarily metered port
revenues);
•
IP conveyance and other network
transfer charges;
•
remaining retail costs; and
•
mean capital employed.
The principal items apportioned by
OCP (i.e. between BT-to-BT and OCPto-BT) for 0845 were:
•
metered port revenues (as above);
241
Stage of analysis
Specifics
Notes
and
•
revenue share payments.
The % split of volumes between
number ranges, and therefore the
basis of the above cost attributions, is
given at table 37.
4. Substitution of transfer
charges with underlying
costs
Wholesale services reflected on a
transfer charge basis were substituted
with their corresponding underlying (i.e.
network component) costs provided by
BT as relating to P346 as follows:
•
call conveyance network
component costs were apportioned
between metered and unmetered
based on their respective
proportion of total metered and
unmetered conveyance call
transfer charges. An adjustment
was then made to eliminate the
origination element from metered
costs.
•
PPP network component costs
were apportioned between
metered and unmetered based on
their respective proportion of total
metered PPP and unmetered PPP
transfer charges
•
for other network costs elements
e.g. for the IP network, no
adjustments were necessary
Once these cost substitutions had
been made, the cost and revenue
apportionments (immediate step
above) were recalculated to reflect
these changes.
5. Calculation of
profitability measures
Both ROS and ROCE were calculated
in the same way for voice and data.
A9.19 A major element of Ofcom’s analysis was the apportionment of costs and revenues
not directly attributable to a specific number range between number ranges (i.e.
”cost and revenue apportionments” in the above tables). Ofcom apportioned these
costs and revenues in direct proportion to relevant call volumes.
A9.20 The relevance of these volume splits is best illustrated by example:
•
242
Voice calls to NTS number ranges incur geographic call termination costs. The
total cost of geographic call termination was therefore apportioned between
number ranges in relation to their percentage of total call volumes. For example,
in 2004/05 calls to Freephone numbers represented 31% of total voice call
volumes, so picked up 31% of total geographic call termination costs.
•
Data calls to NTS number ranges incur some of the cost of BT’s IP network,
which is used to provide both unmetered and metered internet access services.
In 2004/05, 85% of total volumes, both metered and unmetered, related to
unmetered internet access, so the NTS number ranges used to provide
unmetered services picked up 85% of these costs.
A9.21 The effective bases (i.e. volume proportions) used to apportion costs and revenues
(“cost and revenue apportionments” are set out below in table 36 and table 37.
Table 42: Apportionment of BT’s costs as reported in P056 (voice)
All volumes relate to 2004/05
Shared costs to
be apportioned
£ millions**
Distribution of volumes across number ranges (percentages)
Freephone
0845 BT-to- 0845 OCP- 0870 BT-to- 0870 OCPBT
to-BT
BT
to-BT
Apportionment categories
All number ranges
0845 number range only
0870 number range only
Total
[]
** 2004/05 profit & loss end-to-end costs given here for illustrative purposes; MCE and certain revenues also apportioned
Table 43: Apportionment of BT’s costs as reported in P346 (data)
All volumes relate to 2004/05
Distribution of volumes across number ranges (percentages)
Metered
Unmetered
Total
Shared costs to
be apportioned
£millions**
Apportionment categories
Metered & Unmetered
Metered only
0845
0845
BT-to-BT OCP-to-BT
Freephone
& other
Sub-Total
[]
BT-to-BT v OCP-to-BT
** 2004/05 profit & loss end-to-end costs given here for illustrative purposes; MCE and certain revenues also apportioned
243