6.75 Annual minutes of fixed to mobile calls are low relative to total call volumes, and the gap between LRIC and LRIC+ is small.231 The maximum net effect on MCPs’
revenue between LRIC and LRIC+ is therefore relatively modest – around £67 million in 2015/16.232 This is less than 2% of EBITDA and less than 3% of EBITDA minus capex for the largest four operators.233 These effects are likely to be further reduced
229
Ofcom, Infrastructure Report, 2013 Update, 24 October 2013 (updated on 6 December 2013), Paragraphs 4.34-4.38. http://stakeholders.ofcom.org.uk/binaries/research/telecoms-
research/infrastructure-report/IRU_2013.pdf
230
Ofcom, Infrastructure Report, 2013 Update, 24 October 2013 (updated on 6 December 2013), Paragraphs 1.22-1.23. http://stakeholders.ofcom.org.uk/binaries/research/telecoms-
research/infrastructure-report/IRU_2013.pdf. We noted however that, despite coverage levels not having changed significantly over the past year, mobile operators have embarked on major upgrades and reconfigurations of their networks.
231
See Annex 5, Figure A5.25 on Volume of outgoing mobile calls, by type of call. 232
This is based on a modelled gap between LRIC and LRIC+ of 0.40 ppm, and net termination volumes from fixed and international calls of approximately 16.7bn (Source: operators). We note that Vodafone submitted that Ofcom had not calculated LRIC+ with sufficient accuracy. See Annex 8 (Section 5.3 of the Analysys Mason report) for Analysys Mason’s response to this point.
233
MCPs’ public accounts, and Ofcom analysis. Comparison of the net loss of MTR revenue to EBITDA less capex is intended to illustrate that the net loss of MTR revenue is small in relation to the sustainable cash flows of MCPs. Vodafone has suggested that we should compare the net loss of MTR revenue to EBIT. However, EBIT includes amortisation of historic licence costs, which in the case of 3G licences can be based upon balance sheet asset values significantly higher than likely current value, and amortisation of intangible assets added to the balance sheet following M&A activity rather than assets resulting from capital expenditure in the business. We note that EBITDA-capex has been stable over a number of years, as shown in Figure 6. We do not use EBITDA less capex as a definitive measure of profitability, but consider it is a reasonable indicator of the sustainable cash flows that can be generated by MCPs.
by the opportunity to recover lower revenue or margin on MCT from the retail side of the market.
6.76 EE and Vodafone stated that the opportunity to rebalance cost recovery to the retail side of the market would be affected by Ofcom’s recent guidance on General Condition 9.6 (GC9.6).234 They argued that increasing prices for pay monthly customers would therefore risk early termination of contracts by customers and potentially leave MCPs unable to recover their substantial investments on customer acquisition. They argued that this makes it more difficult for them to change retail prices and thus more difficult to recover the lost contribution caused by lower MTRs. However, GC9.6 does not prevent retail price changes in all circumstances. For example, MCPs would be able, without undue constraint by GC9.6, to adjust the tariffs for new customers and top-up charges for pre-pay customers, if they chose to do so. In any case, if the effect of GC9.6 was to significantly delay any waterbed effect, that could be an argument for delaying the period over which MTRs are reduced, but it is not an argument to change the choice of cost standard per se. 6.77 EE and Vodafone also argued that recent academic evidence presented by Genakos
and Valletti shows that the waterbed effect has disappeared.235 In this paper the authors find that the waterbed effect has disappeared on average across all 27 countries in their sample, for two reasons. First, MTRs are now much lower than at the time of the first (2011)236 Genakos and Valletti study that used data up to 2006, and second, because most of the new countries that introduced this termination rate regulation after 2006 did so at a moment when fixed and international calls account for a smaller proportion than previously of calls to mobile devices; as a result, MTRs account for much less of total MCP revenues than before and the waterbed effect for these countries is not existent. However, the authors’ results seem to indicate that on average the waterbed effect is still present for the countries, such as the UK, that introduced MTR regulation before 2006, although the waterbed has reduced significantly over time.237
6.78 However, even if the waterbed effect in retail bills is no longer so clearly discernible, it does seem that MCPs have managed to retain stable profits and margins in the UK; as shown in Figure 6 below (see Figure 14 further below for the EBITDA-capex
234
Under GC9.6, where a price increase would result in “material detriment” to the consumer, a CP must notify the consumer of the change and give them the right to terminate the contract without penalty. In Ofcom’s guidance on ‘material detriment’ under GC9.6 in relation to price rises, we explain that we are likely to treat any price increase to the agreed core subscription price during the fixed term of a contract as a modification that is likely to be of material detriment to consumer and small
business subscribers for the purposes of GC9.6. See Ofcom, Price rises in fixed term contracts: Decision to issue Guidance on General Condition 9.6, 23 October 2013, Annex 1 Guidance on “material detriment” under GC9.6 in relation to prices and notification of contract modifications:
http://stakeholders.ofcom.org.uk/binaries/consultations/gc9/statement/guidance.pdf
235
Genakos, C. and T. Valletti, 2015, ‘Evaluating a decade of mobile termination rate regulation’, Economic Journal (forthcoming), Doi: 10.1111/ecoj.12194 Working paper available at
http://cep.lse.ac.uk/pubs/download/dp1282.pdf (Genakos and Valletti, 2015)
236
Genakos, C. and Valletti, T. (2011), Testing the “waterbed” effect in mobile telephony. Journal of the European Economic Association, 9: 1114–1142. doi: 10.1111/j.1542-4774.2011.01040.x 237
Genakos and Valletti, 2015, paragraph 3 on page 11
margin on sales). This suggests that cost reductions have mitigated the need for retail price increases.238
Figure 6: Aggregate profitability indicators for largest four MCPs, 2012/13 prices
Source: Ofcom, based on Company financial reports (H3G did not publish UK reports before
2010).Vodafone 2013 figure adjusted to exclude estimated impact of C&W. Vodafone figures relate to the year ending March 31st following the year shown.
6.79 Even if the waterbed effect were lower than at the time of the last review, the impact on profitability would still be smaller than at that time. This is because the estimated difference between the 2011 estimates of LRIC and LRIC+ in 2014/15 was around 1ppm,239 compared with an estimated difference now of around 0.40ppm (in 2015/16, in 2012/13 prices) and slightly lower net termination volumes today.