6.63 We now consider how, in theory, MTRs at LRIC rather than LRIC+ affect net revenues, and how changes in net revenues may affect investment.
6.64 If MTRs were reduced from LRIC+ to LRIC, we would expect the following effects on the mobile industry net revenues:
6.64.1 First, there would be revenue reductions, which would occur if there were no increase in retail prices. The fall in MTR revenues from fixed to mobile and international to mobile calls would lead to a reduction in mobile industry net revenue. The fall in MTR revenues from M2M traffic would have no effect on total mobile industry net revenue (since payments balance out at the industry level), but could lead to a redistribution across MCPs.
6.64.2 Second, there may be waterbed effects on retail prices. The loss of revenue from fixed to mobile and international to mobile MTRs may be counteracted by retail price increases, as MCPs seek to recover the lost margin on MTRs from the retail-side of the market. The more competitive is the mobile market, the greater we would expect this waterbed effect to be. 6.64.3 Third, there may also be competition effects. We would expect the
reduction in MTR margins (over LRIC) to increase competition in the mobile sector through the competition effects we describe later in this section. All
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See footnote 223.
else being equal, this would be expected to lead to a reduction in retail prices. There may also be an increase in the constraint on the mobile sector from the fixed sector, which could lead to increased competitive pressure on call prices. The latter could occur because the fall in MTRs would reduce the marginal call costs faced by fixed CPs, which may be passed into lower retail call prices in the fixed sector (although on the available evidence, we would expect this to be a less strong effect than that stemming more directly from lower MTRs on competition between MCPs). 6.65 The observed changes in mobile industry profits (or the ‘profits waterbed’) will
therefore initially depend on the balance of the following factors:
• waterbed effects which will tend to maintain industry profits (in the face of reductions in revenue from fixed to mobile and international to mobile calls), and would be expected to be stronger in a more competitive market;
• increased competition effects as MTR margins are reduced – which will tend to reduce industry profits if they are initially above the competitive level;
• other changes affecting the industry – for example, if the net result of the two preceding factors is overshadowed by annual changes in mobile industry costs the “observed” effect on retail prices and profits will be difficult to detect. 6.66 EE, Vodafone and Telefonica argued that MCPs may also reduce their costs or
investments in response to lost revenue, and that this is harmful for dynamic efficiency. EE’s and Vodafone’s responses to our analysis of dynamic efficiency focused on the idea that MTR cuts would reduce profitability because of an
incomplete waterbed effect. Their responses appear to assume that lower profitability would lead to lower investment.
6.67 We firstly note it is not appropriate to maximise investment at all costs – instead the objective should be to encourage efficient investments that provide benefits to society which are greater than their cost. Further, economic theory does not suggest that there is an automatic relationship between profitability and dynamic efficiency. For example, a monopolist may have high profits but may not invest as much as if it faced competition. We consider that higher profits are more likely to be important for risky investment and innovation, whereas the infrastructure associated with call termination is not likely to fall into this category, because it is not a new or innovative service.
6.68 Vodafone seems to suggest that reduced profits would mean a reduction in the funds available for investment, so that further investment in one area could only be
undertaken at the expense of investment in other areas. However, we think that if MCPs have investment opportunities with expected returns at least as great as the cost of capital, they will be able to fund those through capital markets.
6.69 It is possible that these stakeholders believe that higher MTRs would lead to higher investment because the margin on MTR revenue from fixed and international calls to UK mobile numbers (which represents a net inflow to the UK mobile sector) would be competed away through investment. However, it is not clear why the margin on termination would necessarily be used for investment in MCT or mobile networks more generally, rather than being spent on customer acquisition or retention.
Moreover, if the waterbed effect on retail prices is incomplete, MCPs may choose to retain at least some of the margin as profits.
6.70 There was also some suggestion that returns on past investments would be
unexpectedly reduced, thereby disincentivising future investment. EE, for example, suggested that if MCPs do not have the opportunity to earn a return on previous investments it will affect their willingness to invest in the future. We do not find this argument convincing. For example, investments made since 2011 have been made under a charge control on a trajectory to LRIC (first by 2014 and then, following appeal, 2013). In any case, MCPs have the ability to recover their costs, including the cost of capital, through retail prices.
6.71 Finally, Vodafone, Telefonica and EE made some comments about the risk of lower returns on future investment. We agree that if lower MTRs reduced the return on future investment, this may have an impact on incentives to invest if the waterbed effect is incomplete. With an incomplete waterbed effect, lower MTRs imply that there will be a slightly lower return on any investment relevant to termination. This could disincentivise investment if returns fall below the forward looking cost of capital. However, we do not find this concern compelling for the reasons set out below.