5.27 As explained in the above Section on market power, Market 1 is characterised by, in particular, the current absence of any competitors to BT, very high barriers to entry and sunk costs and economies of scale, scope and density. We therefore consider that BT has the ability and incentive to behave to an appreciable extent
independently of competitors, customers and ultimately consumers.
5.28 In this section we set out our proposals for remedies in Market 1 to address these concerns. We start by discussing three general options for remedies:
Option 1: no remedies;
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Option 2: general access and non-discrimination remedies; and
Option 3: price controls in addition to general access and non-discrimination remedies.
5.29 Having discussed the approach that we consider to be most appropriate, we then discuss each specific SMP condition in relation to whether it meets the relevant legal tests for imposing conditions on a dominant provider.
Option 1 (no regulation)
5.30 As set out in Section 4, Ofcom considers that BT has SMP in Market 1 and that there is little potential for competition in this market. Ofcom considers that it is unlikely to be economically viable to build the networks necessary for the provision of
downstream broadband access services in this market and therefore considers that SMP is entrenched.
5.31 An absence of regulation, therefore, would be unlikely to result in the development of effective competition in downstream services (in terms of price, rollout, service quality and product differentiation). Other providers would be less likely to enter to provide downstream services as they would require access to be provided by BT and, in the absence of regulation, BT would have little incentive to provide services to them. The consequence of this would be a restriction of competition in Market 1 and in the provision of downstream broadband services.
5.32 For these reasons, Ofcom considers that ex-ante regulation is required to ensure that the benefits of competition in terms of price, product differentiation, choice of supplier and quality are optimised for citizens and consumers in Market 1.
Option 2 (access and non-discrimination obligations)
5.33 As set out above, in the absence of regulatory remedies in Market 1, BT would not have the incentive to provide access to other providers and this could restrict competition in the provision of retail offers. An absence of wholesale products is unlikely to stimulate investment from other providers.
5.34 As such, in order to promote competition in the provision of downstream broadband services, a suite of regulatory remedies requiring BT to provide Network Access would be required. These remedies would aim to ensure that other providers can obtain wholesale products from BT.
5.35 Requiring BT to provide Network Access would allow other providers to compete in the downstream market by allowing them to access the products they need, but cannot replicate themselves due to the high costs of deploying the network needed to provide these products.
5.36 The Network Access provided by BT should be that required by third parties to compete in the retail market, including the ability to differentiate their products as far as possible from those of BT’s retail divisions. However, it would not be appropriate to require BT to provide any type of Network Access required by third parties. A requirement to provide Network Access could result in BT being requested to develop multiple products at potentially high costs with very limited customer demand. It would only be appropriate to require BT to meet those requests that are reasonable (for example, have a high expected customer demand, or a low cost of development, or can be charged at a premium to recover costs of development).
5.37 If BT is only required to provide Network Access it may discriminate in favour of its own retail divisions. As the competitors have no other source of supply, this would limit their ability to compete with BT in the downstream market. This discrimination may take the form of setting excessive prices for wholesale products or in providing products of inferior quality or functionality.
5.38 Therefore, the obligation to provide Network Access is more likely to be effective if it is supported by an obligation not to unduly discriminate. In the WBA market this would require BT to provide the same service functionality to its wholesale customers as it provides to its own downstream divisions. For example, BT would be required to allow competitors to have access to the higher maximum available speeds based on the deployment of new technology (e.g. ADSL2+) and to features it uses to meet the needs of its own business customers, such as lower contention ratios.
5.39 In order to ensure BT is complying with the obligations to provide Network Access and the requirement not to unduly discriminate, additional obligations related to ensuring transparency may also be required. In addition, transparency obligations would provide third parties with access to the information they need in order to make informed decisions about purchasing BT’s wholesale products. Without these
obligations, not only would it be difficult for third parties to assess whether BT was meeting its obligations to provide Network Access and to not discriminate unduly, it may also be the case that third parties do not have sufficient information in order to decide whether, or how, to enter the downstream market by purchasing BT’s
wholesale products. This could ultimately result in fewer providers, and therefore less choice, for consumers.
5.40 Transparency obligations would require BT to publish a reference offer, charges, terms and conditions and technical information related to the product with sufficient notice so that third parties could act on the information in a timely manner. Without this, BT could change products or pricing with insufficient or no notice to its
wholesale customers with the intent of discriminating in favour of its retail divisions. 5.41 A further transparency obligation is related to providing information as to quality of
service. BT could seek to favour its own retail divisions by, for example, providing service more quickly to its retail division than to third parties. Alternatively it may offer preferential repair for its retail divisions or prioritise the broadband traffic of its retail customers over thirds party traffic. An obligation to provide transparency as to quality of service would ensure BT complies with its obligation not to unduly discriminate by reporting the quality of service provided internally and externally.
5.42 Given that in Market 1 BT holds a position of SMP and faces no competition from other providers, in the absence of regulation it has no incentive to provide products on equitable terms to potential competitors of its own downstream divisions.
Therefore, we propose general access, non-discrimination and transparency obligations are required in Market 1.
Option 3 (price controls)
5.43 In a competitive market, the pricing of services on the basis of the commercial judgements of individual companies could be expected to deliver cost reflective pricing. However, where competition cannot be expected to provide effective constraints, ex-ante regulation may be desirable to prevent excessive pricing. Such intervention could also have as its objectives the aim of promoting efficiency and of allowing the development of effective competition in downstream markets.
5.44 In Market 1, BT is the only provider. As discussed in Section 4 above, there is little likelihood of entry based on LLU in this market. We do not consider that entry, or the threat of entry, will act to constrain BT’s wholesale prices. As such, BT may have the incentive to set prices above the competitive level. BT’s competitors at the retail level would be forced to pay these high prices in order to provide service on a national basis.
5.45 We did not impose a price control in the previous WBA market review due to
uncertainty about future fixed broadband subscriber growth, and to ensure CP’s had sufficient incentive to invest in LLU in WBA markets with SMP. However, since our previous review, the rate of growth in fixed broadband subscriber numbers and LLU roll-out has decreased, with LLU roll-out beyond 2010 likely to be more limited. Our expectation that any rollout is not likely to be in Market 1 to any significant extent. 5.46 Whilst BT has had some flexibility in the level it set wholesale broadband access
prices, its ability to price excessively in areas where LLU based competition did not develop were constrained by a voluntary price ceiling. Once the current voluntary commitment expires, it may therefore be in BT’s interests to increase this price. We consider that there are four possible approaches to price regulation:
Retail minus;
Cost orientation;
Safeguard cap; or
Charge control.
“Retail minus”
5.47 In the absence of specific pricing obligations, BT may be constrained by the “retail minus” cap that results from the imposition of the requirement to provide Network Access and the obligation not to unduly discriminate. This retail minus approach provides a light touch approach to regulation and is appropriate in certain
circumstances, for example when we consider a market is moving towards being competitive or there is a risk that price regulation could deter investment. However, in Market 1 there is no operator other than BT and significant entry is unlikely during the forward look period of this review. We consider that the position of SMP held by BT is entrenched and the market is not moving towards becoming effectively competitive. 5.48 We therefore are of the view that ex ante pricing obligations are required to address
BT’s SMP in Market 1.
Cost orientation
5.49 Without some intervention in pricing, BT would have the ability to charge excessive prices in order to maximise profits by increasing its revenues. Excessive prices at the wholesale level could make it difficult for third party CPs to compete at the retail level with BT and in the long term, may result in market exit. In terms of the effect on the retail market, unjustifiably high wholesale charges are also likely to result in high retail prices, which indicates that consumers may be paying more for a service than they should expect if wholesale prices were constrained by effective competition. 5.50 A cost orientation obligation would require BT to set prices based on its costs
5.51 LRIC plus an appropriate mark up for common costs and for recovery of cost of capital is the preferred method for this type of regulation in communications markets. This is because communications markets experience economies of scale and scope. Common costs need to be recovered through mark-ups over LRIC in situations of one-way access where rivals buy wholesale inputs from the SMP wholesale provider without also selling wholesale inputs to the SMP wholesale provider. A requirement for charges to reflect an appropriate mark-up allows sufficient flexibility for this to be done in an efficient way whilst avoiding anti-competitive low prices or excessive prices.
5.52 A cost orientation obligation would act in addition to the “retail minus” approach set out above, providing a further constraint on BT. The cost orientation obligation would apply to each and every charge so that BT would not be able to set charges (such as transfers) at excessive levels75.
5.53 If we were to impose just a cost orientation obligation on BT, along with guidance as to the interpretation of this (for example, we could provide guidance that BT’s prices must, as a “first order test”, be between DLRIC76 and DSAC77), BT would be required to adjust its prices to comply with the obligation if its current pricing was outside this range. As such, BT’s prices would be constrained based on the costs incurred in Market 1.
5.54 However, as BT is the monopoly provider in Market 1, it is unlikely to be incentivised to reduce its costs and set prices at the competitive level. It would be likely to be able to recover higher costs through higher prices charged at the wholesale level, which would ultimately be passed on in higher retail charges.
5.55 In addition, as set out above, there are significant costs related to the WBA market that are not currently allocated to geographic markets. BT may seek to recover these costs, as well as common costs, through its prices in Market 1 given the absence of alternate supply.