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Commerce Commission recommends unbundling

Media Release

Issued 18 September 2003-04 /037

Telecommunications Act: Commerce Commission recommends unbundling

The Commerce Commission considers there would be substantial net benefits from unbundling Telecom New Zealand’s local loop network. In its draft report released today, the Commission’s preliminary view is to recommend unbundling of Telecom’s local loop and its fixed Public Data Network.

Unbundling of telecommunications networks is a means of allowing competitors to use parts of the network on a wholesale basis in order to build up a competitive offering of retail services.

The local loop network is the copper wire network that links homes and businesses to a national telephone network. Through obtaining access to Telecom’s copper wire network, other carriers will be able to compete more vigorously with Telecom in the delivery of broadband and voice services both to residential and business users.

Unbundling the Public Data Network will encourage further competition in the supply of data transmission and other data services to businesses.

Telecommunications Commissioner Douglas Webb said the Commission’s preliminary view, based on extensive investigation and the results of the cost-benefit analysis and the findings on competition, is:
- to designate unbundling of Telecom’s local loop network;
- to designate unbundling of Telecom’s fixed Public Data Network;
- to designate access to co-location and backhaul services;
- to apply benchmarking as the Initial Pricing Principle; and
- to apply cost-based pricing as the Final Pricing Principle.

“The Commission has evaluated evidence from a range of sources, including conducting a cost-benefit analysis and evaluating the state of competition in the relevant markets and in overseas jurisdictions.

“While the overseas experience has not been conclusive, the Commission’s cost-benefit analysis shows substantial net benefits from unbundling. The Commission would, however, welcome input and comments to refine this analysis further,” Mr Webb said.

Following the release of its draft report today, the Commission is seeking submissions and will hold a public conference in October in preparation for its final recommendation to the Minister of Communications in December.

The draft report is available at http://www.comcom.govt.nz/telecommunications/localloop.cfm

Submission details

The Commission welcomes submissions on the draft report from interested parties. The closing date for submissions is 16 October 2003. The Commission will hold a public conference on the draft report from 28 to 31 October in Wellington.

Electronic versions should be e-mailed to telecommunications@comcom.govt.nz. These will be published on the Commission’s website. Hard copies of the submissions should be posted to:

Unbundling Draft Report
Network Access Group
Commerce Commission
PO Box 2351, Wellington

Background
Section 64 of the Telecommunications Act 2001 requires the Commerce Commission to conduct a review of the desirability of regulating access to the unbundled elements of Telecom New Zealand’s local loop network and access to the unbundled elements of, and interconnection with, Telecom New Zealand’s fixed Public Data Network.

The Commission commenced the investigations with the release of an Issues Paper and accompanying appendices entitled “Telecommunications Act 2001: Section 64 Reviews into unbundling the Local Loop Network and the fixed Public Data Network” on 10 April 2003. On 4 September 2003 the Commission also launched an investigation under Schedule 3 of the Act into certain aspects of unbundling.

The Executive Summary from the draft report is attached.

Commission media releases can be viewed on its web site www.comcom.govt.nz
Executive Summary

Introduction and process

1. Section 64 of the Telecommunications Act 2001 (“the Act”) requires the Commerce Commission (“the Commission”) to conduct a mandatory review of access to the unbundled elements of Telecom New Zealand’s local loop network and access to the unbundled elements of, and interconnection with, Telecom New Zealand’s fixed Public Data Network (PDN).

2. The Commission must deliver a final report to the Minister within twenty four months of the Act’s commencement, which is by 20 December 2003, with recommendations as to whether Schedule 1 of the Act should be altered as a result of the review.

3. The Commission commenced the section 64 investigation with the publication of an Issues Paper on 10 April 2003. The Commission sought submissions from interested parties on the Issues Paper by 14 May 2003. Submissions were received from fifteen organisations and one member of the public. In some cases, organisations provided more than one submission.

4. On 4 September 2003, the Commission commenced an additional investigation under Schedule 3 of the Telecommunications Act 2001 into whether or not Schedule 1 to the Act should be altered in any of the ways set out in sections 65 to 67 of the Act. The additional matters to be considered concern the desirability of regulating access to:

- The Main Distribution Frame;
- Ancillary Services which may need to accompany unbundling of the local loop network or the fixed Public Data Network, including co-location and backhaul services;
- Line sharing; and
- Data backhaul over the fixed Public Data Network.

5. The Commission has combined the section 64 and Schedule 3 investigations. The services covered in the investigation under section 64 of the Act will be dealt with together with the wider investigation under Schedule 3 of the Act.

6. The Commission will report on both of these simultaneously in a final report to the Minister of Communications.

7. Under the Act, the Commission is required to prepare and give public notice of a draft report which must include the detail of any proposed alteration to Schedule 1.

Legal framework and interpretation of key terms

8. The Commission determines that the definition of the boundary of the local loop network is up to and including the Distribution Frame, Main Distribution Frame, Optical Fibre Distribution Frame or equivalent facility at the local exchange. The Commission is seeking views on the extent to which ‘hybrid loops’, comprising both copper and fibre in the feeder network, should be covered by the definition of the local loop network.

9. In terms of the fixed Public Data Network, the Commission concludes that:
- Fixed PDN means a PDN or the part of a PDN that connects an end-user’s building or building distribution frame to a ‘data switch or equivalent facility’. It also includes the data switch or equivalent facility and the link within the building that connects to the end-user’s equipment;
- An appropriate definition of ‘fixed’ is one which excludes mobile data networks but does not exclude fixed wireless systems;
- A ‘data’ network is, ‘a data network used, or intended for use, in whole or in part, by the public’;
- Telecom’s fixed PDN is limited to the physical assets owned by Telecom, but includes network elements Telecom leases, or exerts control over, for the successful end-to-end transfer of data;
- A network built exclusively for an individual customer is a private network. All other networks are public; and

10. To the extent they do not fall within section 64, line sharing and the Main Distribution Frame are included within the Commission’s investigation under Schedule 3 of the Act. Ancillary services including backhaul and co-location are also included under this investigation.

11. In addition, the Commission has defined the term “end-user” to mean the ultimate user or consumer of telecommunications services. To the extent possible, the Commission considers that the assessment of competition and of the counterfactual should be forward looking over a 5 year period.

Market Assessment

12. The Commission has conducted a market defintion exercise in relation to the relevant markets. This is based on the standard procedure of examining the product dimension, the geographic area from which the goods or services are obtained, and the functional dimension. The Commission has defined a set of wholesale and key downstream markets based on how the services are likely to be used.

13. The Commission has defined the following wholesale markets:
- For local loop services, a wholesale market for local loop services by Exchange Serving Area (ESA);
- A wholesale market for bitstream access by ESA;
- A wholesale market for local loop backhaul services by ESA;
- A wholesale market for co-location space by ESA;
- For PDN services, a wholesale market for PDN services by ESA; and
- A wholesale market for PDN backhaul services.

14. In addition, the Commission has defined the following retail markets:
- For local loop services, a retail market for metropolitan residential local access services;
- A retail market for non-metropolitan access services;
- A retail market for residential broadband services;
- A retail market for business local access services;
- A retail market for business broadband services;
- For PDN services, a retail market for data services in metropolitan areas; and
- A retail market for data services in non-metropolitan areas

15. The following table summarises the Commission’s conclusions with respect to competition in the relevant local loop and PDN markets.

Table 1: Summary of conclusions with respect to competition

Market Competition

Wholesale market for local loops in AK, MWN, MKY, CPC, WN ESAs# Not Limited
Wholesale market for local loops in other ESAs Limited
Wholesale market for backhaul services Limited*
Wholesale market for co-location space Limited*

Wholesale market for PDN services in AK, MWN, MKY, CPC, WN ESAs Not Limited
Wholesale market for PDN services in other ESAs Limited
Wholesale market for PDN backhaul services Limited*
# AK Auckland Central; MWN Mt Wellington; MKY Manukau City; CPC Courtenay Place; WN Wellington.
* Except in respect of AK, MWN, MKY, CPC, WN ESAs.
16. In terms of the relevant downstream markets (relating to local access, broadband, and data services), limited competition is found in all the markets, with the exception of metropolitan business broadband services, and metropolitan data services. No finding was made in relation to corporate local access in metropolitan areas.

17. Competition is limited both in the wholesale markets listed in Table 1 and in a number of related downstream markets in respect of which unbundling of the local loop network and the PDN could promote increased competition through access for entrants to essential intermediate inputs.

Access to the unbundled elements of Telecom’s local loop network: Cost-benefit analysis

18. A range of views were expressed in the responses to the Issues Paper, both for and against unbundling. Of the fifteen responses, approximately eight were in favour of unbundling and six against, with Nortel Networks not expressing a firm opinion.

19. To assess the case for unbundling, the Commission conducted a cost-benefit analysis (CBA) of the regulatory options with the assistance of consultants, Oxford Economic Research Associates (OXERA).

20. A counterfactual is needed against which to assess the case for regulation. The Commission determined the most likely counterfactual as being a continuation of the status quo, but encompassing:
- The existing regulatory regime maintaining its current level of effectiveness;
- The constraint from the threat of regulation being as efficient as it is now. The investigations themselves may have some impact on the future environment; and
- Considerations of the likely trends in technology.

21. The counterfactual should be forward-looking over a 5 year period. There will also be impacts over time from the Commission’s wholesale determination and from the emergence of fixed wireless competition. The CBA makes an adjustment for these factors.

22. In terms of the factuals, the regulatory scenarios, the Commission has assessed the following cases:
- Case 1 Full unbundling;
- Case 2 Line sharing;
- Case 3 Bitstream access;
- Case 4 Unbundling of, and interconnection with, the fixed PDN.

23. The services that will be subject to unbundling are the two types of service that can be delivered to consumers through fixed copper telephone wires: voice and data.

24. The focus of the cost-benefit analysis is on consumer surplus. The CBA shows substantial benefits from unbundling, with full unbundling showing the greatest benefits followed by bitstream access and then line sharing. There are also net benefits from unbundling the PDN of around the same order of magnitude as bitstream access. This is summarised in the following table. This shows the consumer surplus gains over the bases case or counterfactual.

Present value of consumer surplus 2005-10 (NZ$m), central case
Case Specification Designation
Price effect Take-up effect Total Price
effect Take-up effect Total
1: Full 9.0 0.7 9.8 188.8 74.7 263.5
2: Line sharing 7.5 0.8 8.3 33.1 12.6 45.8
3: Bitstream 32.5 4.0 36.5 117.1 42.4 159.5
4. PDN 104.7 0.0 104.7 305.2 0.0 305.2

25. OXERA has conducted a number of sensitivities of the main results, for example, to changes in the assumptions on the elasticity of demand, different price falls, a different Weighted Average Cost of Capital (WACC) and return on sales and a decrease in the range over which broadband services can be supplied. The results of CBA are robust to these sensitivities.

26. In addition, the Commission has conducted a sensitivity on the results to remove the metropolitan areas, which it has found to be competitive, from the cost-benefit analysis. The Commission has further applied a 25% reduction to the net benefit to make an allowance for indirect effects or the effects of regulatory error. This 25% adjustment is purely for the purposes of the CBA. The results are shown in the following table.

Total Net Benefits adjusting for competitive areas and potential regulatory risk NZ $m

Removing Competitive ESAs Applying a 25% discount factor
Specification Designation Specification Designation
Full unbundling - 150.22 - 112.7
PDN unbundling - 122.01 - 91.5


27. Benefits remain substantially positive even with the removal of the competitive areas and applying a 25% discount factor, with $112.7m for full unbundling and $91.5m for PDN unbundling.

28. A key element of the CBA is the prices on which the results are based. The Commission engaged COVEC Limited (COVEC) to report on several price related issues for input into its assessment, under the reviews, of the merits of specifying or designating access to unbundled network elements.

29. COVEC recommends:
- Benchmarking as the initial pricing principle for unbundled access to full and shared local loops and access to the unbundled elements of the fixed Public Data Network; and
- Retail minus pricing for bitstream access.

30. In terms of the final pricing principles, COVEC’s recommendations are as follows:
- To use bottom-up modelling to identify costs;
- To assess costs on a forward-looking costs; and
- To use a similar pricing methodology as the Commission uses in interconnect pricing (LRIC).

31. COVEC suggests that the Commission’s TSLRIC model, which is currently being developed in the context of the determination of pricing for interconnection of the Telecom and TelstraClear networks, could be adapted to derive final prices for unbundled services.

32. For the purposes of the draft recommendation, the Commission has accepted COVEC’s recommendations.

33. In terms of the definition of broadband adopted, the Commission uses a working definition of 256 kbp/s downstream as the threshold for a “broadband” product, in line with a number of other countries. The Commission’s analysis does, however, include products with a downstream speed of 128 kbp/s as ‘entry level’ broadband products, such as the “JetStream Starter” product offered by Telecom.

International experience with unbundling the local loop network

34. The Commission has reviewed relevant international experience and factors driving broadband uptake, including unbundling of the local loop. The Commission does not consider that it is possible to unpack the effect of the possible drivers, such as unbundling of the local loop individually. Statistical analysis is unlikely to provide significant or meaningful results given the limited data set, and the fact that the identified drivers of broadband uptake differ in extent between each jurisdiction.

35. The Commission has concluded that the identified variables offer limited evidence on their individual effect on broadband uptake. The Commission has not been able to separate local loop unbundling from other potential drivers of broadband uptake.

Impact on efficiency

36. Section 18(2) of the Act requires the Commission to consider the efficiencies that will result, or be likely to result, from an act or omission.

37. In each of the unbundling scenarios, there are productive efficiency benefits from unbundling. The productive efficiency gains are smaller in magnitude than the allocative efficiency gains.

38. In each case there are substantial dynamic efficiency benefits from unbundling. All these results are summarised in this report.

39. The Commission places particular weight on dynamic efficiency given the focus in the Act on the long-term benefits of end-users. The Commission has therefore examined the impact of unbundling on investment and innovation using international experience.

40. The Commission is not convinced that unbundling will reduce the overall level of investment in telecommunications networks. It is not clear from overseas empirical evidence that unbundling has the deleterious effect on investment predicted by many commentators. Purchasing unbundled loops, as opposed to, for example, wholesale Digital Subscriber Line products, requires the access seeker to invest in DSLAMs and equipment at local exchanges, such that the quantum of investment is increased overall. Likewise, there are potential gains from service and application innovation as a result of further broadband take-up under unbundling.

Technical and practical considerations for LLU

41. The Commission recognises that the management and resolution of technical and practical issues is critical to the successful implementation of LLU.

42. The Commission has the ability to draw upon the experience of national regulators in United States, Europe, and Australia in developing industry codes and practices, and managing potential conflicts between incumbents and new entrants.

43. The Commission’s assessment of the technical and practical issues has led it to conclude that it is technically and practically feasible to implement unbundling in New Zealand. This is not to say that this would be without difficulty or cost. The technical costs are reflected in the cost-benefit analysis.

Overall assessment of net costs and benefits of LLU regulation

44. In terms of assessing the net costs and benefits of unbundling, the Commission considers that:
- The local loop is likely to be a material component in the supply of local access services, including in the supply of broadband services;
- Regulation would ensure access to these services at cost-based prices;
- Where unbundling is mandated on particular terms and conditions, it can act as a competitive constraint on the incumbent’s ability to exercise market power to the detriment of end-users; and
- To reflect indirect costs or the scope for regulatory error, the net benefits of the various options have been reduced by 25%. Even reducing the net benefits by this amount, substantial net benefits to unbundling remain.

45. Taking account of these points and the results of the CBA, the Commission’s preliminary view is that there is a net overall benefit to unbundling.

Access to the unbundled elements of Telecom’s fixed Public Data Network: Cost-benefit analysis

46. The results of the cost-benefit analysis for the central case of PDN unbundling are reported above. Using a churn rate to competitors of 10% compared with 5% under LLU, the net benefits under designation are $305.2m. The Commission considers that a 10% churn rate is a more realistic assumption for designated PDN services. If the metropolitan areas are removed from the results under designation (areas which the Commission has found to be competitive) the net benefits are decreased by 60%. However, they remain substantially positive at $122m.

International experience with unbundling the fixed Public Data Network

47. The European Commission affirmed in the 8th Report on the Implementation of the Telecommunications Regulatory Package that the timely and efficient availability of a range of leased lines at cost-oriented prices is a necessary condition for the development of effective competition in particular in high speed access to the internet.

48. The Commission agrees that there are some similarities between overseas experience with leased line regulation and the case of regulating the PDN. It is unclear the degree to which this can inform the Commission’s conclusions given the particular circumstances in each country.

Impact on efficiency

49. The Commission’s consultants, OXERA, have found there to be substantial dynamic efficiency benefits from PDN unbundling (see above). The price effect is a mix of allocative, productive and dynamic efficiency benefits.

Technical and practical considerations for PDN unbundling
50. The Commission recognises that the technical and strategic issues involved in the unbundling of the fixed PDN are highly complex. There are not many international precedents from which experience can be drawn. However, a number of countries have regulated the supply of Partial Private Circuits, similar to unbundled access to the fixed PDN. None of these have found the technical and practical costs to be prohibitive. The Commission does not consider that these costs are likely to be excessive.

Overall assessment of net costs and benefits of PDN regulation

51. Under the PDN unbundling scenarios, OXERA found substantial dynamic efficiency gains. Given the Commission’s focus on the long-term under section 18 of the Act, the Commission places particular weight on dynamic efficiency gains. The Commission’s preliminary conclusion is that there is a net overall benefit from unbundling the PDN.

Summary of recommendations

52. In summary the Commission’s draft recommendations are to:

- Designate unbundling of Telecom’s local loop network;
- Designate unbundling of Telecom’s fixed Public Data Network;
- Designate access to co-location and backhaul services;
- Apply benchmarking as the Initial Pricing Principle; and
- Apply TSLRIC as the Final Pricing Principle.

53. The Commission seeks comment on its recommendations and on this draft report by 16 October 2003.


Structure of draft report

54. This paper is divided into eight chapters.

- Chapter 1 sets out the process for conducting the investigations, which is governed by Schedule 3 of the Telecommunications Act 2001. It also presents the Commission’s timetable for completing the investigations;
- Chapter 2 sets out the legal and statutory framework under which the investigations have been conducted;
- Chapter 3 give the interpretations of the key terms;
- Chapter 4 contains the Commission’s assessment of the relevant markets;
- Chapter 5 applies the Commission’s decision making framework to the local loop network and chapter 6 likewise to the fixed Public Data Network;
- Chapter 7 sets out the Commission’s conclusions and draft recommendations; and
- Chapter 8 consolidates the list of questions for consultation.

55. Five appendices accompany the draft report.
- Appendix 1: List of submissions on the Issues Paper
- Appendix 2: Modelling the Impact of Unbundling the Local Lop Network and the Fixed Public Data Network: and Efficiency Analysis to support the Cost-benefit Analysis: Reports by OXERA
- Appendix 3: Pricing of Unbundled Access: Report by COVEC
- Appendix 2: International definitions of ‘Broadband’
- Appendix 3: International Summary Statistics.

56. The Commission seeks comment from all industry participants, and from the public more generally, and will have regard to all submissions received when preparing its Final Report. The Commission particularly encourages the following groups to consider the matters set out in this draft report and make submissions to the Commission to assist it in considering these issues:

Those who will, or who would be likely to, seek access to unbundled elements of the local loop network (LLN), or access to and interconnection with the fixed PDN, should they be designated or specified, along with the access provider
End-users of services where the provision of those services is likely to be affected by the availability to access seekers of access to unbundled LLN or fixed PDN elements and interconnection with the fixed PDN, and
Representatives of these categories (access seekers, access providers and end-users).

ENDS

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