The freephone and local rate calls battle – who’s lost?

2G and 3G masts on a mobile base station

The war between fixed network operators and mobile network operators is a central feature of most mature electronic communications markets, where few operators provide both fixed and mobile networks and services. The UK is no exception.

In the UK the most recent battle in this ongoing war has been in the freephone and local rate calls markets, known by the number prefixes used for the relevant number ranges of 080 (freephone) and 0845/0870 (local call or reduced call rate). In their bid to win customers from each other and reduce their own loss of customers, ie to reduce their churn rate, mobile network operators (MNOs) or their wholesale customers, the mobile virtual network operators (MVNOs) have developed a bewildering array of tariffs. These usually involve a range of bundles for minutes of calls, numbers of text messages and data rates for mobile broadband. A key part of these bundle offerings is the careful selection of which types of calls are included within the minutes permitted in any bundle. In most cases, the MNOs or MVNOs exclude calls to 080 or 0845/0870 numbers (the 08 Calls), perhaps because these calls are almost universally made to fixed network operators’ (FNOs) customers.

As a consequence, MNO and MVNO customers rarely know how much they are being charged to make these 08 Calls (see OFCOM’s Simplifying Non-Geographic Numbers consultation paper of 16 December 2010). The tariffs are not key differentiators or even factors customers consider when selecting an MNO or MVNO. As a result, there is little or no competitive pressure on MNOs and MVNOs for the 08 Calls. It is therefore not surprising that the tariffs charged for these calls can far exceed the network costs to the MNOs of setting up the calls (originating them) and handing them over to the FNOs to route to the called party (or to terminate them). FNOs, on the other hand, as terminating operators, have a monopoly on the market for terminating calls on their networks. Competition law can therefore ensure that the charges the FNOs make to MNOs to terminate the 08 Calls are not abusive, but are fair and non-discriminatory. Consequently, FNOs have long been aggrieved that the majority of revenue generated by for 08 Calls has been retained by the MNOs (and MVNOs).

British Telecommunications plc (BT) was the first to try to change their charges for terminating 080 Calls to get an increased share of this 080 Calls revenue. It was obvious that any change would be opposed by the MNOs. So when BT sought to change their terminating charges by use of Network Charge Change Notices (NCCN), these were disputed by the MNOs.  When these disputes could not be resolved, they were referred by the MNOs to the Office of Communications (OFCOM) for resolution using its statutory dispute resolution powers (see sections 185 to 191 of the Communications Act 2003).

OFCOM issued two determinations in respect of disputes between BT and various MNOs regarding BT’s termination charges and its relevant NCCNs:

• the first dealing with 080 calls on 5 February 2010 – the MNOs concerned being T-Mobile UK Limited (T-Mobile), Orange Personal Communications Services Limited (Orange), Vodafone Limited (Vodafone) and Telefónica O2 UK Limited (O2); and
• the second dealing with 0845 and 0870 calls on 10 August 2010 – the MNOs concerned being Vodafone, T-Mobile, Hutchison 3G UK Limited (H3G), O2, Orange and Everything Everywhere Limited (EE). EE is a 50%-50% joint venture between France Telecom and Deutsche Telekom, which was formed from the combination of their UK subsidiaries Orange and T-Mobile, who operated under the name of EE as a single entity from 1 July 2010.

In each determination OFCOM set out a number of near-identical principles, which it used to assess whether BT’s proposed termination charges were “fair and reasonable”. OFCOM considered that BT’s new charges were not fair and reasonable, as in each determination certain of these principles were not met.  BT was therefore not entitled to introduce the proposed tariffs.

BT appealed OFCOM’s determinations on both the 080 and the 0845/0870 disputes. BT had no fundamental dispute with the principles used by OFCOM to determine whether the proposed tariffs were fair and reasonable; it merely believed that OFCOM had misapplied its own principles.

EE also appealed OFCOM’s 0845/0870 determination.  It’s primary appeal ground was that OFCOM’s principles had failed to address an even more fundamental principle, that BT’s proposed tariffs should be cost-orientated or “cost reflective”. As they were not, they were unlawful. EE’s secondary position was that if OFCOM’s principles for determining the fairness and reasonableness of BT’s tariffs were upheld on appeal, then they had been correctly applied and OFCOM’s conclusions ought also to be upheld.

The Competition Appeal Tribunal (CAT) has recently published its decision in the joined appeals ([2011] CAT 24, 1 August 2011). The CAT had to decide if BT was entitled to impose its proposed tariffs. To do so, the CAT:

• reviewed OFCOM’s approach to resolve the tariff disputes, including OFCOM’s setting of its three cumulative principles according to which the fairness and reasonableness of BT’s tariffs were to be judged and their application to the facts;
• considered whether OFCOM correctly complied with its dispute resolution powers and the process set out in the Communications Act 2003; and
• considered what criteria the CAT must itself apply when hearing appeals of OFCOM’s determinations of disputes.

In a lengthy but well-structured judgement, the CAT had no argument with the principles adopted by OFCOM to resolve the 080 Calls’ tariffs disputes.  It found that Principle 1 (that MNOs should not be denied the opportunity in any tariff structure to recover their efficient originating costs for the calls) was satisfied. The CAT also considered that Principle 3 (that the proposed tariff structure was reasonably practical to implement) was also satisfied.

This left Principle 2, which was made up of several parts.  Principle 2(i) concerned whether the proposed tariffs had benefits to consumers. Principle 2(ii) concerned whether the tariffs avoided material distortion of competition. The CAT did not see how these were cumulative principles so that if either one failed, a new tariff could not take effect. Most importantly for future developments in the electronic communications market and its regulation, the CAT considered that OFCOM had failed to take into account a third factor: the contractual rights of BT.

The CAT believed that Principle 2(ii) concerning distortion of competition was satisfied; the imposition of a “stringent test for the introduction of price changes” by BT itself had the effect of distorting competition by placing a restraint on BT and other operators who wishes to impose similar laddered pricing structures. On Principle 2(i), the CAT did not say that it found the proposed tariffs to be beneficial to consumers; it considered that the outcome was inconclusive. However, it did criticise OFCOM for failing to take into account BT’s relevant market share in the call-hosting market, which, being limited, would dilute the impact of BT’s proposed tariffs. The CAT did not consider that the correct test was that the new tariffs had to be shown to benefit consumers, as this placed undue importance upon OFCOM’s own policy preference over Principle 2(i) and BT’s contractual rights. Instead, this policy preference could only have overridden the other factors OFCOM considered if it could have been clearly and distinctly demonstrated that the new tariffs would act as a material disbenefit to consumers.  An inconclusive finding by OFCOM was not enough to override BT’s contractual rights.

The CAT has therefore recognised the importance of freedom of contract in the promotion of competition. As an aside, this is exactly the argument put forward by Cable & Wireless, as an intervener and FNO in support of BT (see the closing arguments of Daniel Beard QC).

So who lost? This is a difficult question, but on one level the losers may be mobile phone customers. Clearly the MNOs were making healthy profits on their 080 Calls, using this additional revenue to cross-subsidise their bundle packages. These bundles may now reflect more their underlying costs, or in EE’s words, be “cost-reflective”, as more of the 080 Calls revenue is shared with FNOs.

As an aside, it became clear during the dispute from OFCOM’s draft determinations that a retail price of 12.5ppm was a rate that permitted MNOs on average to recover their efficient costs of originating calls to FNOs, both for 080 Calls and to geographic numbers. This rate is therefore is a useful benchmark with which consumers can check the tariffs being offered to them by MNOs and MVNOs.

[Disclaimer: I led the Charles Russell LLP team that acted for Cable & Wireless in the CAT. All information in this post is, as far as I am aware, available in the public domain. Any views expressed here are strictly my own and not those of Charles Russell LLP or Cable & Wireless.]

Opal Telecom -v- BT: an alternative technologically neutral approach

On 14 Septemer 2009 Ofcom published its draft determination to resolve the dispute between Opal Telecom and BT on Opal’s proposed termination rates to be effective from 1 October 2009.  In summary, Ofcom looked at the technology being deployed by Opal Telecom as part of its NGN network in order to determine whether it was appropriate for Opal Telecom to claim that it would be fair and reasonable for it to charge termination rates equivalent to BT’s single tandem termination rate.  The draft answer was, “No”.

Another approach to the dispute would have been to be technologically neutral.  Under the current market review in fixed geographic call termination markets, all operators have SMP in the market for termination on their own networks.  Consequently, all operators are subject to SMP Condition BC1 (or in the case of BT, SMP Condition BA1), which requires them to provide network access on terms, conditions and charges that are fair and reasonable.  BT is subject to further conditions, including SMP Condition BA3, which requires BT to base its charges for fixed geographic call termination on forward looking long run incremental costs (“LRIC”).

In deciding what is fair and reasonable for other operators, Oftel and Ofcom have consistently held that termination rates that are suitably reciprocal with BT’s are de facto fair and reasonable and compliant with SMP Condition BC1.  The “suitable” reciprocity refers to the weighted average of relevant BT termination rates, dependent upon the mix of geographical call termination traffic sent from the other operator to BT on the basis of a sample.  Currently the industry standard reciprocity agreement applies two weighting factors, depending upon whether the other operator is a single or multi-switch operator.  The single switch weighting is based upon a traffic sample in May of each year, to determine the proportion of calls sent to BT which are single tandem or local exchange terminated to be applied to the charges from October for the following year.  The multiple switch weighting uses the single switch weighting factor, together with a second factor to determine the percentage of those calls which are terminated by the operator as multi-switched calls.  This factor is recalculated twice a year, based upon samples of traffic in May and November.

Opal Telecom claimed it was a single switch operator.  This was not a factor in dispute.  Instead, Opal Telecom claimed that terminating traffic on its NGN network was the equivalent of terminating traffic on a single tandem switch.  Ofcom’s draft determination therefore had to analyse and take a view on the technology being deployed by Opal Telecom in its NGN network to come to a view on this claim.

We suggest that instead of considering the technology at issue, an alternative and possibly simpler approach would have been to ignore Opal Telecom’s technology (NGN, traditional TDM switched or otherwise).  An argument can then be made to state that the fair and reasonable termination rate is the higher of:

1. BT’s equivalent termination rate, weighted for the single switch operator rate in accordance with the traffic sent to BT AND weighted for a multi-switch operator rate in accordance with traffic sent by BT to a hypothetical TDM network engineered to carry the same volume of traffic and have the same geographical coverage as the other operator’s actual network; or
2. the other operator’s actual charges for fixed geographic call termination based upon forward looking long run incremental costs.

There is a question as to whether this formula fully complies with all the six principles of pricing and cost recovery used by Ofcom, particularly the principle of reciprocity (where services are provided reciprocally, charges should also be reciprocal), as the other operator’s termination rates under the second limb may be higher than BT’s termination rates.  However, provided the charges are at LRIC, then this may be the price to enable the new market entrant to deploy a new technology fairly (i.e. without an effective susbisdy from all operators sending traffic to be terminated on the new network).  There is also the praticability principle (the mechanism for cost recovery needs to be practicable and relatively easy to implement).  Without speaking to a network engineer, we cannot say whether it would be practical for a hypothetical TDM network to be agreed for the purposes of determining whether a TDM network equivalent to the other operator’s network would be a multi-switch network with any given number of switches.  As for the practicability of the other operator determining its LRIC rates, the burden of proof would be on the other operator to determine its costs to justify the higher termination rate.

We consider you could even propose that such a technology neutral approach could be used no matter what the nature of the other operator (i.e. fixed, mobile, nomadic (WiMAX) etc.), but maybe that it taking matters too far.

Charges for CPS set-up: stitch up and screw up?

CPS Timeline

The history of Carrier Pre-Selection (“CPS”) in the UK (as depicted in the timeline above) may be considered to be a bit of a special interest.  However, the conclusions that may be drawn from Ofcom’s review of CPS set-up charges, following a long-running dispute between CPS operators and BT,  may be of wider interest.

BT became subject to a requirement to provide cost-orientated CPS under an SMP condition made under the new Communications Act 2003 regime on 28 November 2003 (the “First Date” labelled on the timeline).  Ofcom ruled in a Determination dated 13 February 2009 that BT had included the retail costs in dispute in breach of that SMP condition.  BT was ordered to reduce its CPS set-up charge by 78p to £1.69 per customer (a reduction of over 31%) from the date of the Determination (the “Third Date” labelled on the timeline).

However, in a Further Statement dated 6 July 2009 Ofcom decided not to order BT to make any repayment of the overcharges, even though in a draft determination included with the February 2007 Determination, it had proposed ordering BT to make repayments from the date when BT ought to have known that the retail costs were inappropriately being included in the CPS set-up charge, determined to be from the date that the current CPS charges were announced (1 November 2007, the “Second Date” labelled on the timeline).

This is a slightly troubling decision by Ofcom.  It appears to imply that there is no strict liability for breach of an SMP condition.  BT, in the absence of any guidance or ruling from Ofcom, was judged to have reasonably included the disputed retail costs in the CPS set-up charges.  Ofcom accepted BT’s subjective view of what was reasonable in November 2003 and November 2007.  Nowhere in the draft or final determinations is the aggregate amount of the CPS overcharges set out.  However, assuming that the overcharge was 78p for each of the 4,000,000 CPS customers in the UK, it can be estimated that the overcharge gave BT a benefit over 6 years in the order of £3m.  Whatever the actual benefit to BT, this must have been a relevant factor for Ofcom in determining whether their approach was appropriate and proportionate.  It is therefore surprising not to see any indication of the BT benefit in the Determination.

Ofcom avoided reviewing the impact of BT’s overcharging, the so called “competitive distortion”, without much justification.  Ofcom also avoided analysing the fact that BT, in recovering retail costs from CPS operators that they were not themselves able to recover, was arguably acting in a discriminatory manner in breach of a more general non-discrimination SMP condition.

It can therefore be argued that in getting away with overcharging CPS set-up costs since 2003, BT has well and truly stitched up the CPS operators. 

It can also be argued that in:

• not providing clear guidance to BT on what costs could be included in CPS charges in 2003; or
• not carrying out the retail costs review promised in August 2005 for 2006; or
• not carrying out a discrimination or “competitive distortion” analysis in the 2009 CPS determinations;

with the result that BT was able to overcharge for CPS and not be required to repay any of these overcharges, Ofcom has screwed up.

If you would like a copy of the CPS Timeline, email us at critique@charlesrussell.co.ukand we will send you the Excel timeline by return.

We're all going on a [regulatory] holiday…

As is often the case, the devil is in the detail.  Alistair Darling’s Budget speech did not mention Ofcom at any point.  Why would it?  However, there is an interesting statement of intent buried in one of the Budget reports.  Particularly, in paragraph 4.41 of Chapter 4, it states:

In advance of the Digital Britain final report, the Government will review the powers and duties of Ofcom to ensure it can strike the right balance between delivering competition and encouraging investment in the communications infrastructure.

What does this mean?  Does this imply that Ofcom will be pressured to accept that BT be given a regulatory holiday for any broadband roll out?  That is certainly what some sources appear to be suggesting to the Financial Times.

We have also heard rumours that the Council of Ministers may also have included similar wording into the draft revised electronic communications regulatory framework currently going through the EU co-decision procedure. We will have to see what appears in the EU Parliament at Second Reading.

If this means that regulatory holidays are alive and well and living in Europe, then this is a monstrous victory by incumbents, which will arguably put back the liberalisation and development of open competition in the electronics communications sector in the EU by at least three years.  The position in the UK will also be reversed.  No longer will Ofcom’s position as a leading regulator be maintained, and it will destroy the equivalence of access principles developed by Ofcom in its settlement with BT that are considered in many circles to be best international regulatory practice.

Or maybe we are just being too cynical?

BT 21CN (NGN) Security Threat?

We were interested to read over the weekend that there may be hardware trapdoors or software trojans in Huawei next generation network equipment supplied to BT for its 21CN NGN network, according to a report in The Sunday Times.

At what point does this become a regulatory issue?  The Privacy and Electronic Communications (EC Directive) Regulations 2003 impose an obligation on providers of public electronic communications services to:

“take appropriate technical and organisational measures to safeguard the security of that service”  (See Reg. 5).

The service provider can require the network provider to comply with its reasonable requests concerning implementation of these appropriate measures.  Where a significant security risk remains, then subscribers are supposed to be told.

We look forward to Ofcom investigating whether BT has done the appropriate technical due diligence on Huawei equipment and the statement from BT that it has addressed the security risks to its public electronic communications services!