balancing incentives for the migration to fibre networks - …€¦ · · 2018-05-09balancing...

Balancing incentives for the migration to

fibre networksA report by NERA Economic

Consulting for Vodafone Group Plc

Transitioning from copper-based to

fibre networks is essential for faster, more powerful

networks. The creation of the Gigabit Society depends on

this change.

The access pricing paradoxAn incumbent operator will switch from

copper to fibre when the expected profit from fibre is higher. But lowering copper access

prices to alter profitability means consumers will not demand fibre

The copper wedge solutionThe copper wedge creates a gap between the price charged to access seekers for services on the copper network and the amount the infrastructure owner receives.

The surplus revenues are deployed towards investment in fibre

Balancing incentives to promote investment in fibre networks

The copper wedge could:

Be a potentially effective tool for accelerating the switch from copper to fibre

Increase incentives for both incumbents and entrants to transition more rapidly to fibre

Be implemented using generally accepted regulatory principles and techniques

Authors Dr. Jeffrey Eisenach, Senior Vice President and Co-Chair of NERA’s Communications, Media and Internet Practice

Dr. Bruno Soria, Associate Director in NERA’s Communications, Media and Internet Practice

The authors are grateful to Janusz Mrozek, Carey Ransone and Patrick McGervey for their assistance with this report, and to Vodafone for sponsorship.

About NERA Economic Consulting is a global firm of experts dedicated to applying economic, finance and quantitative principles to complex business and legal challenges. For over half a century, NERA’s economists have been creating strategies, studies, reports, expert testimony and policy recommendations for government authorities and the world’s leading law firms and corporations. We bring academic rigour, objectivity and real-world industry experience to bear on issues arising from competition, regulation, public policy, strategy, finance and litigation. The views expressed are exclusively the authors’ own and do not necessarily represent those of NERA Economic Consulting, or any of the institutions with which they are affiliated.

43 Balancing incentives for the migration to fibre networks

Contents

5 The access pricing paradox and the copper wedge

5 The APP in a copper-to-fibre transition

6 Incentive effects of the copper wedge

7 Implementing the copper wedge

7 Setting efficient access prices

8 Establishing geographic boundaries

9 Differentiating among access technologies

9 Applying wedge revenues

10 Implementing the copper wedge: an example

10 The fibre challenge

11 Implementing the copper wedge

14 Conclusion

15 End notes

The access pricing paradoxand the copper wedge

Implementing thecopper wedge

Implementing the copper wedge: an example

Conclusion


We have been asked by Vodafone to assess issues relating to the incentive effects of access pricing schemes in the context of migrations between succeeding generations of technology, specifically migration from copper to fibre broadband access networks. We understand that for European regulators, promoting increased investment in next generation access (NGA) broadband networks, and specifically in fibre-to-the-premises (FTTP) networks, is a high priority. The European Commission has identified that the current regulatory framework has not sufficiently contributed towards promoting the transition towards NGA networks1.

One widely recognised challenge in technology transitions arises because incumbents may have incentives, for a variety of business or competitive reasons, to transition from copper to fibre at a sub-optimal pace. One possible response to this problem is to adjust access prices, ie to lower the price infrastructure owners can charge for copper relative to the price charged for fibre, thus raising the relative return to fibre deployment. One obvious problem with this approach is that the lower price charged for copper reduces the incentives of access seekers to move off the copper network by either switching their access purchases to fibre networks or by investing in their own infrastructures. In either case, the effect is to dilute, or eliminate altogether, the intended effect, which is to incentivise both incumbents and entrants to make efficient investment choices. We refer to this problem as the access pricing paradox (APP).

In its response to the European Commission’s December 2015 public consultation on the review of the regulatory framework for electronic communications2, Vodafone suggested addressing the APP problem by creating a ‘copper wedge’, that is, a gap between the price charged to access seekers for services delivered over the copper network and the price received by the infrastructure owner3. Access seekers would continue to pay the full price for copper access, thus maintaining proper incentives for them to move to fibre, but during the migration period incumbents would receive something less, thus providing the desired additional incentive for fibre investment needed to achieve the optimal pace of migration.

Our purpose in this paper is to offer an independent assessment of both the potential effectiveness and the practical administrability of the copper wedge. To briefly summarise our conclusions, we find:

y The wedge model is a potentially effective tool for accelerating the shift from copper-based to fibre technologies

y By setting the amounts paid by access seekers for copper-based services at a higher level than the price received by infrastructure owners for those services, wedge pricing would increase incentives for both incumbents and entrants to transition more rapidly to fibre

y There are no apparent significant barriers to implementing such an approach using generally accepted regulatory principles and techniques.

IntroductionSpecifically, we find that the wedge model could be implemented through a relatively simple three-step process:

1. Identify areas in which FTTP deployment is economically efficient and viable based on private investment (but has not yet occurred)

2. For copper access lines in these areas, set the price received by the access provider (PR) at a level that does not incentivise further investment in copper (eg at or near short-run incremental cost (SRIC)), while leaving the price paid by access seekers (PP) at or near forward-looking long-run incremental cost (FL-LRIC)

3. When the incumbent completes the transition to FTTP in a given area, and assuming it chooses to leave the copper network in place, remove the wedge by raising PR to equal PP (or, if the wholesale market is sufficiently competitive, consider removing access price regulation altogether), thus effectively rewarding the incumbent’s investment.

We conclude that this approach, in conjunction with other steps such as implementing a workable scheme for access to passive infrastructure (duct and pole access or DPA) and allowing market-based pricing of FTTP services, could accelerate the pace of fibre deployment, increase the likelihood of effective infrastructure-based competition and enhance the potential for reducing regulation.

The remainder of this paper is organised as follows. The next section briefly reviews the literature on the incentive problems that arise in setting efficient access prices for copper and fibre networks during the course of technological migration, and explains broadly how the copper wedge would address them. The following section discusses the issues that would need to be addressed in implementing a wedge pricing regime. Then we look more closely at the specific public policy objectives and market context in the UK as an example and explain how wedge pricing could contribute to achieving stated regulatory objectives. The final section presents a brief conclusion.




Conclusion


Access pricing in telecommunications has been studied extensively by scholars and regulatory bodies, with much of the initial research focusing on the effects of access pricing on investment in infrastructure4.

More recent research has focused on the related question of how to best manage the transition from older to newer generation technology and in particular from copper- to fibre-based, higher-speed broadband5. The regulatory decisions at issue involve not only the price and extent of access to legacy copper infrastructure and to fibre infrastructure, but also whether or not to give access to fibre networks that are only partially deployed or planned. In managing this transition, regulatory tradeoffs arise from differing incentives between incumbents and entrants.

The APP in a copper-to-fibre transitionEarly analyses of the effects of copper access prices on fibre investment arose partly in response to the European Commission’s (EC’s) ‘A Digital Agenda for Europe’ communication in 2010. Among the issues the EC identified in that document was a lack of adequate investment in next generation access (NGA) networks6. In response, the Commission recommended that policy should seek to “[f]oster the deployment of NGA networks” and specifically that “National Regulatory Authorities should be able to impose the most appropriate access remedies in each case, allowing a reasonable investment pace for alternative operators while taking into account the level of competition in any given area7”.

In response to the EC’s questions regarding the appropriate access price, WIK Consulting performed a study for ECTA, finding that higher copper access prices reduce the incumbent’s incentive to invest in fibre. As WIK explained:

“An integrated incumbent will switch from copper to fibre, when copper profit is below the expected fibre profit. Since higher copper access charges increase profits from copper but leave fibre profits unaffected, high access charges for copper reduce the incentives for a switch…. High levels of copper access charges generate negative incentives for incumbents to invest into fibre because of profit cannibalisation8.”

The access pricing paradox and the copper wedgeThe WIK study sparked a further discussion about the role of access pricing in technology transitions. Plum Consulting, working on behalf of the European Telecommunications Network Operators’ Association (ETNO), disputed WIK’s conclusions and argued instead that reducing copper access prices could actually discourage investment in fibre9. The Plum argument rests on the notion that low copper prices will result in low retail prices for copper-based services, increasing the relative price of fibre-based services, thereby reducing demand and making fibre investment less profitable. A CRA study for DG Information Society and Media finds the effect of low access prices for copper on investment in fibre to be ambiguous, especially if copper and fibre are operated in parallel for a period of time10.

The conflicting effects of lowering copper access prices are further analysed in Bourreau, Cambini, and Doğan (2012), who identify three separate effects, which they term the ‘replacement effect’, the ‘wholesale revenue effect’, and the ‘migration effect’11.

y The ‘replacement effect’ is driven by the effect of the copper access price on the relative profitability of using the existing copper network for the entrant: as the price of copper access increases, the entrant finds the purchase of access to be less desirable and so is more inclined to invest in its own infrastructure. Hence, lower copper prices reduce the incentive for entrants to invest in next generation networks (NGNs)

y The ‘wholesale revenue effect’ is, in effect, the converse of the replacement effect, but applied to incumbents: a lower copper access price reduces the incumbent’s return on copper relative to the return on investments in fibre, thereby encouraging increasing fibre investment. This is the effect identified in the WIK study and its primary basis for advocating lower copper access prices as a means of encouraging fibre

y The ‘migration effect’ refers to the fact that lower copper wholesale prices lead to lower retail prices for copper-based products, retarding consumer migration to higher-speed, fibre-based services and thus reducing the demand for fibre and the returns to fibre investment for incumbents and entrants alike.

These three effects are summarised in Table 1 below.

Table 1: Effects of reducing copper access price on fibre investment incentives12

Effect Description Incumbent Entrant

Replacement Lower copper access fees reduce entrants’ incentive to invest in fibre

Neutral (lower copper access fees but may be compensated by higher volume)

Weaker

Wholesale revenue Lower copper access fees increase incumbents’ incentive to invest in fibre

Stronger N/A

Migration Consumers’ demand for fibre-based services depends on the price of copper-based service (which in turn depends on copper access fees)

Weaker Weaker




Conclusion


As Crandall, Eisenach and Ingraham point out, the result of these three conflicting effects is that “the net effect of changes in copper access rates is unpredictable13”. We refer to the policy condundrum that results as the APP.

In essence, the regulator has two instruments in hand, the copper access price and the fibre access price14, to control three desired outcomes, the efficient outcome in the copper access market, the efficient outcome in the fibre access market and the desired rate of transition from copper networks to fibre. On the face of it, the fundamental problem – essentially a maths problem with insufficient degrees of freedom to identify a unique solution – is irreconcilable. Vogelsang (2013) notes that, “the copper wholesale access price as a single instrument cannot implement an efficient policy that is characterised by several tradeoffs.” Furthermore, “[i]t is not clear that a middle road will resolve this controversial issue, although the MEA approach could be promising.” In the same article, however, Vogelsang hints at a potential solution:

“Another compromise would be a commitment contract with an escrow account. In that case, the regulated firm would receive a low wholesale access charge if it does not invest in NGA and a high charge if it does, the difference being held in escrow until the investment has occurred15.”

In effect, the ‘escrow account’ creates an additional instrument, and hence a potential solution. As discussed further below, this idea is similar to and consistent with the copper wedge: both ideas allow for the price received by the incumbent to be adjusted contingent on its choice of technology for new investments.

Incentive effects of the copper wedgeThe copper wedge resolves the conflicting incentives faced by incumbents and entrants by facing each of them with price signals that lead to economically efficient outcomes. Under the wedge model, the access seeker will pay the dynamically efficient price for copper access – ie the price that gives the entrant the economically efficient incentive to invest in its own fibre network, while the incumbent will receive a price designed to remove its incentive to continue investing in its copper network. Importantly, downstream consumers also face an economically efficient price for copper-based services, giving them the incentive to migrate to fibre-based services, and so creating demand for fibre to justify the investments made. Thus, the copper wedge allows the regulator to choose a policy that creates economically efficient incentives for migration to fibre on both the supply/investment and consumer/demand sides of the market. By doing so, it provides an escape from the APP.

Further, because some of the payment made by the entrant is not received by the incumbent, it could in principle be available to satisfy other regulatory objectives, such as expanding service in expensive-to-serve areas.

Consumers are given an incentive to migrate to fibre-based services, creating demand to justify the investments made




Conclusion





Conclusion

This section identifies and discusses four issues that would need to be addressed in implementing a wedge pricing regime: establishing criteria for setting access prices; determining which geographic areas are covered; distinguishing between eligible and ineligible technologies; and determining how to allocate the revenues produced by wedge pricing.

Setting efficient access pricesBy definition, the copper wedge is the difference between the price paid by the access seeker (PP) and the price received by the incumbent (PR)16. The innovation of wedge pricing is that it allows each price to be at a level that incentivises economically efficient conduct by all the respective parties – incumbent, access seeker and downstream consumers. This section discusses the methodologies that might be used for setting PP and PR

17.

Consider first the price received by the incumbent. In most jurisdictions, copper prices for unbundled local loops (ULL) have been set using FL-LRIC, which essentially estimates the costs of deploying and operating a new copper network. As Neu et al point out, FL-LRIC prices are no longer appropriate for copper networks for several reasons, including that copper is no longer considered a modern technology, and that demand for copper access is declining18. They consider a variety of alternatives, but ultimately recommend a modified form of SRIC, which they refer to as SRIC+.

The attraction of SRIC is that it represents essentially a zero-profit level for the incumbent – the price below which the incumbent would shut down the network rather than operating it, since it would be making no contribution to profit: on a forward-looking basis, SRIC-based access prices remove the incumbent’s incentive to continue investing in an obsolete technology. Neu et al suggest that SRIC could be supplemented by “an opportunity cost factor reflecting consumers’ valuation of the network to be determined on the basis of incentive pricing”19. (Hence the “+” in SRIC+.) They further suggest that, in the absence of an independent estimate of SRIC+, historical cost accounting (HCA) could be used as a “default

Implementing the copper wedge

solution,” after properly taking into consideration the extent to which assets have already been depreciated20.

If the regulatory objective is to incentivise investment in fibre rather than copper, something approaching SRIC is the appropriate starting point for setting PR. However, to avoid harming incentives for future investment, it is also important to consider the need to allow a reasonable return on assets whose costs have not yet been fully recovered. Thus, to the extent that copper assets have already been deployed at the time a wedge pricing scheme is implemented, but whose cost has not yet been fully recovered, PR should also include a cost-recovery factor for more recently deployed assets. For clarity, we refer to this concept as modified SRIC, or MSRIC21. Formally:

MSRIC = SRIC + supplement for cost recovery

With respect to PP – the price paid by access seekers – it is well established that PP should reflect the opportunity cost of building out their own networks, plus a small increment designed to incentivise such investment22. Regulators in most jurisdictions have long relied on FL-LRIC pricing models, and the wedge concept provides no reason to change. Thus, while circumstances will differ from jurisdiction to jurisdiction, as a general matter the starting point for PP would be FL-LRIC.

Expressed in terms of per line access prices, the amount of the copper wedge would be the difference between the FL-LRIC price and the MSRIC price – that is:

Copper wedge = PP (FL-LRIC) – PR (MSRIC) > 023

The primary cost concepts that would be most likely to form the basis for wedge pricing are listed in Table 2 below.

Table 2: Primary access price methodologies

Methodology Comments

FL-LRIC (forward-looking long-run incremental cost)

FL-LRIC loses relevance when applied to obsolete technologies (ie copper). An alternative is to base FL-LRIC on the costs for a modern equivalent asset (MEA) (ie fibre). However, if FL-LRIC (fibre) exceeds FL-LRIC (copper), further adjustments are required (ie quality).

FL-LRIC minus (FL-LRIC minus performance delta)

FL-LRIC value for fibre minus a market-based adjustment for quality differences between fibre and copper. Need to assess the value actually placed on quality by customers.

HCA (historical cost accounting) Magnitude will be substantially different from a forward-looking approach when costs are changing over time.

MSRIC (modified short-run incremental cost)

SRIC plus a supplement to ensure cost recovery for not-yet-depreciated investments in recently deployed infrastructure.

SRIC+ (short-run incremental cost plus)

SRIC plus a supplement to reflect consumers’ valuation of the network in excess of operating costs.

SRIC (short-run incremental cost) May induce negative dynamic incentives as it does not allow recovery of recent investments.

The innovation of wedge pricing allows each price to be set so that it incentivises economic conduct by incumbent, access seeker and consumer





Conclusion

To be clear, it is not the purpose of this study to specifically assess which approaches would be best under particular circumstances or in particular jurisdictions. Rather, our point is that the setting of PP and PR can be accomplished without the need for significant regulatory innovation, using generally accepted regulatory techniques, and wedge pricing could be implemented using standard, well-tested procedures.

As with other instances of wholesale pricing regulation, it would be appropriate to review the established prices on a regular basis (eg every three to five years) to reflect changes in markets and technologies.

Establishing geographic boundariesVariation in income and other economic characteristics, population density and topographical characteristics affect the economics of broadband infrastructure deployment. In most jurisdictions the most advanced NGA infrastructures – FTTP and hybrid fibre-coaxial (HFC), which we refer to collectively as NGA+ – are not currently economically viable in all areas. Because the objective of the wedge is to incentivise FTTP deployment in areas where it is economically viable to do so24, its application should be limited to such areas. By the same token, it is possible that some areas are capable of supporting one NGA+ infrastructure but not two. In such areas, public policy should not incentivise inefficient network duplication.

The current status of broadband deployment in many European jurisdictions is illustrated in Figure 1, which divides a hypothetical ‘map’ of a typical jurisdiction into five zones25:

Zone 5: Copper (ADSL/VDSL, etc) deployed; NGA+ not currently viable

Zone 4: Copper (ADSL/VDSL, etc) deployed; NGA+ viable but not deployed

Zone 3: Copper (ADSL/VDSL, etc) deployed; HFC deployed

Zone 2: Copper (ADSL/VDSL, etc) deployed; FTTP deployed

Zone 1: Copper (ADSL/VDSL, etc) deployed; FTTP and HFC deployed

The figure is constructed to illustrate a fairly typical situation: Some form of copper is deployed virtually everywhere; HFC is deployed to a significant number of premises; FTTP is deployed on a more limited basis, partially in areas also served by HFC (and copper) and partly in areas with only copper26.

The purpose of the wedge is to incentivise deployment of NGA+ networks in areas where they are not already present but are economically viable. Thus, it would apply to access lines located in Zone 4 and whatever portion of Zone 3 is determined to be capable of supporting infrastructure-based competition between NGA+ networks27.

The desired end state is illustrated in Figure 2, which shows the same hypothetical jurisdiction after fibre has been deployed in the areas where it is economically viable to do so. In the situation depicted here, most of the population would have coverage from at least one fibre and one HFC infrastructure (plus copper, if not retired), while smaller proportions would be served by copper and HFC, copper and fibre or, in hard-to-serve areas, copper only.

Figures 1 and 2 also illustrate how the wedge model would evolve with the evolution of the network. As fibre is deployed in additional areas, the rationale for the wedge in those areas disappears – that is, there would be no further need for a gap between PP and PR. The regulator would then make a decision about whether competition was sufficient to eliminate or phase out mandated access prices for the copper plant, and also whether to permit (or promote) decommissioning of the copper plant altogether. The considerations involved in these decisions are not specific to the wedge concept, and we do not address them in depth here. What is clear is that, once fibre is deployed, the wedge would disappear and the incumbent would begin receiving PP, effectively providing a further incentive for rapid deployment of fibre28.

Figure 2: Desired state of play

HFC + FTTP

Copper only

Copper + HFC

HFC + FTTP

Copper + FTTP

Figure 1: Current state of play

Copper only/NGA+ not viable

Copper + HFC

Copper only but NGA+ viable

HFC + FTTP

Copper + FTTP

Copper + HFC

87 Balancing incentives for the migration to fibre networks9




Conclusion

Differentiating among access technologiesIn implementing a wedge model, the regulator must determine where to draw the line between technologies that qualify for wedge pricing (ie copper) and those that would be exempt (ie fibre). In practice, a variety of technologies have been or are being implemented, including ASDL, VSDL, G.Fast, FTTN, FTTH (a category that itself comes in several flavours, including P2P, POP, GPON, etc) and HFC, which fall in the category designated NGA+.

While the practicality of the copper wedge does not necessarily depend upon where the line is drawn, a strong case can be made for distinguishing between all forms of FTTP technologies, on the one hand, and all forms of FTTN, on the other29. That case rests on three grounds: future technology path; service quality; and competitive impact.

First, unlike FTTN technologies, FTTP infrastructures are effectively ‘future proof’ with respect to capacity: FTTP (and HFC) either have already achieved or have known upgrade paths to 1 Gbps and faster internet speed service. By contrast, G.Fast, which makes use of fibre technology to the node/cabinet connecting copper loops to the premises, can only achieve 1 Gbps over the shortest copper loops, less than 100m in length. At a distance of 200m performance degrades to only 200 Mbps. That upper limit on speed means that G.Fast is not a technology that can be upgraded to support future demand for increased broadband speed.

Second, NGA+ should also be defined to include technologies with low rates of service failures. Networks based on copper-based technologies, including G.Fast, suffer from greater levels of service failures than do networks based on fibre or HFC technologies, and entail higher levels of maintenance30.

Third, technologies that more readily allow competition to exist between operators and access seekers can lead to improvements in competition in the future, which Ofcom is equally interested in promoting. As Ofcom has stated, “[W]e will step back from regulation where people and businesses no longer need it, including when there is a real prospect of competition. Our ultimate goal is to improve communications services for everyone, not to increase regulation31.” In this context copper-based technologies suffer because of vertical integration issues between operators and access seekers. The access seeker’s dependence on the operator to address basic issues of connection, upgrading and other customer issues necessarily affects the competitive dynamic between the parties. By contrast, FTTP technologies

allow for greater separation of competitors using the same network. Furthermore, those technologies possibly allow for creation of separate logical networks for each network user, such as by using WDM on a GPON network, further reducing integration issues. Finally, network access can be customised to a greater extent, allowing network users to provide additional value through product differentiation.

Applying wedge revenuesOne by-product of the copper wedge is the revenues that would result from the difference between the price paid by access seekers and the price received by incumbents. Wedge revenues in any given period would equal this difference times the number of copper lines used by access seekers. That is:

Wedge revenues = (PP –PR) * L

where L is the number of copper access lines purchased in areas where the wedge model is in place. Wedge revenues would be expected to shrink over time as the number of copper access lines (and the extent of areas covered by wedge pricing) declines and, assuming the wedge were phased out at some point, would disappear altogether. However, at least initially, the amount of revenue involved could be significant. Policymakers would need to determine how these revenues would best be used. Three possibilities seem most obvious.

y Apply wedge revenues to the general fund of the government implementing the programme

y Use wedge revenues to increase investment in and access to high-speed broadband. For example, wedge revenues could be used to subsidise fibre investment in high-cost or remote areas where FTTP deployment is not economically viable through private investment alone

y Use the revenues to enhance competition, eg by improving passive infrastructure, thereby reducing costs for all providers and increasing the feasibility of infrastructure-based competition32.

In any case, an administrative apparatus for collecting, monitoring and spending these amounts would be needed to implement the ‘wedge’, but it is clear that implementing such a system would not pose significant difficulties.

Figure 3: Characteristics of an NGA+ technology

What defines NGA+?

Gigabit technology path

Improved service quality

Dimensions of competition





Conclusion

This section assesses the copper wedge in the context of the broadband market, specifically in the United Kingdom, and in the context of policymakers’ stated objectives to increase investment in and deployment of FTTP infrastructures. We conclude the wedge model could play an important role in aligning incentives for an efficient migration from copper-based networks to fibre. Because the issues now being confronted by Ofcom are also present throughout much of Europe (and, indeed, in other countries as well), the discussion below suggests the copper wedge deserves consideration in other markets as well.

This section is organised as follows. First, we review Ofcom’s stated policy objectives and then assess the extent to which they are likely to be achieved by current market dynamics. Second, we discuss whether a wedge pricing model addresses the problems identified. Third, we address implementation issues in the specific context of the UK market and current policies.

The fibre challengeIncreasing investment in fibre is a central objective of UK communications policy. In particular, the first of Ofcom’s ‘key proposals’ in its Initial Conclusions report is “a strategic shift to large-scale investment in more fibre”33. Several of Ofcom’s other key objectives would be directly advanced by increasing fibre deployment, including its goals of achieving “a step change in quality of service”, to promote competition both within and among infrastructure platforms, and a desire to “deregulate and simplify while protecting consumers”34.

Ofcom explains its focus on fibre deployment in the context of the relatively slow pace of fibre deployment in the UK to date, finding that “the UK is notable for its very limited availability of ultrafast broadband services, including those based on FTTP. On this metric, it compares poorly with the majority of our global peers”35. (See Figure 4.) Further, Ofcom concludes, “ultrafast

Implementing the copper wedge: an examplebroadband … is only widely available from Virgin Media (with speeds of up to 152 Mbit/s) over its limited footprint and from a number of smaller providers such as Hyperoptic and Gigaclear”36, while BT has made only “some limited deployments of fibre-to-the-premises”37.

Currently, the UK market is served by three primary types of infrastructure-based wireline broadband providers: BT (the incumbent telephone company for most of the UK) and KCOM (the incumbent in Hull and East Yorkshire), Virgin Media (the cable television operator), and a handful of infrastructure-based entrants.

Existing and planned deployments of what we have termed NGA+ networks (FTTP and HFC/DOCSIS) are limited. As noted above, BT’s FTTP deployments are de minimus, and its stated strategy is to continue improving its copper network by expanding deployment of G-Fast technology. Virgin Media’s HFC/DOCSIS network currently passes only about 44% of premises, and its stated goal is to reach 59%. KCOM is upgrading its legacy copper network to FTTH38, but its coverage area comprises only 0.7% of UK premises. New fibre players (eg CityFibre) are launching a number of new initiatives, but combined cover only a very limited part of the country. Other existing alternative broadband operators (both fixed unbundlers and mobile network operators) are not engaging in widespread fibre network investments. They have pointed, in their recent contributions to the Strategic Review of Digital Communications, to barriers that hinder large-scale investments in fibre deployments39.

Current and near-future broadband availability in the UK is depicted in Figure 5. As the figure shows, fewer than half of premises currently have access to NGA+ networks, and this figure will increase to 59% as Virgin Media expands its coverage footprint. While some additional UK premises may achieve faster speeds than at present as a result of BT’s expansion of G-Fast, they will not benefit from deployment of FTTP.

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Figure 4: FTTP deployment in OECD countries, 2015

Source: Ofcom DCR Initial Conclusions at Figure 7.





Conclusion

Note also that more than one in six households (17% of UK premises) only have access to ADSL-based broadband, and many have access to only very slow download speeds: 8% of premises do not have access to speeds above 10 Mbps41, and 2% are below 2 Mbps42.

Ofcom also notes that the quality of Openreach service is inadequate, and places a high priority on achieving “a step change in quality of service”43. As noted above, one of the benefits of FTTP deployment is the greater reliability of FTTP infrastructures (including resistance to moisture, temperature variations and radio interference)44. Ofcom’s own tracking of “other metrics affecting performance” including latency, packet loss, domain name system (DNS) resolution, DNS failure, and jitter finds that fibre-to-the-cabinet (FTTC) systems generally outperform ADSL2+ systems45.

On the basis of these findings, Ofcom’s Initial Conclusions report declares its intention to make a fundamental break from the current strategy, especially as it relates to BT’s current strategy of upgrading its copper-based network: “We will make a strategic shift to encourage large-scale deployment of new ultrafast networks, including fibre direct to homes and businesses, as an alternative to the copper-based technologies currently being planned by BT 46.”

Ofcom’s primary strategy for achieving increased fibre deployment is to promote network-based competition. Specifically, the Initial Conclusions report finds that:

“The best driver for investment and innovation is network-based competition: and this is at the heart of our future strategy. We believe competition between different networks (including those built from scratch or built using duct and poles owned by others) is the best way to drive investment in high-quality, innovative services for consumers47.”

Ofcom’s strategy for enhancing competition has four elements. First, access to BT ducts and poles will be improved. Second, Openreach will continue to be regulated where competition is insufficient. Third, and importantly, access prices will be set in order to ensure incentives to build FTTP infrastructure: “In particular, we want to ensure the incentives are there for operators to build new networks as opposed to relying overly on buying access from BT48.

Ofcom’s pricing strategy has four goals:

y Preserving the investment incentives faced by BT

y Preserving the investment incentives faced by competitors to BT

y Protecting retail competition where necessary

y Protecting consumers against the risk of high prices49.

Fourth, Ofcom finds that, despite the functional separation of BT and Openreach, the combined firm continues to have incentives to discriminate against competitors, pointing out that “Today the evidence provided in response to our Discussion Document highlights that, under the current model of functional separation, BT continues to have the ability and incentive to favour its downstream business in certain respects50.” Accordingly, Ofcom proposes to impose a “strengthened model of functional separation” while reserving “the right to take forward structural separation51.”

As we explain below, implementation of a wedge pricing model could contribute to achieving Ofcom’s objectives.

Implementing the copper wedgeWhile the steps proposed by Ofcom would undoubtedly accelerate fibre deployment, we believe the likelihood of significantly increasing access to FTTP in the near term would be significantly increased if they were supplemented by a copper wedge approach to access pricing.

As Ofcom has recognised, the central challenge to FTTP deployment in the UK is BT/Openreach, which has embarked instead on a copper upgrade strategy. While increasing the availability of passive infrastructure would reduce the costs of deploying FTTP for BT’s competitors, it would not enhance the incentives for BT to deploy fibre. Furthermore, it is already known that BT’s reaction to network-based competition from Virgin Media or other firms deploying NGA+ technologies has been and continues to be to upgrade its copper network rather than to migrate to fibre. While a more aggressive approach to functional separation may over time alter BT’s incentives, it is unlikely to have a dramatic or immediate effect. At the end of the day, access pricing will play a central role in determining the incentives of both BT and potential entrants to deploy FTTP.

In this context, it is significant that Ofcom is already contemplating expanding its access price regime to BT’s VDSL infrastructure beginning as early as 2017, while allowing FTTP investments continued pricing flexibility, in the context of its wholesale local access (WLA) market review proceeding52. In considering the appropriate access price for VDSL networks, Ofcom will inevitably confront the APP.

As explained in the previous chapter, implementing a wedge model requires addressing four sets of issues: pricing; geographic coverage; technology eligibility; and, disposition of revenues. The following sections discuss each of these issues in the context of the UK. To be clear, it is not our objective in this brief paper to fully resolve any of these issues, but rather to assess, in the first instance, whether they are capable of resolution, and to outline in broad terms potential outcomes.

0

10

20

30

40

50

60

70

Current coverage Near-future coverage

Cove

rage

sha

re (%

)

Fixed broadband Superfast NGA+

17

3944

1724

59

Figure 5: Coverage share of United Kingdom premises by fastest technology (current and anticipated)40

Source: NERA analysis





Conclusion

Setting access prices As just noted, Ofcom is about to embark, through its WLA review, on a proceeding in which it will consider whether to extend access pricing to all of BT’s copper infrastructure, including its ‘superfast’ FTTC network, and if so, what access prices to set. A decision to implement wedge pricing would be appropriately considered as part of that proceeding. The only difference between the proceeding already contemplated and the one needed to implement the copper wedge is that it would result in the setting of two access prices, PP and PR, rather than only one.

For PP, the price paid by access seekers, the starting point for consideration would, as discussed above, be the FL-LRIC price for each type of copper network. The consultation would need to contemplate whether to embrace some form of MEA approach, and whether to apply a quality-based adjustment. These issues have been addressed in the literature53, and are not fundamentally affected by the introduction of the wedge approach: the regulatory objective in setting PP would continue to be to establish a price that provides entrants with the appropriate incentives to balance reliance on leased lines with investment in new infrastructure. While it is not our purpose to pre-judge the outcome, the fact that the incentive effects of PP would be felt solely by access seekers (and not the incumbent) argues in favour of a purely forward-looking (ie MEA-based) approach.

For the incumbent’s price received, PR, Ofcom would estimate SRIC for the existing copper network using standard procedures, and then consider adding a cost-recovery uplift for investments in the copper network that have not yet been fully recovered, resulting in an MSRIC or MSRIC+ price. Ofcom has already indicated its intention to consider this issue in its Initial Conclusions report54.

While the setting of PR and PP, and hence the size of the wedge, will depend on the WLA consultation, the impact of the copper wedge on BT’s investment incentives is potentially significant. A rough estimate based on overall Openreach financial data suggests that the SRIC+ value for copper would be 62% of current revenues, which means that the copper wedge would be 38%. As Openreach annual revenues from copper leasing are approximately GBP 1.7 billion, that amount would represent GBP 650 million annually55.

Geographic boundaries and access technologiesAs discussed above, the copper wedge operates by establishing a temporary gap between the price paid by access seekers and the revenues received by the incumbent for access lines in areas where FTTP deployment is economically feasible but not yet deployed, then removing the gap once deployment is complete. Specifically, as discussed in the previous chapter, the regulator begins by identifying five geographic zones. In the case of the UK, the five zones would consist of the areas shown in Table 3.

Geographic application of the wedge in the UK would be defined primarily by identifying three types of geographic areas.

(1) Areas in which NGA+ deployment is currently not economically viable, even by a single carrier (Zone 5). In such areas, there is no basis for applying the wedge.

(2) Areas where Virgin Media has deployed or is deploying NGA+ (Zone 3), but where deployment of a second NGA+ network is not economically feasible. While we believe it is likely FTTP deployment is economically viable in all or nearly all of Virgin’s footprint, there may be areas where a single NGA+ infrastructure is preferable and which would thus not be eligible for the wedge.

(3) Areas where FTTP deployment has already occurred or is underway.

All other areas would be eligible for wedge pricing.

The feasibility of this approach in the UK is supported by two factors.

First, Ofcom has extensive experience in assessing network costs throughout the UK, and already conducts all or most of the analysis necessary to define these zones. Ofcom routinely determines the extent of competition in leased lines and the possibility of extending fibre on a postcode sector basis. Its WLA proceeding56 has categorised three levels of competition in the UK: Market A (9.6% of premises), where there are only one or two providers, Market B (89.7% of premises), which Ofcom considers to be effectively competitive, and the Hull area (0.7% of premises), in which KCOM is the only provider and Openreach does not provide services. Finally, Ofcom has access to data on incumbent plans to expand deployment of fibre.

Second, as noted above, wedge pricing would be applied on a geographically averaged basis, thus providing incentives for both the incumbent and access seekers to invest in inframarginal areas. That is, PR and PP would be calculated based on MSRIC and FL-LRIC/MEA (respectively) for the copper network throughout the eligible geographic footprint, and the average would be applied to all eligible access lines. Because avoided costs57 would not vary across geographies for either the incumbent or the entrant, both parties would have the most to gain by investing in areas where costs are lowest.

The implication of geographically averaged wedge pricing is that effective implementation does not depend on the ability to estimate with precision the boundary between areas where NGA+ deployment is economically feasible and those where it is not: the wedge will incentivise investment in the areas where it is most viable.

Table 3: Wedge pricing zones in the UK

Zone Infrastructure deployment Pricing

5 Copper only/NGA+ not viable No wedge (PR=PP)

4 Copper only but NGA+ viable Wedge (PR<PP)

3 Copper + HFC (Virgin Media) Partial wedge?

2 Copper + FTTP (BT or entrant) No wedge (PR=PP)

1 Copper + HFC + FTTP deployed No wedge (PR=PP)





Conclusion

Disposition of wedge revenuesThe main objective of the wedge model is not to collect revenues but to stimulate investment in NGA+ networks. This said, wedge revenues would represent a potentially significant by-product.

For purposes of illustration only, assume NGA+ investment is viable to 60% of access lines (ie essentially the same footprint to which Virgin Media is deploying NGA+). Assume further that FTTP is deployed to that footprint over a five-year period, at a constant rate of 20% of lines per year. Finally, assume the wholesale price of copper lines (PP) remains at GBP 88/year and that the wedge comprises 38% of wholesale revenues to be charged on each copper line (ie PR = GBP 55/year). Table 4 presents the results of this scenario.

Total wedge revenue collected in this scenario would amount to GBP 975 million over five years. A fund this size has the potential to have a significant impact on NGA+ deployment in areas where it would not otherwise be economically viable. For example, wedge revenues of this magnitude would fund more than half of the GBP 1.7 billion superfast broadband programme, which is expected to result in private deployment of superfast broadband to an additional two million UK premises58.

Other issuesOf course, the wedge model does not do away with a variety of further issues that will need to be considered as the transition to FTTP occurs, either in the UK or elsewhere. Ofcom and other regulators will still need to consider whether to continue to be mandated to the copper infrastructure in areas where NGA+ infrastructures have been deployed, and whether to permit (or encourage) copper retirement. For example, ARCEP has recently launched a public consultation to seek comments about the possibility of relaxing or even suppressing copper access regulation in areas where fibre infrastructures are available to all users59. However, these issues are independent of the wedge model, whose main effect would be to hasten the time at which they will be encountered.

Table 4: Potential wedge revenues, 2017–2021

Year 2017 2018 2019 2020 2021

Copper lines in wedge area (end of year) 9,331,200 6,998,400 4,665,600 2,332,800 0

Copper lines in wedge area (year average) 10,497,600 8,164,800 5,832,000 3,499,200 1,166,400

Wholesale copper revenues (GBP million) 924 719 513 308 103

Wedge revenues (GBP million) 351 273 195 117 39





Conclusion

Regulators implementing access pricing regimes face a challenge in creating appropriate incentives for an efficient transition from copper to fibre technologies. As a result of the APP, any single access price creates uneconomic incentives for one or more of the parties. The copper wedge provides a means of separating the price received by incumbents from the price paid by access seekers, thereby potentially resolving the APP.

This study examines the theoretical desirability and practical feasibility of implementing a wedge pricing model. We find that wedge pricing could indeed provide a mechanism for facing both incumbents and access seekers with more efficient incentives to accelerate the transition from copper to fibre. Further, we have identified no significant barriers to implementing such an approach; rather, it could be accomplished without significant regulatory innovation, using generally accepted regulatory principles and techniques. Accordingly, we conclude that the wedge model merits further study as a potentially important tool for incentivising fibre deployment in European markets such as the UK and similarly situated jurisdictions.

Conclusion


End notes1. European Commission, Background to the Public Consultation on the

Evaluation of the Regulatory Framework for Electronic Communications and on its Review.

2. Vodafone, Response to EC’s Telecoms Framework Review.3. Vodafone, Response to Ofcom’s Consultation: Strategic Review of Digital

Communications discussion document, 8 October 2015, page 55 (‘One way to do this would involve inserting a ‘wedge’ between the copper price paid by BT’s rivals and the receipts Openreach would actually obtain from those sales.’)

4. Much of the early work focused on the ‘ladder of investment’ thesis, positing that allowing competitors access to the incumbent’s infrastructure would enable them to get a foothold in the market, making it more likely that they would subsequently invest in their own infrastructure. See Martin Cave and Ingo Vogelsang, How Access Pricing and Entry Interact, Telecommunications Policy 27, 717–728. For a review of the early literature, see Carlo Cambini and Yanyan Jiang, Broadband Investment and Regulation: A Literature Review, Telecommunications Policy 33 (2009) 559-574 at 564.

5. A somewhat related literature addresses the possibility of ‘co-investment’ between incumbent and entrant providers in next generation technology. See Marc Bourreau, Carlo Cambini and S. Hoernig, Ex-ante Regulation and Co-investment in the Transition to Next Generation Access, Telecommunications Policy 36:5 (2012) 399-406, section 4.

6. European Commission, A Digital Agenda for Europe, communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, Brussels, 26 August 2010, page 5–6 (hereafter EC Digital Agenda for Europe 2010).

7. EC Digital Agenda for Europe 2010, page 20.8. Steffen Hoernig, Stephan Jay, Werner Neu, Karl-Heinz Neumann, Thomas

Plückebaum and Ingo Vogelsang, Wholesale Pricing, NGA Take-up and Competition, WIK-Consult, Study for ECTA, 7 April 2011, page 9.

9. Brian Williamson, David Black and Jonathan Wilby, Costing Methodology and the Transition to Next Generation Access: A Report for ETNO, Plum Consulting, March 2011, page 13.

10. Jenny Haydock, Gregor Langus, Vilen Lipatov, Damien Neven and Gareth Shier, Costing Methodologies and Incentives to Invest in Fibre, Charles River Associates, prepared for DG Information Society and Media, July 2012.

11. Marc Bourreau, Carlo Cambini and Pinar Doğan, Access Pricing, Competition, and Incentives to Migrate from ‘Old’ to ‘New’ Technology, International Journal of Industrial Organization 30 (2012) 713–723.

12. See Ingo Vogelsang, The Endgame of Telecommunications Policy? A Survey, Review of Economics 64:3 (2013) 193-269, page 218 (hereafter Vogelsang (2013)) (‘In a world with expected parallel operation of copper and fibre access networks over a long time span, Bourreau, Cambini and Doğan (2012) identify three effects that jointly determine the efficient wholesale access charges for the old technology. The replacement effect calls for a large enough copper access charge so that independent NGA investors have incentives to invest. The wholesale revenue effect calls for a large enough difference between the copper and fibre access charge so that profits from copper alone are lower than profits from operating both a copper and a fibre access network. Replacing copper with fibre needs to be sufficiently profitable in order to induce fibre investment. The migration effect calls for small enough price differences between copper and fibre access so that end-users have incentives to switch from copper to fibre, once fibre is offered. The interaction of the three effects leads to a compromise level of regulated copper wholesale access price, not too high and not too low.’)

13. Robert W. Crandall, Jeffrey A. Eisenach and Allan T. Ingraham, The Long-Run Effects of Copper-Loop Unbundling and the Implications for Fiber, Telecommunications Policy 37 (2013) 262-281, page 278. See also, Marc Bourreau, Carlo Cambini and Steffen Hoernig, Ex Ante Regulation and Co-Investment in the Transition to Next Generation Access, Telecommunications Policy 36 (2012) 399-406, page 402.

14. The fibre price may be the unregulated ‘market’ price or an access price set by the regulator.

15. Vogelsang (2013), page 219. (MEA refers to modern equivalent asset, which uses state-of-the-art fibre networks as the modern equivalent asset of copper networks when calculating regulated access prices.)

16. Note that in markets where there is functional separation, the retail entity would pay PP and the wholesale entity would receive PR.

17. As discussed below, wedge pricing would only apply in areas where fibre deployment is economically feasible but has not yet occurred. In areas where fibre has been deployed (especially when there are multiple fibre or fibre-equivalent networks), the copper access mandate could be removed, or pricing liberalised. In areas where fibre deployment is infeasible, PP = PR.

18. Werner Neu, Karl-Heinz Neumann and Ingo Vogelsang, Cost Methodologies and Pricing Schemes to Support the Transition to NGA, WIK-Consult GmbH, Bad Honnef, Germany, December 2011, page 1 (hereafter Neu et al (2011)) (‘The FL-LRIC cost standard… no longer is appropriate to be applied for the copper access network for five reasons: (1) Copper access is no longer the modern equivalent of a fixed-line access infrastructure; (2) Demand for copper access is declining; (3) No newly entering operator would invest in a copper-based access network anymore; (4) Given the actual lifetime of the copper access network and its status of depreciation, applying FL-LRIC furthermore would lead to a (significant) over-recovery of costs for the network owner; (5) Given the cost drivers of an access network, applying FL-LRIC furthermore would lead to increasing costs, in contrast to the real market value of the copper access network assets and the opportunity costs of the operator.’).

19. Neu et al (2011), page 1. SRIC+ has been adopted by the Swiss regulator as a price floor to protect against below cost access prices that might emerge from its fibre-based MEA approach for setting copper access prices. See http://www.networkedlaw.com/files/1414/1260/1266/Telecoms_Newsletter_Switzerland_-_October_3_2014.pdf and http://www.networkedlaw.com/files/8213/9980/8791/The_Past_and_the_Future_of_Cost_Oriented_Access__The_Draft_Telecommunication_Ordinance.pdf.

20. Neu et al (2011), page 1.21. The literature on stranded cost recovery is relevant here: essentially, for

areas where FTTP is economically viable, the copper network can properly be regarded as ‘stranded investment’.

22. For example, the European Commission recommends BU-LRIC+ (bottom-up FL-LRIC) for setting prices of the regulated wholesale access services. See eg European Commission, Commission Recommendation of 11 September 2013 on consistent non-discrimination obligations and costing methodologies to promote competition and enhance the broadband investment environment, 2013/466/EU, 11 September 2013, page 29.

23. We do not explicitly address the setting of access prices or conditions for FTTP infrastructure, which is a conceptually different exercise from the setting of copper prices to form the wedge. In general, the more extensive access mandates, and lower access prices, will result in less FTTP investment, regardless of the copper prices.

24. By ‘viable’ we mean ‘capable of generating an economic return on the required investment’. A related, but in most jurisdictions probably less empirically significant issue, is the possibility that some areas may be capable of supporting multiple NGA+ infrastructures, such that it might be desirable to leave the wedge in place even after deployment of an HFC and a third-party FTTP network had been deployed.

25. Not shown in the figure is the further distinction between areas – subsets of Zones 2, 3 and 4 – where NGA+ deployment is viable but NGA+ competition is not.

26. In some areas where FTTP is deployed, the copper plant is or eventually will be decommissioned. However, in most jurisdictions copper retirement has either not yet begun or is at a very early stage.

27. The extent to which competition between NGA+ networks is economically viable is an empirical issue that will vary from jurisdiction to jurisdiction, but we believe that many areas capable of supporting one NGA+ network are or soon will be capable of supporting two. See, eg Bruno Soria and Félix Hernández-Gil, Do NGAN Economics Allow for Network Competition? Communications and Strategies 78 (June 2010) 23–78. Another form of intermodal competition may emerge in the form of 4G/5G wireless broadband. The significance of wireless as a competitor to wireline broadband is not specific to the wedge concept and we do not address it here.

28. We propose that PP and PR would be geographically averaged across the eligible footprint. The effect of geographic averaging in this instance is that both incumbents and access seekers would have incentives to deploy fibre in the lowest cost areas first. That is, incumbents would get the same benefit (in terms of reducing the scope of wedge pricing) regardless of where they deployed fibre, and so maximise returns by investing in areas where it is inexpensive to build fibre. By the same token, entrants would pay the same price for copper in all areas, and thus also maximise returns by investing in low-cost areas.




Conclusion


29. While we believe HFC should be categorised as NGA+, from the perspective of the wedge model, this is a secondary question, which relates back to the question of which geographic areas should be eligible for wedge pricing. If economic modelling demonstrates that an area will only support one ultrafast network, and that area is already served by HFC, then it would not be economically efficient to implement the wedge in that area, regardless of whether HFC is formally designated NGA+.

30. Tom Collins, 8 Advantages of Fiber-Optic Internet vs. Copper Cable, atlantech, 28 December 2015 (accessible at https://www.atlantech.net/blog/8-advantages-of-fiber-optic-internet-over-copper-cable) (hereafter Collins (2015)).

31. Ofcom, Making communications work for everyone: Initial conclusions from the Strategic Review of Digital Communications, 25 February 2016, page 1 (hereafter Ofcom DCR Initial Conclusions).

32. As discussed above, for networks that have not yet been fully depreciated, SRIC-based pricing of copper access lines would reduce access payments for copper below levels necessary for full cost recovery. A fourth option for applying wedge revenues would be to use a portion to make up this shortfall. Such a scheme would need to be carefully constructed so as to avoid weakening the incentive effects of wedge pricing.

33. Ofcom DCR Initial Conclusions at 1.34. Ofcom DCR Initial Conclusions at 1.35. Ofcom DCR Initial Conclusions at 4.2.36. Ofcom SRDC 2015 at 6.19.37. Ofcom SRDC 2015 at 6.19.38. See http://www.kcomhome.com/news/articles/kc-accelerates-investment-

in-fibre-broadband-and-prepares-for-business-rebrand/. 39. See eg Ofcom, Summary of Consultation Responses, Annex 1 to Making

Communications Work for Everyone: Initial Conclusions From the Strategic Review of Digital Communications, 25 February 2016, at A1.81, A1.88, A1.94 and A1.209.

40. Fixed broadband coverage is calculated as 100% minus coverage at 30 Mbps or faster as reported in Ofcom, Connected Nations Report 2015, 1 December 2015, at 2.5 (hereafter Ofcom Connected Nations Report 2015). Ultrafast coverage is the coverage by Virgin Media, current and upon completion of roll-out; as reported in Ofcom SRDC 2015, at 4.76. Superfast coverage is 100% minus fixed broadband and ultrafast coverage.

41. Ofcom Connected Nations Report 2015 at 2.7.42. Ofcom Connected Nations Report 2015 at 4.14.43. Ofcom DCR Initial Conclusions at 1.44. See Collins (2015).45. Ofcom, UK Home Broadband Performance, 24 March 2016, Section 6

(hereafter Ofcom UK Broadband 2016). Comparisons across tables in that section by the authors. Network technology is identified by speed: “FTTC usually has headline speeds of either ‘up to’ 38 Mbit/s or ‘up to’ 76 Mbit/s, and cable currently is provided to new consumers with headline speeds of 50 Mbit/s ‘up to’ 100 Mbit/s or ‘up to’ 200 Mbit/s” (Ofcom UK Broadband 2016 at 4). Ofcom does not report results for FTTP.

46. Ofcom DCR Initial Conclusions at 5 (emphasis added).47. Ofcom DCR Initial Conclusions at 4.12.48. Ofcom DCR Initial Conclusions at 4.16.49. Ofcom DCR Initial Conclusions at 4.47.50. Ofcom DCR Initial Conclusions at 6.22.51. Ofcom DCR Initial Conclusions at 6.75.

52. See Ofcom DCR Initial Conclusions at 4.55. Currently, VDSL is subject only to a VULA mandate with prices governed by a margin squeeze test. See Ofcom DCR Initial Conclusions at 6.19. See also Ofcom, Wholesale Local Access Market Review: Consultation on Possible Approaches to Fibre Cost Modelling, 9 May 2016.

53. See eg Karl-Heinz Neumann and Ingo Vogelsang, How to Price the Unbundled Local Loop in the Transition from Copper to Fiber Access Networks, Telecommunications Policy 37 (2013) 893-909. The authors note that, because fibre-based networks provide higher levels of service quality than copper-based networks, rather than a lower price for the same quality, fibre cannot directly serve as an MEA for copper. Their solution is to calculate a performance delta, putting a value to the quality difference, and use the performance delta to scale down the FL-LRIC for fibre, creating an MEA FL-LRIC for use as the copper access price.

54. Ofcom DCR Initial Conclusions at 4.55. (‘By 2020 superfast broadband services are predicted to account for the vast majority of broadband connections. Pricing flexibility will have been applied to BT’s FTTC investment for 10 years. For this market review, there will be a variety of arguments in favour of reduced pricing flexibility, including potentially reaching the original date for expected payback. In this context, we may be coming toward the end of the fair bet, which could result in a transition to some form of charge controls.’)

55. We have calculated these approximate figures as follows. Openreach operating expenses in FY2016 were GBP 2.4 billion on revenues of GBP 5.1 billion, which is roughly 48% of revenues, including common costs. Total capex was GBP 1.4 billion or 27% of revenues. If we assume opex to be constant across products, and half of capex goes to maintenance/replacement rather than new investment, the resulting SRIC+ is roughly 62% of revenues. Thus the wedge could be as high as 38% (100% – 62%) of the access price. Revenues from copper and VDSL leasing were roughly GBP 1.7 billion (GBP 88/year * 5.9 million VDSL lines + GBP 87/year * 13.5 million LLU lines). Applying a 38% wedge to revenues of GBP 1.7 billion yields up to GBP 650 million per year. (Operating and financial data taken from BT Group plc Annual Report & Form 20-F 2016; wholesale prices taken from two Openreach price lists: ‘Generic Ethernet Access Bandwidth Variant Rental Charges – Up to 40 Mbit/s downstream and up to 10 Mbit/s upstream (including Simultaneous Provide)’ for VDSL lines and ‘Local Loop Unubunling-MPF Rental (incl. SML2 in tariff)’ for LLU.)

56. Ofcom, Review of the Wholesale Broadband Access Markets. Statement on Market Definition, Market Power Determinations and Remedies, 26 June 2014.

57. For the incumbent, the avoided cost is the wedge itself, which is removed upon completing FTTP deployment. For the access seeker, it is the cost of line rental.

58. HM Treasury, Copy of the Budget Report – March 2015 as Laid before the House of Commons by the Chancellor of the Exchequer when Opening the Budget, House of Commons, 18 March 2015. To reiterate, the figures above are intended to illustrate the potential order of magnitude of wedge revenues, not as a formal or precise estimate.

59. ARCEP, Évolutions de la tarification des offres d’accès de gros utilisant la boucle locale cuivre, Public Consultation from 23 June to 9 September 2016.




Conclusion

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