Voice over Wi-Fi and the Implications for MNOs

As Apple unveils the iPhone 6 featuring Wi-Fi calling and texting and T-Mobile US immediately puts it into practice, changes are on the horizon for MNOs. A recent analysis of data traffic in the US has shown that over 50% of mobile communications are now carried over a Wi-Fi connection, whilst the rest travel over a cellular network. Whereas indoor Wi-Fi networks were once predominantly confined to homes and offices, they are today becoming increasingly commonplace in public spaces such as retail centres, transport networks and even city centres.

As we go about our day-to-day lives currently, we switch between Wi-Fi and cellular networks when we move from one location to another – perhaps meaning that we are out of Wi-Fi coverage for fewer than 30 minutes a day. If voice over Wi-Fi becomes mainstream, it poses the question of whether many users would want to incur the cost of mobile subscription when they will be able to make calls in numerous Wi-Fi hotspots.

The increased use of indoor Wi-Fi networks has reduced the attraction for MNOs to roll out radio networks in buildings, and seems to have already killed the unborn market of picocells for home coverage. Most of the Wi-Fi -covered venues also have a cellular infrastructure to assure the transport of legacy voice and SMS traffic. With the development of Wi-Fi infrastructure using the latest 802.11 ac wireless networking standard and delivering up to 433 Mbits, mobile operators are now postponing their decision to roll out small LTE cells in the same venues and are increasingly thinking of offloading the cellular traffic to the Wi-Fi network.

This decision by operators not to invest in indoor LTE infrastructure might then prove unwise. A shift to Wi-Fi as a means of carrying data traffic could well result in revenue loss, and may force them to make drastic changes to their business models which are, in essence, made up of investments in a network that is then sold in pieces to subscribers. If this model is to be challenged and potentially overtaken by the introduction of a wide range of mobile communication services over Wi-Fi, MNOs will need to take steps in order to protect their position.

By Philippe Berard, Consultant at Coleago Consulting

Wi-Fi offload won’t reduce the need for more mobile spectrum

During the Wi-Fi Offload Summit in Frankfurt on Jan. 23, a number of interesting developments in the Wi-Fi space were presented. A key question for mobile operators is whether Wi-Fi offload reduces the growth in mobile broadband (HSPA and LTE) traffic and thus the need for more mobile spectrum.

Research presented by Deutsche Telecom from tests in Hamburg and Rotterdam showed that when Wi-Fi is advertised and available free of charge in a particular area, this immediately generates substantial Wi-Fi traffic but does not reduce the volume of mobile data traffic. Towerstream Inc. presented conflicting evidence from its outdoor Wi-Fi offload network in New York.

From other findings presented, it is clear that both Wi-Fi and LTE traffic are increasing dramatically. Perhaps what is at work here is the Jevons paradox, which proposes that as technology progresses, the increase in efficiency with which a resource is used tends to increase (rather than decrease) the rate of consumption of that resource. The increasing availability of free Wi-Fi coupled with a rapid uptake of smartphones and cheap tablets would underpin this theory as one feeds off the other.

The growth in Wi-Fi is also driven by the desire of shops and malls to engage with shoppers on their in-store Wi-Fi networks. There is marketing value for retailers to have shoppers on their Wi-Fi network as soon as the shopper walks into the store. EE in the U.K. is turning this into a small business line, equipping supermarkets such as ASDA with a Wi-Fi infrastructure. Rather than identifying shoppers at the checkout when they swipe their loyalty card, ASDA hopes to be able to identify and engage with shoppers from the minute they are within the store’s Wi-Fi coverage. For example, coupons could be sent to a handset at the beginning of the shopping trip and can be used right away rather than languishing at the bottom of a shopping bag. This is just one of the many marketing benefits of free in-store Wi-Fi.

The simultaneous growth in Wi-Fi and LTE traffic may also be explained by the fact that Wi-Fi has other uses compared to cellular. The proliferation of TV Anywhere apps turns tablets and laptops into TV outlets, and in Canada, Bell has launched the first wireless TV proposition. TV over Wi-Fi creates a surge of Wi-Fi traffic in residential areas. Other devices in offices, public indoor spaces and outdoors rely increasingly on Wi-Fi connectivity because it is cheaper and more flexible than cable connections. This all takes Wi-Fi capacity in cities and raises the Wi-Fi noise floor.

In regard to the rapid adoption of tablets, all are Wi-Fi-enabled, but few are 3G (HSPA) or LTE-enabled. As people take these tablets out of their homes they will look for Wi-Fi access, thus increasing Wi-Fi hotspot usage. However, smartphones have a personal hotspot feature and where tablets are not in Wi-Fi coverage, we are seeing “cellular on-loading” from Wi-Fi devices.

Having paid for a shiny new LTE device, some customers would prefer to pay another €10-20 a month rather than having to faff about with logging onto Wi-Fi. Asking smartphone users to choose between LTE and Wi-Fi is the antithesis of a ubiquitous mobile broadband experience. However, Wi-Fi 2.0 with SIM-based authentication increases the ease of Wi-Fi access and may even be transparent to the user.

Another factor which determines the amount of LTE vs. Wi-Fi traffic are the policies for applications set in smartphones. For example, which bearer is allowed or preferred for which application. Some apps do not work via LTE; for example. FaceTime on the iPhone. In the U.S., the first version of the iPhone 5 with iOS 6 did allow FaceTime over LTE. This came as a bit of a shock to cellular operators as AT&T blocked FaceTime over cellular on most plans, but subsequently changed the policy. What cellular operators really want is to be able to set policies dynamically based on the app, the location, time of day and perhaps even the type of customer.

Nevertheless, most mobile operators have some Wi-Fi offload strategy. The focus is not so much on relieving congestion in busy areas but to deliver an “always best connected” value proposition. In short, LTE and Wi-Fi complement each other. The growth in Wi-Fi does not reduce the need for more cellular spectrum to serve the growth in mobile broadband traffic.

Written by Stefan Zehle, CEO Coleago Consulting

Bidders in spectrum auction attach a high value to 1800MHz spectrum

The multi-band combinatorial spectrum auction (CCA) in Austria ended on the 21^st of October, with bidders paying €2,014 million for 2x30MHz of 800MHz, 2x35MHz of 900MHz and 2x75MHz of 1800MHz spectrum. The 800MHz spectrum was new spectrum whereas the two other bands were renewals. The only bidders were the three incumbent operators Austria Telekom, T-Mobile, Hutchison.

The overall price paid for sub-1GHz spectrum and the 1800MHz spectrum amounted to €0.85/MHz/pop. This is only slightly less than the implied price for the sub-1GHz spectrum of €0.96/MHz/pop.

The price for sub-1 GHz spectrum is roughly in line with prices paid for 800MHz spectrum in recent European auctions.  The price paid for 800MHz spectrum in Germany was €0.73/MHz/pop (May 2010) and the average in Europe during 2010 to 2013 was €0.52/MHz/pop. So the price paid in Austria for 800MHz spectrum is relatively high. Benchmark prices paid to renew 900MHz spectrum are in the €0.19-0.53 range whereas the implied price paid in Austria amounts to €0.96/MHz/pop.

Exhibit 1: Austrian Spectrum Auction Results

 

However, since the overall price per MHz per pop paid is only slightly lower than the implied price for sub-1GHz spectrum, this means that operators valued the 1800Mhz spectrum very highly at €0.76/MHz pop.  This is significantly above prices paid for 1800MHz spectrum in recent auctions, and certainly massively more than prices paid for 2.6GHz spectrum. Benchmark prices paid to renew 1800MHz spectrum are in the €0.10 – 0.21 range.  In this context the comments by Telekom Austria’s CEO Hannes Ametsreiter, referring to a “bitter pill to swallow,” are quite appropriate.

The auction outcome highlights that in the context of the rapid growth of data traffic, spectrum is becoming an ever more valuable resource. The re-farming of 1800MHz from GSM to LTE requires more spectrum in the short term because spectrum resources cannot be used efficiently. In that sense governments can hold a gun to operators’ heads and demand almost any price.

1800MHz spectrum is the spectrum of choice for LTE in Europe. Most operators have built a grid based on 1800MHz and hence the 1800MHz band provides both an LTE capacity and an LTE coverage layer. In contrast 2.6GHz is “only” a capacity band. I placed quotation marks around the word “only” because LTE capacity is of course very important in urban areas and here cell sizes are quite small. Nevertheless, the in-building propagation characteristics of 1800MHz spectrum are significantly better than for 2.6GHz spectrum and in-building capacity matters for mobile broadband.

The auction outcome, with A1 Telekom (Telekom Austria) acquiring 2/3^rds of the 800MHz band means that the company now holds 53.8% of sub-1 GHz spectrum compared to a subscriber market share of around 39%. As the operator with the weakest cash flow it is likely that Hutchison faced budget constraints. The result is that the market leader managed has managed to acquire a disproportionate share of spectrum.

The design of the Austrian auction and the absence of effective caps on sub 1GHz spectrum holdings suggest that the Austrian government is not particularly concerned about the effects of spectrum concentration on competition. On the other hand, the spectrum divesture conditions imposed on Hutchison (European Commission, DG Competition, CASE M.6497) to clear its acquisition of One Austria, suggests a very different view of spectrum concentration is applied when it comes to approving in-market consolidation.  The only saving grace for Hutchison is that there was no new entrant and so the requirement to divest 2x10MHz the 2.6GHz frequency band lapses; however the MVNO access requirement remains.

While Hutchison managed to increase its sub-1 GHz spectrum holding from 1.6MHz to 2x5MHz, the cost per eNodeB of deploying LTE is 2x5MHz is roughly the same as for Telekom Austria deploying LTE in 2x15MHz in the same band. Furthermore, there are already many smartphones with 800MHz LTE, where Telekom Austria acquired 2x20MHz, but as yet, none with 900MHz LTE.

In the light of this the comments by Trionow, CEO of H3G, describing the auction as a “disaster for the industry” are understandable. Certainly it is a disaster for Hutchison and for a competitive mobile broadband market in Austria.

 

Written by Stefan Zehle, CEO, Coleago Consulting

European commission proposal ignores the fundamentals: We need to create an environment that attracts capital into the EU telecoms sector

The European Commission’s adoption of regulatory proposals for a Connected Continent announced by Neelie Kroes on the 11^th of September 2013 are as polemic as can be expected from a politician. The headline grabbing proposal deflects from the failings of member states to adopt sensible policies with regards to developing the telecoms sector. In its opening paragraph the proposal declares that “The overarching aim is to build a connected, competitive continent and enabling sustainable digital jobs and industries; making life better by ensuring consumers can enjoy the digital devices and services they love; and making it easier for European businesses & entrepreneurs to create the jobs of the future.”

To achieve these objectives substantial investments are required. Only 12 days prior to the Commission’s proposal, on Thursday 05 September 2013, PwC published a detailed analysis which showed that mobile operators cannot make adequate returns on capital employed. For the past three years the return on invested capital (ROIC) made by Europe’s telcos was below the cost of capital of around 8%-9%. In the mobile sector this is in part due to the high spectrum licence fees charged by national governments.

And yet with statements such as “It is also essential that citizens … are protected from unfair charges and practices such as roaming rip-offs and opaque contracts” the Commission conjures up an image of ultra-profitable telecoms operators which fleece consumers.

What the European telecoms sector needs most is a climate with the regulatory certainty which is favourable to investment. Only investment in the sector will achieve the Commission’s aim – which we all agree with – of excellent fixed and mobile internet connectivity and communication without borders within the EU.

Furthermore, the Commission proposal contains contradictions. Vice President Neelie Kroes said “The aim is to gradually make the telecoms sector a “normal” economic sector with limited ‘ex ante’ rules and responsibility shifting to ex-post regulation” and then demands that “Operators will have to charge no more than a domestic long-distance call for all fixed line calls to other EU member states. Any extra costs have to be objectively justified.”  “Normal” economic sectors do not “objectively justify” prices based on cost but charge what the market will bear. The image of the Coca Cola bottle in the proposal is a fine example. The price per litre of Coca Cola varies hugely between a discount supermarket and a beach club on the Cote d’Azur. And yet, nobody suggests regulating prices for Coca Cola.

On the positive side, the proposal highlights member states’ regulatory failings and tardiness in allocating spectrum for LTE.  This, with a call for a European authorisation for telecoms operators – and by implication European telecoms regulation – is a very positive development. This is a prerequisite for the much needed consolidation in the EU telecoms sector which will then give investors a chance to earn adequate returns.

Written by Stefan Zehle, CEO of Coleago Consulting

Challenges for EU mobile operators

The European mobile telecoms industry is now at the maturity stage of the industry life cycle.  While the introduction of LTE is still a relatively recent event, there is limited revenue growth and consolidation is starting to set in. Rather than being challengers, in some ways mobile operators themselves have started to look like the old fixed line operators at the start of the telecoms market liberalisation in the 1980s.  National fixed line incumbents (PTTs) went into defensive mode as the EU’s Customer Premises Equipment directive ended their monopoly on the supply of telephones and PABX and the opening to competition of long distance and international calls forced operators into rebalancing and cost orientated pricing.  The European Commission predicted significant contributions of market growth and benefits to consumers and businesses and there is no doubt that the policy delivered this. Indeed, without the EU’s effort to push for liberalisation of telecoms markets we would not have today’s innovative mobile telecoms markets with multiple mobile operators.

Now these very mobile operators are on the defensive as the EU increases pressure to create a single telecoms market and puts its weight behind wholesale price transparency and net neutrality. Three of the statements made by Neelie Kroes, VP of the European Commission responsible for the Digital Agenda in her speech of the 9^th of July 2013 impact significantly on operators:

• —  “Blocking or throttling services isn’t just unfair and annoying for users – it’s a death sentence for innovators too. So I will guarantee net neutrality.”
• —  “European calls shouldn’t count as a costly international call; not within a true single market. …. so any difference in price must be objectively justified by additional costs.”
• —  “In a true single market, there are no artificial roaming charges. It’s irritating, it’s unfair, it belongs to the past.”

In her speech Ms Kroes also addressed the issue of cross border consolidation: “If you’re allowed to operate anywhere in Europe – authorised within an EU framework — then you should be able to operate everywhere in the EU. … Like a single authorisation system with supervision by the home member state.”

While as yet true cross border consolidation has been rare, we already witness increased consolidation within markets either outright through M&A or through RAN sharing. RAN sharing is encouraged by some regulators in order to deliver mobile broadband coverage in rural areas and better LTE speeds in a wider band. For example, the “mutualisation” of spectrum was central to the 800MHz licence award in France. Regulators are well aware of the threat to competition posed by RAN sharing but in a mobile broadband world the economics of deploying LTE in a wide band favour RAN sharing.

These factors – cost orientated pricing, net neutrality, and consolidation – will shape the European mobile industry during the coming years.  They may even lead to the unbundling of mobile access from the provision of services, just as we have seen in the fixed network. Implicit in consolidation at network level is increased price transparency at wholesale level to allow multiple operators to compete fairly at retail level. In this context the elimination of roaming charges points towards the end of the traditional Inter Operator Tariff (IOT) roaming wholesale tariffing. Possibly within the EU bureaucracy someone has already been tasked with drafting a directive that would require EU mobile operators to publish a “reference access price offer”.

Let’s imagine a future where Apple or Google obtain wholesale access (MVNO) agreements in each of the European states and, instead of replicating the national mobile operator model, launch a pan-European service where the EU is a single nation, at least in terms of mobile phone service costs. Far-fetched? Well, many consumers already make smartphone choices ahead of network choices and to many people OTT services such as Skype, FaceTime and WhatsApp matter more than traditional phone calls.  We might even see a resuscitation of the trans-Europe dialling code (+388) designated for the European Telephony Numbering Space or ETNS.

As regards separating access and service, a line of attack comes from operators such as Rebtel in Sweden and Republic Wireless in the USA. These operators use WiFi offload and “push” their customers to make calls using Skype like services.  Mobile networks are only used in an MVNO fashion when out of WiFi coverage.

Is this the nightmare scenario for traditional mobile operators, where they are relegated to perform the role of the much quoted “dumb pipe”?  Firstly there is nothing “dumb” in operating a highly sophisticated LTE network while migrating millions of users from GSM and HSPA and coping with the mobile data tsunami. Secondly the massive growth in mobile broadband requires huge investments. Investments require returns and therefore it is the pipe where returns will be earned.

This scenario may actually be rather benign for investors in the mobile industry. Rather than fighting subsidy wars, being played off against each other by Apple, and driving up prices in spectrum auctions, operators could get on with building a superb mobile broadband infrastructure in an environment that allows investors to earn stable returns. After all, in the history of the European mobile industry the greatest decline in return on capital employed resulted from the 3G auctions in 1999 – 2002. Let others go crazy!  Investors who are attracted to stable returns would continue to invest in mobile network operators whereas those who seek a higher risk / return profile would invest in companies that provide services over these networks.

What has been the reaction of the mobile operators to threat to roaming and international call margins?  Some claimed that the loss of margin from roaming would lead to price increases elsewhere.   Yes, it probably would i.e. prices would become more cost orientated. This is not necessarily a bad thing for the mobile industry.

As the market is opened up and access is unbundled from other value chain activities, this provides an opportunity for new competitors. Operators such as Lebara and Lyca had some success in competing on the basis of low cost international calls from mobile phones. MVNOs such as Truphone, WoldSIM, roamline.com arbitrage the difference between wholesale and retail prices to deliver cheap roaming. Mobile operators watch these trends carefully and will not make general price cuts on high margin services if this reduces overall profits. They are responding in smart ways by offering low cost roaming to those who seek it. For example, EE of the UK which focusses on LTE offers “inclusive unlimited roaming minutes and texts for an extra £5 a month on a 24 month roaming plan”. Here we can see the future of roaming tariffs. The bigger threat is to those niche operators because their arbitrage opportunity reduces.

In response to lower intra-EU roaming charges some operators increased roaming prices outside Europe, but not in a cost orientated manner.  Most operators are wedded to a zonal pricing approach, pretending that somehow costs increase with distance. That’s nonsense.  Some of the highest Inter Operator Tariffs are levied close to Europe. For example, Tunisian mobile operators collude to set wholesale roaming prices as high as €1.50 per minute. While a European operator’s retail price for roaming in Tunisia of €2 per minute including VAT might seem high, it barely covers the wholesale cost. In some other markets much lower wholesale roaming prices can be obtained. This is also evident from the countries covered by EE’s unlimited international roaming deal which includes Europe and an odd mixture of countries including Australia, the US, Peru, Turkey, etc.

And what about the subsidised contract customer, i.e. the customer supposedly “owned” by the operator? After all the separation of handset and SIM was one of the great innovations of GSM because of its potential for increased competition. It is not necessarily the case that a customer life time value is higher for a consumer with an operator provided subsidised smartphone compared to a SIM only smartphone customer with a 30 day rolling contract.

Operators are aware of these trends and their offers are evolving in a segmented response to changes in the regulatory and competitive environment. There may be bumps along the road, but I am optimistic for the future of the mobile industry as a sector worth investing in.

Written by Stefan Zehle, CEO Coleago Consulting

Misguided approach to EU intervention on roaming charges

In her speech on the 9 July 2013, Neelie Kroes, Vice-President of the European Commission responsible for the Digital Agenda, reiterated her assault on roaming charges within the EU. There is talk of regulatory intervention to eliminate roaming charges within the EU.

While mobile operators may earn good margins on roaming, a mandated elimination of roaming charges is ill conceived because mobile operators in different EU countries face different costs. One of the most significant investments made by mobile operators is in buying spectrum.  For example, for the 800MHz digital dividend spectrum, operators in Denmark paid €0.30 per MHz per head of population (€/MHz/pop) whereas in France, operators paid €0.67/MHz/pop i.e. 123% more.  Some cash strapped EU countries set high reserve prices for spectrum €0.58/ MHz/pop in Italy vs. €0.10/MHz/pop in Denmark. Coupled with differences in deploying 4G LTE coverage, this translates into hundreds of million euro differences in capex.

Furthermore there are significant differences in the timing of spectrum allocations and hence the deployment of LTE which translates into huge cost differences for mobile data. Assuming investors like to earn similar returns, these cost differences will result in different wholesale and retail prices. Therefore it does not make sense to mandate the same retail prices regardless of the country in which the traffic occurs.

If the EU and its member countries are really so keen on a single telecoms market, why not start by allowing operators regardless of their country of operation to select a national telecoms regulator of their choice to regulate them.  I suspect the Danish regulator would attract quite a few “customers” whereas the Italian and Greek regulators might go out of business. The resulting reduction in regulatory costs could be passed on consumers in form of lower retail prices.

Written by Stefan Zehle, CEO, Coleago Consulting

New LTE Bands in European Version of iPhone 5S?

When back in September 2012, Apple launched the iPhone5, I commented on the fact that the Region 1 version (Europe and Africa) only included the 1800MHz band for LTE whereas Samsung and HTC already had triple band LTE models in the market with the 800MHz, 1800MHz and 2.6GHz bands.

This week came the announcement that Vodafone UK delayed its LTE launch to coincide with the launch of the iPhone 5S. This seems to indicate that that the new version of the iPhone will include three main Region 1 LTE bands.

It was reported that Vodafone’s Group CEO Vittorio Colao commented on the delayed launch: “End of the summer means when there’s going to be a good commercial moment for launching 4G … EE had a little bit of an advantage because of the iPhone at 1800MHz. To be honest that will go away as soon as we launch our 4G.”

The fact that Vodafone UK organised its launch date around a handset speaks volumes of the marketing power of Apple.  Many consumers make handset choices first and network choices second.  Mobile network operators would gain a lot from promoting Android and Windows phones to counteract the marketing power of Apple. 

Written by Stefan Zehle, CEO Coleago Consulting

Australian spectrum auction failure

The Australian 700MHz and 2.6GHz spectrum auction results were announced on the 7th of May. The most striking result is that 2x15MHz of the 700MHz spectrum remained unsold because VHA (Vodafone) decided not bid and Optus acquired only 2x10MHz. This poor result is due to the extremely high reserve prices. The reserve price for the 700MHz digital dividend spectrum was set at 1.36 $/MHz/pop. This is 186 per cent of the average price paid in other auctions for digital dividend spectrum as shown in the chart below. Furthermore, by comparison the reserve price for digital dividend spectrum in the recent auction in the UK was only 0.30 $/MHz/pop and in Germany the reserve price amounted to less than one cent / MHz / pop.

Digital Dividend Spectrum Price Paid vs. Australian Reserve

The rationale for freeing up spectrum from analogue TV for use by mobile broadband services is the benefit this brings to the economy.  At the start of the process of the digital switchover, the Australian Mobile Telecommunication Association (AMTA) engaged Spectrum Value Partners and Venture Consulting to determine the net economic benefit generated by redeploying the 700MHz spectrum freed up by the switch-off of analogue television, i.e. digital dividend.  They reported that:  “Allocating the optimal mix of UHF spectrum to mobile operators is forecast to generate a net benefit to the economy of between $7bn and $10bn, depending on which overall market scenario is realised. “ (Getting the most out of the digital dividend in Australia, Spectrum Value Partners and Venture Consulting, April 2009).

This estimate assumed that all of the digital dividend spectrum will be allocated to mobile.  In the event one third of the APT band plan 700MHz spectrum remains unsold whereas 100 per cent of the cost of freeing up the spectrum has been incurred. Therefore potentially several billion dollars of benefit to the economy has been lost as a result of setting reserve prices above the level where weaker operators can earn a normal return of capital employed.

The damage that has been inflicted on the Australian economy does not end there.  Since VHA ended up without spectrum it will further weaken their relevance in the market. Since competition is likely to have been weakened this will reduce the “consumer surplus” from the digital dividend i.e. the benefit consumers would gain in the form of lower prices.

Of course the most direct impact is the lower auction revenue for the Government. The Australian government budgeted in revenue from the auction at least equal to the total reserve, i.e. AS$ 2,894 million. In the event the auction raised only AS$ 1,964 million, i.e. 32 per cent below the target.

The auction failure could hardly be more complete.  Yet, it was widely predicted that with these high reserve prices spectrum would remain unsold, in fact Vodafone said it would not bid unless the reserve prices are lowered.  The outcome says a lot about politician’s lack of understanding of how investment decisions are made and also demonstrates an unwillingness to listen to the industry.

The blame for the ACMA’s auction fiasco lies mostly with the government since the reserve prices were set by Communications Minister Stephen Conroy who set out his stall in his now infamous declaration of “unfettered legal power” over telecommunications “The regulation of telecommunications powers in Australia is exclusively federal. That means I am in charge of spectrum auctions, and if I say to everyone in this room ‘if you want to bid in our spectrum auction you’d better wear red underpants on your head’, I’ve got some news for you. You’ll be wearing them on your head … I have unfettered legal power.”

Conroy clearly told everyone that he had no intention of listening to the industry. The reserve prices were set to plug the Government’s budget deficit. This is the worst way to set reserve prices for spectrum. It is devoid of any rationale and is in effect a hidden tax to be paid for by consumers in form of higher prices.

Although Australians are always good for a bit of fun, I very much doubt that bidders in the Australian spectrum auction wore red underpants on their heads. However, in the light of the spectrum auction fiasco, it is plausible that the Minister now wears a red face.

Written by Stefan Zehle, CEO Coleago Consulting

The end of spectrum auctions?

Last week the UK’s National Audit Office (NAO) announced a value-for-money study of Ofcom’s CCA format spectrum auction, with the presumptions that it should have raised more money. Last week the US Department of Justice Anti-Trust Division made a submission to the FCC, questioning whether spectrum auctions deliver the greatest societal value. In March 2013, the Czech Telecommunication Officer (CTO) cited “excessively high” spectrum prices as the main reason for the cancellation of a spectrum auction. While these events come from three different angles, they in effect question whether auctions are the best method of allocating spectrum to mobile operators. Are we witnessing the beginning of the end of spectrum auctions?

Let’s start with a fundamental argument against spectrum auctions. Last week the US Department of Justice Anti-Trust Division made an Ex Parte Submission to the FCC In the Matter of Policies Regarding Mobile Spectrum Holdings. “The Department believes that a set of well-defined, competition-focused rules for spectrum acquisitions, particularly in auctions, would best serve the dual goals of putting spectrum to use quickly and promoting consumer welfare in wireless markets.” The Anti-Trust Division of the DoJ is concerned with competition thus it strives to prevent the emergence of monopolies or oligopolies to ensure that end-users benefit from competitive markets. The DoJ previously voiced its concern with regards to spectrum auctions but it is not the first to realise the potentially negative effects of auctions.

Policy makers believed that market based allocation through competitive auctions were the best method to allocate spectrum in as much they would generate greatest societal benefit. When all bidders are equal, a spectrum auction may well be preferable to a beauty contest style spectrum allocation which lacks objectivity and transparency. It is in that sense that spectrum auctions played a useful role while the wireless industry went through its growth phase.

Auctions are said to be economically efficient if they allocate spectrum to the bidder who places the highest private value on the spectrum. Economic efficiency assumes that the bidder who generates the highest private value also generates the highest social value. If the two diverge then the outcome is not efficient as it is the maximisation of social value that is critical to efficiency. The bidder with the highest private value may therefore not necessarily be the bidder who generates the highest social value.

Coleago has carried out many spectrum valuations projects and a key task is to identify the sources of spectrum value. In many cases the largest source of value was the “blocking value”, i.e. the value to the bidder of keeping out a new entrant or preventing a smaller competitor from acquiring sufficient spectrum resources to compete effectively in the mobile broadband market. The DoJ refers to this as the “foreclosure value” as distinct from “use value”. Regulators are often desperate to prevent this and may set aside spectrum for new entrants (e.g. AWS in Canada, 2008), try to ensure that recent new entrants survive (e.g. 800MHz auction in France, 2010), or set spectrum caps.

Despite the issues highlighted above telecoms regulators are still keen on spectrum auctions and now favour the Combinatorial Clock Auction (CCA) format. A combinatorial auction has many benefits, but also limitations, particularly in a mature mobile market. An unfettered CCA favours large bidders and, depending on the rules, may allow vexatious bidding purely to impose costs on others. Hence regulators introduce all manner of rules to undo what a combinatorial auction is all about, namely to allocate spectrum to the highest bidder. Such “auction limitation rules” include band specific or overall caps, band specific obligations, limitations to bid based on market share, high reserve prices, roaming rules, deployment rules, etc. The imposition of such limitations invalidates the central hypothesis of a combinatorial auction with a second price rule; they are a misuse of this auction format. These limitations are also a tacit admission that auctions are no longer an appropriate spectrum allocation mechanism.

The auction orthodoxy has been further discredited by high reserve prices. In some cases reserve prices are so high that operators merely buy “their share” of the spectrum on offer at the reserve price. The Greek spectrum auction in November 2011 was a fine example. The combined reserve price was set at €82 million and the combined bid value amounted to €82.52 million. In other cases auction formats and reserve prices lead to extremely high prices in terms of €/MHz/pop, taking large amounts of money out of the industry. This is rather schizophrenic. On the one hand governments are taking billions out of the wireless industry and on the other hand they try to promote the building of broadband networks.

In this context the most bizarre event is the cancellation of the multi-band spectrum auction in the Czech Republic in March 2013. The Czech Telecommunication Officer (CTO) cited “excessively high” spectrum prices as the main reason for the cancellation, fearing these high prices would lead to higher prices for mobile broadband and slower deployment. Setting aside the point that the CTO’s arguments are not supported by economic theory, if the CTO does not believe in market based solutions, why have a spectrum auction in the first place?

The CTO’s reaction to high “high prices” is thrown into sharp relief by the announcement of the UK’s National Audit Office (NAO) on 15th of April 2013 to conduct a value-for-money study of Ofcom’s CCA format spectrum auction. The auction which concluded in February 2013 raised £2.3bn, which was £1.2bn less than the UK Chancellor of the Exchequer budgeted for. Apparently the NAO does not believe that the CCA delivered what it should and is taking a politician’s budget target as an indication of the “right price”, and this despite the fact that Ofcom made clear that the primary objective of the auction was not to maximise the amount of money raised.

In most markets the mobile industry is now mature. Rather than new market entry consolidation is the name of the game. This is what is to be expected in maturing markets in any industry. The emphasis should therefore be to ensure that consumers have choice and prices are as low as they can be. This is not necessarily achieved by insisting on spectrum auctions and insisting that there is a large number of competing network operators. Sooner or later regulators will abandon the dogma of auctions and accept that the industry is heading for consolidation, at least network level and may devise administered spectrum allocation mechanism which “distribute” new spectrum among a reasonable number of operators, perhaps 3 or 4 in each market, depending on absolute size.

The DoJ’s filing does not call for an end to auctions, but it clearly voices the opinion that unfettered spectrum auctions are not in the public interest. Implicit in the DoJ’s approach is the belief that government knows best and is best placed to determine what number of network operators generate the greatest benefit to society. However, it is questionable that the public interest is best served by such an approach particularly since governments have erred on the high side with regards to the number of operators that a market can sustain. Enforced competition at network level leads to the destruction of value as has happened for example in Canada, Australia and some other markets. In any event, regulators start to have problems of a different kind: how to deal with global oligopolies created by successful OTT players.

Written by Stefan Zehle, CEO Coleago Consulting

Towards a single EU telecoms market

In a speech delivered at Mobile World Congress 2013, Neelie Kroes, European Commissioner for Digital Agenda, called for the creation of a single telecoms market in the EU. Kroes iterated that it would be of great benefit to the European telecoms industry as well as consumers. There are numerous aspects to this, but mobile telecoms and notably spectrum allocation is most notably one of the focal points.

In recent times, common EU policy has led to the harmonisation of mobile spectrum and technology in the form of GSM at 900MHz and 1800MHz. One could argue that it is this which kicked off the global boom in mobile communications as a result of delivering low equipment prices (terminals and network) as well as international roaming. The benefits to both the European industry and users are undeniable. Mobile communications is now a global business and with the inclusion of multiple LTE bands on chipsets, harmonisation is perhaps a little less important from the technology perspective, but it still matters from a business perspective.

Spectrum allocation mechanisms and prices paid by operators are driven by national policy objectives. Some governments (e.g. Finland) rightly think that spectrum should be made available to operators as cheaply as possible since ultimately this generates the greatest benefit to society. Others (e.g. Ireland and Greece) focus on immediate cash generation. Views on competition may also differ. The 800MHz auction rules in France are a good illustration of a government ensuring the survival of the 4th entrant, whereas in the highly competitive UK market, competition does has not been a big issue in the recent spectrum auction.

These policy differences result in very different costs for mobile operators and yet there is an assumption that prices, notably wholesale prices should be standardised across the EU. Clearly there is a contradiction.

Another key point in pushing for an EU wide approach to telecoms regulation is that cross-border mergers should be made easier in the EU. The fragmentation of telecoms services provision within the EU is a barrier to the single market. An innocent bystander might ask a whole series of questions which demonstrate that the current EU mobile and fixed regulatory environment is unsatisfactory, for example:

—Why is it that a call on a mobile network within a country tends to be included in the bundle whereas a call to a neighbouring country is usually priced at a premium?

—Austria has a smaller population than Bavaria, so why does T-Mobile run Austria as a separate business from its German operation?

—Why are mobile numbers portable within a country but not within the EU?

The current structure of the EU telecoms industry and markets are an artefact of national telecoms regulation. Faced with competition from global OTT players who are not bound by national regulatory regimes, it is the European telecoms companies who suffer. Both industry and end-users would greatly benefit from a truly EU wide approach to telecoms policy and regulation.

Written by Stefan Zehle, CEO, Coleago Consulting