Elimination of EU roaming charges implies a move towards regulated wholesale rates

On the 3^rd of April 2014 the European Parliament voted (with some amendments) to adopt the Commission’s proposal to end roaming charges in the EU by the end of 2015. This was part of a wider vote in support of the Commission’s proposed regulation for a “Connected Continent”, the term used for the telecoms single market. The regulation must be approved by parliament and the European Council. With this, the Commission also moved a step closer to regulated wholesale prices and hence the structural separation of mobile networks into NetCos and RetailCos.

In essence the Commission wants EU consumers be able to use their mobile phone within all EU countries in the same manner as they would at home. “…Further reforms in the field of roaming should give users the confidence to stay connected when they travel in the Union without being subject to additional charges over and above the tariffs which they pay in the Member State where their contract was concluded.”

However, the problem with this is that most consumers chose domestic tariff plans with bundled minutes and data plans, so that within the bundle the incremental cost of usage for consumers is nil. Selling bundles also makes sense from a mobile operator’s perspective because most costs are fixed. In contrast, in a roaming situation an operator’s costs (the wholesale rate an operator has to pay to the visited network) are proportional to usage – i.e. variable. The Commission and the Parliament appear to be aware of this problem, and the adopted text states that operators “may, notwithstanding the abolition of retail roaming charges by 15 December 2015, apply a “fair use clause” to the consumption of regulated retail roaming services provided at the applicable domestic price level, by reference to fair use criteria. These criteria should be applied in such a way that consumers are in a position to confidently replicate the typical domestic consumption pattern associated with their respective domestic retail packages while periodically travelling within the Union.”

Much will depend on how the “fair use clause” is written. If we take at face value the text “consumers are in a position to confidently replicate the typical domestic consumption pattern associated with their respective domestic retail packages while periodically travelling within the Union”, this may mean that customers on large minute and data bundles can use these freely at any time across the EU. Alternatively the EU would have to define what “periodically travelling within the Union” means. Does it mean 30 days a year, or 180 days, or how much? Assuming the Commission does not want to place limits on how much Connected Continent consumers are allowed per year, there will be no time limits. Taken to an extreme, a mobile user could shop around for the cheapest SIM-only deal in Europe regardless of his or her country of residence. A prime example is EU parliamentarians who shuttle between their home country, Strasbourg, Luxembourg and Brussels.

The fair use provision is designed to address the problem that it is ultimately impossible to regulate retail prices without regulating wholesale prices. The Commission appears to be aware of the difficulty in defining “fair usage” and the implication for operators’ margins. The adopted text states: “In addition, the Commission should by 30 June 2015, in advance of that final abolition of retail surcharges, report on any necessary changes to the wholesale rates or wholesale market mechanisms, taking into account also mobile termination rates (MTR) applicable to roaming throughout the Union.” This is the real bombshell because it heralds EU regulation of wholesale prices.  In the same way as the EU has driven the regulation towards lower MTRs this may happen to wholesale prices.  The target might be a Reference Wholesale Access Offer, for example with the €0.002 per Mbyte of data rate imposed on Hutchison 3 Austria to allow their acquisition of Orange Austria to go ahead.

In regulating mobile tariffs, the EU is focusing only on roaming charges, whereas international call pricing is also highly unbalanced. In most cases international calls are not included in a mobile minute bundle and charged at a premium. This leads to oddities. For example, for a UK mobile subscriber with a bundled minute plan the incremental cost of a call to a UK mobile numbers is nil. Hence for a call to a UK number that is roaming in Poland, the marginal cost to the caller is nil and, according to the EU roaming charges cap, the called party pays no more than €0.07 per minute to receive the call. The marginal revenue to the UK operator is €0.07 per minute. However, if a UK mobile user calls a Polish mobile number the price paid is substantially higher. For example, Vodafone’s standard to Europe call price is £1 a minute (€1.20). In other words, Vodafone’s incremental revenue is 17 times higher, although costs are the same.

The Commission also proposed that for European fixed calls “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.”  Will the same principle be applied to mobile operators? If yes, the scenario where a consumer buys a SIM in one country and uses it in another becomes practical. In this scenario, where within the EU distance and geography no longer matter for mobile retail prices, the retail activity of a mobile operator might evolve into what is in effect a pan-European MVNO with an “always best connected” value proposition, regardless of the access network used. Under these circumstances, who will then want to bid for spectrum and invest in networks?

Either way, we are moving to a situation where the EU mobile industry is subject to extensive price regulation. And yet, the EU Directorate General for Competition is totally focussed on preserving competition at network level and in-country consolidation of mobile operators is hard to achieve. This makes little sense. Now that the cost of calling has come down, perhaps Neelie Kroes can afford to make a call to Joaquín Almunia (Vice President of the European Commission responsible for Competition Policy) and attempt to sync policies.

Written by Stefan Zehle, CEO, Coleago Consulting

Hong Kong’s hybrid approach to 3G spectrum renewal creates a “freerider” problem for the incumbents

Hong Kong’s Office of the Communications Authority (OFCA) has decided to adopt a hybrid approach to the renewal of incumbents’ 3G spectrum. OFCA will distribute two thirds of the spectrum to the incumbents through an administered allocation process and the remaining third will be put up for auction. The incumbents have the opportunity to reacquire the spectrum through the auction but it also opens up the opportunity for a new player (and many are speculating the China Mobile Hong Kong is the primary candidate) to acquire the spectrum.

When incumbents value spectrum one of the most significant sources of spectrum value attributed to spectrum in an auction is the ability to block new market entry. This “blocking value” can be very high for incumbents, especially in mature markets, as a new player seeking to win share to drive economies of scale often sparks a value destroying pricing or commission war – the experience of Three entering the UK market is a good case in point.

China Mobile may place a high strategic value on gaining access to 3G spectrum in Hong Kong and so the cost of blocking in the auction could be high. All the incumbents have an incentive to block new market entry. However, in an ideal world an incumbent would prefer “freeride” and rely on another incumbent to pay any premium for market entry. This creates a coordination problem for the incumbents and this risk is that they fail to “reach agreement” through their bidding strategies as to who will take the responsibility for blocking. The result may well be that new entry occurs despite all incumbents being heavily incentivised to avoid it.

Written by Graham Friend, Managing Director, Coleago Consulting

Coleago join a managed services panel session

Chris Buist, Director, Coleago Consulting takes part in a managed services panel session at European Communications’ quarterly seminar.

Chris Buist’s presentation at European Communications’ Managed Services seminar

Hear Chris Buist, Director, Coleago Consulting talk about Managed Services during his keynote speech at European Communications’ quarterly seminar.

Coleago Consulting Appoints New Director to Grow New Business Division

Chris Buist joins to develop network sharing and managed services consultancy

Coleago Consulting, a specialist telecoms management consulting firm, today announced that Chris Buist has become the latest director to join the company. Chris’ role at Coleago will be to grow its new network sharing and managed services consultancy business division.

Chris brings 30 years’ international senior management experience in the telecommunications and media sectors to Coleago. Prior to this role, Chris was head of the communications and media practice at PA Consulting. He is based in Vienna, Austria, and has worked for clients in more than 20 countries including network operators, equipment vendors and media companies. His main areas of expertise include strategic planning and network/OSS/BSS performance improvement particularly through managed services and network sharing.

“Changes in the telecoms industry have led to operators feeling the squeeze and their margins and cash flows are suffering. They now need to create savings on their networks without affecting the performance that consumers have come to expect. We see network sharing and managed services as a potential solution to this dilemma, making these services more important than ever. As such, Chis joining the team could not have been timelier,” said Graham Friend, Managing Director of Coleago Consulting. “At Coleago we are driven to continue to grow and expand our areas of expertise and therefore provide ever better services to our customers. We are excited to have Chris on board and look forward to the opportunities he will bring to Coleago in this new business division.”

Chris joins the Coleago board which currently includes Graham Friend (Managing Director), Stefan Zehle (CEO) and Scott McKenzie (Director).

 

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

The APT Bandwagon Reaches Cruising Speed

On the 7th of February Brazil made the decision to make available 698MHz-806MHz for mobile broadband services. The frequencies are those of the Asia Pacific Telecommunity (APT) band plan. ANATEL, Brazil’s regulator, now has the authority go ahead with clearing and the allocating this 700MHz spectrum to mobile operators for mobile broadband use. This should help Brazil to achieve the goals of the country’s national broadband plan (Plano Nacional de Banda Larga).

Of course the process will take time because the process of moving terrestrial TV from analogue to digital will be lengthy. In some parts of Brazil the spectrum could be cleared as early as 2016. Given the size of the country, a regional approach to opening the band to mobile broadband may be possible, although this potentially creates an interference problem.

Brazil’s decision means that the APT eco-system is gaining the scale which confirms it as a mainstream solution for LTE deployment. This means the 700MHz APT band plan may appear in chipsets and more devices earlier rather than later.

Many Asian countries have committed to the APT plan. However, the clearing of the band appears to be slow and countries such as India have only just launched 3G and therefore Region 2 may not be the main driver in developing the device eco-system. The confirmation of the adoption of the APT band plan in Latin America indicates that it will become well-established in Region 2. In addition some African countries have also looked at the APT band plan and the Russian 700MHz allocation is reasonably close to the APT band plan. Therefore we may see the APT band plan being adopted in also in Region 1.

Exhibit 1: 700MHz Allocation in Russia & APT Band Plan

700MHz Plans	Mobile Transmit	Centre Gap	Mobile Receive
700MHz in Russia	720 MHz to 750 MHz = 30 MHz	750 MHz to 761 MHz	761 MHz to 791 MHz = 30 MHz
APT Band Plan	703 MHz to 748 MHz = 45 MHz	748 MHz to 758 MHz	758 MHz to 803 MHz = 45 MHz

Written by Stefan Zehle, CEO, Coleago Consulting

Margin squeeze issues are attracting increased attention

With the roll-out of Next Generation Networks in the fixed telecoms world and increased network sharing in LTE mobile networks, margin squeeze is attracting increased attention. What’s at stake is to maintain competitive retail markets in a situation where multiple service providers use the network of a network operator which also competes in the retail market.

A margin squeeze may occur where a vertically integrated operator sells both the retail service and an essential wholesale input to that service. Specifically, a squeeze arises when the difference between the operator’s retail price and its wholesale price is too small for an efficient competitor to: i) purchase the wholesale input; ii) provide the remaining inputs needed to create the retail services and iii) sell the retail service on a profitable basis. In practice, there are two main scenarios in which margin squeezes may occur.

Firstly, where the price of a wholesale service is regulated on a retail-minus basis the difference between the retail and wholesale price may be too small for an efficient competitor to compete and make a profit. Secondly, where the wholesale price of the vertically integrated operator is regulated but its retail service is not, retail prices could be set at a level which does not allow competitive operators to be profitable. The intention in such a case could be for the incumbent to drive competitors out of the market so that it can put up its retail price – short term pain for possible long term gain. Looking in more detail at the two cases, retail-minus regulation is used by certain regulators for some fixed network services.

For example, the UK regulator Ofcom has argued that retail minus may be appropriate for certain innovatory services where there is considerable uncertainty about service performance and it is important to encourage new investment. For this reason Ofcom has not imposed price regulation on BT’s VULA service (next generation bitstream) although the service is subject to a number of conditions.

However, it does require that VULA prices are set at a level which ensures there is no margin squeeze. In its draft recommendation on non-discrimination obligations of 7 December the European Commission outlines an approach for NGA (but not legacy access networks) which has something in common with Ofcom’s. The recommendation proposes that NRAs should not maintain or impose cost-orientation on NGA wholesale inputs providing certain conditions are met such as equivalence of input and the satisfactory outcome of an economic replicability (margin squeeze) test. In mobile networks, national roaming charges and prices paid by MVNOs are often set on the basis of commercial negotiations although this may accompanied with the potential threat of retail minus if that does not work.

In practice, commercial negotiation often does the trick, particularly when there are a number of operators in the market, but there is always the possibility of retail minus in the background and hence, the possible need to identify what the margin actually is. As mobile telecoms moves from a voice orientated business to LTE, it becomes increasingly difficult to determine what margins are because there is no clear relationship between data volumes and revenue.

Margin squeeze tests can also be applied in situations where wholesale prices are required to be cost orientated. A potential problem arises in situations where the margin squeeze test is failed since this could result in wholesale prices being set below costs – indeed, this has happened in Austria.

Setting wholesale prices below cost is warranted in situations where the incumbent is trying to squeeze competitors out of the market but seems inappropriate where prices have been reduced to remain competitive in the market. For this reason regulators and competition authorities need to take account of the prevailing circumstances when acting on margin squeeze tests where wholesale input prices are subject to cost orientation.

In this context it is interesting to note that the European Commission Draft Recommendation on non-discrimination obligations does not propose the use of margin squeeze testing for legacy access networks, where cost orientation is required. According to a 2009 ERG survey, 12 NRAs have a procedure to carry out margin squeeze tests and, indeed, a large number of tests have been conducted.

The importance of testing is likely to increase in the future, for example in the context of NGA network rollout. Given the increasing recognition that setting wholesale inputs in NGA networks on a cost orientated basis may have a negative impact on roll-out, margin squeeze testing will inevitably become an essential part of an NRA’s regulatory toolkit. Finally it’s worth saying something about margin squeeze tests themselves. Put simply there are many types of test and the appropriate way to conduct a test will depend on the circumstances under consideration.

In many cases regulators and competition authorities may do well to test for margin squeeze using two or more different methodologies. To give some idea of the approaches/issues involved: tests can be conducted on an ex ante basis or an ex post basis;— tests can be conducted either on an Equally Efficient Operator basis (essentially the incumbent’s costs) or a Reasonably Efficient Operator basis (the costs of a potential competitor). The Commission’s recommendation has, probably sensibly, come out in favour of the former; —tests can examine either projected or realised cash flows and/or look at year by year results.

There are arguments in favour of both approaches;for bundled products tests can be carried out either on a product by product basis or at the level of the aggregate bundle; A further and crucial factor to consider is the period over which the test is to be conducted. This is particularly important for new innovative products such as Next Generation Access where it may take a number of years to achieve a positive rate of return.

Written by Jonathan Wilby, Senior Consultant, Coleago Consulting

From One to 3 in Austria: Will Hutchison be a consolidator in Europe?

Rumours that Hutchison Whampoa’s 3 Austria is close to sealing a deal to acquire Orange Austria (previously One before being rebranded) for €1.4bn may be good news for the Austrian mobile sector which has seen fierce competition as four operators battled it out in a country of eight million people. It is estimated that in service revenue terms Hutchison has about 6% of the Austrian mobile market while Orange has about 19%. By comparison, Telekom Austria has 44% and T-Mobile has 31 % so the merged entity will still be smaller than its larger competitors.  Although the price seems quite steep at circa 7x EBITDA it may well be justified if 3 Austria can extract hundreds of millions of synergies from the deal by rationalising the networks and avoiding damaging price and subscriber acquisition wars. Post-merger execution will needless to say be critical.

The two other operators in the market (Telekom Austria and T-Mobile) will also benefit and no doubt they will be hoping that the deal is approved by the competition authorities. This might explain, if the press reports are true, why Telekom Austria is so keen to help 3 Austria do the deal by, for example, buying Orange’s discount mobile brand Yesss! as well as some 2.1GHz spectrum and 3,000 redundant base stations. Press reports suggest that 3 Austria will raise up to €300m from these divestments which will lower the overall transaction risk.

In the coming years we expect further mobile network operator consolidation in developed markets as the industry becomes increasingly mature and margins come under further pressure. For Hutchison Whampoa, this represents a new wave of investment in Austria and its 3G business and we wonder if it is not a template to be used in other markets where it is finding the going tough.

Written by Scott McKenzie, Director, Coleago Consulting

Vive la différence II

The French telecoms regulator announced at the end of last week that they have finished the 2.6GHz auction process begun in June.

	FDD Allocation (MHz total)	Price (m€)	€/MHz/POP	Obligatory MVNO access
Orance	40	287	0.110	Y
SFR	30	150	0.077	N
Bouygues	30	228	0.116	Y
Free Mobile	40	271	0.104	Y
TOTAL	140	936	0.102

The format used in France was a first price single round sealed bid which meant there was no opportunity to learn and can lead to disparities in prices paid. As if to illustrate this point, one player (SFR) got the spectrum at the reserve and did not need to commit to hosting MVNOs.Although the price per MHz per pop does not look outrageous compared to some other 2.6 GHz auctions (e.g. Denmark and Sweden for example), it is 4.5x that seen in Germany in 2010 and this might be (partially) explained by the fact that the reserve price level set in France was a lot higher than that in Germany – 25x on a per MHz POP basis.

The 800MHz digital dividend spectrum is now to be launched before year end.

Written by Scott McKenzie, Director, Coleago Consulting