2013 SIEPI Workshop Ancona 24-25 January 2013

1. 2013 SIEPI Workshop Ancona24-25 January 2013 ‘The Limits of Unbundling in Communications’ Martin Cave Imperial College Business School The views expressed in this presentation belong to the author alone and not to any organisation with which he is associated

2. Unbundling, or mandatory access. • Unbundling means breaking up a value chain into competitive and non-competitive activities and mandating access to non-competitive assets • As a result, competition across the value chain does not depend on the willingness of the owner of non-competitive assets to make them available to competitors – which might not be present • Unbundling is implemented in the value chains of many network industries where there is a monopoly distribution network, particularly in energy and communications .

3. Unbundling and its alternatives • Access is mandated to parts of the value chain which are non-replicable • One alternative is to forbear from intervention and create an incentive to replicate (or innovate) by allowing the incumbent to make monopoly profits. But the entrant will be driven to invest not by the monopolist’s current prices but by what they will fall to post-entry • Alternatively, the monopoly can be left in place and regulated on an end-to-end basis. But this excludes any benefits from firm rivalry Roughly speaking, Europe unbundles, North America forbears and Asia regulates fixed monopolies

4. Unbundling and barriers to entry If there were no barrier to entry, there would be no need to unbundle Barriers to entry are of two kinds: • ‘Innocent’ barriers, resulting from the nature of costs (high fixed or sunk costs, economies of scale, density and scope) or demand (network externalities) • ‘Strategic’ barriers resulting from the conduct of a dominant firm (predation, foreclosure, raising rivals costs etc) Innocent barriers are unavoidable and permanent; the creation of strategic barriers can be deterred

5. Ex post versus ex ante The difference in principle is clear But in practice much ex ante comprises general prohibitions, eg of non-discrimination, often the same acts proscribed by ex post Ex post sometimes imposes remedies close to those of ex ante Access can be imposed ex post, under the essential facilities doctrine

6. Problems with the competition law approach to unbundling in the case of distribution networks • The conditions for its application are very strict in most jurisdictions. In Europe it has to be shown that a refusal to grant access would eliminate al competition and that access is indispensable, meaning that even a ‘large’ competitor cannot replicate the facility in question • Before taking action, the competitor has to sink heavy investments and then await the uncertain outcome of a complaint.

7. Interim summary • Unbundling may be needed to deal with persistent monopoly elements in a value chain • Alternatives should be considered too • Where the problem arises from permanent cost conditions, an ex ante approach may be preferred; competition law may be more suited where strategic behaviour is involved

8. Steps in an ex ante unbundling analysis • Divide value chain into components with different competitive potential (based on cost characteristics and international experience) • Evaluate current and prospective competitive potential in markets in the area of interest • Where markets are monopolistic or dominated by one or more suppliers, consider alternative remedies.

9. Different activities in the broadband value chain have different degrees of replicability Low Local Loop DSLAMs Backhaul Core Network Retailing High

10. How to proceed • Is there a problem across the value chain in the absence of regulation? • If yes, mandate access to the least replicable input (eg the local loop). Does this solve the problem? • If no, mandate access to the next least replicable product (eg bitstream) • Continue until the competitive problem is resolved.

11. Dynamic access pricing to encourage infrastructure competition • The first section showed how regulators can minimise their intervention by ‘starting’ mandatory access with the least replicable unregulated asset, working through the inputs, and stopping when competition has been achieved • A regulator wanting to promote infrastructure competition can flex the availability and price of access products over time to encourage further investment by competitors. For example the regulator can discourage resale by reducing the retail margin and encouraging operators to invest in a core network, then in backhaul • This is known as ‘climbing the ladder of investment’.

12. The European Regulatory Regime from 2003 • In 2002, the European Union passed a series of Directives which created a new basis for mandating access to wholesale services, in response to the need for a more sophisticated analysis of developing competition • It required each national regulator to define a set of markets based on a template set by the European Commission, to establish if any operator had Significant Market Power (SMP or dominance) in the markets identified, and if so to impose remedies

13. Success with the ladder?

14. Studies on the empirical effects of unbundling • Econometric study by Grajek and Roller, 2009 • Bouckaert and Verboven study of broadband diffusion (Telecoms Policy, December 2010) • Detailed UK study by Nardotto, Valletti and Verboven (CEPR 2012)

15. Empirical study 1: Grajek and Roller* • Regulation has different effects on incumbents’ and entrants’ investment behaviour • Endogeneity of regulation is important, as regulators respond to the level of investment; results are quite different if this is ignored • Access regulation discourages investment by incumbent and individual entrants, but total investment by entrants increases (because access regulation attracts more of them) • Investment by incumbents responds positively to investment by entrants • Net effect of access regulation is to lower investment by €17 bn. over 10 years. *The effect of regulation on investment in network industries: evidence from the telecommunications industry, JLE, 2012.

16. Empirical study 2: Bouckaert, van Dijk & Verboven* • Inter-platform competition (not access-based) increases broadband penetration • Bitstream-based competition reduces it • ULL based competition has an insignificant effect. *Telecommunications Policy, December 2010, pp 661-671

17. Empirical study 3: Nardotto, Valletti and Verboven (CEPR 2012) • Study based on a very detailed UK data set of broadband take-up, including cable, covering 2005-2009 • Finds that the observed effect of local loop unbundling on broadband take-up is very limited • However, unbundling does improve service quality • The presence of a cable competitor has a positive impact on both take-up and service quality

18. Summary of evidence on effects of unbundling • Inter-platform (cable/telco) competition is best for diffusion and prices • Bitstream competition often has disappointing results • No consensus conclusion about ULL-based competition, nor about NGA competition. But for the purpose of policy evaluation, the counterfactual is important. If it is a regulated end-to-end monopoly, unbundling looks more attractive.

19. The debate about wider access • The above discussion, like the European legislation, has focussed upon electronic communication networks and services • With convergence, attention has focussed upon a wider value chain including content and devices

20. The extended value chain Content Internet Backbone Local Loop Retailing Devices

21. The ex ante and ex post debate revisited • What form of intervention is appropriate to deal with the new elements? • Competition law automatically applies, so the issue is whether there are any abuses of dominance • However, in the case of content, voices are raised favouring the extension of the sector-specific exante regime from network services to, especially, non-replicable premium content • It is argued that this is also supported by the growth of consumption including voice, broadband and video.

22. The devices issue • In several jurisdictions issues have arisen over whether exclusive access by an individual network to particular devices, such as the iPhone, distorts competition • Some authorities have decided that it does, but long term exclusivity cuts a device manufacturer off from many or most consumers, and is unlikely to be a profitable long-term strategy • Accordingly the risk is limited to cases where the network market might tip to monopoly. Is this a desirable outcome for a device manufacturer?

23. Content issues • Market definition exercises suggest that some narrow sets of content (first run showings of the Hollywood studios, broadcasts of individual sports leagues) may form separate markets • Competition authorities have imposed several restrictions on transactions, setting limits on the duration of contract between content creators and wholesale or retail programme suppliers, and requiring the splitting of rights between several buyers • But is this enough?

24. Examples of ex ante regulation-the US • In the US, ‘programme access rules’ were imposed by the FCC since 1992 under the Cable Act 1992 • They met concern that cable companies could weaken competitors by starving them of programming • After two renewals, in 2002 and 2007, the rules were allowed to lapse in October 2012

25. Example of attempted ex ante regulation - the UK • Ofcom, using sector-specific legislation, imposed on Sky, a company which both acts a wholesale supplier and a retailer of premium sports rights, an obligation to offer those rights to competitors. Ofcom’s proposal was struck down by the Competition Appeals Tribunal in 2012 • A proposal by Ofcom to attempt to mandate access to movie rights under competition law was struck down by the Competition Commission in the same year

26. How to regulate content • Content lacks the ‘natural monopoly’ properties of some network assets which creates ensure persistent dominance will arise even absent strategic behaviour • It therefore is more naturally suited to the application of competition law which can impose certain structural conditions to transactions supported by large fines.