Select Committee on Trade and Industry Appendices to the Minutes of Evidence


Memorandum submitted by Level 3 Communications Limited


  Level 3 Communications Limited ("Level 3") is a public telecommunications operator licensed under the Telecommunications Act 1984. It has been developing and building, since 1998, one of the most advanced telecommunications networks in the UK. Its customers are typically Internet service providers and other large consumers of bandwidth.

  In its short history, Level 3 has completed or nearly completed the construction of an intercity network in the United States of 25,000 km, connecting 50 cities, an intercity network in Europe of 6,000 km, metropolitan networks around many of these cities, a transatlantic cable with a capacity of up to 1.28 terabits connecting the United Kingdom and the United States and a transpacific cable with a capacity of up to 2.5 terabits connecting Japan and the United States. As at the end of September 2000, the company offered communications services in 41 US, five European and one Asian market. Level 3 pursues a strategy of what it calls "Silicon Economics", also known as price elasticity, whereby it believes that lowering the price for its services will generate greater increases in the volume consumed, to its benefit, as well as to the benefit of consumers. Level 3 notes that this has been the case with personal computers, microprocessors and consumer electronics and should be no different for telecommunications services. For this reason, it has often been the leader in initiating price decreases for telecommunications services.

  Since March 1999, Level 3 has offered to ISPs a product called Managed Modem. This provides ISPs with both the facilities to house their servers and the connections into incumbent local exchange carrier networks to give access to end-customers. Prices at well below the levels offered by other operators providing a similar service, this product has been a big success in the US: in less than a year Level 3 has installed 200,000 64 Kb/s ports, is now processing more than three billion minutes of Internet traffic a month, and is already one of the top three providers of this kind of product in the United States. Level 3 considers that its managed services for ISPs have made a major contribution to the development of cheaper Internet access and to the increase in Internet penetration in the US.

  Level 3 is at present rolling this product out for ISPs in the UK. The customers of these ISPs will frequently be residential or small business users whose sole means of access is the conventional telephone line.

  A recent determination by OFTEL has for the first time in the UK held out the possibility of the competitive provision of unmetered (flat-rate) calling to the Internet. This could significantly reduce the costs of accessing the Internet for the smaller user. However, Level 3 has some serious questions about OFTEL's approach to flat-rate Internet access and these questions are the subject of this memorandum.


  The Committee will no doubt have had many representations relating to Local Loop Unbundling and in particular DSL which is seen as one of the key ways of expanding the reach of high speed Internet access. While DSL shows promise, however, it should be noted that roll out of this technology in the US, where Local Loop Unbundling has been required for a number of years, has been slow and problematic. The problems in the US have been very similar to those that are currently being debated in the UK and have at their core the problem of reliance on the incumbent owner of the local access network for every aspect of installation and maintenance. Furthermore, for most residential users, DSL is, and is likely to remain, in the medium term a relatively expensive technology (BT's current offering of a 500 Kb/s residential DSL service as a £150 installation charge and a £40 monthly fee, whilst a 2 Mb/s business service costs £260 to install and £480 per month). Thus, until DSL is proven as a workable and inexpensive technology in practice, dial-up Internet access using existing (but un-enhanced) telephone lines, will continue for some time to be the prime means of access to the Internet. One of the key drawbacks of dial-up access is, of course, the difficulty for the user in managing the cost of the phone bill.

  For some time there has been pressure on BT to introduce an unmetered (flat-rate) Internet access service. BT, until recently, has resisted this citing fear of overloading its network with Internet calls (BT's local network is designed to deal with three to four minute voice calls rather than calls to the Internet that, if unmetered, might last for many hours).

  In December 1999, however, BT itself launched a flat-rate Internet access retail product, known as SurfTime. SurfTime allows BT telephony customers to pay a monthly fee entitling them to make unlimited calls to Internet service providers on certain specified number ranges. BT, in conjunction with telecoms operators and their ISP customers, can therefore provide an unmetered Internet access using the SurfTime product—that is, the end-user pays a subscription both to BT for SurfTime and to the ISP for Internet access.

  This arrangement, however, gave rise to competition concerns. Another operator of ISP who wanted to offer a flat-rate Internet access service in competition with SurfTime would be faced with the following problem. To provide the service to an end-user connected to the BT network, the operator needs to arrange for BT to convey the calls initially to the point of interconnection with the operator who then terminates the call either with its own ISP, or with an ISP connected to its network. This service (known as call origination) has for a long time been available from BT and is used by indirect access providers offering typically low price national and international voice calls. BT's call origination service is, however, metered (ie on a pence per minute basis). An operator wishing to offer an unmetered service to its customers would have to bear the risk that the BT's charges for conveying metered traffic to the point of interconnection would exceed the flat-rate revenue it obtained from its customers. That is, there might come a point where the end user's usage would lead to an operator having to pay out more to BT than the flat fee it receives.

  Therefore, following a request by MCIWorldCom in December 1999, the Director General made a determination on 26 May 2000 that, with effect from 1 June 2000, BT would be obliged to provide other operators with a flat rate Internet access call origination service to allow them to compete with BT's SurfTime product in the manner described above. This service is known by the acronym FRIACO.

  At the same time the Director General determined that the charge for the FRIACO service should be £424.25[13] per 64 Kb/s point of connection per year, that is to say £424.25 pr voice channel (or ordinary telephone line) per year.


  Whilst Level 3 applauds the actions of the Director General in making the determination that BT should be obliged to provide FRIACO to other operators, it has serious concerns about the development of competition at the wholesale level. Level 3 has been considering whether to take the FRIACO service from BT in order to offer flat-rate access to ISPs. However, it is concerned that the length of time that OFTEL has taken to finalise the details of FRIACO has meant that FRIACO is likely to be attractive only to very few network operators. At the same time, however, BT is proposing to introduce a new service for ISPs, referred to by Level 3 as SurfPort24, which used FRIACO together with individual network elements that BT is not making available to other operators on an element by element basis. Thus, the goal of competition in the provision of flat-rate access risks being jeopardised.

  In more details, Level 3's concerns are:

    (i)  OFTEL indicated in its 26 May determination that it planned to review the charges for FRIACO by 1 December 2000. Whilst the charge of £424.25 per 64 Kb/s port is not in itself fatal to making a business case for the provision of flat-rate Internet access, they are high by comparison with the rates that, for example, are available in the US. Level 3, for instance, is able currently to charge its Managed Modem customers in the US US$30 per 64 Kb/s port per year. Taken together with the concerns outlined in points (ii) and (iii) below, the charges amount to a significant disincentive to the competitive provision of flat-rate Internet access by competing wholesale providers such as Level 3. However, OFTEL has only in the last few days begun consulting on the methodology for calculating the charges. That consultation is due to end on 11 December and the results are unlikely to be announced before January 2001, over one year from when MCIWorldCom made its original request for determination.

    (ii)  The determination only required BT to offer FRIACO to operators interconnected at the local exchange level in the network. In practice, however, operators have always interconnected with BT at switches at the trunk level in the network. Thus, in order to take a FRIACO service most operators, including Level 3, need to acquire and pay for interconnect extension circuits from BT to carry traffic from the trunk to the local level. The cost of these circuits is in addition to the cost of FRIACO. OFTEL announced that it would take expert advice on whether it would be reasonable to require BT to offer FRIACO at the trunk level. This advice was due to be delivered on 1 June but nothing has yet been published. Again, this is now expected soon but the delay has had the effect of limiting the roll-out of competitive flat-rate access.

    (iii)  In the meantime, BT has announced that it will launch a service for IPSs, provisionally called SurfPort24, which threatens to make competitive provision of flat-rate services using FRIACO even more unattractive. SurfPort24 is a combination of FRIACO and an existing service for ISPs which collects traffic at the local exchange and transfers it via modem banks to BT's IP (Internet Protocol) network to the ISP, to allow the ISP to offer a flat-rate service to its customers. This use of BT's IP network in conjunction with FRIACO is a far more efficient and cost-effective way of transferring traffic from the local exchange to the ISPs than the traditional interconnect circuits that other operators are obliged to use, yet it is not a service that BT at this moment is making available to other operators. In Level 3's view, this raises serious concerns that BT is using its monopoly position in the local access market to prevent a wholesale market from being established, which would bring competition and efficiency gains for the public.

  Level 3 has drawn these problems to the attention of officials at OFTEL, but has been told that swift action is unlikely. Level 3 is, therefore, deeply concerned about the time that it might take OFTEL to resolve the two key issues (charging and the provision of FRIACO at the trunk level) that are already delaying the competitive provision of flat-rate Internet access in the UK. The need for speedy action to open up competition in the market for the provision of access to the Internet (whether broadband or narrowband) is illustrated by the actions of the EU institutions which, if the regulation requiring Local Loop Unbundling comes into force as expected in the course of November, will have gone through the entire legislative process in little more than four months. Level 3 can see no reason why OFTEL should not undertake the review of FRIACO with a similar sense of urgency.

  Level 3 is concerned furthermore that OFTEL should be more pro-active in investigating the effect on competition at the wholesale level of new BT products, such as SurfPort24. Just as in the market for broadband access where, as the Committee will no doubt have heard from other operators, BT is entrenching its dominant position by pressing ahead with its ADSL roll-out plans whilst the rest of the industry tries to gain access to its local exchanges, so in the market for flat-rate narrowband access BT is seeking to gain first-mover advantage by creating the conditions where it is impossible for other operators to compete. In both cases BT has been given at least a year's head start on other operators. But this is a problem that needs swift resolution: every customer that signs up to BT's SurfTime is a customer that will have to be won over to an essentially similar although, it is hoped, cheaper service. But, this is no easy task: customer inertia has been one of the main reason why market share for telephony remains high.

  A speedy decision by OFTEL facilitating a viable wholesale offer will, if the US is any example, reduce prices for ISPs and end consumers for access, will foster competition in the flat-rate Internet market, allow ISPs to focus more on their product, and thereby bring about innovation such as shorter access times, richer quality, greater range of services and so on. Such a decision would help to eliminate the digital divide, assure universal service and would help the UK achieve its goal of being the best environment for e-commerce in the EU.


  1.  The telecoms industry is now operating at Internet speed but competition in the provision of flat-rate Internet access risks being stifled unless the outstanding issues around FRIACO are resolved, quickly, so, just as the EU institutions have approved local loop unbundling rapidly, what can OFTEL do to foster a competitive wholesale environment more quickly than at present?

  2.  How does the Director General propose to take a more pro-active approach to the regulation of new products offered by BT to prevent BT gaining the first-mover advantage that it has in the area of flat-rate Internet access? Would he, for example, consider establishing a rule that BT should not launch a retail product until the arrangements for a corresponding wholesale product had been settled?

  3.  Has the Director General considered whether an end-to-end product such as BT's SurfPort24 gives rise to any competition concerns and, if so, what action does he propose to take and on what timescale (recognising that by introducing such products BT is able to place the wholesale market in the position it was in before the introduction of FRIACO)?

7 November 2000

13   NB: this charge contrasts with the charge of £236.51 for the same capacity that OFTEL proposed in the draft determination that it put out to public consultation before making the final determination in May. The difference appears to have arisen because OFTEL accepted representations from BT that to carry the amount of traffic that FRIACO was expected to generate at the local exchange, it would have to set aside more circuits (capacity) in the local portion of the network (ie between the customer and the local exchange) than was previously thought in order to prevent a degradation in the service provided to PSTN (telephony) customers. Back

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