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


Memorandum submitted by the Service Providers Interest Group


  Mobile Independent Service Providers submitted their views to the Trade and Industry committee on the complaints handling process by OFTEL within the SPIG submission in November 1999, prior to your oral session with the Director General on 7 December 1999.

  We would like to bring you up to date with specific issues for our sector. We met the OFTEL Director of Compliance in January 2000 and were reassured that complaints were properly prioritised according to importance for the industry rather for procedural reasons (although OFTEL, like any competition authority, needs to take account of due process).

  Despite these reassurances, little has changed on the ground. A glaring example is OFTEL's announcement of a further inquiry into unfair cross subsidy by the mobile network operators BT Cellnet and Vodafone in July 1999. This is a good example of an investigation, which is of major importance to the mobile sector and yet has moved at glacial pace, despite the concerns of our members.

  The background is instructive but disheartening. For many years it has been widely believed by many of our members that network operators have unfairly cross-subsidised their Tied Service Providers at the expense of Independent Service Providers. In 1994 OFTEL introduced a formula (the "Talkland Formula") which was intended to be the yardstick against which cross-subsidy could be measured. Since then, the Formula has been honoured in the breach only. Meanwhile many of the original Independent Service Providers have been assimilated by the networks as they find it impossible compete on fair terms with the Tied Service Providers (including, ironically, Talkland who launched original complaint over eight years ago).

  OFTEL in its consultative document "Competition in the mobile market" dated February 1999 confirmed that the Talkland formula had been continually breached (unfair cross-subsidy had taken place). Yet after a further 14 months and three case officers OFTEL is still asking for further information before it can take any action. The most recent progress report to Service Providers at the OFTEL Service Provider Forum on 30 March 2000 suggested that OFTEL wishes to update the formula, which appears to be another element of delay and obfuscation. It seems to our members that OFTEL is simply not prepared to come to grips with a major issue—meanwhile the networks apply a tighter margin squeeze, driving Independent Service Providers out of business.

  We accept that radio spectrum is a scarce resource and will always be available only to a small number of networks. Hence we must stress that competition will not stem from four of five vertically integrated businesses acting as an oligarchy, but derives from competition in the provision of services. Competition can only thrive if there is a level playing field for all players providing those services. Independent SPs find it extremely difficult to compete with cross-subsidised operator owned SPs.

  We are concerned that OFTEL is disregarding the limited nature of competition at the network level in its haste to de-regulate. The regulatory controls on Vodafone and BT Cellnet as the two largest operators are now barely adequate—and must not be relaxed further.

  We are also concerned at the continuing staff turnover in the OFTEL competition casework department. We have recently heard that Jane Whittles, the head of casework, is leaving and the turnover among more junior staff continues; for instance we know of complex complaints that have passed through several hands. (And in some cases, the case handlers have been recruited by the network operators they were investigating—which does not inspire confidence among our members.) Telecommunications competition and regulatory casework is highly complex and requires committed and settled case handlers. Rapid turnover of personnel is not compatible with effective investigation. OFTEL must put in place plans for retaining those staff who are key to its effectiveness as a competition authority.

  Mobile communications services will be the backbone of the m-commerce market, but the benefits to customers and the economy will not accrue unless Independent Service Providers and new entrants have confidence that they can compete fairly. We had hoped that OFTEL would have acknowledged the importance of the mobile sector and the crucial impact on competition of the result of their inquiry.


  The Federation of Communication Services, which was formed in 1981, is the representative body for the mobile communications industry. It has represented the interests of the mobile phone service provider community since 1988, initially through the Cellular Service Provider Group and more recently through the autonomous Independent Mobile Service Providers Group, IMSP Group. FCS members are listed in the members directory on the website,

  Both Groups have taken an active role in representing the interests of Service Providers to OFTEL at the OFTEL SP Forum, meetings with OFTEL officials and by means of submissions in response to OFTEL consultations. Independent mobile service providers contributed to the evidence submitted by SPIG to the TAIC in November 1999 regarding complaint handling by OFTEL. They also contributed to the subsequent letter to Martin O'Neill MP dated 16 May 2000, which highlighted concerns about the continuing staff turnover in the OFTEL competition casework department.


  Radiospectrum is a scarce resource. Timescales for release for new spectrum for telephony are measured in years and do not match the pace of market place demand. The scarcity of this resource means there is, and will continue to be, an absolute barrier to entry at the network level. The recent round of auctions for third generation radio spectrum licences has demonstrated that not only is entry limited but is also exceedingly expensive, restricting access only to the large operators. In such circumstances regulatory intervention will continue to be needed to ensure competition can take place. In addition increasing public concern about the siting of radio masts will contribute to the difficulties of rolling out more radio networks. Maximising the use of existing radio infrastructure, therefore, has to be in the public interest.

  The present four-company oligopoly in the mobile market serves to reduce competition at the point of sale by limiting the choice of services available to consumers. Independent provision of services is needed to ensure that competition flourishes and the consumer has a choice from a basket of services. In order to provide competing services independent service providers require access to the mobile networks on fair and reasonable terms.

  Indirect Access, IA, to the mobile networks and establishing Mobile Virtual Network Operators, MVNO, are both ways in which greater occupancy of the mobile networks and diversity of supply can be achieved.

    —  Indirect Access for a particular network provides the consumer with a choice of an outbound carrier.

    —  An MVNO chooses the mobile network to provide services to its customers and controls the customer and service information from the SIM.


  Independent Mobile Service Providers that have wished to access mobile network infrastructure to purchase simple conveyance (call minutes) rather than the operator's branded retail services via IA or MVNO have been unsuccessful. Voluntary negotiations with the mobile licensees have not been fulfilled principally because:

    —  The price offered has been based on "retail minus". Retail minus pricing has been loosely defined by OFTEL as being the operator's retail price for a particular bundle of services less the costs saved by the operator in delivering the services to the service provider rather than to the consumer. Retail minus pricing as determined by OFTEL for IA does not allow independent service providers to operate a viable competing business.

    —  The operators' wish to protect their brand; their vertical market dominance and their high retail prices remain obstacles.

  References to OFTEL for determination of IA issues, in particular the request by INMS Ltd in December 1999 for Indirect Access to BT Cellnet and Vodafone, have led to excessive delays but have not changed the policy of the retail minus charging regime. We are aware that the UK Government has been subject to EC competition action as a result of its handling of the determination.


  Since launch of mobile phone services in 1985, BT Cellnet and Vodafone have been obliged to offer services to service providers. OFTEL has continued to determine that both BT Cellnet and Vodafone have Market Influence and the obligation to offer services continues.

  However, OFTEL has not acted in fact in response to acknowledged licence breaches. OFTEL has failed the independent service provider community and by doing so has given a "green light" to the operators that these practices can continue. The attached background paper summaries an eight year history of failure. During this period many independent SP businesses have ceased trading as a result of unfair competition that OFTEL has not stopped, shrinking the competitive opportunity in services delivery (Annex 1).

  MISP members have the following concerns about OFTEL's conduct:

    —  Dilatoriness in pursuing the margin squeeze investigation which at the very least contributed to the growth of BT Cellnet and Vodafone Tied SPs at the expense of Independent SPs from 1994 to date.

    —  Disregarding clear evidence of a margin squeeze by BT Cellnet and Vodafone prior to Quarter one 2000 when OFTEL finally concluded an investigation.

    —  Launching a review of the mobile market which could well lead to the conclusion that neither BT Cellnet nor Vodafone have continuing Market Influence.

    —  Favouring a policy of network competition over competition in the provision of services at different levels of the market—for example between Independent Service Providers and network operators.


  If m- and e-commerce are to thrive in the UK and provide a competitive edge for the nation, a healthy service provider sector and a regime that encourages new entrants will be essential. Our analysis shows that, as a minimum, the regulatory framework should include the following conditions:

    —  A regulatory regime that recognises in the mobile market there can never be effective competition at the network level because of the absolute barrier to entry.

    —  A Regulator who fairly policies the mobile licensees; who responds to complaints of licence breaches in a timely manner; who uses the powers given to him to remedy any unfair or otherwise anti-competitive behaviour; who can call upon resources to effectively regulate.

    —  A right of access for independent service providers to mobile networks to purchase elemental network services at cost plus prices as inputs for their own competing services for consumers.

    —  Access for independent service providers to, and interfaces with, mobile network infrastructure, on the same terms as the operator provides such access to its internal providers of services, to provide value added services (eg Pre-pay, SMS, Voice and other messaging, Internet access and other non-voice conveyance services, GPRS).


  We have real concern that a regime where the regulator shrinks back to laissez faire, instead of facing up to the abuses of dominance and Market Influence will have the following results:

    —  The mobile operators will continue to exercise complete control over distribution channels to consumers and content through restricted mobile portals.

    —  Prices for basic services will remain high and prices for new services will limit the take up of those services.

    —  The opportunity for a richness of competing products and services (including "new economy" services) will be lost.

    —  Independent service providers will continue to abandon the mobile market and will not be replaced.

    —  The consumer will have less choice.

    —  The mobile operators' will have unhindered monopolistic tendencies.


  The Independent Mobile Service Provider Group encourages the Trade and Industry Committee to consider the issues outlined in this brief submission in its oral hearing with the OFTEL Director General on 14 November 2000. The Director General has recently received a further three year contract to continue at OFTEL and presumably oversee the transition to any new regime outlined in the forthcoming Communications White Paper. Our confidence in the regime as it presently stands is diminishing and we urge a reconsideration of how OFTEL can move forward.

9 November 2000

Annex 1

DateService provider PurchaserEquity stake Subscribers at time of purchase
July 1996TalklandVodafone 67%400,000
November 1996Peoples' Phone Vodafone100%400,000
February 1997AstecVodafone 80%97,000
February 1997DX Communications Cellnet26%n.a.
April 1997The Link Cellnet40%n.a.
October 1997Securicor Cellular Services Cellnet100%(1)254,000
October 1997Securicor Cellular Services Martin Dawes100%(1) 55,000
October 1997BT Mobile Cellnet100%1,200,000
March 1999Martin Dawes Cellnet80%835,000
January 1999Cable & Wireless Communications Vodafone100%100,000
August 1999Securicor BT Cellnet100%
September 1999DX Communications BT Cellnet100%n.a.
September 1999UniqueAire Vodafone100%291,000
November 1999Scottish Power Vodafone100%66,000
March 20003A Telecom Vodafone100%25,000

  1. Securicor Cellular Services transferred its 254,000 consumer and small-medium enterprise subscribers to Cellnet at the same time as transferring its 55,000 corporate subscribers to Martin Dawes.

  Mobile retailers are shown in italics.

  Sources: Various publicly available sources.


  1.  In 1992 Talkland International (UK) Ltd, an independent mobile service provider, submitted a complaint to OFTEL.

  This alleged that the wholly owned downstream arms of the network operators were:

    —  being unfairly cross-subsidised; and

    —  shown undue preference,

to the detriment of Independent Service Providers.

  Other Independent Service Providers supported the complaint during the following year. Even so, the investigation proceeded very slowly during the remainder of 1992 and 1993 despite the concerns of interested Independent Service Providers. Finally, following the appointment of a new Director General (Don Cruikshank) with a more dynamic agenda at the end of 1993, OFTEL announced on 17 May 1994[16] that it had completed the investigation and upheld the most significant elements of the original Talkland complaint.

  OFTEL concluded:

    —  there was historical and continuing unfair cross-subsidies by British Telecommunications Plc (BT) to BT Mobile Communications (a division of BT) and Securicor Group Plc to Securicor Cellular Services Ltd[17] and by Vodafone Group Plc to Vodac Ltd[18]: These cross-subsidies contravened the relevant licences;

    —  if Call Connections Ltd (the wholly owned service provider arm of Cellnet) were acquiring subscribers at a cost which would not allow it to earn a reasonable return on its subscribers, the Director General stated that he would consider that "an unfair cross-subsidy exists" in contravention of the Cellnet and BT licences;[19]

  OFTEL agreed with the complainant that a cross-subsidy is unfair if it "seriously restricts the ability of Independent Service Providers to compete with service providers linked to the network operators."


  OFTEL proposed to remedy these abuses in the long term by insisting that a "mature" [tied] service provider business must make a reasonable return on its investment such as its investors would expect if it were a stand-alone business. The investment was predominately the acquisition of subscribers. Therefore OFTEL linked its definition of a "reasonable return" directly to the net cost of acquiring and servicing a subscriber.

  OFTEL set the required rate of return as 2 per cent per month assuming that the average life of a subscriber was 35 months. OFTEL stated that the rate of 2 per cent "took account of the risky nature of the business, the level of returns earned by the industry as a whole and of representations made during the investigation." These numbers were to be kept under review.


  More immediately, OFTEL issued Directions to end the unfair cross subsidies, which had been taking place.

  Looking forward the two dominant players were told to submit quarterly financial results of their Tied Service Providers Then, Vodac Ltd and VHL Communications Ltd (Vodafone) and BT Mobile Communications, Call Connections Ltd and Securicor Cellular Services Ltd (Cellnet)[20] for independent audit. OFTEL stated that it would:

    "deem an unfair cross-subsidy to have occurred if the average net cost of acquiring subscribers in a quarter exceeds the average economic value of those subscribers."[21]


  OFTEL announced on 17 October 1994 that the Director General had revoked the Direction given to BT and Cellnet:[22] this was followed by a similar announcement over the equivalent Direction to Vodafone. However the Director General stressed that the Directions were only being revoked because financial returns showed that BT and Cellnet and Vodafone were complying with the formula.[23] He made it clear that the decision to revoke the Directions had no effect on the validity of the Talkland Formula.

  "I would, however, like to stress that this decision has no effect on the levels of profitability I am expecting Vodac Ltd to achieve both currently and in the future. I shall be continuing to monitor the financial results of that organisation, and of Vodacom Ltd on the basis of information to be provided to me under Condition 35 of the licence of Vodafone Ltd, and as I noted in my earlier statement, I would expect to take appropriate action if unfair cross-subsidy is found to exist in the future."

  A similar statement was made about the application of the Talkland Formula to the BT and Cellnet Group.[24] However, during the next six years OFTEL consistently failed to make good its promise of "appropriate action".


  Within a year (by mid 1995) Independent Service Providers had serious concerns that the Formula was systematically being breached.[25] The strength of those concerns is shown by a statement by David Savage[26] made on 1 December 1995.

    "Independent cellular service provision, the concept established by the Government to create a competitive environment within the mobile telecoms market, is now in danger of serious erosion. I have received a number of requests from SP industry members calling for a more effective complaints strategy and an OFTEL investigation into independent SP's being bypassed by the cellular networks. We believe that our industry is now on the receiving end of predatory pricing, discriminatory marketing and anti-competitive practices. Our message to the networks is clear: please adhere to your Government licensing agreements."

  During this period, OFTEL received complaints from many other Independent Service Providers that the Formula was systematically being breached by the Network Operators.[27] For example, Talkland lodged a further complaint that the criteria were ineffective in early 1996. A good example of the lengths to which Independent Service Providers were prepared to go to explain their concerns to OFTEL is provided by submission on 23 February 1996 from the well established player, Cellcom.

    "Cross subsidies by network operators of their respective Tied Service Providers and Direct Sales Businesses has made the market un-competitive for Independent Service Providers. Network operators have, mainly as an adjunct to brand advertising, forced their own retail pricing on consumers through the TSP and DSB distribution channels under their control. This has had the effect of virtually stopping competitive tariffs for the consumer."

  Cellcom went on to state its concerns baldly: it was in no doubt that there was a continuing unfair cross-subsidy in contravention of the Talkland Formula.

    "These factors have seriously damaged the business of Independent Service Providers and have combined to put the very future of independent service provision at risk. In addition the increase in direct control of distribution channels by network operators has led to less real competition and choice at the point of sale which is ultimately detrimental for the consumer."

  Although made well aware of these and similar concerns OFTEL took no further enforcement action against the networks.


  OFTEL's next major review of the relationship between Service Providers and the network operators was issued on 24 May 1996.[28] This took the form of a Consultative Document inviting comments by 6 August 1996.[29]

  OFTEL succinctly summarised the Talkland complaint in para 2.9:

    "The particular form taken by the cross-subsidy is that the network operators—then a duopoly—made high charges to service providers for the use of airtime. Given the level of retail prices charged by service providers for hardware, connection and airtime, service provision was unprofitable whilst the network operators made high profits. It was also noted that the network operators exercised a considerable degree of influence over the retail price through their TSPs. This meant that the Independent Service Providers were subject to a `margin squeeze'. Losses made by the TSPs could be supported by cross-subsidy from the network operators; independents did not, of course, have an equivalent source of funds."

  Well aware of the risks of a continued margin squeeze OFTEL, therefore, recommended that Formula should remain in place and would continue to govern the financial relationship between the Cellnet and Vodafone networks and their Service Providers—although with some changes to the detail.

  OFTEL also requested views on the formal exclusion of Orange and One2One from the Formula arrangements because of their lack of market power. OFTEL also consulted on proposals to allow all the networks more freedom to choose distribution channels and to include brand promotion conditions in contracts with independent retailers.

  During the Consultation period Independent Service Providers made extensive representations to OFTEL that the regulatory controls should not be unduly relaxed. They also again expressed concerns that the Talkland Formula was being systematically disregarded.


  There was a further delay of eight months from the close of the consultation before OFTEL issued the follow up Statement "Fair Trading in the Mobile Telephony Market" in April 1997. Despite that delay, OFTEL largely reaffirmed its recommendations made in the Consultation issued the preceding year.[30] In its final published form therefore the April Statement largely focused on the relaxation of regulatory controls from the two smaller network operators.

  Even so OFTEL took the opportunity to reaffirm the relevance of the Talkland Formula to the relationship between the two dominant operators and their Service Providers and to update it in the light of market changes.

  OFTEL reviewed the regulatory framework, which determined its enforcement powers towards the two dominant mobile networks. It stated:

    "7.3.1 For so long as Vodafone and Cellnet continue to possess market power, their licences will remain unmodified with respect to the provision of mobile services. They will therefore continue to contain:

    (a)  an obligation on the licensee to provide wholesale airtime for resale to any service provider requesting it, subject only to a right to refuse to do so where there is reasonable cause to doubt the ability of the service provider to provide services to others "in a proper and efficient manner" or to finance the provision of those services, or where the service provider is unwilling to sign a standard contract. (In Cellnet's licence the relevant provisions are in Conditions 1.1, 37 and 41.5. Vodafone's licence has analogous provisions);

    (b)  an obligation to connect the customers of service providers to its network and not discontinue connections lawfully made (c.f. Cellnet licence c.6.1);

    (c)  an obligation to publish charges and other conditions (in effect wholesale charges, etc) and not to depart from the published terms (c.f. Cellnet licence c.8);

    (d)  an outright prohibition of undue preference and undue discrimination in relation to the provision of MRTS or the connection of mobile apparatus. This will continue to be accompanied by a provision deeming such preference or discrimination to arise if the licensee unfairly favours to a material extent a business carried on by it so as to place others at a significant competitive disadvantage (c.f. Cellnet licence c.9);

    (e)  a power for the Director General to require action to remedy unfair cross-subsidies provided by a Licensee's Systems Business to other businesses it may run, including airtime retailing businesses and the provision of enhanced services (c.f. Cellnet licence, c.40);

    (f)  a requirement for accounting separation of the following Businesses of a Licensee:

    —  Apparatus Supply Business.

    —  Apparatus Production Business.

    —  Direct Business (ie retailing direct to the end-user).

    —  Systems Business.

    —  Supplemental Service Business.

    —  Any other distinct commercial business connected with telecommunications.

  Having stated that the regulatory framework would remain intact so it continued to have enforcement powers to prevent unfair cross-subsidy OFTEL then considered the practicalities of enforcing the Talkland Formula.

    "7.3.3 So long as Cellnet and Vodafone are still deemed to have market power they should continue to be subject to controls on cross-subsidy of tied service provision businesses by means of the OFTEL formula for TSPs, though there is a case for modifying particular parameters of the formula."

  This clearly emphasises OFTEL's awareness of the continuing need for the Talkland Formula was needed to control cross-subsidy by mobile network operators of Tied Service Providers while Cellnet and Vodafone possess market power.


  In the Statement OFTEL announced the following changes to update the Formula:

    —  Its scope was extended to include all incentive payments made by the two network operators direct to dealers or other distributors and which were not channelled through service providers or covered by returns. Vodafone and Cellnet were required to record and monitor those payments and include them in the quarterly returns into OFTEL. In Practice most high street retailers receiving those payments arranged network connections through a Tied Service Provider. Therefore, OFTEL was concerned that these payments could be potentially discriminatory (and an additional source of subsidy) even though they were not channelled overtly to the Tied Service Providers. This change took account of concerns expressed by Independent Service Providers that the dominant networks were unfairly using incentive payments to tie high street retailers to Tied Service Providers.

    —  The Formula was adjusted to take into account:

      —  reductions in subscriber life to around 27 months;

      —  reductions in the required annual rate of return for the service providers to 1.5 per cent a month or just under 20 per cent a year.

  OFTEL also stated that it would review those arrangements in the light of market developments—although the Director General did not "expect this review to be necessary before 1998."


  Independent Service Providers continued to be extremely concerned that Vodafone and Cellnet were disregarding the Formula. OFTEL failed to take any enforcement action to address those concerns. Meanwhile, the number of Independent Service Providers continued to fall as they were absorbed by the dominant network operators.


  In the April 1997 Statement OFTEL had promised a follow up review of the mobile market and, particularly, the effectiveness of the Talkland Formula. This commitment eventually resulted in a further Consultation Document "Competition in the Mobile market" issued in February 1999.

  The Statement covered a wide range of related issues.[31] Even so, OFTEL's response to concerns about the effectiveness of the Talkland Formula formed a large part of Chapter 2 of the new Consultation.

  OFTEL once again confirmed the basic principles behind (and continuing need for) the Talkland Formula—that Tied Service Providers must achieve sufficient margins to earn a reasonable rate of return and that compliance should be measurable. OFTEL also confirmed its view that the Talkland Formula (appropriately adjusted by the 1997 update) continues to be the appropriate yardstick. (Therefore OFTEL—as in 1997—now measured average subscription life at 27 months and the required rate of return at 1.5 per cent per month.)

  OFTEL reaffirmed its awareness of how Independent Service Providers could suffer from a margin squeeze in a statement that is entirely compatible with the principles of Community Competition law in this market.

    (unprofitable margins) "may be viable in the context of the overall Group within which a TSP operates because the parent company is likely to be generating profits through supply of wholesale services [but] it would not enable ISPs to earn a reasonable return."

  OFTEL concluded that:

    "the margins achieved by most of the service providers owned by the operators' Group have fallen below what is reasonable. This suggests that the margins of Independent Service Providers may be being squeezed for anti-competitive purposes."


  OFTEL stated "prior to changes made to the formula in 1997, Cellnet service providers and BT Mobile generally achieved the required return of 2 per cent per month over the 35 months assumed to be the average subscription life. Vodafone's service providers achieved mixed returns, with Vodacom achieving this requirement in most quarters and Vodacall and Vodac consistently failing to achieve the 2 per cent per month minimum rate of return over the assumed average subscription life."

    —  Vodacall and Vodac, which were major Tied Service Providers owned by Vodafone, had received systematic and unfair cross subsidies from May 1994 when the Talkland Formula was set until April 1997 when it was revised;

    —  Even the better performing tied service providers—Vodacom within the Vodafone Group and Cellnet service providers and BT Mobile had received some cross-subsidies during that period.

  Even for that period, there was clear evidence of a margin squeeze used to strengthen the position of the Tied Service Providers. This was in line with the representations made by Independent Service Providers to OFTEL during that period.


  OFTEL's analysis made it clear that compliance with the Talkland Formula had deteriorated still further following its revision in 1997. In reality by February 1999 the dominant networks were simply disregarding it.

    "3.6 Since the formula was changed in 1997, BT Mobile has continued to achieve the required rate of return in every quarter except Q1 of 1998-99. Cellnet's performance has been far less satisfactory, failing to achieve the required rate of return in every quarter except Q2 of 1997-98."

  Vodafone's record was worse.

    "3.7 Vodafone service providers all consistently failed to achieve the required rate of return over the assumed average subscription life."

  OFTEL's conclusion were unequivocal—with the exception of BT Mobile, Tied Service Providers of the dominant networks had been receiving cross-subsidies in clear breach of the Talkland Formula for the entire period. OFTEL then looked at the effects in the market.

    "3.8 The exact values appearing in particular periods do not automatically denote anti-competitive behaviour and the returns must be considered in the light of prevailing circumstances, not in isolation. However, it is now evident that the failures indicated by the returns submitted for the quarters, which immediately followed the modification of the formula, were not isolated events. With the exception of BT Mobile, tied service providers are consistently failing to achieve the margins required by the formula. Furthermore, the minimum average subscription life consistent with achieving the required margins is substantially longer than the assumed average life of 27 months. Indeed in some periods Vodafone service providers report figures, which would take twice the assumed average life to generate the required rate of return. The discrepancies are so great that it is unlikely that they can be accounted for by short-term market fluctuations." (Our italics).

  Meanwhile Vodafone and BT Cellnet acquired many of the major Independent Service Providers, which had been unable to compete on equal terms with the existing Tied Service Providers.


  OFTEL backed away from enforcement action, apparently because it was unsure about how watertight the "Group licence condition was." (This was intended to impute actions of subsidiaries to parent companies.) Instead OFTEL merely stated that it would discuss its concerns with the operators in parallel with the consultation. Action was however, promised for the future. OFTEL stated that if the Director General was still not satisfied then he "will use those enforcement mechanisms which seem most likely to be effective in ensuring that Independent Service Providers are supplied with airtime on a fair and non discriminatory basis."

  Although OFTEL rejected immediate enforcement action because of perceived difficulties with the Group licence it stated that this problem would be overcome by introducing a more watertight replacement condition into operator licences.


  In the meantime OFTEL turned to other possible remedies and considered:

    —  a prohibition on the operator supplying airtime to that other company; and/or

    —  a control of wholesale prices for airtime.

  After some analysis OFTEL consulted on these alternative courses of action (and on wider issues such as the future of enhanced services and branded airtime).


  OFTEL also consulted on a significant adjustment to Talkland Formula.

    "OFTEL does not propose to change any of the economic inputs to the returns, including the minimum monthly rate of return. However, rather than assume, for the purposes of the return, that the life of an average subscription is 27 months, the operators will be asked to treat that figure as a variable established by the actual costs and revenues and OFTEL's requirement that service providers within the parent Group should achieve a minimum return of 1.5 per cent per month. Furthermore, the operators will be asked to state what in practice is the average life of a subscription. OFTEL proposes to publish the two figures."

  However, many Independent Service Providers considered that instead of taking regulatory action against the two dominant operators for systematic breaches of the Talkland Formula, OFTEL was looking for an excuse to abandon measurement of cross-subsidy altogether. If the life of an average subscription became a "variable" figure it would be impossible to measure an acceptable rate of return. (Which had been the entire point of introducing the Formula in May 1994). It would no longer be possible to measure a price squeeze by showing that "the price which the network operator charges in the downstream market is insufficient to allow a reasonably efficient service provider to obtain a normal profit." It seemed that faced by clear evidence of consistent anti-competitive behaviour OFTEL was looking to abandon the appropriate yardstick itself rather risk taking enforcement action in accordance with its duties as a competition authority.


  On 13 July 1999 OFTEL produced this follow up Statement. As with the preceding Consultation it summarised OFTEL's views on the state of competition in the mobile market and covered a number of wider policy issues[32] for the future of the market. Therefore, the relationship between Network Operators and Service Providers did not form a major part of this statement. Even so, the failure of the network operators to comply with the Talkland Formula was analysed at length in Chapter 2.


  OFTEL once again noted the impact of consolidation in the market:

    "2.4 Consolidation has also been paralleled by a tendency for the services and tariffs of Independent Service Providers to approximate to those of the operators' own service providers. There may be many reasons for this, but the structuring of wholesale airtime products in forms which shadow the operators' own retail products, the offering of bonuses and discounts to service providers which are willing to promote the operators' brands and the provision of assistance with marketing programmes reinforcing those brands have played a large part. If this process continues, Independent Service Providers may find themselves forced to become little more than the managers of franchise-type operations."

  OFTEL then correctly linked this consolidation to the continuing margin squeeze in breach of the Talkland Formula.

    "2.5 Independent Service Providers have also been constrained by wholesale airtime prices which, relative to prevailing retail prices, fail to offer a reasonable margin on which to operate. There is evidence that although, in accordance with their licence obligations, BT Cellnet and Vodafone may have charged Independent Service Providers and those within its Group the same prices for wholesale airtime, these operators have conducted a margin squeeze by cross subsidising service providers within their Group with profits taken at the wholesale level. Here again, this has limited the ability of Independent Service Providers to compete with differentiated products." (Our italics).


  For the first time OFTEL unequivocally accepted that systematic unfair cross-subsidy had been taking place between the two dominant networks and their Tied Service Providers in breach of the Talkland Formula.

    "2.7 Following consultation in 1997, OFTEL set the required rate of return at 1.5 per cent per month. Both BT Cellnet and Vodafone have failed to achieve this return of 1.5 per cent per month.

    "2.8 OFTEL considers that failure of service providers within each operator's Group to recover the cost of capital for an undertaking of this kind is an indicator of potential unfair cross-subsidy."


  OFTEL also admitted that neither BT Cellnet nor Vodafone had kept separate regulatory accounts as required under the Accounting Separation regime.[33] Nor had OFTEL called for these accounts in "recent years". We can only assume that this laxity has compounded OFTEL's failure to enforce the Talkland Formula. OFTEL itself commented:

    ". . . in the absence of published accounts reflecting the regulatory businesses defined in the BT Cellnet and Vodafone licences, it is unclear which bonuses, discounts and marketing support programmes are funded at the network level by the Systems Business in order to stimulate incremental use of a network and which are intended to promote the brands and products of service providers within a licensee's Group."

  OFTEL had failed to follow the recommendations of the Access Guidelines by requiring the production of "audited separated accounts dealing with all necessary aspects of the dominant company's business."


  OFTEL again discussed the possibility of enforcement action but again without taking any action. Again OFTEL revisited its powers under the relevant fair trading and competition licence conditions. This time, however, OFTEL stated that it was opening a formal investigation. The remaining Independent Service Providers assumed that this would finally lead to a decision reaffirming OFTEL's preliminary conclusions about systematic unfair cross-subsidy. They asked for a decision by 1 November 1999.

  Even so, despite constant requests OFTEL still failed to complete the investigation or to take any regulatory action against the network operators for systematically failing to comply with the Talkland Formula over the last six years. Meanwhile, Vodafone and BT Cellnet acquired several more of the remaining Independent Service Providers.


  An OFTEL official presented an "update" on the investigation into breaches of the Talkland Formula at the bimonthly industry participation group the "Service Provider Forum" on 30 March 2000. Despite the exhaustive analysis of the market and of the Formula which has been undertaken for previous reviews, OFTEL informed service providers that it still needed to consider further "key parameters" before reaching a decision.

  Those "key parameters" were not, as might be supposed, a list of complex issues. Rather they restated obvious points such as:

    —  Whether cross-subsidy was "unfair";

    —  Whether operators have market power in the mobile market;

    —  Whether developments since 1994 may require the Formula to be updated.


  Service Providers were also informed that OFTEL would be unlikely (despite earlier assurances) to investigate and take action on part abuses of the Talkland Formula. Rather OFTEL proposed to disregard its own clear evidence of a margin squeeze during the previous six years—and which has considerably reduced competition in the market.


  This presentation concentrated not on enforcement action but on options to revise and update the Talkland Formula. This approach was subsequently confirmed in the Consultation Paper on proposed action against BT Cellnet issued on 3 July.


  OFTEL decided to limit the investigation to the first Quarter of 2000 and to disregard the evidence of the failure of BT Cellnet and Vodafone to comply with the Talkland Formula during 1997-99. OFTEL at a later meeting on 23 July rejected requests to widen that investigation to include that period. In effect, OFTEL was trying to "wipe the slate clean."

  OFTEL reaffirmed the continuing market influence of BT Cellnet and Vodafone. The economists had measured the earnings per subscriber of the BT Cellnet and Vodafone Tied Service Providers. For the first Quarter of 2000

    "In all of the tests which OFTEL ran Vodafone achieved positive results, whilst BT Cellnet had negative ones. Consequently the OFTEL formula returns indicate that BT Cellnet is cross-subsidising its TSPs as it is clear from the data that if the TSPs were stand alone companies they would not be covering their costs. It appears to the Director, based on current information, that BT Cellnet's cross-subsidy of its TSPs amounts to, on average, between £1.50 and £8.00 per subscriber."

  OFTEL concluded that this amounted to a margin squeeze.

    "This margin squeeze is made possible by BT Cellnet's cross-subsidisation. (sic). This cross-subsidy significantly restricts the ability of ISPs to compete with the Licensee's TSPs because ISPs still have to compete with the prices of TSPs but in doing so they cannot earn an adequate return."

  Surprisingly OFTEL found no evidence to show that Vodafone was engaged in similar cross-subsidy during that three month period. Hence the draft Direction to end cross-subsidy was addressed to BT Cellnet only.

  OFTEL consulted on these views. ISPs have put their case face to face and in writing. At a meeting on 23 July with the case manager, OFTEL made it clear that it was not prepared to widen the investigation beyond the first Quarter of this year—even though the limited scope excluded a substantial period during which Vodafone and BT Cellnet had almost certainly been engaged in a margin squeeze.

  MISP has subsequently replied to the OFTEL proposal making this point but also raising substantial concerns about the methodology.[34] In particular ISPs believe that OFTEL considerably underestimates the true churn figures for the various reasons—but particularly due to the growth of the pre-pay sector which has a different usage profile. The Group concludes that corrections to the OFTEL assumptions will take pre-paid churn to similar proportions to churn in the subscription sector of the market and produce a subscriber life of at (or even below) 22 months rather than OFTEL's conclusion of 48—52 months[35]. This would of course, have a corresponding effect on the point at which Service Providers can recover their costs. The Group has also raised other concerns about anti-competitive behaviour by Vodafone including unilateral reduction in margins and changes to connection bonuses.

  As far as we know, OFTEL is still considering these and other representations: at 10 November 2000 a final Determination has not yet been issued.


  This is of equal concern: OFTEL launched a full-scale review of the mobile market on 19 September 2000. This will focus on how competition has developed since the 1998—99 review and whether the existing levels of regulation (particularly on BT Cellnet and Vodafone) are still required. At a "Stakeholder" meeting OFTEL officials made it clear that no options have been ruled out—including the removal of regulatory controls from BT Cellnet and Vodafone if they no longer have "Market Influence". The network operators will be lobbying OFTEL hard for this result. It now appears to Independent Service Providers that OFTEL would rather surrender its residual powers of regulation than face up to the responsibilities of enforcement.

13 November 2000

16   May 1994 "Fair Competition in Mobile Service Provision". Back

17   The licences held by the Securicor Group were considered separately from those held by the BT Group because at that time Cellnet was a joint venture between BT and Securicor. Sole ownership was subsequently acquired by BT. Hence elsewhere we have reflected the commercial reality by referring simply to "BT Cellnet". Back

18   Vodafone's Tied Service Provider arm. Back

19   The complaint was rejected for the then new entrant third mobile operator Mercury One2One because it was then in the first year of start up operation (The activities of Orange were not considered in this part of the statement because it was just beginning full national operation under the ownership of Hutchison Cellular Services). As OFTEL never attempted subsequently to enforce the Talkland Formula against Orange or Mercury One2One (a position finally regularised by a licence modification in April 1998) their position is not considered in any detail here. OFTEL also rejected some miscellaneous allegations of undue preference and abuse of dominant position against BT Cellnet and Vodafone. Back

20   Then, Vodac Ltd and VHL Communications Ltd (Vodafone) and BT Mobile Communications, Call Connections Ltd and Securicor Cellular Services Ltd (Cellnet). Back

21   OFTEL also noted that bonuses paid by the network operators and related to the size of the subscriber base were relevant-Tied Service Providers might (through cross-subsidy) obtain larger bases "from which to benefit from the higher bonuses." Therefore, discounts or bonuses were disregarded on any subscriber base in excess of 50,000. Back

22   Then Telecom Cellular Radio Ltd. Back

23   Under the licence Conditions under which OFTEL had taken action a Direction could only be made if the Director General was satisfied that a breach of licence was likely in the future. The Fair Trading Condition was-at least in part intended to remedy this lacuna. Back

24   OFTEL press releases 17 October and 21 October 1994. Back

25   In August 1995 OFTEL extended the exemption for Orange and Mercury One2One-as operators without market power-from the restrictions on cross-subsidy. Back

26   Then Chairman of the Federation of Communications Services (FCS) Cellular Service Providers Group (CSPG). Back

27   The CSPG even asked Mr Ungerer at the Commission to include Fair Trading Condition obligations in the provisions of Mobile Communications Directive. (Letter of 22 September 1995). This was ultimately unsuccessful. Back

28   "Fair Trading in Mobile Service Provision"-The Regulatory regime governing the relationship between the mobile telephone network operators and their service providers. Back

29   The length of the consultation period seemingly reflected the seriousness with which OFTEL was analysing the issues. Back

30   The most important change was the removal of the obligation to sell through service providers from Orange and One2One-this was linked directly to the introduction of the Fair Trading Condition into operator licence. Back

31   Including the competitiveness of the market for calls from mobile phones and (again) whether the two dominant operators should continue to be under an obligation to provide wholesale airtime to service providers. Back

32   Including OFTEL's approach to Indirect Access (Chapter 3) and, more widely, the future regulatory environment (Chapter 4). Back

33   Condition 39 of the BT Cellnet licence and Condition 44 of the Vodafone licence. Back

34   Letter sent 8 August 2000. Back

35   This could even be an underestimate. Experience shows that churn in the first six months following pre-pay connection can exceed 8 per cent per month. Back

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