UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 407-ii

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

Trade and Industry Committee

 

 

Ofcom's Strategic Review of Telecommunications

 

 

Tuesday 8 March 2005

MR JOHN PLUTHERO and MR ANDY MAY

MR BEN VERWAAYEN, MS ANNE HEAL and MR PETER McCARTHY-WARD

Evidence heard in Public Questions 84 - 154

 

 

USE OF THE TRANSCRIPT

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Oral Evidence

Taken before the Trade and Industry Committee

on Tuesday 8 March 2005

Members present

Mr Martin O'Neill, in the Chair

Linda Perham

Sir Robert Smith

________________

Memorandum submitted by Energis Communications Ltd

 

Examination of Witnesses

 

Witnesses: Mr John Pluthero, Chief Executive Officer and Mr Andy May, Director, Regulatory and Public Affairs, Energis Communications Ltd, examined.

Q84 Chairman: Good morning Mr Pluthero. Perhaps you could introduce your colleague and yourself and we will get started.

Mr Pluthero: Good morning and thank you for having us today. My name is John Pluthero; I am Chief Executive of Energis. To my right is Andy May, the Director of Regulation at Energis.

Q85 Chairman: From what we can see you have changed your position somewhat on the question of BT break up. As I understand it, when we last looked at this subject this was not on your agenda and it did not even occur I think in the Phase I evidence that you gave to Ofcom. What is the reason for this Damascene conversion of which we read so much in the press at the weekend?

Mr Pluthero: I think one specific event coupled with a growing realisation of some of the underlying drivers. The specific event is consumer broadband. Energis had a substantial market share in narrowband internet, selling to the likes of Freeserve (and Wanadoo thereafter) and obviously we were very keen to maintain that position in the market and our customers were keen to buy broadband from us. We worked very extensively with BT and with the regulator to see if we could achieve a settlement on DataStream, the wholesale variant, that would allow us both to make money and to offer a suitable product to our customers. I approached BT Wholesale during the autumn of last year to explain that that was proving very difficult, that the determined margin was not enough to cover the on costs and to offer my customers a saving, that there was great uncertainty about that product. We had the poor reservation charge issue which had been left in the market place undetermined which has a fundamental impact on the economics. We could not see a way for bulk migration and various other procedural facts. There was a lack of willingness to do anything about that so we had to unpick some contracts we had with our customers and step out of that market. That made me think about the underlying drivers of what was going on and where I got to was that there was no denying the fundamental commercial conflict involved for BT. The task we asked them to manage is a very difficult one. If they are to do what their shareholders want them to do then it is very difficult for them to provide their competitors with value for money, innovative products. That happens both at the macro-level and the micro-level. And we are not going to win that battle. Those forces are very substantial, very powerful and the management of BT do a very good job. You do not have to assume any maliciousness, any conspiracy theories; they are prosecuting a commercial agenda with vigour and talent and that really precludes willingly gifting market share and opportunity to their competitors.

Q86 Chairman: I hear what you say, but it has been suggested that their opening gambit with Ofcom of separating the business and - presumably with the agreement or at the insistence of Ofcom - the construction of Chinese walls between the businesses would meet some of the challenges that you are putting up to their suggestions. What would you say to that?

Mr Pluthero: I think the opportunity lies on a continuous spectrum; it is really how far along that spectrum you push, creating structures that try to deal with that fundamental commercial conflict. My personal belief is that if you get far enough along that spectrum to really do the job BT is put in a very difficult position because it will end up owning something which is in direct contradiction to its wider group goals and ambitions and what it is saying to the market and what it is trying to deliver. Therefore you really need to go the extra five or ten per cent and separate it out formally. I think the proposals that have been tabled do not sit at that end of the spectrum at all. I think some of the governance that has been included in that does not look strong enough to me to do the job.

Q87 Chairman: What I was really getting at was that they put down their first offer - and we will be discussing that with them later on this morning - and it does accept, at least in theory, the principle that they are different businesses and should be treated differently and should be separated. When we look at the analogy or the precedent of British Gas - tubes are not wires and the technologies are perhaps not as dynamic, but they are reasonably analogous in a regulatory competitive context - Chinese walls were imposed but they were found to be more bother than they were worth so it was a kind of pragmatic process. I just wonder to what extent that pragmatism that was adopted in energy might well be the route down which we go in telecoms. Would you say that that is all very well but the issue is one of greater urgency? Given the dynamisms of the technologies involved in telecommunications as against gas, it might be argued that the approach - which did not take very long for gas - might still be relevant?

Mr Pluthero: Yes, I agree with that and really that is my point about if you go far enough to create the real tension in the system then I think you do bump into that very practical issue of should the group be owning that particular subsidiary or operating entity because its goals and ambitions are so fundamentally different from the ones that you are prosecuting elsewhere in the group.

Q88 Chairman: Alternatively it is not worth a candle in the sense that it is not just a philosophical view; the practicalities of having different arrangements mean that it is more difficult to operate than to have three separate businesses.

Mr Pluthero: Yes.

Q89 Chairman: The other point I just want to raise at this stage is that it has been suggested that Ofcom is only just finding its feet as a new body, thirteen or fourteen months in place, and that perhaps the opening gambit of the break up of BT might be rather premature. How do you view Ofcom in its first fourteen months of existence?

Mr Pluthero: It is not a gambit.

Q90 Chairman: They have offered three options.

Mr Pluthero: I think we welcome Ofcom, a bright bunch of people who understand the dynamics. I thought it was the right and a brave thing to do to launch the strategic review. As part of that, as one of the licensed operators, we were asked for our opinion. I am not sure that it would have been a suitable answer to say, "Oh, it's too early". This is our view on what is a genuinely new regulatory settlement. There is a desire amongst most of the players in the market place to see if there is an alternative to what we have had in the past where BT have to pick their way through an endless myriad of detailed regulations on individual products and the construction of them, and the regulator ends up chasing BT into shadows. It can never hope to have the same degree or resources or understanding of those issues as the incumbent themselves. To try to find a way where we align some of the commercial forces and the way we run these businesses more directly behind the regulatory agenda so the thing is more self-policing. I would like to think that there is a version of equivalence or something like that that would do the job. The more I inspect those options the more I am concerned that until you deal with that fundamental commercial conflict asking BT to be both principal in the market place, a retailer, a seller, and to be providing its competitors with the right ammunition to be market share of itself, I think you are kidding yourself potentially. I think you will find more and more elaborate ways to try to manage that conflict instead of dealing with that conflict and solving that conflict.

Q91 Linda Perham: Ofcom have plans for equivalence before taking the steps to separate BT. Can you expand on why you think that would not work because in your submission you say that the "heart of the situation is lack of equality of access"?

Mr Pluthero: If there is true input equivalence across all the relevant products and services I think that would do a job. If you asked BT to police that system themselves, if you asked them to come up with the ways and means in which that happens I think you throw yourself straight back into that commercial conflict. We have seen it on consumer DSL, on the DataStream product. Broadband has been a product in the consumer market place for four years. We did not have a wholesale variant for the first couple of years and when I asked BT Wholesale why IPStream, their retail product, had good automated processes, fault fixing and all the rest of it, they said because that is where all the demand is. It is difficult for me to create a demand for DataStream when I cannot make the product work and when there is no money in it for me. We had the customers, we had the money to invest in it; we had every intention but it was an uncertain, uneconomic and unworkable product. That is the heart of the matter. Maybe there was a time when proposals were presented to the BT board that said, "You can invest £50 million on a consumer DSL product. If you do that for DataStream you get part of the margin. If you do it for IPStream you get all of the margin." IPStream will always win that conversation; that is always where the money will go and you get into some ridiculous thought experiments and vicious circle where DataStream is not workable as an alternative because no-one wants it but no-one wants it because it is not workable. BT now has 91 per cent market share with IPStream consumer DSL and growing. That is four years on from the launch of consumer DSL. I think it is hard to regard that as a success from a regulatory point of view.

Q92 Linda Perham: So really Ofcom's plans for equivalence you do not think will work. Your bottom line is that the only answer is the separation of BT.

Mr Pluthero: I think achieving true input equivalence, if it is possible, is a decent alternative. It does raise that issue, if you have true input equivalence how do you police it, monitor it, enforce it. When you put in place a scheme that is robust enough to do that I think you end up asking yourselves the question, "Why would BT own that entity?" because it is doing things that are not directly in the group's interests. We are realistic and pragmatic enough to realise that the separation of BT is not going to be an answer that is announced in June but I would like to get to the bottom of it. This is a strategic review of regulation in this industry. You cannot have a strategic review without considering all the proper options that deal with the real situation. I do not think it is good enough to have BT wave separation away with a hand saying that it is too difficult, it is too expensive and the rest of it. You cannot take their word for it. When I ask my twelve year old daughter to tidy her room, if she tells me it is impossible I do not really buy it from her. I would like to see Ofcom and BT and maybe some capable third parties - the consultants of this world, not the competitors of BT - in a group bottoming out the real issues about that so we understand that once and for all. Otherwise you do not have a strategic review; you have a tactical review of saying, "How can we slightly amend what we do today to make it a little bit better?" Whatever the settlement is this year there have to be some metrics that say, "Okay, if you believe that this solution on equivalence, access service division or some mutant of it is going to do the job", then let us set up that path over the next two or three years with the right measures in place and if you do not succeed on that basis then we know that we have to go for something more substantial that deals with that fundamental commercial conflict.

Q93 Linda Perham: I have some bad news for you. My daughters in their mid-twenties do not tidy their rooms so you have a long time to wait.

Mr Pluthero: BT is twenty-one, so perhaps it never ends.

Q94 Linda Perham: If I could ask you about local loop unbundling, Ofcom seem to be relying on injecting greater infrastructure and competition into the market, but again your evidence does not think that that is going to be much help. You talk about no real intention to inter-connection arrangements with network operators until a later phase in the market. Would you like to comment on that?

Mr Pluthero: In terms of the proposal that has been tabled, there is very little that comes under the Access Service Division, just local loop and some rural broadband. The wider question of local loop is a difficult one and most of the players in the market place have shied away from incremental investment in local loop for a number of risk factors, of which the regulatory piece is only one. The ability to create uncertainty and downstream pricing is fundamental to that. It was the issue with DataStream and IPStream because of poor reservation and so on; it is also turning out to be the issue with local loop because BT have said IPStream prices in the 560-odd exchanges are going to drop. Those are the exchanges that people want to unbundle so you get some differential pricing in the market now which directly attacks people who are making that investment. I think there are a few issues in terms of the Access Services Division if that is the angle of your question. It does not contain enough in terms of products and services, the wholesale interconnects and the rest of it. The governance I think is too weak to enforce the right behaviours so the Access board which has some extra people on it I think and those extra people are going to be paid by BT. If you look at the verbs used in the submission the job of that board is: to monitor, to publish, to review, to consider. That does not sound like a lot of teeth to me. If there is a real intent behind that governance structure then let us give it the right powers, let us create it in the right way, let us put Andy Peters from Telephonic or Mary Turner from Tiscali or Francesco or someone on there. Once you get that far you might as well go the whole hog and start separating the group because its objectives to fulfil the regulatory agenda become so in conflict with those of BT group that I think that becomes untenable.

Q95 Sir Robert Smith: When you talk about "if you could have true input equivalence that would address a lot of your concerns", BT say that a lot of the age of their infrastructure makes true input equivalence not possible. From your point of view is that a smokescreen or is there some substance in the argument that the age of the infrastructure makes it difficult?

Mr Pluthero: I do not know; none of us know. We are not inside BT; we do not know their systems. That is why I would like someone to really bottom that out as an option. It clearly can be done. 0₂ was separated from Cellnet - as I guess it was originally - and knowing some of the 0₂ people as I do, although I have never asked them the direct question, they have always talked about it in terms of this was part of BT and splitting it off was done for value creation reasons. They found a way to do that. I just do not know about whether the systems are difficult. Certainly in the proposal that has been tabled, BT give themselves plenty of time to solve those problems. They talk about three or four years; they talk about "only where appropriate" are they going to split those systems up. There is plenty of room for manoeuvre and that is the issue. If you come out and say that we are going to do all of those things people know that you have just knocked X per cent off the value of the business because you are encouraging competition and you are fuelling competition. These are good businessmen we are talking about.

Q96 Chairman: It could be argued, mind you, that in an expanding business retaining the share is in itself enough. I am not defending them, but this is going to be something that is going to continue to grow and it could be argued that they would perhaps not grow as fast as some people would want them to grow, but nevertheless they might not necessarily lose out on what they have at the present moment.

Mr Pluthero: Well, 91 per cent of the smaller market is quite useful; 91 per cent of an even bigger market is even more useful. At the margin there is always that tension in the decision making process. When I tell my suppliers - as I do from time to time - that they are not going to win that £5 million contract I normally get a chief executive on the phone to me within about an hour asking what the problem is, what can they do. We told BT that we would not be pursuing DataStream. That is a £100 million order. How long do you think it took BT Wholesale senior management to call me? It is a trick question, they never did. That is five months ago. Now, I could be personally offended but that normally takes a little more than that to do. The reason I did not get a call was because it actually does not matter to Paul Reynolds; he owns the IPStream product and DataStream would only have been a substitutional of that and actually it is quite good news for him because he does not have to build a new infrastructure around supporting DataStream; he has it all on IPStream and it is better for the BT group because they keep all the margin. It is quite difficult to compete in a market place if the supplier you depend on absolutely for tail circuits and for wholesale infrastructure and so on, notwithstanding the fact that we have eight thousand kilometres of our own network, really does not care - fundamentally does not care - whether you get the product you need or not because it is only substitutional to him; it is not in their commercial interests.

Q97 Sir Robert Smith: Is that them failing to read the future of the market properly because had they been more interest might you have been able to grow the global cake and whilst they would have got their share of the cake in a different way are they damaging it by stifling what you were trying to do or by not responding to you?

Mr Pluthero: No, I think if you are a market leader and you can control the market then you need to behave like a market leader. All the business text books will tell you that. Controlling the pace of roll-out; making sure you leverage and monetise your role in investments fully before you move to the next phase is absolutely par for the course, the right thing to be doing. No, I suspect the equation is in favour of controlling that market quite tightly.

Q98 Sir Robert Smith: How do the 21^st Century Network proposals affect this whole debate? Would it be possible to build equivalence into that Network?

Mr Pluthero: That is a damn good question. It is a little difficult to see and a lot of consultation is going on around 21CN. I actually applaud BT for being the first big incumbent to move to that. It is undoubtedly the future. The way it interfaces with all the existing thoughts about regulation is very challenging. In theory it is distance independent and for people like ourselves who have a big capillary network potentially we get very little return off that in future. It is one of the reasons why a number of players have not gone into local loop because the whole structure of what is the lowest level of infrastructure changes through time. But it challenges the existing regulatory regime and certainly now is a very appropriate moment to reconsider how that works for the future in the light of 21CN.

Mr May: In effect BT is linking 21CN in the strategic review, or at least it appears to be in its response. It talks about 21CN's plans being dependent on an acceptable regulatory settlement and this is hard to reconcile with the degree of development of their plans. They are talking about beginning in April of 2006 and plans are continuing, as John says. There is immense consultation and a huge number of people at BT working on this. It is hard to understand how that can be entirely dependent on the outcome of the strategic review. They are suggesting that all that work is for nothing if they do not get the settlement they want.

Q99 Sir Robert Smith: Is there not an argument that the existing infrastructure, properly driven with competition, would produce for consumers a lot of benefits anyway and that 21^st Century Network might be slightly premature and a slight distraction from making the current system work properly?

Mr Pluthero: You could carry on on the existing infrastructure for some time, that is true, and I think the timetable that has been announced is an aggressive one as you need to have on big, hairy, challenging projects like this, otherwise you take forever. Clearly there is a big pay off to BT in terms of operating cost; there is a bit pay off to Energis when we do our equivalent of it. We all run multi-platform, multi-system networks today. That is very expensive, complicated and the quality suffers as a result. Moving to a single multi-layer environment is much simpler, much cheaper and much more controllable and I think it is absolutely necessary going forward. From a competitive point of view it is a smart thing to do. There are only two players in our industry who have big chunks of money and if that is the case you would tend to use that money to give yourself a competitive advantage when the people you are playing against are limited in their capability to react.

Q100 Sir Robert Smith: If you were breaking up BT would you be breaking it up in the right way that the chunk that will produce the 21^st Century Network would still be there to drive that forward?

Mr Pluthero: I do not really understand the argument that says if you separate it out wholesale you have a net code, the core kind of infrastructure from local loop through the main core network, if you separate that out from the retail activities, why does that change anything? The only way it could possibly change things is if retail was getting a disproportionate return, a supernormal profit because of its conjunction with the Wholesale arm. If it is not, then Wholesale can invest as it needs to on its core network and sell that to the market in an equivalent way to everyone and drive innovation, revenue and profit that way.

Q101 Sir Robert Smith: You do not accept the sort of argument that the retail experience drives the innovation in the Wholesale side.

Mr Pluthero: There is evidence for that. It has happened in the past by BT. That is an absurd notion.

Q102 Chairman: Are you really saying that at the end of the day BT has not really broken free from the mindset of the monopolist in the sense that it is just trying to kill competition?

Mr Pluthero: I am not sure that that is the mindset of a monopolist. I would like to kill my competition as well; it is what we do for a living. It is just that I am not gifted with 91 per cent market share so it is quite difficult for me to do that. I have to try to give customers the kind of service and quality that makes them always choose me.

Q103 Chairman: Local loop unbundling is a classic example of where we could have been making money out of allowing competitors to come in without losing a great deal of market share, but making a lot of money out of rental charges and the like from LLU.

Mr Pluthero: I disagree with that. I think local loop is the gate to the Crown jewels. The local infrastructure, the twisted copper pair is the fundamental kind of attack on BT's cash cow, on its real profitability around residential telephony and around control of the product set to customers. It is unsurprising that they are reluctant to move quickly in that regard and we have seen the battle started on local loop now with the adjudicator being called on. There are a couple of ways around that. One is to walk backwards slowly and the other is to make the local loop environment, the DLE, almost redundant in a few years' time through a combination of 21CN and the various other technologies that allow you to go out to the street cabinet and so on, but also in the meantime to undermine the economics. The people are going to local loop because it represented a way of delivering consumer broadband profitably because there is not an ISP selling the IPStream product today that makes money on it. They are subsidising this market like billyo. But if you drop the price of IPStream only in those locations where local loop unbundling takes place, you make that quite challenging for those businesses. Local loop is important so restricting access to that and making it difficult to the point where it is a redundant piece of infrastructure is pretty smart.

Q104 Chairman: At the moment if you are a medium sized to small player.

Mr Pluthero: We are the third largest in the market.

Q105 Chairman: Nevertheless, given the dominance of BT, let us say that BT is broken up and a number of people have access to customers that hitherto they have not been able to reach for whatever reason, and BT's market share does diminish, what do we do about things like universal service obligation? Should it be a responsibility of all the licensees in proportion to their business? Or should it still be carried as a responsibility by the dominant market player?

Mr Pluthero: That is quite a challenging one. Fundamentally it should sit with what I call BT Wholesale if that is the group which owns the fundamental network asset because that is where access is driven from. One of my concerns about local loop from a public policy point of view is that it has struck me as quite similar to what happened to the post office. You de-regulate a bunch of high-value services like over-night parcel delivery and so on and allow people to compete in those spaces. The network equivalent is allowing people to go into the most attractive exchanges and you take away a degree of the economic return that the incumbent gets which makes funding the second post delivery ban or the local exchange in a rural location somewhat more difficult so I think that does have to be reconciled. I do not see why Wholesale, which would be regulated in a very light touch way if it were separated because all the commercial drivers are then lined up behind a regulatory agenda effectively. They would be selling to everyone equally; they would want to do innovation; they would want to encourage competition because that grows the total cake. They can set aside some part of those returns to ensure that service is provided across all of those locations. I think also that some of the technologies over the next five or ten years will change that.

Q106 Chairman: You said that they would set something aside; would that be by way of a levy or would it be business largesse?

Mr Pluthero: All the licensed operators would pay it by way almost as a kind of purchase tax through Wholesale because their prices would have to be such that they could get the right return to maintain service standards across the country. I do not think you need to step outside of that and say that we are going to charge someone half a million pounds a year for the privilege; we get enough of those charges today. I think then it will fall to who is successful. The more successful you are effectively, the more your picking up of that cost.

Chairman: The danger is that naturally businesses will go for the low hanging fruit first. From a public policy point of view we have to look at this as well. Maybe the nettle does not have to be grasped right away, but I do think it is something we have to get across. Telecoms for some people can be a means to enjoy a hobby; for others it is running a business, but it is a utility and as such has importance and almost life and death terms like you have with gas, electricity and water and I think that maybe we have not looked at it sufficiently closely because it has been under the umbrella of one organisation, but it is something that Ofcom is going to have to address perhaps not in the short term but certainly in the medium term.

Q107 Sir Robert Smith: Your analysis is that it is the Wholesale side that is crucial to the universal service yet would people who are not in the money pot areas be missing out on all of the frills that might come from the bonuses of bringing so much competition in because people would not be competing to reach those customers?

Mr Pluthero: That is right. The wholesaler would get to charge prices to all these customers buying services built off the back of this network in a way that makes sure they can invest in the areas that do not justify it from a direct commercial point of view, but actually this market is no different from most other markets in that regard. There are demographic segments which no-one is chasing because they are not worth it.

Q108 Sir Robert Smith: That is where a universal service protects those people.

Mr Pluthero: That is why you would want some way of making sure there are the funds to provide an appropriate level of service to those areas

Q109 Chairman: I think that has covered our points with you this morning, Mr Pluthero and Mr May. If we need any further information we will get back to you and if you want, on reflection to send us subsequent memoranda then we would be happy to receive it within a reasonable space of time. Thank you very much.

Mr Pluthero: Thank you for your time.

Memorandum submitted by BT

 

Examination of Witnesses

 

Witnesses: Mr Ben Verwaayen, Chief Executive Officer, Ms Anne Heal, Director of Regulatory Affairs, and Mr Peter McCarthy-Ward, Director of Equivalence, BT, examined.

Q110 Chairman: Good morning Mr Verwaayen. Perhaps you could introduce your colleagues and then we will get started.

Mr Verwaayen: I will be glad to do that, thank you very much, and thank you for having us. On my right hand is Anne Heal, Director of Regulatory Affairs; on my left hand is Peter McCarthy who is Director of Equivalence.

Q111 Chairman: Thank you. I think you have been in here since the beginning and you have probably heard and seen what we have been looking at. This is not an inquiry into everything relating to the Ofcom review but really in part it is focussing on some specific areas, one of which obviously is your activities and your proposals. Perhaps we could start off with a general question. What is your impression of the review? Ofcom came into being fourteen months ago. It started what seems in some ways this rather methodical, rigourous process. What is your feeling as an organisation about it since at the end of the day you are the big bear whom everyone walks around and looks at? What is your feeling about it?

Mr Verwaayen: I do not know about a bear, but I do know that the world is changing all around us. If you look to the US, for example, you will see a re-assembly of the pieces that a decade or so ago separated; it is all coming back by market force. Technology is changing dramatically. The ability for people to look to new ways of increasing productivity and increasing lifestyle is dramatically changing. To be honest, if you look to employment in Europe and the migration of employment going on you see a networked economy where people can be dislocated from their offices and factories and participate real time into an economic process which brings an even bigger focus on the need to get world-class telecom infrastructure into a country in order to compete. In that environment where everything is changing and looking back through twenty years of micro-management of all kinds of details, it was, I think a very good move from Ofcom to step away from that and say, "Let's describe the landscape, let's see where we are, let's see what the inputs are and what the outputs are that we need". I think what Ofcom did was a very methodical - I agree with that - and a very professional job.

Q112 Chairman: Turning it round the other way then, when a regulator conducts a review they seek the views and impressions of players of all sizes. Could it be said that this has just been an opportunity - to sustain the animal metaphor - to poke the bear through the bars of the cage? Is it just an opportunity for the people to have a moan about this dreadful organisation that you run?

Mr Verwaayen: I would not say that I run a dreadful organisation at all.

Q113 Chairman: I am merely trying to convey the impression that here is a near monopolist, driving out competition at every turn. Do you get frustrated at that? Is that a caricature?

Mr Verwaayen: I have heard many labels and labelling is part of a way for people to express themselves. Let me say it this way, I am not sure that I understand all the psychology over the last twenty years. Report One was a clear report that was tabling all the alternatives. Report Two had two main streams, I would say. The first one is to get twenty years of frustration off your chest which is a very helpful activity. The need to get it off the chest is learning for us as well. Let me be very direct about it. We may not agree with the things that are said, but dealing with perceptions I think the definition of perception is reality with a time lag. Therefore it is a clear incentive for us to be bold in our proposals if that is the assembly of feelings. I think, to be honest, in many cases, feelings are not always facts and if you dispute the facts you will have on yourself also the task of dealing with the feelings.

Q114 Chairman: One of the things that Ofcom sought to do in their review and they have indicated their desire to focus regulatory attention on what they would call the enduring bottlenecks. Would you consider the access network to be such a bottleneck?

Mr Verwaayen: Let us just look at "bottleneck to what". It starts at a definition of the market. You could argue that the market is a service market so whether you make a phone call over a fixed line or a mobile it is still a phone call and is one market. So you could argue that the market definition that also as a result will have the bottlenecks related to the market definition. We have not taken that route, although we could, because if you look to today's value in a total telecom market BT's value of the total market if 35 to 40 per cent and 60 per cent is somewhere else. We have accepted for the sake of the discussion and the arguments that we are in that we are not going to dispute the market definition as such of the review, although we could. If you take a fixed market, the fixed line market, it is undeniable that a bottleneck is a part of the network that you cannot easily duplicate or replicate. The local loop I that part of the market. You have seen in our proposals that we recognise the bottleneck philosophy and therefore have tried to come with a number of remedies that would do two things. First of all it would solve the issues that were raised; second it would maintain what we think are the benefits for society at large and for BT over the integrated company.

Q115 Chairman: On the question of unbundling - we are going to spend a bit of time on this - the last time you were before us you very rigourously defended the charges you were making at that time; you felt they were reasonable, that the business required that. Since then there has been quite a turnaround in the sense that the charges have been dropped. Could you explain how that has happened?

Mr Verwaayen: I think we agreed last time the product in the UK described as local loop unbundling was basically the stapling of everybody's demands; just put a staple on it and call that a product. At that point in time we had an interesting exchange of views why that was the case. After that we went back to the market, back to Ofcom and we have, I would say in a very professional manner, described a fit for purpose product, that in a way there was a lot of burden around the product and we have made it into a very clean product available to the market. We are in the process of implementing that product and the positive side of that product is well described as "one version". That is what it is; everybody can use it and therefore it is financially attractive for the market to use and for us it is implementable.

Q116 Chairman: So you have made some of the charges cheaper, but what about activation charges? Why have they not come down?

Mr Verwaayen: There are many charges that make the product so you can choose more or less how to combine all those different elements into a bottom line, that is the cost of the product. I have heard some of the evidence today. I wish the case was that BT was in the position to make all those decisions themselves; we are not. These are regulated prices so if you talk about DataStream, for example, it is not BT that sits in a room and decides; it is within a framework and the framework has all kinds of margin squeeze tests. You have to fill all those differences between one product and the other product and the differences between all those products have to have a margin and it is tested by the regulator. So it is not that we are totally free to do all of those things.

Q117 Chairman: So you would be more charitable and reduce them further if the regulator allowed you.

Mr Verwaayen: By the way, the DataStream product just discussed is a growing product of all users going up. You may have been under the impression when John Pluthero was talking that it is a product that is leaving the market; it is a product that is growing.

Q118 Chairman: We spoke about rental before and that has come down. There are a number of other elements that you do not have leeway over, but activation charges, are these regulated or are they within your discretion?

Mr Verwaayen: They are part of the total product cost. You cannot separate one from the other; it is a combination of factors. Some of them have to do with the system cost because, as you know, as a principle we have to be cost based. I think that is a fine principle. We are looking to alternatives for some of those products. We are looking to see whether there are better methods of usage because at the end of the day it may sound strange to you but it is in our interests and it is in the market's interests to make sure that we are responsive to the market. We are responsive because wholesale customers are customers in the first place; they are not competitors, they are customers. That is the fundamental of an organisation that deals with wholesale. Those customers have a voice and of course every customer always asks if it could be cheaper.

Q119 Chairman: Some of us argued with predecessors of yours on the issue of LLU that you - your predecessors anyway - did not see that there was a business opportunity in allowing competition and to an extent that there have been welcome changes and I think from our point of view we would derive some satisfaction having, as it were, directed light into dark corners which perhaps has meant that some of your colleagues are taking the line that you take that it would be desirable to widen the access to LLU. However, there are still questions like the activation charge which seems to be somewhat arbitrary. If it is the case that you are saying to me that on that particular charge "we are not regulated, we have cut somethings, but give us a chance, we have to make some money somewhere", say so.

Mr Verwaayen: No, that would be the wrong answer.

Q120 Chairman: It would certainly be an uncomfortable one.

Mr Verwaayen: It would be uncomfortable but it would not be truth. I hope you will allow me to explain. It is true that on local loop unbundling we are now amongst the cheapest in Europe. The reason for that is not altruism. The reason for that is that we have a much better way of getting to the market; we are a very efficient organisation related to the rest of Europe and we are able to make prices that are attractive. However, there are elements that we are not yet meeting the demands of our customers and you focussed on one of them. We are working on it but I am not going to make a promise that that will be affected tomorrow.

Q121 Chairman: To be frank I do not think we would have expected you to do that, but maybe just one last point on this. Do you think that the Ofcom consultation on the value of your copper network is likely to result in charges coming down even further?

Mr Verwaayen: I do not know. Anne is a bit closer to it; what do you think, Anne?

Ms Heal: Obviously when they are looking at the cost of copper they are looking a number of things, but what we have said in our submission was that we would be intending to reduce the fully unbundled price dependent on the cost of copper. Obviously that is the fully unbundled one; we would not reduce the shared price any further as that has already come down by 70 per cent because that is not related to the cost of copper as an input. There is an intention, a commitment that subject to the output of their study we would reduce further.

Q122 Chairman: Are you trying to anticipate that?

Ms Heal: We need to understand what comes out of Ofcom's thinking. The cost of copper is a very significant study which looks at the value of our copper access network. The copper access is a major input to this and other products and we need to understand the implications.

Q123 Linda Perham: Just going back to local loop unbundling, you say you are fully committed to making it a success, but I just wondered what the purpose is for the wholesale brand of what might be called geographical deaveraging where you reduce the price of IPStream in the most popular exchanges. Is that going to undermine confidence in those considering investment in LLU?

Mr Verwaayen: It would be quite fascinating if we would invest the amount of money we are investing in local loop unbundling and then start to undermine it immediately. I think it is not the reality. First of all we have 169 ISP customers, ISP customers that demand from us services that they can bring to their customer base. We have the most vibrant internet service business in Europe, arguably in the world. Those customers also demand from us a pricing that allows them to compete. Secondly, if you look to local loop unbundling there is still a substantial margin between the averaging pricing on IPStream and local loop unbundling. It is also true that we have said that we do not expect further price reductions in the coming twelve months under certain conditions of course, but let us say in the normal business sense, so there is certainty also for people to invest. I think that local loop unbundling fits certain business models. Some business models it does not fit and you cannot have a market that has one size fits all; you need to have a market as we have baptised a portfolio of opportunities. This is a market that has many players, many interests, not just from infrastructure players but also from service players that need to be served. At the end of the day I can assure you there is no market in Europe - and arguably not in the world - that has this number of players (successful players and sometimes unsuccessful players because some business models work, others do not).

Q124 Linda Perham: Can I just move onto Ofcom's proposals on equivalence? What do you think equivalence should mean in practice? What should it cover?

Mr Verwaayen: I have the Director of Equivalence next to me so I should probably let Peter have a go at that.

Mr McCarthy-Ward: We have been in discussion with Ofcom and with the rest of the industry as to the scope of equivalence and it has a variety of different meanings. If you read the Ofcom consultation it talks sometimes about a concept called equivalence of outcome; it talks sometimes about a concept called equivalence of input. I will deal with them separately. The scope of equivalence of input we see as being applied to a small number of enduring bottleneck services which are vital for future competition. There is a short list of these, they include wholesale line rental, they include unbundled local loops, and they include DataStream and a degree of backhaul services. These are the vital building blocks for competition as it stands today. In terms of equivalence of outcome, there are a series of other network services to which that would apply, including for example, carrier pre-selection and some other call based services. There is a very complicated list which would be boring to the Committee if I read out but we are happy to make it available to the clerk.

Q125 Linda Perham: You talk about input and outcome, but do they together equal equality of access because if you heard Energis' evidence they said that that was at the heart of this matter.

Mr McCarthy-Ward: I see it slightly differently. I see the two equivalence debates as being contributory to the equality of access because the other component of equality of access is to do with governments and organisation and motivation. The suggestion that we have made of creating an Access Services Division is the other component in delivering full equality of access.

Q126 Linda Perham: If equivalence is properly enforced, should that not mimic full structural separation?

Mr Verwaayen: I do not think so. I think we are making a clear distinction between equality of access and structural separation. Let me look to the facts. This is the most - as I said - vibrant market in Europe, arguably in the world. We have broadband coming in this summer to approximately the same amount of people that have running water. We are number one in the G8. Three years ago we were nowhere, on a par with Albania; there is nothing wrong with Albania but you do not want to be on a par with broadband. What is the relationship between the one and the two? It is like starting a mall somewhere, you need an anchor tenant; you need someone to take it and run with it. You need to have it on an end to end basis, understood system-wise and risk-wise. So BT taking that position needs to be maintained. In a situation where you would have structural separation you will drive the bottleneck into its own targets, into its own business objectives that may or may nor be linked with the network and may or may not be linked with the end user's services that are being developed. What we try to do is to give full perception of equivalence. I use the word "perception" because in fact I think we have already given it. I can argue until the cows come home, but if people feel that it is not, I have to address that issue as well. I take your report, I take the Ofcom report, I take the other reports as an encouragement to say, "You may think you are right, but others do not; others disagree. You have two choices, you are going to fight it or you are going to accept, but don't through the baby away with the bath water. Make sure that you maintain the integrity of the system that delivers the services that are needed for our market in the UK." That is what we try to do. We try to listen to what the market says and to what you say and make sure we have an answer to that. We try to do it in a way that maintains the benefits that we see and I think the market will see in an output manner but at the same time ensure that we get an end to the debate. At the end of the day it is a debate that is running in circles. I would say that we are already giving full access and its equivalent; other people would say we are not. If you try to run round faster and faster you end nowhere. So we try to break out of that circle. It goes much further - I would like to stress that - than we are obliged to do. If you read Report Two in our response the offer we have put on the table goes far beyond what we are required to do but I think it is the right thing to do because it should stop the debate where we have been and bring it to the next level.

Q127 Linda Perham: Politicians always have a problem with perception as well as opposed to reality. However, you are saying you think you are doing the right things on equality of access but the perception certainly from our previous interviewees from Energis and from others is that that does not appear to be the case. As the Chairman indicated in his original remarks, you are seen as the big beast out there who is being unfair to all the rest of them and of course you do not want to have this separation because you have vertical integration, you are doing very well and why should you even pay lip service to any kind of competition from lesser players as you see them. How do you get over the perception argument where people clearly feel that you are just keeping it all for yourself basically?

Mr Verwaayen: First of all I think you are right that this is a real issue because perception is hard to fight. Everybody in telco has a retail and a wholesale if you are of any size and meaning. If you compare what happens in the UK with what happens in other countries in Europe, my colleagues in the other countries in Europe are looking to this debate that we have here and they do not understand why we are having it because if you look from a regulatory point of view the UK is more or less the ideal that other markets are striving to reach in the knowledge that they will never get there. That does not exclude us from having this intense debate and I take the responsibility for perception very, very seriously. What we try to do is to look to two things. First of all compliance: do what you promised to do. I can tell you the last couple of years on compliance we have an impeccable record. If you want to know a bit more about the record maybe we can show you some of what we produce. I do not blame anyone for not going through it but I thought it would be a good idea to give you a view of what we are producing. This is all public; we can all read it. We have published a detail record of everything that is going on. At the end of the day it does not do the job because we are having this debate. More of this will not help so we have to do something radically different. On compliance we are impeccable. If it is not compliance, how about the ability for people to communicate with us. We have a manager responsible for local unbundling, paid on their behaviour. We have a manager on the Wholesale line rental, only paid on their behaviour. So we have tried to get the message the market that we take you seriously; we take your input seriously; we understand that we have not been successful in taking the perception where it should be and the only way to do that is to take it step by step by step; there is no magic formula.

Q128 Chairman: I think it is fair to say that across Europe regulation is somewhat patchy and we were one of the first in on the game because of the privatisation policies. You made the point about the US where they had geographical itemisation in much the same way as we had with electricity companies and in fifteen years the situation has changed. However, what has been addressed at least in part in the UK and in other parts of regulation is the issue of vertical integration. I just make the point at this stage. There are still misgivings that some people have. Nobody is saying that you do not comply, because if you did not comply you would be up in court and paying massive fines. So you are damned if you do and you are damned if you do not. I accept that. There is still, however, amongst some people unease about vertical integration and also about the market. As you have hinted, you can integrate vertically and still be fairly small, but when you have vertical integration and market dominance it does create challenges for regulators.

Mr Verwaayen: I accept that but at the same time I look to the reality. This is a scale market. If you want to invest in the UK not just in 560 exchanges but if you have business in Southampton or business in the north of Scotland and want to compete on a world scale, you need to get access to world-class full broadband network. That will require an investment of over £10 billion. You cannot help that; that is what it is. So you need scale to go and do that and at the same time you need to go to the financial market and say, "Not only do we have a great plan for the UK, we also have a great plan for you because you are shareholders, you bring the money, you bring the risk, we have a return for you." What happens in the US today is an acknowledgement of the change in technology and the change of scale. At the end of the day they now have five players left in a country of that size. They will eventually maybe have three left, full integrated on all spectrums, from mobility to triple play, all of that. Why is that? Why do they regard that in the US fully acceptable in a country that is the champion of competition? Well, because there is competition between platforms; mobile platforms compete with fixed platforms; cable platforms compete with mobile platforms and satellite platforms compete. The old way just to measure how many people have access to your copper going from the cabinet to your home is only one way to measure the choice that people have.

Q129 Sir Robert Smith: Would that box be a lot smaller though if you did have properly enforced equivalence that mimics structural separation?

Mr Verwaayen: This box is twenty years of detailed work. Sometimes I have compared it with the Russia dolls, you know, you open up and you get the next one, the next one and the next one. Everybody thinks that asking the next thousand questions will help them because regulation is also part of the competition. If you compete with one another, regulatory rules could help you in the competition. I do not think, to be honest, that all those answers are anything else than our incapability to deal with the bigger issues. That is why we try to get rid of this and put something else in place, equivalence being the biggest of them.

Q130 Sir Robert Smith: If Ofcom were minded to go down equivalence that mimicked full structural separation, is that something you would resist?

Mr Verwaayen: Full structural separation, I cannot imagine that they would do it. Your last report said that it is not desirable. I think that nobody in the world that I have talked to on a policy level anywhere has looked at that as a solution. If they would do it anyway, think it would be a disaster. It would be a disaster not to do the structural separation itself because it would be painful, very costly, very slow, very cumbersome, but the end result for the UK will be very bad because you would structurally separate an end to end service into different entities that may or may not be aligned and all the time they will go from here in a divergence.. So what you will get is the incapability to take and end to end decision to bring innovation where it needs to be.

Q131 Sir Robert Smith: Do you accept thought that behavioural changes are necessary internally within BT?

Mr Verwaayen: I accept that the perception is a leading principle that we have to take that into account. We are the first company in the world that has a director of equivalence and Peter has no peers anywhere in the world. We accept that what we have to do is not only deal with the facts but deal with the perception as well.

Q132 Sir Robert Smith: So the Access Service Division is designed to deal with perception.

Mr Verwaayen: It deals with two ends. It deals with the realities of a bottleneck and tries to ring fence it in a way that you get people focussed on different criteria of success. As Peter was saying, what you try to do in the Access Service Division is to say that we have KPIs, we publish our KPIs, I think if I will on the board as an independent I will take it extremely seriously - it will be my reputation at stake so that will be a major drive - I will chair that board so I do not understand when people say that it is not serious. It is reputation that is at stake. At the same time what I would do is make sure that the reward system, the payment system, the bonus system is all focussed on the equivalence factor and on the performance factor. Equivalence is one thing but you can be equivalent and be very poor. If we are all very bad we are still equivalent but it is not good enough. At the end of the day it is the demanding consumers, demanding customers that will drive the behaviour.

Q133 Sir Robert Smith: Can you see ways of making it more independent to reassure the witnesses we have heard? Can you think of a way of reassuring them?

Mr Verwaayen: I think what we have done, if you look through history, is pretty stunning. Just take five years back, three years back when I arrived and see what our proposals are today, I think we have dealt with the issues. You and others have been very eloquent in pointing out to me what the perception of the market and the perception of the public is. I think we have given a very robust response and I think we would be much better off to go and implement and make sure that we do it flawlessly without giving people the wrong impression. This is a monumental task; this is a truly monumental task. If people say that the systems are in place, yes, they are built over twenty-five, thirty years. They are built piecemeal because technology comes in piecemeal. If you have to untangle those and bring them into a state of the art where we are, it is a monumental task which involves a lot of effort from a lot of people. What I would like to do is to go on with it and demonstrate that we can do it.

Q134 Sir Robert Smith: In one of the earlier answers about the geographical deaveraging and the effect on investors you talked about a twelve month stability period, but in a sense there are a lot of people going into local loop unbundling and it takes more than twelve months to get a return on their investment.

Mr Verwaayen: Yes, but as in every market you take decisions not just on the regulation, not just on BT. If I have to make good for everybody's business assumption I have to say to you that I am incapable of doing that. Going into business is taking risk. I do not know whether the local loop unbundling plans from people who have them will address the needs of their customers. I do not know because local loop unbundling is not a magic word; it is a way to get service to people who may buy or may not buy.

Q135 Sir Robert Smith: Is it a way of getting more variety into the market?

Mr Verwaayen: Yes.

Q136 Sir Robert Smith: If the 169 ISPs are all buying at the very end from you in a sense, there is a very narrow market.

Mr Verwaayen: They will not because some of them are integrated companies as well. They will do ISP and LLU. You have heard of Wanadoo and with the knowledge of their French parent they are very well aware of how regulated markets may or may not work and they see a fantastic opportunity in the UK. They are integrated on a different level and that is fine. I think that what you see is a market that will have different models, some will be successful others will not, but you cannot come to BT and say, "Here is Jo and he was not successful and it's your mistake". That is not the way to look at it.

Q137 Sir Robert Smith: That is the problem that you are going to have to address, achieving the confidence.

Mr Verwaayen: I give that to you; that is true. I have not heard anybody ever not say, "I made a mistake but it's also BT". With some we have to live with; with others we have to scratch our head and ask what we can do about it. That is true.

Q138 Chairman: You admit the point that you have a very big task ahead of you. Why is it such a big task? Is it down to the internal workings of a former monopoly? Or is it down to inadequate regulation in the past and they should have been nudging you towards this or helping you clear up some of the rubble that has accumulated?

Mr Verwaayen: To be honest I think it is all of the above and more. It is systems. You cannot change systems overnight and everything is related to everything. It is regular. These big books of details that I would not dare to say that I fully understand; it is sometimes attitude; it is sometimes what we call culture. I think we have changed dramatically as a company. We understand customer needs; we put customers first. We have a hundred million customer context per month in any way shape or form. The slightest percentage of things going wrong means that everybody has an example where we have gone wrong. I will take it as a personal issue that we go after each and every one of them. Having said all that, the combination of that makes it into a big task, we will not deny that.

Q139 Chairman: Should we view what you are doing as concessions or as improvement in management ambition?

Mr Verwaayen: They are not concessions because a concession.

Q140 Chairman: Let us put it this way then, you have offered this up because if you do not offer up something there is a possibility that a solution will be imposed which you might find more uncomfortable.

Mr Verwaayen: That is the perception of the carrot and the stick.

Q141 Chairman: It is also the perception of getting in quickly before the others have made up their mind and perhaps influencing the debate.

Mr Verwaayen: You asked me to tell you how I feel. I have heard many speculations of what is going on in mind which is always fascinating to see and read. Let met tell you what is going on in my mind. I think this is a unique opportunity to re-set the clock; that is how I see it, to start afresh. As long as we try to make better what is already there we will fail because that is preset mindsets all over, from our side, from their side, from everybody's side. I think this is a unique opportunity to clean the field and I have to say that that was the brilliant stroke from Ofcom to give that opportunity. Steven Carter has, of course, his past, the regulatory past; I have to deal with our past; the competition has to deal with their past. At the end it is just the consumer who is looking and asking what is in it for them. The customers demand more so resetting the field has the purpose of creating something very dynamic in the UK that will bring our infrastructure - which is like oil, an input for competition or productivity and in input for lifestyle - into a new fresh start. That is my motivation.

Q142 Linda Perham: You said in the Phase II response that hindrance to full input equivalence is the age of the infrastructure. Do you think the 21^st Century Network can remove that problem?

Mr Verwaayen: I think it can and I cannot describe how important this is for all of us. We still have 1930s equipment somewhere in the network. It was once described as a plate of spaghetti and if you pull here you will never know what is happening there. If you want to introduce a new service you have to go through 512 different systems and they are all related. From a speed perspective it is no surprise that major telcos in the world take eighteen months to introduce a new service because that is how long it will take. I think we need a much better, much thinner layer where it is much more transparent and transparency is the friend of equivalence. Today we have a situation that we have to go and say, well we would like to do it but we cannot. You will not believe that, but it is the truth; we cannot because somewhere there is someone in the network who says, get away, that particular piece of equipment cannot be taught a new trick. So it is a very poor situation to be in.

Mr McCarthy-Ward: I think the heart of the problem for us lies with the fact that the systems that deliver are core outputs and were built in the 1980s, state of the art at the time, with 13 million lines of bespoke cobalt code at the centre of our systems. It was designed to deliver the outputs of a vertically integrated operator. The arrival of the requirement of find wholesale services came after that system had been designed. So we have a series of bolt-ons to this heartland which contorted to produce outputs for which it was never originally intended. And as those wholesale services multiplied so this edifice creeks even more. There is a fantastic opportunity in replacing that, but it is a difficult and complex task. The systems deal with 23 million, 160 call records a day. A trivial mistake which gives you a small percentage error is catastrophic in terms of its input on the quality of service that we deliver to everybody. So it is a change that we need to make but we need to make it with planning, care and skilful execution. Telecom Italia have just finished this process. They have not put equivalence into it but they have built a change out of their system and it took them four years. We think we can do it faster than that, but it is a massive task and it is a limitation on our flexibility for our own retail customers and for our wholesale customers.

Q143 Linda Perham: Are you saying you cannot build in equivalence from the start because of the history of the 1930's equipment et cetera?

Mr Verwaayen: If you define equivalence using the same computer equipment, if you define equivalence as getting the same level of service we can, but now if you say no, it is only true if I use the same equipment on your side - which sometimes is not fair because a small ISP having to buy the same computers as we have is ridiculous - if that is your definition then we cannot do it today. We are going to built something new and if you want to have that as equivalence we can give it to you.

Q144 Linda Perham: You are saying it would be equality of outcome, back to what you were saying before.

Mr McCarthy-Ward: Yes. Equality of outcome is something we can deliver quickly and we are delivering now, for example on carrier pre-selection. As for equivalence of input it will take us a little time to deliver but we are committed to delivering it as we change the systems we use and can provide common interfaces for ourselves and for our competitors.

Q145 Chairman: You have mentioned this variable age of the kit that you have across the country. Where would you find the 1930's equipment and how significant is that in your network at the present moment?

Mr Verwaayen: If you look to how our network is built, we have all started from a voice network and a voice network is upgraded over time. For example, in the local loop there are still passive components that have been there for ages and ages and ages. Over time we went from rotary systems to analogue systems to digital systems and we have made generations of changes but not in every corner of the country so sometimes you still find 1960, 1970 in the switching because that is the level of the economy that has also been used to make sure that you have an end to end business that makes sense. The big change is now from digital - which is still switching - to IP which is non-switching.

Q146 Chairman: Is the old kit more likely to be in remote areas?

Mr Verwaayen: No, you cannot say that; it is all over. Sometimes you have upgraded by leaving the old in but putting a computer next to it which will take certain tasks. That is how it is done sometimes.

Q147 Chairman: You start this 21^st Century Network, you move through it very quickly but such is the speed of the dynamic of technical change that even in a relatively short period what you are putting in at the end is different from what you started putting in.

Mr Verwaayen: I think that what we are going to do in 21CN is basically collapsing all those different networks in one and the beauty of that is that the core network will be service agnostic, it will not know whether it is voice data or video, it will just be bits and bytes. The intelligence will be at the edge of the network. So if you have to change that - and we will over time when new technology comes in - it is much easier to do because you can go to the edge and leave the centre in place. The centre basically is fibre that sends at the speed of light the bits and bytes. The intelligence to translate it to a voice search or a video search or a data search will be done at the edge.

Q148 Chairman: Where is the funding for this change coming from?

Mr Verwaayen: From our purses. This is a business decision that BT takes. We are a profitable business. I think we invest heavily. Our capex is arguably one of the strongest in the business and we do that because we think to be first out of the blocks has big advantages for our customers and therefore for us but we pay it, as we pay all our capex, out of our proceeds.

Q149 Chairman: Would these be proceeds that come from this particular area of activity or would they be coming from across?

Mr Verwaayen: It is BT; we do not label our money.

Q150 Chairman: Do you not have profit centres for different parts of your operation?

Mr Verwaayen: We do and what we have are business cases and the business cases have to be proven to be profitable business cases. Of course what we do is that we look to the business case and see whether it can stand on its own feet and that is what you would expect from us, that is what we do.

Q151 Sir Robert Smith: Why does the 21^st Century Network require you to be in the retail business?

Mr Verwaayen: Because if I am going to produce on a wholesale level services I need to know whether those services that are risk taking entities that are guaranteeing me to bring those services. Let me take the example of broadband. When we decided to go radical on broadband we lowered our wholesale prices substantially. You will remember that, three years ago, from being one of the highest in Europe to being one of the lowest in Europe in one big bang. I could do that because I could see that we would make broadband the number one that we needed to get to. I could not do it through another organisation. Another organisation could say that it is not on my priority list so I am not going to do it or yes, I will do it later or prove to me first that it is viable, I am not going to have trained people to go and sell it. There are a whole range of issues that if you do not control end to end you would never take the risk and go on to invest that. From that perspective I think the anchor tenant's role for retail is always underestimated but it is a crucial one.

Q152 Sir Robert Smith: You described this 21^st Century as being at the heart and then on the edges would be the changes and the innovations. What are the chances of the rural areas and the more peripheral areas of the UK being at the forefront or being engaged then in the next generation of services?

Mr Verwaayen: I am very passionate about this issue. We have a coverage of broadband in the UK second to none in the world because I am fully of the opinion that economy cannot drive businesses just to certain areas and leave others alone. I think it is absolutely crucial that you get the coverage. From an economic model it is much more convenient just to look to dense areas. I think that would be a big mistake. The same goes for 21CN. I think that 21CN as a network is useless unless it produces services that are available to as many customers as possible and we do need to get ourselves into the situation that we cover end to end.

Q153 Chairman: The opening up of equivalence, the opening up of the market, people will come in and take advantage of this, your share may reduce. It might almost be obvious that that would happen. How would you see issues such as universal service obligations being shared amongst the players? At the moment you, with the broad shoulders you have, are able to carry that. Do you think you could come to a situation where others might have to share it with you?

Mr Verwaayen: This is a different issue. Maybe Anne can say a few words about what we have submitted on that.

Ms Heal: I think what we have put forward is a suggestion that in time - and we would suggest sooner rather than later - perhaps Ofcom should look at how it tackles the universal service obligation. It should consider alternative ways of funding it, possibly even alternative ways of people tendering for it. We think that because we think the market has changed tremendously since it was first created. If you think back to 1984 where mobile phones did not exist, where the internet did not exist, where there was really only one supplier - BT - you see a very different picture now. You see a vibrant market with a great many people playing all the way across the UK and you say that perhaps we should be looking at this differently because perhaps consumers are wanting different things and perhaps there are more effective ways to provide them, perhaps with some sort of levy or some sort of sharing of a fund. However, we do not put solutions forward; we think it is something that Ofcom would want to consider.

Q154 Chairman: We have been round the track on vertical integration and the separation of the business into entities, I am not meaning this in a derogatory sense but you have pre-empted what might be the outcome of the Ofcom inquiry by setting up your model of three separate businesses and you have indicated that you feel that you have gone as far as you can realistically go in having them separate but equal and still integrated. The experience when, for instance British Gas did this some time ago when it had a pipe system and a retail division and a wholesale division and I know it is not quite analogous but it is to an extent analogous. They got to the point where the separate parts of the business were required to become more separate and Chinese walls, for want of a better expression, were introduced. Then they came to the conclusion that perhaps it was not worth it to carry on as an entity so businesses were spun off. I know there is talk of some of them perhaps coming together again but that is a different issue at the moment. How do you consider that by making this pre-emptive strike - if I can put it that way - you might be in fact creating something that you will not be able to control and you will end up having to split it into three parts? This Committee on its last look at this felt that as an international player, as a driver of innovation and investment that it would be inappropriate for you to be broken up because of the requirement to get 21CN and things like that in place. We are not coming at it in some kind of Austrian school of economics but do you see there is a danger that you might create three Frankensteins?

Mr Verwaayen: I am an optimist Mr Chairman, as I understand you are as well, so I think that making walls and daring proposals do not encourage people to go into a step that would destroy the benefits of their proposal. Is there a danger? Life is always full of risks; that makes it an interesting adventure. I think we have very strong arguments, I think we have demonstrated not only intent but capability to execute. I think that the climate is changing and people do accept that even large organisations like ours can learn a few things and accept the power of perception and the necessity to deal with that in an appropriate manner. As an optimist I would say that I think in a balanced way we have put something forward that will be appealing enough to carry the day. Time will tell.

Chairman: We will find out in due course. Thank you very much. We appreciate your time this morning.