Written evidence submitted by Telefónica
UK Limited |
proposed Combinatorial Clock Auction (CCA), with safeguard caps,
will address the competition concerns identified by Ofcom both
to this Committee and in the consultation.
proposed spectrum floors cannot be justified, based on the proposition
put before this Committee and contained within the consultation.
They will distort the prices paid in the auction could give rise
to £1 billion of unlawful state aid to "hugely resourced
policymakers include a coverage obligation, then they should also
ensure that suitable backhaul products are available nationally,
otherwise the objective of the obligation will not be achievable.
1. Telefónica UK Limited welcomes this
opportunity to respond to the CMS Committee's call for evidence
to its spectrum inquiry. Telefónica trades under the "O2"
brand in the UK mobile market, serving 22.3 million customers.
Our network also provides services to other "virtual"
network operators, such as Tesco Mobile, which has a further 2.6
million customers. Telefónica has the smallest volume of
spectrum available on a "per customer" basis. Equitable
access to further spectrum for 4G is therefore of particular importance
Whether the proposed method of spectrum allocation
promotes, or hinders, competition in the provision of mobile broadband
Ofcom's position before the Committee
2. An open auction should determine the most
efficient assignment of scarce resources by allocating those resources
to the bidders that value them the most. Ofcom's view is that
a completely open auction might lead to negative competitive outcomes.
As Mr Richards put it:
"We should design the auction to support
four [operators] and we should let competition unfold from there.....
If you didn't do that, in a sense, you might as well just have
a spectrum free-for-all, but the consequence of a spectrum free-for-all,
it is almost a racing certainty that you would move to three quite
quickly and possibly to two in due course. I think consumers,
both ordinary individuals and businesses, would pay for that in
the long term." (3 May 2011)
3. The underlying assumption behind Mr Richards'
comment is that it is only the number of licensees that determines
the intensity of competition in the market. If this were the case,
the European Commission would not have approved the T-Mobile UK/Orange
UK merger, as a priori, a reduction in the number of competitors
would have reduced competitive intensity. The equation that determines
competitive intensity is much more complex than Ofcom suggests.
4. In Ofcom's view, the auction design itself
should not be a trigger for a market consolidation to take place.
Whilst Ofcom would like there to be "four players",
under the proposed rules if it transpires that only three players
have viable investment cases and were willing to pay the reserve
prices, only three players would emerge. If bidders do not have
viable investment cases, it is not a legitimate concern for Ofcom.
It is not Ofcom's place to prop-up businesses with unsustainable
5. Ofcom consulted on two competition remedies
for the Combined Award. They are proposed in order to remove the
competition concern articulated by Mr Richards:
caps, which limit the total holdings of specific classes of spectrum
(to which Telefónica does not object); and
floors, which effectively ensure that there will be two "guaranteed
winners" of minimum quantities of spectrum in the auction.
On Ofcom's reasoning this gives rise to "four players"
being on the 4G market (however defined) when Telefónica
and Vodafone are included.
No strategic behaviour possible
6. Ofcom's argument for the spectrum floors rests
entirely on the contention at Annex 6 §5.8 of the consultation:
"Those national wholesalers who currently
have spectrum holdings that may enable them in the future to provide
higher quality data services may have an incentive to pay more
in the auction, in order to keep other national wholesalers from
being able to match the services they can offer. Because
of this, we consider there is a material risk that
only three national wholesalers (or possibly even only two) may
emerge from the combined award with spectrum portfolios that allow
them an unmatchable competitive advantage in the provision of
higher quality data services that are likely to be valued by consumers."
7. Ofcom's technical analysis seeks to show that
Telefónica and Vodafone have (uniquely) "spectrum
holdings that may enable them in the future to provide higher
quality data services", ie it is the bidding behaviour
of Telefónica (and Vodafone) which is of concern to Ofcom.
8. This appears an odd justification, as Ofcom
has specifically chosen a type of auction that minimises the ability
of bidders to act in such a strategic manner (it relies on this,
in terms). Furthermore, the "safeguard caps" limit Telefónica
to no more than 2x10MHz 800MHz in the auction. Telefónica's
bidding is therefore not pivotal to the auction outcome. It could
not undertake a foreclosure strategy even if it wanted to (which
it does not).
9. There is no "free-for-all",
which was Mr Richards' primary concern. Ofcom's CCA design and
safeguard caps remove the ability for strategic bidding by Telefónica
10. The CCA and safeguard caps are an efficient
mechanism to allocate scarce resources to those that place value
on them. There is no justification to go beyond these remedies
and introduce spectrum floors.
Technical justification for discriminating against
Telefónica is also flawed
11. Mobile communications technology and the
whole issue of spectrum is particularly complex, as Ofcom's Chair
identified to the Committee.
With regard to the issue of 2G liberalisation, reaching an evidence
based decision took six years and 2,000 pages of analysis by Ofcom.
Ofcom's position quite rightly and properly moved significantly,
as the factual matrix became clearer to it. This experience demonstrates
the risk of regulatory failure inherent in such a complex subject.
Intervention must be kept to a minimum and be soundly based in
12. Ofcom's technical analysis attempts to demonstrate
that the 900MHz holdings of Telefónica and Vodafone (2x17.4MHz
each) create the incentive effect set out at Annex 6 §5.8
of the consultation.
13. It is easy to demonstrate that it is not
the volume of spectrum an operator has that counts, but what can
be done with that spectrum. Ofcom's presumption rests on large
volumes (2x15MHz or more) of 900MHz spectrum providing Telefónica
or Vodafone each with a competitive advantage in a hypothetical
future 4G market. However, whilst we have 2x17.4MHz of 900MHz,
the standards for LTE900 are such that only a 2x10MHz carrier
is (and will be) supported in the standards, network equipment
14. There is a simple reason for this; only three
out of around one hundred operators in Europe have more than 2x10MHz
of 900MHz. Manufacturers will not make devices or equipment for
such a small market of operators, there being no scale economies.
This crucial fact undermines the whole basis for discriminating
against Telefónica and Vodafone through the spectrum floors
15. It is unclear to us why Ofcom has not alighted
on this fact in preparing its competition assessment.
Negative consequences for competition and consumers
arising from spectrum floors
16. If, by virtue of the auction rules, operators
cannot gain access to spectrum assets they are willing to purchase,
their network costs will be driven up. Less spectrum equates to
more base stations, which leads to higher costs which will be
passed through to consumers; whereas if others are allocated resources
that they are not otherwise willing to pay for, they will accrue
windfall gains. These gains will either accrue to shareholders
or be ploughed back into the retail market thus distorting competition.
Whether the upcoming auction can provide value
for money for tax payers and how that should be balanced with
benefits for consumers.
17. The "spectrum floors" proposed
by Ofcom mean that at least two bidders will each be guaranteed
a "minimum quantity" of spectrum. This may have three
(a) Those bidders might only bid for the minimum
quantity and acquire it at the reserve price, whilst other bidders
will pay the price determined by the level of competition in the
auction (this effect is recognised in the consultation); or
(b) If acquiring more than the minimum quantity
becomes too expensive as the auction prices rise, "guaranteed
winners" have the option to reduce their demand such that
they acquire the minimum quantity at the reserve price, a strategy
not open to other bidders; and
(c) The bidding activity of those bidders guaranteed
to pick up spectrum (potentially only at the reserve) will still
have inflated the prices paid by those bidders not guaranteed
to pick up spectrum.
18. It is our strong view that this would amount
to a state aid. Ofcom would be selling assets to one set of bidders
at preferential rates, whereas other bidderscompeting on
the same market and in the same geographical areaswould
be sold the same inputs at the full price determined by the auction.
19. Whilst the courts have stated that it is
acceptable for the same type of spectrum to be sold at different
the courts have been clear that it is not open to Member States
to award spectrum to one group of licensees based on one pricing
mechanism (or set of rules) and to award the same asset to another
group based on a different pricing mechanism.
20. In its consultation document Ofcom helpfully
estimates the potential market value of the spectrum to be awarded.
By deducting the reserve prices from these estimates, we can project
the magnitude of the state aid. On this basis, the level of state
aid granted would be around £1billion of tax payers' assets.
21. We believe that such state aid is unlikely
to be compatible with the EU Treaty. If such state aid were to
be contemplated, then it would have to be notified to the European
Commission, which recently published guidelines regarding state
aid in the delivery of broadband infrastructure (the relevant
product market). Those guidelines clearly state:
"The Commission has taken an overwhelmingly
favourable view towards State measures for broadband deployment
for rural and underserved areas, whilst being more critical
for aid measures in areas where a broadband infrastructure already
exists and competition takes place."
22. If Ofcom constructs the auction so that state
aid arises, it is unlikely to be compatible with the internal
market. Consequently the auction would be declared null and void,
causing significant delay. We would also expect there to be substantial
litigation, as both winners and losers in the auction will have
already disclosed their preferences and valuations, potentially
distorting any future award.
The potential for next generation mobile internet
services offered by the forthcoming availability of spectrum.
23. The move from 3G to 4G is analogous to the
migration from copper based ADSL to fibre based broadband in the
fixed internet. The capacity, quality and speed of the bearer
technology is vastly improved. The 2x100MHz spectrum to be sold
in the Combined Award represents a c.50% increase in the supply
of resources. In the long run, when all mobile spectrum migrates
to 4G we would expect the total available mobile broadband capacity
in the UK to increase by between 20-40 times from what we see
Whether the upcoming auction can deliver improved
mobile broadband coverage in rural areas, as well as cities.
24. We believe that ensuring the broadest possible
ownership of 800MHz spectrum will secure competition in rural
coverage provision. This is why we have proposed a 2x10MHz 800MHz
cap, as happened in the Swedish auction.
25. Whist coverage obligations are superficially
attractive, they can have the effect of deterring entry by new
players and therefore potentially reduce the level of competition
in the auction. The higher the obligation (in terms of %pop. coverage
and/or shorter timescale), the larger the entry deterrent effect.
There is a clear trade-off to be made between encouraging more
competition and securing more coverage than the market might otherwise
deliver (an externality).
26. In addition, any coverage obligation will
distort network investment incentives in pursuit of an arbitrary
objective. We note the research from eBay regarding the untapped
potential for m-commerce in both rural areas (due to coverage)
and some urban areas (due to reliability and capacity issues).
This research demonstrates the diffuse nature of the network investment
27. eBay's commercial interest in better 4G coverage
shows that there are other well funded actors in the value chain
that have the incentive to contribute towards network investments.
Business models will emerge that tap into these incentives. If
coverage is a key driver of value for eBay and others then they
should use their commercial relationships with the networks to
drive investment in (their) desired level of quality and coverage.
We do not believe that eBay and other content providers should
leave the burden of funding the coverage externality to the taxpayer
(through lower auction receipts).
28. If, notwithstanding the above, coverage obligations
are included in licences then, to be effective in delivering rural
mobile broadband coverage, they must go hand-in-hand with the
availability of cost effective backhaul
solutions from BT, plus the ability to use BT's "ducts and
poles". There is little value in forcing mobile operators
to build masts when those masts cannot be connected back to the
core network with a fit for purpose backhaul solution.
Whether the licence fees for mobile operators
have previously been set at appropriate levels, and how this should
29. Ofcom is required to have a sound factual
and empirical basis for determining future spectrum fees. Ofcom's
view is that the auction may provide an indicator of "full
market value" that would allow proportionate spectrum fees
to be calculated.
How the position of the UK compares with other
countries, with regards to the allocation and utilisation of mobile
broadband spectrum; what is the possible impact on alternative
uses for spectrum?
30. All countries in the EU have broadly the
same volume of available spectrum for mobile services, but very
different numbers of potential mobile customers (ie population).
Countries with large populations, therefore, tend to have mobile
networks that are more capacity constrained than smaller Member
States. This means that mobile spectrum is a particularly scarce
and valuable resource for the UK's mobile sector.
31. If there were less spectrum available more
base stations (masts) would have to be built to make up for the
shortfall in capacity. There is therefore a substantial environmental
benefit for citizens in securing as much spectrum as possible
for mobile uses.
32. We recognise that Ofcom is keen to avoid
strategic behaviour in its auction. This is achieved by a CCA
plus the safeguard caps proposed in the consultation. The case
for spectrum floors, as put forward by Ofcom, isn't supported
by the evidence and goes beyond what is necessary, based on the
justification put forward.
33. We believe that an auction without spectrum
floors will secure four players, if there are four players with
viable 4G investment cases. An open and transparent auction is
the best way to allocate scarce resourcestaxpayers' assets.
The regulator is not best placed to predetermine which operator
should get what, which is the effect of Ofcom's spectrum floors
proposal. Ofcom simply cannot second guess the efficient market
outcome, it lacks sufficient technical expertise and the private
information known only to bidders. The proposed provision of £1
billion of state aid for, most likely, Hutchison and Everything
Everywhere is unlawful and, in any event, wholly inappropriate
given the current economic climate.
34. If Ofcom wishes to revisit its spectrum floors
proposal, then it will need to consult on a new factual basis.
Whatever remedy it proposes must not distort the prices paid in
35. Ensuring the broadest possible access to
will, in our view, create a sufficiently competitive environment
for rural 4G coverage over time. If policymakers wish to accelerate
the delivery of that coverage, through licence obligations, then
the auction must allow bidders to clearly express the cost of
the obligation in their bids, the current design does not do that.
Any coverage obligation must be accompanied by certainty of supply
for the backhaul necessary to deliver a 4G experience to rural
customers. Without that piece of the jigsaw, rural customers will
remain in the data slow lane.
4 Uncorrected oral evidence to the Committee (3 May
The spectrum floors are specifically designed to ensure that Telefónica
and Vodafone are not guaranteed to win any 4G spectrum on the
erroneous presumption that their existing spectrum holdings will
"It is simultaneously somewhat complex but exceedingly
important" (3 May 2011) Back
Telefónica UK, Vodafone UK and Mobilkom Austria Back
For example, in France the original 3G spectrum award process
led to an unsold licence, which was later sold at a lower price
than the licences in the original award process. Back
See in particular the CFI in Cases T-474/04 Bouygues SA v Commission
 II-02097 and C-431/07P Bouygues SA v Commission 
ECR I-02665 at §110 of the CFI's judgment "if the
national authorities decide as a general principle that licences
will be awarded free of charge, or awarded by means of public
auctions or awarded at a standard price, there is no aid element,
provided these terms are applied to all the operators concerned
without distinction." [our emphasis] Back
§9 of http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2009:235:0007:0025:EN:PDF
Backhaul refers to the connection between the base station and
the main network of the operator. In order to move from 2G/3G
to 4G, such connections will need to be upgraded to fibre based
solutions in order to deliver the higher speeds and throughput. Back
A 2x10MHz 800MHz cap in the auction, meaning that at least three
players will have either LTE800 or LTE1800 to deploy nationally. Back