Spectrum - Culture, Media and Sport Committee Contents


Written evidence submitted by Telefónica UK Limited

SUMMARY

—  Ofcom's proposed Combinatorial Clock Auction (CCA), with safeguard caps, will address the competition concerns identified by Ofcom both to this Committee and in the consultation.

—  The 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 global corporations".[4]

—  If 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.

SUBMISSION

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 to us.

Whether the proposed method of spectrum allocation promotes, or hinders, competition in the provision of mobile broadband services.

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 business models.

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:

—  (a)  Safeguard caps, which limit the total holdings of specific classes of spectrum (to which Telefónica does not object); and

—  (b)  Spectrum floors, which effectively ensure that there will be two "guaranteed winners" of minimum quantities of spectrum in the auction.[5] 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." [our emphasis]

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 or Vodafone.

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.[6] 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 fact.

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 and devices.

14.  There is a simple reason for this; only three[7] 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 proposal.

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 effects:

(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 bidders—competing on the same market and in the same geographical areas—would 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 prices,[8] 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.[9]

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."[10] [our emphasis]

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 today.

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).[11] This research demonstrates the diffuse nature of the network investment challenge.

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[12] 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 be assessed.

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.

CONCLUSIONS

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 resources—taxpayers' 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 the auction.

35.  Ensuring the broadest possible access to 800MHz spectrum[13] 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.

June 2011


4   Uncorrected oral evidence to the Committee (3 May 2011) Back

5   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 suffice. Back

6   "It is simultaneously somewhat complex but exceedingly important" (3 May 2011) Back

7   Telefónica UK, Vodafone UK and Mobilkom Austria Back

8   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

9   See in particular the CFI in Cases T-474/04 Bouygues SA v Commission [2007] II-02097 and C-431/07P Bouygues SA v Commission [2009] 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

10   §9 of http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2009:235:0007:0025:EN:PDF  Back

11   http://www.ebay-mediacentre.co.uk/Latest-News/ACT-NOW-ON-M-COMMERCE-TO-UNLOCK-1-3BN-BOOST-TO-ECONOMY-EBAY-fa.aspx  Back

12   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

13   A 2x10MHz 800MHz cap in the auction, meaning that at least three players will have either LTE800 or LTE1800 to deploy nationally. Back


 
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Prepared 3 November 2011