Spectrum - Culture, Media and Sport Committee Contents

Written evidence submitted by Vodafone

Spectrum has been a contentious subject for the mobile operators for a number of years. We are now at particularly critical point. For the first time in over ten years a significant amount of new spectrum is available for purchase. This spectrum is a vital to the provision of the next generation of higher speed mobile broadband services - known as Long Term Evolution (LTE) or 4G. We welcome the Committee's timely inquiry.

The Committee has invited submissions on a number of matters. In our response we have focused mainly on the issues of competition, coverage and licence fees.


Vodafone has no in-built advantage in providing high speed mobile broadband, either now or in the foreseeable future, because of its current holdings of spectrum. Our existing spectrum is being fully utilised by over 19 million customers and it cannot be freed up quickly enough to be a substitute for the clean spectrum sold in the auction. Ofcom's assumption to the contrary has led it to make errors in the way in which it wishes to allocate spectrum. These errors could be to the detriment of both competition and consumers.

The proposed spectrum floors and caps distort the auction and competition because, in effect, they give Everything Everywhere (EE) an advantage by all but guaranteeing that it wins spectrum in the auction. And yet the European Commission established that EE already had sufficient spectrum for 4G deployment. EE therefore has a material advantage over its competitors and requires no additional protection.

Vodafone therefore believes that the auction should be allowed to run freely without restrictions. We consider that the auction rules, as currently proposed, will distort competition and ultimately harm consumers. Vodafone accepts that some operators may be unsuccessful in the auction—not because others will bid simply to force them out but because others will value the spectrum more—but the evidence from today's market shows that the successful bidders will compete hard to supply them with a wholesale service.

Vodafone acknowledges that its annual spectrum fees need to be reviewed in light of the Direction from Government. However the method proposed by Ofcom is likely to distort the outcome of the auction. Spectrum fees, by law, cannot be a tax on the mobile operators; they are in place to ensure that operators use their spectrum efficiently; the review must have this objective at its heart. We know of no evidence that suggests that spectrum has been used inefficiently by the mobile operators subject to the current regulatory regime for annual licence fees.

Other operators have made much of the fact that Vodafone and O2 are now permitted by Ofcom to use their low frequency spectrum to provide 3G data services (known as re-farming). In reaching its decision Ofcom carried out a thorough competition assessment. It concluded that competition would not be harmed by re-farming because both EE and 3 could match any improved coverage on the part of Vodafone and O2 by using their existing networks. There is therefore no sense in which the forthcoming auction needs to be tilted to the benefit of EE and 3 in order to "level the playing field".

High speed mobile broadband can serve less densely populated areas—this is already happening in Germany—however achieving this will require the building of additional sites rather than simply upgrading existing ones. The danger for the auction is that this additional cost may deter bidders from purchasing the lot of spectrum with the coverage obligation. Analysis of this risk requires further joint work between Ofcom and the mobile operators.

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

1.  The current holdings of mobile spectrum in the UK together with the bands to be auctioned next year are shown in the table below. Vodafone and O2 hold all of the available sub-1GHz or low frequency spectrum and EE holds a large part of the higher frequency spectrum both before and after the divestment of spectrum agreed with the European Commission.

Frequency (MHz) 9001800 2100
O217.45.8 10.0
Vodafone17.4 5.814.9
Everything Everywhere 60.0[28] 20.0
3 14.8

2.  Auctions are now the preferred method in most countries of allocating spectrum. Individual bidders put a value on the spectrum that they wish to buy and, in a free auction, those with the lowest valuations drop out of the running until the number of bidders is equal to the available spectrum. Consumers are well served by this mechanism because these valuations ultimately come from a calculation of the benefits that they are expected to receive.

3.  Ofcom is not proposing to have a "free auction". Their proposed method of spectrum allocation is via an auction that is restricted by both spectrum floors and spectrum caps. Although the auction is designed to foster competition we believe that it could have the opposite effect.

The spectrum floors could distort competition

4.  Ofcom believes that a new market for higher quality data services will emerge in which coverage within buildings will be particularly important. In view of this, Ofcom says that holding sub-1GHz (or low frequency) spectrum will be critical because of its superior ability to provide a signal indoors. In fact, it will be so important that any operator with access to a significant holding of sub-1GHz spectrum (Vodafone and O2) would have an "unmatchable competitive advantage" which could never be equaled by those with only access to the higher frequencies above 1GHz (EE and 3). Knowing this, Vodafone and O2 would bid "strategically" in the auction to shut out one or more competitors: an "I'm alright jack pull up the ladder" strategy.

5.  Ofcom conducts a technical analysis to determine the minimum amounts of low frequency and higher frequency spectrum which would enable its holder to match the performance of a network with significant holding of sub-1GHz spectrum. These minimum holdings are translated into a number of spectrum floors and the auction is structured to deliver at least four operators (the minimum number that Ofcom says is required for a competitive market) who have the minimum portfolio of spectrum required to compete.[29]

6.  However, Ofcom has incorrectly assumed that Vodafone's existing low frequency spectrum can be used to provide the next generation of mobile broadband services in the near term ie, by early 2013 when the 800MHz band will become available. Vodafone's existing holding of 900MHz spectrum is already used in providing voice and data services; we carried around 42 billion voice minutes across our networks in the last financial year. To clear the 900MHz band within the space of a year would require thousands more sites because we would need to cater for the calls and data services displaced from the cleared spectrum in other spectrum. This is clearly impractical and would result in a terrible experience for our customers.

7.  What we can see is that EE is the only mobile operator in the UK with sufficient spectrum to be able to roll out a high speed mobile broadband network in the near future. This is what the European Commission found when it reviewed the merger between T-Mobile and Orange. It was the potential adverse consequences of this spectrum advantage for competition that persuaded the European Commission to require EE to give up 25% of its 1800MHz spectrum.

8.  The spectrum floors thus distort the auction to the advantage of EE by all but guaranteeing it a block of 800MHz.

The spectrum caps will distort competition

9.  This serious shortcoming in the auction design is then compounded by the proposed spectrum caps which allow EE to buy 2x25MHz or over 80% of the sub-1GHz spectrum for sale in the auction. This could have potentially serious consequences for competition in the future by creating a two-tier market.

Unsuccessful bidders can buy wholesale capacity from others

10.  We believe that the auction should simply be allowed to run without restrictions. We acknowledge that there is a possibility that the smallest operator (and others) will fail to acquire any low frequency spectrum. This would not be because the other operators will bid strategically[30] to force out a competitor but because they simply put a higher value on the spectrum. This is what happens in a competitive market and it is what happened in the German auction. All the current available evidence from the UK suggests that those unsuccessful operators would then conclude a commercial wholesale arrangement with one of the successful bidders. Failing this, Ofcom could intervene ex post or even ex ante by attaching a wholesale access obligation to one or more of the 800MHz lots.

Using the auction to set annual licence fees will distort its outcome

11.  Ofcom's proposals for the setting of the annual licence fee (ALF) will also distort the outcome of the auction. The proposals mean that the amounts paid in the auction for 800MHz spectrum will translate directly into the annual fees for 900MHz spectrum paid by Vodafone and O2.[31] In effect, Vodafone is required to pay twice for any spectrum that it purchases: once in the auction and once via the new annual licence fee. The simplified example in the box shows how the auction can be distorted.

Suppose there is only one 2x10MHz lot which is being contested by two bidders: A and B where A is a 900MHz operator and B has no 900 or 1800MHz spectrum. Suppose that A and B have the following true valuations of the lot which is the most that each would be prepared to pay:

A  £1,100 million

B  £500 million

In other words if A has to pay more than £1,100 million for the lot it is not worth them acquiring the spectrum. Similarly, if B has to pay more than £500 million then it is not worth them winning the spectrum.

In a free auction A would acquire the lot. B would drop out once the bidding reached £500 million and this is what A would pay. However, the ALF distortion means that A will not bid as much as £500 million and therefore it will not acquire the spectrum.

Why? This is because A would not bid more than £400 million. At £400 million the extra cost to A via the increase in the annual licence fee will be the average price per MHz in this simple example grossed up for the amount of 900MHz spectrum that A holds ie,17.5/10 x 400 million = £700 million. So if A bids more than £400 million it knows that the total cost to it will be over £1,100 million. The spectrum is therefore acquired by B even though A puts a higher value on it.

In fact, the distortion is further compounded: given that A knows (or it can reasonably suspect) that B will acquire the spectrum then it should not bid for the lot at all; every bid that A makes just drives up the price that B will have to pay, and so drives up A's ALF. In these circumstances the best thing that A can do is to let B acquire the spectrum for the reserve price.

12.  The distortion arises because the disincentive effect is not faced by all bidders. 3 and any potential new entrants do not hold either 900 or 1800MHz spectrum and so will not face this disincentive to bid.

13.  Vodafone accepts that the annual licence fees must be reviewed but we believe that the method adopted should break the link between the prices paid in the auction and the level of the fees. Ofcom has a tried and tested method for doing this which it can adapt for the future.

The auction does not need to" level the playing field"

14.  In a recent briefing on spectrum 3 said that "[t]here is a real risk that unless the auction addresses the advantage that the older mobile networks gain from being permitted to use their legacy spectrum for mobile broadband, competition will be distorted and the consumer benefits that have flowed from a competitive market will be lost."

15.  Ofcom looked at this matter in 2010. Ofcom concluded that there was little likelihood of a competitive distortion as a consequence of allowing Vodafone and O2 to use the 900MHz spectrum ("our legacy spectrum") for 3G. It recognised that, because of the merger, EE, and to a lesser extent H3G through its network sharing arrangement with EE, is already in the strongest position in terms of network capability for providing mobile broadband services. They have the largest amount of 2100MHz spectrum and access to the largest number of base station sites. These operators would be able to improve their coverage (if required) and consequently reduce any competitive advantage that O2 or Vodafone might realise from using 900MHz spectrum for the provision of 3G services.

16.  Therefore the decision to allow Vodafone and O2 to re-farm confers no distortive advantage on these operators. The service provided can be replicated by EE and H3G using their access to a greater number of sites. There is therefore no sense in which either EE or H3G needs to be advantaged in the forthcoming auction of sub-1GHz spectrum in order to correct for a distortion caused by the re-farming decision. Such restorative rough justice, by Ofcom's own analysis, has no basis in evidence.

Whether licence fees for mobile operators have previously been set at appropriate levels, and how this should be assessed;

17.  Under section 13(3) of the 2006 Wireless Telegraphy Act, Ofcom may, if it thinks fit, prescribe charges that would be greater than those that would be necessary for the purposes of recovering costs incurred by Ofcom in connection with its functions relating to the management of the radio spectrum.

18.  These fees however are not a tax; they must take into account the need to promote the efficient use of spectrum, innovation and competition. Ofcom previously reviewed the level of fees for mobile spectrum in 2005. It emphasised that "Ofcom can only set fees in excess of the costs of administration in order to promote efficiency in the use of spectrum" and concluded that "Ofcom has no evidence that the current level of fees is, or is likely in future, to give rise to inefficient under-utilisation of this spectrum. At the same time Ofcom is not convinced that it would be appropriate to increase these fees at this time.."[32]

19.  We concur with Ofcom. We know of no evidence that the mobile operators are using spectrum inefficiently or that their use of spectrum is "crowding out" other higher value uses. We consider that the proposed approach to setting spectrum charges in future will likely distort the auction process and future competition.

Whether the upcoming auction can provide value for money for tax payers and how that should be balanced with benefits for consumers

20.  Ofcom is required by law to consider the need to promote the efficient use of spectrum and competition when allocating spectrum rather than raising revenues. However, it is questionable whether the proposed auction structure will provide value for money for tax payers because the use of the spectrum floors (together with the distortive effect of the proposed setting of annual licence fees) means that it is perfectly possible that one-third of the sub-1GHz spectrum will find its way into the hands of EE and 3 for the reserve price.

21.  We do not believe that removing the spectrum floors will harm competition and consumers: EE already has sufficient spectrum to deploy a mobile broadband network and 3 can either acquire more spectrum or, if it is unsuccessful, buy wholesale capacity from one of the successful bidders. If this fails then Ofcom has the power to intervene.

Whether the upcoming auction can deliver improved mobile broadband coverage in rural areas, as well as cities;

22.  Ofcom has recently published research on mobile not-spots.[33] Ofcom quotes figures of approximately 97% of the UK population and 91% of the UK land mass for 2G coverage and 87% of the population and 76% of the land mass for 3G coverage. Ofcom finds that "[i]n the vast majority of case study areas, not-spots existed because it was not a commercial priority for mobile operators to extend their coverage, influenced by low levels of traffic discouraging investment."[34]

23.  However, there are good reasons to believe that coverage of 3G will improve over time. First, as operators reduce costs through sharing infrastructure (for example Vodafone and O2) it becomes more economic to expand coverage. Second operators will seek innovative ways to improve indoor coverage; for example, Vodafone is the only provider currently offering consumers "Sure Signal" which uses femtocell technology (indoor equipment that looks like a wireless router and connects via a fixed line broadband connection) as a potential solution to improve indoor coverage and for which we have hundreds of thousands of registered users. And third, all operators now have a 90% coverage obligation in their 3G licences.

24.  Ofcom has proposed that one of the spectrum lots in the 800MHz has an indoor coverage obligation for 95% of the population by 2017. This will mean that the upcoming auction can deliver improved mobile broadband coverage in rural areas; Vodafone Germany has live base stations using the 800MHz frequency band providing coverage to communities with fewer than 5,000 inhabitants in Northrhine-Westphalia.

25.  However, our estimates of the cost of meeting the proposed coverage obligation are somewhat higher than Ofcom has suggested; it is not just a case of upgrading existing infrastructure with the right equipment but new sites will have to be built in order to comply. This may be a problem if it dissuades bidders from acquiring the lot with the coverage obligation.

June 2011

28   EE is required to divest 15MHz of this spectrum Back

29   Vodafone and O2 are assumed to have enough spectrum to be able to supply 4G services and so neither needs to acquire any new spectrum in the auction. In contrast, EE and 3 are all but guaranteed at least one block of 800MHz spectrum each in the auction by virtue of the spectrum floors. Back

30   The auction is explicitly designed to minimise the risk that participants can bid strategically because the identity of the bidders is not revealed. Back

31   A similar method is proposed for calculating the annual licence fee payable on 1800MHz spectrum based on the average of the price paid for the 800MHz and 2.6GHz spectrum. Back

32   Spectrum Pricing: A statement on proposals for setting Wireless Telegraphy Act licence fees paragraph 3.16 Back

33   Mobile not- spots - An update on our research. November 2010 Back

34   Paragraph 2.15 Back

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© Parliamentary copyright 2011
Prepared 3 November 2011