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.
SUMMARY OF
OUR SUBMISSION
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.
TOTAL PAIRED SPECTRUM HOLDINGS IN EACH BAND
| Frequency (MHz) |
900 | 1800
| 2100 |
| O2 | 17.4 | 5.8
| 10.0 |
| Vodafone | 17.4 |
5.8 | 14.9 |
| 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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