Levelling Telstra's playing field

One of the many challenges confronting the proposed new National Broadband Network (NBN) is how to convince Telstra's competitors to migrate their customers from a copper network that generates fabulous margins and returns on investment to a fibre environment where returns and margins will be significantly less attractive. Judging by a letter penned by the chief executives of seven of Telstra's biggest competitors last week, the Australian Competition and Consumer Commission may have developed a strategy to deal with that problem.

The CEOs of Netspace Networks, Macquarie Telecom, Optus, iiNet, Primus, Internode and TransACT wrote to the ACCC chairman Graeme Samuel late last week expressing their deep concern about draft pricing principles and indicative prices for fixed line wholesale services that the commission issued late last month.

What was notable about the indicative prices was that the ACCC is, for the first time in living memory, proposing to increase the prices Telstra can charge its competitors for access to its unconditioned local loop (ULL). In the urban 'zone A', which covers more than 80 per cent of the population, ULL prices would rise from $16.90 a month this financial year to $23.60 a month in 2011-12.

However, the commission also proposes significant reductions in access to the local carriage and line sharing services while more or less holding wholesale line rental service charges as they are.

The effect of the proposed new pricing regime would be to make it less attractive for Telstra's competitors to seek ULL access and to install their own infrastructure – digital subscriber line access multiplexers (DSLAMs) – in Telstra's exchanges and relatively more attractive to be wholesale customers.

Telstra's competitors say the proposed pricing would raise the end price for consumers of all fixed line services. They also say that the direction of the prices is at odds with the "clear direction" from the commission over many years that competitors were expected to invest more deeply in the copper network in competition with Telstra.

"Having committed that investment, we now find the commission, apparently due to a strict commitment to a theoretic cost model, proposes to dramatically increase the cost to us of accessing the raw copper that we need to use to connect to customers. This will deliver a windfall to Telstra and underline the value of our investment," they said.

It is arguable that, given the offsetting reductions in the other access prices, whether the proposals would deliver a windfall – there are those who say that it will be a big net loser over time. The telcos are, however, right when they say the new regime would push up the costs of providing ULL-based services.

The proposed changes ostensibly flow from the ACCC's use of a new theoretical model to assess Telstra's costs, in place of the old theoretical model. The commission itself, however, also said that it was now "less clear" that the build/buy rationale for access prices remained as strong.

Despite the rollout of hybrid fibre coaxial networks and 3G wireless networks, they haven't been widespread enough to represent widespread end-to-end competing infrastructure able to provide services at comparable prices and quality to Telstra's copper network.

Telstra, and others, have argued in the past that the ACCC's focus on continuously driving access prices down – Telstra has claimed that access prices have been set below its actual marginal costs – has distorted the build/buy signal by providing an overwhelming incentive for competitors to buy access rather than build competing infrastructure.

Competitors have, as ULL pricing was steadily forced down, installed a lot of DSLAMs in Telstra's exchanges to capture most of the margin from those customers. With margins in the mid-60 per cent range and a pay back on the investment of perhaps two to two-and-a-half years, the incentives for pursuing ULL-based strategies have been compelling.

The problem with that in the context of the NBN is that the returns available from exploiting the access regime and milking Telstra's copper are too attractive. Unless it were massively subsidised, the returns to the telcos from the NBN would be a fraction of what they are generating today.

If the NBN is to be remotely successful it will need to attract an early migration of internet service providers and their customers from Telstra's copper to its own fibre.

For that to occur, there would need to be a glide path that steadily reduced the returns available from ULL access, that turned a greater proportion of Telstra's competitors and their customers into wholesale customers and ultimately made it attractive for the competitors to switch their focus from the copper network to the higher-speed NBN.

Ultimately, as the NBN is built out, it would also need Telstra to migrate its retail and wholesale customer base across as well – while Telstra might privately enjoy finally seeing its competitors shocked by the proposed reversion of the long-establish trend of ever-decreasing access prices, it would expect that the regulatory regime will be used to "encourage" it to hand its customers over to the NBN too.

In effect, where pricing was used to shift customers and profit from Telstra and its aging but fully-depreciated copper network to its competitors, the ACCC will now have to create a regime that shifts customers, revenue and margin from the entire industry to the new and higher-cost NBN.

That can't happen unless the federal government is prepared to massively subsidise the NBN's costs to make it competitive with the Telstra network, or until margins and returns for ULL access fall and prices for end-users rise.

In the absence of a change of heart from the commission, it appears it has started the process off weaning Telstra's competitors off cheap access to Telstra's network in order to ensure that its own regulatory regime and the super-returns it has made available to them doesn't deter them from switching to the NBN as it is built.