NBN Co's faulty economics

On Wednesday the Australian Competition and Consumer Commission (ACCC) suspended its scrutiny of NBN Co's proposed Special Access Undertaking, stating NBN Co would soon lodge a revised SAU.

The SAU is a set of enforceable rules about NBN Co's pricing and conduct over the next 30 years for which it must obtain ACCC approval.  This marks the third time NBN Co has changed its approach to the SAU in the face of resistance from a regulator plainly worried about the implications for Australian consumers.

This latest backdown should finally put to bed NBN Co CEO Michael Quigley's claims that a government-run communications monopoly will somehow be friendlier and more civic-minded than private sector firms.

Remember, in August 2011 Mr Quigley told Alan Kohler:

“…This network is being built as a public good. It's not being built to maximise profit. The way in which we've approached the network design and the network build is to provide the Australian public with the best possible utility network we can at the lowest cost as a public good. It's not to maximise profits, which is why no commercial entity would ever build this network.” 

So according to Mr Quigley, the National Broadband Network serves a higher purpose than simply maximising financial returns. Yet the aggressive nature of the SAU terms that NBN Co has asked the ACCC to rubber stamp is virtually without precedent, as noted by business journalist John Durie:

“One member comments the amount of discretion being sought by NBN boss Mike Quigley would make even the Telstra of old blush.”

There are at least three major problems with the currently proposed SAU:

• The price constraints are not binding in all circumstances.  They leave NBN Co with scope to lift prices and rapidly increase the amount it earns from each user, particularly with its CVC (or data volume) charge.  The NBN has also sought to exempt the price of many product offerings from the undertaking.
• NBN Co has made no service level assurances to Retail Service Providers (RSPs).  That makes it impossible for retailers such as Telstra and Optus to be certain they can meet their legal obligation to provide a guaranteed quality of service to end users.
• There is no scope for the ACCC or anyone else to assess whether NBN Co's planned investment in the network is prudent – or whether it is ‘gold plating' that sets up consumers for large price hikes, as we've seen in the electricity sector.

All of this boils down to one elementary flaw of the NBN: A monopoly given unchecked power to recoup its capital expenditure will always charge consumers more than an enterprise which has invested wisely.  Competition is the best way to ensure investment is appropriate.

And it's not a surprise that NBN Co has sought ‘flexibility' given two crucial constraints imposed by Government.

The first constraint is that Senator Conroy asked NBN Co to set its initial prices so that they were comparable to those in the market at the moment for ADSL2 broadband products. 

This was supposedly to ensure a smooth migration to the National Broadband Network from existing networks (although I note the NBN added just over 100 customers in Tasmania during the past year and the take-up rate is still only 18 per cent there).  But I suspect the objective was more political in nature – to create the illusion that NBN pricing roughly competitive with existing prices was sustainable despite the vast expense of the network.

Synergies Consulting explicitly mentioned this constraint in its review of the NBN's SAU, which the NBN submitted to the ACCC:

“The risks of having to price to ‘meet the market' in accordance with government expectations, are best managed by providing NBN Co with a degree of pricing flexibility.”  (Available online here, p.9)

The second constraint imposed by Labor is that the NBN Co has to make a positive return for taxpayers on the entire amount invested in its network – in fact a return of seven  per cent, a little more than the historic average for the long bond rate, has been targeted.  Yet the government never gave the NBN Co the scope to invest more prudently and achieve very fast broadband more economically– for instance by using a fibre-to-the-node architecture where this makes sense.

In Telstra's response to the ACCC's first consultation paper (available online here, p.14), it noted that NBN Co would have wide scope to claw back revenue, particularly through CVC charges.  Its modelling showed that a customer buying a 100 Megabits per second package whose usage of data increased 30 per cent each year would see their CVC charge per month rise from $1 per connection in 2012 to $50 per month by 2025.

Instead of going back to the drawing board to find new ways to gouge consumers, NBN Co should be given the freedom to explore new ways to invest its capital more cost-effectively.

This post was first published on Thursday June 21. Republished with permission.