Protecting the broadband value chain

While there is an enormous amount of debate around what kind of technologies should be used to make the NBN ‘cheaper’, those involved in those debates, reviews, and plans, keep missing the point.

I will not concentrate this article on the social and economic benefits of the NBN that are essential for Australia to soften the economic recession in years to come. I will suffice to state here that our government policies, our workforce, and our infrastructure, are not well prepared for the rapid economic and social transformation that is happening around the globe.

What I want to discuss this time is the fundamental policy and strategy behind the NBN, which is based on a wholesale-only model.

The delicate nature of a wholesale-only model

The reason for developing a utilities-based wholesale-only model is to create a national network that is both affordable and high quality. However, the development of such wholesale networks, particularly in the USA, has failed because commercial organisations are not able to build economically viable models within the current telecoms market structure. The current vertically-integrated structures require integrated profit levels of 30 to 40 per cent within short periods of time of around three to four years.

Wherever you look at community network broadband- or utilities-based infrastructure, you see in general lower retail prices for higher quality broadband services compared with prices and services from incumbent operators.

In order to achieve affordability and high quality broadband services, you therefore need to look at wholesale-only based models. The reasons why such models fail if they are provided within the traditional vertically-integrated telco telecoms marketplace are that, in order to protect shareholders’ value of their current telco models and technologies, the incumbents will typically thwart and delay any wholesale-only model that provides new levels of competition and innovation that they are unable to compete with.

They undermine the development of new business models by mounting campaigns of misinformation, seeking barriers to entry, using litigation as a competitive weapon, and engaging in predatory pricing or targeted rate discrimination.

Structural separation allows for wholesale-only model

In Australia, after a decade of such behaviour by Telstra, both sides of Parliament agreed that enough was enough and supported the structural separation of the incumbent. Only that arrangement opened up the way to develop an NBN based on the wholesale-only model.

It is important to see these two activities – structural separation and wholesale-only infrastructure – interlinked; if we start to unravel either one the overall model will collapse.

The reason for this is that, for a national or community wholesale-only model to work, the network owner must obtain sufficient revenue from its retailers to cover all its network costs, including depreciation and periodic upgrades. The retailers, in turn, must collectively earn enough revenue to pay the network owner’s costs plus their own additional costs, including building and equipment, marketing, technical support, customer service, regulatory compliance, and overheads, as well as a level of profit.

If the wholesale-only model is not protected by regulation, other network operators and retail service providers (RSPs) will naturally look for cherry-picking options to get faster and higher profits, which in turn will make it impossible for wholesale-only organisations such as NBN Co to operate an economically viable business model.

There are also extra costs involved in operating a wholesale-only model, such as administering often complex wholesale arrangements with the RSPs.

To operate a wholesale-only network in competition with incumbents is therefore simply impossible.

No demand for fibre-based services?

One of the commercial problems often discussed is that there are still not enough services that require a fibre optic network. As mentioned above, it is not in the financial interests of the incumbents to pursue options that could generate new high quality fibre-based services, because models based on delivering digital-economy services will mostly require an open network approach because few large-scale services can be developed in an economic way on a vertically-integrated model.

Those services would simply be too costly and too restrictive for those interested in developing digital economy, e-health, e-education, smart grids, smart city, and similar applications.

The wholesale-only operator will build a model that takes the utility, low-profit approach, while the retailers on the other hand are pursuing high- and short-term profits. As there is little room for differentiation on the network level, RSPs are forced to look at value-added services to successfully compete with each other. This will lead to innovation, new models, and a serious effort to maximise the opportunities of an all-fibre network.

Unfortunately, right now the level of innovation coming from these RSPs remains low. They are steeped in the old telecoms models and very few are able to escape their engineering-dominated nature. As a result, we could see a continuation of poor customer service, misleading advertising, and poor marketing, so there is an urgent need to extend the RSPs model beyond the current level of plain old telco providers.

On the other hand, we do see the continuing rise of companies such as Google, Amazon, Apple, Facebook, and others, who are able to use infrastructure as a utility input for innovation, new business models and new opportunities. Increasingly high-quality broadband services will be developed and delivered by these companies, rather than by the traditional RSPs.

National digital productivity

A national wholesale-only model also makes it possible for the government to work in close cooperation with the operator to develop national economic and social strategies.

For example, to create an attractive business climate for companies moving into the digital economy, attract investments that will deliver new jobs, foster the growth of digital productivity and develop policies for their own departments and institutions (healthcare, education, energy) to use the infrastructure.

Perhaps with the exception of the Scandinavian countries, such a level of cooperation is not happening with the traditional vertically-integrated incumbent operators, and there is plenty of evidence from around the world to support this view.

All of this intertwines: the structurally separated wholesale-only infrastructure model, the need for RSPs to focus on innovation and value-add, and the importance of the NBN for the economy and for the wellbeing of its citizens. Once one element of this complex structure is unravelled, there is a great risk that all other elements will unravel as well.

This is an edited version of a post originally published on January 17. Paul Budde is the managing director of BuddeComm, an independent telecommunications research and consultancy company, which includes 45 national and international researchers in 15 countries.