The opposition communications spokesman says broadband will get a whole lot more expensive once the NBN monopoly is set in stone.

Technology Spectator

"Now what’s going to happen here is because there is no competition, because this is a government monopoly and because they are spending so much money so they’re overcapitalising it, inevitably prices are going to be high.” Malcolm Turnbull – February 1, 2012 [1].

But is that right? Some NBN supporters argue my comment is unfair and inaccurate. They reject any suggestion that the NBN will result in broadband costs that are higher than they would have been in its absence.

We need to get real about this. When you are committing tens of billions of dollars to replacing the entire existing infrastructure of a vital industry, you cannot be sentimental or self deluding. There are no fairies at the bottom of the NBN garden to suspend the laws of economics.

By any measure the NBN is a massive investment. The Government says the direct capital cost of the network will be $37 billion and the peak funding required by NBN Co $41 billion. Most industry experts expect the eventual cost to be significantly higher, and some estimates exceed $60 billion.

It is difficult to demur: let’s face it, what was the last government infrastructure finished on time and on budget? Most projects that run over budget involve types of infrastructure where the likely costs, economic drivers and probable operational complications are well understood because of previous experience – the likes of roads, dams, tunnels and major buildings. But the NBN is entirely new in the Australian context; nobody has deployed a large scale fibre to the premises network in established areas. And insofar as there is one relevant point of comparison in South Brisbane, where Telstra is currently building an FTTP network, all publicly available information indicates that it costs a lot more and takes a lot longer than projected.

The NBN is also going to be a monopoly, given other fixed-line infrastructure will either be decommissioned or contractually prohibited from competing. So the only competition for carriage of broadband services will be provided by wireless networks, which in some cases will be a substitute product, but in many will not (as Senator Conroy is so fond of pointing out). The NBN in fixed line terms will be the only game in town.

Every enterprise wants to get a good return (ideally a high return) on its invested capital. If it cannot get a reasonable return then it won’t be able to meet its obligations to its lenders or pay dividends to its shareholders.

However, sometimes people do over invest – whether it is the toll road that overestimates traffic volumes or the restaurant with an excessively flash fit out.

And if they are operating in a competitive market (if, for instance, motorists can take another route or diners choose another restaurant) they will find that the return they can earn is less than the cost of the capital they have spent, and have to write down the value of that investment. You have to meet the market price that is determined by your competition.

However, where a business is a monopoly it is able to exploit its market power and charge much higher prices.

Of course doing this is an integral part of the NBN business plan. Everywhere else in the world (and in Australia to date) HFC networks are used for high-speed broadband, and usually for voice traffic as well. In most markets the HFC networks belong to cable TV companies who compete fiercely with telco services delivered over fibre, copper or a combination of both.

However in Australia, Telstra and Optus are being paid billions not to use their HFC networks for broadband or voice precisely so they cannot compete with the NBN. Because the HFC networks were built a long time ago in fairly densely settled areas, Telstra and Optus would be able to offer comparable services and undercut the prices NBN wants to charge for its brand new FTTP network – resulting in NBN having to cut its rates to meet the market. So in order to prevent that happening, billions of dollars of taxes have gone to pay off Telstra and Optus not to compete.

All monopolies will attempt to charge excessive prices (extract economic rent) and so typically they will be the subject of regulation – as in the case of our water, gas and electricity providers.

And that will be the case, to some degree, with the NBN which is generously proposing that it will not seek to earn more than the Government’s chosen benchmark of a seven per cent return on its invested capital.

However, this begs the question as to whether the level of capital that is being invested is appropriate. In a competitive market a business cannot maintain high prices because it wants to get a particular return on its capital. Its customers will say "that’s your problem” and move onto a cheaper service or product.

This issue of the level of invested capital is a vexed one with regulated utilities. Many people, including Rod Sims (formerly head of IPART in NSW and now chairman of the ACCC) have argued that electricity distributors were encouraged to overinvest in their transmission and distribution networks because they were entitled to charge whatever prices were needed to deliver the return on their investment allowed by regulators – given that regulated return was higher than their cost of borrowings, it gave them an incentive to invest as heavily as they could. Regulators’ ability to declare particular investments as "unreasonable” was usually very limited – and, according to Sims, this overinvestment has been the major factor behind the rapid growth in electricity prices [2].

The Australian Energy Regulator Chairman, Andrew Reeves, recently warned against overinvestment or "gold plating", saying it has led to sharp price increases:

"NSW and Queensland are getting more infrastructure than we think they need and we are required to approve price increases to pay for it”[3].

So let us re-examine the logic. A monopoly will always have the ability to charge higher prices than a business which is operating in a competitive market. An answer to that is to regulate the monopoly. But if the regulator simply requires that the prices charged by the monopoly only be constrained by a maximum allowed return on capital, that will still most likely result in higher prices – especially if the capital invested is far greater than is needed to deliver the services or products consumers actually want at a given point in time.

And the more desperate a government is to prevent its supposedly "commercial" investment from turning up as red ink on the budget, the more certain you can be that it will do everything in its power to recoup money from consumers and keep ROI up.

When the NBN Co talks about "flexibility" in future pricing in documents submitted as part of its Special Access Undertaking (SAU), there should be no doubt what they are really talking about: sacrificing affordability. Analyst Ian Martin, for one, has noted that for the NBN business case to be viable, average wholesale revenue per customer will have to increase by 34 per cent from current levels [4].

At the simplest level there is simply more capital earning a return. In its latest review of Telstra’s access charges, the ACCC valued the current Telstra network at just over $17 billion [5]. The NBN’s direct network capital cost is $35 billion in 2010 dollars or $41 billion in real dollars. Its peak funding requirement is higher taking into account the $11 billion (in after-tax 2010 dollars) paid to Telstra to shut down its network and migrate customers and $800 million paid to Optus for similar commitments. Whether these figures are counted as operational expenditure or capital expenditure is irrelevant from a customer’s point of view – any losses they lead to will be counted as recoverable capital, and thus contribute to the eventual level of charges for use of the network.

It would be wrong to assume that any prices so far offered by the NBN Co are sustainable. In its SAU lodged with the ACCC, the NBN Co included a consultant report conducted by Synergies Economic Consulting (available online here) which states:

"NBN Co has set its initial prices to ‘meet the market’ as a means of ensuring the smooth migration of end user connections from legacy networks to the NBN and to also meet the Australian Government’s objectives of setting wholesale prices to achieve the 'broadband take up targets agreed by Government through the NBN Co Corporate Plan and Business Case', again as set out in the Statement of Expectations”. (p.8)

As the consultants note, the low starting base for wholesale prices is an argument for granting NBN Co "pricing flexibility" to recoup its costs at a later date:

"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.” (p.9)

Until now, the deregulated Australian telecommunications market has typically led to falling nominal and real prices for most services.

The nominal retail price of ADSL broadband fell by 69 per cent between 2005 and 2010, according to figures compiled by the OECD [6]. Between 1997-98 and 2008-09 inflation-adjusted prices fell 34 per cent for fixed-line telephone services and 49 per cent for mobile services, according to the ACCC [7].

Compare that with what we know about the NBN’s plans so far. In terms of access, NBN Co has applied to the regulator for permission to raise nominal prices by 50 per cent of the rate of inflation, per year [8]. But note this restriction only applies to access – unlike current wholesale pricing, NBN Co will also be charging usage fees (via its CVC).

NBN also has made no commitments about its pricing of more sophisticated services such as multicast video. And in any case, if the NBN gets its way, the ACCC would have its power to enforce any price commitments offered in the Special Access Undertaking overridden by separate Wholesale Broadband Agreements NBN Co signs with individual retailers.

With barely 4000 users connected to the NBN after four years of Labor government, NBN Co is yet to report that it has earned revenue from selling broadband services, and completion of the rollout a decade away at best, claims and counterclaims about NBN pricing are at present entirely in the realm of theory. That is as true of the rate cards announced by various ISPs as any other indicator – we all know those rates can change.

But if anyone really believes all of the above points to NBN prices for broadband below where they would have been without it, I know someone who could sell them a very nice bridge with views of the Opera House.

Malcolm Turnbull is the Federal Member for Wentworth. You can read his blog here.

[1] Interview with Ben Fordham on 2GB

[2] Sims, R., (2011), "IPart Concerned About Rising Electricity Network and Green Scheme Costs”. Professor Ross Garnaut also addresses the topic of overinvestment in electricity networks in a recent update on electricity prices (Garnaut, 2011, "Transforming the Electricity Sector”, available online

[3] Martin, P., (2011), "Pricing Rules Boost Power of Energy Suppliers”, in The Sydney Morning Herald, available online here.

[4] Martin, I., (2011), "A Significant Gap in the NBN Corporate Plan” in The Telecommunications Journal of Australia, Vol 61, No3, p.51.5 available online here.

[5] Battersby, L., (2010), "Action by the ACCC Slashed Telstra Value by Billions”, in The Sydney Morning Herald, available online here.

[6] OECD, (2011), Communications Outlook, p.293

[7] ACCC, (2011), Telecommunications Report, p.21 available online here.

[8] NBN Co, (2011), "NBN Co Special Access Undertaking”, available online here.

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