Troubled times at Telstra: the inside story

IT WAS an exciting, brash and colourful time in a complex and boring industry. Even more fun than last year's fight over the national broadband network (NBN).

In late 2005 the government was looking to sell its last stake in the telephone company, juggling political support with market timing. But over at Telstra, an aggressive new American management team was waging a public campaign against regulation.

The nadir was regulatory and policy chief Phil Burgess's comments that he would not recommend Telstra shares to his mother.

One can just imagine the exasperated foot stomping in the ministerial wing when papers printed the quote and Telstra's share price plummeted. Voyeurs loved it.

Outside the public view another fight was going on between Telstra, four ministers and their departments.

Using freedom of information laws, BusinessDay has obtained confidential documents containing candid opinions from government officials about Telstra's request to charge a flat $30 national price to unbundle local loops. It was regulatory disputes such as this that led Burgess to set up the propaganda blog "Now We Are Talking".

"Telstra thinks the Australian Competition and Consumer Commission (ACCC) should set unbundled local loop prices fairly so that costs can be recovered and at the same rate everywhere in Australia," someone wrote on the blog in 2005.

"Our competitors don't like this idea they like cherry-picking . . . and they make good profits from the city customers."

To translate unbundled local loop (ULL) is the industry term for Telstra disentangling a customer's telephone line from its own switchboard and re-attaching it to a competitor's switchboard. Telstra asked the competition watchdog if it could charge $30 per line per month across Australia, rather than staggered prices of $13 per month for inner-city areas, $22 in urban areas, $40 in regional areas and $100 in remote areas.

The prices do not affect Telstra's costs but can discourage competitors from serving customers if the ULL price is too high, because it pushes up retail prices.

In August 2005 it became clear the ACCC was going to reject this application, so Telstra started lobbying the government to do something unprecedented: issue a ministerial determination. The determination mechanism would override the ACCC and had never been used before.

Perversely, NBN Co has just announced it will charge a flat national price of $24 a month on its broadband network. But more on this later.

The documents show that the government did not believe Telstra's warnings it would lose too much retail business to maintain an internal cross-subsidy for rural areas. Except for Finance, which was encouraging its minister, Nick Minchin, to support Telstra's proposal.

The documents comprise a government committee report discussing Telstra's request, and a copy of Finance and Administration's dissenting submission. The committee was set up by the Howard government to assess the ULL proposal and regulatory conditions ahead of the final Telstra sale. In it were officials from five departments Communications, Information Technology and the Arts, Prime Minister and Cabinet, Finance and Administration, and Transport and Regional Services. In other words, Senator Helen Coonan, prime minister John Howard, Senator Nick Minchin and deputy prime minister Mark Vaile.

The committee recommended the government trust the ACCC's decision but ask it to double-check what would happen to retail line rental prices in rural areas.

"In the interdepartmental committee's (IDC) view, Telstra has not made a case for the government to intervene to override the ACCC decision on Telstra's ULL undertaking," officials wrote in a draft of the report.

"Telstra's margins will not be under serious threat in the short to medium term from ULL competition because, on Telstra's own estimates, it is expected that only around 13 per cent of ULL lines will be taken up by competitors by 2010."

Telstra claimed a $13 and $22 monthly price in populous areas would enable competitors to offer discounts, forcing Telstra to lower its own prices. Lower revenue from cities would make it harder for Telstra to maintain an internal cross-subsidy of regional and rural customers.

When US businessman Solomon Trujillo joined Telstra in July 2005 Telstra's profits were still high but the outlook for revenue from fixed-line telephones was falling by 5 per cent a year.

Two factors were causing this an increase in mobile phone usage and the start of ADSL internet. Many households or businesses had a second phone line in the early 2000s to get dial-up internet, but ADSL did not need a second line. People were ditching the second line and making fewer fixed-line calls. Management was pressured to improve the outlook before the sale.

To win support for the legislation to privatise Telstra fully, then National's leader Vaile told his party telephone prices would not rise in country areas after the sale. In Finance's submission, Telstra cross-subsidised rural customers by between $600 million and $1.2 billion a year.

The cross-subsidy only became an issue after privatisation, because Telstra knew it would have to keep providing rural customers with services regardless of how many high-profit city customers it lost.

Finance officials were also concerned with the impact staggered local-loop pricing would have on Telstra's share price.

"Finance does not agree that the government should allow the current ULLS pricing process to continue without intervening as soon as practicable to provide, through a ministerial determination, policy direction to the ACCC," it submitted.

"Whilst this might be the first time such a determination was utilised, it would provide a definitive decision on ULLS pricing."

Finance was also concerned about how Telstra would take the rejection. The fact that a minister had never used the determination powers was why the other departments did not want Coonan to use it.

"[It] would be highly controversial," the final committee report noted.

Retail prices in regional areas have remained the same as city areas because in December 2005 the government slapped an obligation on Telstra to keep pricing parity.

The committee report also reveals public servants outside Finance did not believe Telstra's predictions of financial ruin and destruction if prices were not averaged.

"[Finance] appears to propose a significant policy change for the government that would have the impact of increasing Telstra's market power, and therefore Telstra's share price, at the cost of other stakeholders.

"Its conclusions . . . are based on Telstra's views . . . which the other departments do not believe are supported by the balance of evidence."

One important insight into government thinking is found in neat cursive handwriting next to the main committee's objections to Finance's position. It reads: "Has 10 years of competition (and tax breaks) generated alternative infrastructure investment or innovations (bar wireless) by competitors who have parent companies with substantial worldwide market presence and power?"

The comments could be referring to Vodafone or Optus; or the unknown author could also be asking why large foreign companies have avoided the sector.

Australia has a small, wealthy population spread over a vast area. Connecting people is difficult and expensive, but the government has chosen to help people live in rural areas at similar costs to living in metropolitan areas. Enter the NBN and the issue of why government-owned NBN Co can offer flat national pricing but Telstra couldn't.

According to ACCC commissioner Ed Willett, the answer is in NBN Co's decision to reach the most remote customers with wireless and satellite services. It would not have been fair for the expensive last 7 per cent on the copper network to drive up the costs for everyone, he says. "The difference is that with NBN using efficient technology then the cost of remote services is not so distortionary."

What if Telstra had tried to average prices across metro, urban and regional areas but had left remote customers at $100 a month?

"The commission would have been much more sympathetic to that sort of approach," Willett said last week.

Telstra took its request to the Administrative Appeals Tribunal before giving up. Early in 2011 the ACCC is expected to release a new method of calculating the value of Telstra's fixed telephone network, which could change ULL prices again.

That may be the last big fight over fixed-line pricing between the two old foes before the ACCC focuses on the next monopoly NBN Co. One trusts public servants to treat NBN Co's pricing requests with the same scrutiny.