Hard News by Russell Brown

A long post on telecommunications

I'm inclined to believe that the Business Roundtable's submission of a column by its chairman Rob McLeod arguing against regulation of Telecom - without the fairly important declaration that McLeod is a director of Telecom - was an error, rather than an attempt to mislead the public. I'm less inclined to credit McLeod's argument.

The Business Roundtable has been a quite consistent champion of property rights and opponent of regulation - even to the extent of lining up against the political centre-right on the foreshore and seabed issue. Its view might be encapsulated in this paragraph from the column:

Marketplace competition seldom operates perfectly, but just because a fish can't fly doesn't mean a rhinoceros can do better. The heavy hand of regulation is often far worse.
Greater intervention by the government in electricity has led to the current unholy mess. Do we want telecommunications to go the way of state-controlled electricity and roads?

Let's put it another way: would we want our roads run like our telecommunications? You won't get many backers for that motion, Rob.

For nearly 20 years, New Zealand's official approach to telecommunications has been unique in the world, embodying a philosophy of "light-handed regulation", and (until recently) eschewing an industry-specific regulator. It's too long to go through here, but Auckland network industries specialist Paul Hewlett has an excellent backgrounder on events since the Post Office monopoly was broken up in 1987, and the network placed with a new entity, Telecom Corporation of New Zealand.

Although most of the horror stories about the Post Office era are true - it sometimes took two or three months to get the phone on - the old system had some successes. We had a very high penetration of phone lines relative to our population. In three years of public ownership, the new corporation made another important step; establishing digital connections to nearly every exchange in the country.

One of the most striking parts of the story is the then-Labour government's acceptance of an "undertaking" from Telecom's new management that it would "ensure that interconnection would be provided to competitors on a fair basis, and the relationships between Telecom companies would not disadvantage competitors." On this vague assurance, any mention of interconnection was left out of the Telecommunications Act.

It is difficult now to credit the stupidity of those who devised the policy. After Telecom was sold to Ameritech and Bell Atlantic (themselves, ironically the product of the greatest regulatory intervention in telecommunications history - the forcible break-up of AT&T in 1982) for $4.25 billion (the money was prudently used to retire external debt) in 1990, there was no way that its private owners would - or even should - have made any agreement not to their advantage.

It wasn't all bad: Clear Communications entered the market, negotiated an interconnection agreement for distance calling and set toll rates on a steep slide. But it was different when Clear tried to get into the local calling market: that precipitated a legal battle over the cost of connecting to Telecom's network that churned on for nearly a decade. All the while, National's Communications minister, Maurice Williamson, defended the New Zealand way: "How you do better than the best, I do not know," he said in 1993.

Ironically, it was business customers that suffered the most: the Kiwi Share's requirement for free local calling, with increases no greater than the rate of inflation, offered some protection to residential users. But, while the American shareholders drew extraordinary dividends, Telecom's capital investment fell below the rate of depreciation in the 1990s.

Meanwhile, other nations began to embark on a different path. When they broke up their public monopolies, they either completely separated the wholesale and retail elements of those networks, or foreshadowed local loop unbundling, under which incumbents would be required to allow new entrants access to the "last mile" to residential homes, on decreed terms.

We didn't. And the theory of why we didn't is plain enough. The market would sort things out. If prospective competitors were given a break to allow them to piggyback on Telecom's network, that would be a disincentive for them to invest in their own networks. And anyway, those old copper lines were on the way out. Fibre was the future.

That theory began to unravel in the mid-90s, when DSL arrived. This new technology would allow data to be delivered at pretty decent rates over the existing copper. Telecom, understandably, slammed on the brakes on what had been envisaged as an epochal fibre installation strategy. The various permutations of Saturn, Clear and Telstra installed cable in parts of Wellington and Christchurch but ran out of money. CityLink wired the hell out of the Wellington CBD, and, more recently, several companies laid fibre in the Auckland CBD, but it was clear enough that fibre to our homes would be a long time coming, if ever. It wasn't that the state stood in the way - pretty much anyone can be a network operator under the Telecommunications Act - it just wasn't competitive.

Meanwhile, everyone else unbundled. According to McLeod's column, it hasn't gone too well:

Overseas, unbundling has been fraught with difficulties. In Britain, where local loop unbundling has been in place for over five years, fewer than 300,000 lines have been unbundled. In New Zealand terms that amounts to around 20,000 lines, about the number of broadband connections Telecom sells every six weeks. In Australia the number of unbundled loops is also low and the industry is embroiled in major legal and policy debates on the issue.

This is accurate, but misleading. Bulk migration of lines only began last year in Britain. But last month, the British regulator trebled its previous forecast for the number of lines to be unbundled in 2006 - to three million. Its previous forecast was made in November, the month when the per capita penetration of broadband in Britain exceeded that of the US. From The Times:

Tim Johnson, of Point Topic, said the US broadband market was now less competitive than Britain's. "Although the US telecoms players face strong competition from cable companies, they do not face the same fierce level of competition from resellers and local loop unbundling that there is in the UK," he said.

The BBC had a story yesterday on the new British broadband boom. It quoted a consumer analyst:

"The influx of broadband providers last year caused huge competitive waves, and has resulted in a greater number of cheap and accessible broadband packages being available on the market.

"We fully expect a further price war before the summer as a result of mergers, acquisitions and local loop unbundling which could result in broadband connections being widely available for less than £10 a month," he said.

The reality is, to put it mildly, rather different from the picture painted by McLeod.

So you're thinking: what does unbundling mean again? Basically, it means that competitors can purchase and place their own equipment in the exchanges of the incumbent telco, and use that equipment to deliver service over the "last mile" of copper, at a price related to the cost on the incumbent. It's not cost-free, and in New Zealand, perhaps only Ihug, TelstraClear and Orcon would do so in the short term (Ihug has already announced its spending plans from the day of unbundling). In Britain, hundreds of millions of pounds are being invested in delivering services over the unbundled network.

Amid all this, reports Public Address reader Andrew Kivell, the British broadband market has swung back to competition on line rate: "8Mb is the new 2Mb, and 20+Mb is available. My 'slow' 2Mb costs a flat rate £15/mth (5 beers in Universal Currency) with no download cap, no fixed contract term, and an upgrade to 8Mb as soon as the exchange is enabled." Our geographical isolation from the core Internet will always have a bearing on price and service here, but I think this reiterates that it's in the higher-end broadband products that we're most poorly served.

The British regulator's report had another line of considerable interest: "There are no Disputes in progress at the present time." In a market where there is "a dispute in progress" most of the time that sounds pretty damn good.

But here's the thing: almost all the growth in broadband connections worldwide is in DSL Even in the US, where broadband Internet has been dominated by cable TV providers who worked out how to repurpose their coaxial networks for Internet access, more than half of the new connections are DSL. Those unglamorous copper wires are much more important than anyone thought they would be 10 or 15 years ago.

Unlike Canada, New Zealand did not have the advantage of dot-com era telcos coming in and laying fibre like crazy, then going belly-up, leaving thousands of kilometres of cable in the ground as a sunk cost. The reality is that there will never be a big-bang installation of residential cable in New Zealand. At best, fibre to the home will grow incrementally, but the degree of investment implied by a pervasive new residential network is currently a fantasy. Most of that new fibre will be installed by Telecom, not any new entrant. But the kind of investment implied in unbundling - from tens to hundreds of millions - that's possible. Britain has shown that.

At this point, the promise of wireless data services is usually invoked. I have one of those myself: Wired Country via Ihug. I cling to it, even though Wired Country is a bit of a shambles, and Ihug would like to move me to cheaper DSL, because as a 2Mbit/s synchronous connection, it kicks Telecom DSL into next week. Woosh Wireless may have sorted out its technical issues by now, but its residential service offerings are abysmal. BCL shows no sign of moving into the residential market and, even with WiMax looming, I'm still waiting for someone to show me that wireless will be anything more than a niche.

So what's the problem? As McLeod points out, nearly all New Zealand homes now have the choice to pony up for broadband. A lack of market dynamism is the problem: a lack of competition on price and service. Telecom's miserable contention rates are a symptom of that problem. The contention rate is the ratio between the bandwidth flowing out from an exchange to individual users, and the bandwidth provided to that exchange. It would be silly and uneconomic to offer a contention ration of 1: that is, if you had 1000 people on 2Mbit/s DSL connections to an exchange, you'd provide 2 gigabits into it from the network - effectively assuming that everyone will be using their full 2Mbit/s all the time. It would be like designing a roading system that didn't slow down at rush hour, but looked kind of empty every other time.

Elsewhere (the UK, for example), a minimum contention rate for residential use is about 50 (it is often a good deal lower). For business customers, it’s more like 20, and in competitive markets, business customers can affordably demand contention rates of 1. Telecom's contention rate is around 80, and - amazingly - the rate for its new 3.5Mbit/s service (so warmly hailed by McLeod) is said to be 148. That's a joke. But why should Telecom do any different? Because almost all broadband in New Zealand is a Telecom service resold on Telecom's terms, it is hardly at any competitive risk. In the 1990s, the Commerce Commission declared Telecom "the de facto regulator" in its own market. We have a regulator now, but things aren't so different.

Telecom dictates the speed, terms and price of any DSL service offered in New Zealand. The revised Telecommunications Act holds out the possibility of a major competitor being able to offer the service of its choice, subject to Telecom's technical support (ie: about 8Mbit/s, although DSL now potentially runs up to 24Mbit/s for users close to an exchange), but not without spending a long, long time in court, and out of the market. Telecom simply has no incentive to permit a service enhancement it doesn't feel like offering itself. No prizes for guessing why the market is a bit dead.

Yes, the number of New Zealand broadband connections grew nearly 70% between Q3 2004 and Q4 2005, but that's still less than Thailand, India, China, Pakistan and Australia, in the Asia-Pacific region alone. And were it not for a modest extension of regulation and accompanying government pressure, it's hard to believe we'd have done that well.

So, anyway, I've been leery for a long time about local loop unbundling, for reasons related to those cited by McLeod - it's a difficult step this far down the line. But the reality of the world economy in telecommunications is such that I'm over the leeriness. If it's not full LLU, then the government will need to impose some complex regulatory requirements on Telecom. LLU has the advantage of relative simplicity.

Full LLU would also, of course, immediately introduce something that the nearly 20 years since corporatisation has conspicuously failed to deliver: nationwide competition on residential voice calling services. (My Wired Country connection includes an IP-based phone service from Ihug: it's louder, clearer and has many more features than our Telecom phone. Imagine if you could have your pick of such services via your existing phone line. Would you like that?)

McLeod's column hails the progress of Vodafone in our "competitive" mobile calling sector, without acknowledging that the benefits of that competition have failed to flow through to the consumer: our mobile termination rates (especially when calling from fixed lines) are the highest in the OECD. Theories must be subject to evidence, and the evidence of two decades of "light-handed" regulation is not impressive.

Frankly, I think Telecom can rise to the challenge. It has shown excellence in the past, most notably in the work of the team (of which Theresa Gattung was part) which responded to the sudden challenge to the telephone network when the Internet went mainstream in the mid-1990s, and people suddenly started spending hours, rather than minutes, "on the phone". Will there be perverse effects? Probably. Every bit of regulation from the Kiwi Share on has had its perverse effects. There will probably be compensation involved - money out of your pocket and mine. But I simply do not believe those effects will outweigh the benefits of unbundling in the interests of genuinely competitive exploitation of the only pervasive network we’re likely to have for a long, long time.