The European telecom sector is faced with significant challenges in terms of rapidly emerging new technologies and new forms of competition and business models driven by these technology changes. 2015 will be a pivotal year for European policy makers, regulators and competition watchdogs to improve the environment for the European telecom sector. Regulation is the single most important driver in the telecoms sector. HSBC’s Global Regulatory Heatmap report[1] aims to take the regulatory temperature globally and to identify those countries where regulation is most and least supportive of investment, and then to assess how the world’s largest operators are exposed to these conditions. The report shows, that the European region has faced the harshest regulation, although there are now encouraging indications the environment here is starting to improve.
The telecom sector is widely regarded as an enabler of innovation, productivity growth and international work sharing in the context of an increasingly competitive and globalised economy. Academic research indicates that economic progress in any given country is driven less by the mere arrival of new technologies, and more by the speed, breadth and depth of their adoption. Consequently, it is tremendously important that network operators invest heavily so as to ensure that the latest telecoms technologies are available on as ubiquitous a basis as possible.
Network investment is important for another reason also: as set out in HSBC’s Supercollider report[2], it can be clearly demonstrated that the primary driver of lower prices in telecoms is CAPEX. In deploying more of the most modern systems, operators take advantage of new technology that is the basis for innovation, capable of handling traffic with greater efficiency, and thus at lower unit cost[3]. Lowering unit costs and prices should be a primary policy goal, as it is this that enables the development and adoption of novel applications and contributes towards productivity growth in the broader economy. However it has to be mentioned that there is a Babylonian confusion in the public debate on “price” meaning either the monthly bill or the price per unit (MB, text, minute voice).
This obviously raises the question of what might induce operators to raise their CAPEX, and here the empirical evidence is plain. The most effective driver of higher network spending is higher EBITDA margin for MNOs and competition[4], as this gives MNOs both the means and the incentive to invest. The central challenge facing regulatory policy makers is therefore how to best to secure a benign investment environment, in which healthy margins support heavy CAPEX. To this end it has to be kept in mind, that regulation is the single most important driver for securing EBITDA margins.
However, the current regulatory framework in Europe lacks incentives to invest and shows clear signs of obsolescence. Therefore it should be fundamentally overhauled in the course of the next framework review process. To name only two examples of obsolescence: (1) The current framework is too narrowly focused on legacy apps, still centered around traditional voice telephony, text messages and broadcast TV, now just legacy applications of a much bigger space: i.e. the digital services. (2) The current framework is inherently slow, leading to inappropriate multi-year/multi-step iterative procedures that fail to keep pace with market and technology evolution.
Along the future regulatory trajectory in Europe, there are a series of challenging issues andrequired steps for regulatory modernization to be dealt with. When defining the trajectory of regulatory modernisation, Europe should avoid going for incremental improvement and rather aim at an ambitious scenario and step in a “Virtuous Circle”, based on innovation, investment and smart regulation (“Regulation 2.0”)[5]. The following listing of issues is not comprehensive; the order of listing does not indicate priorities:
(1) From traditional telco services to internet-based ecosystems – SMP regulation: In the telecom legacy world, telcos acted as gatekeepers aiming at monetizing single products or integrated value chains. Now, ecosystems controlled by the internet giants (OTT players or ‘edge providers’) are the new competitive engines that capture and deliver value. These competitors were never foreseen by regulators, and yet have amassed customer bases that dwarf those of even the largest telecoms companies (for example the merged Facebook – WhatsApp conglomerate). The emergence of such powerful forces does prompt the question of whether conventional regulation of the sector, stratifying the industry between incumbents obliged to provide wholesale capacity and resellers able to obtain this capacity on favourable wholesale terms, still remains appropriate.
(2) New regulatory bottlenecks: driven by the changes described earlier, traditional regulatory bottlenecks, like access to infrastructure will become less important or even become obsolete whereas access to the huge data collection and processing capabilities of the OTTs will be (or is already!) a crucial bottleneck for all players in the digital services sector to be dealt with.
(3) Market definitions: Will the current set of ‘recommended markets’ (even the most recent revised list of recommended markets) be a future proof instrument for regulators and competition authorities? Looking at the Facebook – WhatsApp merger, access to data collection and processing, the ‘machine room’ of the internet giants seems to be a relevant topic for market definitions. Market definitions need to get broader, more flexible and include OTT. They may also be either extended beyond national borders, or defined at a sub-national level[6]. In other words, will we continue to differentiate among separated vertical markets and spend considerable time and resources for their definitions and updates, whilst cross-subsidized business models exploit and profit shifts?
(4) Definition of services and categories, SMP-based regulation: The names and definitions of the current regulatory categories of “Information Society Services” and of “Electronic Communications Services” used in the European regulation, have become obsolete. The obligations associated with these categories should be reorganized as well as the legal instruments to be used. Luisa Rossi[7] (Orange) recently pointed out that, “…the old rules are no longer adequate and yet still apply, while new issues are not addressed and require action. This is why it is now important for the legislative framework and regulatory practices to embrace this phase of development… The starting point for the reforms should be the creation of a digital services categorywith the reclassification of traditional communication services, followed by the reorganisation of the associated obligations such as transparency and non-discrimination, security, privacy, data retention, emergency services, interoperability and portability. Hence, digital services would be subject to a common set of rules enshrined in a new horizontal European legislation, whichever the provider or the technology used. Such an approach should be preferred to sector specific rules.“
(5) Reciprocal regulation: Corporates from neighbouring areas of the economy such as payTV – to give just one example – have the right to purchase telecoms infrastructure, without there being the reciprocal right of telecoms operators to purchase exclusive media content on a similar basis.
(6) Preference for investments in infrastructure: While it may be desirable to address bottlenecks, such as in the access to fixed-line or even mobile infrastructure (via measures such as unbundling and MVNOs respectively), is it really desirable that those reselling the capacity should have an advantage over those building it? The consequence of this tilt to the competitive landscape will be that less infrastructure is deployed.
(7) Modernizing Competition Policy: DG COMPETITION statements referring to Austrian consolidation discuss the lack of an entrant as if it was a failure – on the contrary, it was a successful experiment to determine whether there was economic viability for a fourth player, and the answer was clear: there was not. A negative outcome from an experiment is not a failure (Karl Popper on ‘Falsifiability’ [8]). Let dynamic efficiency gains work! Current competition policy and practice obviously overlooks that a growing part of the entire digital services market (OTTs) is completely unregulated and the remainder – much smaller part of the digital services sector – is strongly micro-regulated. A recent set of papers by Papai and Csorba[9] casts doubt on the assumption that introducing more mobile competitors into a national market is necessarily better for consumers. Forget the mantra of the crucial importance of the famous ‘forth player’, there is no special magic in the number “four”!
(8) Regulator’s dilemma and challenges: Legislators and regulators have two principal choices in this debate; full de-regulation or continued (selective) regulation. Key issues are: is regulation really capable of specifying how markets should function? Most would concede this is something that is easier to achieve in industries subject to a slower pace of technological change and disruption, such as utility businesses. By contrast, in telecoms the scope for disruptive technologies to transform the industry (for example, mobile, WiFi, voice over IP, OTTs, etc.) makes the system far more chaotic. Given this inherent unpredictability, one group argues that there is an argument for allowing the market to take its natural course and that the competitive dynamics of an industry subject to Moore’s Law are perfectly sufficient. On the other hand, those who do wish to see continued regulatory intervention argue that the question is rather how better to identify those areas that would benefit from it. The so-called ‘three criteria test’ remains the preferred yardstick (the presence of sustained barriers to entry, the absence of effective competition, and the inadequacy of existing competition law to deal with the issue). In any case, regulators should do their utmost to stay updated with leading edge developments, technologies and innovations on a global level to understand better the markets on the move and to base their decisions on these insights.
(9) Spectrum Policy: Europe’s method of allocating spectrum is one of the least harmonised and least efficient on a global scale. Most industry parties agree that there is an urgent need to harmonise this process, in terms of awarding methods, coordinating the timing of awards, the duration of usage rights and the conditions on which spectrum can be traded. One possibility could be the creation of pan-European licences. However, any such proposals (as per those in the “Connected Continent” (or “Telecom-Single-Market”) proposal seem bound to raise concerns amongst the member states. Stronger instruments for the harmonization of timetables and awarding methods, license durations when assigning new spectrum are urgently needed. In particular, Europe should be quick and harmonized in allocating and assigning spectrum for mobile broadband in the 700MHz band (2nd digital dividend). Measures should include: (1) No – or significantly higher – spectrum caps, (2) Perpetual usage rights with ‘use it or lose it’ rule imposed, (3) Fostering secondary spectrum market.
(10) Net Neutrality: The EU legislation on net neutrality should allow operator innovation with specialized services, which will be a key for 5G, subject to transparency and other appropriate safeguards. This is also a question relevant for the competitiveness of the European industry. If the US will be allowing for the equivalent of specialized services in the future (which is an open issue for the time being), so if EU operators are not able to innovate with specialized services, such innovations will likely happen outside the EU, in places like the US. An example would be the Connected Continent proposals on net neutrality, which initially amounted to a very judicious compromise in the eyes of many industry experts, but which was subsequently heavily modified in the European Parliament.
(11) Change process in EU: Perpetual regulatory intervention tends to necessitate more and complex legislation, and the legislative process is itself fraught with risk, since there may be a tendency for positive proposals to be diluted or even reversed when these highly complex topics are debated.
(12) Benefits of scale: Scale already plays an important role within the industry, and in future there will probably be opportunities to extend scale effects still further: for instance, as platforms standardise around IP technology, greater cross-border synergies should become feasible. This is welcome, since many recent regulatory reforms (such as with regard to termination rates and roaming charges) have arguably reduced the incentive for cross-border consolidation.
(13) License to fail: In a dynamic and competitive market, there will, by necessity, be companies that fail. Indeed, the very fact that there are losers actually indicates the success of competition. However, European regulation has often shied away from recognising this. For example, it has been particularly difficult to use the ‘failing firm’ defence to justify a merger – including in those cases where financial investors would have concluded that the target company could not sustain the level of network and customer investment required to be able to compete effectively. Even those industry observers looking for regulatory reform rather than programmatic de-regulation agree that the consolidation of smaller players (thereby creating stronger entities with margins better able to support investment) would be a powerful positive – hence the widespread support for four to three in-country mobile consolidation.
In conclusion, there is much agreement amongst industry experts that the current regulatory framework in Europe shows clear signs of obsolescence and should be without further delay fundamentally overhauled. All sides call for a more cohesive approach, and the formation of a coherent industrial policy for the telecoms sector, so that it is better able to compete against its global rivals – in terms of investment ability, innovation adoption, network capability and attractive unit pricing.
Acknowledgements: This article reflects recent work for my clients as a Senior Advisor to Arthur D. Little (ADL) and as an independent consultant. It is strongly inspired by the work with GROUP20, an independent, non-partisan think-tank, organized by Stephen Howard (HSBC Global Research) and myself; Special gratitude goes to Stephen Howard, Scott Marcus (WIK), Richard Swinford (ADL), Andrea Faggiano (ADL), Vikram Gupta (ADL) and Paul Pisjak (RTR) for many inspiring inputs and fruitful discussions.
Literature:
- Luisa Rossi (Regulatory Affairs, Orange): „Proposal for the reform of the regulation of digital services“ (2. December 2014)
- HSBC Global Telecoms – Regulatory Heatmap (27. October 2014)
- Gergely Csorba & Zoltán Pápai: „Does one more or one less mobile operator affect prices? A comprehensive ex-post evaluation of entries and mergers in European mobile telecommunication markets“ (23 October 2013), ITS Conference, Florence
- Philippe Aghion et al: “Competition and Innovation: An Inverted-U Relationship”, The Quarterly Journal of Economics (May 2005)
Footnotes:
[1]Literature list (2)
[2]https://www.research.hsbc.com/R/20/QwKEJII5xmsz
[3] As pointed out in the Supercollider Study, this mechanism is a classic example of dynamic efficiency gains in action
[4] In the absence of competition, this policy could lead to the creation of a monopoly offering the highest margins without any incentive to invest. See also Philippe Aghion’s paper on the relation between ability and incentive to invest and relevant margins: „Inverted U“ (Literature list 4).
[5]http://www.serentschy.com/wp-content/uploads/2014/02/The_Virtuous_Circle_Buch-download.pdf
[6] See the current initiative from German regulator Bundesnetzagentur (BNetzA)
[7]Literature list (1)
[8] Karl Popper: „Falsifiability is the criterion of science; Falsifiability = the logical possibility of being proven false by observation”
[9] For example, literature list (3)