Broadband, Information Society, and National System in Japan

Transcription

1 Martin Fransman ed. Broadband, Information Society, and National Systems Stanford University Press, forthcoming Broadband, Information Society, and National System in Japan Takanori Ida Associate Professor, Graduate School of Economics, Kyoto University Yoshida, Sakyo, Kyoto Japan Tel&Fax: I would like to thank Professor Martin Fransman (the editor of this book) for his helpful advice on writing this report, and Adam Peake for providing me with useful materials to work from. I would also like to thank Hideyuki Ohashi and all the staff at the Ministry of Internal Affairs and Communications who worked with me on a joint study to assess the effective competition in Japan s telecommunications. Most of the data presented here was taken from this effective competition review. 1

2 1. Introduction A broadband big bang has swept through various parts of Asia including Japan and South Korea, where the popularity of broadband services has grown explosively. But why did this happen? It is indeed a puzzle, as Professor Fransman has said. In the lost decade of the 1990s, Japan suffered from the collapse of the bubble economy ( ) and the prolonged period of recession that followed it. The Nikkei Stock Average which had once topped $352 ($227 in terms of PPP) fell less than $100, and negative economic growth was also recorded. 1 Finance businesses found themselves in difficulties with bad loans, manufacturing industries were plagued by deindustrialization, and structural reforms of the Japanese economy were never completed. But in the midst of this economic turmoil, the telecommunications industry began a sudden spurt of growth in 2000, especially in the ADSL and FTTH markets, and is now leading the world in terms of price and service standards. Professor Fransman attributes this boom to a combination of vicious competition and strong regulation by the Japanese government. Based on his discussions, I will argue that these factors originate from damaging interactions between NTT and newcomers to the telecommunications market, and from the policy of deregulation that developed due to the fact that NTT was not broken up. Japan s broadband market first started to take off in 2001 when SoftBank BB joined the ADSL market with aggressively low prices. ADSL users greatly appreciated the always-on connectivity and low pricing offered by this service. However, they were not so happy with the communication speeds because the speed of ADSL is highly asymmetric (the download speed is much faster than the upload speed) and because the effective transfer rates drop dramatically with increasing distance from the local 1 In the rest of this report, an exchange rate of $1= 108 and an OECD PPP rate of $1= 137 are used based on the 2004 statistics published by the OECD. 2

3 exchange. It is therefore likely that ADSL users will eventually migrate to FTTH out of necessity. The cost of FTTH services was originally much higher than ADSL. But in 2002, K-Opticom (a subsidiary of Kansai Electric Power Co., Inc.) broke into the FTTH market with their own optical fiber network, thereby initiating competition in terms of the installed equipment base. This led to a rapid reduction in the price of FTTH, almost eliminating the price differential with ADSL. SoftBank BB were able to participate in this price war because NTT had been strongly regulated into providing line sharing at very low prices. Also, while NTT was duty bound to allow other carriers to use its optical fibers, the electric power companies were able to participate without this obligation. This bias against NTT benefited its competitors. But why was NTT able to financially endure these excessively harsh regulations? To put it simply, it is because NTT is a comprehensive communications provider that includes both fixed-line and mobile phone services. In particular, its profits from the rapidly growing mobile phone sector allow it to accommodate deficits in the fixed-line phone sector in an implicit way. Abundant resources of capital are important for making the transition from old public exchange phone networks to new optical IP networks. The NTT group had the money to achieve this. However, the broadband big bang is causing a new problem, which is being called the digital divide. Optical IP networks now offer complete coverage of urban districts, but have made little progress in the provinces. Furthermore, in provincial regions there are more households with single old-aged occupants, and IT literacy levels are very low. Since there is no demand for broadband in the provinces, it has been argued that there is no point installing optical fibers in these regions. Personally I am opposed to this view. Broadband is not just a faster means of accessing the Internet, it is a means of providing public services such as HDTV broadcasts, remote medical checkups and consulting, remote education, and remote administration. The people most likely to benefit from these public services are probably the less IT-savvy members of regional communities where the transport situation is not so good. Therefore, since the introduction of broadband services has so far relied on competition between NTT and 3

4 newcomers in urban areas, the government will eventually have to lead the way in closing the digital divide in the provinces. These are the main points I will be making in this chapter, which is structured as follows: Section 2 discusses the reasons behind the success of the broadband big bang in Japan. Section 3 describes the broadband services available in Japan, especially ADSL and FTTH. Section 4 discusses the digital divide and measures for overcoming it, and the conclusions are presented in section The reasons for Japan s success In the 1990s, Japan s telecommunication industry was said to be lagging 10 years behind Europe and the US. But the broadband big bang that started in Japan in the following decade attracted a great deal of attention from overseas. This turnaround in the fortunes of Japan s telecommunications industry probably looked like a puzzle to foreign analysts. According to an analysis by Ida (2005), the factors behind the success of broadband in Japan are: (1) unintentional benefits of Japan s telecommunications policy; (2) intentional benefits of Japan s telecommunications policy; (3) the appearance of newcomers with strong capabilities and desires; (4) reluctant but concerted efforts by NTT s management. These factors are discussed in detail below. 2.1 Unintentional benefits of Japan s telecommunications policy Unintentional benefits occurred because NTT was not broken apart like AT&T. The fact that NTT was left intact was advantageous when it came to installing a nationwide optical fiber network. The events relating to the proposed breakup of NTT are summarized below. In 1982 the Second Administrative Examining Committee proposed breaking up NTT public corporation; in 1985 NTT public corporation was privatized, and the 4

5 breakup of NTT was to be reconsidered within 5 years; in 1990 the telecommunications council issued another report on the breakup of NTT; in 1991 NTT breakup was to be reconsidered after 5 years according to government measures ; in 1996 Telecommunications Council published final report on NTT breakup (source: Ministry of Internal Affairs and Communications; 2. In December 1996, the Ministry of Posts and Telecommunications and NTT finally reached the following agreement: 3 (1) NTT is to be reconfigured under a holding company into separate regional companies for the east and west of Japan, and a long-distance company. (2) The system of subsidiary companies must allow NTT to make inroads into the international communications arena. This compromise agreement is said to have been influenced by the then Prime Minister Ryutaro Hashimoto who wanted Japan to have a strong flag carrier. These 15 years of discussion over NTT s breakup had a beneficial effect on its investment in optical fibers. In 1990, to resist the breakup proposals put forward by the Ministry of Posts and Telecommunications, NTT unveiled its plans for contributing to society with a VI&P (Visual, Intelligent and Personal Communication Service) concept 2 The council s report called for a regrouping of NTT along the following specific lines: (1) NTT to be regrouped into a long-distance carrier and two separate regional carriers for east and west Japan. (2) The long-distance carrier should be completely privatized, and should admit competition in international communication, CATV, content provision and regional communication services. (3) The regional carriers should be administered as semigovernmental corporations for the time being, but should admit competition from other carriers between regions. 3 In January 2001, the Ministry of Posts and Telecommunications was regrouped together with the Management and Coordination Agency and the Home Affairs Ministry to form a new Ministry of Internal Affairs and Communications. In this report I will use the titles applicable at each point in time. 5

6 based on B(Broadband)-ISDN, and announced that it would finish the installation of a nationwide optical fiber network by NTT s announcement of the VI&P concept is said to have pre-empted US vice president Al Gore s proposal of an information super-highway in Once the US began to stir, the Japanese government hurriedly established a bureau for the promotion of an advanced information and telecommunications society in 1995, and stated that their fundamental policy was to establish a nationwide optical fiber network by In the middle of the arguments over the breakup of NTT, it was essential that the first proposals for the installation of Japan s optical fiber network should come from NTT rather than the Ministry of Posts and Telecommunications. Since the 1990s, NTT East Japan and NTT West Japan have continued to invest over $200 billion ($157 billion in PPP) in optical fiber installation. This flow remained unaffected by the regrouping of NTT. The area coverage of NTT East/West is shown in Table 1. Table 1. The area coverage of NTT East/West (est.) Urban areas 60/50 65/56 84/68 82/84 95/92 98/93 Provincial towns 36/25 43/37 62/43 78/66 86/86 88/89 Other 19/10 29/17 41/36 49/50 55/63 57/64 Total 41/29 48/37 66/50 76/67 81/80 83/81 The numbers either side of the slash represent the coverage rates of NTT East (left) and West (right). Source: NTT East and West 6

7 At present, NTT s installation of nationwide optical fiber facilities is getting close to achieving its target. Japan s optical fiber facilities are a side-effect of the contention surrounding NTT s breakup, and the fact that NTT was not broken up contributed to the ongoing investment in optical fibers. 2.2 Intentional benefits of Japan s telecommunications policy An intentional benefit was the government s policy of thoroughly deregulating NTT s regional communications networks. The excessively harsh and imbalanced regulations imposed on NTT helped to promote the activities of many newcomers, and as a result NTT s infrastructure ended up being used efficiently by the whole society. The process behind this deregulation policy is summarized below. In 1987 an additional charge scheme was used whereby long-distance NCCs paid NTT charges for local calls, with no interconnection charge system in place; in 1994 an interconnection charge system was introduced by the communication carriers, whereby public network interconnection charges were calculated based on historical expenses; in 1999 dry copper unbundling was introduced and line sharing started; in 2000 public network interconnection charges was determined based on long-run incremental costs (LRIC) and dark fiber unbundling was introduced; in 2001 regional IP network unbundling was introduced (source: Ministry of Internal Affairs and Communications; Two major consequences of Japan s broadband big bang were the appearance of line-sharing in 1999 and dark fiber in Thanks to the policy of thoroughly open access to NTT s regional communications networks and optical fibers, it became possible for newcomers to offer ADSL and FTTH services without having their own infrastructure. The degree of openness of Japan s regional communication networks in 2001 compared with foreign networks is summarized as follows: (1) Japan: LRIC introduction (Good), Metal unbundling (Good), Optical fiber unbundling (Good); (2) US: LRIC introduction (Fair), Metal unbundling (Fair), Optical fiber unbundling 7

8 (Fair);(3) UK: LRIC introduction (Good), Metal unbundling (Good), Optical fiber unbundling (Bad);(4) France: LRIC introduction (Bad), Metal unbundling (Good), Optical fiber unbundling (Bad); (5) Germany: LRIC introduction (Bad), Metal unbundling (Good), Optical fiber unbundling (Good). Although the Ministry of Posts and Telecommunications was unable to bring about a breakup of NTT, it thoroughly supported NTT s local loop unbundling (LLU), and as a result the regional communications networks became more open in Japan than in any other country in the world. It should also be noted that low charges were set for line sharing and dark fiber. NTT calculated that the initial line sharing cost would be $3.7 ($2.9 in PPP), but this was eventually brought down to $1.7 ($1.3 in PPP). NTT also claimed that the dark fiber cost of subscriber systems would be $185 ($146 in PPP), but this was brought down to $73 ($57 in PPP) during trial service provision, and to $48 ($38 in PPP) during full-scale provision. This LLU policy with low charges forced NTT to slash its cost prices, allowing a wide range of newcomers onto the scene. NTT was able to withstand these harsh deregulation policies thanks to the rich financial reserves of the intact NTT group (especially NTT DoCoMo). 2.3 The appearance of newcomers with strong capabilities and desires To understand how the broadband big bang occurred in Japan, it is important to consider the arrival of newcomers with strong capabilities and desires. In particular, the presence of SoftBank BB in the ADSL market and K-Opticom (a subsidiary of Kansai Electric Power Co., Inc.) in the FTTH market cannot be overlooked, as these companies came to dominate the market in terms of price. In fact, NTT East and West were only just able to keep up with their low-price strategies. ADSL services first became available in Japan in 1999, but they made very little progress because of their high cost and restricted service areas. ADSL did not take off in Japan until 2001 when SoftBank BB joined the ADSL market with a monthly charge, including ISP fees, of $21 ($17 in PPP), which is half what NTT were charging. 8

9 SoftBank Japan is a PC software company which was founded in 1981 by Masayoshi Son. The history of this company is summarized below. In 1981 Masayoshi Son established SoftBank Japan; in 1996 SoftBank invested as a primary stockholder in Yahoo! Inc.; in 1998 the stock was listed in the First Section of the Tokyo Stock Exchange, and SoftBank introduced a holding company system; in 2001 Yahoo! BB (8M) ADSL services launched; in 2002 Yahoo! BB12M launched, and the number of subscribers topped 1 million; in 2003 Yahoo! BB 26M launched, the IP phone services launched, and the number of subscribers topped 3 million; in 2004 Yahoo! BB 45M launched, and SoftBank began field trials of 3G mobile phone services, and the number of subscribers topped 4 million (source: SoftBank; By forging links with other companies such as Microsoft, Sony and Tokyo Electric Power, SoftBank has started various forms of communication and broadcasting businesses, but so far without success. Of the services started by SoftBank, only the ADSL services have come to anything. However, even the ADSL business is unsuccessful as far as SoftBank is concerned. Although SoftBank originally aimed to turn a profit after reaching 1 million subscribers, it was still $810 million ($640 million in PPP) in the red in 2003 despite having passed the 3 million subscriber mark. It has been predicted that losses in the broadband sector will decrease after 2004, but it seems very likely that the ADSL market will sooner or later be absorbed by the FTTH market. So although SoftBank may have fired up the ADSL market, it has not yet succeeded in this business. Meanwhile, NTT East and West have had no choice but to follow SoftBank s lead in price reductions, resulting in Japan having the cheapest and fastest broadband connections in the world. In other words, the winners of the price war in Japan s ADSL market are consumers, not businesses. SoftBank will probably move from ADSL services into FTTH services at some point, but they are unlikely to have a smooth ride along the way. But without SoftBank s dynamic influence, Japan s broadband big bang would probably never have happened. 9

10 If SoftBank was responsible for getting the ADSL market moving, then the prime mover behind the FTTH market is probably K-Opticom 4. K-Opticom is a subsidiary of Kansai Electric Power Co., Inc. a brand name to rival NTT West and is aiming to compete on the basis of its own optical fiber installations, which are completely independent of NTT s optical fibers. The history of K-Opticom is briefly summarized below. In 1988 K-Opticom was started up as a communication equipment service for the Kansai region; in 2000 it acquired a type 1 telecommunication carrier s license; in 2002 the eo FTTH services launched; in 2004 it slashed the cost of eo services, and optical IP phone services launched (source: K-Opticom; K-Opticom inherited an electrical communication network from Kansai Electric Power, and it also had no problems finding ducts and telegraph poles to use for the installation of optical fibers. Due to this advantage, K-Opticom has achieved a coverage of 70% of households, and is now able to provide FTTH (100M) connections for a charge of just $58 ($46 in PPP), including ISP charges. 5 Apart from NTT, only electric power companies are able to compete on the basis of their own installed equipment. Power companies also have greater freedom because, unlike NTT East and West, they 4 Note that Tokyo Electric Power Company (TEPCO), the largest electric power company in Japan, started late on providing the FTTH service, compared with Kansai Electric Power. The reason for this is that the company-wide cover-up of the troubles of atomic power generators was revealed in 2002; the president of TEPCO took responsibility for it and resigned, and TEPCO was obliged to refrain from developing new businesses on a large scale for some years. However, TEPCO has aimed a recovery in the FTTH market since Accordingly, the competition in the FTTH market will become fierce even in East Japan including the Tokyo metropolitan area. 5 They also achieved an operating profit in 2003 when they purchased Osaka Media Port. 10

11 are not duty bound to provide a universal service or to let anyone else use their optical fiber facilities. In 2004, K-Opticom cut its prices by 20% and began providing optical IP phone services with quality guaranteed to be on a par with fixed-line phone services. So it appears that NTT s ultimate rivals are electric power companies. 2.4 Reluctant but concerted efforts by NTT s management After NTT Co. was privatized, it became embroiled in a dispute with the Ministry of Posts and Telecommunications over the breakup plans, and it has trod a thorny path ever since. The changes that took place in NTT between its privatization in 1985 and the regrouping in 1999 are quite surprising: for example, (1) the number of employees fell from 313,600 (in 1985) to 138,200 (in 1999); (2) the number of branch offices, from 70 to 11; the number of branch stores, from 1,700 to 47; (3) the number of telephone subscribers, 45,300,000 to 58,470,000 6 ; (4) long-distance call charge (for a 3-minute daytime call), $3.7 ($2.9 in PPP) to $0.8 ($0.6 in PPP) (source: NTT East and NTT West; As a result of shedding ten thousand employees per year, the number of employees has decreased by 175,400, which is more than half the number of employees in NTT has also substantially rationalized its branch offices and branch stores. Meanwhile, the number of telephone subscribers has increased, while call charges have plummeted. In the middle of this desperate management rationalization, NTT aimed to soften the calls by the Ministry of Posts and Telecommunications for a breakup of the 6 The number of subscriber telephones peaked at million in 1997, and has been declining since then. 7 However, 72,600 of these positions were outsourced, so the number of acute job losses was 100,

12 company, and to respond to criticisms from the long-distance NCCs. In either case, the management efforts made by NTT after privatization have to be highly regarded. But when NTT was regrouped in 1999, the structure of the industry changed from fixed-line voice services to mobile and IP services, and the financial situation of NTT East and West rapidly deteriorated due to the appearance of competing policies such as the introduction of MyLine carrier selection services and long-run incremental costing. It became clear that NTT East and West would not survive this competition unless they underwent further drastic management rationalization. Therefore in 2002 NTT East and West implemented the following structural reforms: (1) a total of 100,000 positions, including 60,000 from NTT East and West were transferred to outsourcing companies, and their salaries were cut by 15 30%; a further 16,400 jobs were lost through voluntary retirement; as a result, personnel costs were cut by a total of $1 billion; (2) cuts were also made in various other forms of expenditure, such as investment in facilities. As a result, overall costs were reduced by $1.5 billion. Assuming the management rationalizations carried out at NTT before the regrouping were the result of external pressure, the structural reforms they made after regrouping were performed under their own volition as a matter of survival. The managerial status of NTT East and West after the regrouping is shown in Table 2. Table 2. The managerial status of NTT East and West NTT East Japan Turnover 259 (204) 238 (188) 218 (171) 210 (165) ( 7.7) ( 8.6) ( 3.3) Operating profit 3.1 (2.5) 0.4 (0.3) 4.5 (3.5) 8.0 (6.3) Ordinary profit 1.3 (1.0) 0.7 (0.5) 5.9 (4.6) 9.1 (7.1) NTT West Japan 12

13 Turnover 244 (192) 223 (175) 205 (161) 201(158) ( 8.8) ( 8.0) ( 2.2) Operating profit 9.3 ( 7.3) 15.4 ( 12.1) 3.9 (3.1) 8.0 (6.3) Ordinary profit 9.8 ( 7.7) 15.8 ( 12.4) 4.2 (3.3) 8.4 (6.6) Units: $100 million ($100 million in PPP). Percentage growth shown in brackets. Source: NTT East and West After the NTT regrouping, the turnover of NTT East and West steadily decreased. The fall in revenue from voice communication services was particularly severe. Due to the structural reform of NTT East and West in 2002, the management performance made a slight recovery. However, it is doubtful whether this recovery will continue because, with the growing popularity of broadband and increasing use of IP phone services, subscribers are canceling their fixed-line contracts so that NTT East and West do not receive any call charge revenues at all. That is why the NTT holding company published a mid-term management strategy in November 2004 to announce their plans to move away from phones into broadband: (1) promote the growth of high-speed broadband services, and aim for 30 million broadband service users by 2010; (2) by 2010, draw up concrete plans for switching the whole country from the fixed-line phone network to an optical IP network. Hitherto, NTT s structural reforms have mainly involved cutting back on personnel expenses. The structural reforms that NTT will face in the future involve dismantling the public exchange telephone network and installing a nationwide optical IP network. Moreover, NTT East and West will remain duty bound to provide a universal phone service and open up their optical fiber resources. This means NTT has a heavy social burden to carry. No matter how many newcomers appear on the scene, it is probably only NTT that is capable of providing broadband services on a nationwide scale. Ieyasu Tokugawa ( ), the first shogun of the Edo Bakufu government, 13

14 is reported to have once said, Peasants should be taxed not to death, but almost to death. It looks like the same could also be said of NTT. 3. The current state of the broadband market The growth of broadband Internet access in Japan has been remarkably quick. This section describes the current situation of broadband in Japan. Every month, the Ministry of Internal Affairs and Communications issues a report on the changing numbers of people using Internet service providers. From the end of 1999 to the end of 2004, the trends in narrowband Internet users and broadband Internet users were as in Table 3. Table 3. The trends in narrowband Internet users and broadband Internet users December December December December December December Narrowband Broadband ADSL FTTH CATV Internet Units: million users. Source: Ministry of Internal Affairs and Communications 14

15 Narrowband Internet users grew steadily until 2002, but then started falling again from On the other hand, the number of broadband Internet users remained very low until 2001, but the number of ADSL users grew explosively in 2002, and the number of broadband Internet users eventually overtook the number of narrowband Internet users in August By the end of 2004, about 70% of households were connected to some form of Internet service, comprising 35% narrowband users and 35% broadband users. A breakdown of the broadband Internet statistics is shown below. Every month, the Ministry of Internal Affairs and Communications issues a report on the changing numbers of people using broadband Internet service providers. Since the start of the broadband boom in 2002, the numbers of broadband (ADSL, FTTH, and CATV Internet) users have varied as in Table 3. First of all, it can be seen that Japan s broadband market is mainly growing in the ADSL sector. In 2003, the number of ADSL users passed the 10 million mark, making Japan the world s second largest ADSL user behind South Korea. These figures also show that FTTH is making solid progress, with the number of users exceeding 1 million in Japan is the first country in the world where the number of FTTH users has passed this milestone. As for CATV Internet users, although they now number more than 2 million, the rate of growth in this sector is not very large. Japan s broadband usage is thus not dominated by CATV Internet, unlike the US. With regard to the standard charges for these services, it could be said that Japan s broadband is the fastest and cheapest in the world. An ITU publication entitled Internet Report: the Birth of Broadband compared the Internet access speeds and charges of various countries to evaluate the charge per 100 kbps bandwidth. The results 15

16 show that Japan ($0.09) is far faster and cheaper than the US ($3.53) or UK ($6.37) although the report does not take the Japanese FTTH service into consideration 8. Next, I will discuss the demand substitution properties of broadband with reference to Ida and Kuroda (2004). This survey was implemented using a web questionnaire from the viewpoint of costs and efficiency, and obtained responses from a sample of 1013 users in environments were all five of the following types of ISP service were available: (1) fixed-line telephone dial-up (DU), (2) always-on connected ISDN, (3) ADSL, (4) CATV Internet, and (5) FTTH. After eliminating leaked entries and outliers from the results, a total of 799 valid samples were obtained. The selection ratios were as follows: DU: 2%, ISDN 5%, ADSL: 67%, FTTH: 8%, and CATV: 18%. Closer examination of the data shows that the average monthly expenditures (the sum of Internet communication charges and Internet provider charges) were as follows: DU: $37 ($29 in PPP), ISDN $48 ($38 in PPP), ADSL: $40 ($32 in PPP), FTTH: $55 ($43 in PPP), and CATV: $48 ($38 in PPP). The average nominal speeds of these services were DU: 52 kbps, ISDN: 65 kbps, ADSL: 10 Mbps, FTTH: 82 Mbps, and CATV: 11 Mbps. Broadband and narrowband differ widely in terms of price and speed, and even within broadband there are large differences between ADSL, CATV and FTTH. The reasons given for using ISP services were, in decreasing order, (1) searching the web: 44.7%, (2) %, (3) online shopping: 5.5%, (4) chat rooms & message boards: 4.2% (multiple responses were allowed in this question). Ida and Kuroda (2004) calculated the elasticity of demand for ADSL subscribers i.e., the ratio of the rate of change of monthly charges to the rate of 8 The detailed figures are: (1) Japan ($0.09), (2) Korea ($0.25), (3) Belgium ($1.15), (4) Hong Kong ($1.27), (5) Singapore ($2.21), (6) Macao ($2.56), (7) New Zealand ($2.71), (8) Canada ($3.25), (9) Holland ($3.36), (10) USA ($3.53), (11) Israel ($3.98), (12) Germany ($4.42), (13) Denmark ($5.81), (14) Austria ($5.89) (source: Internet Reports: Birth of Broadband, ITU, 2004). 16

17 change of subscriber access demand. As a result, they obtained a value of 0.8 which shows that ADSL is less elastic than FTTH (3.2) or CATV broadband (2.5) However, since the ADSL market is very large-scale, they calculated the elasticity separately for low-speed ADSL (1 1.5M), medium-speed ADSL (8 12M) and high-speed ADSL (24 40M), and obtained the following results: low-speed ADSL: 10.6, medium-speed ADSL: 2.6, high-speed ADSL: 9.1. To sum up, there is very little elasticity of demand in the market for ADSL, which is the current market leader, but when this elasticity is calculated separately for low-speed, medium-speed and high-speed ADSL, it can be seen that there is much more elasticity in the demand especially for low-speed and high-speed ADSL. This indicates that there is a significant influx and outflux of subscribers at the extremities of the ADSL market. The general status of Japan s broadband market has been described above, but in the following, the ADSL and FTTH markets are described separately. 3.1 The current state of the ADSL market At present (September 2004), 72% of Japan s broadband users are on ADSL connections. Let s start by examining the ADSL-market trends in line subscriber numbers at NTT East and West and at other communications carriers: Table 4. The ADSL-market trends at NTT East and West September 2002 September 2003 September 2004 NTT East Japan NTT West Japan Others

18 TOTAL Units: million subscribers Source: Ministry of Internal Affairs and Communications The number of ADSL subscriber lines is increasing every year, and had reached 26% of all households by September These figures prove that ADSL has been the driving force behind the growth of broadband services in Japan. The market share of NTT East and West has been decreasing from 41% 37% 37%, but has recently stabilized. This reflects the fact that NTT has faced fierce competition in urban areas but still has a large share of the market in the provinces. In fact, the recent expansion of the ADSL market is based on increased usage of ADSL in provincial regions. However, a few clouds have recently appeared on the horizon of the ADSL market. First of all, there are still large differences between different parts of Japan in terms of the percentage of households with ADSL connections. As of September 2004, Tokyo has the greatest coverage (35%), while Kagoshima prefecture has the lowest (15%). This is due to reduced usage in remote areas, because ADSL cannot be provided far from the exchange. Second, there has been a falloff in the rate of increase in the number of ADSL contracts. From 2002 to 2004, the rate of increase dropped from 28% to 12% and then to 6%. This probably means that the ADSL market is becoming saturated, and sooner or later the number of ADSL subscribers is likely to start falling as users switch to FTTH services. Next, let s look at the supply structure of the ADSL market. As of September 2004, the numbers of ADSL contracts from different providers break down as follows: NTT East and West, 4.74 (38%); SoftBank BB, 4.49 (35%); eaccess, 1.78 (14%); ACCA Networks, 1.25 (10%) (units: million subscribers; the numbers in brackets represent market share; source: Ministry of Internal Affairs and Communications; 18

19 Between them, the two leaders NTT East and West (38%) and SoftBank BB (35%) lead the ADSL market with a combined market share of 73%. For the top 4 companies, the combined market share rises to 97%, showing that the ADSL market is dominated by a small oligopoly. However, the price competition between these top four players is very fierce, and prices have come down a long way. This has been going on since SoftBank BB suddenly came in with a price of just $21 ($17 in PPP) in 2001, forcing NTT and the other carriers to cut their own prices substantially. This is illustrated numerically by the Table 5, which shows the change of standard ADSL charges (including ISP charges). Table 5. The change of standard ADSL charges March September September September NTT East (1.5M) 54 (43) 52 (41) 43 (34) 41 (32) NTT East (8M) 44 (35) 41 (32) NTT East (12M) 42 (33) NTT East (24M) 42 (33) SoftBank BB (8M) 21 (17) 21 (17) 21 (17) SoftBank BB (12M) 24 (19) 24 (19) SoftBank BB (26M) 25 (20) Units: $ ($ in PPP) Source: Ministry of Internal Affairs and Communications 19

20 These figures show how much SoftBank BB s involvement has broken down the prices. As a result of these low prices, SoftBank BB have managed to gain a market share comparable to NTT East and West in just two years. But although SoftBank BB originally aimed to break even after gaining 1 million subscribers, it is still in the red even with 4 million subscribers. SoftBank BB s aggressive pricing policy and billboard advertising campaigns may have been successful at gaining subscribers, they have not been able to translate these gains into increased profits. There is still a very large difference between the charges levied by NTT East and West and by SoftBank BB. But it is interesting to note that in spite of this difference, they both have more or less equal market shares. This is due to their different business models. The business model of NTT East and West is called vertically separated. NTT only sells ADSL circuit services, leaving users free to choose their own ISP. As a result, users have a great deal of freedom over their choice of circuit service and ISP, but they have to pay charges both to NTT and to their ISP. Accordingly, it is suitable for users who want to continue using the same ISP, even though they end up paying higher charges. On the other hand, SoftBank BB has a called vertically integrated business model, which means that they provide the ISP functions as well as the ADSL lines. SoftBank BB also ties these services in with its BB phone IP phone services. As a result, users have no freedom in their choice of circuit service and ISP, but they only have to pay charges to SoftBank BB. This approach combines the convenience of a one-stop service with low charges. Finally, let s look at the demand structure of the ADSL market. According to a report by the Ministry of Internal Affairs and Communications entitled Review of competition in the telecommunications field (2003), the main reasons given for choosing ADSL are (1) always-on connectivity (65%), (2) fixed pricing (40%), (3) bandwidth (30%), and (4) low charges (29%) (multiple responses allowed). Compared with conventional dial-up connections, it can be seen that ADSL is rated more highly for its always-on connectivity and fixed prices. However, since ADSL provides less bandwidth than FTTH, users will probably start migrating from ADSL to FTTH at some 20

21 point. Among users that considered choosing ADSL but decided against it, the reasons given were as follows: (1) insufficient bandwidth (24%), (2) awkward to set up (21%), and (3) too expensive (17%), so evidently dissatisfaction with the bandwidth offered by ADSL is the largest factor (multiple choices allowed). The results of asking current ADSL users what kind of circuit they would like to be using one year later were as follows: (1) ADSL (37%), (2) FTTH (34%), and (3) CATV Internet (7%). To sum up, the users who have enjoyed always-on connections and fixed pricing are likely to develop higher standards and become dissatisfied with ADSL, and may switch over to FTTH instead. 3.2 The current state of the FTTH market At present (September 2004), 12% of Japan s broadband users are on FTTH connections. First, let s look at how the number of line contracts has changed at NTT East and West and at the other carriers, as in Table 6. Table 6. The FTTH-market trends at NTT East and West September 2002 September 2003 September 2004 NTT East Japan NTT West Japan Others Total ,030 Units: thousand users Source: Ministry of Internal Affairs and Communications 21

22 The number of FTTH line contracts is still small, although it is increasing every year, and at present (September 2004) it is only used in 4% of households. However, from 2005 substantial growth is expected in the number of users ditching ADSL in favor of FTTH, and the coverage of FTTH is likely to grow sharply in the future. The market share of NTT East and West is still high, and is tending to increase (37% 58 60%). Of the other carriers besides NTT East and West, the electric power companies are putting up a strong fight and currently occupy 13% of the market. K-Opticom (a subsidiary of Kansai Electric Power Co., Inc.) is doing particularly well. However, the FTTH market differs from the ADSL market in that it is so far only making serious progress in urban areas. It has only reached more than 5% of households in just six administrative regions of Japan, such as Tokyo and Osaka. On a finer level, the FTTH market can be divided into housing complex consumes and detached house consumers. As of September 2004, the change in the market share of NTT East and West in each of these sectors is as follows: for FTTH (for housing complexes), (1) NTT East and West, 270 (32%), (2) USEN, 170 (20%), (3) Power companies, 80 (9%), (4) Fiber-Bit, 70 (8%), (5) Others, 280 (31%), Total, 870 (100%); for FTTH (for detached houses), (1) NTT East and West, 940 (81%), (2) Power companies, 200 (17%), (3) USEN, 20 (2%), (4) Others, 60 (1%), Total, 1,140 (100%) (units: thousand subscribers; market share shown in brackets; source: Ministry of Internal Affairs and Communications; The market share of NTT East and West clearly differs between the FTTH market for housing complexes and the FTTH market for detached houses. Surprisingly, NTT East and West have an even lower share in the housing complex FTTH market than in the ADSL market. Meanwhile, in the detached house FTTH market, the market share of NTT East and West is far higher at over 80%. However, the electric power company carriers are also putting up a strong fight in the FTTH market for detached houses in urban areas, and the FTTH market seems to be highly variable between housing complexes and detached houses, and between urban regions and provincial regions. 22

23 Next, let s look at how the charging levels have changed. Each company continued to reduce its prices after 2004, shown in Table 7, so essentially the price differential between FTTH and ADSL continued to decrease. In particular, K-Opticom and KDDI have started to provide optical IP phone services with quality guaranteed to match that of fixed telephone lines, so by subscribing to FTTH, users can get rid of their fixed-line telephones. Accordingly, cases are arising where FTTH works out cheaper than the combination of ADSL and a fixed phone line. Table 7. The change of standard FTTH charges September 2002 September 2003 NTT East Japan (housing complexes) 35 (28) 32 (26) USEN (housing complexes) 36 (28) 31 (24) NTT East Japan (detached houses) 54 (42) 42 (33) USEN (detached houses) 48 (38) 44 (35) Units: $ ($ in PPP). ISP charges are not included in the figures for NTT East Japan, but are included in the figures for USEN. Source: Ministry of Internal Affairs and Communications FTTH business models can be divided into three types: NTT East and West employ a vertically separated model in which it lets users choose ISP freely, K-Opticom employs a vertically integrated model in which it has their own optical fiber, and KDDI employs a vertically integrated model in which it rents their optical fiber. In 2003 KDDI brought out a triple-play option combining high-speed Internet access with optical IP phone and video delivery services, and in 2004 K-Opticom also brought out a triple play package and reduced their charges. Faced with this sort of fierce competition from other 23

24 carriers, NTT East and West also brought out an optical IP phone service from For NTT East and West, providing optical IP phone services means canceling fixed-line contracts, so this means they are swallowing a bitter pill that will not necessarily lead to increased profits. Furthermore, since SoftBank BB seems likely to move from the ADSL market into the FTTH market at some point in the future, it is likely that fresh price cuts will occur. Finally, let s look at the demand structure of the FTTH market. According to a report by the Ministry of Internal Affairs and Communications entitled Review of competition in the telecommunications field (2003), the main reasons given for choosing FTTH are (1) very large bandwidth (72%), (2) always-on connectivity (35%), (3) fixed pricing (20%), and (4) home circumstances (20%) (multiple responses allowed). This shows that the advantages of FTTH basically boil down to its high speed. On the other hand, among users that considered choosing FTTH but decided against it, the reasons given were as follows: (1) charges are too high (63%), (2) set-up costs are too high (39%), and (3) awkward to set up (32%), so obviously cost is the main deterrent (multiple responses allowed). However, the price differential between FTTH and ADSL is rapidly closing, and since it offers the possibility of triple play contracts, it is able to command much higher prices. Accordingly, although FTTH has so far been given a wide berth due to its high charges, it will gain more subscribers in the future as prices fall. However, this still only applies to urban regions which are the only places where FTTH has so far been made available. No FTTH services have yet been started up in provincial regions, so it will be necessary to start by providing FTTH services in these areas. This issue is dealt with in more detail in the next section. 4. The broadband digital divide There are currently two forms of digital divide in broadband services. The first is the digital divide between urban and provincial regions. Although FTTH is now 24

25 starting to become available in cities and towns with a population of more than 50,000 (October 2004), there is hardly any provision of FTTH starting in towns or villages with smaller populations. For ADSL, the critical mass is a population of 5, The second is the digital divide that occurs even in the same community. As of April 2004, there are many regions where FTTH is still unavailable, but even where it is available, it can only be provided to a small fraction of households. In the future, as FTTH becomes available to a wider range of communities, the regional digital divide will probably become as important an issue as it is in ADSL 10. With regard to the issue of switching from older networks to newer ones, the digital divide can be rephrased as the following two issues: (1) How can metal-based telephone networks be disposed of quickly and systematically?; (2) How can an optical IP infrastructure be deployed quickly and systematically? 9 The details are given as follows: (1) 50,000 or more (478 cases): FTTH (93.9%), ADSL (100%); (2) 10,000 through 50,000 (1186 cases): FTTH (33.8%), ADSL (99.2%); (3) 5,000 through 10,000 (783 cases): FTTH (10.6%), ADSL (89.9%); (4) 1,000 or less (676 cases): FTTH (2.1%), ADSL (48.8%) (note: the numbers represent the percentage of communities where the service is at least partially available; source: Ministry of Internal Affairs and Communications; 10 The details are given as follows: (1) Available to 100% of households: FTTH (4.6%), ADSL (51.3%); (2) Available to % of households: FTTH (9.6%), ADSL (20.6%); (3) Available to 50 80% of households: FTTH (6.8%), ADSL (9.3%); (4) Available to 0 50% of households: FTTH (9.2%), ADSL (5.1%); (5) Available to 0% of households: FTTH (69.8%), ADSL (13.7%) (note: the numbers represent the percentage of communities where the service is at least partially available; source: Ministry of Internal Affairs and Communications; 25

26 The first issue is the problem of how to avoid causing a digital divide with old universal telephone services. The second issue is the problem of how to prevent a digital divide in new broadband services. The first issue (disposing of the old infrastructure) will probably have to be addressed before the second issue (installing new infrastructure). Both involve time lags, and will probably require the implementation of connection policies involving the use of wireless or cable technology or the like. But eventually an official program for addressing the second issue will have to be clearly laid out in order to gain public approval for plans to resolve the first issue. The first and second issues are therefore interrelated. The second issue cannot be resolved without resolving the first, and the first cannot be resolved without having plans in place for resolving the second. Market mechanisms do not assess the true value of services that have external effects. In other words, the installation of an optical network would create social benefits and cost savings in the field of public services such as health, welfare, education and government, but since there is an intrinsic limit to how far these fields are implicated in market pricing mechanisms, it is difficult to incorporate this social value into the pricing structure of optical IP networks. 4.1 Is it possible for FTTH networks to extend into provincial regions? Since an optical IP infrastructure is very costly, it is often said that it is not worthwhile extending the infrastructure into provincial regions with a small demand density. Let me explain why I think this opinion is incorrect. There is no denying the fact that installing an optical IP infrastructure is a massive undertaking. According to rough calculations, it could cost something like $3,000 ($2,800 in PPP) per household depending on the initial conditions. Naturally the cost would be higher in provincial regions. However, in economics it is important to compare opportunity costs. Although several carriers have started providing optical IP services in urban regions, maintaining the public exchange telephone networks only in provincial regions will in itself lead to 26

27 higher costs. I don t think the public are likely to accept a situation where cheap optical IP services are available in urban regions, while the provinces have to pay higher charges just to keep their existing telephone services. To put it another way, it took a whole century for the telephone network to be completed. Installing a nationwide telephone network was much harder than installing a nationwide optical IP network is likely to be. That is because NTT Co. (more precisely, NTT Public Co.) had to build the telephone network from scratch, including the infrastructure such as exchanges, ducts, telephone tunnels, and telegraph poles. An optical IP network, on the other hand, could be installed more cheaply because it is possible to utilize this hardware legacy of the telephone network. In fact, over the past decade, Japan has made steady progress in converting networks to optical technology as far as the parts just beyond the subscriber lines, and is now close to achieving the important target of implementing a nationwide FTTH network. Once an optical IP network has been set up over the whole country, it will cost less to maintain the optical IP network due to differences in network technology between public exchange networks and IP networks. It is also likely that the concept of a message area (MA) limited to a telephone exchange unit will also cease to be relevant. Furthermore, in an optical IP world, people would be more likely to use high-level services such as video messaging than low-level services such as ordinary voice calls, thereby facilitating the introduction of new ways of working such as video conferencing and telecommuting, and leading to savings in terms of travel time and commuting costs. As I have mentioned already, an optical IP network can build directly on the existing telephone network infrastructure such as switching offices, ducts, telephone tunnels and telegraph poles, while the exchange equipment and metal lines can be disposed of, so in the long run it can be achieved economically. The rest depends on how the initial cost burden can be alleviated by concentrating the sparse demand in provincial regions. 27