Wholesale Line Rental: Reviewing and setting charge ceilings for WLR services

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1 Wholesale Line Rental: Reviewing and setting charge ceilings for WLR services Cable & Wireless response to Ofcom consultation 9 th December

2 Introduction Cable & Wireless welcome the opportunity to respond to this consultation document regarding the proposed charge ceilings for WLR. In general we agree with the concept of setting charge ceilings and we would not dispute the actual levels proposed for both retail and business analogue WLR. However, there are a couple of issues where we have some concerns, namely ISDN2 WLR charges and the efficiency factor. WLR ISDN2 Charges In addition to the retail and business analogue WLR charge ceilings, Ofcom has also considered whether there is a need to set charge ceilings for business ISDN2 WLR. We note that BT is under an obligation to ensure that any charges for ISDN2 are cost oriented but that Ofcom has not set charges in the past. However, last year Ofcom did investigate BT s ISDN2 WLR charges; at the time the annual rental was That investigation was closed after BT reduced the annual rental charge to 220 suggesting that Ofcom was happy at that time that the new charges were cost oriented. The 2004/5 Regulatory Accounts appear to confirm this; they show the cost was 111 per channel (giving 222 per line) that is just marginally above the new price. Subsequently Ofcom has undertaken two key projects that consider the cost of BT s access products, the review of the cost of BT s copper access costs and the review of their cost of capital. The combination of these projects has resulted in significant reductions in the cost, and hence the price, for other key wholesale access products. For example they have resulted in a reduction of nearly 10 pa for analogue WLR. Copper does represent a smaller proportion of the cost of ISDN2 than for an analogue line but on an absolute basis an ISDN2 line (rather than channel) uses a similar amount of copper. In addition the impact of the lower cost of capital impacts upon all aspects of the cost base and not just the copper. We therefore expect that this will generate a material reduction in the costs of ISDN2 WLR, a product that we believe was already cost oriented. We have undertaken our own cost modelling, starting with the regulatory accounts, and that suggests that a new cost oriented price would be over 6% lower than the current price. As a result of this we are surprised by Ofcom s conclusion that the current charges remain reasonable. We understand Ofcom would prefer not to have to include ISDN2 WLR in a charge control given that it has not been necessary in the past. However, by drawing the conclusion that it has, Ofcom has signalled that it does not believe a price change is required to ensure continued cost orientation. In order to draw such a conclusion must have required detailed cost modelling and yet no substantial details of the cost modelling are provided. Given the counter-intuitive nature of the conclusion we find this lack of information disappointing. If Ofcom s analysis is correct, and the current charges do remain appropriate, then either the 2004/5 regulatory accounting information is incorrect or additional costs, over and above those in the accounts, have become relevant. We would like to see details of the analysis that Ofcom has undertaken and details of where this apparent discrepancy lies. We would also like an explanation of how the price of a product 1

3 that is apparently successfully cost oriented can remain constant when there is a material change to its cost base. Efficiency Factor In our response to previous consultations, we have raised the issue that the general efficiency analysis carried out by NERA may not be the best view of BT s efficiency in its local loop. However, Ofcom has still not addressed this concern. We would urge Ofcom to undertake a specific project looking into this issue as soon as possible. Answers to specific questions Question 1: Do you agree that Ofcom should set ceilings for the WLR rental and transfer charges? Cable & Wireless would agree that setting ceilings is appropriate. Question 2: Do you agree that Ofcom should use forecast costs for 05/06? If not, please explain why. We agree that Ofcom should use forecast costs for 2005/06. Question 3: If you agree that Ofcom should forecast the costs for 05/06, is an RPI of 2.5% the most appropriate methodology to use? An RPI of 2.5% is the most appropriate methodology to forecast. Question 4: Do you agree that Ofcom should apply an efficiency factor of 1.5%? Please provide any evidence to support you answer. The assessment of the efficiency of BT s local access business is a vital part of setting a charge ceiling for WLR. Although BT has been subject to competition for many years there has been limited competition in the provision of copper access. Whilst it can be seen that competition, combined with regulation and pressures from the financial markets, has driven much efficiency improvement within BT the exact nature of those improvements is less clear. However, it is reasonable to assume that the areas that have seen the most efficiency improvements are those where the pressure has been greatest and that is not in the operation of BT s monopoly local loop. As a result the use of the general efficiency analysis carried out by NERA on behalf of Ofcom may not provide the best view of BT s efficiency in its local loop. We believe that the local loop is likely to be less efficient than BT as a whole. And the lack of local loop competition to BT means that absent regulatory pressure the incentives on BT are not as strong in this area as in others. In our response to Ofcom s consultation on the value of BT s copper access network we raised this as an area of concern. We suggested that Ofcom commission a detailed examination of BT s processes and operating costs within its copper access network. Ofcom acknowledged the potential for inefficiency but stated that the issue 2

4 should be addressed in the context of a charge control rather than the copper project. However, the issue was not addressed in the LLU charge ceiling consultation so we again raised this point. Therefore we are disappointed that the only consideration of BT s efficiency appears to still come from the general work undertaken by NERA to inform the network charge control. We believe the operational efficiency adjustment of 1.5% is insufficient and Ofcom should undertake some work to specifically consider the efficiency of BT s local access business. We believe it necessary for Ofcom to make firm commitment to undertaking this work as soon as possible. Question 5: Do you agree with Ofcom s approach to excluding both Pair Gain costs and the adjustment for DACS? We would agree with Ofcom s approach on this. Question 6: Do you think that the methodology put forward by Ofcom for the recovery of drop wire costs is appropriate? BT has previously proposed a normalisation of the drop wire capital costs to take account of the fact that the capital employed has not yet reached its steady state following the 2000/01 changes in accounting treatment. The cost of pre 2000/01 drop wires has already been recovered and so to make that normalisation now would result in the costs being recovered for a second time. Therefore Ofcom is correct not to include these. We also note that although the accounting treatment of drop wires was changed in 2000/01 the charge control modelling for the retail price control assumed that they were still expensed. This means that BT has been able to recover the full cost of residential drop wires within the year they are incurred through its retail charges. We would therefore agree that it is appropriate for the capital costs of business drop wires to be fully included in the charge ceiling for business WLR, but that a reduced allowance is made for retail lines. Question 7: Do you think that Ofcom s approach in applying a CVE to S&GA costs is appropriate? Ofcom s approach would appear appropriate. Question 8: Do you agree with Ofcom s proposal to not set charges or charge ceilings for business ISDN2 WLR? Ofcom has not set a charge for ISDN2 WLR in the past and therefore we would not think it appropriate to set one now unless BT were proved to be failing to meet their cost oriented obligation or there is a requirement for increased stability to encourage investment. We note that the size of the price reduction last year arising from Ofcom s investigation suggests that BT were failing in their obligation prior to that but had then resolved the issue. If, as a result of another investigation, BT were found to once again be charging above cost we believe this would justify the setting of a charge or charge ceiling for ISDN2 WLR. 3

5 In this consultation Ofcom has sent a clear signal that they are happy with the current charges. This conclusion gives us some concern as it appears counter-intuitive and is not supported by sufficient analysis or explanation. Our own analysis, as discussed in detail in the introduction, suggests that a reduction in the ISDN2 WLR rental price is required to maintain cost orientation and we believe BT should be given the opportunity to make that reduction. If BT were to fail to make that reduction in a timely manner and subsequently Ofcom found that the reduction was justified then a charge ceiling should be set. 4

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