The minimum set of leased lines retail market

The minimum set of leased lines retail market Identification of the relevant market, analysis of competition, designation of service provider(s) having significant market power, imposing obligation(s) in Hungary I. Identification of the relevant market The starting point for the definition of the market was for the National Communications Authority s Board (hereinafter referred to as Board ) an analysis of the retail market No. 7 set forth in the Annex to the European Commission Recommendation 2003/311/EC of 11 February 2003 (hereinafter referred to as Recommendation ), namely The minimum set of leased lines. The Recommendation proposes for market analysis and considers to be relevant market for ex ante regulation the above retail markets. In the market definition procedure the Board defined the content of the services on the basis of the identification of the market and the terms defined in laws. The Board also examined the substitution possibilities which may exist on the examined market which can have an impact on the boundaries of the examined service market and whether the parameters of the domestic market justify extending the EU s minimum set of leased lines. The Board also examined whether it is justified to distinguish within the minimum set of leased lines separate service markets defined by bandwidth limits whose parameters radically differ from the service markets which include leased line services with other bandwidths. After the definition of the examined service market the boundaries of the geographic market were identified. Analysis of substitution The Board found that the notified service has the following basic characteristics on the examined market: According to the definition by law leased line means the totality of electronic communications devices which provide transparent transmission capacity between network access points, but do not include switching functions which can be controlled by the user. In harmony with this definition the Board considers all electronic communications devices to be leased lines which provide transparent transmission capacity between two points and do not include switching or routing function which can be controlled by the user. In the definition of the examined market the Board was looking for substitution possibilities which can modify the boundaries of the market. In the procedure of identification of the retail leased line services market when demand-side substitution was examined the substitution impact of the following services was examined: 1

whether the international leased line service is included in the examined retail market, whether leased lines with differing bandwidths are included in the same retail market, whether the analogue and digital leased line services constitute the same retail market, whether the leased line services and the following other data transmission services are included in the same retail market: VPN (Virtual Private Network) IP-VPN (IP Virtual Private Network), IP (Internet Protocol) based Virtual Private Network ATM (Asynchronous Transfer Mode) based transmission service Frame Relay based transmission service Ethernet based transmission service SDSL service The Board determined the service market taking into account first of all the functional characteristics stipulated in the basic definition, and the usage and commercial (price, payment and service provision conditions, etc.) characteristics. Considering these conditions the consumer decides at using up the service, whether the service offered substitutes the defined leased line service. According to the Board s preliminary view a domestic retail leased line with both access points located in Hungary cannot be substituted with a leased line connection between Hungary and another country. The conditions of provision of international leased line service are radically different from the conditions of domestic leased line service. The typical distance between the access points is much larger, and the price of the service is much higher partly for this reason, partly because the scope of customers requesting this service have higher readiness for consumption, generally the requested bandwidth is also higher, in case of international leased line connections only a few operators can provide competitive offer, especially using basically its own network for the retail service. On the basis of the above considerations the Board established that with regard to both demandside and the supply-side substitution factors the domestic and the international retail leased line markets constitute separate markets. The examined market is the domestic retail leased line market. The Board examined whether retail leased lines with different bandwidths are included in the same retail product market. The Board established that in functional terms a higher bandwidth leased line can substitute a lower bandwidth leased line service while providing at least the same level application, but in functional terms a lower bandwidth leased line cannot perfectly substitute a higher bandwidth leased line service. Leased line services with adjacent bandwidth (differing from the given 2

bandwidth service by 64 kbps) can be considered substitute services for each other for an essential threshold consumer 1 group in respect of services with bandwidth up to 2 Mbps. Such substitution is not existing between the categories up to 2 Mbps and over 2 Mbps since the price of these services is much higher will all major operators in the over 2 Mbps category than in the up to 2 Mbps category (primarily due to the generally different technologies used in the two categories). On the basis of the above considerations the Board established that the up to 2 Mbps and the over 2 Mbps bandwidth leased line services are in separate markets, i.e. it is not justified to extend the market of the minimum set of leased line services set forth in the Recommendation with the higher bandwidth leased line services. The examined retail leased line market is the leased line market with up to 2 Mbps bandwidth. In respect of separation of analogue and digital leased lines the Board established that there is no significant functional difference between low-bandwidth digital (64 kbps) and analogue leased lines since a) both analogue and digital leased lines support voice and data transmission, and b) the physical medium used for the provision of both types of low-bandwidth leased line is the same, the network devices differ only in respect of the terminal equipment. Low-bandwidth analogue and digital retail leased line services are in the same service market. In the analysis of whether the other data transmission services belong to the market of retail services provided with the minimum set of leased lines the Board primarily examined, in addition to an analysis of functional substitution, what pressure these services can exert on the pricing of retail leased lines. The Board analysed these products in terms of whether they can influence the conditions of retail leased line services as a result of the competition generated through potential substitution, i.e. whether it is justified to extend the definition of the examined market. The considerable majority of retail leased lines with bandwidth of 2 Mbit/s and below 2 Mbit/s are provided by the Magyar Telekom Co. by a technology based on copper pair. The alternative (optical fibre) infrastructure is used to a small extent for providing leased lines with a bandwidth below 2 Mbit/s, because applying the market price for services with a bandwidth below 2 Mbit/s the investment of the optical network would not return. The Board determined that undertaking the costs of building out an infrastructure suitable for provision of low bandwidth service is improbable by a new entrant, taking into account the high sunk costs and the high economies of scale and economies of scale, as well as the density of the network of the Magyar Telekom Co. The competing operators build out high bandwidth optical infrastructure concentrated first of all in the city-areas. The Board established that there are no demand-side or supply-side substitution possibilities partly due to the differing functionality, partly due to the definition differing from that of leased 1 A given group of users can be considered a threshold user group is their substitution behaviour can actually influence the behaviour of the operators. 3

lines mostly depending on the technology, partly due to the differing pricing, which would justify extension of the examined market. Geographical scope of the relevant market The Board examined the area of the geographic market in terms of whether the competition conditions of the examined dedicated services are sufficiently homogeneous. The geographic market comprises the area within which the operators provide or request the given service and the competition conditions can be considered sufficiently homogeneous and distinguishable from the adjacent areas where the competition conditions are significantly differing from those in the examined area. On the basis of the above considerations one of the major factors of analysis is coverage with local network since the local network links are the last section of the low-bandwidth retail leased lines and consequently their possession can theoretically decisively impact the competition conditions on the given geographic area. The geographic market comprises the area within which the operators provide or request the given service and the competition conditions can be considered sufficiently homogeneous and distinguishable from the adjacent areas where the competition conditions are significantly differing from those in the examined area. The smallest geographic unit of the examination of the area of networks is the numbering area. In each of the 54 numbering areas typically the same operator, the earlier concession holder telephone operator possesses the local network. However, network coverage is less determining on the retail leased lines market since the two access points of retail leased lines are in most cases in differing primary areas, i.e. the boundaries of the earlier concession areas are not decisive in respect of the access points of the leased line service, each of the operators providing service on the retail market can use local leased line links with wholesale conditions 2 from the network owner. The typically large company end-users of retail leased line services generally do not request a service offer for a given leased line link when procuring this service, but for numerous leased line links which are generally not restricted to a given earlier concession area, but can be located practically anywhere within Hungary. Out of the 9 major players on the up to 2 Mbps bandwidth retail leased line market only three are earlier concession holders and the approach based on the earlier concessionbased telephone service areas is further weakened by the fact that Magyar Telekom Co. having the largest revenue share on the market did not specify differences by numbering area in respect of its own leased line market, but declared itself a national operator. Antenna Telecommunications Co., that is a major player on the up to 2 Mbps leased line services market, can also provide national leased line service. Additionally GTS-Datanet 2 which are often laid down in retail contracts including significant discounts for the user operator 4

and PanTel possess national networks constructed totally independently of the numbering areas. On the basis of these considerations the role of the boundaries of earlier concession areas on the retail market of leased lines is not significant, the national homogeneity of the market is ensured by the national market presence of the largest market player and operators possessing a network that is totally independent of the numerous numbering area boundaries. On the basis of the available data the Board established that the geographic market of retail leased lines covers the whole territory of Hungary. Checking the three cumulative ex-ante criteria After the definition of the market the Board examined whether the defined market can be considered relevant market in regulatory terms. The Board established the necessity of ex ante regulation of the market with the examination of the following three conditions. 1. Existence of high and not temporary entry barriers on the market 2. Tending towards efficient competition 3. Insufficiency of the (ex post) application of competition law The Board considered necessary to emphasise that these criteria are not the full scope of criteria for market analysis, but are used only for preliminary analyses to decide whether more detailed analysis of the market would be reasonable. Out of the market entry barriers on the retail market of the minimum set of leased lines basically the structural barriers impact negatively the market possibilities of the later market entrants. Construction of new leased line infrastructure would involve high sunk costs and their payback would generally be not at all sure since it would mean basically the construction of a network parallel to the existing network which is suitable for the same services. The highness of the structural barriers is also shown by the fact that although several alternative operators entered this market since 5-6 years, none of those could build out leased line access infrastructure with considerable coverage, especially in case of infrastructure of low bandwidth (up to 2 Mbit/s) services. The state of uncertainty of investors is also indicated by the multiple change of owners of several undertakings (GTS-DataNet, PanTel), and by the mergers (Novacom, PanTel). The merger of Emitel Co and Magyar Telekom Co. has been carried out and the merger of Invitel Co., PanTel Ltd., Hungarotel Co. and Euroweb Co. also has been reported. Today the legal and administrative entry barriers with an infrastructure suitable for the provision of leased line service are not significant, the electronic communications laws do not include any restriction. However construction of a new network infrastructure suitable for the provision of leased line service can be made in some cases difficult, more lengthy than reasonable and in certain cases more expensive by the law implementation practice of the local municipalities that act as building authority depending on the municipality. 5

The Board established that competition conditions on the retail market of the minimum set of leased lines is to a great extent determined by the fact that the major part of the copper pair access infrastructure, that is the major technical basis of the low-bandwidth (up to 2 Mbps) services, is still held by the largest earlier concession holder operator. This means that there is hardly any leased line connection used for retail leased line services up to 2 Mbps bandwidth where at least one of the access points is not using the access network of the largest earlier concession holder operator. Over the last 3 years the price of low-bandwidth (up to 2 Mbps) retail leased line services has changed only insignificantly and the market share of the operator has not decreased significantly. On the basis of the above considerations the Board established that today there is nothing on the market as a result of which the market would tend towards the efficient competition. The rules applicable to the electronic communications markets describe at least three criteria and circumstances on the basis of which the conclusion can be drawn that the methods of competition law are not sufficient in themselves. These are the following: - identification of the conditions of intervention needed for correction of a market distortion (e.g. excessive pricing) and control of their existence is a complex and complicated task (e.g. detailed regulatory purpose accounting statements, cost analyses, control of conditions involving technical aspects too, etc.) - recurring and/or time-consuming interventions (tests) are unavoidable - creating legal certainty is of very high importance. Analysis of these cases shows that competition law in itself is not sufficient for the regulation of the given communications market. The Board examined the Minimum set of leased lines retail market and established that each of the 3 ex ante criteria applied by the European Commission in respect of the examined market are fulfilled, so the Board established that the identified market can be considered relevant market for regulation. II. Market analysis, designation of SMP operators According to the Board s view the following criteria used for examination of market power are theoretically important on the relevant market: 1. market share 2. lack of potential competition, obstacles to expansion 3. control of infrastructure not easily duplicated 4. overall size of the operator 5. easy or privileged access to capital markets and financial resources 6. economies of scale 7. economies of scope 8. vertical integration 9. low countervailing buying power 6

To ensure a comprehensive analysis the Board also examined aspects, which are less important for judging significant market power. - technological advantages or superiority - product/services diversification - a highly developed distribution and sales network Magyar Telekom Co. having the largest market share considering the number of access points is market leader also in respect of the revenue-based market share and this market share is even higher than the market share based on the number of access points. On the basis of this fact the Board established that Magyar Telekom Co., the largest operator on the relevant market has a market share that with great probability ensures its dominant position. It cannot be actually expected that new operators enter the retail market of low-bandwidth (up to 2 Mbps) leased line services in addition to the dominant operator on the market without using its wholesale services. For this reason the impact of potential competition cannot countervail the dominance of the operator having the largest market share. It is a risky business venture to duplicate the infrastructure with the same technology. Development of the market so far showed that no parallel copper pair based infrastructure that is basically used for the provision of leased line services up to 2 Mbps bandwidth has been constructed and there is no actual chance for this in the future either. The Board established that the operator with the largest market share and the largest size has the strongest financial background due to its stable cash flow and high profitability of operations (e.g. EBITDA figure). The size and financial capabilities of the other players on the market are much behind those of the market leader operator. In respect of the largest market player vertical integration contributes to its being in much better position on the given relevant retail market than its competitors and this circumstance can contribute to enabling the operator with significant market power using its dominant position on the relevant wholesale market (without regulation). The Board established that the operator with the largest market share on the relevant market has much higher economies of scale than its competitors, in particular in respect of the local network, which can further strengthen the market power of the given operator and it can use the benefits of economies of scope since it can offer a very wide scope of services on the same infrastructure. The concentration of the customers of the largest operator on the given relevant market cannot be considered high. The cost of migration to another operator is high, customers are generally bound to an operator by multi-year contracts with very high cost of termination. Price elasticity of customers is low in respect of the given retail market. The countervailing buying power of the players on the given retail market can be considered weak and cannot actually countervail the dominance of the operator with the largest share on the retail market. 7

On the basis of the above considerations the Board established that Matáv Co. has significant market power on the Minimum set of leased lines in the territory of the Republic of Hungary retail market. III. Imposition of obligations In the procedure of definition of obligations the Board considered, in addition to the general objectives, the following principles: The obligations must aim at remedying the consequences of lack of competition on the retail market of the minimum set of leased lines. The imposed obligations must be justified by the obstacles to competition revealed and be proportional to them. The imposed obligations may not result in unreasonable burden for the operators. The obligations should to the highest possible extent reflect the particularities of the defined markets. On the basis of the Community and national laws the following obligations can be imposed on the retail market of leased lines: regulation of retail prices obligation to provide the minimum set of leased lines The Board can impose an obligation through regulation of retail prices on the relevant retail service market only if it established on the basis of market analysis that the competition is not sufficiently efficient on the retail market and imposition of obligations on the wholesale market would not be sufficient to reach efficient competition on the relevant retail market. Out of the potential competition problems the following ones should be paid special attention: It is not necessarily in the interest of the operator with significant market power on the given market to serve all potential customers and to provide to them a service included in the retail market of the minimum set of leased lines. The SMP operator operating on the market can use numerous price-based and nonprice-based tools with which it can use its significant market power on the given relevant market. In the procedure of definition of obligations the Board examined the listed regulatory tools in terms of how much they are suitable for remedying the explored competition problems. The following obligations can be imposed on the leased lines retail market: 1. regulation of retail prices According to the Board s view it is not justified to regulate retail prices. The more intensive competition created due to the expectedly better conditions for the eligible operators as a result of the wholesale price regulation to be applied on the wholesale leased line termination segment market can probably remedy the excessive pricing that can be used on the retail market. 8

The other part of price-based problems (predatory pricing, etc.) can be hindered through the obligation of using prices without price squeeze that is generally applied to operators with significant market power. 2. obligation to provide the minimum set of leased lines The Board imposed on the operator with significant market power the obligation to provide the minimum set of leased lines. This obligation can hinder the following non-price-based problems: low service standard and deterioration of quality, the discrimination in provision of information for the consumers; and the following price-based problems: pricing discrimination and the abovementioned general potential problem of rejecting to provide the service. This obligation is proportional to the described potential competition problems and they can be treated in the less burdening way by imposition of this obligation. Imposition of this obligation will not result in disproportionate burden for the operator, this obligation has been in force so far for the given operator. IV. Notification procedure The draft decision has been sent to EU Commission and the Commission registered the notification on 10 th December 2007. In its letter dated on 11 th December the Commission requested the following supplementary information: - In the notifications related to the wholesale leased lines markets NCAH found the wholesale trunk segments market competitive and plans to impose price regulation in the wholesale terminating segments market. Considering that the operators could buy the necessary wholesale input at competitive or at regulated prices, the Commission requested explanation on why NCAH think that entry barriers remain high in this market. - In the notification, the analysis of SMP is based on data only up to 2006. The Commission requested data on the development of market shares in 2007, where available. - The Commission requested information on the price trends in the retail leased line market. In particular, data showing how the average prices of the main operators developed over the past three years. - In the light of the changes in the market structure (the merger of Invitel, PanTel and Hungarotel), The Commission asked, why NCAH considers that the market is not expected to become competitive in the time horizon of the market review. NCAH sent its response on 14 th December. - NCAH explained that in the retail market of the minimum set of leased lines basically the structural barriers influence disadvantageously the market chances of the undertakings entering the market later due to the high sunk costs of built-out of the new leased line 9

infrastructure. The return of these investments is uncertain, because a parallel network, suitable for provision of basically identical services should be built out. This is especially characteristic for the built out of copper-based leased line infrastructure up to bandwidth of 2 Mbit/s due to the considerable investment demand. - The NCAH informed the Commission that market share data for the year 2007 are not yet available. - The development of price trends has been shown in detail for the Commission. - The NCAH explained that the Magyar Telekom s market share even examined in a long term, appears so stable that the decrease below the SMP threshold not expectable in the foreseeable time horizon. This position just will be stabilized by the merger with Emitel. The HTCC Group merger can influence this situation expectedly beyond a foreseeable period The notification procedure has been closed by the comment letter of the Commission dated on 9 th January 2008, in which the Commission asked the NCAH the efficient execution of the wholesale regulation related to wholesale market of terminating segments of leased lines, as the basis of the decrease of the entry barriers. Pursuant to Article 7(5) of the Framework Directive the Board adopted the draft decision on National Communications Authority of Hungary 10