An analysis of residential customers' substitution of traditional fixed telephony with IPbased and mobile telephony

DATE REPORT NUMBER 5 September 2006 PTS-ER-2006:38 ISSN 1650-9862 FILE REFERENCE 06-3845/23 An analysis of residential customers' substitution of traditional fixed telephony with IPbased and mobile telephony

Foreword The National Post and Telecom Agency (PTS) is the sector authority within the electronic communications sector. One of the tasks of PTS is to determine on an ongoing basis those product and service markets within the sector with characteristics that may justify the introduction of obligations under the Electronic Communications Act (EkomL). PTS shall also continually analyse the relevant markets determined and establish whether effective competition prevails in each of these markets. If effective competition does not prevail in a determined market, PTS should also identify those undertakings with significant power within the market and issue a decision about obligations for these undertakings on the basis of EkomL. This report has been produced as part of PTS's market analysis work in accordance with Chapter 8, Sections 5 and 6 of EkomL. Two of the markets that were analysed by PTS are the market for access to the public telephone network via a fixed interconnection point for residential customers and the market for publicly available local and/or national telephony services provided via a fixed interconnection point for residential customers. In a decision taken a year ago (2005), PTS found that effective competition did not prevail in the former market, but that effective competition prevailed in the latter market. 1 PTS identified TeliaSonera AB (TeliaSonera) as the undertaking with significant power in the telephony services market. PTS should, however, analyse the markets in question on an ongoing basis and it is intended that the conclusions of this report should serve as a basis for any future analyses that PTS carries out. As a basis for the market descriptions in this report, PTS used first two consultative studies that have been conducted for PTS and second the market data that PTS compiles as part of its ongoing market analysis work. PTS has also interviewed providers of access and communications services for this work. The work of the report has been led by Susanna Mattsson. In addition, Cecilia Baksa, Ola Bergström, Camilla Jönsson and Susanne Severin Tedborn have contributed to this work, as has the consulting firm A-focus. The Swedish Competition Authority has been consulted. Stockholm, September 2006 Marianne Treschow Director-General 1 See PTS's decision of 18 February 2005 in matter no. 04-6943/23 and 15 September 2005 in matter no. 04-6945/23 respectively National Post and Telecom Agency

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Contents Summary (in Swedish)...8 Summary (in English)...11 1 Introduction...13 1.1 Background...13 1.2 Aim...15 1.3 Method...15 1.4 Structure...16 2 Different categories of IP-based telephony...17 2.1 Category A - Fixed IP-based telephony...18 2.2 Category B Nomadic IP-based telephony with emergency calls...19 2.3 Category C Nomadic IP-based telephony without emergency calls...19 2.4 Category D Internet telephony without the possibility of making calls to ordinary telephone numbers...20 2.5 Summary of the different categories of IP-based telephony...21 3 How do other European regulatory authorities regard the issue of substitution?...23 3.1 The Netherlands...25 3.1.1 IP-based telephony...25 3.1.2 Fixed-mobile substitution...26 3.2 France...27 3.2.1 IP-based telephony...27 3.2.2 Fixed mobile substitution...28 3.3 Norway...29 3.3.1 IP-based telephony...29 3.3.2 Fixed-mobile substitution...30 3.4 Denmark...31 3.4.1 IP-based telephony...31 3.4.2 Fixed-mobile substitution...32 3.5 Germany...33 3.5.1 IP-based telephony...33 3.6 United Kingdom...33 3.6.1 IP-based telephony...33 3.6.2 Fixed-mobile substitution...34 3.7 Summary...35 4 How is the degree of substitution determined?...36 4.1 Regulation...36 4.2 Definition of relevant market...36 4.2.1 Relevant product market...37 4.3 Demand substitution and the SSNIP test...38 4.3.1 The concept of the marginal customer and defining customer groups...39 4.3.2 Product and market definition...40 4.3.3 Replacement costs...40 4.4 Guide to determining the impact of the degree of substitution on market definition...40 5 Market descriptions...43 5.1 Introduction...43 5.2 Traditional fixed telephony...45 5.2.1 Revenue and traffic volume, national calls...49 5.2.2 Consumer choice and operators market share...49 5.2.3 Price trends...50 5.3 IP-based telephony...52 5.3.1 Broadband penetration in Sweden...56 National Post and Telecom Agency 5

5.4 Mobile telephony...57 5.5 Summary and analysis...60 6 Comparison between traditional fixed telephony, mobile telephony and IP-based telephony...62 6.1 Introduction...62 6.2 Distinctive characteristics according to previous SMP decisions...63 6.3 Characteristics of IP-based telephony categories in relation to the decisions...63 6.3.1 Access to other networks and services...63 6.3.2 Numbering and addressing issues...64 6.3.3 Emergency calls...64 6.3.4 Are users tied to one location?...65 6.3.5 Value-added and supplementary services...65 6.4 Characteristics of mobile telephony in relation to the decisions...66 6.4.1 Traditional mobile subscriptions...66 6.5 Other aspects to take into account when comparing traditional fixed telephony with mobile and IP-based telephony...67 6.5.1 The price sensitivity of residential customers...67 6.5.2 Cost of necessary terminals...70 6.5.3 Quality aspects (QoS)...70 6.6 Analysis...71 7 Developments during the next three-year period...76 7.1 Introduction...76 7.2 The importance of broadband access...77 7.3 Other factors that may affect the degree of substitution...80 7.4 Forward-looking substitution assessment...81 8 Chapter 8. Summarised assessment...83 8.1 Introduction...83 8.2 Mobile telephony...83 8.3 IP-based telephony...85 8.3.1 IP-based telephony in Category A...86 8.3.2 IP-based telephony in Category B...86 8.3.3 IP-based telephony in Category C...86 8.3.4 IP-based telephony in Category D...87 8.4 Rounding up...87 6 National Post and Telecom Agency

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Summary (in Swedish) Denna rapport har tagits fram som ett led i PTS arbete med analyser av marknader enligt 8 kap. 5 och 6 EkomL. Enligt etablerad rättspraxis omfattar en relevant produkt- eller tjänstemarknad alla produkter respektive tjänster som i tillfredsställande mån på grund av sina egenskaper, sitt pris och den tilltänkta användningen, av köparna betraktas som utbytbara eller substituerbara. I denna rapport undersöks huruvida olika kategorier av IP-baserad telefoni respektive mobil telefoni utgör substitut till den traditionella fasta telefonin och om de i så fall bör inkluderas i de marknader som dels avser tillträde till det allmänna telefonnätet via en fast anslutningspunkt för hushåll, dels marknaden för allmänt tillgängliga lokala och/eller nationella telefonitjänster som tillhandahålls via en fast anslutningspunkt för hushåll. I rapporten delas IP-baserad telefoni in i fyra kategorier, där en viktig skiljelinje är om leverantören kontrollerar accessnätet eller inte. Substitutionsanalysen har genomförts i tre steg. För det första beskrivs utvecklingen under senare år vad gäller förändringar i pris och i kvantitet för traditionell fast telefoni, mobil telefoni och IP-baserad telefoni. Syftet är att skapa en bild av hur efterfrågan för de olika slagen av telefoni har förändrats, både vad gäller abonnemang och telefonitjänster, egentligen trafikminuter, för att på det sättet få en förståelse för omfattningen av hushållskundernas substitution mellan de olika slagen av telefoni. För det andra jämförs egenskaperna hos respektive slag av telefoni för att se om de ur en hushållskunds perspektiv kan uppfattas som utbytbara med varandra. Utgångspunkten för jämförelsen är de egenskaper som användes i första generationens SMP-beslut för att avgränsa de aktuella produktmarknaderna. Därutöver beaktas ytterligare ett antal egenskaper vilka bedöms vara av intresse för konsumenters uppfattning om huruvida de olika slagen av telefoni är utbytbara med varandra. För det tredje diskuteras faktorer som kan påverka hushållskunders framtida substitution av traditionell fast telefoni med mobil telefoni och/eller någon form av IP-baserad telefoni. Den sammanfattande bedömningen är att det finns skäl att betrakta den kategori av IP-baserad telefoni som erbjuds av leverantörer som kontrollerar accessnätet som i tillfredsställande mån utbytbar med traditionell fast telefoni. När det gäller övriga kategorier av IP-baserad telefoni och mobil telefoni är den sammanfattande bedömningen att de inte i tillfredsställande mån är utbytbara med traditionell fast telefoni. Implikationerna av denna bedömning är delvis avhängigt hur kommissionens rekommendation om relevanta marknader kommer att se ut vid tidpunkten för 8 National Post and Telecom Agency

nästa generations SMP-beslut. I förhållande till den nu gällande rekommendationen är implikationen att IP-baserad telefoni som erbjuds av leverantörer som kontrollerar accessnätet bör inkluderas dels i marknad 1 och marknad 3. I förhållande till det förslag om ny rekommendation är implikationen att IP-baserad telefoni som erbjuds av leverantörer som kontrollerar accessnätet bör inkluderas i marknad 1. National Post and Telecom Agency 9

Summary (in English) This report has been produced as part of PTS's market analysis work in accordance with Chapter 8, Sections 5 and 6 of EkomL. According to established case law, a relevant product or service market includes all products or services that purchasers regard to a sufficient extent as being interchangeable or substitutable on the basis of their characteristics, their price and the intended use. This report investigates whether the different categories of IP-based telephony and mobile telephony represent a substitute for traditional fixed telephony and, if that is the case, whether they should be included in the markets that are directed first at access to the public telephony network via a fixed interconnection point for residential customers and second at publicly available local and/or national telephony services provided via a fixed interconnection point for residential customers. The report divides IP-based telephony into four categories, with the crucial dividing line being whether or not providers control the last mile network. The substitution analysis has been carried out in three stages. The first stage describes the development trends of recent years where these concern changes in the price and quantity for traditional fixed telephony, mobile telephony and IP-based telephony. The aim of this is to paint a picture of how the demand for different kinds of telephony has changed, both as regards subscriptions and telephony services actual traffic minutes in order to get an understanding of the extent to which residential customers are substituting between the different types of telephony. The second stage compares the characteristics of the respective types of telephony in order to see whether, from the perspective of a residential customer, they may be viewed as interchangeable with each other. The starting point for this comparison is the characteristics used by the first generation's SMP decisions to define the product markets in question. In addition to this, a number of additional characteristics are taken into account that are considered of interest for the consumers' perception of whether the different types of telephony are interchangeable with each other. The third stage discusses the factors that may influence the residential customer's substitution of traditional fixed telephony with mobile telephony and/or some form of IP-based telephony in the future. The summarised assessment is that there are reasons to regard the IP-based category of telephony being offered by providers who control the last mile network, as to a sufficient extent interchangeable with traditional fixed telephony. The summarised assessment of the other categories of IP-based telephony and National Post and Telecom Agency 11

mobile telephony is that they are not, to a sufficient extent, interchangeable with traditional fixed telephony. The implications of this assessment partly depend on what the European Commission's recommendation on relevant markets will be at the time of the next generation's SMP decisions. The implication in relation to the current recommendation is that IP-based telephony offered by providers who control the last mile network should be included in markets 1 and 3. The implication in relation to the proposal for a new recommendation is that IP-based telephony offered by providers who control the last mile network should be included in market 1. 12 National Post and Telecom Agency

1 Introduction 1.1 Background In February 2002, the European Parliament and the Council of Ministers agreed on a regulatory framework in the EU within the area of electronic communications. One of the primary aims of this new regulatory framework is to increase the benefits for users and consumers as regards supply, price and quality by promoting and securing effective competition. For this reason, the national regulatory authorities should define those markets within their territory and in compliance with the principles of competition law that are not characterised by effective competition. This is done through the national regulatory authorities carrying out market analyses according to the rules laid down in the Framework Directive. These rules mean that market analyses, including an assessment of operators with significant power, are implemented in three stages. The first stage defines the relevant markets. In the second, an analysis is carried out to determine whether the market is characterised by effective competition and, if that is not the case, operators with significant power are identified. In the third stage, obligations are chosen for the operators who were identified by the second stage. The national regulatory authorities are proceeding on the basis of the recommendation provided by the Commission about which product and service markets have such characteristics that may justify the introduction of regulatory obligations. When the national regulatory authorities carry out their assessments, these should be based on the circumstances in the respective country. The definition of relevant markets can be gradually amended as soon as the characteristics of products and services are developed and the possibility of substitution is changed from a demand and supply aspect. The above means that regulatory authorities should regularly monitor market development in those sub-markets identified and that they should review the analyses previously made. The substitution analysis presented in this report is part of the review work started by PTS on the markets defined. It focuses on the first of the three stages mentioned in the market analysis by illustrating, from different aspects, whether there is reason to amend the definition of the two markets that the Commission reported in the original recommendation as suitable for ex ante regulation. As explained in particular, this includes whether either mobile telephony or IP-based telephony can be viewed as being equivalent to traditional fixed telephony, and thus should bring about a revision of the market definitions that were previously made. National Post and Telecom Agency 13

In the current recommendation, which is referred to as the 'original' in this document, the Commission identified 18 relevant markets, six of which were relevant end user markets and twelve relevant wholesale markets. The Commission consequently assessed that if effective competition could be secured, these markets would be in need of ex ante regulation. The markets affected by the substitution analysis include: 1. Access to the public telephone network via a fixed interconnection point for residential customers 2. Publicly available local and/or national telephony services provided via a fixed interconnection point for residential customers In June 2006, the Commission published a proposal for a new recommendation on relevant markets. Here, the number of relevant end user markets has been slimmed down to one (1) and the number of wholesale markets has been reduced to eleven (11). The relevant end user market in the proposal is defined as: 1. Access to the public telephone network via a fixed interconnection point for both residential and non-residential customers It is consequently proposed that telephony service markets 3 to 6 should be removed from the list of markets that require ex ante regulation in order to be characterised by effective competition. The Commission has assessed that ex ante regulation at a wholesale level, including pre-selection and prefix selection, is sufficient to enable the markets for telephony services at an end user level to continue to develop towards effective competition. The Commission therefore makes the same assessment that PTS made earlier based on the Swedish situation. In spite of this, the demand for telephony services is described and analysed in the substitution analysis. The reason for this is that, from an end user perspective, demand is not merely about purchasing an access product or a telephony service, i.e. the end user does not purchase an access product for its own sake, but in order to be able to make and receive calls. By considering the development of both the access and the telephony service markets, an understanding can be achieved about the extent of the degree of substitution between the different kinds of telephony. As regards access markets 1 and 2, the Commission states that the experience from the market analyses and notifications that the national regulatory authorities have made since 2003 shows that there are no significant or systematic differences between the contractual conditions for residential customers and for other customers (businesses and organisations) in respect of access to the public telephone network via a fixed interconnection point. On this basis, the Commission consequently proposes that the previously separate relevant markets be combined into one common relevant market for access to the public telephone network via a fixed interconnection point. 14 National Post and Telecom Agency

The present substitution analysis takes the Commission's proposal into account. Where this applies to the amalgamation of the access markets, the substitution analysis has been carried out from the hypothesis that PTS point of view is that the access markets should, in the light of national circumstances, also hereafter be divided up as in the original recommendation. This working hypothesis does not prevent PTS being able to recommend another standpoint at a later stage. 2 1.2 Aim The aim of the project is to analyse whether the market definitions that currently apply according to PTS's decisions 3 should be revised as a consequence of changes having taken place in the demand and supply patterns for mobile telephony, traditional fixed telephony and the different categories of IP-based telephony. The project is being carried out in the form of a substitution analysis within the framework of the SMP work performed by the National Post and Telecom Agency. It is not the task of the project to make any decisions on the issue of how the relevant product markets should be defined. This will take place within the framework of the forthcoming market review. 1.3 Method The method to investigate how markets should be defined follows the Commission's recommendations on how regulatory authorities should set about defining the relevant product markets. This means, among other things, that an attempt has been made to put into operation the 'SSNIP test'. This test is described in more detail in Chapter 4. The report investigates the extent to which the different categories of IP-based telephony and mobile telephony are viewed as interchangeable with traditional fixed telephony on the basis of their characteristics, their price and also, to a certain extent, the consumers' intended use. The actual market development in the relevant markets is described and analysed in terms of how residential customers choose between the different telephony services in practice. PTS has also described and analysed the factors for and against the degree of substitution increasing over the next few years. The work of the assignment has been conducted in project form within PTS. 2 PTS will submit views on the Commission's proposal during autumn 2006 3 Compare decision 04-6945/23 where this applies to market 3 and decision 04-6943/23 where this applies to market 1 National Post and Telecom Agency 15

Two consultative studies, which have been carried out for PTS, have been used as a basis for the market descriptions: - Beskrivning av marknaden för IP-baserad telefoni [A description of the IP-based telephony market from the end user perspective], HiQ Data AB - IP-telefoni ur ett konkurrensperspektiv [IP telephony from a competition perspective], A-focus AB In addition to this, PTS has used market data compiled from its ongoing market analysis work. PTS has also interviewed providers of access and communications services for this work. The Swedish Competition Authority has been consulted. 1.4 Structure The remainder of the report is structured as follows. Chapter 2 includes a description of IP-based telephony. This chapter also introduces the subdivision of IP-based telephony into the four different categories used in this report. The report does not include a corresponding description of mobile telephony. This is due to there not being any reason to separate the different categories of mobile telephony for the sake of the present substitution investigation. Chapter 3 puts the present substitution investigation into a European context with a brief survey of how a selection of PTS's European sister authorities regard the issue of whether or not IP-based and mobile telephony should be included in markets 1 and 3. Chapter 4 describes the Commission's recommended course of action for defining the relevant markets. The investigation itself has been divided into three stages that correspond to Chapters 5 to 7 of the report. The first of these stages is implemented in Chapter 5 and describes the market development of the different types of telephony. In Chapter 6, which corresponds to the second stage of the investigation, the characteristics of mobile telephony and the different categories of IP-based telephony are compared with the characteristics that PTS, in previous decisions, defined as being characteristic of the relevant product markets. The final stage, i.e. Chapter 7, focuses on a discussion of the barriers and impetus that enable residential customers to substitute traditional fixed telephony with either IP-based telephony or mobile telephony in the future. The report's eighth and final chapter contains a summarised assessment about whether the results of the study carried out should affect the definition of the markets in question in the forthcoming market review. 16 National Post and Telecom Agency

2 Different categories of IP-based telephony The term IP-based telephony is used in different contexts and with various meanings and includes different types of telephony where the Internet Protocol (IP) is the carrier of the service. In this report, IP-based telephony is divided into various categories depending on whether the service provider has control of its own access, whether the end user can make emergency calls, whether the end user can reach users of numbers from the Swedish numbering plan for telephony, and whether the service is fixed or nomadic (i.e. whether the service is bound to the location of the fixed interconnection point or whether the user can take the service with them to another connection point). 4 These are the most commonly occurring forms of IP-based telephony in Sweden today. It should be noted that this division into four categories is not the only conceivable option. Other grounds for division are shown in Chapter 3. A Fibre LAN Cable TV xdsl, - etc. - Emergency services - centre B Fibre LAN Cable - - TV xdsl, - etc. - Own IP network - Gateway PSTN C Fibre LAN - Cable -TV xdsl, -etc. - Internet Gateway D Fibre LAN Cable - TV xdsl- - Figure 2:1 Different kinds of IP-based telephony The last mile network to the subscriber can be a fibre LAN, 5 a reverse-activated cable television network, or xdsl 6 over an existing traditional copper network. All of these cases are illustrated in the diagram above. Each category is dealt with in detail in the following sections. 4 Compare PTS s report to the Government Utredning av IP-baserad telefoni och andra elektroniska kommunikationstjänster samt möjligheten att nå nödnummer 112 [investigation of IP-based telephony and other electronic communications services, and the possibility of reaching emergency number 112], PTS-ER-2006:15 5 LAN: Local Area Network 6 DSL: Digital Subscriber Line National Post and Telecom Agency 17

2.1 Category A - Fixed IP-based telephony In Category A fixed IP-based telephony the service providers control the last mile network and can thereby control the properties of the network. The service enables calls to be made to numbers in the Swedish numbering plan for telephony and enables emergency calls. Nomadic use may be technically possible within a service provider s last mile network, but services that are currently provided are limited to fixed telephony, that cannot be moved geographically by the end user. Services within this category are marketed to both residential and non-residential customers as a substitute for traditional fixed telephony. An Internet connection is not actually required, although in practice this is usually offered by the access provider together with this kind of IP-based telephony. A Fibre LAN Cable TV xdsl, -etc. Emergency services centre B Fibre LAN Cable - TV xdsl, - - etc. Own IP network - Gateway PSTN C Fibre LAN Cable - TV xdsl, - -etc. Internet Gateway D Fibre LAN Cable - - TV xdsl, - -etc. Figure 2:2 Fixed IP-based telephony (Category A) Service providers are upgrading and/or expanding their existing networks to all- IP with the aim of offering broadband access, telephone subscriptions and television to residential customers via one and the same access line. These service providers have not normally in the first instance built their infrastructure for telephony, but now have the opportunity to provide telephony by upgrading the networks. This upgrading can increase the service providers revenue per customer. Performance and security are potentially comparable with that of traditional fixed telephony. Like service providers oriented towards residential customers, providers in the non-residential market are also upgrading their infrastructure to all-ip so that they can supply more services through a common infrastructure. In contrast to the residential market, there have been a multitude of services and technical solutions for telephony in the non-residential market for a long time. Bredbandsbolaget and Com Hem are examples of access and service providers to the residential market. TDC Song and Telenor are examples of providers to the business market. 18 National Post and Telecom Agency

2.2 Category B Nomadic IP-based telephony with emergency calls In Category B nomadic IP-based telephony with emergency calls service providers supply the service through another access provider s network. They offer IP-based telephony as a separate service and not bundled with broadband access. The service provider consequently has no control over the underlying last mile network. The service enables calls to be made to numbers in the Swedish numbering plan for telephony and enables emergency calls. Nomadic use is possible through the networks of different access providers and mobile use is also possible in certain cases. The service is marketed as a substitute for traditional fixed telephony by certain providers and by others as a nomadic alternative to traditional fixed telephony. A Fibre LAN Cable - -TV xdsl, - - etc. Emergenc y services- centre B C Fibre LAN Cable TV - xdsl, - etc. Fibre LAN Cable TV xdsl, - - etc - Own IP network - Internet Gateway Gateway PSTN D Fibre LAN Cable TV - xdsl, - - etc. Figure 2:3 Nomadic IP-based telephony with emergency calls (Category B) The stakeholders represent a heterogeneous group where the product supply and marketing differ according to the other operations of the undertaking. However, a common feature is that they emphasise the difference between the IP-based telephony service and the traditional telephony service in their marketing. Affinity Telecom, Cellip, Digisip, Tele2 and TeliaSonera are examples of providers. 2.3 Category C Nomadic IP-based telephony without emergency calls In Category C nomadic IP-based telephony without emergency calls the service provider operates through another access provider s network. The service provider consequently has no control over the underlying last mile network. All solutions can be used nomadically if the user so wishes; mobile solutions are available in certain cases. National Post and Telecom Agency 19

A B Fibre LAN - - Cable -TV - xdsl, etc. Fibre LAN Cable - TV xdsl, - etc. Own IP network Gateway PSTN Emergency services centre - C Fibre LAN - Cable -TV - xdsl, -etc. Internet Gateway D Fibre LAN Cable - -TV xdsl, - -etc. Figure 2:4 Nomadic IP-based telephony without the possibility of making emergency calls (Category C) The service provider offers a service that can reach or be reached via traditional telephone numbers from the Swedish numbering plan for telephony, but cannot forward emergency calls. The service is not a telephony service according to the definition contained in the Electronic Communications Act (2003:389) (EkomL). Skype In/Out is an example of a provider. 2.4 Category D Internet telephony without the possibility of making calls to ordinary telephone numbers In Category D Internet telephony without the possibility of making calls to ordinary telephone numbers the service provider operates through another access provider s network. The service provider consequently has no control over the underlying last mile network. It is not possible to make calls to numbers in the Swedish numbering plan for telephony with this service and consequently emergency calls are not possible either. Nomadic use is possible and in certain cases mobile use is possible as well. The service is not a telephony service according to the definition contained in EkomL. 20 National Post and Telecom Agency

A Fibre LAN Cable - -TV xdsl, -etc Emergency services centre - B Fibre LAN Cable - - TV xdsl, - -etc. Own IP network - Gateway PSTN C Fibre LAN Cable - TV - xdsl, - etc. - Internet Gateway D Fibre LAN Cable - TV xdsl, - - etc. - Figure 2:5 Illustration of IP-based telephony without a connection to the traditional telephone network (Category D) The service provider offers software for computers, which enables users to call each other via the Internet. They address users within their own service with a user name and there is no support for external addressing. These service providers have defined telephony in a different way by viewing telephony as a computer application. The providers also offer other applications, such as chat, file sharing, address books, etc. The marketing conducted by the stakeholders themselves is minimal, although they have received a great deal of mass media attention, which helps to increase public awareness about them. They market the service as inexpensive voice communication; it is obvious to the user that this service is different from traditional telephony and this does not have to be marketed. Google Talk, Microsoft (MSN Messenger), Skype Classic and Yahoo Messenger are examples of stakeholders. 2.5 Summary of the different categories of IP-based telephony To summarise, there are four different categories of IP-based services on the market, which can be illustrated in the following way; see Figure 2:6. National Post and Telecom Agency 21

Reaches emergency number A B C Does not reach emergency number D Reaches numbers in the Swedish numbering plan for telephony Does not reach numbers in the Swedish numbering plan for telephony Nomadic Figure 2:6 Illustration of the relationship between different kinds of IP-based telephony Service and access for fixed IP-based telephony (Category A) are supplied by the same provider. Nomadic IP-based telephony with emergency calls (Category B) and nomadic IPbased telephony without emergency calls (Category C) can relay calls to numbers in the numbering plan for telephony. Internet telephony without the possibility of making calls to ordinary telephone numbers (Category D) is not connected to the traditional telephone network. 22 National Post and Telecom Agency

3 How do other European regulatory authorities regard the issue of substitution? As previously mentioned, the increased use of IP-based telephony is a global phenomenon. In many countries, the effect of IP-based telephony on the market is currently being discussed and whether, and in this case to what extent, the current regulatory framework must be adapted for this development. Different countries have different attitudes to IP-based telephony from some countries prohibiting some forms of IP-based telephony to others wanting to promote its development. 7 In Europe, there have been clear signals from the European Commission; it wants a light touch regulation for IP-based telephony to enable the development of new services. 8 The Commission differentiates between managed and unmanaged VoB (Voice over Broadband) 9 and hereby differentiates between services where the provider can or cannot control the quality of service (QoS). On 28 June 2006, the Commission proposed a new recommendation on relevant markets. In this proposal, the Commission wrote that the regulatory authorities in terms of national circumstances should investigate a number of indicators in an analysis of whether IP-based telephony should be included in the end user markets. 10 With the help of these indicators and other factors, the regulatory authorities should assess whether IP-based telephony is exerting competitive pressure on traditional fixed telephony. In the proposed new recommendation, the Commission states that the market analyses carried out to date indicate that accessibility to VoB services has increased in the European Union. The issue of whether substitutability prevails between VoB and traditional telephony 11 depends on a number of factors, including product characteristics, numbering issues, QoS, pricing and broadband penetration. In countries with significant broadband penetration, VoB services can exert competitive pressure on narrowband telephony services, given that the dominant operator is not able to discriminate in terms of price between customers who only have a narrowband connection and customers who also have a broadband connection. Where interchangeability exists, VoB shall be included in the markets for call services at an end user level. Differences in the quality and characteristics of the products (for example whether conventional terminals/telephones can be used and whether computers have to be turned on in order to be able to receive calls) lead the Commission to currently view unmanaged VoB as less of a substitute for narrowband telephony than managed VoB. However, this difference may eventually be reduced in pace with an improvement in the quality of unmanaged VoB and changing technical functions. 7 GSR 2005 Discussion Paper, VoIP and Regulation, November 2005, ITU 8 Speech by Commissioner Viviane Reding, 10 October 2005 9 The term IP-based telephony is also used by the Commission 10 See also the Commission's comments on ARCEP's notification SG-Greffe (2005) D/205048 11 The Commission uses the term narrowband telephony National Post and Telecom Agency 23

PTS is working together with other European regulatory authorities to achieve a common position on the various issues concerning IP-based telephony. A common policy for IP-based telephony in Europe is described in ERG's 12 Common Statement for VoIP regulatory approaches of 11 February 2005. The ambition is to - support the development and use of IP-based telephony services in Europe, and - support a harmonised approach to IP-based telephony in Europe. A brief description is provided below of the different views of the European regulatory authorities to illustrate the problems related to the issue of whether, and in that case which, category of IP-based telephony should be viewed as interchangeable with traditional fixed telephony. It has proved relatively difficult to find information and published material showing how other European regulatory authorities have so far worked with the issue of whether IP-based telephony should be viewed as interchangeable with traditional telephony. This is probably because most authorities have not worked with the issue for very long. The variety of terms for IP-based telephony also varies between the different regulatory authorities, which makes the whole situation rather difficult to assess. This also means that it may be complicated to compare different countries with each other. The aim is to compare each regulatory authority's classification of IP-based telephony with the classification used by PTS. The countries discussed in the comparison have been chosen because the information has been viewed as interesting and relevant to the substitution analysis. 13 Besides a description about whether IP-based telephony has been included in the relevant markets, this chapter also discusses how the different countries view the substitution from fixed telephony to mobile telephony. Once again, it is important to bear in mind that this study is not comprehensive, but should be seen as information that may hopefully paint a relatively accurate picture of how certain countries have handled the issue up to now. 12 European Regulators Group, cooperation body for regulatory authorities within the EU 13 The information about IP-based telephony is mainly based on information from and through Cullen International, for example flash messages from Cullen and links to, for example, the Commission's comments. http://www.cullen-international.com/documents/cullen/prindex.cfm 24 National Post and Telecom Agency

3.1 The Netherlands 14 3.1.1 IP-based telephony The Dutch regulatory authority, OPTA, notified markets 1-6 on 4 November 2005. The authority included managed VoB in markets 1-6. OPTA differentiates between: - Voice over Broadband (VoB), which is provided by operators with their own broadband access and is also referred to as managed VoB. The quality of service is viewed as equivalent to the quality for traditional fixed telephony. Based on the categorisation used by PTS in this report, this corresponds to Category A; and - Voice over the Internet (VoI), also referred to as unmanaged VoB, which is provided by operators without broadband access. Unmanaged VoB often means lower service quality than traditional fixed telephony services. Also, a headset or microphone is often required in order to be able to speak/listen. Computers also have to be turned on to make or receive calls. This corresponds best to Category D according to the categorisation used by PTS in this report. The categories that PTS denotes as B and C in this report are difficult to place in any of OPTA's VoB and VoI categories. In the report Potential competition problems in voice-over-broadband service from November 2005, written for OPTA by the Oxera consulting firm, different competitive aspects are discussed concerning VoB services. This report was written as a result of differences of opinion between the regulatory authority and the dominant operator, KPN. The differences of opinion were based on OPTA's proposal of July 2005 that broadband telephony (VoB) should be included in the same relevant market as fixed telephony for both calls and access. OPTA also proposed an obligation on price regulation to prevent KPN underpricing VoB services. KPN did not agree with this and had two consultative reports written to counter OPTA's proposal. Oxera's report was written in response to these consultative reports. Oxera's report states that the use of VoB is still limited in the Netherlands, but that OPTA estimates that VoB will represent between 10 and 30 per cent of all connections by 2008. According to OPTA, this means that VoB will subject traditional telephony services to significant competitive pressure and consequently should be included in the markets for access and calls. On the other hand, KPN claims that this conclusion could very well be different if the analysis used VoB as its starting point instead of traditional fixed telephony. In this way, consideration would be taken of the possibility that relevant markets may be defined 14 This information has mainly been taken from Cullen International, EU Telecommunications flash message 181/2005, the European Commission's comments of 2 December 2005, SG-Greffe (2005) D/206586 as well as the Oxera consulting firm's report Potential competition problems in voice-over-broadband services, report prepared for OPTA, 2 November 2005 National Post and Telecom Agency 25

asymmetrically, i.e. even if VoB limits the development of fixed telephony, it is uncertain whether fixed telephony will limit the development of VoB. However, Oxera states that consideration must be taken of the connections that exist between VoB on the one hand and fixed telephony and broadband services on the other. These connections could mean that market power is transferred from traditional fixed telephony and/or broadband access to the provision of growing VoB services. The Oxera consulting firm discusses certain arguments raised by the abovementioned consultative reports, but which Oxera does not agree with. According to Oxera, for example, both of the other consultative reports state that a market description based on VoB is difficult to carry out without empirical evidence. For instance, it is difficult to know how price sensitive consumers are to VoB services, both as regards the actual price level and the price level in relation to that of traditional fixed telephony. Also, one of the reports asserts that it is unlikely that fixed telephony will impede competition as regards the development of VoB. Arguments for this view include lower costs for the provision of VoB and lower end user prices compared with PSTN 15, that certain functions differ between PSTN and VoB (for example nomadicity), and also the unlikelihood that consumers, who have already chosen VoB, would revert to traditional fixed telephony services (asymmetric substitution). Oxera does agree that there are many uncertainty factors about how VoB development will appear in the future. However, Oxera is convinced that undertakings currently providing VoB do not primarily compete with other undertakings providing this service, but with undertakings providing traditional fixed telephony. At present and most likely for a number of years in the future, traditional fixed telephony will thus exert a pressure impeding competition as regards the development of VoB. 3.1.2 Fixed-mobile substitution OPTA has also highlighted the phenomenon of fixed to mobile substitution and that this may mean future changes in how the relevant markets are defined. In its analysis of the fixed telephony market, OPTA states that: De facto the mobile networks are the only relevant infrastructure-based access competitive alternative in the residential market. Although OPTA currently concludes that mobile access does not belong to the same relevant market as fixed narrowband access, substitution needs further attention in the near future. If the degree of substitution develops at the same speed as over the last few years, a critical loss analysis may generate a different conclusion in a few years. 15 A PSTN subscription is equivalent to a main line to an own end user. Usually, the operator owns the main line or leases it from a network operator (for example, through full or shared access) or purchases a WLR. 26 National Post and Telecom Agency

OPTA commissioned the Ovum consulting firm to carry out a study about fixed to mobile substitution in the Netherlands. For example, it can be gathered from the report that there is a link between the penetration of mobile telephony and a country's PPP 16 per capita. If GDP PPP per capita is above a certain level, the increased convenience of mobility is a factor for the adoption of mobile telephony. In the market survey mentioned in this report, the consulting firm has chosen to exclude the effect that VoIP may have on the substitution from fixed telephony to mobile telephony as a result of the difficulty in understanding how the market would react to the introduction of VoIP. The report states that substitution from fixed to mobile telephony exists, but Ovum does not believe that many people will abandon their fixed connections to use a mobile connection only. In its report, Ovum also describes different scenarios for the development of substitution from fixed to mobile telephony and believes that gradual call substitution will be the most likely development; price competition between mobile operators and the later launch of 3G will make mobile telephony less expensive. It is believed that this development, together with the convenience of mobile telephony, will stimulate a gradual migration from fixed telephony to mobile telephony. 17 3.2 France 18 3.2.1 IP-based telephony The French regulatory authority, ARCEP, notified markets 1-6 on 29 July 2005. ARCEP differentiates between: - Voice over Broadband (VoB), where the provider of the broadband connection maintains control over the packet-based access network and thus maintains control over quality of service. The quality is equivalent to the quality of traditional telephony. This form of telephony is also referred to as managed IP-based telephony. Based on the categorisation that PTS uses in this report, this corresponds best to Category A. - Voice over Internet (VoI), where telephony is generally not supplied by the broadband provider and where users must have a PC connected in order to make and receive calls. This form of telephony is also referred to as unmanaged IP-based telephony. The operator providing the telephony service has no control over the underlying last mile network and for this reason cannot guarantee the quality of service. The quality of 16 GDP PPP Gross Domestic Product Purchasing Power Parities. Estimates carried out by several international organisations, for example OECD and EUROSTAT, which can, among other things, be used as a basis for evaluating how the telecommunications sector compares with the economy as a whole in the EU, etc. 17 Fixed Mobile Substitution in the Netherlands. Market research and high level strategic analysis for OPTA. Undertaken by Nadia Griffiths & Angel Dobardziev, Ovum, 5 December 2003 18 This information has been taken from Cullen International, EU Telecommunications flash message 125/2005 in addition to the European Commission's comments of 15 September 2005, SG-Greffe (2005) D/205048 National Post and Telecom Agency 27

VoI is considerably lower than that of the traditional telephony service. This best corresponds to Category D based on the categorisation used by PTS in this report. Based on the categorisation used by PTS in this report, it is difficult to place IPbased telephony of Categories B and C in any of ARCEP's VoB and VoI categories. ARCEP includes VoB services in the relevant end user markets for telephony services via fixed network interconnection points (markets 3-6). The authority emphasises that VoB services have the same functionality as traditional telephony, for example that it is possible to make in- and outgoing calls and that the quality of service is the same as that of PSTN telephony. Also, the telephones that are used for VoB services are similar to those used for traditional telephony. This is in contrast to VoI, which up until now has been considerably different compared to traditional telephony. In other words, ARCEP is of the opinion that VoB and traditional PSTN belong to the same relevant market. As regards the competitive pressure that VoB exerts on traditional telephony, ARCEP states that between 30 and 40 per cent of French residential customers have broadband access and therefore could easily change over to VoB offers. Data from ARCEP indicates that prices for PSTN tend to lie at the same level as lower price VoB telephony services. ARCEP is also of the opinion that, as France Telecom has a USO obligation to offer equivalent end user prices nationally for connection and calls for residential customers, this means that price cuts on PSTN calls could benefit all residential customers, even those without a broadband connection. ARCEP has drawn the conclusion from this that VoB and PSTN services exert competitive pressure on each other. As regards access markets 1-2, ARCEP nevertheless excludes connection products that are available via broadband and which are largely intended for purposes other than voice telephony (for example high speed broadband and/or television broadcasts). The authority bases this view on the fact that the connection products needed to make or receive calls via broadband are a form of side service to the main service (for example, broadcasting). In other words, consumers do not buy these products as a replacement for their traditional telephony connection and for this reason they should not, from a demand perspective, be viewed as a substitute for a PSTN connection. However, the authority believes that it will be more common in the future for offers to be solely or mainly focused on the telephony service. In such cases, ARCEP believes that the connection will be seen as a substitute for a PSTN connection. 3.2.2 Fixed mobile substitution The existence of fixed to mobile substitution does not lead ARCEP to define the markets for fixed and mobile telephony as belonging to the same relevant market. The main argument for this is that mobile services cannot be replaced by fixed telephony services. This is partly due to the mobility feature naturally leading the user to perceive the two types of telephony service as being different. However, ARCEP believes that it is possible to discern limited substitutability between the 28 National Post and Telecom Agency