Fibre, copper and telcos

March 23rd, 2011 at 9:00 am by David Farrar

There’s been a number of news stories on the Government’s Telecommunications Amendment Bill, which is currently before the Finance & Expenditure Select Committee. A typical story is this one at Computerworld.

The telecommunications sector is always somewhat controversial, but this bill has attracted criticism from just about everyone – telcos, ISPs, the Commerce Commissions and user groups. This post is aimed to explain what the debate is about, and reflects my views.

It is worth noting that most of what is in the TAB is not controversial, and is generally well supported.

Three aspects which are controversial are:

  1. a “regulatory holiday” for the local companies until 31 December 2019.
  2. “re-averaging” the costs of local loop unbundling and unbundled bitstream, which will lower the wholesale cost in rural areas but increase the wholesale cost in urban areas by around 20%
  3. possible structural separation of if they win the majority of regions for fibre rollout

In this post I will leave (3) for now as that little baby is so complicated it needs its own post. I want to focus on (1) and (2) and these will apply (if passed) regardless of whether Telecom wins most of the regions for urban fibre, or the lines companies led by Vector win most of the regions.

You may ask why would the Government consider giving the future fibre companies an exemption from the normal regulatory oversight of the ? Well the short answer is because the companies bidding to be future fibre companies have asked for it.

Okay well companies ask for lots of things from the Government. Many companies would like to be exempt from the Commerce Commission until 2010. Why would the Government agree to this?

The answer is because then the bidders will make better bids. They value having a regulatory holiday, so they will agree to roll out more fibre for the same subsidy. It is what Sir Roger Douglas (very perceptively) said was a regulatory subsidy instead of a greater direct financual subsidy.

Now before we talk about the pros and cons of this approach, you need to know the background. In the 2008 election National pledged $1.5b towards having ultra-fast rolled out to 75% of NZ over the next decade. This was a lot of money (Labour committed only $300m – 1/5th of what National did) and it was in my opinion a great policy.

Work done by the NZ Institute concluded that investing in ultra-fast broadband, would result in significantly higher economic growth, and there is evidence from other countries to back this view up.

Now the cost of rolling out fibre to 75% of NZ is hard enough to estimate, let alone what the direct commercial returns will be on doing so in ten years time. The amount of subsidy needed to achieve the 75% target was estimated at $1.5 billion, but this was an estimate. An opposition does not have the resources available to get a precise projection, and even when you do have access in Government to Treasury, even then projections can be wrong.

To some degree one was never going to know until the actual commercial negotiations conclude, whether $1.5b was enough. InternetNZ did try to get some idea of how much it would cost to reaach the goal of 75%, and what would be the best way to go about it. They (which includes me)  commissioned a report from Network Strategies, a specialist economics consulting firm, which is here.  It was published in 2008.

The report concluded that the cost of fibre to 75% of NZ was around $3.3b if one utilised existing utility companies for at least half of it, and that the government’s contribution would need to be around $1.75b. So the $1.5b was a pretty good estimate, but may be not quite enough.

So this takes us back to why the Government is seeking to legislate a regulatory holiday – it makes it more attractive to its potential commercial partners, and helps close the gap. So the motivation is good – to save the taxpayer money.

However that does not mean it is the right decision. If there is a funding gap between the 75% target and what you can achieve with $1.5b, I would rather it be dealt with directly, not indirectly by way of regulatory holiday. Options are to increase the $1.55b on offer, or to reduce the coverage area from say 75% to 70% or push out the timeframe from say 10 years to 12 years etc.

The concern over the regulatory holiday is that whomever wins the contract, will be exempt from the Commerce Commission regulating access to their services until 2010. The Government will be relying just on the contracts they had to regulate the price, However this places Crown Fibre Holdings in the unenviable dual role of being an investor and a regulator. Also 2020 is almost nine years away, and that is a lifetime in the Internet world. The costs and prices of fibre and data may have changed massively in that time. Many people are very nervous about what could happen in the next nine years. This is partly because of the lessons from the past with Telecom (note again they may not be the fibre companies).

Now the Minister has pointed out that as the local fibre companies can not be owned by a company that will provide retail services over them, then it is less likely there will be a need for regulation, as the fibre companies should operate on an open access platform to all providers. But a lot of devil is in the detail. For example you could have Chorus (if they win) saying it will operate a volume discount scheme that only Telecom Retail will qualify for due to its size.

The Minister also says that as the fibre products will be competing against the regulated copper and that the challenge will be ensuring uptake, which will keep prices down also. I suspect Steven is right on the prices – but from my thinking why remove the safety net of the Commerce Commission, in case you’re not.

Now the other major change is that the calculation of costs and hence prices for the current copper based broadband services is to change from deaveraged to reaveraged. At present the costs and prices reflect the fact it is cheaper in urban areas than rural areas. The Government is proposing to legislate to change this, which means the price of broadband over copper will increase in urban areas. The estimate I have seen is by 20%.

So again why would you do this? The answer is the same. It means those bidding for the fibre contracts will be motivated to invest more money into them. Because if the price of broadband over copper increases, then you can be confident that more customers will switch over to broadband over fibre.

So again the rationale is quite understandable, but again that does not mean it is necessairly a good thing. It means people in urban NZ will pay higher prices than they should for broadband over copper for the next six years or so. Should the Government be effectively tilting the playing field to favour fibre over copper?  Again I’m in favour of tilting the field by way of Government subsidy, but not in favour of tilting the field by interfering with a regulatory regime that actually has worked very well in the last few years.

As I said, in a separate post, I’ll cover the possible structural separation of Telecom, and how this may result in a really great outcome or a really lousy outcome, depending on how the structural separation is done. And the consequences of getting it wrong will reverbate for a couple of decades. This is not something to rush.

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27 Responses to “Fibre, copper and telcos”

  1. ben (2,379 comments) says:

    The policy exemption is an absolutely terrible approach and is all but guaranteed to lower not raise New Zealand’s wealth.

    a) the exemption is a reward for lobbying and for personal connections, neither of which have any value to the country. The exemption sets a precedent and weakens property rights, which really matters for investment in fixed technology assets. The next major technology development will now be setting aside millions in their budget for lawyers, PR and political consulting fees. That’s money not available for investment in services, and is pure deadweight loss.

    b) the exemption precedent will stifle future investment. Where exemptions are not initially granted, investment now less likely to occur, because an investor will always fear the government will change their mind, grant an exemption later, and expropriate whoever went first

    c) the power to exempt, being arbitrary and in the hands of Ministers and senior officials, is a substantial transfer of power from the many to the few. The suits Ministers and senior officials just fine, at the expense of everyone else.

    d) exemptions are not granted to anybody. They are granted to large and established companies, because those companies have prior relationships established and are less likely to embarrass the Minister granting the exemption. So: Advantage: large corporates and SOEs. Disadvantage: technology start ups. Overall: bad for innovation.

    In short, not a fan of this at all.

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  2. bij (66 comments) says:

    it isn’t that weird to have a reg holiday, just a weird way of doing it. Australia has regulatory contracts, i.e. for long-lived infrastructure assets with high upfront capital costs (that take a long time to recover by filling that initially surplus capacity with subscribers), how else can investors be certain that the Govt or ComCom won’t disallow those early investments in past periods by saying prices are currently too high?
    why invest when there is a risk that the capital will be expropriated? its a blunt tool, but not exactly unorthodox in the intent.
    fibre companies, before they invest, want certainty that they can price what ever way they want (i.e. price discriminate) to recover their costs, because that will take some time.

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  3. bij (66 comments) says:

    … but i agree with the criticism. it would be better to *fix* competition law and the effect on investment generally in NZ. that’s a much bigger job.

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  4. virtualmark (1,523 comments) says:

    DPF, a few things to note about the “regulatory holiday”:

    Firstly, this is in large part a reaction to the Commerce Commission’s behaviour over the last 10 years. The lines companies have had bitter experience of the ComCom price and rate of return regimes that are unrealistically low and which leave the lines companies squeezed between needing to maintain system reliability and stability yet facing a real risk of insufficient returns on their capex. The lines companies are not rushing to repeat that experience in a new field. And Telecom has found the ComCom un-commercial to deal with in their negotiations on operational separation.

    The Commerce Commission’s input in the development of the UFBI programme wasn’t all that commercial either, which didn’t bode well for their contribution over the next 10 years.

    Secondly, all parties – I believe including the Government – have had concerns about the Commerce Commission’s ability to stick to an agreed regulatory approach over the long term. Lines companies are supposedly subject to a “CPI-X” pricing regime. Yet the ComCom were quite happy to take Vector on over differential pricing between regions and on rates of return – even though Vector was in compliance with the CPI-X regulations. Frankly, commercial operators do not trust the Commerce Commission to set sensible rules and then butt out. No one is prepared to invest multi-billions in a risky new venture while taking the ComCom on trust that they will not change their minds in 5 years time.

    Thirdly, each LFC is based on a contract between the Government and its partner which sets, among other things, the price cap for each service and the rate of increase in that price cap. So a regulatory price path control is baked into the LFC. Why do we need yet another regulator on top of that?

    Fourthly, and very importantly, don’t forget that the Government itself will be a shareholder in the LFCs and will be represented on their boards. In fact the commercial model for LFCs all but ensures that the Government – via CFH – will control the voting rights of the LFCs for most of the 10 year regulatory holiday period. This gives the Government direct levers it can pull to stop any perceived uncompetitive behaviour.

    In summary, the commercial world has lost faith in the ComCom’s ability to set reasonable commercial terms which encourage investment. Yet the Government’s clear intention with the UFBI is to encourage investment faster than rational commercial incentives would dictate. Neither party could trust the Commerce Commission to not have a brain explosion in the future. Both parties agreed to instead bake the regulations right into the LFC model, hence meaning there is little need for the ComCom, and hence this regulation.

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  5. dog_eat_dog (780 comments) says:

    Someone needs to ask them why we should exempt them from regulation when many telecos seem incapable of correctly describing their products without misleading consumers, have admitted to using confusion as a “marketing tool” and whose products have been hugely overpriced for several years when compared with other countries. These are the last companies in the country that should have a “regulatory holiday”.

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  6. berend (1,708 comments) says:

    May I suggest a radical approach? Just leave it broadband to the market. The current ADSL market is in a limbo. There are hardly any changes, everyone is just waiting for the government.

    But I’m afraid this only happens when National Party voters will see the enormous gap between the National Party’s talk about free enterprise, private property and free markets, and their dictatorial behaviour.

    And to @dog_eat_dog: consumers should be able to sue over misleading advertising.

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  7. dog_eat_dog (780 comments) says:

    Berened, I agree. Another huge issue is that of changing plans. My grandparents were being charged rates on a plan that hadn’t existed (as in, been offered to the public) since the late 90s, yet being charged three times what an equivalent plan would have cost them had they signed up that day. Not once did the teleco in question call them or advise them of this. This is hugely common with internet providers, who overhaul their plans and often won’t migrate you unless it works out better for them. I know a lot of people still love being on Go-Large, and I respect that, but it should be compulsory to advise people that plans are changing AND the savings each account holder would make by switching based on recent usage. I’d also be interested to see how the per-GB charge rates have fallen over the last ten years. I suspect they simply stopped falling around about 2004, and may have crept up at some point.

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  8. kiwibrew (3 comments) says:

    @virtualmark

    a.) The lines companies suffering under ComCom regulations are those who sold over-valued assets to private equity companies, who exist to extract value from those assets. That’s maybe three of the 28. The balance are doing well, and many give generously back to their communities.

    b.) A number of lines companies were happy to invest in fibre well before UFB or any regulatory holiday was on the table. See Northpower, Vector, Counties Power, Unison, Centralines, Network Tasman, Electricity Ashburton, Delta, and Powernet. They didn’t seem too worried about the Commerce Commission then. (Funny, no privately owned lines companies in that list!)

    c.) The government is a shareholder in Kordia, who have a history of uncompetitive behaviour in the telecommunications space. In the words of Geoff Hunt, “Kordia’s job is to provide services and make money. It is not a social service.” (Computerworld, 2008-05-29) I don’t believe that having the government as a shareholder is going to prevent uncompetitive behaviour in this new regime.

    “The Commerce Commission is a government agency charged with enforcing legislation promoting competition in New Zealand markets and prohibits misleading and deceptive conduct by traders.” (Wikipedia, 2011-03-23) This seems like a simple, useful, and positive mission. If there’s something broken with the legislation, fix the legislation. Why have the legislation then prevent it from being enforced?

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  9. davidp (3,581 comments) says:

    Why is the government picking a particular technology, namely fibre? I’m guessing that tablets will become all pervasive over the next few years and most internet access will be mobile. But I’m not willing to bet billions of dollars on my guess. I’d rather the government left this up to the market rather than try to pick a winner.

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  10. virtualmark (1,523 comments) says:

    davidp … how do you think the data is going to get to the mobile basestation serving your tablet?

    Vodafone’s big problem today vis-a-vis Telecom is that many of their basestations are served by T1 lines, rather than fibre, and Voda simply can’t get enough data to the basestation to serve the mobile devices.

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  11. virtualmark (1,523 comments) says:

    dog-eat-dog … remember the LFCs are only providing the physical fibre connection. They sell these to retailers, as a wholesale product. End consumers will not contract directly with LFCs.

    All the product plans etc are higher-level services which will be sold by the retailers. The retailers remain (largely) unregulated.

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  12. berend (1,708 comments) says:

    @dog_eat_dog, disagree over your plan stuff: consumers have a responsibility as well: a free market only exists, if the two parties in the contract are both diligent. Apparently your grandparents didn’t mind paying this huge amount of money, and were not interested in looking for better deals.

    The best way to get improved service from companies is not to deal with those that don’t provide good service.

    But alas, in our days, even if consumers did that, the government would bail them out.

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  13. davidp (3,581 comments) says:

    virtualmark>how do you think the data is going to get to the mobile basestation serving your tablet

    Either microwave, or fibre to the basestation rather than to homes. But either option can be provided by entrepreneurial telcos taking a punt on mobile services, rather than public servants and National Party politicians.

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  14. virtualmark (1,523 comments) says:

    kiwibrew …

    a) Which lines companies sold to private equity investors??? Powerco was sold to an infrastructure fund, but I wouldn’t class them as a “private equity investor” because they are a natural long-term owner of that asset. Vector was partially floated. I’m not aware of any lines company that I would class as having a financial owner, rather than a strategic owner.

    Lines companies are not doing well. Their return on capital is miserly. No rational investor would rush to invest more money into lines company assets given the meagre returns. The Commerce Commission is largely responsible for those meagre returns.

    In my opinion the Commerce Commission (and Electricity Commission) needs to realise that the cost to NZ Inc of slight over-investment (due to allowing higher rates of return) is much less than the cost to NZ Inc of slight over-underinvestment (brown-outs, power crises etc).

    b) Granted. But none of them were making any money out of it. And none of them were prepared to pull the trigger on large-scale fibre deployments.

    c) I would content that the cautionary note from Kordia is that they are a great example of a poorly-run and poorly-directed company, and that they show why government’s shouldn’t own 100% of a commercial enterprise. Compare Kordia to Air New Zealand and you’ll see why partial-floats of the SOEs is likely to lead to significant improvements in strategy, performance, customer service etc.

    Re your comment on the Commerce Commission. Yes, it sounds like a wonderful idea. We should buy two. But the reality is that the Commerce Commission is staffed by people who have little or no direct real understanding of competitive markets. They are theory wonks who have never built their own company and had to struggle in a competitive market. They are also imbued in a public service culture which is bureaucratic and which doesn’t understand the profit motive. The idea is good. The people executing it don’t have the right skills.

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  15. virtualmark (1,523 comments) says:

    davidp … what technology do you plan to use to deliver even 1Gbps wirelessly to every house in New Zealand? There just isn’t the radio spectrum available to do that, let alone the other technical problems you’d face.

    Fibre to the home is the sensible next technical step. Just that right now it’s the not-sensible next commercial step. So if the government wants FTTH then it needs to somehow bridge the commercial gap. Which is the UFBI programme.

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  16. davidp (3,581 comments) says:

    virtualmark>what technology do you plan to use to deliver even 1Gbps wirelessly to every house in New Zealand?

    None. If there was a demand for 1gig to every house in NZ then people would be pushing telcos to deliver the service and telcos would be making a fortune building the networks required to support them. But neither of these is true. The demand isn’t coming from householders, but from National Party politicians and public servants.

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  17. wreck1080 (3,905 comments) says:

    This looks like it is going pear shaped .

    They are not even offering great speeds on the new network. I already get 21mbps through telecom (close to the cabinet), and they are only increasing to 30mbps. Upstream is much more , but, most data is downstream so upstream does not matter much to many consumers.

    Now, they are saying 50gb is ‘heavy’ usage for a cap (http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10714330)

    A single bluray disc can be about 40gb, so you get one high def movie per month and you are screwed. The whole idea is you’d be able to stream high def as much as you like. but,this is patently not going to be the case.

    We are replacing one terrible monopoly, with another. The only customers on the new network will be corporates and those on the outer edge of adsl connectivity.

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  18. chrisw76 (85 comments) says:

    Wireless is definitely not a solution. Having been without broadband for a couple of weeks and relying on Vodafone’s network, it was incredibly frustrating with dropped connections, slow (old skool modem slow) web site loading and then when there was good speed the perpetual worry that you are going to break through the cap and be penalised with overage fees. $50 per month for 1GB, while better is still rubbish.

    Between reliability and cost, nothing beats broadband at this stage if mobility isn’t necessary (beyond your own WiFi network).

    Cheers, Chris W.

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  19. wreck1080 (3,905 comments) says:

    Oh yes, whoever thinks wireless is a solution must be joking.

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  20. kiwibrew (3 comments) says:

    @virtualmark

    WELLINGTON ELECTRICITY DISTRIBUTION NETWORK HOLDINGS LIMITED
    M B & H Corporate Services Limited, Mareva House, 4 George Street, Nassau, Bahamas

    PowerCo now appears to be ultimately owned by Brookfield (www.brookfield.com)

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  21. peterwn (3,271 comments) says:

    kiwibrew – Powerco is NOT Wellington Electricity. WE was sold to Chinese interests, but is managed and operated by Kiwis. As far as I know the owners and management are highly regarded for their commitment to the network, for example the present installation of new 33,000 volt cables from Wilton Grid Exit into Thorndon to better secure CBD supplies.

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  22. kiwibrew (3 comments) says:

    @peterwn

    Two separate bits of information, I’m sorry if I wasn’t clear.

    1. WE is overseas owned – Chinese? Via the Bahamas? Ok, whatever the case. Private, for-profit.
    2. PowerCo is overseas owned – now ultimately via Brookfield. Definitely private and for-profit.

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  23. virtualmark (1,523 comments) says:

    Kiwibrew …

    Wellington Electricity is owned by Chueng Kong Infrastructure (www.cki.com.hk). They’re a big infrastructure owner out of Hong Kong.

    Powerco is owned by Brookfield Infrastructure, who are a big infrastructure owner out of the USA.

    Both are what I would term “strategic owners”. They are long-term owners of this type of asset. They have real experience and capability in owning infrastructure assets.

    They are not “financial owners”, whose only interest is to buy something for a dollar and sell it for two dollars in a few years time.

    Yes they are “for profit” owners. Beats “for loss” owners every day. Yes some lines companies are owned by consumer trusts. But those consumer trusts are still “for profit” owners too. It’s just that on the whole the consumer trusts are ignorant owners who don’t bring any real infrastructure experience, expertise or capability to the table and who all to often accept poor financial returns that don’t even match what they’d get from having the same value of money sitting on call in a bank account.

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  24. Colonel Blimp (8 comments) says:

    This has all the potential to be Bradford/electricity stuff-up; remember that?- we are still paying. Let the market decide. No CC holidays. Short term pain for long term gain is preferable.

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  25. dog_eat_dog (780 comments) says:

    @Berend – Yes, that’s probably a fair call to make, but I do think there needs to be some study how the price of data has changed over the past few years.

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  26. Anthony (796 comments) says:

    VM, Telecom know about the profit motive all too well which is one reason why NZers face the highest residential line rental in the OECD! You can’t leave the free market to run a natural monopoly or consumers suffer. That is the economic theory which is well proven in the real world.

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  27. virtualmark (1,523 comments) says:

    Anthony … no one’s suggesting LFCs won’t have controls. Just that they will be applied by contract, enforced by Government shareholding, and won’t directly involve the Commerce Commission.

    If the Commerce Commission were to be unfettered then none of the Crown’s private sector partners would agree to invest in their share of the UFBI costs – which will total around $3 billion in aggregate. No one has confidence the Commerce Commission wouldn’t try to change the rules in the future. And without that confidence no one is going to put their money at risk.

    The bad news is that even the Government has come to not trust the Commerce Commission – hence this legislation to sideline them.

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