Silviase/jgov_v1.4_full_ann huggingface dataset:
### 1.8 Regulation of New Services

One of the key elements of the telecommunication policy emerging from the duopoly review in 1991 was a decision to prohibit BT and Mercury from providing broadcast entertainment services under their main licences. Like other companies, they are entitled to bid for local delivery franchises for entertainment from the Independent Television Commission. Having obtained such a licence, they would be entitled, if they wished, to provide telecommunications and broadcast services over the same network within the relevant franchise area. But without such licences they cannot provide or convey broadcast services. The Government recorded in 1991 its decision that this restriction should last until 2001 and not be reviewed before 1998. Its purpose was to provide cable companies with a window of opportunity in which they could lay down their networks.

This restriction has elicited some criticism, both from BT and from other commentators. It is asserted that it hampers the development in the United Kingdom of the national information infrastructure or “super highway”. However, both the Secretary of State for Trade and Industry and the Director-General of Telecommunications have recently reaffirmed their support for this policy.

The restriction applies only to broadcast (point to multi-point) services. It does not apply to switched entertainment services relayed on an individual basis to a subscriber. As a consequence, BT is able to offer the service known as video-on-demand on its network. Moreover, recent advances in compression techniques now make it possible to supply such services on a copper wire, using what is known as ADSL (asymmetric digital subscriber line) technology.

BT has undertaken a preliminary technical trial of video-on-demand and proposes a larger commercial trial in eastern England in mid-1995. From a regulatory standpoint, the new services present a number of problems. Should there be any restrictions on BT's ability to provide video services over its network? On what terms should other service providers have access to BT's network for the delivery of entertainment programmes? Should they pay at standard interconnection rates, or should they pay the standard retail tariff? How should costs be allocated when the same copper wire is carrying both an entertainment programme and a telephone call? OFTEL proposes to publish a consultation document on these and related matters in mid-1995.

### 1.9 Mobile Telecommunication Services

The previous discussion has covered fixed services, including fixed wireless services such as that to be employed by Ionica. Simultaneously with these developments, throughout the 1980s, the British Government licensed a number of mobile services. The key events are shown in Table 1.10.

The principal factor governing the early development of mobile markets was the decision in 1985 to license two analogue cellular operators. One of these, Cellnet, is owned 60% by BT
and 40% by Securicor. The other, Vodafone, was owned by the electronics group, Racal, but was subsequently demerged as a separate company. The resulting duopoly gave network operators considerable market power, as attested in the pricing and profitability data reported in Section 2.5 below. In the late 1980s, attempts were made to launch a new cheaper service known as Telepoint or CT-2, which permitted subscribers to make outgoing calls only within a fairly narrow radius of a base station. However, these services foundered.

The next key development was the announcement in 1989 of three licences for personal communications networks (PCN). Two of the licensees subsequently merged. One PCN operator, Mercury One-2-One began service in late 1993, initially in the London area. The other operator, Orange, began service in 1994. In 1994 too Cellnet and Vodafone launched digital services in addition to their pre-existing analogue services.

A major feature of the initial regulatory regime was the decision made at the outset to separate network operation and service provision. Cellnet and Vodafone were prohibited as operators from selling services to the public. Instead, they had to sell air time to service providers, which would then package it with mobile telephones and sell directly, or through dealers, to the public. The two network operators, or their parent companies, could themselves own service providers, but they had to be separately accounted for and the parents were not permitted to cross-subsidise these subsidiaries. The purpose of the system was to encourage extensive competition amongst service providers, even though network operation remained a duopoly.

When the PCN operators were licensed, they were permitted to deal directly with the public through direct service organisations although their licences contained a requirement to account separately for and not cross-subsidise such operations. To restore symmetry, in 1994 Cellnet and Vodafone gained the same right. In practice, however, they continue to deal largely through service providers, while the PCS operators sell directly to the public or through retailers.

The relationship between network operators and service providers received regulatory attention in 1994, when independent service providers complained that network owners were subsidising their own affiliated service providers. The DGT issued a Directive, subsequently revoked, requiring Cellnet and Vodafone to cease such cross-subsidies. At the same time, the new network operators (i.e. the PCN companies) were allowed a period of one year (subsequently raised to two) in the course of which they could subsidise their direct service organisation. Thereafter, those organisations would have to be self-financing.

## SECTION 2 - OUTCOMES

### 2.1 Entry and Market Share

Section 1.1 above has described the licensing regime for UK telecommunications sector since 1983. As noted, it consists of the duopoly period from 1983 to 1991, followed by liberalisation of domestic markets. This section describes the entry which has occurred, and
long-distance network introduced. Investment levels during this period were twice the level before privatisation, and it has been suggested that one of the beneficial consequences of the change in ownership was to allow the company to escape from the investment restrictions to which it was subject as a public corporation. Employment levels within the company remained virtually constant or even increased slightly in the period immediately following privatisation. Since 1990, however, they have fallen sharply, by about 35% between 1990 and 1994. The company has now adopted an employment target of 100,000 by the end of the decade. This decline occurred in a period when output grew sharply. A recent study has estimated that over the period 1989 to 1994, BT's total factor productivity grew at an annual rate of 7.2% (Bishop and Green, 1995). Table 2.12 reports the variation in lines per employee between 1986 and 1994, in the course of which there was an increase of nearly 90%. Although this series almost certainly reflects improved labour productivity, it is subject to well known difficulties of interpretation and should be treated with caution.

Apart from the cable companies, Mercury has been responsible for the other principal investments made in the UK telecommunications sector since 1984. Table 2.13 gives a summary of the company's turnover, operating profit, net assets and average number of employees. Cumulative capital investment had by 1993 exceeded £2 billion. Although operating profit rose steadily to 1993/94, towards the end of 1994 the company recognised a decline in profitability and undertook a restructuring and refocussing of its activities. These have led to a reduction in its work force by about one quarter.

### 2.4 Quality of Service

Procedures for regulating quality of service have been described in Section 1.7 above. We now review the changes in quality of service which have occurred over the period.

Table 2.14 shows a series of BT's network reliability over the period since 1983. It shows a continuous improvement, with the exception of 1987. Local call failures now occur at approximately 5% of the 1984 rate, and the improvement in national call failures has been even more spectacular. Data on the company's fault repair service also show improvements. Mercury publishes quality of service data in a different pattern. It too has shown improvements since 1987.

### 2.5 Changes in Consumer Surplus from Fixed Link Telecommunications

It would be convenient to be able to summarise the impact upon consumers of telecommunications services of the changes in price and quality of service described above, in the form of changes in the consumer surplus. There are, however, a number of obstacles to such an exercise. In the first place, it requires knowledge of BT's outputs or revenues on a disaggregated basis, in order to take account of the substantial changes in relative prices shown in Table 2.5 above. Such data are not publicly available. Second, the growth of competition to BT from other operators such as Mercury and the cable companies now makes it desirable to include their
output in the calculation. But even less data are available concerning BT's competitors. Third, the period since 1984 has exhibited significant changes in quality of service. The fall in quality-adjusted price changes thus exceeds that the unadjusted price change. Estimates of changes in consumer surplus made without a quality adjustment would thus significantly understate improvement.

An estimate of the change in consumer surplus associated with the UK telecommunications industry in the 1980s is available from a World Bank study (Galal et al, 1994). The authors had access to BT data which are not generally available. Their study ends in 1990, when Mercury's market share was still small. Since their concern was to evaluate the welfare consequences of privatisation, they also cover the few years prior to the sale of the majority of BT's shares in 1984. It is well known that estimating changes in consumer surplus is difficult when the demand curve is shifting. For the purposes of their study, the authors adopted what is known as the Slutsky compensation approach, which as a first approximation measures only the unambiguous portion of the change in consumer surplus - the change in real price multiplied by the previous year's quantity.

Table 2.15 shows the change in consumer surplus associated with BT's main services, over two periods - 1980 to 1990 and 1984 to 1990. Not surprisingly, the bulk of benefits derived from the substantial changes in call prices, especially long distance and international call prices, over the period of privatisation. Table 2.16 breaks down the changes by year. 1981 and 1982 saw substantial increases in real rental charges, and more modest increases in call charges. These led to substantial declines in consumer surplus. Subsequently, however, consumer surplus increased substantially.

As noted above, because of data limitations, it has not proved possible to extend the analysis to the 1990s. It is quite clear, however, that the progressive tightening of BT's price cap, combined with the entry of competitors undercutting BT's prices by a substantial margin, will have led to much larger improvements in consumer surplus. It should be borne in mind, however, that these benefits have accrued particularly to business rather than residential subscribers, as the bills of the former have fallen much faster than those of the latter. Thus what is being computed is not strictly consumer surplus. To the extent, however, that declines in the real price of telecommunications services sold to businesses have been reflected in similar declines in the prices of goods and services to which they are an input, households will have benefitted from these price cuts as well.

### 2.6 Mobile Services

Table 2.17 tracks the growth of mobile service subscribers since 1985. It shows increases in penetration occurring at much faster rates than in other European countries, with the exception of Nordic countries. The market shares of Cellnet and Vodafone in the analogue market have remained exceptionally stable. The first PCS service, Mercury One-2-One has gained a significant market share. Orange is developing more slowly. The rate of migration
networks currently in operation, although attempts have been made within the industry to provide them.

## SECTION 3 - EVALUATION AND PROSPECTS

The UK telecommunications industry has undergone a series of radical regulatory changes over the past 10 to 15 years. In that period, BT was privatised, opened up to competition (originally from Mercury alone, and since 1991 from other entrants as well), and subjected to a series of progressively more rigorous retail price controls and to other significant regulatory interventions on such matters as quality of service and interconnection. Crucially, however, it escaped the vertical separation applied to the US telecommunications industry and to the UK electricity supply industry. The company has thus remained integrated, offering network services through interconnection to its rivals in service provision. This has exacerbated the regulatory conflicts within the industry.

The period since privatisation has seen substantial improvements in the performance of the sector. The data presented in Section 2 above show that prices have fallen significantly in real terms, productivity (according to the imperfect measures shown above) has improved and quality of service has been substantially enhanced. It would, of course, be wrong to attribute these changes to privatisation, regulation or the introduction of competition. Over the past decade and a half, the telecommunications sector has benefitted from substantial technological development associated with the introduction of digitalisation and fibre optics. All operators have benefitted. There is, however, persuasive evidence from the OECD (1995) and the International Telecommunications Users Group (INTUG) that customers have enjoyed more substantial price falls in countries characterised by competition.

Further evidence of the relative position of the UK telecommunications sector is provided by a recent bench-marking exercise carried out for the UK Department of Trade and Industry by an independent consultant (DTI, 1994). The report concluded that:

“Altogether the state of development of the UK telecommunications infrastructure and the range of services available to users compare well with the other countries covered by the study. The UK’s position benefits from the number of new operators in taking up the opportunity to install up to date networks, and the competitive pressure this has introduced. But it would be misleading to imply that BT, as the major operator, is lagging in any significant respect. On the contrary, BT’s network is one of the most modern in the world.

Although never the most advanced in any one area, the UK is consistently second and does not lag significantly in any major respect.... UK price levels are, by comparison with other countries, generally reasonable for business, although they compare less favourably for residential users." (pp x - xi)
incorporation of international call charges in 1991 was prefigured by OFTEL in setting the price control for 1989 to 1993.) The DGT has on occasion defended the profits BT has earned, within a price control period, as a reward for improved efficiency. Moreover, the successive price caps have been set in ways which have not led to the exceptional returns which have characterised certain other privatised utilities in the United Kingdom.

Two related criticisms have been made of the price cap regime in telecommunications. It has been argued particularly that the current price cap of RPI-7½ is too rigorous, and that it damages long term consumer interests by hampering the development of competition through the low prices enforced on BT. More generally it is claimed that price caps, like other forms of regulation, are systematically defective and are no substitute for competition. The issue at stake in the former criticism is the inter-temporal distribution of benefits to consumers, but the criticism appears to be misplaced. A less rigorous price cap might benefit competitors in the short-run, but if they are unable to match the incumbent's costs in the long-run, then they will be unable to survive in the market. Moreover, what is likely to determine entrants' investment decisions is not the pre-entry regulatory system, but their conjectures about how the incumbent will price once entry on a substantial scale has occurred. It is thus doubtful whether the long-term harm to competition results from a rigorous current price cap. If the regulator wants to offer short-run assistance to entrants, it is more effective and transparent and less damaging to consumers to do so via specific temporary measures, such as abatement of interconnection charges, than by a relaxed control over retail prices.

The second and more fundamental criticism concerns the alleged failure of regulation to yield benefits of the kind associated with competition. Dealing with this point adequately would require a fuller examination of the institutional framework of regulation and the motives of regulators than is possible here. Moreover, regulation and the progressive introduction of competition in telecommunication are complements rather than substitutes. Nonetheless, the UK experience with price caps described above suggests that they can aid the process of reducing prices, restructuring prices to make them more cost reflective, and enhancing productivity.
Analysys, (1994), Counting the Cost: A Comparison of European Telecommunication Charges, Cambridge, UK.

Baumol, W., and Sidak, J., (1994), “The Pricing of Inputs Sold to Competitors”, Yale Journal on Regulation, pp 171-201.

Bishop, M., and Green, M., (1995), Privatisation and Recession - The Miracle Tested, CRI, London.

Cave, M. et al, (1984), Meeting Universal Service Obligations in a Competitive Telecommunications Sector, European Commission, DGIV, Brussels.

CRI, (1995), Regulated Industries 1995, CRI, London.

DTI, (1990), Competition and Choice: Telecommunications Policy for the 1990s, Consultation Document, HMSO, Cm 1303, London.

DTI, (1991), Competition and Choice: Telecommunications Policy for the 1990s, White Paper, HMSO, Cm 1461, London.

DTI, (1994), Study of the International Competitiveness of UK Telecommunications Infrastructure, London, 1994.

Galal, A. et al, (1994), Welfare Consequences of Selling Public Enterprises, Oxford University Press.

Laffont, J-J., and Tirole, J., (1994), Creating Competition Through Interconnection Theory and Practice, Mimeo, IDEI, University of Toulouse.

Littlechild, S., (1993), Regulation of British Telecommunications Profitability, HMSO, London.

NAO, (1993), The Office of Telecommunications: Licence Compliance and Consumer Protection, National Audit Office, London, HMSO.

OECD, (1995), The Benefits of Telecommunications Infrastructure Competition, Paris.

OFTEL, (1985), BT-Mercury Interconnection Determination, OFTEL, London.

OFTEL, (1992), BT's Cost of Capital: A Consultation Document, OFTEL, London.

OFTEL, (1993), BT-Mercury Interconnection Determination, OFTEL, London.

OFTEL, (1994a), Interconnection and Accounting Separation: The Next Steps, OFTEL, London.

OFTEL, (1994b), A Framework for Effective Competition: A Consultative Document on the Future of Interconnection and Related Issues, OFTEL, London.

OFTEL, (1995a), Market Report, OFTEL, London.

OFTEL, (1995b), A Framework for Effective Competition, Consultative Document issued by the Director-General of Telecommunications, OFTEL, London.
# TABLE 1.1 CHRONOLOGY OF MAJOR OWNERSHIP AND REGULATORY CHANGES IN FIXED LINK TELECOMS

1981 Separation of telecommunications and Post Office functions and creation of British Telecom as a public corporation
1982 Licensing of Mercury
1983 Announcement of the duopoly policy
1984 Privatisation of 50.2% of BT's shares
Retail price cap of RPI-3 for five years
1985 BT/Mercury interconnection by OFTEL
1989 Renewal of BT's price cap at RPI-4½ for four year period
1990 Publication of Consultation Document on the duopoly policy
1991 Abandonment of duopoly policy
Extension of BT's price cap to international calls and increase to RPI-6¼ for two year period
Approval of system of access deficit contributions
Sale of second tranche of BT shares
1992 BT and Mercury seek review of 1985 interconnection determination
OFTEL initiates review of interconnection arrangements
1993 Renewal of BT's price cap at RPI-7½% for four years
Sale of third tranche of BT shares
Redetermination of BT/Mercury interconnection prices
1994 OFTEL decisions to propose separate accounting for BT's network and retail services and standard price list for interconnection
Mercury takes court action against BT and OFTEL over interpretation of interconnection arrangements
Publication by OFTEL of options for interconnection pricing
1995 OFTEL publishes market share data
### TABLE 1.2 REGULATORY RESPONSIBILITIES IN UK TELECOMMUNICATIONS

## SECRETARY OF STATE

Responsible for overall direction of telecommunications policy

Has duties to:

(a) To secure that telecommunications services are provided throughout the United Kingdom to satisfy all reasonable demands for them including, in particular, emergency services, etc.

(b) To secure that any person by whom such services are provided is able to finance the provision of those services.

These duties have further guidelines associated with them including:-

(c) Protection of the interest of consumers

(d) Promotion of competition

(e) Efficiency and economy

(f) Promotion of research and development

(g) The establishment of businesses in the UK by overseas telecommunications firms

(h) The international competitiveness of UK firms in providing telecommunications services and apparatus, etc

Appoints Director-General of Telecommunications

May instruct the DGT not to propose licence amendments

## DIRECTOR-GENERAL OF TELECOMMUNICATIONS

Shares above duties with Secretary of State

Implements licence conditions and proposes amendments

May investigate firms' conduct under Competition and Fair Trading Acts and make references to MMC

## MONOPOLIES AND MERGERS COMMISSION

Reviews disputed licence amendments or other matters referred by the DGT and specifies, where appropriate, adverse effects to be remedied by the DGT Investigates matters referred by the DGT under the Competition and Fair Trading Acts

## OFFICE OF FAIR TRADING

Has limited responsibilities concurrent with OFTEL over general competition issues

## THE COURTS

May at the request of affected parties review decisions taken by the Secretary of State, DGT or others for procedural irregularity and other defects