Silviase/jgov_v1.4_full_ann huggingface dataset:
## I NTRODUCTION

This paper offers an account and an evaluation of the reforms that have taken place in the UK telecommunications industry since the early 1980s. The period has seen major developments, including the commercialisation and privatisation of the dominant firm, British Telecom and -especially since 1991 - a major liberalisation of entry into the industry. New telecommunications technologies have been employed. Developments over the period have been hectic, and many are still occurring. Accordingly, the process described in this paper is still incomplete, and key regulatory and market changes are occurring at - if anything - an accelerated rate.

The structure of the paper is as follows. Section 1 is devoted to an account of developments in the ownership and regulation of telecommunications. It begins with a description of regulatory institutions and ownership changes, and then discusses in turn a variety of regulatory issues including: licensing, pricing, interconnection, universal service obligations, quality, new services and mobile services.

Section 2 of the paper then analyses outturns under a number of headings: number of firms and market shares; prices charged by the two principal fixed link operators, BT and Mercury; profits, investment and employment in the sector; quality of service; availability of new services; and effects on consumer surplus. As in Section 1, a separate section is devoted to mobile services. Finally, Section 3 discusses the lessons of the UK experience.

## SECTION 1 - DEVELOPMENT OF REGULATORY POLICY

This section describes the principal changes in the ownership and regulation of the UK telecommunications sector since the start of the 1980s. A chronology of events in fixed services is shown at Table 1.1. Mobile developments are summarised in Table 1.10.

### 1.1 Ownership

At the start of the 1980s, telecommunications in Britain were run as a monopoly and as part of the Post Office (with the exception of services in the city of Kingston Upon Hull, which were provided by a municipally-owned organisation). In 1981, telecommunications activities were separated from the Post Office and entrusted to British Telecom, a public corporation (hereafter known as BT). The corporation subsequently became a public limited company, its shares owned entirely by the British Government.

In 1984, as part of its privatisation policies, the Government decided to sell the first tranche, 50.2%, of BT shares. The decision to sell a bare majority of the shares was the result of two considerations: first, a desire to have the majority of shares in private hands, and second a concern that the capacity of financial markets might be inadequate to assimilate the sale of 100% of the company. In the event, however, the issue was substantially oversubscribed. Many
shares being bought by individuals attracted to the purchase by the possibility of paying for shares in instalments and - above all - by the prospect of immediate capital gains. Such gains were, indeed, realised, and at the end of the first day's trading, shares bought with a first instalment of 40p closed at 73p.

Under the terms of the sale, the Government retained one “golden share” which gave it a power of veto over certain critical decisions. The purpose of this arrangement was to prevent loss of control of such a sensitive industry to inappropriate interests. In all other respects, BT was run as a private company, the Government committing itself not to exercise its very substantial minority holding to influence company policy.

Later, the Government sold its remaining equity stake in BT in two further tranches - one in 1991 and the other in 1993. The revenues gained in each of the three sales were, respectively, £3.9 billion, £5.3 billion and £5.5 billion. The company's current market capitalisation is £24 billion.

The second significant change of ownership involving the UK telecommunications sector was the sale by the Government of its holding of Cable and Wireless, a company historically involved in international telegraphy and telephony. This was sold in three instalments between 1981 and 1985 for £1.1 billion. Cable and Wireless was involved at the outset in the second operator licensed in the United Kingdom in 1983 - Mercury. Subsequently, Mercury became fully owned by Cable and Wireless until the sale in 1992 of a 20% interest to Bell Canada.

### 1.2 Regulatory Institutions

As a government department or public corporation, the Post Office and BT were regulated by the UK Government, its owner, under the terms of successive Government White Papers on control of nationalised industries. The arrangements involved supervision of the corporation's activities by the sponsoring department, the Department of Trade and Industry, and by the Treasury. Investment plans were subject to an external financial limit set by the Government as an element in its macro-economic strategy.

The decision to privatise British Telecom made it necessary to establish a new regulatory framework. This framework was created by the 1984 Telecommunications Act, and divided regulatory responsibility among a number of actors (see Table 1.2). In summary, principal regulatory authority is divided between the Secretary of State for the Department of Trade and Industry (DTI) and the Director-General of Telecommunications (DGT), head of a non-ministerial Government department (OFTEL), currently employing about 170 staff.

The Department is responsible for the overall direction of telecommunications policy. The Secretary of State appoints the DGT and is responsible for issuing licences to public telecommunications operators, after consulting the DGT. The Secretary of State and DGT share duties, of which the principal are to ensure that telecommunications services are provided and can be financed; to ensure that operators comply with their Licence conditions; to maintain and promote effective competition in the sector and to promote the interests of consumers of
Other operators have condemned the secrecy with which they claim that OFTEL negotiates with BT over licence amendments and other matters which affect the whole sector. In response to these criticisms, and as competition has developed, the current Director-General has sought to discuss and seek resolution of more issues in public arenas such as industry working groups, and to discourage confidential submissions by operators on issues subject to consultation.

In 1993, the National Audit Office investigated the licence compliance and consumer protection practices of the Office of Telecommunications (NAO, 1993). Although making a number of detailed suggestions for change, the NAO was broadly satisfied with OFTEL's performance in these respects.

### 1.3 Licensing

The succeeding parts of this section describe the development of regulatory policy in a number of key areas. We begin with the fundamental issue in structural regulation - how many firms are licensed to operate in or enter the sector, and what licence conditions are they subject to?

The focus of this section is on the licensing of operators supplying their own infrastructure. Entry into the value added services market has been open since 1981, currently under a class licence administered by OFTEL. Initially, simple resale of domestic capacity (defined as use of a private circuit for conveyance of a call which uses the public network at each end, with no value added) was restricted, as a result of concerns about the imbalance between call charges and the charges for leased lines; the latter were so low that there was a risk that reselling might undermine call charges for switched services. This imbalance was corrected, however, and in 1989 domestic simple resale was permitted. The situation with regard to international simple resale is discussed below.

The initial approach of the British Government towards infrastructure competition was enshrined in what became known as the duopoly policy, enunciated in 1983. Under that policy, the Government undertook to licence no more than two competing operators (BT and Kingston Communications, each in its relevant service area, and Mercury). An undertaking was given that the policy would operate for at least seven years, with the prospect of a review at the end of that period.

The justification of the policy was that it would permit Mercury to raise the investment necessary to construct its own network, without fear of subsequent entry. In order to ensure the spread of competition, the Government imposed roll-out conditions for the Mercury network (see Section 1.6 below). If Mercury were to accept these conditions, it was thought that the company required a breathing space in which it was free from competition from other operators.

In the years following 1983, Mercury did indeed construct the network specified in its licence conditions, and made limited inroads into BT's markets. (For market share data see Section 2.1 below.) Other operators were also laying down networks with a telecommunications potential. Under the 1982 Cable Act, cable television licences were issued throughout the 1980s.
However, under the duopoly policy, cable companies were excluded from providing telecommunications services on their own account. They had to form an agreement with a licenced operator to provide switching services. In practical terms, this obliged them to co-operate with Mercury. However, the latter offered what the cable companies regarded as unfavourable terms, and few cable companies became involved in telecommunications until the 1990s.

In November 1990 the Secretary of State for Trade and Industry published a Consultative Document, Competition and Choice: Telecommunications Policy for the 1990s, (Cm 1303), which initiated a public consultation over the duopoly policy. The Consultative Document indicated from the outset that the Government was inclined to abandon the policy, in favour of a more liberal regime in domestic telecommunications. The duopolists themselves were reluctant to support an extension of the policy, although Mercury briefly toyed with the idea that it might become a “second force” carriers’ carrier, serving local competitors in a long-distance market with restricted entry. Other respondents to the Consultative Document were almost unanimous in their support for liberalisation, although anxieties were expressed about its effect on BT’s capacity to fulfil social obligations.

It was therefore no surprise that the Government’s subsequent White Paper reached the following firm conclusion (DTI, 1991, para 3.6):

“The Government has decided to end the duopoly policy. It will consider on its merits any application for a licence to offer telecommunications services over fixed links within the UK. Licence applications will be considered against the provisions of the Telecommunications Act 1984.”

The concomitant decision to continue to restrict entry into international services is discussed below.

Having signalled clearly its willingness to issue telecommunications licences subject to the minimal conditions, the Government expected, and received, a significant number of such applications. Among the first to respond were the cable operators, which were now entitled to provide telecommunications services in their own right. Most of them sought permission to do so, using a simplified procedure. As a result, 59 cable franchisees now provide telecommunications services within their licence areas. They have now gained three quarters of a million subscribers (see Section 2.1 below).

By the end of 1994, the DTI had issued 16 licences to public fixed link operators (in addition to those granted to BT, Kingston Communications and Mercury). The new licensees are shown in Table 1.3. The list contains a number of points of interest:

a. licensees intending to offer local service include Ionica, which proposes to propose a service to fixed subscribers using radio, and operators such as City of London
Telecommunications (COLT) and MFS, offering services similar to those provided by competitive access providers in the United States and elsewhere;

b. several licences have been issued to companies in other regulated industries, especially electricity. These include the licence granted to Energis, a subsidiary of the National Grid Company, which provides a long-distance service using pylons to carry optic fibre, and licences granted to electricity distribution companies intending to benefit from economies of scope;

c. mobile operators such as Vodafone have been granted licences to provide fixed link services;

d. many of the new licensees are overseas companies, notably AT&T which has been licensed to provide domestic switched voice and data services, private line services and international resale.

In addition to the public fixed link licences, many others of more limited scope have been issued. By February 1995, a total of 62 licences had been issued; 36 further applications were under consideration by the Secretary of State.

The scope for competition in domestic services is thus extensive. In contrast, entry into international telephony remains restricted. The Government reported in its White Paper (DTI, 1991, para 3.20) the conclusion that although the duopoly policy in respect of new international operators was to be formally ended, it was unlikely to grant new international operating licences in the short-term. The explanation for this difference of approach is to be found in the nature of settlement arrangements for international calls. Operators pay each other for terminating one another's calls, although settlements only have to be made on the net balance of traffic. The bargaining position of UK operators in negotiating such payments would be weakened if many of them faced a single overseas monopolist. Although these dangers could be averted by regulatory intervention (such as a requirement of "parallel accounting"), if settlement rates remained high the UK might still suffer if domestic competition brought down outgoing call charges, increased call volumes and thus led to greater payments of overseas operators. As a result, the Government has chosen until now to retain a duopoly of international operators. It has, however, permitted international simple resale on routes where it is judged that competitive opportunities at each end are broadly equivalent. To date, the routes where international simple resale is permitted connect the United Kingdom with Australia, Canada, Sweden and the United States.

### 1.4 Price Regulation

The decision to privatise British Telecom provoked the search for an appropriate method of price regulation. It was recognised that BT would remain in a dominant position in some telecommunications markets for some time. Two questions were thus raised:

a. What services should be covered by price control?
introduced.

c. A further variant, closer to current market conditions, places a price cap on BT's network services, with, possibly, a price cap on retail tariffs as well.

Most operators expressed a desire to move towards Option 4, with the important proviso in the case of entrants that the United Kingdom's inadequate competition law be strengthened to deal with possible abuses by BT of its dominant position. However, this was recognised by most parties as being a longer term objective. OFTEL's current proposal (1995b) is to permit greater flexibility in BT's interconnection prices through a price cap on network services, supplemented by regulatory determination of call termination charges. However, the level of costs which BT will be permitted to recover under the price cap is still a subject of debate.

### 1.6 Social Obligations

The licences of UK telecommunications operators contain statements of the obligations to supply placed upon them. These vary from operator to operator, with BT carrying the most onerous obligations (see Cave et al, 1994).

BT's universal service obligation is expressed in Condition 1 of its Licence, which states:

“The Licensee shall provide to every person who requests the provision of such services at any place in the Licensed Area:

a. voice telephony services; and

b. other telecommunications services consisting in the conveyance of Messages

by means of the Applicable Systems, except to the extent that the Director [General of Telecommunications] is satisfied that any reasonable demand is to be met by other means and that accordingly it would not be reasonable in the circumstances to require the Licensee to provide the services requested; and the Licensee shall ensure that Applicable Systems are installed, kept installed and run for those purposes."

The obligation imposed on the UK's second operator, Mercury, took a different form, reflecting the view that its principal role was to build a competing long-distance network. Its obligations were:

“The Licensee shall install, keep installed and run the Applicable Systems in such a way as to provide by the end of the period of:

a. two years after the grant of this Licence Nodes at or near fifteen [major cities in England]; and
b. five years after the grant of this Licence Nodes at or near [four specified cities in Scotland and Wales]

and the Licensee shall ensure that circuits comprised in the applicable Systems or in earth-orbiting apparatus are provided for the conveyance of Messages between such Nodes as have been installed.

The Licensee shall install, keep installed and run the Applicable Systems in such a way as to provide further Nodes and circuits comprised in the Applicable Systems and installed in other parts of England, Northern Ireland, Scotland and Wales, wherever their installation is in the opinion of the Licensee practicable and consistent with the sound commercial development of the Applicable Systems."

As more operators were licensed, the issue of defining their universal service obligations became more difficult. Where cable television operators are licensed to offer telecommunications services, they are obliged to make the service available over a progressively larger part of their franchise area, as they roll out their network. Other operators, however, now receive an obligation worded thus:

"If:"

a. the Licensee has become, in the opinion of the Director, a well-established operator in the provision of any telecommunication service of a particular description in the United Kingdom or within any part or locality thereof; and

b. the arrangements made by the Licensee are inadequate to secure the availability of such a service within the United Kingdom or within

c. that part or locality thereof to any person who may reasonably request it,

the Director may direct the Licensee to install, keep installed and run the Applicable Systems in such a way as to secure that such a service is available from the Licensee in the United Kingdom or within that part or locality thereof to any person who may reasonably request it and the Licensee shall comply with any such direction.

In this Condition, ‘well established operator’ means that the Licensee has 25% or more of what is in the opinion of the Director the relevant market.”

With the development of competition, it has been suggested that the costs of universal service obligations should be shared among operators, rather than borne almost exclusively by BT. (Because only BT has to offer subscribers averaged tariffs irrespective of costs, only it suffers from the costs of such an obligation; other operators can adjust tariffs to cost.) In 1994, OFTEL commissioned research to make a preliminary estimate of the net cost of BT's universal service
obligations. The consultants estimated the cost by aggregating the losses imposed on BT by “unprofitable” customers. A customer was deemed to be unprofitable if the avoidable costs of serving that customer exceeded the revenues associated with that customer (defined as the bill augmented by the value of incoming calls from other “profitable” customers). The estimates of the costs of the USO fell into the £90 to £160 million - only about 1% of BT's revenue (OFTEL, 1994b). A more detailed analysis of the cost of USOs has been undertaken and will probably be published in mid 1995.

It is now widely recognised that, in order to increase penetration rates, it is more sensible to introduce targeted subsidies than to impose a uniform limit on connection charges and quarterly rentals. Since the mid 1980s, BT has offered, with OFTEL's support or at its insistence, a series of schemes designed to reduce the quarterly rental charge for residential customers with small bills. The current scheme benefits those whose bills fall into the lowest 21% of the distribution. (Lines connected to second homes or burglar alarms are excluded from this benefit.) At present the maximum equivalent discount on the quarterly rental, for a subscriber making no calls at all, is 60%. Any price cuts under the scheme count towards fulfillment of BT's price cap, and the customers on it are taken into account where appropriate, in the estimate of BT's USO costs.

### 1.7 Quality of Service

When BT was privatised in 1984, it was not subject to explicit quality of service regulation. This was despite the fact that price cap regulation is at first sight likely to put pressure on quality: a company can evade the downward pressure on prices imposed by a price cap by degrading the quality of the service it provides. These concerns were heightened when, after privatisation, BT discontinued the publication of quality of service measures on the grounds of commercial confidentiality. In 1986, the DGT published a consultation document on quality of service, followed by his first report. BT resumed publication of its own quality of service measures in October 1987. In this year, BT had faced considerable adverse publicity relating to its service quality, as a result of a strike and serious problems with pay-phone reliability. These problems were gradually rectified, however, as the quality of service data published in.

Section 2.4 below demonstrate. Legislation passed in 1992 gave the Director-General explicit powers to set quality of service standards.

Quality attributes such as network reliability are essentially “public” in nature: they apply equally to all subscribers. Other quality testings are “private” however. Examples are breakdown of service to a single subscriber or failure to keep appointments with customers. In order to deal with the latter issues, OFTEL encouraged BT to introduce compensation for breakdowns of service for more than specified periods. This contract-based system was given explicit legislative backing by the 1992 Act.