O2 plus 3 does not equal competition, says Vestager. Wrong!

Written by on May 11, 2016 in Features with 0 Comments

myopiaTelecom investors have focused their attention on the decision on the proposed merger of Hutchison 3G UK and Telefonica UK (O2). EU Commissioner for Competition Margrethe Vestager announced —via Twitter—that she would block the deal. This is bad news for the European telecom industry and the larger goals of the European Commission’s Digital Single Market. However it is good news for the shareholders of British Telecom (BT), which DG Comp has protected as the only player in the UK that can offer a quad play solution (broadband, video, wireless, and telephony). No other player in the UK has the infrastructure or scale to compete with BT, just recently awarded an approval for the acquisition of Everything Everywhere (EE), the largest UK mobile provider.

Strand Consult has it on record that Margrethe Vestager and her team at DG Comp do not understand the telecommunications market and what it takes to compete with a player such as BT/EE or the advantages that a quad play provider can enjoy when its only competitors are single play dwarves.

The most galling thing about the announcement is that Vestager declares its purpose is “to serve UK consumers – affordable prices and innovation.”  While the documents about the denied merger have yet to be released from DG Comp, we do not expect there to be any empirical evidence that blocking mergers in the competitive mobile industry leads to lower prices and more innovation. If anything, it is the opposite. Following the averted merger in Denmark last fall, all operators raised their prices within one month. Strand Consult which has studied the mobile industry for 20 years describes what drives innovation; it is technological development, not the number of providers in the market. 

What Vestager’s statement does reflect, however, is that the European Commission, sensing the deep disappointment across Europe about Brussels, will do anything it can to appear to be consumer-friendly, even if it means pursuing a policy that ultimately will not work.  We suspect that many are tired the Commission’s populistic pandering on issues such as net neutrality and roaming, as they have seen nearly a decade of economic decline in the EU. Indeed many in the UK want to leave the EU all together. DG Comp’s blocking the merger will likely be interpreted by some in UK as more meddling from Brussels in what is a “national affair.” 

Strand Consult recommends that Hutchison sue DG Comp and expose the commission authority’s lack of transparency and lack of knowledge about how the modern telecom industry operates. The Black Box of DG Comp has persisted for far too long.

This announcement comes on the heels of an averted deal between Telia and Telenor in Denmark last fall, which DG Comp claimed would increase prices in Denmark. Earlier this year the UK Competition and Markets Authority approved the merger of British Telecom (BT) and Everything Everywhere (EE) without remedies, a £12.5 billion deal combining the country’s largest fixed line and mobile businesses.  Unlike the BT/EE deal, the 3/O2 deal needs EU approval. This research note, based in part on leaked documents from DG Comp, reveals that the agency is making decisions about an industry which it does not understand, and this bodes poorly for the merger.

Strand Consult has followed the consolidation of the European telecom market for many years and has frequently criticized the unpredictable black box of DG Comp. Predictable regulation is a prerequisite for investment in a capital intensive industry such as telecommunications which requires a long time view.

In spite of much discussion about the need for investment, the European Commission has not succeeded in creating an environment conducive to building and running telecom networks. The problem stems from a conflict in leadership and policies from competing agencies within the Commission. Using empirical evidence and ongoing surveys of member states, DG Connect attempts to design a modern framework for telecommunications. Meanwhile DG Comp, using its rules of thumb, determines the future by deciding which mergers happen. Whether enterprises can succeed to merge is a crucial factor in whether they will invest. 

DG Competition behind on how the modern telecommunications market functions

In this research note, we assess DG Comp’s market descriptions, whether it is true, and whether it can be used to base regulatory decisions. Then we will look at how professionals with knowledge of the telecommunications industry make market descriptions when developing and implementing their marketing strategies. One of the documents Strand Consult reviewed is called Hutchison – Telefonica UK oral hearing from March 2016 containing DG Comp’s outlook on the UK market. It is not an exaggeration to say that if an undergraduate student in a marketing or business program submitted such an assessment, she would flunk. No person working at a telecom operator, nor investor for that matter, would consider competition in such simplistic, monolithic terms. DG’s Comp’s analysis is not only misleading, it shows that the agency does not understand what drives competition in the market. 

It is clear that DG Comp sees the Hutchison/O2 the deal in UK from the paradigm of the market vertical. That is that the telecommunications market consists of distinct networks (mobile, fixed line, broadband, TV, etc.) which have little or no influence on the other. In practice, however, the modern telecom operation is assembled horizontally, offering bundled products commonly known as triple and quad play solutions. DG’s Comp’s obsolete view is likely rooted in the fact that its employees have limited understanding of how the telecommunications market works in practice and don’t understand how triple and quad play providers benefit consumers, or they refuse to update their framework as it would create political challenges.

Documentation – A market description must be horizontal; a vertical view is too narrow

Let’s deal with the facts. Single play providers, both Hutchison and O2 in this case, offer their customers service via the mobile network.  This is very different from a triple or quad play provider which offers not just mobile service, but broadband, TV, and wireline telephony.  In practice, competition is it not just about being able to offer customers a one-stop shop but also about the opportunities to reduce costs in marketing, distribution and customer service; and the ability to cross-subsidise products. In the UK, BT paid millions of pounds for TV rights to the Premier League football. But the deal would not be so valuable for BT if it could not bundle the Premier League with its broadband product, thereby cross-subsidising one business line to another. Needless to say, pure play mobile operators don’t have this capability. 

To explain in further detail, consider that while the cost of infrastructure is considerable for a telecoms operator, some 10-20 percent of revenue, this amount pales in comparison to the cost of customer acquisition and retention, about 25-30 percent of revenue. One must also look at how the churn (customer defection) from single play versus triple and quad play providers. To get an insight into how triple and quad players can leverage lower costs across the enterprise, check out the presentation at TDC’s Capital Market Day. Slide 19 shows that churn of customers who only have one product is 21 percent; those with two products is 16 percent; those with three products is 13 percent; and those who have four products is 11 percent. In practice, the marketing cost to retain triple and quad play customers is significantly less than those who buy a single solution from a mobile operator. It terms of the UK deal, this means that it’s far cheaper for BT/EE to keep a customer on its rolls than for Hutchison or O2 to acquire him. For DG Comp not to discuss the reality of the modern mobile operation, means they do not provide a true and accurate representation of the market. And hence their predictions of the future—essentially what DG Comp does when it approves or denies a merger—is made on incomplete information and is likely to be wrong.

It begs the question that if telecom operators and investors recognise the role of triple and quad play in their analysis, why does DG Comp not? It is likely that should DG Comp incorporate any new information into its frameworks, then it will create a political problem by revealing the mistakes it made in the past, for example the mergers not approved because of an incomplete analysis. Because of its fear of being exposed, DG Comp continues down the same misguided path rather than admitting that it is not omnipotent. However, if the competition authority were to admit its mistakes, it could actually gain credibility. Indeed it would take some of the sting out of the length of time it takes to review mergers, which drag on one third longer for telecom than they do for other digital industries.

To be sure the blame does not fall solely on DG Comp. The same Consumer Market Authority in the UK which approved the BT/EE deal without remedies (thus creating one of the strongest incumbents in Europe ) told DG Comp to block the merger of Hutchison/O2.  European merger policy has been criticised as protectionist by nations outside the EU, but it’s hard not to make the same case in the UK.  Indeed the European Commission which has been advocating “cross border” consolidation as the key to its Digital Single Market would seem to have the ideal case with Hutchison and O2, two foreign firms in the UK. It’s not the first time that a nation’s incumbents have been rewarded at the expense of entrants, and indeed that competition and regulatory authorities continue to delay the modernisation of their regimes only serves the cosy relationship they keep with the largest companies they regulate, not to mention delaying the true free market competition that makes such authorities obsolete.

There is no doubt that network sharing which criss-crosses the UK is complex, but this is manageable compared to the fundamental problem of erecting mobile masts and towers. Not only are building permissions difficult to obtain in the UK, the rental price for land has exploded, as private landlords with a monopoly on essential locations have made a practice of extorting mobile operators. Strand Consult’s report 10 Steps to reduce cost for mobile masts and improve mast regulation documents the fact that it will not be possible to split the UK operators’ shared network and create three independent network entities within a 4-7 year time window, yet another harebrained idea from the authorities.

The conclusion is clear – Competition authorities will do greater damage to the European telecom market than any in-market consolidation

It is not in-market consolidation that is the problem. Mergers are a logical outcome to a maturing market, technological change, and falling prices. The problem is the outmoded framework practiced by insulated competition authorities with little to no honesty or accountability. It would be quite a different world if competition authorities made their work transparent and were held accountable for their decisions. Instead they make their decisions in secret based on incomplete knowledge, while in public they pronounce their decisions with arrogance about what the future will bring.

As Strand Consult observed at the FT–ETNO event in Brussels, the European Commission lacks coordination. It may well be that Andrus Ansip and Günther Oettinger of DG Connect have a grand vision for European telecommunications, but it doesn’t mean a hill of beans because Margrethe Vestager calls the shots. The mergers that are approved today or not are what determines what investment happens in the future. The EU has a €100 billion gap in private investment, and it’s DG Comp which bears much of the responsibility for the shortfall.

Telecom investors from around the world who are confounded by the European Commission whose actions exacerbate the problem of the EU becoming ever less competitive compared to other regions in the world. The next crisis impacting the EU will likely be digital, as people will want services from networks, but the networks will not have been built for lack of investment.

Learn more about Strand Consult’s insight into this market – Request the free report The Wireless Ecosystem, US vs. EU. Contact Strand Consult CEO John Strand at +45 2085 0444 or js@strandconsult.dk.

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About the Author

About the Author: John is CEO of Strand Consult. In 1994 John founded Strand Consult. In the early days of Strand Consult the primary focus was on CRM - analyzing and evaluating sales processes and performance for the IT, Telco, Media and Finance sector and helping customers optimize these, enabling them to move more merchandise at reduced cost. He is one of the best-known and most respected consultants in the business. .

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