The longest last mile

How much should Telstra be charging for unconditioned local loop?

Telstra's own suggestion of $30 prompted the ACCC to call for industry submissions on the matter. Many ISPs have built business models based on a much lower cost. It's a complex subject and in this first episode of Twisted Wire, Phil Dobbie gets the views from across the board, including Telstra's David Quilty, Unwired's David Havyatt, iiNet's Steve Dalby and ex-ACCC commissioner Stephen King.

To help resolve the issue, David Havyatt unearths a suggestion from the Productivity Commission that could have merit.

Press the "play" symbol below to listen to the podcast.

Phil Dobbie is a broadcaster and businessman with more than 15 years commercial experience across the telecommunications, internet, tourism, advertising and radio industries. Phil also provides a daily podcast for our sister site BNET.com. Join him for BTalk Australia, where he provides a lively and insightful view on business issues, adding his blend of irony and humour to the discussions.

Transcript

Narrator: This is Twisted Wire.

Phil Dobbie: Hello, I'm Phil Dobbie. Today on Twisted Wire: getting the right price for ULL, that last mile that connects the phone exchange to a home. It's generally owned by Telstra who have a virtual monopoly here and that makes it difficult to determine a fair price for wholesale customers who need it to provide phone and broadband services to their customers.

Stephen Dalby: I think the ACCC's basic underlying philosophy, is to try and fix the prices of ULL to reflect what one would expect in a reasonably competitive market for fixed line broadband services, that's the right starting point.

Dobbie: Today on Twisted Wire we're going to look at the arguments from each side and the impact the pricing is having and could continue to have on the industry. And we'll look at a way that might solve the whole problem for everyone. Get ready for the definitive story on ULL pricing.

Narrator: Twisted, Twisted, Twisted Wire.

Dobbie: Towards the end of last month, Telstra issued a press release saying low ULL prices were holding back investment in alternate technologies because it's cheaper just to buy the local loop from Telstra. They cited their submission, from Unwired to the ACCC, as supporting the case.

David Quilty: We found that Unwired, a week or two back, had reached the conclusion that the very low ULL prices were actually discouraging it in terms of its investment in competing wireless broadband networks. So the prices are effectively distorting investment decisions and preventing the onset of competing networks.

Dobbie: That's Telstra's David Quilty who is quoted in the Telstra press release.

David Havyatt: Yes, and I responded to that press release on Telstra's wonderful, Now We Are Talking blog, with a few points about the fact that they are misquoting me.

Dobbie: That's Unwired's David Havyatt who wrote the submission for Unwired to the ACCC. He says he doesn't support Telstra on all counts. For start, he doesn't support Telstra's undertaking last March to charge $30 for ULL in metropolitan areas. Telstra actually said the cost was north of $40 but they'd offer it at $30 just to show how benevolent they are. Here's David Quilty again.

Quilty: We certainly believe it's a price that more accurately reflects the cost of providing the services and obviously the network that underpins the provision of those services. We have been working now for more than 12 months in developing what we consider a world-leading network cost model, which in terms of the numbers indicates that the actual costs are north of $30 but we believe that $30 is a realistic price.

Dobbie: As you'd expect, not everyone agrees. Steve Dalby is the Chief regulatory officer at iiNET.

Steve Dalby: If they're arguing that the cost to them of providing unconditioned local loop is in the high 40s that really is the basis for the provision of a whole range of services, retail services like telephone lines and you know ATM lines, EFTPOS lines, all sorts of things. And yet most of those are provided much lower than that at a retail level and they've got a whole lot of conditioning and services added to them. So if one component is truly, honestly $48 a month for Telstra then they'd be running at a loss right across that product range and I don't think they are.

Dobbie: So how will the right price be determined? Until the end of last year Stephen King was a commissioner at the ACCC. He's now the Dean of the faculty of business and economics at Monash University.

Stephen King: There's always going to be conflict on what the right ULL price should be, whenever you have a cost-based or bottom-up type of approach because you're always going to have arguments about, well, what should the costing model be? What are the exact parameters that go in and the sort of numbers that you can get out of costing models very hugely?

Dobbie: As we've already started to see, those prices have ranged from less than $15 to $30 or $40 dollars or more. Although everyone agrees on roughly the same approach, it's the value of the inputs that you put in that determine the price that you're going to get.

King: A simple one for example, should you make assumptions on a brown field or green field basis? Should you be saying, well, if someone comes along today and was going to replace the copper network from a switch into the home they'd have to dig up an awful lot of infrastructure to do that. That's expensive so that cost should be reflected in the model. Or do you say, well, the copper was originally laid down but there weren't pavements, there weren't streets there that had to be dug up so should you be doing it on the green field site which reflects what Telstra, at some stage in the not too distant past, would have actually paid. But that sort of assumption, that sort of difference in assumption could make a huge difference to the end result.

Dobbie: So you can see the huge scope for disagreement with Telstra's wholesale customers fighting for a price well below the $30 mark that Telstra suggested. Are they just trying it on? Here's David Quilty again talking about Telstra's model for network costs.

Quilty: Obviously, the incentive for them is to get as low a possible cost as they can in terms of their own cost input. The fact of the matter is that in terms of this model we have put in all of the cost inputs. We have made the model available to the wider industry and to the ACCC. The model has been and continues to be independently assessed by some of the world's leading network economists. So I think that always there are questions and issues. The idea is obviously to try and resolve as many of them and to narrow the points of dispute and that's what we're attempting to do with the cost model. Obviously a lot of this depends on making sure that you are costing an efficient network and we are looking to do that as much as possible. It also depends in terms of what are the underpinning principles and the underpinning principle of long-run incremental costs in terms of the cost of building a replacement network has been the underlying principal for nearly a decade and our cost model is based upon that.

Dobbie: So Telstra's view is that the cost should be determined on building a replacement network, part of the reason for the discrepancy perhaps. After all, many people say the networks paid for itself and the price should be a lot lower.

King: I think there're is arguments when you're looking at infrastructure such as the copper network that really was laid down a long time ago and has probably been written off by Telstra three or four times. I know there's bits of it that are being upgraded. I feel there's an argument that you know possibly 16 or 20 is too high.

Dobbie: Stephen King. That written-down argument doesn't wash with Unwired's David Havyatt.

Havyatt: Yeah, yeah, I've heard that argument many a time and there's two responses to it. The first is an economic efficiency argument says you'd still price at the cost to build it, not the cost that it might be written down to because you try and mimic an efficient build by division.

Dobbie: And that seems to be the key. If the price is set to relate to costs of building an alternative network then it should be at a price where a sizable player considers a build of their own as a viable alternative to buying from Telstra.

Quilty: I totally reject any view that building a competing infrastructure is not a good thing. I think in the mobile or the wireless space we've seen the massive benefits of competing infrastructure. We've seen very quick and world-leading advances in terms of wireless broadband. Australia now effectively leads the world in terms of speed and capability and coverage. And that's come about largely because of a light-touch regulatory regime and encouragement of infrastructure investment. And what we're seeing is now very strong head-to-head competition starting to arrive between mobiles and fixed and that's got to be a good thing, I think, for consumers at the end of the day.

Dobbie: And David Havyatt sort of agrees, drawing a parallel with the energy markets.

Havyatt: In energy markets no one has ever suggested in the domestic market we should duplicate the electricity grid or electricity distribution network owns nor has anyone ever suggested we should duplicate the gas distribution network at the homes. But no one questions the logic of having both electricity and gas going to the same houses and that's my analogy. You shouldn't use the pricing of the electricity distribution network down to create competition for city distributors. If what that means is that gas distribution now faces an inefficient or ineffective market.

Dobbie: So low-priced electricity will be a bonus to the gas providers or vice versa, although they're not totally substitute technologies, are they? Not unless someone invents the gas-powered plasma TV. But is it in the public interest to reach a point in wholesale pricing that forces people to build an alternative network? Stephen King.

King: If you set the price high enough on something else that you believe is an essential facility, there will be alternatives that will develop. Most people think and almost every economist around the country would agree that distribution and transmission of electricity in actual monopolies you can't just leave it to the private market because there would be huge markups there and very large monopoly profits. But if you did leave it to the private market at some point substitutes would start appearing. There may be people having diesel generators in their homes rather than relying on the electricity network. Now is that a good thing? Most people would say, well, no that's pretty stupid. You've got a substitute technology coming in there that is not efficient. The better approach is to say, well let's try and get the price right on ULL. Let's try in some ways mimic what we think a reasonably competitive market would look like for ULL, recognising the fact that you just can't have that market in the fixed-line infrastructure because there's only the one of them.

Dobbie: Telstra of course argues that there is more than one last mile solution. ULL pricing at one time was high enough for Optus to build their own cable network and if it was more expensive or more realistically priced now, wouldn't Optus be expanding its own cable network? And if they did that couldn't we then be assured that the price was right because it was encouraging alternative investments? That's what Telstra's David Quilty believes but Unwired's David Havyatt says that's not really the case because first and foremost that initial Optus investment was a paid TV play, which they lost.

Quilty: Anyone who looks at the paid TV market and understands anything at all about it knows that Foxtel won that paid TV war and the way that was structured meant that Optus look at a second stringer. Secondly, they happen to make some bad choices about their telephony. It's not a very good implementation of telephony. And then thirdly their own internal problem was that they tried to price internally the access on the HFC originally at the same prices as Telstra was charging wholesale. So there was no incentive that was internally. So there's a whole range of things that conspired to destroy the HFC model and for Telstra to be running around the block now saying, well Optus should be investing in HFC is nonsense because the newer technology called DSL is just cheaper. It's not cheaper on the ULL component. It's cheaper physically on the deployment component because you don't need to do a truck roll.

Dobbie: That's a view David Quilty doesn't agree with. I asked him if it's fair to compare two different technologies given the advantages of DSL.

Quilty: Well it's certainly not the same technologies, I recognise that fact. However, when you look around the world in terms of cable providers you hardly see any of them preferring to buy wholesale from the incumbent rather than use their own networks, quite the opposite. What's happening is that cable providers are making use of advances in cable technologies so called DOCSIS advances that enable high speeds and a wide array of services and they're actually using that cable infrastructure to compete head-to-head with incumbent providers around the world. That's actually one of the primary means by which there's real competition in the market, which is driving greater choice and to a large extent also driving better value for money for customers. So certainly they're not the same technologies but what's happening in Australia in terms of Optus is certainly out of kilter with what's happening around the world.

Dobbie: So we're back to finding out what the price should be. iiNet is a long way from building their own last-mile solution but they have built a lot of their own Dslam infrastructure in Telstra exchanges. What would Telstra's $30 price mean for their business? Steve Dalby.

Dalby: It would mean that if you looked at just our retail of residential products today, about 5 of the 7 residential products that we offer would be unviable at the current prices.

Dobbie: So $30 is too high for companies like iiNet and Stephen King, who, remember was the commissioner at the ACCC, thinks $30 is too high. But is the $15 to $20 mark suggested by some ISPs too low?

King: No I certainly don't think it's too low. I think that's probably about right. I certainly haven't seen anything to suggest that it's not the sort of range of figure that we should be looking at. I know it's significantly better than what Telstra is arguing is a correct figure or would be a figure that properly reflects the competitive market. But you'd expect that from the incumbent, I mean, after all, every dollar that it goes up is an extra dollar in their pocket.

Dobbie: So is this the figure that the ACCC is aiming for? If it is, Telstra isn't the only one saying that that figure is too low.

Havyatt: I think there is a real concern that the commission has a focus on making sure that they can get as low a price for ULL as possible to encourage their version of infrastructure competition. It does appear to me that they're doing anything that they can to make the price lower. Having said that I also think the price Telstra was claiming they're undertaking was ridiculously high.

Dobbie: David Havyatt, who says that lower pricing has encouraged multiple service providers to invest in their own Dslam infrastructure in the exchanges, which isn't the best public outcome. The best public outcome of course is fiber to the node or better still to the home but for many ISP's the focus has always been on Dslams.

Havyatt: I think the give away about how cheap the price is is the fact that there are people building multiple deployments. It's hard to argue a rational case to six people putting Dslams in the way exchange. You know these are the same people who wanted to partner in fiber to the node. Why aren't they partnering in some of these Dslam deployments? The answer is because the whole investment is underpriced because of the ULL price.

Dobbie: Is that because the ULL price is to low or is it because Dslams are so cheap?

Dalby: I agree with you that around about 2004 we first were attracted to the Erickson Dslam equipment. It was a new generation of equipment which was more compact. It was capable of being deployed on a much smaller scale in the 100s rather than in the 1,000s and you know that's a big part of our decision and others to deploy those Dslams.

Dobbie: iinet's Steve Dalby, so ISP's are building their own business models based on lower-priced Dslams and lower priced ULL. David Havyatt said this is because the ACCC has been sending all the wrong signals.

Havyatt: So it just seems to me to be a case of the commission sending signals so you're going to get people making decisions about what they expect the commission's ULL pricing to be in the future and they'll expect it to be lower. That doesn't necessarily promote rational business decisions. If you actually think you're going to get a lower price in the future without any real justification.

Dobbie: That's a view echoed not surprisingly by Telstra. Too low a price is sending the wrong message and it could be holding back investment in a fibre-to-the-node network.

Quilty: Such a network obviously involves a very large amount of capital estimated around 10 billion dollars if not more and it's simply not possible to make a business case if one expects that the prices that will be charged at the wholesale and the end-user level will be based on the current ULL prices. At those prices it's simply not possible for anyone to invest the $10 billion required to upgrade Australia's broadband infrastructure.

Dobbie: But does anyone seriously expect the current ULL pricing to be the same as access pricing for fibre-to-the-node network?

Quilty: I'm not sure if there's that assumption but that's obviously the starting point, if you'd like. That's the existing pricing so in terms of you know the impact as far as wholesale and retail customers are concerned there's a need to transition them from the ULL prices to obviously more realistic prices in the fibre broadband world. I'd certainly argue that the fibre world would provide much better value for money and the services will be no longer as distance-dependent. There will be a guarantee, in terms of speed. And obviously the array of services that can be provided will be far wider so there's certainly a lot of upstart in terms of providing value for money but there is a real problem that the starting point price settings, if you like, are the ULL prices.

Dobbie: Hmm, maybe, and maybe the ACCC is pushing the price lower than it should because it's concerned about Telstra's market power and it's monopoly over the last mile. Here's Stephen King.

King: The easy answer is no. I think the ACCC is trying to, as much as it can, work out what is the appropriate proxy for a competitive price or price that would exist for ULL services if that market looked like a competitive market rather than a monopoly market.

Dobbie: And the other answer?

King: I'm sure Telstra will say yes they're penalising. Well of course they're being penalised compared to being allowed to use their monopoly power and make a lot more profit, of course. But that's what regulation is about. Similarly with the electricity network, I mean the distribution companies could come back and say, God, if only you would let us charge a higher price we'd make more money. Well of course, but that's why you're being regulated. You're being regulated because competition isn't there to stop you from overcharging consumers, the same for Telstra. The reason why you face regulations is because the competition isn't there to stop you from overcharging consumers. Is that a penalty when the regulator comes back and says, no, this is more of the competitive price than the one you wanted to charge? Well, it's a penalty but it's a penalty that's being imposed on them in the greater good of the Australian public.

Quilty: I think that you run into problems if you're basing competition policy and regulatory decisions on, you know, what sort of market shares that particular companies have. The reason for that is that market share can be dependent upon a whole range of things and probably more than anything else it's dependent on superior strategy. Obviously the issue you need to look at fundamentally is whether there are actual bottlenecks in terms of the provision of competitive services. And if there are, well then there's a fair argument for regulation but if there isn't, my view is that the best results will always come from open competition in the marketplace.

Dobbie: Telstra's David Quilty, who, in case you haven't already gathered, thinks the scope for more competition from people building a substitute technology. So does that mean he'd like to see a less hands-on approach from the ACCC over the ULL pricing issue?

Quilty: Well I think that it's a very interesting question and where there clearly is a need for or there's not sufficient competition, I think that there is a valid role for the ACCC in terms of ensuring access and setting prices that are based on actual costs. But, you know, what we're finding around the world that as, particularly metropolitan capital city markets become very competitive there's a rolling back of the footprint in terms of regulation. We've found that in a number of European countries. In fact, very interestingly Telstra, in terms of a range of other services, sought a rollback in metropolitan areas where there were at least three ULL competitors. The ACCC agreed to that rollback with certain conditions, but at this stage it's being overturned by the Australian competition tribunal. So in that particular case you've got a rather rare situation where the ACCC and Telstra are standing in the one corner together.

Dobbie: That's right the ACCC going to bat in for Telstra. We don't see that happen often, do we?

Quilty: Not often enough, I don't think.

Dobbie: So here's the obvious question for the consumer. If Telstra says ULL prices are too low and ISPs are assuming that they're going to be too low in the future, does that mean the consumer is enjoying prices for broadband that should be higher? Here's David Havyatt.

Havyatt: It's too hard to answer the question as to say whether the prices are too low or not. There's a range of factors that come into that equation. One of the things people forget that in Australia part of the broadband price remains the cost of transmission between locations in Australia and the price of transmission out of Australia. And unlike our colleagues in America, for example, every single bit of stuff we want to get off YouTube someone's paying for to get out of America. And so there's a very large slab of the cost base that an ISP faces, which is that component. So because if I got out now and said, I guess the ULL broadband prices are too low in Australia I'd have all those people running around giving me comparisons about broadband prices in Australia versus other countries. But we are probably the most dependent upon the longest haul for getting our content you know and off Asian colleagues who get a lot of our content likely because it's all you know in domestic markets. Whereas we tend to get a lot of our content from US and we're a bloody long way away. Is it too low? No, but I don't think there's a lot of leeway for it to come down much lower in the near term.

Dobbie: And it will go up if ISPs have all got their last mile costs wrong. So what's the answer? Stephen King thinks we need to think more laterally about the problem. There are alternative solutions like changing ownership of the copper wire to the household so when you buy a house you buy the last mile and are open to choose who maintains it and who provides the service. Or for the copper wire to be sold off to local operators who would provide the service in their community.

King: I sometimes get worried that we sort of think of very short-term regulatory solutions and obviously, you know, in the ACCC they can only work within the legislation that they've got and if they are working within that legislation they're doing the best they can. But really from the broader government perspective, should they be thinking perhaps in a less rigid way and looking at more innovative solutions.

Dobbie: Maybe life would have been a lot easier if when Telstra was sold off the last mile hadn't been part of the package. So what does David Havyatt think the ACCC should be doing now to bring all this to a head?

Havyatt: I think the ACCC should be taking a thorough review of the way it's been making a series of decisions about networks and market power. It should be building one coherent view about what it understands that to be. Rather than the choice being do we regulate and be a price setter or do we not regulate, they should be saying we regulate but we're a market facilitator.

Dobbie: And here's how they could do that. David points to the productivity commissioner who had a smart solution back in 2000 called the Baseball Arbitration. Let's let him explain how it would work.

Havyatt: The Baseball Arbitration rather than the commission choosing an answer they thought was the right answer, both parties come in and say what they think is the right answer and the commission is only able to choose one of those two answers, whichever one they think is the most right. That kind of process drives the parties together in what their view of the price is because if you want to be the most accurate, whereas what we've got now is a system that encourages people to be arguing from extremes, you know. If they think the commission is going to come in the middle, well then one party wants to argue as low as they can the other as high as they can to get to the answer in the middle. So there's a fundamental flaw in the process and I don't agree with anything Telstra would say about the real flaw is that there's too much regulation. It's the approach that Telstra primarily took and the commission has also followed in being, thinking of themselves as an ongoing process.

Dobbie: Makes a lot of sense doesn't it, if it worked. So what does Telstra's David Quilty think of the idea?

Quilty: I'm not fully across that particular approach but I would say that I think that the critical starting point always has to be commercial negotiation and unfortunately we've over time moved to a situation where a number of people in the industry believe that rather than seeking to get an outcome through commercial negotiation instead the first thing that should happen is to go to the regulator for a result. And I think the other thing that is vital in terms of giving the industry some clear direction and some certainty is to set down some very strong underlying principles in terms of how prices will be set. And that way, in terms of commercial negotiations, the parties will have a lot more of an idea as to where pricing outcomes are likely to happen if regulation is called upon.

Dobbie: Well that's not a no, is it? A framework that everyone agrees on then the Baseball Arbitration approach would seem like a sensible way forward, at least looking from the outside. And of course there's Telstra's model.

Quilty: We put forward a model in consultation with a number of others last September through an independent process which called for some of these changes and also called for a very strong pro-investment objective in the regulatory regime. We'll continue to push that model inside the industry and with government and with regulators. In my view, you know, it's not a model that knows all one-way traffic. Obviously we don't put forward models that we think are against Telstra's interest but I think when people look at it, it is a model that would pass normal public interest tests. So we're intending this year to continue to advocate strongly. I think we have a situation where change and reform and greater certainty are urgently required. The problem at the moment is because of disputation and lack of certainty we're seeing an absolute lack of investment at a critical time when the country really needs it and if we do get investment in broadband we can really start to drive productivity across the economy. So the answer is yes, we are continuing to talk. I had a good conversation with David Havyatt after Unwired made its comments.

Dobbie: So did I. [laughter]

Quilty: And Dave and I've agreed to get together soon. We obviously won't agree on everything but the fact that he's keen to get together and talk things through I find very positive.

Dobbie: There's obviously more of a vested interest in the case of Unwired, isn't it, because they're not investing in ULL. They're looking at alternate technologies. Have you for example sat down with your model, sat down with the likes of Michael Malone or some of the larger ISPs to say, you know here we've got a world-class model, let's argue the inputs and try and arrive at something without using the regulator. That would be a sensible approach, wouldn't it?

Quilty: Yes, that's potentially the sort of next steps that we're looking at. What we've done today is we've worked up the model. We've obviously gone public with it. We've put it on the Now We're Talking website and now we're looking to engender a public debate. So talking to others in the industry who have open minds and are keen to move forward certainly is the next step that I'm looking at.

Dobbie: Good. I tell you we're almost there. Let's leave the last word to David Havyatt who, even though he doesn't work for Telstra, has been doing a great job of standing up for them today.

Havyatt: There's always been this irrational view that for an access seeker that you always want the lowest price possible but equally you don't want the client who's investing in the finger accessing to not get a return because then you'll stop building it. You know the access provider doesn't want just any rate because if you price it too high people will get the ability to go and build something else cheaper and that was Telstra's experience when they HFC network and almost all said that they fought about build. Telstra realised that that access price was too high and happily saw it drop. So there's a rational midpoint that ultimately both the buyers and sellers would converge on if the process was designed to help them converge rather than the process designed to make them diverge.

Dobbie: Pick your number. It's somewhere between $15 and $30. I'm reckoning it's going to be somewhere close to the top end of that scale.

This is Twisted Wire.

Well, it's been a long first episode of Twisted Wire but I hope it's given you some insights into the whole ULL debate. We'll be back again with another subject related to the Telco online and new media industries next week.