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Joshua Gans and Stephen King
Date: 18th January, 2010
Melbourne Business School
200 Leicester St Carlton VIC 3053
T (03) 9349 8173
The Federal Government’s plan to build a National Broadband Network (NBN) is an example of a ‘big bang’ reform. The government has established a company to develop the NBN as “the single largest nation building infrastructure project in Australia’s history.”1 The company will invest up to $43 billion over 8 years to develop a fibre-to-the-premises (FTTP) network so that “90 percent of all Australian homes, schools and workplaces [will connect] to broadband services with speeds up to 100 megabits per second.” The network will be augmented with wireless and satellite technologies so that even premises in regional and remote locations will have broadband speeds of at least 12 megabits per second. Further, the broadband services will be “affordable.” The big bang development of the NBN is a stark contrast to the previous 25 years of incremental reform in Australian telecommunications. However, history matters. The government is not building the NBN as a ‘greenfield’ project. Both fixed-line and wireless broadband networks already exist in Australia. These networks are governed by a range of legislation and actively compete, albeit in a highly regulated environment. The exact way that the government develops the NBN, its short-term and long-term ownership, and the eventual success of the NBN, will depend how the government deals with the existing telecommunications players and the regulations that it establishes for the new network. In this paper, we briefly analyse the current state of telecommunications in Australia and the government’s broadband policy. We then consider the decisions that the government needs to consider for the NBN to be a success – how to deal with existing telecommunications infrastructure; what rules to have in place for future competition; and what co-investments may be required by government to ensure the success of the NBN.
In the 20th century, Australian telecommunications was dominated by the Federal Government and its statutory authorities; first the Postmaster-General (PMG) from federation until 1975, then the Australian Telecommunications Commission (Telecom) and the Overseas Telecommunications Commission (OTC) until 1991.2 The Telecommunications Act 1991, for the first time, allowed for limited network competition in both fixed-line and wireless phone services. Optus Communications was selected as a second general telecommunications carrier to compete against the government-
See Prime Minister, Treasurer, Minister for Finance, Minister for Broadband (2009) New National Broadband Network, Joint Media Release, April 7, Canberra. 2 OTC was established in 1946 and operated along side the PMG until 1975 when the PMG was broken up into the Australian Postal Commission and Telecom. See Raiche, H. (2004) “The policy context”, chapter 1 in Australian Telecommunications Regulation (3rd ed), (Alasdair Grant, ed), UNSW Press, Sydney for a more detailed background on recent telecommunications reforms.
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owned Telstra in both fixed-line and digital wireless services. Vodafone was licensed to provide digital wireless services in competition against both Telstra and Optus.3 General telecommunications competition was only permitted following the Telecommunications Act 1997. This led to entry by a large number of resellers of internet, fixed-line telephone and mobile telephone services. While these resellers have invested in particular network elements (such as DSLAMs which are needed to provide DSL internet services), no new competitive telecommunications carriers have emerged since 1997.4 Indeed, the main ‘reform’ in telecommunications since 1997 was the privatization of Telstra. The government sold 30% of its share in Telstra in November 1997 and a further 16.6% in October 1999. The final government stake in Telstra was sold in November 2006, although a government investment vehicle, the Future Fund, retained a significant shareholding. In late 2009, the Future Fund remained Telstra’s single largest shareholder with 10.9% of Telstra’s equity.5 The incremental reforms since 1991 have resulted in a highly concentrated network structure. Telstra dominates fixed-line network ownership. Wireless telecommunications is dominated by the three chosen carriers from the 1991-1997 period, Telstra, Optus and Vodafone (now VHA). This dominance is reflected in market shares.6 In 2007-08, Telstra’s share of fixed-line telephone subscribers was 71.55%, while Optus had 10.53%. Remaining subscribers were divided between resellers who resellers predominantly provided calls using Telstra’s wholesale Public Switched Telephone Network (PSTN) services. While Telstra and Optus combined had a lower total share for retail fixed-line broadband services (58.38% and 16.39% respectively for 2007-08), most competitors provided DSL services that depend on Telstra’s PSTN to access end users. Put simply, almost every Australian retail customer relies on Telstra’s PSTN as an input for their fixed-line telephone and internet services. The concentrated market structure has resulted in muted competition. As the ACCC (2009, p.iii) notes: [T]he competitive markets anticipated in 1997 do not appear to be emerging. The major downstream services continue to exhibit high levels of concentration, regulatory mechanisms are still heavily relied upon for promoting and maintaining competitive outcomes and the levels of consumer complaints about the industry reached new heights in 2007-08.
3 Formally, Telecom and OTC were merged in 1992 to form the Australian and Overseas Telecommunications Corporation (AOTC). It was later renamed Telstra Corporation. 4 The exception was Hutchison Australia that established the first 3G wireless network in significant parts of Australia. However, Vodafone and a Hutchison Australia, merged in 2009, to form Vodafone Hutchison Australia (VHA), returning mobile telephony to its 1990s triopoly structure. 5 See Business Spectator (2009) Future Fund trims Telstra stake; shares now in 6-month lock up, August 22, available at: http://www.businessspectator.com.au/bs.nsf/Article/Future-Fund-trims-Telstra-stake-pd20090820-V4AVW?OpenDocument. 6 All market share numbers are from appendix C in Australian Competition and Consumer Commission (2009) Telecommunications competitive safeguards for 2007-08, Commonwealth of Australia, Canberra.
The core competitive impediment is the concentrated ownership of the networks. [T]he telecommunications sector in 2007-08 demonstrates the extent to which competition is hindered by the industry’s underlying structural features, with very high concentration levels being observed and high, specialized and largely ‘sunk’ investment costs continuing to impose high barriers to entry for competitors.7 The existing concentrated network structure is relevant for the NBN for three reasons. First, lack of competition is a driver behind Australia’s current relatively poor performance in broadband services. Second, the NBN, by creating a different network that can be used to provide wholesale telecommunications services, has the potential to significantly change the competitive landscape in Australian telecommunications. Third, the most cost effective way to build an NBN involves utilizing parts of existing telecommunications networks. This will require the government to actively negotiate with the dominant fixed-line network company, Telstra. We consider the implications of these three issues in the next section.
The NBN policy as competition reform
Australia lags many OECD countries in terms of broadband speed and investment. In June 2009, the OECD ranked Australia 16th in terms of broadband penetration. Further, Australia’s relative level of broadband penetration decreased between June 2008 and June 2009 with Australia ranking 20th in terms of the growth of broadband penetration.8 The OECD penetration figures may be criticized as a blunt measure. The Information Technology and Innovation Foundation (ITIF) augments the OECD numbers to produce an alternative ranking that takes both speed and price into account. However, based on the ITIF 2008 report, such a comparison lowers Australia’s ranking.9 In particular, Australia’s broadband is very slow by OECD standards with Australia ranked 27th out of 30 OECD countries in terms of broadband speed in the ITIF report. It can be argued that Australia’s relatively low level of broadband access reflects the dominance of Telstra in fixed-line networks. Almost uniquely among the OECD, Australia has a single, vertically-integrated telecommunications firm with the largest market shares in mobile telephony and internet service provision and a near monopoly in cable television and fixed-line telecommunications. Telstra owns the infrastructure used by most Australian’s to access broadband services. Around 80% of Australian subscribers access broadband through DSL technology that uses Tel-
ACCC (2009, p.3) See the ‘OECD Broadband Portal” at www.oecd.org. 9 See The Information Technology & Innovation Foundation (2008) “2008 ITIF Broadband Rankings”, available at www.itif.org/files/2008BBRankings.pdf. For the June 2008 OECD data on penetration used by the ITFI, Australia ranks 9th. However, when adjusted for price and speed, Australia’s ranking on the ITIF table falls to 12. In this sense, the OECD rankings may overstate Australia’s relative broadband position.
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stra’s PSTN.10 Most of the remaining subscribers access broadband services through Telstra’s hybrid fibre coaxial (HFC) cable network. In other words, for fixed-line broadband internet, Telstra is close to a monopoly in terms of network ownership. Regulation has had a limited impact assisting retail level broadband competition. Australia’s telecommunications laws are relatively cumbersome. The ACCC, as the key telecommunications regulator, has powers to arbitrate access disputes and, where relevant, determine appropriate access prices. However, arbitration decisions and other ACCC rulings can be subject to court appeals that extend disputes for years. For example: The industry continues to have an extremely high level of disputation and litigation – in 2007-08, the ACCC was notified of 28 new access disputes and had 18 of its arbitral determinations subject to judicial review by the Federal Court. This was in addition to merits reviews for a number of its exemption decisions (at least one of which has since been subject to further judicial review by the Full Federal Court). … [T]he level of disputation and litigation in the telecommunications sector far outstrips that in any other regulated sector and is contributing to some frustration of competitive outcomes.11 Telstra’s vertically integrated structure is a key regulatory hurdle. While Telstra is required by law to provide wholesale network access to its retail competitors, it has a strong incentive to both limit access and raise the wholesale price. The NBN is an alternative way to improve broadband internet services in Australia. Most obviously, the NBN will move Australia to the top of the OECD in terms of broadband speed and access. However, the NBN will also alter the competitive landscape. The NBN will be a wholesale network. It will develop a fibre network to provide wholesale broadband access to Australian premises but will not provide retail broadband services.12 Retail services will be left to competitive providers who can use the network and complementary investments to provide a range of differentiated and innovative products to end users. In this sense, the NBN aims to overcome both the structural and the competitive impediments to broadband competition and innovation. The dual aim of the NBN – to provide a cost-effective, ubiquitous, high-speed broadband network and to significantly improve effective competition in the provision of telecommunications markets – creates a policy problem for the government. The most efficient way to develop the NBN is to utilize existing network facilities. Telstra owns many of the relevant fixed-line assets. Thus, economically efficient development of the NBN will involve close cooperation between the government’s NBN Company and the (now privately owned) Telstra. However, Telstra is the main benefiReported on the ‘OECD Broadband Portal” at www.oecd.org. ACCC (2009) , p.iv. 12 See Prime Minister, Treasurer, Minister for Finance, Minister for Broadband (2009) New National Broadband Network, Joint Media Release, April 7, Canberra. where it states that “[t]he new investment is also the biggest reform in telecommunications in two decades because it delivers separation between the infrastructure provider and retail service providers”.
ciary of the current lack of competition in Australian telecommunications. If the NBN is successful it will undermine Telstra’s dominance in telecommunications. The conflicting incentives created by the existing structure of fixed-line telecommunications and the proposed rollout of the NBN, has resulted in two significant developments. First, Telstra brought an action against the Federal Government claiming that the telecommunications access regime effected an acquisition of parts of the PSTN other than on just terms, contrary to s.51 of the constitution. In 2008, the High Court dismissed Telstra’s claim. It noted that Telstra’s ownership of the PSTN has always been limited by the regulatory environment established by the Telecommunications Act 1991. Thus, “Telstra’s bundle of rights in respect of the PSTN has always been subject to the rights of its competitors to require access to and use of the assets.”13 Second, the government has moved to reform telecommunications regulation and provide incentives for “Telstra to structurally separate, on a voluntary and cooperative basis”.14 The part of Telstra that controls the wholesale network will work with the NBN Company to develop the NBN. The separated retail part of Telstra will compete with a variety of other retailers who purchase access to the NBN. At present, we are yet to see whether or not this outcome is achieved. The development of a FTTP network makes redundant Telstra’s most valuable fixed-line assets: the PSTN and its HFC cable. While the government needs some of Telstra’s network assets to reduce the cost of building the NBN, Telstra potentially loses far more if it does not join with the NBN Company. The government’s public commitment to the NBN together with the High Court decision on Telstra’s restricted ownership rights over the PSTN, provides significant incentive for Telstra to cooperate with the NBN Company. The government has backed up this incentive through regulatory threat. In this sense the NBN is not just a big bang infrastructure development. It is also a big bang regulatory reform. It will fundamentally change the nature of broadband regulation and competition in Australia.
Regulation and the NBN
The NBN will not remove the need for telecommunications regulation. It will, however, change the nature of that regulation. A key element will be the maintenance of strong vertical separation between the owner and operator of the NBN and the provision of retail services using the NBN. Vertical integration means that the owner of a monopoly network can have strong incentives to undermine retail competition. After all, if there is profit to be made at the retail level, the network owner would like to keep that profit for itself. If it is unable to do this by raising the network access fee to a monopoly level, then it will be tempted to undermine its retail competitors by reducing the quality
13 High Court of Australia (2008), Telstra Corporation Limited and the Commonwealth of Australia and Others, Commonwealth Law Reports, 210-235, at paragraph 52. 14 Minister for Broadband, Communications and the Digital Economy, (2009) “Historic reforms to telecommunications regulation”, Media Release, 15 September.
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of access services. As Australia’s recent experience of telecommunications regulation shows, it is difficult, if not impossible, for a regulator to prevent such discrimination by an integrated network owner. In contrast, a vertically separated network owner has significantly less incentive to favour specific retailers. Given the wholesale network price, a vertically separated NBN Company will simply wish to sell as much wholesale access as possible. While it would like a higher wholesale price, it does not want to restrict network access, unlike its vertically integrated counterpart. This means that NBN regulation should look a lot like the existing regulation of electricity transmission. In Victoria, where the transmission system is privately owned, regulators have strictly enforced vertical separation. This includes using the merger provisions of the Trade Practices Act 1974 to prevent integration between the transmission network owner and either upstream or downstream service providers.15 Similar strict requirements for vertical separation will be needed for the NBN. Vertical separation does not remove the need for price regulation. A monopoly network owner will still want to charge a monopoly price for network access. This will inevitably create a conflict between the NBN earning a ‘commercial’ return and providing affordable broadband access to Australians. Of course, it is far from obvious that the NBN should earn a commercial return. Once the NBN is constructed, marginal cost pricing will maximize economic benefits. However, as the NBN is likely to have average costs well above marginal costs, at least until it reaches capacity, marginal cost pricing for wholesale access to the NBN will not cover capital costs or lead to a commercial return. This highlights the need for the government to develop in advance the regulations for the NBN, including the rules for pricing access. The government needs to make the regulatory framework explicit both to encourage private investment in complementary assets and to avoid gaming by vested interests after the NBN is built. This is particularly the case if the government plans to privatise the NBN in the future. The NBN is a risky investment. The government is choosing a particular fixed-line broadband technology. This technology will be competing against wireless internet services and, potentially, other fixed line technologies. Inevitably, Australian taxpayers will bear the risk associated with the NBN. However, care is needed to ensure that these costs are minimized and that taxpayers do not ‘pay’ for the risks multiple times. For example, the NBN Company, especially if it is privately owned or is otherwise required to maximise its commercial return, will have an incentive to lobby the government to restrict competition. This could mean restricting wireless technologies that can be used in
15 See for example ACCC (2004) “ACCC assessment of S P Energy’s acquisition of TXU Australia”, Public Competition Assessment, 19 July. A subsequent sale of assets by S P Energy is discussed at ACCC (2005) “China Light & Power’s proposed acquisition of Australian non-regulated energy assets of Singapore Power”, Public Competition Assessment, 14 April.
Australia. Such restrictions, however, will inevitably harm consumers. Similarly, private investors in the NBN will undoubtedly wish to be compensated for technological risk up front. These same investors will naturally seek to be further compensated at a later date if the NBN is subject to vigorous competition from an alternative technology. Again, the government can overcome future problems by clearly setting out the ground rules for risk allocation of the NBN in advance. Allowing private investors to compete against the NBN through alternative technologies, if they believe it is privately profitable to do so, should be allowed. Traditionally, Australian governments have sought to ‘average’ utility prices over urban and regional areas. This can result in an implicit subsidy to regional consumers and makes the relevant service provider subject to ‘cream skimming’ by private competitors. This is highly likely to occur with the NBN. If the government wishes to equalize urban and regional NBN prices then it should do this through an explicit and transparent subsidy. Again, the basis for this subsidy should be clearly established in advance to avoid future manipulation by the NBN Company. Regulation of the NBN may mean that regulation can be scaled back in other areas. For example, if wireless and fixed-line internet services are close enough competitors, then explicit regulation of wireless internet services will be unnecessary. Similarly, as the NBN can be used to provide standard telecommunications services, most existing telecommunications regulation will be redundant. Finally, the government could also use the NBN to reduce its own costs of providing public services. For example, if internet access through the NBN is ubiquitous, then it can be used to communicate with the general public and provide a variety of government services. To ensure universality, the government may wish to make a basic broadband service (say with a speed of 1Mbps) freely available to all households. The provision of this service, together with a basic ‘netbook’ for lowincome households, could be tendered by the government. The service could potentially pay for itself by lowering government costs in other areas such as social security and taxation.
Is the NBN worth it?
Some commentators have been critical of the lack of a comprehensive cost-benefit analysis of the proposed National Broadband Network. This criticism has some validity. It is desirable for government investments, such as the NBN, to be appropriately costed and evaluated before taxpayers funds are committed to their development. Investment funds are finite and building the NBN will inevitably mean that resources are drawn away from other potential investments. At the same time, it must be recognized that any analysis of the social benefits of the NBN will be extremely imprecise. Alternative cost-benefit analyses of the NBN have been presented.16 These
16 Gans, J.S. (2009) “The right policy for telecommunications and broadband”, Submission t the Senate Select Committee on the National Broadband Network, June 18. Ergas, H. and A. Robson (2009) “The social loss from inefficient infrastructure projects: recent Australian experience”, paper presented to the Productivity Commission Round Table: Strengthening evidence based policy in the Australian Federation, 17-18 August.
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studies reach substantially different conclusions – from large net positive to large net negative social returns. This gap is unsurprising. The studies make very different assumptions. This is understandable and reflects the significant uncertainty surrounding a project like the NBN. It is impossible to precisely measure the costs and benefits of the NBN. Many of the benefits will depend on complementary investments by the government or private companies. It is likely that services that have not even been invented yet will be provided by the NBN once it is built. In this sense, to require that the NBN be subject to a precise cost-benefit analysis is simply a waste of time. A more appropriate approach is for the government to undertake a broad risk analysis of the NBN. It is possible that the NBN will be a ‘white elephant’ that is based on redundant technology, but whether this risk is large or small is not clear. Similarly, it is possible that the NBN will revolutionise the economy leading to massive productivity gains for Australia, however the probability of this is also unclear. While it is impossible to derive a single number, or even a well-defined range of net benefit estimates, for a project like the NBN, it is possible to analyse the broad possibilities, their benefits and their likelihoods. Such a risk analysis will never be definitive, but it will help educated public debate about the NBN. Finally, the benchmark for any risk evaluation of the NBN is clear. The relevant benchmark is the net social benefits from the NBN. Whether or not the NBN is commercially profitable is irrelevant. Indeed, if the NBN was commercially profitable then there would be no need for the government to be involved in the project at all.
What other investments should be made?
The National Broadband Network provides the infrastructure for high-speed internet connections. However, by itself the network does not necessarily create demand for such connections. Indeed, evidence from Japan and South Korea where fast Internet connections are available, suggests that demand is mainly for video downloads and gaming. The recent National Innovation Review recognised that there is a gap between the government’s broadband investment and applications to utilise it effectively: With the National Broadband Network, Australia needs to ensure that the relevant applications – specific to local needs – are developed to leverage that infrastructure for the purpose of government policy. This includes applications in open democracy, database and privacy standards for health information, tools to facilitate educational use of broadband, traffic systems and standards, and national collections of information and knowledge.17
17 Cutler and Company (2008), VenturousAustralia: Building Strengths [http://www.innovation.gov.au/innovationreview/Documents/NIS_review_Web3.pdf]
The Federal government should complement its NBN investment on two fronts. First, it needs to encourage applications that leverage the network. These could be in e-health, e-education or videoconferencing (that might save on commuting costs). In each of these, active reviews of government legislation, information assets and policies needs to be taken so as to ensure there are no governmental bottlenecks to the development of such applications (e.g., medical liability laws preventing off-site health diagnosis and treatment). To explore this further, consider e-health. Usually, what is envisaged is a surgeon in Sydney operating on a critically injured patient at some outback station. However, it is far more likely that e-health will be used for the most routine and mundane of medical issues rather than the most specialised and exceptional. For example, e-health services can provide significant benefits for outof-hours medical treatment of routine health issues, such as a child with a fever. A GP connected to the patient through the NBN can interpret data and email a prescription to the pharmacist, saving time, inconvenience and reducing pressure on hospital emergency services. Why isn’t this service being offered? The technologies exist to transmit the relevant information to doctors at a low cost. The problem is that the liability laws and health regulations (including Medicare reimbursement) do not envisage this situation and stand in its way. By facilitating ehealth transactions rather than preventing them, the government could stimulate significant innovation. The second complementary investment involves hardware. This includes computer equipment and complementary hardware that is required, for example, to access e-health services. As already noted, the ability of the government to deal with citizens through the NBN can lead to significant savings and may justify the government supporting low income families in accessing basic computer hardware.
The National Broadband Network investment is more than about just higher speed broadband. It is a bold move towards infrastructure-based competition in telecommunications in Australia; an industry for which regulation has achieved gains for consumers but not long-lasting and significant gains in competitive market structure. This paper has highlighted this broader context and argued that the government and others should evaluate the NBN and its social returns on that basis. Nonetheless, we have noted that significant uncertainty remains and, in particular, the social benefits are likely to be substantially impacted on by policy decisions in the NBN’s implementation, ownership structure and complementary investments.
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