Director General's statement on the Competition

Commission's report on mobile termination charges

22 January 2003

I am publishing today the key conclusions from the Competition Commission’s report
to me on its inquiry into mobile termination charges. The Competition Commission
has endorsed Oftel’s analysis and proposals in this important area. Implementation
will bring substantial benefits for consumers.

Background

In 2000-01, I reviewed both the broad mobile market (ie the state of competition in
the provision of mobile telephony services to mobile customers) and the call
termination market (ie the state of competition in the delivery of inbound calls to
mobile customers) separately. This was not a theoretical exercise. We consulted
extensively with the industry and consumer groups, including setting up a joint
industry working group to discuss costing issues. In addition we undertook
substantial consumer research.

On the broader market review, although the market was not effectively competitive, I
found growing evidence of competition. As a result, I was able to roll back some of
the access requirements on Vodafone and BT Cellnet (as it was then named).
Although we identified some issues for ongoing monitoring, the overwhelming thrust
of that review was deregulatory.

This was in line with my general aim to limit regulation to the absolute necessary
minimum. However, I must take targeted and proportionate action in markets where
consumers need protection. The Competition Commission has agreed that call
termination is just such a case.

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What is call termination?

Interconnection

Mobile or fixed Mobile operator (B)

operator (A)

Calling party pays Terminating operator receives

originating operator interconnection charge from the
originating operator Termination
charges ‘capped’

Retail price (peak) Termination charge

30 ppm off-net 13.2 ppm
20 ppm fixed to mobile

When a call is made to a mobile phone, whether from a fixed line or from a mobile on
another network, the call passes from the originating operator (A) to the terminating
operator (B). The terminating operator charges a fee for connecting the call to its
customer – the termination charge. This charge is paid by the originating operator
and passed on to the caller in the retail price they pay for their call.

The key point about call termination is that it is the caller, not the person being
called, who pays for the call and so pays the termination charge. However, it is the
person being called who chooses the mobile network operator (MNO) on which the
call terminates (operator (B)) and which sets the termination charge. So the normal
market discipline of consumers reacting to higher prices, forcing the MNO to bring
down charges, does not happen because the consumer who pays the charge is not
the customer of the MNO which sets the charge.

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Oftel’s proposal

Oftel imposed a price cap of RPI-9 on the termination rates of Vodafone and O2 (BT
Cellnet) in 1999 after an earlier Competition Commission investigation. Our task in
the 2000-01 review was to check whether competition was sufficient, or was likely to
be sufficient in the near future, to constrain the level of termination charges or
whether regulation such as a continuation of the charge caps was still necessary.

In examining call termination, we first had to review the relevant market. We

concluded that the correct market to examine was that for termination on each
individual network. This is because if a call is made to a particular number, there is
no other way to connect the call to that person’s number except by terminating it on
the network to which the person subscribes. The Competition Commission has
agreed with my analysis, pointing out that “there are currently no practical
technological means of terminating a call other than on the network of the MNO to
which the called party subscribes”. The European Commission has also indicated
their agreement that this is the correct market definition and the Competition
Commission has now also endorsed our judgement.

This market definition implies that each MNO has a monopoly for termination on its
own network and that competitive pressures are insufficient to constrain the
termination charge. Again, both Oftel and the Competition Commission looked very
closely at the MNOs’ arguments about future technological change and the nature of
mobile calls. They did not convince either of us that this monopoly position would
erode quickly.

In the light of this, I concluded that the termination charge should be made cost-
reflective. My scrutiny of the data revealed a major gap between costs and the
charges. I proposed a charge cap of RPI-12 for each of the four years from 2001-02
to 2005-06 to bring the charges into line with costs. In addition to the cost of
termination, an allowance was made for the benefits to callers of being able to make
a call to a mobile customer.

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The MNOs rejected my proposed modification to their licences. I then referred this
issue to the Competition Commission for it to consider whether the absence of
controls on termination charges would act against the public interest. This has had
the effect of delaying benefits reaching consumers and has increased uncertainty in
the market place. The MNOs made substantial representations to the Competition
Commission to try and persuade it that Oftel had its analysis wrong. The report
shows that that they have totally failed to convince the Competition Commission.

The Competition Commission’s verdict

The Competition Commission has spent a year on its inquiry and has thoroughly
analysed all relevant issues. The Competition Commission has concluded that the
absence of a control on termination charges would be against the public interest.
The CC has concluded that:

• the termination charges of the four mobile operators operate against the
public interest;
• current termination charges are 30-40% above a fair charge;
• consumers pay too much for calls from fixed lines to mobiles and from one
mobile network to another;
• the high cost of termination deters people from calling mobiles; and
• those who make more calls to mobiles, either from a fixed line or another
network, unfairly subsidise other mobile owners who mainly receive calls or
make on-net calls.

This is in line with Oftel’s conclusions, which we set out in our original proposal and
with the Competition Commission in hearings and in technical papers. I am pleased
that the Competition Commission has endorsed Oftel’s analysis and conclusions.

The Competition Commission has also agreed with the key elements of the remedies
I put forward. It agrees the need for cost-reflective termination charges and they
agree that Long Run Incremental Cost is the best basis for such charges. It has had

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access to a broader range of data from the MNOs than my team had available and
have therefore produced slightly different caps. It recommends that:

• each MNO should reduce the level of the total termination charge by 15 per
cent in real terms before 25 July this year;
• O2's and Vodafone’s charges should be subject to a further reductions of RPI-
15% reduction between 25 July and 31 March 2004 and for each of the two
subsequent financial years.
• Orange’s and T-Mobile’s charges should be reduced by RPI-14% in each of
these subsequent two time periods.
(The difference represents the Competition Commission's view of the difference
between the relevant costs of the operators).

I accept the Competition Commission’s conclusion on a one-off cut of 15% by July.

Formal licence modifications to the MNO’s licences are currently being considered
and will be put out to public consultation shortly. Arrangements for the control of
termination charges after July 2003 will be considered in the market review to be
undertaken by Oftel under the requirements of the new European Directives.

Oftel issues

The Competition Commission has tackled head on a number of concerns put forward
by the MNOs in the course of their investigation.

The MNOs argued that retail prices would increase if termination rates were capped.
Oftel argued that this would not happen and the Competition Commission agrees.
The MNOs’ existing business plans already project a downward trend of retail prices
and whilst retail prices might not fall as fast as predicted, the Competition
Commission concludes that they will not need to rise as a result of the proposed
charge controls.

The MNOs argued that the number of mobile subscribers would fall because handset
subsidies would decrease. Oftel did not believe that the capping termination reduced

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the networks’ ability to gain and retain marginal customers through targeted
packages. Again the Competition Commission agreed with our analysis.

I was mindful of the need not to undermine the viability of any of the MNOs in my
original proposals. Some of the MNOs argued that my proposals were draconian and
would force them to consider leaving the market. The Competition Commission’s
analysis shows this claim to be unfounded.

The MNOs have claimed that action to reduce termination charges will delay the
rollout of 3G networks. There is no reason why this should be the case. The
Competition Commission agrees with Oftel’s analysis that the business case for 3G
should stand on its own merits. It argues that, as a matter of principle, 3G investment
does not justify termination charges that are above a reasonable estimate of their
cost, particularly if those charges are ultimately derived from fixed line customers.

What this means for consumers

Oftel has estimated that, for example, a peak rate call from BT to Vodafone would
fall from 20 pence per minute to 13.5 pence per minute over the period of the control
proposed by the Commission. Although Oftel does not regulate retail mobile prices,
as lower termination charges reduce the costs to MNOs of providing off-net calls, it
should make it easier for them to reduce headline off-net call prices or include more
off-net calls in their pricing packages.

The lower prices resulting from the implementation of the proposals will lead on
average to consumers saving £18 in the last year of the charge control for calls to
mobile phones from fixed line phones. Overall, Oftel estimates that consumers
should benefit by £190m per year through lower prices for fixed to mobile calls as a
result of a 15 per cent cut in termination rates to be made by July 2003. The
Competition Commission also proposes further cuts in 2003/04 and over the
following two years.

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Oftel’s next steps

I will publish the Commission’s full report in early February. Also, I will consult
publicly for not less than 28 days on the precise licence modifications to be made.
At present, I expect the consultation to begin in February in order to give effect to the
Competition Commission’s first recommendation by April.

I now need to review the termination market afresh for the purpose of introducing the
new European Telecoms framework with effect from 25 July this year. The
Competition Commission’s thorough forward-looking analysis, which both vindicates
and builds on Oftel’s conclusions, now gives the best possible starting point for that
work.