Supporting network investment: structural separation not broadband deregulation

Monday 22 June 2015 | 14:06 CET | Market Commentary
Nearly all the European incumbent operators have called on the EU to relax regulation of the sector. "We need a level playing field. (...) WhatsApp is doing communications, Facebook is doing communications. I don't see why they should be treated differently," according to the joint letter sent to EU President Donald Tusk. Eircom (Ireland) and TDC (Denmark) were the only two incumbents not to sign the letter. 

This is not the first time they've stated such a position, but the aim remains debatable. As a few years ago the claim by many operators that 'they're using my pipes for free' didn't stop the adoption of net neutrality laws and guidelines, the call for a 'level playing field' may put structural separation on the policy agenda. While deregulation of the broadband market is not possible, the sector's margins continue to fall to structurally lower levels. This means increasingly less cash for investments. The separation of the network from services provision means only one party has to invest in the (passive) infrastructure.

Level playing field

The operators want a 'level playing field' with the OTT sector. While at first glance there's nothing wrong with this, a closer looks shows it's a hopeless endeavour. The operators complain of their weakened position on the communications market and now want compensation through less regulation in broadband. The fact that these are actually two completely different markets shows how doomed their efforts are.

The call for a 'level playing field' is really only viable on the communications market. But imposing regulations such as 112 access on players like Skype and Viber is probably not what the incumbents are after. Furthermore, there's nothing standing in the way of the operators offering their own OTT services. While previous joint efforts such as joyn may have failed to get off the ground, they have had more success on the entertainment market with OTT services to rival Netflix, such Horizon Go (Ziggo), KPN iTV Online and KPN Play.

In any case, relaxing regulations on the broadband market has nothing to do with this. It's not the OTT sector that would be impacted, but the challengers, such as Tele2.

Structurally lower margins

It's clear the telecom sector is having a difficult time. Broadband is providing some growth but can't make up completely for the decline in traditional markets (telephony, SMS, TV, VOD). These traditional services are commodities, supplied by utilities. The operators have traditionally bundled these services with access (connectivity) and have focused in recent years more and more on bundles (double, triple quad and even quintuple play). But this isn't paying off. WhatsApp, Viber, Netflix and other apps are replacing traditional services, causing a major problem for operators. But if deregulation of broadband is not the solution, then what is?

In broad terms, the operators need to look at a few options:

  • Reducing costs, something driving the latest round of mergers and acquisitions. Technology developers such as NFV (delinking hardware and software) and SDN (delinking network management and equipment) will also play a role in the coming years.
  • Developing new revenues sources and services.
  • Developing new platforms, complimentary to existing platforms for telephony, SMS, TV and VOD. This means things like mobile payments, the Internet of Things, connected cars, robotics and the 'smart city'.
  • If operators want to compete with the OTT sector, they can offer cloud services (see Deutsche Telekom), launch their own OTT services or enter the advertising market.
  • Work with other players providing content or services and share the revenues.

It's unclear how much each of these will contribute to improving results, and the sector may have to resolve itself to structurally lower margins. Brussels cannot and will not fix this. It's a reality the sector and its investors will have to accept, however painful it may be.

Structural separation

The fundamental question is what is the day-to-day role of an operator: a service provider or a network company? In terms of services, the OTT sector, much better at innovation, is gaining ground on all fronts. As for network expertise, this is now mainly in the hands of equipment vendors (Ericsson, Alcatel-Lucent, Nokia, Huawei, ZTE), and their role is only growing in importance due to the increased outsourcing of network operations. As for the platforms mentioned above, the telecom sector still needs to prove whether it can remain in the lead. All this means the natural role of the operator is a question for considerable debate.

The incumbents called in their letter for the EU to ensure a stable investment climate. They also made a veiled threat against net neutrality ("To ensure that the final rules enshrined in the Telecom Single Market regulation do not harm innovation and investment, e.g. by limiting innovation in networks and new business models"). Deregulation of the broadband market though appears to have no chance. In the EU, too much is based on ensuring competition.

If there's not enough cash in the sector, then to guarantee investment for the coming years there is an alternative: structural separation. Cable aside, this would create a single national infrastructure, minimising the need for investment. Telecom Italia's recent IPO of its mobile towers arm Inwit underlines this logic. In the US, a similar trend is underway, where AT&T and Verizon are selling off parts of their fixed networks (in order to concentrate on mobile) to operators such as Frontier Communications, which then use government subsidies to finance broadband upgrades.

Structural separation ensures sufficient competition on retail markets, removing the situation where one player is wearing two hats (the incumbent offering both its own retail services and wholesale services to competitors). The network company can focus on infrastructure and also attract new capital from investors such as pension funds, which are interested in this kind of low-risk, long-term investment. The incumbents can then focus on providing services, and with the initiatives outlined above, are free to compete with the OTT sector. 

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