Telecom NZ proposes 'voluntary' structural separation

Thursday 27 May 2010 | 16:10 CET | Market Commentary

Speculation rose in New Zealand about the future of the incumbent, Telecom NZ. CEO Paul Reynolds has proposed some radical scenarios in response to the government’s Ultra-Fast Broadband Initiative (UFB). A structural separation of the company’s wholesale and retail divisions was suggested in order for Telecom NZ to be able to take part in the UFB tender process.

In early 2009, the government launched the UFB plan with a fund of NZD 1.5 billion to build broadband in New Zealand. The plan aimed to connect 75 percent of homes in 25 cities to fibre within six years. The plan was further developed in March 2009 with the establishment of the Crown Fibre Investment Company (CFIC), which is looking for co-investors in the 25 Local Fibre Companies (LFC) project. These investors are being asked to invest 1.5 billion NZ dollars. Principles of the network include: wholesale only (no ISP role) and open access for service providers. In September 2009, more elaborations to the plan came on board, as well as some delays. The goal now is to provide 75 percent of the population with at least 100 Mbps by 2020. Meanwhile, several parties have responded to the tender, including a Canadian combined Axia NetMedia as well as Vodafone NZ. The winner is expected to be announced in late June.

Telecom NZ has, just like Telstra in Australia, been placed in a tough spot with the government plan: to participate or compete? Incorporating Telecom NZ’s infrastructure is a foregone conclusion, but the government has set an inflexible demand: 'wholesale only', leading to Telecom NZ 'voluntarily' suggesting a possible structural separation. This would be a step beyond the existing functional separation of retail, wholesale and network. The question now is whether retail should be separated from the rest (wholesale + network), or whether the network (Chorus) should be sold off. But Paul Reynolds, formerly of BT Wholesale, has also left open the option of competing with full UFB and not participating in the tender process.

It is clear that the government has put Telecom NZ before a difficult choice. Competing with public funds is generally difficult, especially if FTTP or FTTH (premise or home) is pitted against FTTC or FTTN (node or cabinet, with VDSL from there to the subscriber). Structural separation is considered by most telecommunications companies as a negative. The cost and risks are considerably high and companies lose the existing synergies from vertical integration, something that Paul Reynolds has explicitly explained. Shareholders are also wondering about those costs and risks, judging by the recent stock price plunge - which also takes into account the debacle in the mobile market with the difficulties encountered by Telecom Nz and Alcatel-Lucent in the rollout of a 3G network.Vodafone, also interested in FTTH, would see its market share improve.

It is clear that the benefits of structural separation have been ignored. First, a market inequality is removed because the incumbent is no longer the only one to enjoy the advantages of vertical integration and cross-subsidisation. Secondly, it is difficult to compete with your customer and that iss exactly what is going on between the retail and wholesale division. Some telecom companies are very clear when explaining this disadvantage, such as Bouwfonds in the Netherlands, which through CIFpurchased the CAIW infrastructure. CIF categorically refuses to take on the role of service provider. Axia NetMedia also subscribes to this view. Many telecom companies do not want to go beyond functional separation, with additional wholesale revenues due to open access obligations remaining with the incumbent. Moreover there are also good margins to be made (KPN wholesale roughly has double the margins of KPN retail).

The government is taking a clear stand and Telecom NZ is being forced to bend (structural separation) or bust (compete with UFB). This problem is worldwide, but is especially topical in New Zealand, Italy and Australia (see earlier commentaries “Telecom Italia 'forces' competition into FTTH initiative"). The consumer is the real winner here, because competition will increase anyway. And that is exactly what every government and regulator wants.

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