Have you ever wondered?

Peter Farmer

19th May 2022

By Peter Farmer

One of the banes of life as someone that works in the field of telecommunications regulation is the expectation that we will somehow magically understand precisely what the regulator means within five minutes of them publishing a document. 

In some cases, such as the 2016 Business Connectivity Market Review, these publications are 2,000 or more pages long. Granted, regular readers know they can skip over certain sections, such as Ofcom rehearsing certain powers it has, but you are still left with 80% or more of detailed analysis and discourse to cogitate. 

There are two reasons that Ofcom’s decisions must be so lengthy. Firstly, European Union law (in this case, law which the UK still needs to abide by as a result of the manner in which Brexit was achieved) affords anyone affected by an Ofcom decision the ability to appeal to the courts, on the merits. 

“On the merits” is key here, it means that the appeal is not on a narrow point of law (that comes when you appeal the appeal) but is, essentially, a complete do-over of the original decision. When the outcome of a market review can be a cost of tens of millions or more, it is no surprise that the largest operators take a roll of the dice and dispatch their barristers.

Secondly, the decision making, guided by the economists – actually, strictly speaking, the dark magic of regulatory economists, is a very complex area and requires a substantial amount of discourse. 

Why the TED talk on regulatory economics? Because it goes to the heart of what Simon recently said on this blog about transit. Simwood recently wrote to Ofcom on the subject, outlining its concerns that the assumptions that underpin Ofcom’s decision that the transit market is sufficiently competitive to not warrant regulation, have been disproven in practice. 

I’m going to attempt to explain how Ofcom reached that conclusion, in a few short paragraphs, which, by definition, means it does a disservice to the field, given it takes war and peace for it to be sufficiently rigorous to withstand judicial scrutiny… Here goes.

In a market which is constrained by competition, no one provider will be able to earn a disproportionate profit (economic rent is the fancy term) for the provision of a service. Now, here comes the big non-sequitur … a monopolist can be constrained by competition.

Yep! Bear with me… Let’s say you have a monopoly provider of cabbages – just one farming conglomerate on Earth that produces cabbage. The grade-school version of economics would suggest that they can charge anything they want for cabbage. While that may be true for certain products or services, such as a unique vaccine, or water, when we are talking about vegetables, other factors can come into play. 

If the cabbage cartel, for sake of argument let’s call them Fel Squante, hiked up the price of cabbage, say five or ten times, it would certainly suck for coleslaw-lovers, but the market will adjust. From sowing a cabbage seed, to shredding it and adding mayonnaise, is 120 days, so within four months, existing carrot or onion farmers enter the market, and the surplus cabbage forces prices back down to the competitive level.

Cabbage-lovers may also seek a substitute and decide that an iceberg lettuce at a fraction of the price is suitable enough for their needs, meaning that the over-priced cabbage rots in the fields and on the shelves, forcing Fel Squante to reduce the price to the competitive level.

In other words, the dirty monopolist is unable to abuse their position in any meaningful way.

In economic terms, I’ve just described (economic professors please don’t @ me, I know this is very over-simplified) the Small but Significant Non-transitory Increase in Price test, or SSNIP. It’s a hypothetical test which an economist performs to see if a monopolist or oligopolist could, in reality, profit from hiking prices. If they cannot, then the market is self-governing, if they can, the mission is then to find what the minimum interventions are required to allow the market to self-govern. 

In telecommunications terms, we see this play out. Every Original Range Holder is deemed to have Significant Market Power and is charge-controlled because it is a monopolist for which there is no substitute or potential for a new entrant. Only Simwood can provide termination for Simwood numbers, for example. However, there are hundreds of electronic communications networks which can provide services for people to call international numbers, with substitutes like Teams and WhatsApp to boot, meaning that part of our market is deemed entirely competitive. 

Somewhere in the middle we have transit. Until last year, it was fair to say the market for transit to major routes was competitive. BT could not earn a supernormal profit on transiting calls to Vodafone, because every major player had a Vodafone route and undercut them – the system worked. 

Unfortunately, it never worked for minor routes. Simwood transiting calls to “networks” with a couple of E1s worth of TDM interconnect with BT has a monopolist transit provider – BT. These entities are not resourced enough to manage a nexus of interconnects. Nor are some major operators – constructive refusals to supply, despite the clear legal rights to interconnect afforded to their peers, are common. 

As a rule, the timescale for the market to react to an SSNIP and still be deemed competitive is 12 months – interconnect, despite the clear rights, can take longer than that in many cases. 

Ofcom will invariably point to a blend of major and minor routes and point out that the vast majority of minutes have competitive transit. Well, it did, until two major players either exited the market or cooled off as a result of the complexity of origin-based surcharges, meaning the market is concentrated in a monopolist again. 

If you were to plot inflation versus BT’s transit prices, you would understand why some think a supernormal economic rent is being earned. Marvel Avengers level of super after the Hulk downs a Red Bull. 

Until recently, Simwood grudgingly accepted the economic view of major transit routes, but recent news has changed that paradigm – and to that end, we have written to Ofcom to invite them to investigate the transit market and consider whether their underpinning assumptions need revision.

We aren’t going to hold our breath – reopening a market review during the period to which it applies is a high threshold, but at a time when UK consumers are experiencing an unprecedented (at least in a generation or two) squeeze on the cost of living, we are not going to sit idle and risk our liberal and competitive industry suffer the risk of re-monopolisation – and we hope Ofcom don’t sit idly by either.

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