Response to OPTA’s Consultation
On the Price Squeeze Test
(OPTA, 9 October 2000)
Summary
WorldCom welcomes the opportunity to respond to OPTA’s consultative document “Price Squeeze”, issued on the 9th of October 2000.
Together with Energis, GTS, Versatel and UPC, WorldCom has hired legal
assistance from Houthoff Buruma and economic assistance from NERA to comment on the proposals OPTA has outlined in its consultation document. This has resulted in two reports, which are attached to this document. The reports should be
considered to form integral part of WorldCom’s comments, unless we explicitly state it should not be considered as such.
In sum our main comments are given below.
1. Price Squeeze Test needed for sustainable competition.
We agree with OPTA that the installation of a Price Squeeze Test is a critical precondition for the further competitive development of the Dutch
telecommunications market. In our view there is clear evidence that currently there is a price squeeze for certain services (e.g. BIBA, BUBA and Fixed-to-Mobile). If this anti-competitive situation is not corrected, this will eventually prevent efficient new entrants from entering the market and may even drive efficient new entrants out of the market, at the expense of higher prices, less choice and lower quality for customers in the longer term.
2. Legal basis and procedures.
We agree with OPTA that the Price Squeeze Test can be based on the principle of cost-orientation. However, for legal certainty we would recommend it is advisable that the Minister confirms this in an Explanatory Note to the BOHT or regulates the price squeeze concept in a separate article in the BOHT. Further we would recommend that OPTA together with the Competition Authority publish Guidelines for the application of the Price Squeeze Test in individual cases. Such a dual approach seems reasonable since general competition law is also
applicable on price squeezing and would strengthen the legal basis for such a test. We also recommend an amendment of the BOHT to ensure transparent procedures, possibilities for third party appeal, rights for third parties to be heard, etc.
3. The need for (accounting) separation and the alignment of retail and
interconnection prices.
Since the consultation document explicitly states hat KPN itself internally does not pay interconnection charges that are equal to the charges new entrants pay, we believe it is crucial that accounting separation gets installed as soon as possible, to ensure that this discriminatory situation is ended. This is a strict obligation in the light of national and European telecommunications regulation. At the same time we believe accounting separation should only be considered as a second best solution for the problems that arise with vertically integrated firms, since in fact is only is a “simulation” of a structural separation. In fact a structural separation would be better and we strongly believe this issue should be high on the agenda of discussion.
4. The alignment of retail and interconnection prices.
geography, in line with the OFTEL’s requirements for BT. Because the
implementation of these two measures does not ensure that a price squeeze will not happen, in addition a Price Squeeze Test is needed to ensure that KPN’s retail prices are not too low.
5. The test proposed by OPTA
We agree with OPTA that the Test that is needed can and should be simple and straightforward and look at: (a) the relevant KPN end-user tariffs, (b) the relevant costs related to the purchase of interconnection (input costs), and (c) the Retail Costs. If (a) < (b) + (c), then there is a price squeeze, and KPN should adjust its end-user prices. Our further comments on the different elements of the test are discussed below (points 6, 7 and 8).
6. End-user tariffs.
We agree with OPTA that end-user tariffs should be assessed according to destination, time period and call length. With regard to the latter we recommend OPTA to use all call lengths up to 1 hour. Furthermore we strongly believe that not only the discounts for residential customers but also the discounts for
business customers should be taken into account. Not doing so would leave KPN a loophole through which it could still engage in price squeezing, without being caught by the Price Squeeze Test.
7. Input costs.
In principle we believe the input costs should be based on the assumption of an efficient new entrant, but at the same time we agree with OPTA that at this stage it might be too difficult to define an imaginary efficient operator. If OPTA sticks to its KPN on-net approach we strongly believe that certain corrections (that are based on the concept of an efficient new entrant) are needed. Charges related to ports and circuits as well as the additional costs incurred when calls terminate on others operator’s networks (including mobile networks) should be included in the input costs. Further we believe that a correction should be made for the fact that efficient new entrants currently can not interconnect at KPN’s local switch level. This means that instead of assuming KPN pays local interconnection, it should be assumed KPN pays regional interconnect charges, at the least as long as local interconnection is restricted. Finally, we believe a correction should be made for the fact that in reality KPN does not pay interconnection charges, but internal transfer prices (which we assume are lower than the interconnection charges other operators pay). With regard to the last two corrections we suggest, there is also a critical issue of timing, by which we means these corrections should be made on a temporary basis. This needs to be addressed carefully, because at a certain moment in time these corrections might be less effective.
8. Retail Costs.
The retail mark-up should cover all costs including customer service, marketing, sales, billing and associated overheads. We strongly believe OPTA’s proposal of 25% underestimates these costs. Compared to the retail mark-ups implied by BT’s fully allocated retail costs (taken from its published separated accounts) the mark-up should be substantially higher. We also believe the mark-up should incorporate an extra allowance, at least on a temporary basis, for the fact that new entrants are confronted with very high and enduring switching costs that are asymmetrical.
9. Application of the Price Squeeze Test.
obliged to offer services on a cost-oriented basis. We also agree with OPTA that KPN should not be permitted to offer retail prices below the level of the Price Squeeze Test, not even as a price follower. Further we really would like to understand better what causes the differences in results when OPTA runs the test and when we run the same test. We believe more transparency on the precise manner in which KPN routes its traffic via its network might be helpful. 10. Scope of the Test.
From the consultation document it implicitly appears that OPTA assumes the Price Squeeze Test will only be applicable for BIBA and BUBA calls. We strongly believe such a narrow scope would be unjustified and that in principle the test should apply to all services for which KPN has Significant Market Power in the upstream and/or downstream market. If this is not the case, then the Price Squeeze Test of course should not be applicable. Amongst others we believe international calls and fixed-to-mobile calls (for which currently a huge price squeeze exists), but also DSL, should fall within the Price Squeeze Test. 11. Solutions for BIBA-traffic.
First of all we would like to point out that we do not agree with OPTA that
currently there only is a price squeeze for BIBA. We believe there also is a price squeeze for Fixed-to-Mobile and for BUBA traffic, during off-peak for calls longer than 5 minutes. In respect of BIBA we believe a structural remedy is needed, since competition in Holland for BIBA is strongly restricted due to the price squeeze. Excluding BIBA traffic to neighbouring areas as an option we strongly reject, since this would mean OPTA and others would accept there is no
competition possible for this kind of traffic. A real structural solution might only be possible if BIBA is divided into local and regional traffic. This however is a
solution that might need some time to get installed. Therefore we believe we also need an interim solution on a very short term. At first sight we feel that OPTA’s suggestion to allow KPN only to charge C(P)S providers any more than local terminating for the execution of BIBA traffic that KPN itself would rout at a low level in its network could very well serve as such an interim remedy. A more detailed reaction to this specific part of the consultation document will be
separate send to OPTA in the context of the complaint on local calls via CPS that WorldCom and other filed at OPTA and the NCA.
12. The Way Forward
At the Hearing on 8 November OPTA expressed its ambition is to install the Price Squeeze Test at the end of this year. WorldCom fully agrees with OPTA that in the light of the current problems (especially with regard to BIBA and Fixed-to-Mobile) the first priority should be to have a Test installed as soon as possible. At the same time we would suggest OPTA to take a sort of two-step approach, by which we mean that after the instalment of the (first version of) test by the end of the year, OPTA should initiate a procedure for the further refinement of the test in liaison with market parties.
The specifications of the proposed Price Squeeze Test
We agree with OPTA that the Price Squeeze Test looks at:
(a) The relevant KPN end-user price that should be taken into account. (b) The relevant cost related to the purchase of interconnection (input costs). (c) The retail Surcharge (retail costs).
If (a) < (b) + (c), then there is a Price Squeeze.
A. The determination of the relevant End-user Price
In paragraph 5.2 OPTA describes the way end-user prices will be determined.
A stated before WorldCom agree with OPTA that end-user tariffs should be assessed according to destination, time period and call length. We recommend OPTA to use all call lengths op to 1 hour.
We strongly believe that not only the discounts for residential customers but also the discounts for business customers should be taken into account. Not doing so would leave KPN a loophole through which it could still engage in price squeezing, without being caught by the Price Squeeze Test.
The level at which to determine end-user prices
In the consultation document OPTA considers three main options at which KPN’s end-user tariffs could be assessed (on the basis of the cost-orientation requirement. These are:
A. The level of the service in its entirety (e.g. local, regional, national) B. The level of the various time periods (peak, off-peak and weekend)
C. The level of the various tariff components (as B plus the assessment of the other separate tariff components, such as the set-up tariff).
KPN’s end user prices vary primarily according to destination, time and length. This means that if OPTA were only to consider end-user tariffs at the service level in its entirety, KPN would still be able to engage in price squeezing by doing so selectively at a lower level. It could charge below costs for calls where it faces greater
competition and above costs for calls where it faces less competition. If OPTA were only to test for a price squeeze at the level of the service in its entirety KPN Retail might still be profitable and so price squeezing on, say, off peak calls would not be picked up.
Assessing tariffs at a more detailed level still entails considering separate call set up and conveyance costs (the third bullet above). This would involve comparing
• end-user call set up with interconnection call set up plus a retail mark up;
• end-user per minute charge with interconnection per minute charge plus a retail mark-up.
We do not believe that it is necessary to consider tariffs at this level because conducting the test at level B (by time period and destination) and for a variety of different call lengths will be sufficient, especially if a comprehensive range of calls is used. Furthermore it is unlikely that a separate market exists for set up and
conveyance because users buy the two together and so it would not make sense to consider price squeezing on the two components separately.
The call lengths that should be used
OPTA states that it will use call lengths of 1, 4, and 30 minutes for short, average and long calls respectively. There is no evidence cited in the consultation document in support of these particular figures, nor argumentation as to why only 3 call lengths have been selected. The “average” call length is of course likely to differ according to factors such as the time period in which the call is made and the type of customer. We believe that OPTA should monitor more than 3 call lengths. If it only considers 3 it is leaving significant gaps in the distribution of call lengths which KPN could then exploit to conduct price squeezes. In our opinion OPTA should in principle test calls of all lengths up to 1 hour. Using this wider range of call lengths would improve the accuracy of OPTA’s price test considerably. It would not increase the burden on OPTA significantly however since can be quickly and easily conducted using a spreadsheet. We therefore consider that the benefits of adopting a more comprehensive test are likely to far outweigh the limited costs.
However if OPTA continues to believe that it is only necessary to look at 3 call lengths, our own figures for the Netherlands suggest that the average (business) call to a fixed national (BIBA and BUBA) destination is 2.5 minutes, to an international destination is 2.8 minutes and to national mobile is 1.7 minutes (for the period January – September 2000). In addition, our figures suggest that 20 minutes is more representative for a long call.
How to take discounts into account
KPN offers residential and business customers a range of discounts. OPTA appears to have focused solely on the former, since it only takes into account the so-called “VoorDeelNummer-regeling”, that is primarily focussed on the consumer market. This may be because OPTA only intends to test consumer tariffs, which we would strongly reject.
We believe the starting point should be that a Price Squeeze could occur in different market segments, the residential segment as well as the business segments. This is also recognised by OPTA itself in its Consultation Document (see paragraph 181).
1
We therefore believe OPTA should consider end-user tariffs and discounts for both consumers and business customers.
KPN offers business users a different set of discounts. The WorldLine discounts are presented in the Table below. As can be seen a wide range of discounts is available, from 2 to 25%.
TABLE - KPN’s Discounts for Business Users, WorldLine (%)
NLG / month
BIBA BUBA International Mobile
> 100 0 4 9 2 > 450 0 5 12 2 > 1250 0 7 15 2 > 2500 0 8 18 2 > 6250 0 8 20 2 > 10000 0 8 22 2 > 20000 0 9 25 2
Another business tariff offered by KPN is TotalLine. This gives a further 3% discount on top of the WorldLine discounts shown in the TABLE above. If a company pays its bills by direct debit then it is entitled to a further 0.5% (KPN’s costs will also be lower with direct debit payments). However to obtain the TotalLine discount the company must make an upfront payment. This makes it difficult to assess what the effective discount is. On the basis of KPN’s business discounts and our knowledge of the market, WorldCom’s best estimates of business users’ average discounts are set out in the TABLE below.
TABLE - Best Estimate of Average Discount for Business Users
Call Destination Average Discount (%)
BIBA 0.5
BUBA 7.5
International 15.5
National mobile 2.5
Under the current “VoorDeelNummer-regeling” KPN gives a 10% discount to end-users regardless of their call pattern on up to ten numbers. On the basis of this discount alone OPTA considers that the effective discount, when considered across all calls made, is likely to be around 5%. It therefore proposes to use 5% as the effective discount on KPN end tariffs in its price squeeze test. We do not have specific data for the Dutch consumer market to support or contradict OPTA’s choice of 5% as the effective discount here. But we note that this assessment of the
B. Determination of the relevant Purchase Price (The Input
costs)
In paragraph 5.3 OPTA asks whether the network costs used in the test should be KPN’s or those of an efficient new entrant.
In principle we believe the input costs should be based on the assumption of an efficient new entrant, but at the same time we agree with OPTA that at this stage it might be too difficult to define an imaginary efficient operator.
If OPTA sticks to its KPN on-net approach we strongly believe that certain
corrections (that are based on the concept of an efficient new entrant) are needed.
• Charges related to ports and circuits as well as the additional costs incurred when calls terminate on others operator’s networks (including mobile networks) should be included in the input costs.
• Further we believe that a correction should be made for the fact that efficient new entrants currently can not interconnect at KPN’s local switch level. This means that instead of assuming KPN pays local interconnection, it should be assumed KPN pays regional interconnect charges, as long as local interconnected is inhibited by KPN.
• Finally, a correction should be made for the fact that in reality KPN does not pay interconnection charges, but internal transfer prices (which we assume are lower than the interconnection charges others pay).
The efficient new entrant approach versus the KPN on-net approach
We believe that in principle the input costs should look at the costs of an efficient new entrant. But this raises a lot of questions that are difficult to answer. What are these input costs? Are they the costs new entrants actually pay, or are they what new entrants would pay if they had more points of interconnection (e.g. if they actually bought local call termination instead of single transit or if we directly connected to the mobile network operator instead of transiting via the PTT). Another question is whether we are talking about a hypothetical optimal new entrant or what new entrants actually are? If the former, what model should be used? At the limit, it is a new entrant who has completely replicated the PTT network (and has input costs comparable to those of the PTT themselves). But is this what competition is intended to achieve? And, if not, why have a test that relies upon it to work?
If the latter, then this would mean that each new entrant has a different price squeeze claim against the PTT depending on the Point of Interconnect configuration. And, if you use an actual new entrant input cost, would you worry that that allowed inefficient entry because no new entrant interconnects in an optimal fashion?
should they worry about that). This is another version of the switching cost issue, but this time related to input cost assumptions rather than retail cost assumptions.
Furthermore, should one include the ‘diseconomies of interconnection’ in defining the input costs? These would include interconnect links and extra switching stages which are inevitable in interconnected networks but are avoided within the PTT ‘on-net’ routing. Regulators who favour infrastructure competition assume that these
diseconomies are overcome by the gains attributable to network competition. But do you include these costs in the input costs; they are a necessary part of buying the input but they are not costs incurred by the PTT themselves? If so, why should these be included? And, if so, why do you include these but assume a hypothetically optimal entrant in all other respects?
We noticed that some of these questions are also posed by OPTA in its consultation document, and that OPTA encounters difficulty answering them. We further noticed that OPTA’s choice for the other approach, to assess input costs based on KPN on-net calls, in fact is a negative choice. In paragraph 66 of the consultation document OPTA concludes that since it is not possible to developed an objective measure for an efficient new entrant and related input costs, it has no other choice than taking the KPN on-net approach. We agree with OPTA that answering these questions is not simple, but at the same time we feel that these questions have to be addressed by OPTA in more depth, because the consequences of it have to be considered carefully. In our opinion these questions should be part of the procedure we
suggested in the summary (point 12) for the further refinement of the price squeeze test in liaison with market parties, after the instalment of a first version of the test by the end of this year.
NOTE – WorldCom does not believe the way NERA tries to discuss the tension between the KPN on net approach and the efficient new entrant approach in paragraph 2.6 of its report is adequate.
Minimum requirements for the KPN on-net approach
In the light of the above we feel that it only is legitimate for OPTA to use the KPN on-net approach for the assessment of the relevant input costs (in the first version of the test by the end of this year), if at the same time it is ensured that some corrections are made given the fact that this approach never succeeds in reflecting the relevant input costs any efficient new entrant would have. The amendments we propose below could also be viewed as a way in which one could partially and temporary solve the dilemma between the KPN on-net approach and the efficient new entrant approach. In fact it is an attempt to built a sort of bridge between the two different approaches by making corrections to the KPN on-net approach that are based on the actual situation that new entrants face with regard to their input costs.
We believe this fact should either be corrected via the determination of the relevant Purchase price or via the installation of an additional mark-up for Retail Costs. The correction should of course be (an assessment of) the difference between the situation if KPN would have to pay interconnection costs and KPN’s real (internal transfer) costs. In our opinion this correction should stay in place as long as non-discriminatory pricing between KPN and its competitors is not ensured (which is not the case right now, as is stated in OPTA’s consultation document).
Another correction that is needed is that the approach should also take into account the “real life” possibilities for interconnection with KPN’s network. By that we mean that if a certain form of interconnection is not yet offered by KPN to new entrants in a feasible manner, this needs to be corrected when “simulating” the interconnection prices KPN itself should pay for the routing of traffic via its network. In the current Dutch market situation this means that it should not be assumed that KPN pays local interconnection charges. The reason for this is that there still is no decent KPN offer for local interconnection (KPN officially always states they offer local interconnection, but this offer only exists on paper, because if requested KPN always replies that it is not possible yet). We therefore believe that instead of using local interconnection charges for KPN on-net traffic, OPTA should use regional interconnection charges for traffic that is routed via KPN’s local switches. We believe this correction can only be lifted if KPN’s “paper” offer for local interconnection becomes reality.
Furthermore we believe that all of KPN’s network costs should be included in the purchase price. At present OPTA does not appear to take into account all the
relevant costs and as a result the purchase price underestimates the true costs KPN incurs. The following costs should therefore also be included:
• The additional interconnection charges for calls that terminate on other operators’ networks (including the termination charges that KPN will incur for fixed to mobile calls);
C. Determination of the Margin between the Purchase Price
and the Retail Price (The Retail Costs)
In Paragraph 5.4 of the Consultation Document OPTA argues - based on undisclosed information from KPN - that the retail mark-up should be 25%. WorldCom’s opinion is that a mark-up of 25% is not realistic:
• The mark-up is very low compared to mark-ups implied by BT’s retail costs. We therefore propose to use BT’s mark-ups as a reference;
• We question the economic efficiency of one mark-up for all relevant services. Economically it would make sense to have differential mark-up for the different services;
• We believe the mark-up should incorporate an extra allowance for the fact that new entrants are confronted with very high and enduring switching costs that are asymmetrical.
The suggested 25% is too low
If LRIC figures were available at the retail level then this would provide a floor for the mark-up. However this in itself would not be sufficient. KPN has scope to recover its common fixed costs from a number of different services (and this would remain the case for KPN Retail if there were separated accounts). Whilst it may be efficient for an operator to vary the proportion of common costs that are recovered on different services in line with price elasticity’s of demand, this must take place at the level of relevant market elasticity’s and not own-price elasticity’s. Otherwise the risk is that KPN will choose to recover its common costs almost entirely on areas where it faces little or no competition and avoid recovering costs where it does face competition. For this reason the mark-up allowed should be above LRIC for retail activities, closer to the mark-up of fully allocated retail costs over interconnection charges.
Clearly the ideal would be to measure KPN’s retail costs separately and on a regular basis to feed into the price squeeze test. Assuming this is not a feasible solution we have considered what alternative figures are more readily available.
TABLE - BT's retail mark ups (%) Call destination 1998 1999 2000 Local 46 39 35 National 64 45 42 International 48 44 41 Mobile 18 15 13
Directory Enquiry 8 8 N/A
Payphones 39 41 48 Average 42 35 36* Private Circuits 25 23 24 Other 52 50 40 Average (including private circuits and other)* 41 36 35*
Differential mark-ups for different services
The mark-up for BT also varies from service to service. This seems to be a more realistic outcome than setting one fixed mark-up over incremental cost for different markets. It also fits economic rationale. It is efficient for an operator to vary the proportion of common costs which are recovered in line with market elasticities and these are likely to vary from market to market. For this reason, setting one single mark-up across different services (markets) could be distortionary. There are no economic arguments to justify a single mark-up across different markets.
Consumer switching costs
A particular feature of the fixed telecommunications market is that there appear to be high costs involved in changing from one supplier to another (“switching costs”). This is because the vast majority of users have established a long relationship with the incumbent operator but are relatively unaware of not only the existence of the other potential suppliers, but also their quality of service, in particular their reliability.
Application of the Price Squeeze Test
In paragraph 5.5.of the consultation document OPTA states in which circumstances the Price Squeeze Test is applicable.
WorldCom agrees with OPTA that:
• The Price Squeeze Test is only applicable on KPN, since KPN is the only market party with Significant Market Power, and that
• KPN should not be permitted to offer retail prices below the level of the Price Squeeze Test, not even as a price follower.
We however would like to understand better what causes the differences in results when OPTA runs the Price Squeeze Test and when we run the same test. This is discussed below.
How to explain the differences between OPTA and WorldCom when running the Price Squeeze Test?
OPTA’s conclusion in the consultation document is that when the Price Squeeze Test is applied to the current tariffs for KPN’s BIBA and BUBA traffic, the result is that there is no price squeeze for BUBA (the BUBA-tariffs pass the test for all periods of the day and week) and that there is a price squeeze with regard to BIBA for longer calls and calls made during the evening hours and in the weekend.
WorldCom has also run the Price Squeeze Test based on the formula outlined in OPTA’s consultation document and based on the actual interconnection and retail tariffs of KPN. Our results differ quite substantially from the results OPTA reports in the consultation document:
• In our Test we found that there also is a price squeeze for BUBA calls that are longer than 5 minutes during off-peak
• Further we found that for BIBA there is a Price Squeeze for calls (longer than 1 minute) during peak and for calls longer than 4 minutes during off-peak.
ATTACHMENT I contains graphical presentations of these results, and
ATTACHMENT II contains the excel-file we used for this test. The test was based on the formula’s that were included in OPTA’s document and we used the current prices for retail and interconnection. ATTACHMENT III contains another excel-file. In this file we also use OPTA’s formula but we included some of the corrections we suggested in the above.
We feel these differences should be clarified and we would appreciate it if OPTA would give us some feedback on the way WorldCom applied the test.
We further believe that information with regard to the actual routing of calls via KPN’s network (including the proportion local, regional, national) should be disclosed. Public knowledge of this information is unlikely to yield KPN’s competitors any significant commercial advantage but would significantly improve the transparency of the test
Scope of Price Squeeze Test
From the consultation document it implicitly appears that OPTA assumes the Price Squeeze Test will only be applicable for BIBA and BUBA calls. We strongly believe such a narrow scope would be unjustified and that in principle the test should apply to all services for which KPN has Significant Market Power. Amongst other
international calls and fixed-to-mobile calls (for which currently a huge price squeeze exists) should also be included. From the consultation document it appears that OPTA only focuses its Price Squeeze Test on BIBA and BUBA calls, excluding other services.
WorldCom believes the Price Squeeze test should in principle be applicable to at least the following KPN services.
• BIBA
• BUBA
• International calls (at the level of individual destinations)
• Fixed-to-Mobile (mobile termination charges should be included in the Purchase Price element of the Test)
• Internet Dial Up (in case of an Origination wholesale service an amended model is needed)
• DSL-services
• Leased Lines
ATTACHMENT I
WORLDCOM RESULTS WHEN RUNNING OPTA’S PRICE SQUEEZE TEST FOR BIBA, BUBA AND FIXED-TO-MOBILE
Fixed-to-(KPN)Mobile Peak
Fixed-to-(KPN)Mobile Off Peak
BIBA Peak
BIBA Off Peak
