5. Policy Framework and Document Structure
46. This section outlines the problems that operational separation can address, the legislative objectives for Telecom's operational separation, and the document structure.
5.1 Operational Separation as a Regulatory Remedy
47. The telecommunications services industry is characterised by vertically integrated incumbents, who supply wholesale services to those that they compete with in downstream markets.
48. A vertically integrated telecommunications service provider (such as Telecom NZ) with significant market power in an upstream market may have the ability and incentives:
- To supply regulated services to access seekers on discriminatory price and non-price terms and conditions; and
- To strategically delay or limit investment in access services and related infrastructure.
49. These incentives may lead to behaviour that limits competition in the provision or the availability of services, including new and improved services.
50. The primary objective of vertical separation of an integrated telecommunications provider is to remove or limit the incentives and ability of such a provider to engage in vertical leveraging and discriminatory conduct. This is conduct whereby the provider, by virtue of its control over a "bottleneck" upstream input/asset, is able to lessen, damage or exclude competition in downstream markets. For example, types of discriminatory behaviour that a vertically integrated telecommunications provider might engage in include:
- Price discrimination – where the access provider charges a higher price (which is usually above costs) to its downstream competitors than is implicitly charged to its own retail affiliate.
- Discriminatory use or withholding of information – where the access provider provides its retail arm with information it does not provide to access seekers or refuses to supply other information which is necessary to take up the wholesale offer and/or to supply the retail service. For example, the fixed network operator refuses to provide its retail competitors with information about future changes to the network topology. This leads to increased costs for competitors and in the worst case, the competitor may not be able to provide the retail service.
- Delaying tactics, sometimes referred to as a provisioning squeeze – where the access provider supplies a certain input to a downstream competitor at a later point in time compared to its own retail arm. Delaying tactics may come in various forms, such as lengthy negotiations or pretended technical problems. This has the effect of giving the access provider a first mover advantage, which would not have been achieved if the required wholesale product had been provided to all retail service providers at the same point in time.
- Quality discrimination – where the access provider supplies products and services at a lesser quality to downstream competitors than it supplies them to its own retail arm. For example, the access provider may give priority to its own traffic at network bottlenecks or, in case of network breakdowns, may give priority to its own customers when fixing the problem. A competitor will face increased costs in trying to offset the quality disadvantage. Or where the quality disadvantage cannot be offset, end-users may reduce their demand for a competitor's products.
- Strategic design of product characteristics – Strategic design can embrace all types of product characteristics like design, compatibility, norms and standards etc. The access provider may, for example, use standards which are easy to meet for their own retail arm but not for alternative operators. The alternative operators are thus forced to make additional investments to ensure compatibility or make access/interconnection technically possible.
- Undue use of information – This may arise where an access provider obtains certain information about the customers of its downstream competitors. Based on this information, the access provider can target it competitors' customers with tailor-made offers and so can restrict its competitors sales and or raise its rivals costs.
51. In respect of telecommunications, the relevant bottleneck upstream input(s)/asset(s) are generally identified as elements of the network (most often the access network). The relevant downstream markets are generally identified as the retail markets for telecommunications services that rely in whole or part on access to these bottleneck network elements.
52. The basic concept of vertical separation in telecommunications (be it, operational or ownership separation) is to "separate" the bottleneck upstream network inputs/assets so that control of access to them cannot be used to lessen, damage or exclude competition in retail telecommunications markets.
53. Vertical separation can be an effective regulatory tool for:
- Promoting equivalent and non-discriminatory treatment, by the separated "bottleneck" network business, of third-party access seekers and the provider's own business operations.
- Improving the confidence of access seekers and end-users that they are being treated fairly by enhancing the transparency of a provider's operations.
- Assisting in facilitating efficient investment in access services and infrastructure, both by the incumbent and access seekers.
54. This can then lead on to improved competition in telecommunications markets and improved services to end-users of telecommunications services in New Zealand. A high performing telecommunications services sector is considered critical to increasing New Zealand's international competitiveness and achieving economy-wide economic transformation objectives.
55. These potential positive effects do, however, need to be considered in light of potential disadvantages associated with vertical separation, such as loss in vertical integration scale and scope economies, and an increase in the transaction costs of dealing between internal business units.
5.2 Legislative Objectives for Operational Separation
56. Section 69A of the Telecommunications Act 2001 sets out that the purposes of Part 2A are:
- To promote competition in telecommunications markets for the long-term benefit of end-users of telecommunications services in New Zealand; and
- To require transparency, non-discrimination, and equivalence of supply in relation to certain telecommunications services; and
- To facilitate efficient investment in telecommunications infrastructure and services.
Discussion Question
Section 69F (2)(a) provides that the Minister's Determination may include the objectives and outcomes that the separation undertakings are required to give effect to.
1. Do you see any value in the Minister specifying additional objectives and outcomes in his Determination of further requirements for Telecom's separation undertakings?
5.3 Development of the Separation Requirements
57. The development of the separation model in this document has been guided by considering whether they effectively deliver the purpose of Part 2A.
58. Additionally, the following more specific factors are important to delivering on the legislative purpose and were considered in developing the separation model:
- Removal of Incentives to Discriminate: the operational separation model needs to be effective in removing Telecom's incentives and ability to discriminate against its downstream competitors. This will be critical to effectively delivering achieving the second legislative objective of non-discrimination and equivalence of supply in relation to certain telecommunications services. Telecom's incentives will be linked to the exact content of the undertakings and to the counterfactuals and penalties should they not deliver on the Undertakings or if the Undertakings finally agreed do not deliver on the overarching policy objectives set by Cabinet.
- Cost of Implementation: the costs of implementing the model need to be reasonable and proportionate to the expected benefits of operational separation. If costs were not reasonable and proportionate, then that could compromise achievement of the third legislative objective of facilitating efficient investment. Appropriate due diligence will be required to verify any costs expected by the incumbent.
- Timeframe for Implementation: given the dynamic nature of the industry, it is important that the model is able to be implemented with a reasonable period and without disrupting other important time-sensitive initiatives (such as local loop unbundling). This is important to meet the third legislative objective of facilitating efficient investment.
- Degree of Complexity: the model needs to be understandable and needs to support efficient internal and external transactions and operations. This factor is also relevant to achieving the third legislative objective of facilitating efficient investment.
- Monitoring and compliance: the model should be simple, transparent and facilitate effective monitoring and compliance. Appropriate and robust monitoring and compliance is required to ensure that the second legislative objective is met.
- Flexibility to Address Technical and Commercial Change: the model needs to incorporate appropriate mechanisms to ensure that it can accommodate, or adapt to, technological and commercial changes (such as transition to Next Generation Networks). It is also important that the model allows Telecom the flexibility to manage, operate and organise other parts of its business as it sees fit, provided that this does not compromise or have the potential to undermine the operational separation requirements. This flexibility is crucial for meeting the third legislative objective of facilitating efficient investment.
- Regulatory coherence: the model needs to be consistent with, and complementary to, the rest of the telecommunications regulatory regime as it is only one key component of the package introduced by the Telecommunications Amendment Bill in December 2006. In particular, implementation will need to have regard to the broader government policy objectives.
59. Finally, it is important to acknowledge the useful precedent of the British Telecom operational separation undertakings (the "BT Undertakings"), which have greatly informed the development of the proposed model for Telecom's operational separation.
5.4 Document Structure
60. The following referenced heading sections of the document discuss the key features of the proposed model of operational separation for Telecom and seek comment, as follows:
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