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129. One of the purposes of the operational separation of Telecom (under s69A, Part 2A of the Act) is to require transparency, non-discrimination and equivalence of supply in relation to certain telecommunications services.

130. The regulated access regime (Part 2 of the Act) requires Telecom to supply certain wholesale services in order to promote competition for the long term benefit of end-users. However, Telecom currently has both the incentives and ability to supply wholesale services to its competitors on a less than equivalent basis than supplies to its own retail arm. Such discriminatory behaviour can have the effect of raising other service providers' costs and degrading other service providers' products relative to Telecom's own retail offerings. Such behaviour can frustrate competition to the detriment of end-users of telecommunications services.

131. Since the introduction of the Telecommunications Act, the telecommunications access regime in New Zealand has always had a non-discrimination obligation on access providers i.e. the standard access principles in subpart 2 of Schedule 1. However, under the access regime, such discrimination is often difficult to detect as there is a large information asymmetry between the regulated firm and the regulator.

132. To detect discriminatory behaviour, the regulator must first be able to identify what services and quality levels that Telecom is supplying to itself and must then be able to judge whether Telecom has breached relevant non-discrimination obligations. Detection is complicated by the level of technical complexity and rapid change that characterises the telecommunications industry.

133. Operational separation can be an effective non-discrimination remedy as it enhances the transparency of internal transactions, thus making discrimination much easier to detect, verify and enforce. A critical part of achieving this equivalence is having clear standards by which the enforcement agency (I. the Commission) can judge whether the discrimination is occurring in the first place.

134. Section 69D(1)(f) of the Act requires Telecom's operational separation plan to ensure transparency and equivalence in relation to the supply by Telecom of relevant services. This section discusses the proposed equivalence standards for service delivery and which wholesale services the Minister should require these standards to be applied to.

7.1 Defining the Equivalence Standards for Service Delivery

135. This section discusses the proposed definitions of equivalence to be adopted at a service delivery level. Clearly defined equivalence requirements for relevant services are considered critical to delivering equivalence of access.

136. Section 69E of the Act provides the following general definition of equivalence:

"Section 69D(1)(f) requires equivalence of supply of wholesale telecommunications services and access to Telecom's network so that third party access seekers are treated in the same or an equivalent way to Telecom's own business operations, including in relation to pricing, procedures, operational support, supply of information, and other relevant matters."

137. However, section 69F(2) states that the Minister's determination may specify how equivalence is to apply to each of the relevant services. This provision allows the Minister's requirements to contain a more detailed definition that applies equivalence in a tailored fashion to the specific relevant services (provided that definition is consistent with section 69E).

138. During Phase 2 of their review of the UK telecommunications markets and regulation (the "Strategic Review"), Ofcom explored concepts of equivalence in relation to service delivery. In particular, Ofcom developed two new models of equivalence: "Equivalence of Inputs" and "Equivalence of Outcomes".

139. The "Equivalence of Inputs" (EOI) model is a key feature of the BT Undertakings. It requires that BT's wholesale customers and BT:

• Use the same product, on the same timescales and conditions (including price and service levels).
• By means of the same systems and processes, with the same degree of reliability and performance.
• Receive the same commercial information about product development, product launch dates and network coverage and capabilities etc.

140. Providing EOI to the standards required by Ofcom involves creation of new service ordering and management gateways to be used by all customers (including BT) and separating out the operations and information systems which previously held data and functionality for many unrelated services. This systems separation is potentially very costly and time consuming, especially for older fully integrated systems designed for BT's previous company structure.

141. In contrast, the "Equivalence of Outcome" (EOO) model is a lower standard of equivalence which Ofcom identifies as potentially ensuring that BT's competitors would have access to regulated wholesale products which offered similar functionality at a similar price to the product used by BT's retail activities. However, the product may be provided by different systems and processes.

142. Ofcom considered that EOI offered many advantages over EOO, including:

• Better incentives for BT to deliver efficient processes and systems.
• Easier to monitor compliance and requiring less intervention by the regulator.
• Increased transparency of process and information.

143. An important feature of EOI is that the vertically integrated service provider must "consume" the relevant EOI services. A service would not be considered to be EOI if the vertically integrated service provider did not "buy" this service itself as the input to relevant downstream products. Because the vertically integrated service provider essentially has to "consume" its own wholesale products, it is expected that the service provider is better incentivised to provide "fit for purpose" wholesale products.

144. Ofcom also identified the following disadvantages of the EOO model:

"The disadvantage of the equivalence of outcome model is that it will not necessarily overcome all of the problems of the approach used by Oftel, and therefore might not achieve equality of access. BT would still have some incentive and ability to access the network more efficiently. [……..] This model still requires regulatory intervention to decide whether differences between regulated wholesale products are acceptable, and therefore there still remain the potential for lag. There are also the same problems of lack of transparency, information asymmetry and the incentive to game the regulator"

145. Whilst the both the EOO and EOI models of equivalence have received substantive attention from commentators, the BT Undertakings only require EOI on a specified set of products. The BT Undertakings do not actually require EOO in respect of any BT products. BT has noted that whilst it earlier argued unsuccessfully for EOO coverage of some services, EOI has provided greater transparency and stronger performance incentives.

146. Similarly, it is proposed that the Minister's Determination will not adopt the EOO model either, but rather, will adopt the EOI model in respect of certain key wholesale services. For the reasons outlined by Ofcom, it is considered that the EOI standard will be more effective in delivering equivalence and will also simplify monitoring and compliance.

147. It is proposed to adopt a similar EOI definition as the BT Undertakings, subject only to any amendments that are necessary to fit with the New Zealand legislative framework. The EOI definition in the BT Undertakings is:

148. Whilst there are a number of advantages to the EOI model (identified in the preceding section), there are also a number of risks. These include:

• Costs and delays as systems are developed and customers migrated, particularly in the case of existing wholesale services.
• Potential reduction in Telecom's incentives to innovate.
• Failure to recognise that there may be legitimate technical or commercial reasons why regulated wholesale products offered to Telecom's competitors are different to those offered to Telecom's retail arm, and these differences may be genuinely desirable.

149. In practice, BT and Ofcom have also experienced some issues with the implementation of EOI. Ofcom reported in its September 2006 report on the BT Undertakings that it had concerns over the difficulty of EOI implementation of the wholesale line rental product (a legacy PSTN telephone service) which involves.

• Migrating a large number of end-user customers.
• Dealing with legacy provisioning and management systems.
• Meeting the needs of access-seekers who may not have the time or resources to adapt their interfaces for EOI.

7.2 Application of "Equivalence of Inputs" (EOI)

150. The following key considerations were taken into account in determining which wholesale services it would be most effective to require Telecom to supply on an EOI basis:

1. Regulatory coherence: In general, EOI should only be required for wholesale services (including variants and successor services where relevant), which Telecom is compelled to provide to access-seekers under the Act (i.e. Telecom services listed in Schedule 1 of the Act or subject to a registered undertaking under Schedule 3A of the Act). Mandating supply of new services to third parties should continue to be assessed in accordance with the existing processes under the Act.
2. The relative position of the wholesale service within its product value chain: There will likely be diminishing benefits from each additional application of equivalence of input within the same product value chain: For example, i.e. in the "broadband" value chain, the biggest benefit from EOI is likely to be gained from applying it to LLU and the least incremental value would be obtained from applying it to resale broadband. LLU is a "deeper" point of network wholesale access than resale broadband.
3. The nature and characteristics of the wholesale service are not a good fit with the EOI concept:
   1. Some services are incompatible with the EOI concept as they are either supplied on a once only basis to an access seeker, including by Telecom to itself, such as fixed PSTN interconnection and fixed network number portability.
   2. Some services are not a good fit with the EOI concept. For example, the application of the EOI standard to wholesale provision of retail services would require Telecom to treat third party access seekers equally in the development and launch of new and improved services. Given that the retail division drives retail service developments, such a requirement would be at odds with supporting incentives to develop innovative retail service offerings. It would also either require the wholesale division to drive the development of retail services or require the retail division to be subject to EOI for relevant services.
4. The extent to which the wholesale service is a "legacy service" or is supported by legacy Operational Support Systems (OSS): EOI requires products to be provided by means of the same systems and processes. Thus, a potentially significant implementation cost of EOI arises where legacy OSS and provisioning systems need to be re-designed to meet EOI requirements. EOI may not be cost-justified for services that have only a short lifetime.
   1. The incremental cost of applying EOI to new services is expected to be substantially lower than for existing services currently supplied on legacy platforms. For future OSS systems (and provisioning processes), EOI can be built in from the start. However, EOI requires the service provider to consume its own wholesale services. Thus, where a new EOI service is an input to a legacy service, some redesign of OSS systems may still be required.
   2. The cost of implementing EOI for existing or legacy services supported by legacy OSS systems will be lower if the implementation timeframe allows for delivery via new OSS. This would avoid some of the costs of re-designing legacy systems. EOI implementation is discussed further in section 11.

7.2.1 Summary Table

151. EOI could potentially be required for all fixed network regulated services. However, given the potentially significant implementation costs of EOI and the considerations identified in the previous section, a targeted approach is preferred. The table below summarises the preferred approach to application of EOI.

152. The priority services for EOI are considered to be LLU and unbundled bitstream services. Under section 10 "Implementation", comment is sought on the relative implementation priorities for stakeholders between LLU and bitstream services.

7.2.2 Local Loop Unbundled (LLU) Services and Unbundled Bitstream Services

153. In its paper describing the formation and structure of the future Access Division, "Operational Separation, Establishment of a separate Access Network Services Unit, February 2007", Azimuth Consulting identifies the key asset bottlenecks as:

• Local loop (last mile access).
• Local and regional backhaul up to and including the "Tier 3" node in Telecom's evolving network architecture.
• The entire physical infrastructure used to deliver access and backhaul, including poles, ducts, electronics, cabinets, towers and buildings.

154. Network Strategies¹⁶ notes that the corresponding currently regulated access services are LLU, LLU backhaul and co-location. These services are at the deepest possible point of network access and, when provided on an equivalent basis to all access seekers, may allow limited competition in some higher level regulated markets (such as partial circuits or UBS). On this basis, it is preferable for an EOI level of equivalence to apply for LLU, regional backhaul and co-location services.

155. In respect of bitstream services, Network Strategies¹⁷ notes that "in addition to helping new entrants up the investment ladder, bitstream may also be the only viable service option (in the short to medium term) for any operator other than Telecom in rural and low population density areas".

156. LLU and bitstream services are considered critical wholesale services to promoting competition and critical to delivering on the government's objective of reducing New Zealand's broadband performance gap relative to other OECD countries. Therefore, the level of equivalence (and implementation timeframe) required for these services should reflect this. An EOI standard of equivalence is proposed for LLU and bitstream services.

7.2.3 Future Regulated Fixed Network Services

157. In order that Telecom's operational separation is sufficiently "future-proof", it is considered that equivalence requirements should not be restricted to existing wholesale services. Where relevant, EOI should also apply to future regulated fixed network services. The incremental cost of applying EOI to new services is expected to be substantially lower than for existing services currently supplied on legacy platforms.

158. The definition of the "relevant services" that are covered by the undertakings would address the potential for new services to be regulated in future and become subject to an equivalence requirement. For example, if services that use the Access Network assets, such as fibre-based services, become listed in Schedule 1 of the Act or become subject to a registered undertaking under Schedule 3A of the Act, then the default position would be that the ANS Unit would be required to provide those services on an EOI basis.

7.2.4 Resale Services, including Basic Telephone Service

159. Resale services are not a good fit with the EOI concept as discussed earlier in the section. It is also considered that there will likely be little additional value of requiring EOI for resale broadband services if EOI is required for wholesale services further up the broadband value chain i.e. LLU and bitstream services. Therefore it is not proposed to require full EOI for resale services.

160. Consideration is still being given to an appropriate equivalence standard for resale services. In particular, basic telephone service is a strategically important service for the promotion of competition. Despite the emergence of substitute services (such as Voice Over IP), the mass market is likely to continue to purchase basic telephone service for some time to come.

161. An equivalence approach will be developed for re-sale that balances the implementation challenges of modifying legacy platforms and services, with the need to promote competition in the provision of critical wholesale services. This is likely to involve some prioritisation and cost-benefit trade-offs but will still require a strong level of equivalence for service delivery.

7.3 Equivalence in the Development and Lifecycle of Services

162. Achieving equivalence in relation to key wholesale services is not just a static requirement. During its Strategic Review, Ofcom differentiated between equivalence as it applies to an existing product or process and equivalence in the development and change of products and process.

163. To achieve a robust operational separation of Telecom NZ, it is considered that equivalence should be applied to service development and in-life service management as well as the service delivery stage. To achieve equivalence on relevant services, this will require:

1. Equivalence in the ability of Telecom's wholesale customers to influence the forecasting and prioritisation of new service developments, and in these customers' awareness of changes in products.
2. Equivalence in the ability of Telecom's wholesale customers to influence and or be aware of changes in services that arise through the lifecycle of services, such as provisioning, fault management and billing.

164. Delivering equivalence in the above areas will include:

1. Applying Equivalence of Inputs (EOI) to relevant wholesale services (as identified in the preceding section): the proposed EOI definition requires that wholesale customers (including relevant Telecom business units) are provided with the "same Commercial Information about such products, services, systems and processes". This should ensure that customers are aware of changes in services to the extent that it is an EOI service.
2. Restricting the ability of relevant Telecom units to access information and influence the commercial policy of the ANS or the Wholesale Unit where such mechanisms and processes are not available to third party wholesale customers. This is discussed further in Section 8 (Governance and "Arms-Length" Requirements).
3. Obligations on the way that the ANS Unit receives and evaluates new product requests.