What lies behind NZ broadband prices?

New Zealand customers will pay more for broadband services delivered by the copper network. Spark, Vodafone and Callplus all say they will raise prices. Let’s look behind the headlines.

The price rises follow last week’s draft decision by the Commerce Commission setting the wholesale price Chorus charges for using its copper-based network.

That price is now set at $38.39 a month. Until recently the monthly line charge was $44. Last year the Commerce Commission ruled the price should drop to $34.44.

This price cut, or something like it, was always going to happen. The Commerce Commission timetabled a review of copper access prices when Chorus demerged from Telecom.

Chorus copper problem

In the event the original drop caused problems for Chorus. A copper access price of $34.44 would have left Chorus shareholders with a billion dollar funding hole to fill as the network operator build’s the lion’s share of the nationwide UFB fibre network.

That, in turn, became a political problem for the government. It planned to step in and change the Telecommunications Act to accommodate Chorus shareholders but couldn’t get the legislation through Parliament.

Chorus always had the option to insist on a complete price determination. It reckoned the Commerce Commission set the price too low last year, so Chorus set the ball rolling. That process lead to last week’s draft decision.

Draft decision

Strictly speaking last week’s decision is only a draft. The Commerce Commission has asked interested parties to comment and will release a final decision early next year. That may see yet another price change, but, going by recent history, it probably won’t amount to much.

A further complication is that the Commerce Commission hasn’t made it clear if it will backdate the new wholesale charges. Chorus is now pushing for that to happen, the service providers are pushing back.

And that’s the real story here: Two sets of shareholders fighting over what is effectively a fixed pool of money[1]. If the copper access price rises Chorus shareholders do better at the cost of the people who invested in the service providers. The reverse is also true.

Customers affected

As far as Chorus and the Commerce Commission are concerned what amounts to an esoteric argument about wholesale prices shouldn’t affect consumers.

The service providers say last week’s decision took them by surprise and that they had already factored the roughly $10 price cut from $44 to $34.44 into the prices they charge consumers. So when the $10 wholesale price cut becomes a $6 price cut they face making a loss.

There’s been some debate about that. Clearly Chorus wouldn’t have pushed for the fuller price determination if it didn’t expect a price cut. Surely the service providers should have planned for that possibility?

In truth they must have done exactly that. Somewhere in Spark, Vodafone and Callplus there will be spreadsheets outlining a range of possible prices set by the Commerce Commission. Some will have been even higher than the eventual $38.39 level.

To do anything else would have been irresponsible and bad business practice.

Profit-free zone

There’s something else going on here: None of the three large service providers waxes fat on broadband profits. Margins are wafer thin and competition between the three big service providers and the long tail of smaller service providers is intense.

To put it in perspective, Spark accounts for close to half the broadband market in New Zealand. It has 500,000 connections. And yet in its most recent annual report Spark’s broadband operation showed a $12 million loss. Inside the telco, executives talk of broadband as being “a profit-free zone”.

It’s unlikely Vodafone or Callplus do better. You might wonder why telcos bother to sell broadband if they don’t make money from it [2].

That $4 a month per line might not sound like much, but it amounts to roughly 5 percent of the typical revenue a service provider earns. In an industry with single digit profit margins, it’s a big deal.

Tuanz not happy

Not everyone believes the service providers can justify passing these costs on to their customers. CommsDay reports comments by Tuanz CEO Craig Young who says he is disappointed with Spark’s price increase:

Tuanz is not convinced that the move is warranted as we were unconvinced that the full IPP reduction had been competed out of the retail price. We will watch with interest what the more agile service providers do given this is an opportunity to gain market share from the larger player.

That’s an interesting point. Does New Zealand have agile service providers able to win market share from the big players? We often assume that broadband services is a business where larger players enjoy economies of scale, perhaps that’s not right.

The recent problems met by Orcon before CallPlus acquired it indicates otherwise, but that could be a special case.

InternetNZ also says it is not happy about the wholesale copper price rise.

Labour speaks out

Labour ICT spokesperson Clare Curran also spoke out against the move, she blames the government.

John Key’s controversial assurance two years ago to Chorus chair Sue Sheldon that he would sort out the copper price issue to protect Chorus shareholders continues to hurt Kiwi households.

When the Commerce Commission accepted Chorus’ argument about the value and replacement cost of a new network the die was cast to keep the copper broadband price higher. The telcos are now raising prices to protect their own revenue margins and satisfy their shareholders.

Curran touches on an important point. Nearly all the problems here are down to government policy. On one level the New Zealand Government did a fine job designing and implementing a nationwide fibre-to-the-premises network which will soon reach about 80 percent of households. Just compare this with the mess in Australia over the NBN.

Too clever

However, New Zealand’s government was a touch too clever when it held Telecom’s feet to the flames while negotiating the terms of the UFB network deal which included separating Chorus from the phone business. There was an assumption a separated Chorus would be a conventional utility business like, say, an electric lines company, with all that implies for shareholders.

Chorus was saddled with utility type levels of debt, but without utility-like predictable revenue flows and a leadership role in a fast-changing industry. Chorus shareholders have every reason to feel the government mislead them in the first place and let them down again when Prime Minister John Key failed to deliver on his promised protection.

What’s interesting here is how telecommunications customers have short memories. Only a year or so ago people were agitated about the government tinkering with the Telecommunications Act to “help out Chorus shareholders”. The current price rises are, in part, a consequence of what didn’t happen then.

Perspective needed

Some perspective is needed on the planned price increases. Depending on how you measure these things [3], New Zealand broadband prices have fallen by around 20 percent in the last three years. A lot of this has been down to competitive pressure as the main players jockey for market share. The talked about increase is about five percent, so in effect prices have dropped, just not by as much as we thought they might drop.

More perspective comes from comparisons with Australia. Just three years ago New Zealanders were typically paying more than Australians for less in the way of broadband services. Today Australian and New Zealand ADSL prices are on a par. VDSL is harder to find in Australia than New Zealand. You could argue we have a better deal.

New Zealand’s urban copper network won’t be around forever. The fibre network will be complete in 2019. It’s already time to start thinking about a post-copper market.

If the government wanted to do something positive to help the telecommunications industry and consumers, to hose down the fuss over a ‘copper tax’ and any rage over the recently announced price rises, naming a date for closing the urban copper network would be a good start.

[1]: Fixed pool of money. New Zealand’s broadband market is effectively saturated, there’s little scope for growth. With service providers now offering unlimited data plans at a little over $100 a month, there’s not much headroom to sell bigger plans although there is scope to convert users on low-end plans to the higher-end plans.

[2]: You might wonder why telcos bother to sell broadband if they don’t make money from it. In part this has a lot to do with the way telcos sell bundles of services and need to protect their profitable lines of business.

If, say, Spark conceded broadband market share to other service providers those companies would have an open door to sell other telecommunications services to the customers. In other words, when Spark loses a broadband customer, there’s an increased chance it will lose all that customer’s business.

Also having a broadband customer is an opportunity to sell bolt-on services. Vodafone offers its broadband customers Sky TV services.

As New Zealanders move off copper and on to fibre there will be fresh opportunities for telcos to get better margins from the broadband business.

[3]: Depending on how you measure these things. Some headline prices have dropped, but service providers have re-jigged plans. In most cases people pay the same but get more data than they had with earlier plans. Getting more for the same price might not feel like a price cut, but economists would argue otherwise.