Unbundling fibre: Be careful what you wish for

Vocus and Vodafone want cheaper fibre unbundling. If we take their words at face value, they want fibre wholesalers to sell at a loss.

That would be a disaster.

It would kill the fibre companies. They would go broke.

Unbundling on terms that would keep Vocus and Vodafone happy would unravel the telecommunications industry restructure that took place a decade ago. It would also mess with the intent of the recent Telecommunications Amendment Act.

In the process, unbundling fibre in the way Vocus and Vodafone want would wipe out the small service providers. That may well be one of their goals. It threatens to undermine the entire broadband sector.

Unbundling means more expensive broadband

If all that sounds remote to readers who don’t work or invest in telecommunications, try this: if Vocus and Vodafone get their way, unbundling means most customers will pay more for broadband.

You could pay a lot more. We’ll come back to this later.

What looks like a simple squabble over price is the tip of a complex iceberg.

In June Vocus and Vodafone issued a press release (published in full at the bottom of this page) saying: “Chorus is torpedoing broadband innovation with predatory pricing”.

Predatory?

There is a curious thing about that sentence¹. Vocus and Vodafone single out Chorus as the problem. No other fibre company is named.

Yet Chorus is only one of four New Zealand four fibre wholesale companies. Chorus’ unbundled fibre offer is the cheapest of the four. It is the most generous of the four. Some of the others want even more money.

To single out the cheapest, most amenable unbundled wholesaler, for special criticism is odd.

Presumably, it is because Chorus has the highest profile. Everyone has heard of Chorus. This tells us Vocus and Vodafone’s move is more about politics than informing the public or making a case. It is only there to mess with your head.

This is political. It always was. Unbundling was a political bolt-on to the fibre project. By law, All four fibre companies have to offer unbundled fibre from January 2020.

Legal

The law doesn’t say anything about the price or the unbundling process. These are not regulated at this stage.

Ideally, the politicians, regulators and government officials would prefer the industry to sort out fibre unbundling terms through commercial negotiations. If that doesn’t work, then the regulator steps in.

Going by the language in the press release, we’re already at that point or close to it.

Unbundling background

Unbundling fibre sounds simple. It isn’t.

First, there’s the question of the integrity of the fibre network. Fibre companies worry that letting outsiders cut their glass strands could be chaotic.

As things stand that’s not going to happen. Yet it was an early bone of contention.

A harder problem is pricing unbundled fibre so networks cover their costs and earn a fair return. It looks as if this can’t be done in a way that would satisfy Vocus and Vodafone.

Layers

Today, New Zealand’s fibre companies offer what is known as bitstream or layer 2 services. You don’t need to worry about all the layers. Unbundled fibre is layer 1.

Layer 1 is an active fibre link between two points. Layer 2 is where there are electronics at both ends to handle the traffic.

Regulations mean wholesale fibre companies cannot sell directly to end-users. They sell to retail service providers or RSPs like Vocus, Vodafone and Spark. At the moment wholesalers only sell layer 2 services.

Unbundling regulations

The price of a basic wholesale fibre service is fixed and regulated at $42 a month.

The regulated price of fibre is based on an estimate of the cost to the wholesaler of providing the service.

That cost includes the investment a fibre company made building the network and then providing continuing services. The biggest cost component is civil engineering.

There’s a formula that looks at what the regulator describes as allowable input costs’.

This is quite different from the way regulated costs were determined for the copper network. That was based on benchmarking against costs for similar networks overseas.

The new method gives fibre companies more certainty and makes it easier for them to judge the worth of further network investments. If we didn’t use this method or something like it, then there would have been few takers to build the networks.

Not much price difference

Fibre wholesalers can and do offer faster speeds at unregulated prices. As you’d imagine, these unregulated prices are higher. A gigabit line costs around $60.

There is not much cost difference between providing a basic fibre broadband plan and delivering the fastest speeds available.

Almost all of the cost of providing a fibre connection is in the engineering, digging trenches and running cables from poles. A fibre company needs to dig the same trenches and roll out the same cable regardless of the line speed or who owns the hardware at each end.

The only significant input cost difference between a bundled and unbundled line is the equipment at each end of the fibre.

Unbundled service providers buy their own hardware. Fibre wholesalers wrap the cost of this hardware into their layer 2 prices. A little extra money may be needed to cover the costs of dealing with more data passing through the network, but that’s near negligible.

At most, the total extra input cost of providing a fast connection is a couple of dollars. Likewise, the only saving the wholesaler makes with an unbundled line is not buying this equipment. In other words, for a wholesaler, the cost difference between delivering layer 1 and layer 2 is marginal.

Cost-based pricing

At most, the practical cost to a wholesaler of providing an unbundled fibre line is a dollar or two less than the cost of providing a bundled line. This explains why the fibre companies have come up with the unbundled prices you see today.

Vocus and Vodafone don’t like these prices, but they have been arrived at using the same logic as the regulated layer 2 prices.

To argue against these unbundled prices is to argue against the regulated model established by the government. If Vocus and Vodafone have an argument, it is with the Commerce Commission, Crown Infrastructure Holdings and maybe the government itself.

That’s where any anger should be directed. Given the success of the UFB project, they are unlikely to get anywhere attacking the government organisations, but they need a target for publicity purposes.

If the big service providers unpick the unbundled fibre price, they unpick the entire regulatory structure. This means upsetting a regime that works.

It also swipes the financial legs from under the fibre companies.

Margins

Wholesale fibre companies make better margins from selling faster, connections where the prices are not regulated. Overall fibre company margins are good enough to keep investors interested.

As we’ve seen, wholesaler input costs are much the same whatever a customer’s connection speed. But the value delivered to a customer rises as the speed rises. Hence people willingly pay more for faster broadband.

In New Zealand, the price difference between a basic fibre service and the fastest service is less than in most overseas markets.

That’s important because you could argue customers who buy faster broadband plans, 100 Mbps or 1Gbps services, subsidise people on basic plans.

Using today’s technology fibre lines can typically work at up to 10Gbps. The cost of 10Gbps circuit hardware is not 300 times the cost of 30mbps hardware but it will run at 300 times the speed.

10Gbps unbundling demonstration

At a press function, Vocus and Vodafone used a 10Gbps connection to demonstrate the potential of unbundling.

When they buy an unbundled line, they are, in effect, already buying a 10Gbps connection for less than the regulated cost of a 30mbps connection. They know the cost of providing 10Gbps is only fractionally higher than a 30mbps connection.

This is a form of arbitrage, they can buy something cheap, spend next to nothing turning it into something expensive.

Unbundling connections, then bumping the speed to 10Gbps, makes it hard for fibre companies to operate a price structure where the low margin lines that make up the bulk of their business are offset by a small number of more lucrative options.

Making that unbundled connection price cheaper still would undermine layer 2 services. It would remove all the cream from fibre company revenues.

Basic fibre service margins are thin.

If enough customers buy connections from unbundled service providers, fibre company revenue will fall.

Regulatory goals

Let’s go back and look at the points made at the top of the story.

Should it intervene, the Commerce Commission is unlikely to set the regulated price of an unbundled connection at a level where fibre companies lose money.

If they did, they’d have to raise the price of regulated layer 2 services to a level where the fibre companies still make enough money to keep everything ticking over. That means higher broadband prices for everyone.

Media release

21 June 2019

Vocus, Vodafone welcome Commerce Commission scrutiny on unbundled broadband pricing

Telecommunications operators Vocus Group and Vodafone have made clear their belief that Chorus is torpedoing broadband innovation with predatory pricing, and labelled a proposed Chorus price drop of 15c a month ‘pathetic’.

The companies have welcomed action from the Commerce Commission announced last week which will clarify legal interpretations of Chorus’ obligations to provide commercially viable unbundled access to the Ultra-Fast Broadband network.

Vocus and Vodafone demonstrated an unbundled UFB connection in February and then sought commercial pricing from Chorus in preparation for a launch in 2020.

After multiple delays, and despite a deadline of December 2018, Chorus announced wholesale pricing for unbundled connections in April of this year. Vocus and Vodafone protested the pricing as ‘cynical and protectionist’, noting that it exceeded that of bundled connections.

The companies approached the Commerce Commission with their views, backed by an independent assessment by Network Strategies which demonstrated the cost to third parties should have been less than 50 percent of that proposed by Chorus.

Yesterday Chorus released a new proposed pricing model that was just 15cents a month lower than its original pricing.

This month, the Commerce Commission noted[1] that it has the authority to assess whether offers (pricing) made by Chorus and the LFCs comply with their respective obligations under the Telecommunications Act of 2001. It has advised Vocus and Vodafone that ‘If we consider that a breach of the Fibre Deeds is likely to occur or has occurred, we will decide whether to bring enforcement action’.

“This is a step in the right direction, and we welcome the attention that the Commerce Commission is giving to the issue,” says Vocus Group Chief Executive Mark Callander.

“We have to remember that Chorus benefited from a billion-dollar interest free loan from the government. That means every New Zealander should get the best possible benefit from the UFB network, and unbundling is the key to unlocking innovation that drives those benefits.

“Today Chorus proposed a new price that was merely 15 cents a month lower. That’s outrageous, pathetic and quite frankly insulting.”

‘Unbundling’ allows third parties like Vocus and Vodafone to use their own equipment at the end of a Chorus or LFC owned fibre line. Innovation including the creation of new and faster services is possible, rather than a ‘one size fits all’ approach to market.

“The problem right now is simple. Pricing makes or breaks the business case for unbundled access,” says Vodafone Chief Executive Jason Paris. “The proposed numbers make unbundling impossible. And that restricts innovation, denying New Zealanders their right to the best value from the investment of their tax dollars in the UFB network.”

The Commerce Commission has committed to look into the matter in the coming months.

Callander has welcomed the Commission’s work, but notes that the Vocus and Vodafone have made clear their intention of introducing an unbundled service by January 2020, and that a suitable price needs to be determined quickly. “Right now, the country’s investment in UFB is stranded in the hands of the Chorus monopoly.

We’re confident that the Commerce Commission will find that Chorus is expected to act in the best interests of customers – and pricing is something we’re all sensitive to.”

1. Make that two curious things. How can you innovate with broadband? Almost all your ‘innovation’ options involve impeding the speed. ↩︎