Part XIB Case Study: Broadband Price Squeeze Investigation Australian Communications and Media Authority & International Telecommunication Union International Training Program 2006 By Mark Rakers Communications Group Compliance Section ACCC

Overview  Investigation in relation to Telstra’s wholesale and retail pricing of broadband services (‘vertical price squeeze’)  Part A Competition Notice issued to Telstra over broadband internet pricing  Series of wholesale price reductions occurred  Negotiated outcome, $6.5m rebate  Notification Protocol (safeguard mechanism)  Significant growth in broadband take-up

ADSL Broadband market in Australia  Telstra dominant supplier of ADSL wholesale services – control of copper access network  Vertical integration - Telstra also provides retail ADSL services via BigPond (Telstra’s internet arm)  In 2004, approximately 300 competitors in Australia offering dial-up and broadband services

Telstra’s retail price reductions  In February 2004, Telstra announced a new pricing structure for its broadband retail services  ‘BigPond Broadband at dial-up prices’ ADSL Plan SpeedNew Monthly PriceReduction 256kbps$ % 512kbps$ % 1500kbps$119.95>50%

Introduction of Download Caps  New BigPond retail plans offered download caps  Usage previously charged at 19.9 cents per MB  New plans - excess usage charged at 15 cents per MB once cap exceeded ADSL Plan SpeedDownload Cap 256kbps200MB 512kbps500MB 1500kbps‘Unlimited’ (rate-shaping after > 10GB)

Telstra’s wholesale prices  ACCC received a large number of complaints from Telstra’s wholesale customers following the announcement of the new retail prices  Telstra’s wholesale customers (and retail competitors) claimed a vertical price squeeze existed, as the new retail prices were below Telstra’s wholesale rates for the same services Telstra retail prices < Telstra wholesale access charges

Vertical Price Squeeze  Vertical price squeeze – anti-competitive ‘low’ pricing: Vertically-integrated firm Market power for supply of key input in ‘upstream market’ (wholesale broadband access market) Reduced margins for competitors who must purchase key input (insufficient to cover downstream costs) Affects competitors ability to compete in ‘downstream market’ (retail broadband market)  Vertical price squeeze can be identified by the use of imputation testing

Imputation Testing  Imputation test involves a comparison of: retail prices charged by the vertically- integrated firm for the downstream service wholesale price charged by the vertically- integrated firm for the upstream service + additional costs incurred in transforming the wholesale service into the retail service  Price squeeze if: Retail price < wholesale price + additional costs

ACCC competition concerns  ACCC concerned that Telstra’s retail price reductions not matched by a similar reduction in its wholesale price for similar services  Without reduction in Telstra’s wholesale rates, impossible to match Telstra’s new retail prices on a sustained basis  Key competition concerns at the important entry level area of broadband market  Possible foreclosure of retail broadband market at a vital stage of broadband growth

ACCC Consumer Protection Role  The primary focus of the investigation involved competition concerns  From a consumer perspective, ACCC was concerned about impact of megabyte usage limits on new broadband plans  For entry level plans, usage limits can be reached very quickly, especially by consumers new to broadband services  ACCC publicised concerns that consumers should be aware of excess usage costs

Advisory Notice  Prior to the retail prices taking effect, ACCC issued an Advisory Notice to Telstra  Advisory Notice essentially a strong warning  “Change conduct to avoid a breach of the competition rule”  Telstra was advised to reduce its wholesale prices to a level below its retail prices

Wholesale price reductions followed ‘1 st round of reductions’  In response to Advisory Notice, Telstra announced reductions for some wholesale broadband services  ACCC assessed full impact of wholesale price changes (imputation testing)  ACCC continued to investigate the matter to determine any anti-competitive conduct

Consultation Notice  ACCC then issued a Consultation Notice  ‘Reason to believe’ that Telstra has engaged in anti-competitive conduct  Consultation Notice informs Telstra that the ACCC proposes to issue a Competition Notice  Opportunity for Telstra to respond  ACCC must consider Telstra submissions before determining whether or not to issue a Competition Notice

Further wholesale price reductions ‘2 nd round of reductions’  In response to the Consultation Notice, Telstra announced further reductions for some wholesale customers  Reductions occurred for wholesale rates at the entry level area of the market  Other reductions on wholesale charges (eg. installation charges) separate to monthly wholesale rates

Part A Competition Notice  ACCC issued Part A Competition Notice to Telstra  ACCC still concerned as to ability of Telstra’s retail competitors to compete in medium-long term  ACCC considers Telstra has engaged, and is engaging, in at least one instance of anti- competitive conduct  Competition Notice:  allows retail competitors to seek damages for specified anti-competitive conduct while notice is in force  In maximum penalties: $10m for each contravention, $1m for each day conduct continues

Telstra revised wholesale broadband pricing structure ‘3 rd round of reductions ’  In response to the Competition Notice, Telstra revised its wholesale broadband pricing structure  2 wholesale pricing packages offered on a mutually exclusive basis Protected Rates package:  Wholesale charges set at rates 40% discount off retail prices across all plans (including entry level plans)  Designed to address concerns about available margin between retail and wholesale prices Growth Option package:  Wholesale charges with further price reductions on high-speed plans  Designed to allow retail competitors to differentiate their retail offerings from Telstra’s plans

Competition concerns still existed  Protected Rates option discouraged competitors from selling high-speed plans (limited to entry level area of the market)  Growth option discouraged competition for entry level plans (competitors still faced high wholesale rates for entry level)  Mutually exclusive basis forced Telstra’s retail competitors to choose between being a provider to entry level customers or to high- speed customers  Telstra still free to compete for both areas

Competition Notice remained in force  ACCC decided to keep the notice in force, still having reason to believe that Telstra was engaging in anti-competitive conduct of a kind described in the Competition Notice  Wholesale pricing still likely to substantially hinder the ability of Telstra’s wholesale customers to compete at the retail level

Preparation to commence proceedings for breach of the competition rule  Higher threshold - level of evidence required to determine whether the ACCC should take further action is greater than that required to decide to issue or to revoke a Competition Notice  ACCC consulted retail competitors (complainants) in relation to evidence and preparation of witness statements  ACCC also had the benefit of information gathering (s. 155) powers to require documents and information from Telstra

Legal advice sought  ACCC gathered witness statements from industry  Legal advice sought as to strength of case  ACCC made the decision to accept the series of measures offered by Telstra to resolve the matter after obtaining senior legal advice and taking account of evidence received from a number of Telstra’s wholesale customers

Negotiated Outcome  The ACCC reached agreement with Telstra resolving matters raised in Competition Notice  Telstra made further reductions to its wholesale pricing  ACCC considered that efficient wholesale customers no longer hindered from competing with Telstra’s retail plans  Telstra agreed to rebate $6.5m to its affected wholesale customers

Acknowledgement by Telstra  Telstra acknowledged that its pricing changes made in February 2004 for its retail broadband services may have adversely affected the competitive position of its wholesale broadband customers.

Notification Protocol  Important part of resolution was the introduction of a safeguard mechanism to prevent the recurrence of similar conduct in the future  Formal arrangement entered into which obliges Telstra to advise the ACCC up to 15 working days in advance of future retail broadband prices and specials  Allows the ACCC to assess the likely effect on competition of price changes and specials  After preliminary assessment, any concerns may be raised with Telstra prior to price changes taking effect

Broadband growth in  Australia’s broadband penetration increased by approximately 100% during  ADSL services continued to achieve the highest growth rates  Broadband growth was shared between Telstra and its retail competitors  Level of broadband take-up has made it increasingly more viable for access seekers to roll out their own DSL infrastructure

ACCC Communications Compliance  Any questions?  Our website:  See ‘Telecommunications’, ‘NewsCentre’, ‘Publications’  Information paper on website - “Assessing vertical price squeezes for ADSL services”