Part XIB Case Study: Broadband Price Squeeze Investigation

1. 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

2. 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

3. 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

4. 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’

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. Wholesale price reductions followed ‘1st 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

13. 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

14. Further wholesale price reductions‘2nd 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

15. 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 2004 - maximum penalties: $10m for each contravention, $1m for each day conduct continues

16. Telstra revised wholesale broadband pricing structure‘3rd 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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.

23. 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

24. Broadband growth in 2004-2005 • Australia’s broadband penetration increased by approximately 100% during 2004-2005 • 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

25. ACCC Communications Compliance • Any questions? • Our website: www.accc.gov.au • See ‘Telecommunications’, ‘NewsCentre’, ‘Publications’ • Information paper on website - “Assessing vertical price squeezes for ADSL services”