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‘Big Bang’ Telecommunications Reform

Joshua Gans and Stephen King

Date: 18th January, 2010

Melbourne Business School 200 Leicester St Carlton VIC 3053 T (03) 9349 8173 E J.Gans@unimelb.edu.au W www.mbs.edu/cite
Introduction
The Federal Government’s plan to build a National Broadband Network (NBN) is an example of a
‘big bang’ reform. The government has established a company to develop the NBN as “the single
largest nation building infrastructure project in Australia’s history.”1 The company will invest up to
$43 billion over 8 years to develop a fibre-to-the-premises (FTTP) network so that “90 percent of
all Australian homes, schools and workplaces [will connect] to broadband services with speeds up
to 100 megabits per second.” The network will be augmented with wireless and satellite
technologies so that even premises in regional and remote locations will have broadband speeds of
at least 12 megabits per second. Further, the broadband services will be “affordable.”

The big bang development of the NBN is a stark contrast to the previous 25 years of incremental
reform in Australian telecommunications. However, history matters. The government is not
building the NBN as a ‘greenfield’ project. Both fixed-line and wireless broadband networks
already exist in Australia. These networks are governed by a range of legislation and actively
compete, albeit in a highly regulated environment. The exact way that the government develops the
NBN, its short-term and long-term ownership, and the eventual success of the NBN, will depend
how the government deals with the existing telecommunications players and the regulations that it
establishes for the new network.

In this paper, we briefly analyse the current state of telecommunications in Australia and the
government’s broadband policy. We then consider the decisions that the government needs to
consider for the NBN to be a success – how to deal with existing telecommunications infrastructure;
what rules to have in place for future competition; and what co-investments may be required by
government to ensure the success of the NBN.

Background
In the 20th century, Australian telecommunications was dominated by the Federal Government and
its statutory authorities; first the Postmaster-General (PMG) from federation until 1975, then the
Australian Telecommunications Commission (Telecom) and the Overseas Telecommunications
Commission (OTC) until 1991.2 The Telecommunications Act 1991, for the first time, allowed for
limited network competition in both fixed-line and wireless phone services. Optus Communications
was selected as a second general telecommunications carrier to compete against the government-

1
See Prime Minister, Treasurer, Minister for Finance, Minister for Broadband (2009) New National Broadband Network, Joint Media Re-
lease, April 7, Canberra.
2
OTC was established in 1946 and operated along side the PMG until 1975 when the PMG was broken up into the Australian Postal Com-
mission and Telecom. See Raiche, H. (2004) “The policy context”, chapter 1 in Australian Telecommunications Regulation (3rd ed), (Alasdair
Grant, ed), UNSW Press, Sydney for a more detailed background on recent telecommunications reforms.
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owned Telstra in both fixed-line and digital wireless services. Vodafone was licensed to provide
digital wireless services in competition against both Telstra and Optus.3

General telecommunications competition was only permitted following the Telecommunications


Act 1997. This led to entry by a large number of resellers of internet, fixed-line telephone and
mobile telephone services. While these resellers have invested in particular network elements (such
as DSLAMs which are needed to provide DSL internet services), no new competitive
telecommunications carriers have emerged since 1997.4 Indeed, the main ‘reform’ in
telecommunications since 1997 was the privatization of Telstra. The government sold 30% of its
share in Telstra in November 1997 and a further 16.6% in October 1999. The final government
stake in Telstra was sold in November 2006, although a government investment vehicle, the Future
Fund, retained a significant shareholding. In late 2009, the Future Fund remained Telstra’s single
largest shareholder with 10.9% of Telstra’s equity.5

The incremental reforms since 1991 have resulted in a highly concentrated network structure.
Telstra dominates fixed-line network ownership. Wireless telecommunications is dominated by the
three chosen carriers from the 1991-1997 period, Telstra, Optus and Vodafone (now VHA).

This dominance is reflected in market shares.6 In 2007-08, Telstra’s share of fixed-line telephone
subscribers was 71.55%, while Optus had 10.53%. Remaining subscribers were divided between
resellers who resellers predominantly provided calls using Telstra’s wholesale Public Switched
Telephone Network (PSTN) services. While Telstra and Optus combined had a lower total share for
retail fixed-line broadband services (58.38% and 16.39% respectively for 2007-08), most
competitors provided DSL services that depend on Telstra’s PSTN to access end users. Put simply,
almost every Australian retail customer relies on Telstra’s PSTN as an input for their fixed-line
telephone and internet services.

The concentrated market structure has resulted in muted competition. As the ACCC (2009, p.iii)
notes:

[T]he competitive markets anticipated in 1997 do not appear to be


emerging. The major downstream services continue to exhibit high levels of
concentration, regulatory mechanisms are still heavily relied upon for
promoting and maintaining competitive outcomes and the levels of
consumer complaints about the industry reached new heights in 2007-08.

3
Formally, Telecom and OTC were merged in 1992 to form the Australian and Overseas Telecommunications Corporation (AOTC). It was
later renamed Telstra Corporation.
4
The exception was Hutchison Australia that established the first 3G wireless network in significant parts of Australia. However, Vodafone
and a Hutchison Australia, merged in 2009, to form Vodafone Hutchison Australia (VHA), returning mobile telephony to its 1990s triopoly
structure.
5
See Business Spectator (2009) Future Fund trims Telstra stake; shares now in 6-month lock up, August 22, available at:
http://www.businessspectator.com.au/bs.nsf/Article/Future-Fund-trims-Telstra-stake-pd20090820-V4AVW?OpenDocument.
6
All market share numbers are from appendix C in Australian Competition and Consumer Commission (2009) Telecommunications com-
petitive safeguards for 2007-08, Commonwealth of Australia, Canberra.
2
The core competitive impediment is the concentrated ownership of the networks.

[T]he telecommunications sector in 2007-08 demonstrates the extent to


which competition is hindered by the industry’s underlying structural
features, with very high concentration levels being observed and high,
specialized and largely ‘sunk’ investment costs continuing to impose high
barriers to entry for competitors.7
The existing concentrated network structure is relevant for the NBN for three reasons. First, lack of
competition is a driver behind Australia’s current relatively poor performance in broadband
services. Second, the NBN, by creating a different network that can be used to provide wholesale
telecommunications services, has the potential to significantly change the competitive landscape in
Australian telecommunications. Third, the most cost effective way to build an NBN involves
utilizing parts of existing telecommunications networks. This will require the government to
actively negotiate with the dominant fixed-line network company, Telstra. We consider the
implications of these three issues in the next section.

The NBN policy as competition reform


Australia lags many OECD countries in terms of broadband speed and investment. In June 2009,
the OECD ranked Australia 16th in terms of broadband penetration. Further, Australia’s relative
level of broadband penetration decreased between June 2008 and June 2009 with Australia ranking
20th in terms of the growth of broadband penetration.8

The OECD penetration figures may be criticized as a blunt measure. The Information Technology
and Innovation Foundation (ITIF) augments the OECD numbers to produce an alternative ranking
that takes both speed and price into account. However, based on the ITIF 2008 report, such a com-
parison lowers Australia’s ranking.9 In particular, Australia’s broadband is very slow by OECD
standards with Australia ranked 27th out of 30 OECD countries in terms of broadband speed in the
ITIF report.

It can be argued that Australia’s relatively low level of broadband access reflects the dominance of
Telstra in fixed-line networks. Almost uniquely among the OECD, Australia has a single, verti-
cally-integrated telecommunications firm with the largest market shares in mobile telephony and
internet service provision and a near monopoly in cable television and fixed-line telecommunica-
tions. Telstra owns the infrastructure used by most Australian’s to access broadband services.
Around 80% of Australian subscribers access broadband through DSL technology that uses Tel-

7
ACCC (2009, p.3)
8
See the ‘OECD Broadband Portal” at www.oecd.org.
9
See The Information Technology & Innovation Foundation (2008) “2008 ITIF Broadband Rankings”, available at
www.itif.org/files/2008BBRankings.pdf. For the June 2008 OECD data on penetration used by the ITFI, Australia ranks 9th. However, when
adjusted for price and speed, Australia’s ranking on the ITIF table falls to 12. In this sense, the OECD rankings may overstate Australia’s
relative broadband position.
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stra’s PSTN.10 Most of the remaining subscribers access broadband services through Telstra’s hy-
brid fibre coaxial (HFC) cable network. In other words, for fixed-line broadband internet, Telstra is
close to a monopoly in terms of network ownership.

Regulation has had a limited impact assisting retail level broadband competition. Australia’s tele-
communications laws are relatively cumbersome. The ACCC, as the key telecommunications regu-
lator, has powers to arbitrate access disputes and, where relevant, determine appropriate access
prices. However, arbitration decisions and other ACCC rulings can be subject to court appeals that
extend disputes for years. For example:

The industry continues to have an extremely high level of disputation and


litigation – in 2007-08, the ACCC was notified of 28 new access disputes
and had 18 of its arbitral determinations subject to judicial review by the
Federal Court. This was in addition to merits reviews for a number of its ex-
emption decisions (at least one of which has since been subject to further
judicial review by the Full Federal Court). … [T]he level of disputation and
litigation in the telecommunications sector far outstrips that in any other
regulated sector and is contributing to some frustration of competitive out-
comes.11
Telstra’s vertically integrated structure is a key regulatory hurdle. While Telstra is required by law
to provide wholesale network access to its retail competitors, it has a strong incentive to both limit
access and raise the wholesale price.

The NBN is an alternative way to improve broadband internet services in Australia. Most obvi-
ously, the NBN will move Australia to the top of the OECD in terms of broadband speed and ac-
cess. However, the NBN will also alter the competitive landscape. The NBN will be a wholesale
network. It will develop a fibre network to provide wholesale broadband access to Australian prem-
ises but will not provide retail broadband services.12 Retail services will be left to competitive pro-
viders who can use the network and complementary investments to provide a range of differentiated
and innovative products to end users. In this sense, the NBN aims to overcome both the structural
and the competitive impediments to broadband competition and innovation.

The dual aim of the NBN – to provide a cost-effective, ubiquitous, high-speed broadband network
and to significantly improve effective competition in the provision of telecommunications markets
– creates a policy problem for the government. The most efficient way to develop the NBN is to
utilize existing network facilities. Telstra owns many of the relevant fixed-line assets. Thus, eco-
nomically efficient development of the NBN will involve close cooperation between the govern-
ment’s NBN Company and the (now privately owned) Telstra. However, Telstra is the main benefi-

10
Reported on the ‘OECD Broadband Portal” at www.oecd.org.
11
ACCC (2009) , p.iv.
12
See Prime Minister, Treasurer, Minister for Finance, Minister for Broadband (2009) New National Broadband Network, Joint Media Re-
lease, April 7, Canberra. where it states that “[t]he new investment is also the biggest reform in telecommunications in two decades because
it delivers separation between the infrastructure provider and retail service providers”.
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ciary of the current lack of competition in Australian telecommunications. If the NBN is successful
it will undermine Telstra’s dominance in telecommunications.

The conflicting incentives created by the existing structure of fixed-line telecommunications and
the proposed rollout of the NBN, has resulted in two significant developments. First, Telstra
brought an action against the Federal Government claiming that the telecommunications access re-
gime effected an acquisition of parts of the PSTN other than on just terms, contrary to s.51 of the
constitution. In 2008, the High Court dismissed Telstra’s claim. It noted that Telstra’s ownership of
the PSTN has always been limited by the regulatory environment established by the Telecommuni-
cations Act 1991. Thus, “Telstra’s bundle of rights in respect of the PSTN has always been subject
to the rights of its competitors to require access to and use of the assets.”13

Second, the government has moved to reform telecommunications regulation and provide incen-
tives for “Telstra to structurally separate, on a voluntary and cooperative basis”.14 The part of Tel-
stra that controls the wholesale network will work with the NBN Company to develop the NBN.
The separated retail part of Telstra will compete with a variety of other retailers who purchase ac-
cess to the NBN. At present, we are yet to see whether or not this outcome is achieved.

The development of a FTTP network makes redundant Telstra’s most valuable fixed-line assets: the
PSTN and its HFC cable. While the government needs some of Telstra’s network assets to reduce
the cost of building the NBN, Telstra potentially loses far more if it does not join with the NBN
Company. The government’s public commitment to the NBN together with the High Court decision
on Telstra’s restricted ownership rights over the PSTN, provides significant incentive for Telstra to
cooperate with the NBN Company. The government has backed up this incentive through regula-
tory threat. In this sense the NBN is not just a big bang infrastructure development. It is also a big
bang regulatory reform. It will fundamentally change the nature of broadband regulation and com-
petition in Australia.

Regulation and the NBN


The NBN will not remove the need for telecommunications regulation. It will, however, change the
nature of that regulation. A key element will be the maintenance of strong vertical separation be-
tween the owner and operator of the NBN and the provision of retail services using the NBN. Verti-
cal integration means that the owner of a monopoly network can have strong incentives to under-
mine retail competition. After all, if there is profit to be made at the retail level, the network owner
would like to keep that profit for itself. If it is unable to do this by raising the network access fee to
a monopoly level, then it will be tempted to undermine its retail competitors by reducing the quality

13
High Court of Australia (2008), Telstra Corporation Limited and the Commonwealth of Australia and Others, Commonwealth Law Reports,
210-235, at paragraph 52.
14
Minister for Broadband, Communications and the Digital Economy, (2009) “Historic reforms to telecommunications regulation”, Media
Release, 15 September.
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of access services. As Australia’s recent experience of telecommunications regulation shows, it is


difficult, if not impossible, for a regulator to prevent such discrimination by an integrated network
owner.

In contrast, a vertically separated network owner has significantly less incentive to favour specific
retailers. Given the wholesale network price, a vertically separated NBN Company will simply wish
to sell as much wholesale access as possible. While it would like a higher wholesale price, it does
not want to restrict network access, unlike its vertically integrated counterpart.

This means that NBN regulation should look a lot like the existing regulation of electricity trans-
mission. In Victoria, where the transmission system is privately owned, regulators have strictly en-
forced vertical separation. This includes using the merger provisions of the Trade Practices Act
1974 to prevent integration between the transmission network owner and either upstream or down-
stream service providers.15 Similar strict requirements for vertical separation will be needed for the
NBN.

Vertical separation does not remove the need for price regulation. A monopoly network owner will
still want to charge a monopoly price for network access. This will inevitably create a conflict be-
tween the NBN earning a ‘commercial’ return and providing affordable broadband access to Aus-
tralians. Of course, it is far from obvious that the NBN should earn a commercial return. Once the
NBN is constructed, marginal cost pricing will maximize economic benefits. However, as the NBN
is likely to have average costs well above marginal costs, at least until it reaches capacity, marginal
cost pricing for wholesale access to the NBN will not cover capital costs or lead to a commercial
return.

This highlights the need for the government to develop in advance the regulations for the NBN, in-
cluding the rules for pricing access. The government needs to make the regulatory framework ex-
plicit both to encourage private investment in complementary assets and to avoid gaming by vested
interests after the NBN is built. This is particularly the case if the government plans to privatise the
NBN in the future.

The NBN is a risky investment. The government is choosing a particular fixed-line broadband tech-
nology. This technology will be competing against wireless internet services and, potentially, other
fixed line technologies. Inevitably, Australian taxpayers will bear the risk associated with the NBN.
However, care is needed to ensure that these costs are minimized and that taxpayers do not ‘pay’ for
the risks multiple times. For example, the NBN Company, especially if it is privately owned or is
otherwise required to maximise its commercial return, will have an incentive to lobby the govern-
ment to restrict competition. This could mean restricting wireless technologies that can be used in

15
See for example ACCC (2004) “ACCC assessment of S P Energy’s acquisition of TXU Australia”, Public Competition Assessment, 19
July. A subsequent sale of assets by S P Energy is discussed at ACCC (2005) “China Light & Power’s proposed acquisition of Australian
non-regulated energy assets of Singapore Power”, Public Competition Assessment, 14 April.
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Australia. Such restrictions, however, will inevitably harm consumers. Similarly, private investors
in the NBN will undoubtedly wish to be compensated for technological risk up front. These same
investors will naturally seek to be further compensated at a later date if the NBN is subject to vigor-
ous competition from an alternative technology. Again, the government can overcome future prob-
lems by clearly setting out the ground rules for risk allocation of the NBN in advance. Allowing
private investors to compete against the NBN through alternative technologies, if they believe it is
privately profitable to do so, should be allowed.

Traditionally, Australian governments have sought to ‘average’ utility prices over urban and re-
gional areas. This can result in an implicit subsidy to regional consumers and makes the relevant
service provider subject to ‘cream skimming’ by private competitors. This is highly likely to occur
with the NBN. If the government wishes to equalize urban and regional NBN prices then it should
do this through an explicit and transparent subsidy. Again, the basis for this subsidy should be
clearly established in advance to avoid future manipulation by the NBN Company.

Regulation of the NBN may mean that regulation can be scaled back in other areas. For example, if
wireless and fixed-line internet services are close enough competitors, then explicit regulation of
wireless internet services will be unnecessary. Similarly, as the NBN can be used to provide stan-
dard telecommunications services, most existing telecommunications regulation will be redundant.

Finally, the government could also use the NBN to reduce its own costs of providing public serv-
ices. For example, if internet access through the NBN is ubiquitous, then it can be used to commu-
nicate with the general public and provide a variety of government services. To ensure universality,
the government may wish to make a basic broadband service (say with a speed of 1Mbps) freely
available to all households. The provision of this service, together with a basic ‘netbook’ for low-
income households, could be tendered by the government. The service could potentially pay for it-
self by lowering government costs in other areas such as social security and taxation.

Is the NBN worth it?


Some commentators have been critical of the lack of a comprehensive cost-benefit analysis of the
proposed National Broadband Network. This criticism has some validity. It is desirable for gov-
ernment investments, such as the NBN, to be appropriately costed and evaluated before taxpayers
funds are committed to their development. Investment funds are finite and building the NBN will
inevitably mean that resources are drawn away from other potential investments.

At the same time, it must be recognized that any analysis of the social benefits of the NBN will be
extremely imprecise. Alternative cost-benefit analyses of the NBN have been presented.16 These

16
Gans, J.S. (2009) “The right policy for telecommunications and broadband”, Submission t the Senate Select Committee on the National
Broadband Network, June 18. Ergas, H. and A. Robson (2009) “The social loss from inefficient infrastructure projects: recent Australian
experience”, paper presented to the Productivity Commission Round Table: Strengthening evidence based policy in the Australian Federa-
tion, 17-18 August.
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studies reach substantially different conclusions – from large net positive to large net negative so-
cial returns. This gap is unsurprising. The studies make very different assumptions. This is under-
standable and reflects the significant uncertainty surrounding a project like the NBN.

It is impossible to precisely measure the costs and benefits of the NBN. Many of the benefits will
depend on complementary investments by the government or private companies. It is likely that
services that have not even been invented yet will be provided by the NBN once it is built. In this
sense, to require that the NBN be subject to a precise cost-benefit analysis is simply a waste of time.

A more appropriate approach is for the government to undertake a broad risk analysis of the NBN.
It is possible that the NBN will be a ‘white elephant’ that is based on redundant technology, but
whether this risk is large or small is not clear. Similarly, it is possible that the NBN will revolution-
ise the economy leading to massive productivity gains for Australia, however the probability of this
is also unclear. While it is impossible to derive a single number, or even a well-defined range of net
benefit estimates, for a project like the NBN, it is possible to analyse the broad possibilities, their
benefits and their likelihoods. Such a risk analysis will never be definitive, but it will help educated
public debate about the NBN.

Finally, the benchmark for any risk evaluation of the NBN is clear. The relevant benchmark is the
net social benefits from the NBN. Whether or not the NBN is commercially profitable is irrelevant.
Indeed, if the NBN was commercially profitable then there would be no need for the government to
be involved in the project at all.

What other investments should be made?


The National Broadband Network provides the infrastructure for high-speed internet connections.
However, by itself the network does not necessarily create demand for such connections. Indeed,
evidence from Japan and South Korea where fast Internet connections are available, suggests that
demand is mainly for video downloads and gaming.

The recent National Innovation Review recognised that there is a gap between the government’s
broadband investment and applications to utilise it effectively:

With the National Broadband Network, Australia needs to ensure that the relevant
applications – specific to local needs – are developed to leverage that infrastructure for
the purpose of government policy. This includes applications in open democracy,
database and privacy standards for health information, tools to facilitate educational use
of broadband, traffic systems and standards, and national collections of information and
knowledge.17

17
Cutler and Company (2008), VenturousAustralia: Building Strengths in Innovation, Melbourne, p.145
[http://www.innovation.gov.au/innovationreview/Documents/NIS_review_Web3.pdf]
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The Federal government should complement its NBN investment on two fronts. First, it needs to
encourage applications that leverage the network. These could be in e-health, e-education or video-
conferencing (that might save on commuting costs). In each of these, active reviews of government
legislation, information assets and policies needs to be taken so as to ensure there are no
governmental bottlenecks to the development of such applications (e.g., medical liability laws
preventing off-site health diagnosis and treatment).

To explore this further, consider e-health. Usually, what is envisaged is a surgeon in Sydney
operating on a critically injured patient at some outback station. However, it is far more likely that
e-health will be used for the most routine and mundane of medical issues rather than the most
specialised and exceptional. For example, e-health services can provide significant benefits for out-
of-hours medical treatment of routine health issues, such as a child with a fever. A GP connected to
the patient through the NBN can interpret data and email a prescription to the pharmacist, saving
time, inconvenience and reducing pressure on hospital emergency services.

Why isn’t this service being offered? The technologies exist to transmit the relevant information to
doctors at a low cost. The problem is that the liability laws and health regulations (including
Medicare reimbursement) do not envisage this situation and stand in its way. By facilitating e-
health transactions rather than preventing them, the government could stimulate significant
innovation.

The second complementary investment involves hardware. This includes computer equipment and
complementary hardware that is required, for example, to access e-health services. As already
noted, the ability of the government to deal with citizens through the NBN can lead to significant
savings and may justify the government supporting low income families in accessing basic
computer hardware.

Conclusion
The National Broadband Network investment is more than about just higher speed broadband. It is
a bold move towards infrastructure-based competition in telecommunications in Australia; an
industry for which regulation has achieved gains for consumers but not long-lasting and significant
gains in competitive market structure. This paper has highlighted this broader context and argued
that the government and others should evaluate the NBN and its social returns on that basis.
Nonetheless, we have noted that significant uncertainty remains and, in particular, the social
benefits are likely to be substantially impacted on by policy decisions in the NBN’s
implementation, ownership structure and complementary investments.