> Executive Briefing

Dr. Arnulf Heuermann

Arnulf.Heuermann@detecon.com

Regulating NGN Access

Networks in Germany
For a decade the German regulatory system focused on service
competition, in particular reducing retail prices and opening the
existing copper based local loop infrastructure to competitors. The
transition to a next generation network, however, will require an
upgrade or replacement of the access networks by fiber with high
infrastructure investments. The regulatory focus of the future
therefore needs to be on incentives for investment by Deutsche
Telekom and its competitors into such a new infrastructure and
on ensuring that such services are universally available. It is
questionable whether the existing instruments will be sufficient in this
respect.

The author’s opinion and conclusions expressed in this paper are not
official positions of Deutsche Telekom.

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 Regulating NGN Access
Regulating NGN Access Networks in Germany

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Introduction
Ten years after the complete opening of the German telecommunications markets to
competition the regulatory system needs to change. For a decade the regulatory focus was
on service competition, namely reducing the monopolistic or significant market power of
the incumbent. This was done by opening it’s infrastructure to competitors, improving
service variety, preventing predatory or excessive pricing, and reducing the retail price level
for consumers. Infrastructure investment by new competitors concentrated on long distance
networks. As the local telephone access network was in good shape and connected virtually
every building, new providers offered services via interconnection and local loop unbundling
or resale rather than building new local loops. Efforts to use wireless technologies as a
competing infrastructure have failed so far, and nor have the CATV network providers in
Germany managed to offer an alternative on a significant scale.

Now the market environment is changing: Broadband access services have shown
tremendous growth and could be handled by the copper access networks at bandwidth
requirements well below 12 Mbit/s. Bandwidth demand is growing exponentially, in particular
through video elements in virtual reality games, IPTV or HDTV services as part of a “triple
play” offer. In a next generation network the access lines will therefore need to be upgraded
or replaced by fiber to achieve very high data rates of 50 Mbit/s and beyond.

Broadband Access Strategies

Most experts agree that in the long run fixed access networks will be based on a Fiber-to-
the-Home (GPON) technology capable of offering downlink speeds of more than 100 Mbit/s.
It is also common sense that for some years to come a lower bandwidth would be sufficient
for the majority of users. An immediate replacement of the existing copper networks by
Fiber-to-the-Home would not generate positive returns on investment. Most European
carriers have therefore decided to upgrade parts of the access networks first and offer VDSL
services with a downlink speed of up to 50 Mbit/s. Deutsche Telekom for example started to
invest in an overlay strategy for Fiber-to-the-Curb (FTTC) in the 10 largest German cities in
2006 and work is now in progress for the 40 next largest cities.

In this context Fiber-to-the-Curb and VDSL investment are just an interim step to a
fully fiber based NGN access network. Substituting the “2nd mile” of the copper local loop
with fiber optic cables while leaving the “1st mile” with copper cables is a roll-out strategy that
is only profitable under certain conditions. Figure 1 shows the CAPEX requirements of
different fiber roll-out situations.

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CAPEX Index for different FTTx Solutions

Access Fibre & DSLAM in

Hardware trenching Cabinet

FTTC 17 17 8 42

FTTH in
existing ducts
33 17 50

FTTH aereal 58 17 75

FTTH new 83 17 100

Source: Detecon projects, Alcatel-Lucent – CAPEX including CPE

Figure 1: CAPEX for Fiber to the Home and Fiber to the Cabinet

Deutsche Telekom for example has chosen the FTTC solution as most primary pair cables
are not buried in ducts in the country’s old telephone network. It therefore appears more
economical to make an interim investment in new DSLAMs in the 300.000 cabinets in
Germany, rather than to dig up the streets to reach 40 million homes and completely replace
the old copper network. Civil works typically count for two-thirds of total CAPEX.

In other countries FTTH may already be a viable option:

Q In the United Arab Emirates, for example, Etisalat is directly investing into a FTTH
network, as the existing primary cables are also buried in ducts. Replacement with fiber
is therefore relatively cheap, additional CAPEX compared to FTTC is small.
Q For similar reasons NTT in Japan is investing directly in FTTH. Here primary cables can
be connected to homes via aerial loops.
Q France Télécom is also starting with FTTH pilot projects in Paris. Their decision against a
FTTC overlay solution is based on the fact that their old copper access networks have a
much longer average cable length between the cabinet and the end user.

Recent Federal Network Agency (FNA) Decisions on VDSL Regulation

Following a fierce debate on whether VDSL investments would create a new market in line
with the new § 9a of the German Telecommunications Law, and could thus be excluded from
ex-ante regulation, the FNA made two major decisions.

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In June 2007 FNA adopted its final decision on the wholesale market for unbundled local
loop, or Market 11. It designated Deutsche Telekom as having significant market power due
to its high market share, high barriers to entry, vertical integration, lack of actual and
potential competition, and lack of countervailing buying power.
Q Deutsche Telekom was obliged to grant access and collocation, non-discrimination and
ex ante price control for its wholesale services. A reference unbundling offer is to be
published. Currently competitors have co-location facilities in about 2000 of the 8000
Main Distribution Frames (MDFs).
Q In addition Deutsche Telekom is obliged to grant access to ducts between the MDFs and
the street cabinets. In cases where there is no free capacity available it also has to offer
access to dark fiber.

FNA has also drafted a first round decision for Market 12. This is the market for “IP bitstream
access at the IP layer 3 at different points of access in network hierarchy including high
frequency broadband access”. This market would be an alternative way for competitors to
achieve broadband access to the customers. According to the draft Deutsche Telekom has
been designated as having significant market power in this market too and will be obliged to
offer bitstream access products for xDSL connections, grant access and collocation and will
be subject to ex-ante price control for its wholesale services. A reference bitstream access
offer has to be published.

In summary the FNA has subsumed VDSL as part of the existing markets 11 and 12,
refused to define it as a “new market”, and thus made it subject to ex ante regulation.
Competitors wishing to provide customers with an alternative broadband access offer may
then choose to invest in:
Q their own complete access network, like NetCologne, who are establishing a Fiber to the
Building network in and around Cologne,
Q an access network up to the street cabinets, and then use Deutsche Telekom’s last
copper loop,
Q a small access network, co-locate at the MDF, and then use Deutsche Telekom’s
complete local loop, or
Q just a backbone network, and get bitstream access at Deutsche Telekom’s BB-PoPs.

The first solution requires the highest CAPEX and minimizes wholesale costs, the last option
minimizes CAPEX and has the highest wholesale cost. In addition the bitstream access
solution offers least opportunity to differentiate products in terms of quality of service.

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Deutsche Telekom’s competitors’ decision as to whether to build their own FTTH

infrastructure or simply use the existing DT platform will therefore mainly depend on the
Federal Network Agency’s (FNA) decision, at which level the ex-ante price regulation will be
fixed. In this context it is problematic that unlike most other European Regulatory
Agencies the German Regulator decided to introduce “ex ante price control based on
costs of efficient service provision”. This concept is widely used to regulate wholesale
prices in legacy markets. For innovative markets, however, regulatory decisions should
simulate competitive results of an investment into a risky, innovative infrastructure, where the
investor has to earn a risk premium. Otherwise investments into VDSL and FTTH from
incumbent and competitors may be delayed or reduced.

Deutsche Telekom recently announced that it plans to reduce its VDSL roll-out, fearing that
wholesale prices might be calculated on traditionally long-run-incremental cost basis for
competitors and therefore pressing retail prices below a level that would be sufficient to re-
capture the infrastructure investment.

The high cost of building new duct systems is the major barrier to investment in FTTH
for both the incumbent and new carriers.

A policy that would open all existing duct infrastructures could effectively boost real
infrastructure competition between DT and other operators offering FTTx solutions. If
infrastructure competition really starts, ex ante regulation could be replaced by ex post
regulation - the original idea of “regulatory holidays”.

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Regulating NGN Access Networks in Germany

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Conclusion & Recommendations

The regulation of NGN access networks currently focuses on the traditional approach of
opening the incumbent infrastructure to competitors. This approach may not be appropriate
to create incentives for efficient new infrastructure competition in the local loop:
Q Incentives to invest in VDSL may be decreased for DT if the margins for regulated
wholesale prices are too low. Regulated wholesale prices for access to new
infrastructures (e.g. dark fiber) therefore have to include a market conform risk premium.
Q Alternative operators must also have incentives to serve customers with their own FTTx
solutions.
VDSL is an element in the transformation of the legacy platforms to NGN. In the NGN the
existing business model of local loop unbundling with access at the MDF will be largely
phased out. Incumbents may benefit from sales of obsolete property at the MDF level and
from lower OPEX spending. This has to be weighed up against the new competitors’ current
LLU business. Regulators should concentrate on preventing anti-competitive behavior
in this transition process, while not blocking the most economic solutions.
The FNA is currently opening a new market for sub-loop unbundling, which will only be a
transitory market until the final development step from VDSL (FTTC) to FTTH is done.
Regulators should encourage the Bitstream Access or alternative own access
network business models, as these are both viable in the long term.
Economies of scale speak against a duplication of VDSL fiber optic networks in a single area
as this increases total costs for the economy as a whole. Efficient infrastructure competition
either means competitive investment in areas other than those covered by the incumbent or
in other technical solutions, e.g. FTTB, FTTH or wireless access. In both cases, however,
access to DT infrastructure is of limited value. Regulators should encourage a cross
industry approach for access to usable duct systems, the major bottleneck for fixed
line access. This would include obligations to open municipal duct systems, waste
water systems, empty electricity ducts etc. to fiber cables.

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