The Strategic Implications of VOIP for Regulating the Electronic Communications Markets

Richard CadmanDirectorStrategy & Policy Consultants Network Ltd

+44 1603 871162Richard.Cadman@spcnetwork.co.uk

Disruptive Potential of VOIP

Voice over the Internet has the potential to restructureelectronic communications markets making existing regulation redundant, but leaving a new monopoly.

To ensure the survival of the competitive gains enjoyed since 1998, NRAs will need to re-evaluate the remedies

imposed on SMP operators.

Agenda

• Introduction to SPC Network

• VOIP’s Disruptive Potential

• Rate of Substitution

• Implications for Interconnection & Regulation

Introduction to SPC Network

• Specialist policy and strategy consultancy in electronic communications

• Rigorous analysis: exceptional advice

• Built on three key assets:– Services– Experience– People

• Founded in 2003• Have worked for 19 clients

including….

Policy

EconomicsRegulation

Introduction to SPC Network

Introduction to SPC Network

• Presentation paper based on

– Paper prepared for a client on VOIP and the future of regulation

– Report being prepared to be published by Market Cohesion Ltd (www.marketcohesion.com)

The Market Review Process

• 18 markets determined by European Commission

• Implemented slightly differently by NRAs

• Product and geographic markets• Voice access, Origination,

Transit and Termination• Broadband access and

conveyance

Marketdefinition

The Market Review Process

Marketdefinition

Assessmentof market

power

Applicationof remedies

Voice Markets

TransitTransit

AccessOrigination

Termination

Incumbent dominant in Access, Origination and Transit

Own network dominancein termination

Interconnection charges are distance dependent so incentivise Altnets to build out to DLE

Broadband Markets

wwwwww

ConveyanceConveyance

W/sale AccessRetail Access

Incumbent dominant at wholesale level

Bitstream access charges generally capacity based

Convergence

• Current:– Separate voice and broadband supplier – Voice market measured by connections/minutes– Broadband measured by connections

• Future–Integrated supplier of voice and broadband–Market measured by connections

Convergence

All-IP backbone

All-IP backbone

www

PSTN/mobile

PSTN/mobile

Termination

www

Access

Broadband server

Customer premises

ServiceProvider

ServiceProvider

Convergence

“All-IP Architecture”

DWDM (usually)

Fibre

IP

“Traditional Architecture”

IP

ATM

SDH

Fibre

DWDM (sometimes)

Convergence

Voice Video Data StorageThen

Telephone Network

Telephone Network

Broadcast Network

Broadcast Network

IPNetwork

IPNetwork

Storage Area

Network

Storage Area

Network

Telephone Network

Telephone Network

Broadcast Network

Broadcast Network

IPNetwork

IPNetwork

Storage Area

Network

Storage Area

Network

Now

Convergence

“The impact of IP on the traditional telephony world will be to replace voice services with integrated voice and IP-basedapplications. These will extend through messaging and e-commerce,supporting applications with which the traditional telephony networkarchitecture cannot compete technically or economically.”

Trends in IP Technology: Their impact on the the traditional Telephony carrier worldOECD March 2002

Currently separated voice origination/transmissionand broadband access market definitions will no longer be

relevant.

Rate of Substitution

• What will drive consumers to switch from traditional voice services to an integrated Voice and Internet platform? – Price– Convenience– Quality

Price

• Calls to other VoIP phones free

• Substantial savings on international rates

Price (All GB£)

4.0

4.0

4.0

3.08.01.51.1USA

20208.19.6 – 10.5India

3.08.01.51.1Germany

4.08.01.51.1France

One-TelBT

(Option 3)

Gossiptel(World 500)*

Skype

*£9.99 monthly cost Source: company websitesJanuary 2005

Price

• Calls to other VoIP phones free

• Substantial savings on international rates

• But….. Less convincing savings on calls to PSTN/Mobile

Price

Based on calls to Vodafone

5516Weekends

61016Evenings

161516Peak

BT (Option 3)

Gossiptel(World 500)

Skype

Source: company websitesJanuary 2005

Convenience & Quality

• Both rapidly improving• VoIP handsets available – no longer an enthusiasts’

toy• Quality related to price but acceptable even at “best

efforts” level

Rate of Substitution

• How quickly will VOIP be taken up?

– Mercer: 30% of UK homes by 2007– Jupiter Research: 17% of US homes by 2009– Ovum: 197 million users worldwide by end of

2008– Skype: 80,000 downloads per day

Rate of Substitution

“However, Voice over IP-based (VoIP) applications are likely to be best implemented when they are used in opening new sources of revenue for service providers rather than as a means of competing directly against traditional telephony whose vast infrastructure is likely to co-exist and be interconnected to IP-based infrastructure for many years ahead.”

OECD

Implications for Interconnection & Regulation

Economics of Competition: Today

LRACI

LRACE

€

Size of Network

Current voice interconnectregime encourages buildingout to DLEs to allowentrant (E) to realiseeconomies of scale and tobenefit from more efficienttechnology.

Entrant therefore able to beprice competitive.

Economics of Competition: Future

LRACI

€

Size of Network

LRACE

All-IP networks are built on standard protocols/equipment.

Can entrant gain efficiency/scale advantages over incumbent?

Wholesale Interconnection

Entrant (E) has choice of adding increment i of capacity through own build or buying from the incumbent (I).

Assume that I’s price for i is regulated at LRIC+ based on I’s cost model and data.

E’s LRIC is likely to greater than I’s due to smaller discounts and higher cost of capital reflecting greater risk.

E is faced with two prices for increment: I’s or its own Always more rational for E to buy rather than build.Incentive to buy is compounded given that there is no advantage in

building out to the DLE, as there is no distance related charging so no additional benefit to be gained from a larger network.

DANGER DANGER DANGER

MONOPOLY RE-EMERGING

Is IP access and transit a

natural monopoly?

Mandate interconnectdeep enough in the network to allow service providers to control product

differentiation

Yes

Here?

Here?

Here?

“All-IP Architecture”

DWDM (usually)

Fibre

IP

Civil infrastructure

Is IP access and transit a

natural monopoly?

Mandate interconnectdeep enough in the network to allow service providers

to control product quality

Yes

Do not regulate as if it were a monopoly. Do notimpose remedies whichdiscourage competitive

investment

No

The national regulatory authorities shall promote competition in the provision of electronic communications networks, electronic communications services and associated facilities and services

Framework Directive, Article 8, para 2.

But, tools available to NRA, i.e. remedies to apply to SMPoperators, are designed to control monopoly behaviour.Can such tools also promote competition?

Summary

• Significant retail uptake of VoIP is likely to lead to restructuring of electronic communications markets

• Separate voice and broadband markets will converge to form a unitary market

• Will All-IP networks revitalise scale advantages of incumbent operators leading to a renewed “natural monopoly”?

• If yes, regulators must mandate interconnection at a sufficiently low level of the network to encourage differentiated competition

• If no, regulators must use regulation to encourage, not mimic, competition

Rigorous analysis: Exceptional advice

www.spcnetwork.co.uk