ULL: Turning Perfect Competition* into an Oligopoly

(*Perfect Competition refers to retail provision of services and not the regulated wholesale access charges which will remain regulated, but be a lower percentage of the total cost of communications services in the ULL regime)

There is nothing a telco hates more than perfect competition and historically, they use all their cunning to turn a perfect competition situation into at a minimum an oligopoly. Personally, I think the consequence of the way ULL is being introduced in the UK and will turn a competitive market into an oligopoly.

Once the dust has settled I can see four huge consumer brands: BT, Sky, Orange and O2 dominating the provision of B2H (Broadband to the Home) market. The typical “barriers to entry” feature set of oligopolistic markets are already starting to be raised with the entry of the “experts” into the market: Sky in a digital world was built on subsidising and seeding the market; Orange, O2 and mobile industry in general are experts in bundling; and BT can’t possibly lose from the position they are in. When you are crossing the chasm it helps if you have a huge brand and that needs a lot more investment in branding than sponsorship of a second tier Football Club and medium sized ISPs are about to find out just how expensive it is.

I know that ntl/Telewest have new management and starts from a position of the highest current retail market share. Ntl’s biggest competitive advantage is that existing customers have no way of currently churning onto BT’s ULL network, but that will not last long. Despite ntl being under new ownership, I’m sure they still have a few executives around who will remember that Sky not only ripped up their P&L, but also put their balance sheet on the line in taking ntl, telewest & itv to the cleaners in the last brawl they fought. Sky are already preparing shareholders for the battle ahead. Worst of all, Ntl/telewest/virgin are heading into this fight with around ₤5.8bn of net debt and not a lot of excess Free Cash Flow to service this debt.

Also missing from the list of survivors is Carphone Warehouse/TalkTalk and I think that is a real shame because Charles Dunstone has through the years with his boobing and weaving done a lot of good for the mobile industry and the fixed line business. However, I just don’t see CPW having the firepower or cashflows to compete in the medium term.

The big wildcard is Vodafone and they have immense firepower. Despite the well-documented problems Vodafone is still a huge cash machine. In the UK alone in the y/e Mar 2006, they generated Operating Profits of ₤698m with Depreciation of ₤486m, Amortization of ₤438m and Capex of ₤676m gives huge Free Cash Flow (circa ₤900m) just for the UK Operation. This is a lot of cash to protect if the UK Exec’s believe that having no place in Broadband Britain will hurt the in long term the cellular operations. To place, this in context Tiscali one of current Big 6 with over 1m customers generated in the UK €69m – small fry!!! Perhaps Vodafone might wait for the fall-out, just focus on the corporate market or even a new CEO might bring a radical strategy like buying ntl and going for the quad-play in style.

Another wild-card is T-Mobile and I suspect T-Mobile's parent company will require little convincing if a prime asset, such as AOL, is about to purchased by Orange.

Of the remaining current big 5 ISPs: I think AOL will be sold soon and Tiscali will eventually be sold.

That leaves the unfortunate C&W who is more and more looking like the first big casualty of the broadband wars (before they even get into full swing) I feel as if Pluthero was using his 100k ULL customers as a lever to sign a heavy hitter (aka a mobile operator) as the anchor tenant on the proposed wholesaling operation. The problem for C&W shareholders is that I don’t think a wholesale market will emerge in LLU. First the big mobile operators are already well interconnected into BT’s network and have huge data/voice switching & routing capabilities (the data bit is probably underutilized from a lack of 3G traffic). All they need to add is the Access Kit which I’m sure the Chinese Army (aka Huawei) will more or less give away to the right “strategic” customer. I will not be in the slightest bit surprised if Pipex announce in the morning they have done an unfathomable deal with C&W for wholesale access in return for the Bulldog customer base.

There is another problem in the C&W wholesale strategy: which of the current army of resellers are going to buy the service? More importantly why won’t they stick will BT? After all, 30% of the consumer market (ie the rural smaller exchanges) for the next couple of years will only be served by BT (these will not be served by C&W) and potentially will be profitable for the re-sellers, especially the regional one’s. Next, the resellers will be busy developing offerings not based upon price. Also, shaving a few percent off the network costs for suburban areas will probably be eaten away by the need to develop IT systems to interface with multiple suppliers’ networks. Finally, after 1.5m LLU customers, BT can reduce its’ wholesale prices – the majority of resellers probably will wait until at least then.

In conclusion, I believe LLU will create an oligopoly and kill off the hundreds of small ISPs aimed at the consumer market, some of who will sell up, some will refocus on the SME or Geek Market and some will go bust. BT will dominate in rural England for the time being, whilst the suburbs will be a battleground for BT, Sky, Orange and O2. There is real potential for Broadband Britain to bypass the inner-cities completely unless someone develops a workable pre-pay model, which will probably require State funding. Eventually in 3-5 years, prices will settle down, market share will stabilize and four players will have a steady business delivering excellent cashflows. New entrants will occasionally come along, but find they have a huge disadvantage with the additional capex they need to spend compared to the others, huge investments are needed for customer acquisition to deliver scale and worst of all the big four charge huge “regulated” interconnection costs coupled with the network effect means it almost impossible to upset the status quo.

Allegedly, the only thing that a telco loves more than an oligopoly is a pseudo-monopoly or cartel. Personally, I can’t see how that will occur. Or could they really get away with that?