Strand Consult has analyzed the European telecoms market for over two decades and published reports on the pros and cons infrastructure sharing and structural separation on fixed line networks. Operators Telefonica, TIM, BT, and others now consider spinning off their infrastructure into separate companies. This research note reviews the drivers of the current trend and their consequences.
It is not news to say that the EU faces a €150 billion network investment gap to reach its 2025 connectivity goals. The more interesting question is why European Commission policies purported to incentivize investment haven’t worked. Moreover why the European Commission, rather than admitting its mistakes and changing course, continues to make policies and regulations that have proven not to work. That Europe continues with heavy-handed policy choices is even more perplexing when compared to the demonstrated success of the light-touch approach taken by the US, Japan and South Korea. These nations are advancing on 5G. Moreover, the US has delivered twice the investment per capita for more than a decade compared to the EU. Importantly, it quickly reversed harmful internet regulation after it observed two years of falling network investment and broadband deployment.
In recent months, European operators have considered to sell all or major parts of their networks. In Denmark, TDC has been purchased by three Danish pension funds ATP, PFA, and PKA and the Australian Macquarie. The acquisition will split TDC into two companies, an infrastructure company and a retail company. The first year of the new entity will see TDC´s CAPEX reduced from 22% to 18% in a market where TDC represents over 50% of the total telecom CAPEX. The questions are who will benefit in the short run, and what are the long-term consequences.
The deal is a voluntary functional separation that splits network infrastructure from the retail side of the business. The investment in the underlying infrastructure is made by one company while another sells the services and subscriptions. It’s a concept increasingly in vogue with European telecom regulators as the net effect of their policies has been to maintain incumbent dominance without creating competing infrastructure, the very opposite of their promised goal more than a decade ago.
Competition expert Bronwyn Howell notes the experience of the model from the electricity sector and explains that the costs of contracting increase when short-term focused retail operations are separated from longer-term generational infrastructure investments (which require large up-front fixed and sunk cost components). The combination of mismatches in investment horizons, entry barriers, and risk preference and information asymmetries between network operators and retailers leads to thin contract markets, increased hold-up risk, perverse wholesale risk management incentives, and bankruptcies. Competition between vertically integrated telecom providers would likely induce more efficient and sustainable investment and competition than would separation.
Indeed, the outcome looks a lot like the centrally-planned European rail industry. It was at one time innovative, but the government-owned and operated rail companies have fallen into disrepair. Rails across Europe are often old and slow, and many wait to be electrified.
Strand Consult observes that structural separation is a logical outcome of the EU’s long broken telecom policy. Simply put, European policymakers have made it unattractive to invest in European networks. The policy of mandated access, or the artificial stimulation of competition through regulated reselling, makes it more profitable to be a retailer than an investor in networks. Why would anyone invest in a network if the government forces the owner to provide access to competitors at low prices? It’s not surprising that network operators are now spinning off their infrastructure and focusing instead of the retail part of the business where they can make more money. Ironically, regulators adopted the policy because they believed it would lead to greater network investment and that retailers would climb the “ladder of investment” to turn themselves into network owners. Outside of a handful of special cases, it hasn’t happened.
Given that regulators have tipped the scales in favor of resellers (as well as over the top or OTT providers which get to use networks without paying for them), it’s no wonder that operators want to exit the expensive, long-term business of network operation, which regulators have made increasingly unprofitable.
It is interesting to note that structural separation attracts a distinct kind of investor, that of the pension fund which works to a large extent with government employees. Pension funds are not expected to deliver the same returns as telecom operators. Some claim that these investors are more risk averse, we disagree. Pensions funds do not want to drive technological development or innovation, like private operators. They focus on securing their shareholders a low, stable return and adjust their investments based on the cash flow they generate.
For some time, European operators Telenor, Telia, Vodafone, Telefonica etc. have made huge investments outside the EU. While Deutsche Telecom's investment in Germany has increased somewhat in recent years, many observe that Deutsche Telecom has historically under-invested in Germany to prioritize its investment in T-Mobile USA, where it can get a significantly better return. Pending the acquisition of Sprint in a $26.5 billion deal, T-Mobile promises to invest $40 billion in the US over three years to realize 5G. By rejecting consolidation in the EU, it appears that the European Commission’s objective is to maximize operators’ telecom investment outside the EU where there are better returns.
In Lebanon the two state-owned mobile operators made agreements with retail partners Zain and Alfa to provide services on top of networks. In practice the Lebanese government decides when to roll out new network technologies. The results speak for themselves. Lebanon didn’t get around to rolling out 3G until November 2011 (one of the last places in the world to do so), and it has some of the highest mobile prices in the world. Structural separation has been the rage in New Zealand and United Kingdom. As the New Zealand-based Howell assiduously documents, the policy has not produced more or better infrastructure or more innovative broadband products.
If the government had a better way to do it, then we should have seen state-of-the-art communications infrastructure in former East Europe. When the Berlin Wall came down in 1989, one was lucky to find a rotary telephone.
While structural separation may please some investors in the short run, it is likely that divestiture of networks and subsequent separation will slow next generation network investment and innovation, the opposite of the EU’s stated policy goals. That policymakers continue to make bad policy choices with no penalties suggests a lack of a feedback mechanism. The telecom industry has lost hundreds of thousands of jobs from regulators’ decisions. As far as Strand Consult can determine, regulators have kept their jobs, even expanded their staff while the companies they regulate have become less viable.
Spinning off networks is not a fail-safe plan for operators. The scheme is subject to political risk, particularly in the EU today when so many countries are revolting against Brussels for policies which have not delivered promised growth and competitiveness.
While countries across EU have introduced broadband subsidies, Strand Consult concludes that subsides are not necessary if the regulator has the right framework.
Strand Consult describes other infrastructure models for mobile networks. The report How a carrier’s carrier can add value to a mobile market highlights the opportunities, the necessary conditions for the model to work, and the how the actors can maximize the benefits of the model. Learn How a carrier’s carrier can develop and add value to a mobile market can help your organization by contacting Strand Consult.