“In a report published today, Tuesday 19 July 2016, the Culture, Media and Sport Select Committee says BT is “significantly under-investing” in Openreach, its infrastructure subsidiary. Based on a report commissioned from a panel of independent experts, the Committee concluded the shortfall in investment could potentially be hundreds of millions of pounds a year.”
I was not involved in this report, having given evidence, alongside over a hundred others. I had not seen it before receiving the press release. I therefore I reproduce the release verbatim before making a few quick comments:
“The Committee says BT has exploited its position to make strategic decisions that “favour the Group’s priorities and interests”—and is likely to have sacrificed shareholder value and customer benefit as a result. Capital investment in Openreach has been broadly flat since 2009 until this year, and quality of service remains poor.
The Committee is demanding that BT invest significantly more in Openreach, and allows Openreach much more autonomy over what it invests, when and where. It supports Ofcom’s plans for establishing greater separation between Openreach and BT Group, but makes clear that if BT fails to “offer the reforms and investment assurances necessary to satisfy our concerns”, Ofcom should move to enforce full separation of Openreach.
In the Committee’s judgment, Ofcom has not placed enough emphasis in the past on improving Openreach’s quality of service: it says the prospect of stiffer penalties should also encourage BT to voluntarily invest more in infrastructure.
The Committee convened a panel of expert advisers for the inquiry, including nationally recognised specialists in finance, regulation, communications and infrastructure provision, whose expert report is also published today with our own report.
The report concludes:
— The lack of transparency in BT Openreach’s costs and deployment plans in relation to the BDUK programme has stifled local competition and thwarted other network providers’ planning.
— BT has allowed service quality levels to remain low at Openreach in recent years—from an arguably low base—while investment in Openreach has been flat. Ofcom was slow to introduce minimum service standards with financial penalties for Openreach, some nine years after its creation.
— The shortfall in investment in Openreach could potentially be hundreds of millions of pounds a year. It arises because BT appears to be deliberately investing in higher-risk, higher-return assets such as media properties, and not investing in profitable lower risk infrastructure and services through Openreach.
— BT Group is exploiting the position of vertical integration to make strategic decisions that favour the Group’s priorities and interests, at the expense of its access infrastructure business. Its current structure allows it to use Openreach’s utility-type assets to cross-subsidise riskier activities elsewhere in the Group, while significantly under-investing in the access infrastructure and services on which a large part of the public rely.
— Ofcom’s charge control regime has kept a downward pressure on prices, so that the UK’s communications prices are among the lowest compared with similar EU countries. But this mechanism has not been successful in holding Openreach to an adequate quality of service; and it is an open question how effective overall it has been in stimulating investment in Openreach’s infrastructure.
— For those households and businesses in the “final five per cent” there will need to be judicious deployments of interim technology solutions to provide improved connectivity to those households and businesses which currently have little or no coverage.
— The challenge of reaching the “final five per cent” is likely to demand the active and willing co-operation of local communities wherever possible. BDUK will need to offer guidance and support in key areas such as: choosing the right technology solutions, raising finance, stimulating demand and minimising other costs of provision.
— That there is a compelling case for expanding the current USO for telephony and dial-up internet to cover broadband, given the vital role it plays in people’s lives.
— Ideally, the USO must be designed so as not to impose too great a burden on industry: to incentivise investment, without creating consumer detriment or overly inhibiting take-up.”
After reading the press release I do recommend you read the summary and take a look at the list of advisors at the start of the appendix on regulation, competition and cost of capital before setting aside time to read the report in full – as I will. My first reaction is 10 out of 10 for the quality of the analysis accuracy the accuracy of the diagnosis. A few sections particuarly caught my eye during my first reading of the summary of the report
“Openreach. Openreach, local bodies and BDUK are to be congratulated for hitting their 90% coverage target for superfast broadband. But one consequence of this rapid rollout has been that the programme appears to have tackled the easier-to-reach premises within the interventions areas first and has not delivered coverage to whole areas. Instead, it has left a patchwork of premises that have not been reached, and created much uncertainty among local residents as to whether or not they will be connected or receive improved speeds.
A further downside of the BDUK programme has been the lack of transparency in Openreach’s costs and deployment plans, the apparent effect of which has been to stifle local competition and thwart other network providers’ planning. At the same time, Openreach’s historically poor service record has failed to improve in the face of escalating demands on the network.”
Although standards of service, specifically customer service, are also problematic in the wider industry, Ofcom has in particular identified the quality of Openreach’s wholesale service to communications providers, including to BT’s businesses, as being highly unsatisfactory … Openreach has been “over-earning” substantially in relation to its cost of capital while Openreach’s investments, including in fibre, have until this year barely increased since 2009.
“there appears to be compelling evidence that BT Group is exploiting the position of vertical integration to make strategic decisions that favour the Group’s priorities and interests, at the expense of its access infrastructure business. BT does not lack access to capital. Its current structure allows it to use Openreach’s utility-type assets to cross-subsidise riskier activities elsewhere in the Group, while significantly under-investing in the access infrastructure and services on which a large part of the public rely.”
“It came as a surprise to us that BT employs an investment hurdle rate significantly above Openreach’s actual cost of capital, as estimated and allowed for by Ofcom. This means that a potentially very significant amount of annual investment in broadband access and services, investment that would likely add to shareholder value, is not at present being made.”
“it is not clear how the presence of a utility-style operator would be compatible with promoting competition, or would work successfully alongside current market players such as Virgin Media, to say nothing of the many other smaller providers of broadband access infrastructure, without stifling competition and the growth of alternative networks.”
“We believe Ofcom has been right not to rule out full separation; that option should be kept firmly on the table … If the regulator were to place more emphasis on Openreach’s quality of service, BT would voluntarily invest more in the infrastructure to avoid significant penalties. Should BT fail to offer the reforms and investment assurances necessary to satisfy Ofcom’s and our own concerns, then the regulator will need to set in train the steps to enforce full separation of the Openreach business.
… Should Openreach remain part of the BT Group under a strengthened model of functional separation, BT should be obliged to allow Openreach to raise finance independently in the capital markets in its own right, and to make investments that meet the business’s own cost of capital. We have every reason to believe that Openreach would be a very attractive investment vehicle to longer-term institutional investors, which could in turn facilitate increased investment in infrastructure.”