Deregulation of the Telecom Sector and its Impact on the Overall Economy

November, 2005 www.adlittle.com

Executive Summary

Deregulation stimulates infrastructure investment and has a positive impact on the overall economic growth and consumer welfare
Executive Summary In many countries deregulation of the telecoms sector is being discussed as a means to stimulate investment into new infrastructure The continuation of a regulatory policy that was designed to support the liberalization of telecoms markets favors competition on existing technology platforms and makes investment into new infrastructure less attractive By analyzing regulatory policy changes in the US over the last years it becomes evident that deregulation has led to significant investment announcements of the leading fixed operators in the country Several studies suggest a positive impact of deregulation on the amount of investments in the telecoms sector and on the overall economy; a positive relationship between investments into the ICT sector and economic growth is common sense To realize welfare gains, regulatory policy must pay attention to market and technology changes and consider deregulation to stimulate investments into new infrastructure platforms

Agenda

1 2 3 4 A

Introduction (De-)Regulation Perspectives Market Perspectives Conclusions Annex

Introduction Key Questions

In many telecom markets, deregulation is currently discussed; this discussion paper examines the impact of deregulation on the overall economy

Having achieved significant welfare gains after liberalization of the telecom industry, many markets are considering deregulation
Key Questions In which countries is deregulation currently disscussed and what are the most relevant issues? What would be the impact of deregulation on investment, innovation and overall welfare? Is there evidence of successful deregulation and what are the lessons learned?

In this paper we will:

Explain the life cycle from liberalization and regulation towards deregulation and give an overview of countries where deregulation is currently discussed Describe the relationship between (de-)regulation, market dynamics and telecom operator's investment decisions Provide evidence of the positive relationship between deregulation and investment decisions based on a country case study Draw conclusions on how deregulation can create incentives for more innovation and investment

Introduction Definitions

Regulation supports the liberalization process from a monopoly to a competitive market

Market liberalization encourages the entry of new players Liberalized markets are often regulated to prevent abuses by de facto or legal monopolies and to protect consumers' and new entrants' rights Liberalized telecom markets have been regulated to achieve publicinterest objectives (such as widespread service availability) and to avoid abuse of market power by incumbents through price discrimination, cross subsidization and remonopolization Network owners viewed as having considerable market power are obliged to provide access to other market players (non-discriminating and based on regulated prices) While achieving a lasting competitive market environment, deregulation is a logical step to sustain the further development of the industry The rationale for deregulation is that less regulation will lead to higher competitive intensity, an increase in related investments, more innovation and higher customer benefits

Liberalization

Regulation

Deregulation

Introduction Milestones

Deregulation is the process of lowering the level of imposed regulation and should be introduced as competition develops
Regulatory Milestones in Establishing Efficient Markets Liberalization
Main targets
Encourage competition to increase efficiency and lower prices

not exhaustive

Regulation
Achieve public interest objectives Avoid sub-optimal market structures Existing public interests - information society - broadband diffusion - avoidance of digital divide Public interests not achieved Discrimination (service & price) Low investment level Lack of innovation

Deregulation
Stimulate investment in new infrastructure Establish technology competition Efficient market and competing technologies Players that are willing to invest in (additional) networks Technology alternatives available Limited investments and therefore limited technological innovation Stagnating price / performance levels due to limited technology competition

Preconditions

Established basic infrastructure Additional players that are interested in entering the market No sustainable competition will develop High prices due to inefficiencies Lack of innovation due to low level of competition

Consequences of failure

Agenda

1 2 3 4 A

Introduction (De-)Regulation Perspectives Market Perspectives Conclusions Annex

(De-)Regulation Perspectives Regulatory policy crossroad

Policy makers face a choice between protecting competition in static markets by regulation or accelerating dynamic market effects by deregulation
Regulatory Policy Crossroad Ongoing Regulation
Provide equal terms of access Universal service obligation Price regulation Local Loop Unbundling (LLU) Wholesale obligation Regulatory certainty constricted in favor of consumer interests Competition is mainly based on existing technology platforms (infrastructure) Limited possibilities to differentiate due to enforced infrastructure sharing obligations at regulated prices Limited investment incentives for incumbents due to expected low / negative ROI

Deregulation
Prioritization of regulatory certainty Regulation limited to bottlenecks Focus on provisioning of high investment incentives (i.e. regulatory holidays) No regulation of new infrastructure and markets (regulatory forbearance) Market is driven by technology innovation Investment into new infrastructure could be used as a means to differentiate Increase of infrastructure based competition Acceptance of short term market inefficiencies

Regulatory Policy

Regulatory Impact

Continued regulation supports development of static markets

Deregulation supports development of dynamic markets

Deregulate if the expected overall welfare gains outweigh short term market inefficiencies
7

(De-)Regulation Perspectives Deregulation Discussions

To stimulate additional investments in the telecom sector, deregulation is being discussed in many countries
Current Deregulation Discussions
Country US Intention of Deregulation
Fade out of unbundling, line sharing and collocation obligations for broadband connections No unbundling obligations for future FTTx infrastructure Fade out of unbundling obligations for FTTx Ending of compulsory provision of LLU Enable potential investors to set out access terms and conditions before investment Framework for forbearance of high speed intra-exchange digital services Partial deregulation of local telecom market "Regulatory holiday" i.e. forbearance of unbundling obligation for FTTx/VDSL infrastructure investment Deregulation of international calls

not exhaustive
Background / Reasoning
Decline in investment Imparity between cable and telco regulation Enable investments in network infrastructure to earn returns adequate to the associated risk Investment certainty for additional networks

Status

Implemented

Hong Kong

Implemented; LLU phase-out 2008

Australia

Subject to approval

Canada

Bell Canada's application to react on pricing and fierce competition

Ongoing hearing, decision Jan. 2006 Need for EU approval; Affiliation in German telecom act

Germany

Investment incentives Regulatory certainty Incumbent lost significant market power in the international voice business

Source: Country regulators 2005 8

Agenda

1 2 3 4 A

Introduction (De-)Regulation Perspectives Market Perspectives Conclusions Annex

Market Perspectives - Chapter Summary

Deregulation encourages operators to innovate by investing in new access technologies

Summary
Increased infrastructure competition raises consumer welfare and operators would be willing to invest in case of an adequate ROI Market convergence may result in the entrance of neighbouring players in each others core business, increasing the pressure for innovation and related investment Market convergence and related infrastructure competition is more likely to take place in dynamic markets Deregulation is expected to positively influence the infrastructure investment decisions of incumbents and to unlock dynamic market effects Based on market studies in the US, we expect deregulation of the telecom sector to stimulate investment in new infrastructure There is a common understanding in the US that regulation resulted in a decline of infrastructure investment Recent studies suggest that deregulation of the telecom sector has a considerable positive impact on employment, tax receipts, consumption and GDP

10

Agenda

1 2 3

Introduction (De-)Regulation Perspectives Market Perspectives 3.1 3.2 Market Drivers Case Study

4 A

Conclusions Annex
11

Market Perspectives Market convergence

3.1

Market convergence may result in the entrance of neighboring players in each others core business, increasing the pressure for innovation and related investment
observed convergence trends

Fixed Operators

Mobile Operators
Mobile enters fixed voice & broadband market

Comments Convergence increases the choice for consumers Players are increasingly under pressure to differentiate through investments into new infrastructure and technology Incumbents find it hard to defend themselves because they are the only market participants restrained by regulation policy. Differentiation through capital expenditure is not possible if regulatory policy will grant access to new infrastructure to competitors

Fixed enters TV market (TVoDSL)

Fixed enters mobile voice market

Mobile enters TV market (DVB-H)

Cable enters fixed voice & broadband market

Platforms enter fixed & mobile voice market (VoIP) DVB-T and satellite attack cable TV

Cable / TV

Other Platforms & Players

12

Market Perspectives Market dynamics

3.1

Market convergence and related infrastructure competition is more likely to take place in dynamic markets
Dynamic Market
Generation of new revenue sources Long term welfare gains 6 Competition between multiple technologies Regulation 1 Competition on existing infrastructure

Static Market
Lower consumer prices Revenue decline

Service 5 innovation based on new infrastructure

Service commoditisation

4 Investment to innovate Investment multiplier effects

Capital expenditure Deregulation

3 Differentiation (service, brand, etc)

Investment to stabilize returns only Short term welfare gains

Company related results

Market development & company (re-)actions

Welfare related results 13

Market Perspectives Operators Options

3.1

Deregulation is expected to positively influence the infrastructure investment decisions of incumbents and to unlock dynamic market effects
Incumbents Investment Options
Options
1 2a 2b

illustrative

"Business as usual"
Description No investment in new infrastructure Differentiation is focused on marketing, brand, service application and packaging issues Competition is carried out on existing technology platforms which leads to commoditisation and limited differentiation potential

Invest (based on current regulation)

Investment in new infrastructure but regulation behaviour potentially destroys business case, creating financial uncertainty High risk results in lower expected ROI No competitive edge and limited differentiation possibilities due to access and wholesale requirements

Invest (after deregulation)

Investment in new infrastructure Market development and competitors behaviour during investment phase still unclear Possible first mover advantages Investment payoff is unproven

Implications

Attractiveness

Impact on Economy

Risk of aging infrastructure Innovation might be limited to existing technology platforms

Ongoing arbitrage business models

Positive impact on welfare due to additional investments and service innovation

14

Agenda

1 2 3

Introduction (De-)Regulation Perspectives Market Perspectives 3.1 3.2 Market Drivers Case Study

4 A

Conclusions Annex
15

Market Perspectives Case Study

3.2

There is a common understanding in the US that regulation resulted in a decline of infrastructure investment
Overview of US Regulation Approach
Federal Communications Commission (FCC) Principles & Policy Goals:
Encourage the ubiquitous availability of broadband access to the Internet for all Americans Ensure that broadband services exist in a minimal regulatory environment that promotes investment and innovation Develop an analytical framework that is as consistent as possible, across multiple platforms

Telecom Act of 1996

Mandatory items: Interconnection Resale Unbundled access to network elements Number Portability Universal service contributions 911 rules Definition of details in the following years Extensive unbundling and resale obligations on RBOCs to encourage competitive entry of competitors into local markets

Market development
No significant development of infrastructure based competition for local telecom services Market exit of numerous resellers Asymmetric regulation between cable and telecom operators Significant decline in long distance market revenues Significant decline of investment in the public telecom market since Y2000

Annual ILEC & CLEC Capital Expenditures (bn USD)

50 40 30 20 10 0
1996 1997 1998 1999 2000 2001 2002 2003

Sources: FCC and court documents, T. Rowe Price, Arthur D. Little analysis 16

Market Perspectives Case Study

3.2

In the US unbundling obligations for new infrastructure investments by RBOCs have been abolished
Obligations to Regional Bell Operating Companies in US
Obligation UNE-P Explanation
Unbundled network elements-platform. Allows end to end service without owning infrastructure Unbundled network elements-loop. Local copper loop (does not include switching) Access to the higher frequency portions of the local copper loop to provide DSL services Allowed ISPs to buy DSL services at wholesale prices and resell them to end customers Refers to both FTTH and FTTC with a final copper connection

Telecom Act 1996

In force, "costbased" pricing

New Rule
Eliminated

Comments
Effective dates of UNE-P elimination are not uniformly defined

UNE-L

In force, "costbased" pricing

Remains

CLECs will not be able to service customers unless they combine UNE-L and installation of their own infrastructure Line sharing is no longer available as an unbundled element. A 3 year transition period is established, with new orders only being accepted during the first year No future obligation to provide access to wholesale wireline broadband Internet services. One year transition period. ISPs may still negotiate commercial wholesale agreements with an RBOC No unbundling requirement in greenfield situations. Where fibre replaces copper or is installed alongside, limited unbundling requirements (either provide access to narrowband fibre or to a spare copper loop)

Line Sharing

In force, "costbased" pricing

Eliminated

Wholesale DSL Services Fibre and Hybrid Loop Unbundling

In force, "costbased" pricing

Eliminated

No rule

Not required

Note: Please refer to glossary in appendix

Sources: FCC and court documents, Arthur D. Little analysis 17

Market Perspectives Case Study

3.2

FCC deregulation decisions have been directly followed by investment announcements of telco operators
Timeline of Deregulation and Market Reactions
FCC Decisions
December: FCC introduces amended regulation concerning unbundling obligations

March: Cable modem declared as "information service" by FCC*

February: FCC deregulates new FTTx connections, line sharing and collocation obligations

August: FCC deregulates fiber to apartment buidings

October: FCC confirms the deregulation of FTTC connections

August: FCC deregulates wireline broadband Internet access services (copperline DSL)

2002
Reactions

2003
August: Verizon Statement

2004
October: SBC Statement

2005
June: BellSouth Statement

Investment

October: SBC Investment Announcement

October: Verizon Investment Announcement

June: BellSouth Investment Announcement

*In June 2005 the Supreme Court asserted the FCC's cable ruling (Brand X Case) Source: FCC Policy highlights of Michael K. Powell's FCC Tenure (2005); FCC Press Releases and Web Site; Arthur D. Little analysis 18

Market Perspectives Case Study

3.2

The FCC' deregulation decisions have been highly welcomed by the largest s local incumbents
Statements to Deregulation by RBOCs
1

This is an important step This decision will help accelerate deployment of broadband networks, enabling greater choice and increased access for consumers. Susanne A. Guyer, Verizon senior vice president for federal regulatory affairs, August 5, 2004

"with this positive policy movementThe path forward is much clearer. This is the latest in a series of broadband rulings that demonstrate this Administration and the FCC understand that keeping outdated regulation off of tomorrow's technology will boost jobs, investment and innovation.." SBC Chairman and CEO Edward E. Whitacre Jr., 14 October 2004

"By rejecting the CLEC petitions and moving quickly to bring regulatory parity for highspeed broadband providers, the FCC can spark even more investment and faster delivery of innovative services to customers..." Herschel Abbott, BellSouth vice president governmental affairs, June 30, 2005

Source: Press clippings, Arthur D. Little analysis

19

Market Perspectives Case Study

3.2

The deregulation decision was followed by large scale investment announcements by the RBOCs
Investment Announcements by RBOCs*
Company
4

Announcement
Fast as light, Verizon is moving to roll out advanced fiber-based broadband technology to customers in six more states.
At a news conference here today, the company announced new fiber-to-the-premises (FTTP) deployment to homes and businesses News Release, Oct. 25, 2004

Details
Target is for about half of the homes in the covered areas to have FTTH or FTTN by end-2008, i.e. 15 million Total investment of $15-20 billion Intention to hire between 3,000 and 5,000 new employees by the end of 2005 Project Lightspeed: Target is to reach 18 million homes by 2007 / 2008 (17 mio FTTN + 1 mio FTTH) Cumulative capex over 3 years is expected to be about $4 billion + $1 billion for investment in customer activations Capex in new infrastructure is about 1 bn$ in 2004 and 1.3 bn$ in 2005 Installations of fiber-to-the-curb in 2004 were 126,000 and 200,000 are estimated in 2005

SBC Communications Will Deploy Advanced Broadband Services To Reach 18 Million Homes In 2-3 Years
SBC Communications Inc. said today it will dramatically accelerate its plan to build a new fiber-optics network into neighborhoodsin two to three years rather than five years as previously announced Press Release, Oct. 14, 2004

BellSouth Boosts Fiber Deployment Following FCC Order

BellSouth told the FCC today that it plans to deploy fiber to almost 60 percent more locations in 2005 than it did in 2004Although BellSouth had installed fiber in many branches of its network, the rate of deployment rapidly increased once the commission's action removed the disincentive Press, June 30, 2005

Source: Press clippings, Arthur D. Little analysis

*) Qwest has not made an investment announcement related to the FCC rulings

20

Market Perspectives Case Study

3.2

There will be significant increase of new infrastructure investment and additional FTTx homes passed until 2007
RBOCs Communicated FTTx Investment
Company Annual Capex in New Infrastructure ($ bn)
4 3 2 1 0 2003 4 3 2 1 0 4 3 2 1 0 2003
10 5
3,4
Verizon SBC Bellsouth Qwest Verizon Verizon +SBC + Qwest Verizon + BS

RBOC Coverage

n.a.

0,9

2,0

2,9

3,8

2004

2005e

2006e

2007e

n.a.
2003

n.a.
2004

n.a.
2005e

1,6

Annual add. FTTx homes passed (m)

2007e
15

2006e

n.a.

1,0

1,3

n.a.
2006e

n.a.
2007e

0 2003 2004 2005e 2006e 2007e

2004

2005e

Source: Press clippings, Arthur D. Little analysis

21

Market Perspectives Case Study

3.2

In addition to RBOCs, cable operators and competitors have announced to invest into broadband technology
Investment Announcments by Other Market Players
Company Announcement

examples
Details

OEN

OEN plans to offer integrated IPTV OEN Plans Large-Scale FTTH Deployment in Houston announced plans to deploy FTTH to 1,600,000 households in service, 10 to 100 Mbps Internet, Voice, Video-on-Demand (VOD) and other Houston, the 10th largest television market in the U.S. The broadband applications company plans to launch its United States service offering in OEN said it has acquired programming December 2005 agreements for IPTV distribution of over Press release, October 2005 400 television channels Agreement with Level 3 Comcast Extends National Fiber Infrastructure Communications to expand fiber to provide inter-city and metro dark fiber as part of Comcast's footprint extension of its fiber footprint. This backbone ensures that Network expansion including fiber Comcast has a technically advanced and fully upgradeable capacity, routing and optical nationwide broadband network equipment Company press release, December 7, 2004

Covad Announces 2004 Network Expansion Initiative Covad today announced plans to expand its nationwide coverage area and customer reach for digital subscriber line (DSL), frame access, and T1 broadband services. Company press release, January 7, 2004

Installation of additional broadband equipment in approximately 200 central offices across the nation, increasing Covad's nationwide broadband network to more than 2,000 central offices broadening the access network enables Covad to more efficiently utilize its core ATM network

Source: Press clipings, Arthur D. Little analysis

22

Market Perspectives Case Study

3.2

Deregulation is expected to trigger substantial growth of consumer surplus due to increased broadband penetration
Expected Broadband Penetration & Consumer Surplus
Consumer surplus ($ bn)
45 40 35 30 25 20 15 10 5 0
4,5 5,9 6,6 17,7 22 8,1 26,4 34% 41% 10,6 47% 12,9 52%

Household broadband penetration (%)

57%

Comment
Consumer surplus is defined as the value consumers place on a good or service above what they actually pay A report to the US chamber of commerce predicts that consumer surplus from broadband alone will increase between 46% and 76% per year due to deregulation compared to the baseline case Cumulative additional consumer surplus in the years from 2005 to 2009 could be up to 42.7 billion US Dollars

60% 50% 40% 30% 20% 10% 0%

12,1

2005

2006

2007
Incremental surplus due to deregulation

2008

2009

Baseline growth in surplus

Broadband penetration

Source: Hazlett et al.: Sending the right signals (2004)

23

Market Perspectives Case Study

3.2

Recent studies suggest that deregulation of the telecom sector has a considerable positive impact on employment, tax receipts, consumption and GDP
Expected Economic Impact of Deregulation in the US
Difference in Level ($ bn)
30
110

Additional jobs per annum (' 000)

130 114 20,3 19,7

Comment
A study prepared by Allen Sinai et al. for the ACCF (American Council for Capital Formation) expects that deregulation will contribute up to 0.2% of additional GDP growth over the next years On average, 91,000 new jobs will be generated annually through 2008 Cumulative additional federal tax receipts will be up to $14.4 billion Personal consumption expenditure will increase from an additional $8.6 billion in 2005 to an additional $20.3 billion in 2007

140 120 100

16,6

20
69 12,9

16,4

18,3

18,8

80 60 40

10

30 6,6 1,1 2 2,3

8,6 3,4 3,9 3,7

20 0

2004
Federal Tax Receipts

2005

2006
Personal Consumption Expenditures

2007
GDP

2008
Employment

Source: Sinai et al.: Macroeconomic Effects of Telecommunication Deregulation (2004)

24

Market Perspectives Case Study

3.2

There are several studies supporting the conclusions that deregulation of the telecom sector triggers investments and overall growth of the economy
Extracts from Studies about Deregulation
1

An accurate scorecard of the Telecommunications Act 1996: Rejoinder to the Phoenix Centre Study No.7 (Crandall et al. 2003): Unbundling decreases ILECs cash flowscash flows are used to finance ILEC investments unbundling generally lowers ILEC investment in a proportionate manner "Capex increase resulting from the elimination of UNE-P regulations would have had a multiplicative effect on the economy" Regulation caused decrease of Capex leads to lower ROI and in consequence to the elimination of jobs "to address the profit squeeze"

How telecom regulations harm California consumers (Pociask 2003):

"Regulations that impede telecommunications investment harm the economy ICT investments fuel growth of productivity and are worth approximately $56bn in output for GDP (CA) Intense regulations harm investments and reduce the economic output meaning fewer jobs and lower wages

Telecom deregulation and the economy The impact of UNE-P on jobs, investment and growth (Eisenach et al. 2003): Deregulation significantly fuels further Capex "Cascading effect on overall economic growth" might lead to $13bn additional Capex in 3 years Major impact on GDP: Reform of UNE rules (-> deregulation) could increase GDP up to $102bn in 3 years Reform of UNE rules (deregulation) and resulting investments in the ICT market could create up to 669k jobs in 3 years

Mandatory unbundling and irreversible investment in telecom networks 4 (Pindyck 2004):

"[The Telecom Act of 1996] leads to an asymmetric allocation of risk and return which creates a significant investment disincentive[and] reduce incentives to build new networks or upgrade existing ones"

All studies came to the conclusion that deregulation would trigger additional investments and boost the overall welfare of the economy
25

Agenda

1 2 3 4 A

Introduction (De-)Regulation perspectives Market Perspectives Conclusions Annex

26

Conclusions Economic Impact of Deregulation

Deregulation stimulates additional investments in new infrastructure enabling overall welfare gains
Conclusions: Effects of Deregulation
Status Quo Infrastructure Investments Competition Price Decline Service Innovation Broadband Penetration GDP Overall Employment Level
Investments primarily in existing infrastructure (stable to decreasing) Limited incentive to invest into new infrastructure Competition is carried out on existing platform (static market view) Focus on arbitrage business models Competition ensures decreasing prices due to commoditization Service innovation limited to existing technologies and hence focused on e.g. service applications, product bundles and pricing only Stable growth until maturity stage Contribution to GDP by fixed telecom sector will slowly decline Declining due to high cost pressure

Deregulation
Additional potential investments by incumbents due to positive business cases Potential competitor related bandwagon investment effect Competition is carried out between platforms (dynamic market view) Business model focus on innovation More competition on access networks and services leads to decreasing prices Service innovation based on new infrastructure and technology competition Additional service innovation Increased infrastructure competition accelerates broadband penetration Positive impact through additional investments and multiplier effects The employment level in the telco industry will be stabilized due to the roll out of new infrastructure and services Potential positive impact on employment in other industries due to spillover effects

Expected Effect

27

Conclusions Economic Impact of Deregulation

Studies point out the positive relationship of ICT investments and GDP growth
Extracts from Studies on ICT Investment and GDP Growth
The economic impact of ICT Measurement, Evidence and Implications (OECD 2004): ICT investments contribute to an overall increase in capital and an increase in labor productivity ICT capital investment contributed on average 0.5% to GDP growth in OECD countries from 1995 to 2001 The contribution of ICT capital to GDP growth has strongly increased since the first half of the 1990s The effects of ubiquitous broadband adoption on investment, jobs and the US economy (Criterion Economics 2003): Effects of increased investment in current generation broadband technologies - 61,000 new jobs could be created on average per year until 2021 - Wide adoption of broadband (DSL, cable) could lead to an increase in GDP of $179.9bn until 2021 Investments into more advanced technologies (FTTH) could be up to $82.8bn until 2021 The combined investments into existing and advanced broadband technologies - will be up to $146.4bn until 2021 - will lead to a cumulative additional GDP of $414bn until 2021 - Generate on average 140,000 new jobs per year

Studies suggest that there is a considerable relation between ICT investments and GDP growth
28

Conclusions Key Success Factors of Regulators

To realize welfare gains, regulators must pay attention to possible pitfalls and behave accordingly
No Regulation of New Infrastructure
If regulation of new infrastructure investments reduces the expected ROI far below market returns of the same investment in an unregulated environment, potential investors are likely to refrain from taking the risk associated with investments To overcome this problem, regulatory policy must provide investment incentives, i.e. allow investors to benefit from first mover advantages by not regulating (or deregulating) new investments or granting regulatory holidays If the regulatory approach does not match current market conditions, regulation leads to market distortions, i.e. the risk of absent or delayed investments The regulatory approach must be reviewed on a regular basis to identify deregulation possibilities in order to keep up with market and technological developments; subsequently remaining regulation has to transfer to general competition law If market participants believe that the regulator changes the rules during the game, investments and innovation may be held back due to the uncertain regulatory environment Once the regulator has committed to a certain regulatory approach, it must also define a planning horizon during which regulation conditions are not changed

Timing of Regulatory Easing

Avoid Uncertainty

29

Conclusions Summary

Deregulation clearly stimulates investments and recent studies in the US suggest a significant positive impact on the overall economy resulting in higher welfare gains
Putting it All Together
Key Questions about Deregulation
While establishing sustainable competition in the telecom industry, many markets are considering a reduction in regulation The debate is whether and to what degree deregulation will stimulate investment and growth

(De-)Regulation Perspectives: Challenge between Operators and Customers Interests

Policy makers face a choice between protecting competition in static markets by regulation or accelerating dynamic market effects by deregulation Deregulation is a logical step on the way from a monopoly to an efficient market

Market Perspectives: Market Demand and Operators Willingness to Invest

Increased infrastructure competition raises consumer welfare and operators would be willing to invest if ROI is adequate Deregulation is expected to positively influence the infrastructure investment decisions of incumbents and to unlock dynamic market effects

Conclusion: Deregulation Results in Higher Welfare Gains!

As indicated by several studies, deregulation stimulates additional investments in network infrastructure and results in a positive economic impact To stimulate economic growth, regulatory policy must consider market and technology changes

30

Agenda

1 2 3 4 A

Introduction (De-)Regulation Perspectives Market Perspectives Conclusions Annex

31

Glossary of Abbreviations

Term Capex CLEC DSL FCC FTTC FTTH FTTN FTTP FTTx GDP GSM ICT ILEC IPTV

Definition Capital Expenditures Competitive Local Exchange Carrier Digital Subscriber Line Federal Communications Commission. US national regulation authority for telecommunications and broadcast Fiber To The Curb Fiber To The Home Fiber To The Node Fiber To The Premises Superordinate term for the different levels of Fiber deployment Gross Domestic Product Global System for Mobile Communications Informations and Communications Technology Incumbent Local Exchange Carrier IP Television

Term IP ISP LLU MIMO NGN RBOC ROI UMTS UNE UNE-L

Definition Internet Protocol Internet Service Provider Local Loop Unbundling Multiple Input Multiple Output Next Generation Network Regional Bell Operating Company (US) Return on Investment Universal Mobile Telecommunications System Unbundled Network Elements Unbundled Network Elements-Loop. Refers to the local copper loop itself, but does not include switching facilities (US) Unbundled Network Elements-Platform. Endto-end service on third party infrastructure (US) Voice over Internet Protocol

UNE-P VoIP

32

Deregulation Case Study United States

RBOCs attributed the decline in infrastructure investment to the existing regulation framework not providing investment incentives
Comment on FCC Regulation by Verizon April 25, 2001
Testimony (extracts) of Thomas Tauke, Senior Vice President Public Policy, Verizon before U.S. House Energy and Commerce Committee
Existing federal regulations handicap Verizons provision of DSL. The FCC has applied the section 251 unbundling and resale requirements to Verizon and other incumbent local telephone companies. They require Verizon to allow competitors to put their DSL equipment not only in our central office equipment buildings but also in small "remote terminal" boxes in local neighborhoods. They require us to provide not only unbundled lines from our locations to customers, but also "subloop" pieces of those lines. The FCC first required us to provide DSL-capable loops, then it required "line sharing" -- allowing a competitor to use only a portion of the capacity of the loop almost for free to provide DSL service while Verizon provided the underlying basic telephone service. Now we are also required to "line split" -- to arrange for two different competitors to share our lines, while we provide no service at all to the customer. The FCC is now considering requests from other carriers that we be required to provide our new DSL services to them at very low TELRIC prices -- that is prices that are below our costs. If we have to do this, what incentive will we have to make the investments that make these services possible? And yet that investment is exactly what you and the public expect from us. The other characteristic of the regulatory landscape is uncertainty -- participants and investors dont know for sure what the rules are. Whether Verizon must provide wholesale DSL services at discounts to their competitors and whether it must unbundle its retail DSL service are now before the courts. Our investment decisions, and the investment decisions of our competitors, will be affected by the actions of these courts and by the Commissions actions in response to them

33

Deregulation Case Study United States

Verizon announced a significant increase in infrastructure investment after the deregulation decision of the FCC
Verizon
Verizon comment to FCC decision regarding the removal of common carrier obligations and to create parity in the regulatory treatment between cable and phone company-provided broadband services. Susanne A. Guyer, Verizon senior vice president for federal regulatory affairs, August 5, 2004: This is an important step This decision will help accelerate deployment of broadband networks, enabling greater choice and increased access for consumers We commend Chairman Martin and the commission for acting quickly to move us closer to the presidents goal of broadband deployment to all Americans by 2007. Ivan Seidenberg, CEO Verizon 09/05 "Verizon wants to pass an incremental 50% of homes in his territory in the next three years"
Source: Company documents, CIBC, Arthur D. Little analysis 34 Annual capex in new infrastructure ($ bn)
4 3 2
2,9 3,8 2,0 0,9

Annual add. FTTx homes passed (m)

15 10 5 0 2005e 2006e 2007e

1 0 2003
1

2004

Verizons plans are the most ambitious of the RBOCs Roll out target is for about half of the homes in the areas in which it has traditional telephone franchises to have FTTH or FTTN by end-2008, i.e. 15 million Total investment of $15-20 billion Intention to hire between 3,000 and 5,000 new employees by the end of 2005 to help build the network Video will initially be provided in traditional multichannel cable TV distribution mode, with IPTV (only requested channels are sent to a home) later

Deregulation Case Study United States

The FCC deregulation decision paved the way for accelerated SBC investment and FTTN roll out
SBC (Rebranding to at&t)
SBC comment on the FCC decision to remove common carrier obligations and to create parity in the regulatory treatment between cable and phone company-provided broadband services. SBC Chairman and CEO Edward E. Whitacre Jr., 14 October 2004 "with this positive policy movement, the delivery of next-generation broadband and video services is no longer at some distant point in the future. The path forward is much clearer. This is the latest in a series of broadband rulings that demonstrate this Administration and the FCC understand that keeping outdated regulation off of tomorrow' technology will s boost jobs, investment and innovation. It will be equally important at the state and local level that the path remain clear of unnecessary regulatory or legislative hurdles."
Annual capex in new infrastructure ($ bn)
4 3
10

Annual add. FTTx homes passed (m)

15 10
6 1,6 0,0 0,0 0 0,0 3,4

2 1 0

5 0

2003

2004

2005e

2006e

2007e

SBC Communications announced in Oct. 2004 that it will dramatically accelerate its plan to build a new fiber-optics network into neighborhoods Project Lightspeed: Roll out target is to reach 18 million homes by 2007 / 2008 (17 mio FTTN + 1 mio FTTH) Cumulative capital investment over 3 years is expected to be about $4 billion + $1 billion for investment in customer activations Provisioning of 25Mbps, four streams of HQ video per line, Internet access and VoIP service (U.S. expectation is to offer 4 different video channels at any one time to different viewers in a household)

Source: Company documents, Press releases, Arthur D. Little analysis 35

Deregulation Case Study United States

Although BellSouth had installed fiber in many branches of its network, the rate of deployment rapidly increased once the FCC' ruling removed the s disincentive to invest
BellSouth
Bellsouth comment on the FCC decision to remove common carrier obligations and to create parity in the regulatory treatment between cable and phone company-provided broadband services. Herschel Abbott, BellSouth vice president governmental affairs. "By rejecting the CLEC petitions and moving quickly to bring regulatory parity for high-speed broadband providers, the FCC can spark even more investment and faster delivery of innovative services to customers The radical rewriting of the fiber-to-thecurb order proposed by [CLECs] runs the risk of paralyzing the ability of incumbents to evolve their networks and implement new, advanced technologies."
Annual capex in new infrastructure ($ bn)
4 3 2 1 0 2003 2004 2005e
0,13 1,0 0,20 1,3

Annual add. FTTx homes passed (m)

1,0

0,5

0,10

0,0

Capex in new infrastructure is about 1 bn$ in 2004 and 1.3 bn$ in 2005 Installations of fiber-to-the-curb were 126,000 in 2004 and 200,000 are estimated for 2005 The increase is being attributed to the decision to have no unbundling obligations on FTTC installations

Source: Company documents, Wachovia, Arthur D. Little analysis 36

Deregulation Case Study United States

OEN is an example for an alternative operator investing in new infrastructure

Optical Entertainment Network

OEN Plans Large-Scale FTTH Deployment in Houston (Oct. 2005) Optical Entertainment Network (OEN), a private investor-backed company based in Texas, announced plans to deploy FTTH to 1,600,000 households in Houston, the 10th largest television market in the U.S. The company, which has partnered with leading European and North American vendors plans to launch its United States service offering in December 2005 and begin European operations in Q2 of 2006. The company plans to offer integrated IPTV service, 10 to 100 Mbps Internet, Voice, Video-on-Demand (VOD) and other broadband applications such as, Home Security, videoconferencing and telemedicine. OEN said it has acquired programming agreements for IPTV distribution from top programming television networks and will deliver over 400 television channels, including 50 plus channels of HDTV. OEN's first deployment partner is Phonoscope of Houston, Texas, owner of the largest privately held metro fiber networks. Already the existing network reaches 200,000 household easements and is within 100 to 500 yards of approximately 1.6 million households in the 6 county areas around Houston.
Announced Services 10 to 100 Mbps Internet OEN's FISION will provide Internet service at speeds of 10 to 100 Mbps and each FISION subscriber will receive a minimum of 10 Mbps of symmetrical connectivity. Online gaming Digital video recorder with time shifting capabilities Tailored advertising Imagine seeing commercials that are tailored to customer's lifestyle and interests Personalized TV Unlimited local, national and global television channels

Source: Company website

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Deregulation Case Study United States

Infrastructure suppliers endorse the deregulation in the US in order to sustain the growth of the US broadband market
Alcatel
November 9, 2005 The following statement should be attributed to Tim Krause, Chief Marketing Officer and Senior Vice President for Government Relations for Alcatel in North America, who testified today before the Telecommunications and Internet Subcommittee on the forthcoming BITS (Broadband Internet Transmission Services) Act: "Alcatel endorses the BITS Act, and requests the Committee move it forward in the legislative process without delay. The BITS Act will ensure the continued growth of the U.S. broadband market by creating legal and regulatory certainty for the services that flow over powerful new broadband networks, such as the IPTV networks being built by Alcatel for U.S. telecommunications carriers, in several ways: "First, it generally protects nascent broadband services from regulation at the Federal, State, and local level, and does so in a socially conscious manner by preserving important public policies, such as E911. (emphasis added) "The bill creates a streamlined Federal video franchise process for broadband video services that will ensure they can be a key driver of continued broadband deployment immediately. The BITS Act achieves this goal while protecting the ability of municipalities to manage their local rights of way, as well as the video franchise fee revenue streams they have come to rely on. "Alcatel also supports the inclusion into the BITS Act of Internet Neutrality principles, which promotes consumer broadband demand, as well as protections for municipal entry into the broadband market when necessary."
Source: Verizon; Alcatel (system integrator for SBCs Project Lightspeed)

Example

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Deregulation Case Study Hong Kong (1/2)

The market liberalization has led to substantial competition and the regulator started to review its policy in 2003
Regulation Background
Type II interconnection policy was introduced in 1995 Type II interconnection is interconnection to a fixed carrier's network at the customer access network level The policy made unbundling for the incumbent (PCCW-HKT Telephone Ltd.) mandatory but required regulatory intervention only if commercial negotiations failed The policy mainly applied to three new entrants: Wharf T&T Ltd. New World Communications Ltd. Hutchison Global Communications Ltd. New competitors entering the market from 2003 were not eligible for Type II interconnection as of right (i.e. Hong Kong Broadband Network)

Results
Since 1995, new entrants followed different strategies in the Hong Kong market Hong Kong Broadband Network had no choice but to build its own network infrastructure Hutchison also started to invest into its own infrastructure New World Communications and Wharf T&T relied mainly on Type II interconnection In 2004, about 53% of households were connected by at least two independent networks, including that of the incumbent The broadband market share of new entrants (including broadband offers from the Hong Kong cable operator) amounted to 45% Narrowband market share for new competitors was about 28% of the total market

The Telecommunication Authority found that the continuation of mandatory access was justified only if benefits from facilitating competition and consumer choice would outweigh detriments arising from dampening of incentives for investment in network infrastructure and began to review its policy in 2003
Source: Hong Kong Legislative Council Brief (2004)

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Deregulation Case Study Hong Kong (2/2)

The outcome of the policy review induced the Telecommunications Authority to decide in favor of a regulation fade-out

Analysis

The interconnection rules were only partially responsible for the development of the market The infrastructure on which interconnection is based has limitations concerning future services Additional investments into new infrastructure should be stimulated to keep Hong Kong's leading edge

Options Implications

Continue regulation
Discourage further investments into advanced telecommunications networks High level of services competition and enhanced customer choice

Regulation fade-out
A regulation fade-out would mean that customers could face a reduction of choices in the short to mid-term In the medium to long term, the accelerated rollout of networks should more than compensate 75%-80% of consumers

End regulation immediately

Total withdrawal would mean that around 400 000 customers would be forced to switch to another telecommunications provider Competitors relying on interconnection would be forced to invest immediately

Decision

The Hong Kong Telecommunication Authority has chosen to fade-out interconnection until 2008 This fade out is limited to buildings which are connected by two alternative networks The Telecommunications Authority hopes that this policy will give both incumbents and competitors incentives for further investments into advanced networks

Source: Hong Kong Legislative Council Brief (2004) 40

Deregulation Case Study Canada

In Canada deregulation is discussed with respect to local exchange and digital broadband services
Canada
Intention of Deregulation Details
The regulatory body CRTC* opened a proceeding in April 2005 to determine the framework and the criteria for a framework for forbearance from the regulation of residential and business local exchange services. The proceeding covers the following issues: 1) the local exchange services that should be within the scope 2) the relevant market(s) with respect to services and geographic areas 3) the criteria to be applied to determine whether the relevant market(s) is/are sufficiently competitive for forbearance 4) the appropriate scope of the Commission's forbearance from its powers and duties 5) post-forbearance criteria and conditions 6) the process for future applications for forbearance from the regulation of local exchange services In addition the CRTC intends to determine whether there should be a transitional regime that provides ILECs with more regulatory flexibility prior to forbearance through: 1) lessening or removing competitive safeguards on promotions and the no-contact restriction under the winback rules 2) permitting the ex parte filing of tariff applications for promotions 3) the waiving of service charges for residential local winbacks The CRTC opened a proceeding in June 2005 to establish the framework and the criteria for forbearance from regulation of intra-exchange high-speed digital services (HSDS). The proceeding covers the following issues: the definition of intra-exchange HSDS; 1. the relevant market(s) with respect to services and geographic areas 2. the qualitative and quantitative criteria for determining market power 3. the scope of the Commission's forbearance from its powers and duties 4. the process to consider future applications for forbearance of intra-exchange HSDS 5. post-forbearance criteria, conditions or safeguards
*Canadian Radio-television and Telecommunications Commission

Forbearance of regulation of local exchange services

Telecom Public Notice CRTC 2005-2

Framework for forbearance of high speed intra-exchange digital services

Telecom Public Notice CRTC 2005-8

Source: CRTC, Arthur D. Little analysis

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