09/10/2006 09:00

Ballarat Community Enterprise forum

Speech by David Havyatt, General Manager Public Affairs, AAPT Ltd.

Introduction
While the title of this address is “Is there a future for regional telecommunications”, my approach is to look at the future of telecommunications in general and then come back to regional issues at the end.

In Saturday’s Sydney Morning Herald Telstra’s Phil Burgess was reported to have chosen to explain the Government’s stance on the regulation of telecommunications as “arbitrary, capricious, onerous and intrusive”. It was another big spray, delivered as an aside during an investor briefing – because, of course, Dr Burgess has been muzzled during the T3 sales process.[ 1]

But it is clear that the claim made remains the position of Telstra management. And I can assure you from a speech I heard at a Trans Tasman Business Circle lunch the Telstra Chairman Donald McGauchie agrees with the management – and the same Herald article says the Chairman was on the same theme at an Australian Institute of Company Directors lunch last week.

Is the Telstra line correct – is the regulation of telecommunications “arbitrary, capricious, onerous and intrusive”. These four words provide a convenient structure to discuss telecommunications in Australia today.

Intrusive – constitutional history
The first word to explore is “intrusive”. And I think to commence that analysis we need to start with a few bits of history.

We all know that until 1975 telecommunications was delivered by the Post-Master General’s department operating as the Australian Post Office. It is often taken as a given in Australia that the reason for telecommunications being delivered by Government was that it was either an essential service or what economists call a public good and therefore had to be supplied by Government because the private sector never would.

However, the reality is slightly different. The country in the world that always led in telephone penetration was the USA which always had a private sector delivery model. So clearly that model worked.

American academic Eli Noam in his book Telecommunications in Europe explains that the different model of Government ownership in Europe and their empires was due to two factors. The first was that the Royal postal services throughout Europe had remained one source of revenue available to monarchs that could be spent without the approval of parliaments. They were classically profitable monopolies. The second factor was that the monarchs all zealously protected their monopoly and hence when the new potentially competitive services of the telegraph and then telephones emerged these were added to their monopoly – thus creating what in the literature became referred to as the PTTs.[ 2]

The model adopted in Australia was the same as that in the UK, though until federation each colony was running its own Post Office. From the position of hindsight in 2006, where we have a raging debate about federalism and what services might be better delivered federally, we probably think there was a great deal of foresight in s51(v) of the constitution by which the Parliament shall, subject to this Constitution, have power to make laws for the peace, order, and good government of the Commonwealth with respect to postal, telegraphic, telephonic, and other like services.[ 3]

However, it appears that there was not necessarily a great degree of foresight involved. Joseph Cook, the last Postmaster-General of New South Wales and future Prime Minister observed on the eve of Federation that, though it had always been assumed that the post office should be taken over at the Commonwealth’s formation, he himself “had not heard a single effective argument in favour of doing so”.[ 4]

So there we have the essential part of the history, why Australia built a Government owned telecommunications system. And we have a history of a century of Government ownership developing a monopoly. The high market shares that Telstra enjoys of over 60% of total revenue and 90% of profit has nothing to do with the marketing genius of Solomon Dennis Trujillo III or any of the managers over the last decade – it is the consequence of over a hundred years of legislated monopoly.

Is the regulatory regime “intrusive”? Too right it is, we the Australian people decided that this was an area we wanted regulated by our national government, and over a century of regulation delivered a monopoly.

Capricious - Competition
But we all know the story didn’t end there, through the 1970s and into the 1990s a number of changes were made to introduce competition, to end the monopoly. And that is where the set of rules have been imposed that probably led to the charge that the regime is “capricious”. Certainly the regime now places great emphasis on rulings by the ACCC and it could be argued that this is all a regime just based on the whims of the Chair of that body.

To understand this charge in more detail we need to talk about competition. Competition policy in general has become pretty contentious. There are instances where primary producers have questioned a system that reduces the price for their product while increasing prices to final consumers – milk being one example.

The reasons for the change in telecommunications were simple - too many consumers were simply dissatisfied with what they were getting in telecommunications. Large business customers were frustrated at the slowness of introducing high speed data services, some like AAPT’s original parent, AAP, were frustrated that the interconnection rules prohibited them selling their content services directly. To connect a data line from AAP to customer A, and a data line from AAP to customer B was deemed to be interconnecting A and B and hence illegal. Residential customers were frustrated by an investment program that managed unsatisfied demand as the key performance measure.

At the same time technological changes from the first phase of digitisation made competition a possibility. Indeed, the global equipment industry that had been great supporters of their monopoly customers, were part of the call for change as they saw new customer opportunities. In part this was from the burgeoning corporate PABX market.

This wasn’t happening only in Australia but all around the world – it was a seismic shift. And the realisation about telecommunications intersected with a revolution in public policy about the role of the market – and the fact that some hundred and fifty years after the problem of monopoly was described by economists public policy rediscovered it. Put simply the problem of monopoly is that a monopolist produces less and therefore charges a higher price than would occur in a competitive market.

But the public policy challenge was what form should competition take. There was a suggestion that the network was a so-called natural monopoly so that competition should only be on services – this is a model called resale competition and was the first competition in mobiles. But others thought this wasn’t sufficient and there should be competition by companies building their own facilities – so called facilities based competition. The latter was the model ultimately chosen – but it did not mean that every competitor had to build a complete alternate network.

The other big issue was about the whole series of cross-subsidies that existed – from business to residential, from long distance to local and finally from city to bush. We will talk more about the USO question later.

It has been the response of Telstra to competition that has been most instructive. The very first case of note was the response of Telecom Australia to the proposal for an Australian satellite in the 1980s. One of the proposed benefits of the satellite would be to provide phone service in the most remote parts of Australia. Now this was an area that had been consistently ignored by the PMG and then Telecom Australia. While there is a bit of a story about the idea that it was a long held goal to provide telephone service to all Australians, the reality is otherwise. When the Federal Cabinet in 1968 was first considering the end of part privately erected connection to the network the submission stated;

In considering any liberalisation of the current conditions, it is necessary to exclude the vast remote areas served by the radio communications systems of the Royal Flying Doctor Service and other Outpost radio networks. The capital cost of serving these sparsely settled areas with conventional telephone facilities would run into more than $50m…. Strong pressures will continue to be exerted by those excluded but it would exceed all reasonable bounds for the Post Office to bear the huge cost of provision and maintenance of normal telephone services in such areas, especially as there would be the prospect of only very small financial return from most of the services. No other country in the world with anything like comparable areas accepts such a responsibility.

As the satellite solution was being considered Telecom Australia suddenly rediscovered these citizens and deployed the Digital Radio Concentrator System.

This behaviour was repeated in the 1990s when Optus decided to build a Hybrid Fibre Coax (HFC) network for Pay TV and telephony in the cities. Telstra followed Optus up the streets like a kid following an ice-cream truck deploying their own network.

So, the first Telstra tactic is to overbuild competitive networks that provide better services than the Telstra network.

In the bowels of competing phone companies when considering what our market offers should be we regularly delude ourselves that Telstra can’t respond because they would have to cannibalise their own base. But we know that is not true. While Telstra bleats about the supposed Government policy of uniform pricing they habitually find the ability to maintain “winback” pricing plans or to offer to communities suddenly new cheaper prices – just because there has been a whiff of competition. Economists call it price discrimination, and it used to be outlawed under the Trade Practices Act.[ 5]

The question for consumers is whether this is the behaviour you should reward or is it the behaviour that will ultimately take away all the benefits of competition.

Is the regulatory regime “capricious”? Too right it is, because it invites competition but does nothing to protect consumers from the long term consequences of Telstra’s behaviour.

Arbitrary – the USO
The next charge levelled against the regime is that it is “arbitrary”. To discuss this claim we can perhaps best start by looking at current events.

The biggest news in telecommunications discussions over recent times has been Telstra’s announced plans to build a Fibre to the Node Network (FTTN) and its subsequent decision not to because of the regulatory settings.

The negotiation with the ACCC broke down because, in the words of Dr Burgess “we ran into trouble on the levels of funding required to deliver services to households outside the FTTN footprint”, that is in regional, rural and remote Australia.[ 6] In the briefing Dr Burgess only referred to some instances of the specific connection costs of new services, but the underlying principle – that Telstra is under-funded for the Universal Service Obligation – has been often stated.

The history of the question of what the level of subsidy should be is quite torturous. But let’s have a go. From 1997 a scheme based on funding Telstra’s losses on the basis of share of industry revenue was introduced. At the same time a model developed for AUSTEL (the first telecommunications regulator) costed the USO at $1.8B. The methodology was to define a number of “ Net Loss Areas” and only regard as an area for inclusion where the net of all the revenues and all the costs was a loss. Now after the ACA (the successor to AUSTEL) had reviewed the model with industry the conclusion reached was that the actual cost was more like $550M.

Now none of this cost reflected the intangible benefit Telstra gets for “wrapping itself in the flag” of being the great Aussie telco going everywhere to connect phones. Some of you might remember the infamous Katherine ad that Telstra developed showing themselves as community spirited in how they helped out the flood stricken town - the ad was pulled because it wasn’t actually Katherine footage and one person they did show had died. But the reality is that is a Net Loss Area – funded through the USO subsidy.

The ACA and Government have assumed that costs continue to decline – and Telstra hasn’t been faced with a massive growth in the services provided in regional areas. The net cost has now come down to $180M.

Against this the ACCC has calculated the cost of the Unconditioned Local Loop service on a de-averaged basis. This calculates prices for four bands, CBD, Metro, Provincial and Rural. The ACCC prices for Bands 3 and 4 are above Telstra’s line rental price – so Telstra has now concluded that the USO cost is therefore the gap between the ULL price and line rental times the number of customers. They conclude the real cost of the USO is therefore $1.4B – and that’s what they should be compensated.

Unfortunately, they are wrong. Firstly they confuse the line loss with net loss. Secondly they forget that the cost model for subsidy is based on efficient costs – we don’t subsidise just anything. In the model it assumes that wireless is used where it is efficient, it assumes satellite is used where it is efficient. And I am still struggling to understand how Telstra justifies a National Farmers Federation affinity scheme whereby members of the NFF get a further 3% discount – surely these are already loss making customers Telstra is forced to serve?

So, I’m truly up for a discussion on the USO and its costing. But what I’d like is for customers who are deemed to be receiving a USO service that their bill arrives in a brown paper envelope that says “On Her Majesty’s Service” on the front and is a bill just for the line. That way Telstra gets to put the value on the intangibles – and the Government gets to choose the efficient technology to be used.

So is the regulatory regime “arbitrary”? Well yes I think that’s a reasonable charge. But the obligation placed on Telstra is nothing more than it already had and they have been compensated rightly for it, but the mechanisms and different costing models applied in different proceedings creates this sense of an arbitrary approach to pricing and community obligations. I’m up for a conversation on how the USO regime can be run differently.

Onerous - The future
Finally Telstra’s charge is that the regime is “onerous”. By that they mean onerous on them, and by extension that it is impeding their plans to invest.

So what happens now? We know the Government has argued that T3 was necessary to get out of the position of being poacher and gamekeeper. But will the Government fundamentally change anything after T3? I doubt anything will happen for three years after privatisation.

What we do know is that the management of Telstra thinks it is all about the shareholder. That is very modern management speak and I don’t want to go into the full version of why it is wrong. But, in brief, firms don’t get created by groups of capital coagulating in a paddock and saying “let’s grow shareholder value”. Firms are formed by people recognising a market need and proposing to meet that need by acquiring certain inputs, which includes labour and capital. They have a business if the revenue they can earn can cover the compensation they have to pay for the inputs. So it is really always about the customer, not about the shareholder.

We know that the management team in place has form in not delivering to rural and regional constituents. At least that was the substance of Dateline on SBS on 20 September. And in the interview on that show Dr Burgess gave us a view of the future in Australia when he said “We ended up in an imbroglio with that regulator. And so until that regulator came to its senses, we simply didn’t make the investments that would require us to make those investments out of the back pocket of our shareholders. We just didn’t do it.”

In all this Telstra’s management has this view that they are the whole story, that the objective of them servicing customers to make money for shareholders is the entire story and that, simply, the Government should butt out. But I’d remind them that it isn’t that simple. It is very easy to get a licence to be a telecommunications carrier in Australia. But with that licence comes some massive benefits – primarily the ability to install and maintain many facilities exempt from all State planning laws. That is a massive concession for which it is reasonable that Government impose significant obligations.

So is the regime “onerous”? Yes, but it is onerous because of the benefits the Government bestows on telecommunications carriers.

Conclusion
So I’ve agreed with Dr Burgess’s description of the regime as “arbitrary, capricious, onerous and intrusive”, but it has those features largely because that is what we as citizens expect.

For most Australians this is a commercial and political battle that they can’t directly affect. Citizens as consumers can make decisions about what corporate behaviour they wish to reward with their custom and make decisions based on more than just price.

Communities like Ballarat are lucky to a degree. You can say enough is enough – we want to take responsibility for our telecommunications future.

You can’t from a standing start transform a hundred years of telecommunications history. You can’t alone start forming a telecommunications carrier.

What you can do is be united in deciding you will determine your future. Don’t leave your future in the hands of policy makers in Canberra or the managers in Sydney and Melbourne who have expressed their view that shareholders come first. The decisions about Ballarat need to be made by you in Ballarat.

[ 1] Kate Askew, Colin Kruger, Lisa Murray and Matt O’Sullivan “After the Deluge” Sydney Morning Herald Saturday, October 7-8, 2006. Pp 37, 40

[ 2] Eli Noam Telecommunications in Europe

[ 3] Constitution of Australia available at http://www.aph.gov.au/Library/handbook/41stparl/pdf/PH_05_PART4.pdf

[ 4] Ann Moyal Clear Across Australia

[ 5] The theory of abolishing the specific provision was that where price discrimination had negative consequences it would be caught by s46.

[ 6] Dr Burgess Burgess “Telstra Fibre to the Node Briefing” 7 August 2006, available in ASX Announcements of the Investor Centre on Telstra.com.