Opinion: An unfortunate truth about network investment

IDC analyst Rosalie Nelson looks at the impact that regulation, in particular with regard to mobile termination rates, has on investment

It is finished (almost). Like the dance hall competitions of old, the mobile termination tango that began with such vigour seven years ago had become an exhausted industry shuffle with most parties praying for the music to stop. The lights have not quite been raised – but the industry is summoning energy for that last regulatory whirl.

The Commission’s final mobile termination determination brings both certainty and controversy: Vodafone is arguing the new rate is significantly below cost and it plans to seek a pricing or judicial review. New entrant 2degrees will continue to argue for the Commission to impose a condition that limits different pricing structures between users on the same network (on-net) and calling other networks, if the market does not respond rapidly to the threat of intervention. Telecom is keeping its head down, wisely avoiding the regulatory debate.

IDC believes the main impact of the new regulated rates is to change the underlying dynamics of market competition, which will over time flow into both pricing and the nature of mobile calling plans.

It will remove incentives for price plans to be designed to either avoid termination costs or maximise termination revenues. But it is naïve – despite the public hype – to see this as the primary input into retail prices that must also reflect cost of sales, capital investment returns and competitive strategies.

We need to view this in the wider context: MTR is no longer an industry specific-regulatory debate. It is becoming the poster child for the expression of public discontent with the industry. The public believes it has been price gouged for years by mobile (and indeed fixed) operators. And, quite frankly, industry leaders have done themselves few favours in their response.

Minimal public data means telcos have struggled to substantiate their argument about falling mobile prices and increased value over the years. They have publicly run complex investment arguments against termination, which have been translated as ‘regulate and we will refuse to invest’ — a protection of profits at the expense of public good.

There is a clear parallel in public sentiment to 2006, when Telecom was at war with government, although this time the backlash is focused on Vodafone.

And that is a pity. Yes, without question, the mobile sector has grown strongly and proved highly profitable, delivering services to a captive market with high barriers to entry. In the past two years increased competition has benefited consumers. And much of that has been driven by an empowered regulator and strong political will.

But it is also important that a balance is struck between managing short-to-mid term competitive and consumer benefits, and retaining economic incentives for investment. This goes much wider and deeper than the arguments around mobile termination: it goes to the very heart of the industry’s future. Simple economics dictate that if network investment cannot deliver a return over a reasonable period of time, then the investment won’t be made.

Here in New Zealand that argument has lost credibility: each time the incumbent has warned that investment will decline as a result of regulatory intervention, the reverse has happened once regulation is implemented. In the past three years, New Zealand has experienced unprecedented network investment growth at a time of greatest regulatory intervention.

Is that sustainable? IDC tracks and forecasts market revenues, connections and investment. It is clear total revenues are falling, remaining profit pools are being increasingly regulated, and competition is increasing, at a time of unprecedented demand for new technology and bandwidth investment.

Economic fundamentals dictate that long-term revenue and margin decline does not lead to investment growth. We are a small scale market heavily dependent on international investment - no matter the ideology of the rights and wrongs of the telco investment model, we need to be able to offer the return on investments, and the regulatory and political certainty to attract private sector capital.

Let us be clear: this is not an argument in favour of monopoly rents or a return to a model of vertically-integrated command and control.

It is, however, an argument for informed debate over the nature of infrastructure we want in New Zealand’s future.

It is a debate that has already begun, given the Government’s part-funding of the Ultra-Fast Broadband Initiative. But it has not yet addressed the impact on alternative private investment or long-term mobile infrastructure.

New Zealand’s telecommunications industry is in a process of deep and fundamental transformation. It will change all assumptions about market leadership and what defines the telco business.

It will force change in revenue and margin expectations — the days of 35 percent to 45 percent margin are gone. But it is critical that in this process the pendulum doesn’t swing too far the other way: that we don’t create an environment that marginalises investment incentives in our drive to promote competition.

It comes down to simple economics. We need to be careful that the heat of rhetoric doesn’t incinerate all opportunity for what is a valid (if unpopular) debate about how we foster and fund future investment.

Nelson is Research Director, Telecommunications at IDC

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