Ofcom's Strategic Review of Telecommunications - Phase II

Ofcom’s Strategic Review of Telecommunications – Phase II

                           Response by Vodafone UK

                                      Summary

The bulk of this second consultation document on Ofcom’s Strategic Review of
Telecommunications is concerned with an analysis of and proposals for dealing with
issues arising in the fixed telecommunications market. In general, there is a great deal
in Ofcom’s analysis and proposed way forward with which Vodafone agrees.
However, given Vodafone’s status as a mobile company, this response is limited to
those issues which have a bearing on the mobile market or are otherwise of direct
importance to Vodafone.

The only issue of real substance for mobile which is discussed at some length in the
consultation document is customer switching behaviour, and factors which might
encourage or inhibit that. Vodafone commented extensively on this area in its
response to the Phase I Strategic Review of Telecommunications consultation
document, and stands by those comments. This response expands on some of the
issues raised, and deals specifically with the questions and proposals covered by
Ofcom, but Vodafone’s overall position remains the same: there is no customer
information or switching problem in mobile which would merit regulatory
intervention.

                                Specific Questions

1. Do you agree with Ofcom’s proposed principles for regulation of telecoms
markets?

Subject to one proviso, Vodafone agrees with each of the seven principles. The
proviso is that it is vital to couple the regulatory principle with the trigger for
regulation at all. This concept is captured in Ofcom’s overall regulatory principles,
which stress that, for example, “Ofcom will operate with a bias against intervention
...” and “Ofcom will always seek the least intrusive regulatory mechanisms to achieve
its policy objectives”.

This broader perspective is critical to an acceptable application of the seven proposed
telecoms regulatory principles. For instance, it is not appropriate to “promote
competition at the deepest levels of infrastructure where it will be effective and
sustainable” unless there is a real problem arising from lack of competition bringing
disbenefits to end-customers which requires intervention in the first place.

Similarly, Vodafone does not agree that it would always be appropriate to “create
scope for market entry that could, over time, remove economic bottlenecks”. Ofcom
should first make an assessment about the extent of the disbenefits for end-users

associated with the apparent economic bottleneck, and the extent of interference in the
market which would be required to create scope for market entry that might overcome
those disbenefits. In Vodafone’s view, it is quite possible that in some circumstances
this assessment could conclude that the medicine would be more harmful that the
ailment.

A concrete example from the mobile arena would be call termination. Ofcom has
concluded that this is an economic bottleneck which requires regulation, with the
appropriate remedy being some form of price controls. However, there is still
substantial scope for disagreement over the real extent of any disbenefits to end-
customers which might actually arise from unregulated mobile call termination. This
suggests that there are two tests which Ofcom would have to address prior to
encouraging market entry to remove this apparent bottleneck:

   •   Establish the real extent of customer disbenefits, and assess whether that level
       is sufficient to justify any form of regulatory intervention
   •   If the conclusion was that regulatory intervention would be appropriate,
       consider whether continuation of some form of price controls would be less
       intrusive than intervention in the mobile value chain to artificially encourage
       market entry to remove the supposed call termination bottleneck.

3. In what circumstances would it be appropriate for Ofcom to make a reference
under Section 131 of the Enterprise Act?

In Vodafone’s view, this has to be a real option for Ofcom, but there is a high hurdle
to be surmounted before any such reference would be appropriate. BT should not be
permitted to frustrate the legitimate demands of Ofcom to change its fundamental
approach to decision-making and dealing with competitors, but BT should be allowed
a reasonable period of time to demonstrate that this will not be the outcome.

4. Should Ofcom adopt a broad approach of focusing regulation on enduring
economic bottlenecks while tackling the problem of inequality of access head-on?

Vodafone supports Ofcom’s proposals in this area. As a mobile operator, Vodafone is
not directly affected in the way that fixed operators typically are. However, mobile
operators have also had experience of the difficulty of dealing with BT in a context in
which they are a competitor as well as a supplier. There is a great deal to do in terms
of changing attitudes and outcomes.

There is a real danger that by trying not to place undue obstacles in the way of BT’s
efficient operation Ofcom will go too far towards accommodating a continuation of
BT’s past approach and practices. This is a rare – possibly unique – opportunity to
bring about a step change in the operation of the UK telecoms market, and to take full
advantage of that may well require Ofcom to impose certain inefficiencies on BT to
deliver the best overall outcome.

If it were to prove impossible to make an “equality of access” approach work in
practice – without driving BT to voluntary break-up, that is - that would cast a serious

doubt over whether the sectoral behavioural approach to regulation in telecoms could
ever justify its existence.

5. How can real equality of access be achieved at the product level?

5 a) Do you agree with Ofcom’s definitions of the various forms of equivalence?

5 b) Do you agree that equivalence of inputs can deliver more effective equality
than application of equivalence of outcomes?

5 c) Do you agree with the principles proposed on where equivalence should be
applied and the specific suggestions for individual products?

5 d) How do you suggest the principle of equality is achieved for ‘associated
products’ that BT does not depend on (such as migration products)?

This last subsidiary question is the one of most direct interest to Vodafone, as it is a
major buyer from BT, but typically not the same “products” as BT would provide to
itself. In Vodafone’s view, there is no answer separate from the answers to the
broader questions about making equality of access work on common products. In
other words, if BT makes the necessary organisational and cultural transition to be
able to provide effective equality of access on common products, it is possible -
perhaps likely - that the position on associated products will be acceptable. If not, it is
hard to see how anything changes from the position today, which is by no means
satisfactory. BT’s supply of associated products is not, yet, customer-driven: it is
determined more by what will suit BT rather than BT’s customer, and it is clear at
times that “what would suit BT” encompasses BT’s commercial as well as its
operational interests. If BT becomes genuinely customer-focused in relation to
common products, there is a reasonable chance that this will read across to associated
products, at least to a greater extent than today.

Because Vodafone is concerned about this linkage, it is concerned about the possible
implications of Ofcom’s discussion about the different forms of equivalence.
Vodafone would not dispute that the two forms could both exist, but it is sceptical that
targetting equivalance of outcomes would ever really amount to a substantial change
from the status quo. It may be that that is the only rational approach to take in the
case of certain products, particularly those reaching the end of their lives, but it is
vital that the programme as a whole is heavily focused on delivering equivalance of
inputs. Only that will drive the internal changes necessary within BT. So Vodafone
would urge Ofcom to be very demanding when presented with arguments as to why
equivalence of outcomes is appropriate for a particular product or products. As noted
above, this is really a one-time only opportunity. It should not be allowed to be
watered down to the point where the concept of equality of access is emasculated.

6. What behavioural changes by BT do you believe would be necessary to achieve
real equality of access?

Critically, BT must become customer-focused in relation to dealings with telecoms
companies – even though these are necessarily also its competitors. This is not an
easy transition for any company, least of all one with BT’s in-built incentives to
favour its own priorities and put obstacles in the way of competitors, so BT will need
lots of encouragement.

7. How should Ofcom reflect the competing considerations of efficient investment
and consumer protection in determining the regulated returns that BT may earn
from its network?

Vodafone has addressed this question in its response to Ofcom’s related consultation
on Next Generation Networks. For ease of reference, the relevant part of Vodafone’s
response is repeated below.

Vodafone agrees with the three core considerations relevant to BT’s regulated return
outlined in paragraph 7.5 of Phase 2 of the Strategic Telecommunications Review:

   •   The relative importance of the incentives for BT to invest

   •   The scope for investment by competing network providers

   •   The need to protect the consumers from excessive charging

However, when applying these principles generally and in considering the last of
these factors Vodafone urges Ofcom to keep in mind that narrow market definitions
can mask the effect of competition in two-sided markets.

A market is two-sided when there are two distinct groups of customers, those
customers need each other in some way, and a ‘platform’ can bring the two sides
together and harvest the externalities between them in ways that they cannot do for
themselves.

A mobile network is an example of a two-sided market. It provides a two-sided
platform in the business of helping people who want to receive calls ‘get together’
with, amongst others, people who want to make calls to them from their fixed line. In
two-sided markets competition will act to keep the overall level of prices in line with
costs, as it does in other types of market; the individual prices of services supplied to
the two sides, however, can differ from the individual costs, no matter how strong
competition among platforms.

Vodafone sets out below some principles relevant to regulated returns allowed by
BT’s NGN. However, Vodafone would like to sound a note of caution. Ofcom must
be careful to assess the relative weight of the incentives on BT to invest in its 21CN.
As Ofcom notes in paragraph 1.5 “BT’s stated aims for the programme are to reduce
costs (by £1 billion per annum by 2008/9), improve speed to market for new services,
and to improve customer experience”. Vodafone accepts that market risks should be
reflected in the cost of capital permitted. However, deployment risk should only be
accommodated to the extent that it is outside of the control of BT i.e., it is a market
rather than a firm specific risk. If Ofcom were convinced that the primary benefits of

21CN in the core are savings in cost (“…[m]any considered that network operators
will have a strong cost-reduction incentives to deploy such networks1) then this
investment may be no more ‘risky’ (in terms of the returns expected by BT’s owners)
than BT’s historic investments (or compared with investment in a Next Generation
Access Network).

Ofcom recognises that “[t]here are a number of ways in which Ofcom can influence
the investment climate…” including “[s]etting appropriate regulated returns for BT’s
regulated products, that take account of the commercial and technical risks associated
with its investment in 21CN”. (para 1.18)

To the extent that it is necessary to apply economic regulation to BT’s Next
Generation Networks (NGNs), two issues are important:

      •   the depreciation profile assumed in the “regulatory contract”;

      •   the appropriate regulated return for such investments.

Depreciation profile assumed in the “regulatory contract”

The key to incentivising investment in NGNs (where such investment subject to
economic regulation) will lie in establishing the correct “regulatory contract” between
BT and Ofcom. In particular, the depreciation profile will need to be agreed such that
BT can expect, a priori, to recover its investment (including an adequate rate of return
allowing for risk) over the life of the asset.

The importance of the “regulatory contract” is clearly demonstrated when one
considers that utilisation on the NGN may be low in the early years of investment.
An economic depreciation profile would allow BT to recover little of its initial
investment in the early years, but provide an a priori expectation of higher revenue
towards the later years of the assets’ life. Such a scheme is acceptable only if
consistently applied throughout the assets’ life under the “regulatory contract” (and
accompanied by a sufficient rate of return to allow for the additional risk of expected
revenue recovery skewed towards future years).

Ofcom and BT must be clear about the depreciation profile that will be used, either
whether this is exogenously input into the regulatory price determinations, or is
implicit through an existing price cap. For example, if origination and termination of
voice calls are migrated to an NGN under existing regulated charges, the implied
contribution of these calls to capital cost recovery of the NGN must be specifically
noted in the context of the agreed depreciation profile for the NGN assets over their
entire expected life span.

It would be unacceptable for an existing price cap to be used in the early years of the
assets’ life, with a new economic depreciation profile imposed in later years, without
any attempt at achieving an expectation of full cost recovery over the assets’ whole

1
    Paragraph 3.23 Strategic Review of Telecommunications – Phase 2 Consultation.

life, including a return that reflects risk inherent in a cost recovery that anticipates
volumes in future years.

The appropriate regulated return on NGNs

The consultative document states “Ofcom could also take account of the risk attaching
to new investments in risky assets relative to stable legacy assets by applying a
different estimate of the cost of capital for such investments.” (para 3.40)

To the extent economic regulation of NGNs is required, Vodafone agrees it is
essential that an appropriate cost of capital be used, taking full account of the risk of
the investment. Vodafone looks forward to contributing to this debate in the
forthcoming consultation that it understands Ofcom will be initiating shortly (referred
to in paragraph 3.40 of Ofcom’s Consultation Document).

However, Vodafone would like to note a few comments prior to this consultation. In
summary, these are:

    • The risk of an NGN investment may have asymmetric properties, implying that
       a CAPM framework will result in a downward bias to the estimate of the true
       cost of capital;

    • The risk of an NGN investment will be related to the depreciation profile
       assumed in the “regulatory contract”.

    The risk of an NGN investment may have asymmetric properties, implying that a
    CAPM framework will result in a downward bias to the estimate of the true cost of
    capital

The asymmetric property of investment returns arises since regulation will only
constrain returns from the investment if it proves to be profitable. If the investment is
loss making, BT risks losing a high proportion of the investment. However, if the
investment is successful, the regulatory price cap will constrain returns. This is
especially the case if, once demand has been proven, Ofcom takes the view that the
risk is low, and resets the price cap prior to full recovery of the initial investment
(which be many years in the case of a fibre network). This suggests that the
“regulatory contract” must include provision for a continuing risk adjusted cost of
capital for the entire life of the initial investment, even after demand for new services
provided by the NGN has been proven.

The asymmetric risk of NGN investment will also arise if Ofcom decides to adopt a
“most efficient technology” approach to regulation. BT will commit to NGN
technology, but the cost saving benefits will be contingent on a degree of new service
demand. If these savings materialise (or are exceeded) BT will share these saving
with consumers in future cap reviews. If, the net savings do not materialise, and
Ofcom decide to retain a cost based on the old technology (which under hindsight is
the most efficient), BT will suffer the entire loss. BT’s risk will again be asymmetric.

Again, a possible solution is that the “regulatory contract” makes clear that a higher
risk adjusted cost of capital will apply throughout the life of the initial investment in
the NGN, even after demand has been proven.

It could be argued that compensation for these (asymmetric) risks are already
embedded in BT’s cost of capital, and that economic regulation, using a current
estimation of the cost of capital, will provide the required incentive to invest. Ofcom
estimates the cost of capital from an application of the Capital Asset Pricing Model or
CAPM. This measures risk from the company’s “beta”, the degree of co-variation of
the expected future returns of the company with those of the market, on the
assumption of symmetric and normally distributed risk. In practice, the expected
future beta is proxied by the observed historical beta over recent years. There are,
therefore, two reasons why the CAPM will not pick up the degree of risk associated in
NGN investment. First, on a theoretical level, the CAPM’s assumption of symmetric
risk is crucially violated, making the CAPM theoretically unsuitable for this element
of risk. Second, the normal methods of estimating beta from the historic co-variation
in stock price returns will not capture the forward looking risk anticipated by
investors.

   The risk of an NGN investment will be related to the depreciation profile assumed
   in the “regulatory contract”

Ofcom should also consider the fact that the degree of risk in any investment
(especially a long life asset with a fixed sunk cost base) will be affected by the time
profile for the return on investment allowed in the “regulatory contract”. For
example, if returns are “back loaded” and dependent on levels of demand towards the
end of the assets’ life, there will be a higher risk than if the return is evenly spread
over the life of the assets.

The key determinant of the time profile of the returns on the regulated assets will be
the depreciation profile used. For example, if demand is expected to grow over time,
an economic depreciation will tend to “back load” the returns to where the expected
demand is higher. This increases the risk to returns at the end of the asset’s life.

It appears, therefore, that risk, and the cost of capital, could be reduced if a more even
depreciation profile was used. This would imply a higher regulated price in the short
term, but a benefit from a lower price in the medium to long term, conditional on
demand reaching anticipated levels.

Conclusion

Economic regulation of NGNs raises complex issues in order to preserve incentives to
invest. These relate to the “regulatory contract” used to recover investment, and the
possibility that on-going re-setting of price caps within the life of the investment will
create asymmetric risk for BT, which will be difficult to quantify.

Ofcom should consider an approach of reducing the degree of asymmetric risk to BT
through a “regulatory contract” that biases cost recovery towards the front end of
investment. This will have the effect of redistributing some of the risk of NGN

investment to consumers, but will yield the benefits of a lower cost of capital feeding
through to lower regulated prices.

9. Do you agree with Ofcom’s proposed approach to deregulation of voice
services?

9 g) When do you expect fixed-mobile substitution to result in a single economic
market for voice call origination?

It is impossible to suggest a date in answer to this question not just because of the
inherent uncertainties in predicting market developments but because the implicit
assumption in the question of a single fixed market merging with a single mobile
market seems likely to prove inappropriate. It is already apparent that the degree of
substitutability of mobile and fixed services differs significantly for different
customer groups. That is true both of demographic groups within the consumer
market and for different categories of businesses. In practice, what we are likely to
see is a gradual increase in the overall competitive constraint which mobile exercises
upon the fixed market, supplemented by spikes of near- or full-substitutability for
discrete market segments. As that overall competitive constraint on the fixed market
grows, it is also likely that the mobile market will increasingly adjust to meet
customer expectations originating from experience of the fixed market, both in terms
of prices and service characteristics (such as signal strength and network reliability in
the home or place of work).

These are all healthy trends for the telecoms market overall, and in Vodafone’s view
Ofcom should encourage and track these trends and make case-by-case assessments
of the impact of fixed-mobile substitution where particular competition questions
arise rather than operate on the basis that at some future date it may be able to treat
both markets as one.

12. How can the arrangements for access and interconnection to next
generation networks best address our proposed regulatory
principles?

Vodafone has addressed this question in its response to Ofcom’s related consultation
on Next Generation Networks. For ease of reference, the relevant part of Vodafone’s
response is repeated below.

Vodafone understands that legacy interconnect will be available until 2010 and, up
until that date, migration to new interconnect will be a matter of choice for the
operator.

The transition from legacy interconnect arrangements to new interconnect
arrangements should include the following principles:

       •   A reasonable notice period of at least 12 months

       •   A binding and independent adjudication process to resolve disputes.

•   The process should not only be transparent but consistent across all
           affected parties, including BT Retail. The key issue here is timescales.
           BT retail should be given no advantage through advanced warning of
           changes (e.g., DLE closures) or be offered preferential migration
           timescales.

13. What should Ofcom’s regulatory approach be to next generation
access networks?

Vodafone has addressed this question in its response to Ofcom’s related consultation
on Next Generation Networks. For ease of reference, the relevant part of Vodafone’s
response is repeated below.

Vodafone would expect the potential for competition, as it does at the moment, to
vary by geography. BT’s move to 21CN will clearly not affect regional variations in
population density throughout the UK. This suggests that Ofcom should focus on
regulating access and interconnection where the potential for competition is limited
i.e., at the MSAN rather than the metro node (although some regulation of metro node
interconnection may be required in the short term). Vodafone supports the view that
the access and interconnection arrangements for the 21CN should not be allowed to
limit competition in core network provision.

Vodafone will leave it to others to comment on the specific areas suitable for
regulatory withdrawal. Vodafone supports the principle that the availability of fit-for-
purpose wholesale products (including those that have been commercially negotiated)
should remove the need for regulation in downstream markets. However, Ofcom will
need to be explicit about the point at which it will withdraw from regulation. At
present it is far from clear what phrases such as “as soon as competitive conditions
allow” (Ofcom’s third principle of regulation) will actually mean in practice. For
example, is the availability of a fit-for-purpose wholesale product sufficient or do
competing suppliers have to be supplying a service, or have reached a threshold
market share? Vodafone suggests that the trigger for deregulation should be evidence
of inputs (i.e., investment by competing providers e.g., advertising, brand building
etc) rather than outputs (e.g., numbers of customers acquired by the competing
downstream provider or market share achieved).

Vodafone is however sceptical that access-based competition provides a stepping-
stone to facilities-based competition—the so-called ‘ladder of investment’ thesis.
This hypothesis states that imposing access obligations will prompt market entry by
firms who, having acquired sufficient scale, will replicate the facilities that are
provided under regulation. On this view access regulation is a transitory phenomenon
that is necessary to secure the long-term development of infrastructure investment and
full competition in the upstream market.

Investments in network capex are, on this view, directly substitutional to the regulated
facilities rather than complementary or additive. The thesis is testable by examining

the investment profiles of the firms. Hausman and Sidak2 find that there is little
evidence of this having occurred in fixed markets in the United States or Canada3. US
CLECs such as Z-Tel or Citizens Communication spent $55m and $270m
respectively on renting unbundled loops in 2003 whilst incurring less than $20m in
capital expenditure between them during the same period4. In other markets such as
Canada, the capex/sales ratio of the incumbent fixed operators has exceeded that of
the access seekers. Such results are not consistent with the ‘ladder of investment’
hypothesis.

15. What can be done to facilitate the migration of complex corporate services
(e.g. VPNs) between suppliers?

This is an important issue for mobile as well as for fixed operators, as mobile can
increasingly offer services which compete with fixed. Ofcom needs to ensure that
there are no distortionary barriers to customers switching between suppliers, whether
fixed or mobile.

16. Are any alternative structures for call termination appropriate? Could
evolution to IP interconnection introduce market mechanisms that make
intrusive regulation unnecessary?

See the answer to Question 1 above.

17. What approaches should Ofcom adopt to reducing search and switching costs
in telecoms?

Vodafone will provide in a separate confidential Annex a more thorough analysis of
this issue including confidential market research data. What follows here is a
summary of Vodafone’s position relating to search and switching costs within the
mobile sector.

Vodafone acknowledges that there is a perception amongst some customers, and some
opinion-formers, that it is difficult to compare services and prices in the mobile
market. In some cases, this perception seems to extend to a belief that mobile
operators have deliberately engineered this state of affairs and wish to see it continue
as it is of commercial benefit to them. Vodafone categorically refutes this last
argument. While it can be complex to compare all mobile services and prices, this is
absolutely not Vodafone’s intention. Nor would it be possible to a single operator to
remove any such complexity. Vodafone has taken big steps in the past to address that
situation, and continues to modify its services and procedures to remove complexity.

2
  Did Mandatory Unbundling Achieve Its Purpose? Empirical Evidence from Five Countries.
Jerry A. Hausman and J. Gregory Sidak (Research commissioned by Vodafone).
3
  Hausman and Sidak find that US CLEC investments in facilities-based lines remained
broadly flat (at around 6m lines) since 2001 and that CLECs are have become more reliant,
not less, upon Unbundled Network Elements during the period 1999 to 2003.
4
  Criterion Economics analysis for SEC Form 10-Ks

Not only does Vodafone try wherever it can to avoid complexity for customers, it is
not in its commercial interests to do so.

Vodafone will continue to make efforts to communicate more effectively both with
customers and opinion-formers about why complexity arises in the mobile market and
how hard Vodafone is trying to reduce it, but the fundamental characteristics and
arguments remain. Vodafone put many of them in comments on Ofcom’s first
consultation paper, and stands by those arguments.

Ofcom’s own research data, and the discussion in the consultation document, strongly
suggest that there is no problem in terms of customer information and switching in the
UK mobile market.

However, Ofcom’s consultation document quotes the Consumer Panel as saying that
information in the telecoms market (not specifically mobile) is “often confusing or
patchy”. This is an important statement which merits careful attention
(notwithstanding Ofcom’s own research suggesting that many customers consider
information to be both adequate and easy to understand), insofar as the Consumer
Panel’s comment may be taken as a proxy for the views of other opinion-formers who
may express concerns from time to time.

   •   Is information on mobile services and tariffs confusing? As Vodafone
       acknowledged in its response to the first Telecoms Review consultation
       document, it may be that some customers find the complexity of the mobile
       market confusing at first. The number of serious national brands is now
       approaching double figures. Most have a variety of tariffs aimed at different
       market segments. Selling through retailers introduces a further tier of special
       offers. Even if there was only a single established service (voice) on offer,
       there would be a lot of information to gather to do a full comparison. In
       practice, there is also a high level of innovation, with new services (SMS,
       MMS, video, etc) and new pricing structures (such as combined text and voice
       or bundled data elements) being introduced all the time. The sheer volume
       and variety of relevant data may indeed appear confusing, especially for a
       consumer new to this market.
   •   Is information on mobile services and tariffs patchy? It follows from the
       previous point that some consumers may find that they are in possession of
       what looks like patchy information. It may take some time and effort for them
       to be sure they have assembled all of the information which they could have
       obtained.
   •   How much does it matter if information is sometimes confusing or patchy?
       Information is only a means to an end: the consumer wants to decide whether
       or not to buy any mobile service and, if so, which supplier and which tariff.
       Consumers – and Ofcom – have to decide how much information is necessary
       to make a reasonable purchase decision. In Vodafone’s view, “reasonable”
       cannot be defined as “the perfect decision” (however “perfect” might be
       construed – based on price, quality, flexibility, etc). That is not how
       commerce as a whole functions. Most consumers in most contexts are
       “satisficers”: they aim to make a purchase which satisfies their primary
       requirements. That process is just as possible within the mobile market as in
       consumer markets as a whole. Indeed, the fact that all the major players are

national operators, and provide all the key information on websites, makes it
       possible to collect more information about a substantial proportion of the
       available market in mobile than in many other high street purchases.

As part of a consideration of whether there are any features of the mobile market
which appear not to be operating satisfactorily, it is worth noting two crucial
omissions from Ofcom’s own discussion of the issue.

   •   The first is simply the role of competition in addressing any perceived
       problems. As Ofcom itself has now repeatedly confirmed, the UK mobile
       market is extremely competitive. At the retail level, there are now several
       MVNOs with a substantial market presence alongside the five network
       operators. Several of these MVNOs have based their competitive positioning
       on simple propositions – for example, Tesco Mobile prices all domestic calls
       at 20p per minute at any time, and all texts at 10p. They have clearly sensed
       the perception of complexity amongst some customers and are responding in
       the way players in a competitive market should respond. Although its product
       range is much wider than an MVNO like Tesco Mobile, Vodafone has also
       been simplifying its customer propositions over the same period (as well as
       beforehand) so at one level the market should now be more straightforward for
       customers. However, while the complexity of each competitor’s offering has
       been reduced, the number of competitors has grown: more competition means,
       at this level, more complexity. As argued above, this calls for a different
       purchasing approach for customers than the one they may traditionally have
       adopted in telecoms.
   •   The second and even more critical missing element is an understanding of
       where customers’ uncertainty arises. The most important component is the
       uncertainty customer themselves bring to the purchase decision. Unlike, for
       example, switching electricity supplier, a mobile customer will frequently not
       know what their own usage is going to be like in future. A variety of factors
       may influence this, including the introduction of new services by operators
       (such as picture messaging or video calling) and customers’ life-stage
       changes. Indeed, these may be precisely what is driving the decision to obtain
       a new handset or move to a new tariff. Telecommunications is not a
       commodity, and mobile telecommunications especially so. A customer cannot
       simply say they have consumed x units of mobile telecommunications in the
       past so they can assume they will consume x in future. For a customer new to
       mobile (as opposed to a switcher), this uncertainty is necessarily even greater.
   •   The operators’ competitive response to this situation has been to offer
       packages of services – bundles – which remove the need for a customer to be
       precise about their anticipated behaviour in order to make a sensible purchase
       decision. Customers have responded by buying such bundles in huge
       numbers.
   •   At the other end of the spectrum, even larger numbers of customers prefer the
       flexibility of paying for their mobile calls and texts as they go along. This
       prepay segment of the market is characterised by fewer and simpler tariff
       plans that the contract segment, and is particularly attractive to those who
       expect to make few calls and whose total mobile bills are therefore very low.
       Many of the new MVNOs have targeted the prepay segment first, which is
       good from the viewpoint of more competition, but does mean that companies

trying to build some kind of brand recognition in mobile are competing
       fiercely to find some “angle” on prepay pricing to catch the consumer’s eye.
       This increases the overall noise level in the marketplace which may be
       perceived by some consumers as making it more difficult to reach a decision.
       It is worth observing that the simplicity of the prepay segment, and its value,
       especially for low users, are probably far less visible to many opinion-formers
       than the contract services they themselves typically buy. Given that prepay
       customers represent around two-thirds of the entire mobile market, this would
       be a important blindspot.

The important conclusion to draw from this is not that the complexity of mobile
telecommunications is problematic, but that the dynamism of the market, and of
customers’ own usage, makes it inappropriate to approach the purchase decision as
being a question of finding the “perfect”, or even the “best” operator and tariff.
Customers should set out to find an operator and a tariff which fits their needs. If they
later decide that they have either identified a “better” operator or tariff, or their needs
have changed, then it is not difficult to switch, and the evidence is that many of them
do so.

As Vodafone argued in phase 1 of the Telecoms Review, Ofcom’s conclusion should
be that if any action is appropriate, it is in the area of media literacy; more
specifically, in helping to communicate to consumers and opinion-formers the
essential nature of a competitive, non-utility marketplace. Vodafone recognises that it
also has a responsibility to pursue the same objective.

Vodafone’s assessment is that the discussion at the end of Section 9 of the
consultation document about options to reduce search and switching costs is relevant
only for the fixed market, both because of the analysis set out above and because at a
number of critical points the Ofcom text points towards the fixed market only. If, in
contrast, Ofcom were to conclude that any of these measures appeared appropriate for
the mobile market, Vodafone would expect to have a further opportunity to comment
in detail at that stage.

18. What should be the arrangements for funding the USO in future?
19. How could competition for the delivery of the USO be organised in future?
20. Should mobile technologies be used to help address the existing USO?

Vodafone will respond in more detail to Ofcom’s separate consultation on Universal
Service.

Vodafone’s general approach is that so long as the current approach on funding
remains appropriate it is premature to start considering alternatives. Funding
arrangements must go hand-in-hand with the actual range of USO requirements, since
the anticipated costs and benefits of the latter will critically affect whether a broader
funding mechanism might be needed. Similar considerations apply to the question of
whether there could be competition to deliver USO services in future: it will depend
on the scope and value of the services required. In general, Vodafone would expect to
see the range and extent of universal services declining over time, reflecting factors
such as increasing competition, the growing range of telecommunications services

available, falling prices and increasing national prosperity. Mobile is a good example
of a new service which has partially removed the need for BT’s Low User service (at
least to judge from the take-up figures). Given the now almost universal take-up of
mobile services across all customer segments, Vodafone can see no reason why a
mobile service should not be on offer as one way of meeting a Universal Service
obligation.