Vodafone and Three merger with unusual remedies is a huge gamble

Regulatory dogmatism about having four mobile networks per country means Europe's telcos rarely get to merge. On the occasions they do, operators must usually relinquish spectrum or other assets as a condition of the deal. But this kind of "structural" remedy will almost certainly not be imposed on Vodafone and Three, the UK telcos whose proposed marriage is likely to secure the regulator's blessing a few days from now. Under preferred "behavioral" remedies, they would instead be forced to keep prices below a certain threshold for low-spending customers. Like an errant pupil in school, the merged companies would also be strictly supervised on the work they do.

Documents show they would rather be assessed on input rather than output, and Ofcom, the regulatory body likely to be their supervisor, seems to agree this would be more effective and easier to manage. It would not, however, simply mean proving they have invested a required amount in capital expenditure each year. At regular intervals, Vodafone-Three will have to show it has completed 5G site upgrades in particular spectrum bands across a certain percentage of the network.

The preference for monitoring of inputs rather than outputs makes a good deal of sense. For a start, as the telcos have argued, outputs such as speed, coverage and capacity are always a product of two basic things – the amount of spectrum in service and the number of sites in operation. Take care of those easy-to-measure inputs and the result should be a 5G network that ticks all the appropriate performance boxes. Policing Vodafone-Three based on traditional outputs would also be tricky. Average speeds at a site might drop well below normal levels on the day of a major festival that brings thousands more people into the area, for example.

Progress on 5G is essential from the perspective of the Competition and Markets Authority, the government body investigating the merger. Among its chief concerns are that price rises will hurt consumers (hence the proposed remedy to cap certain tariffs) and that Vodafone-Three will renege on a promise to invest £11 billion (US$13.9 billion) in the rollout of a nationwide 5G network over the next decade.

Simply requiring Vodafone-Three to meet capital expenditure targets would be risky. The company might do so while pumping money into activities that do not directly improve 5G speed, coverage and capacity. To show it has activated sites and put frequencies into service, Vodafone-Three will have to be judicious about its investments.

Not as big as it sounds

But there is concern among analysts it has not made a sufficient commitment to the 5G effort. The initial statement is also misleading. "MergeCo intends to invest over £6 billion [$7.6 billion] in the first five years, and £11 billion over a ten-year plan, to create a best-in-class 5G network," said the operators when they announced the deal in June last year. A footnote, however, shows this £11 billion would really be the "total combined capex spend," inevitably covering a lot more than just 5G.

What's more, as big as it sounds, this £11 billion works out at just £1.1 billion ($1.4 billion) annually over a ten-year period. That's even less than the £1.2 billion ($1.5 billion) Vodafone and Three spent last year, and a substantial reduction compared with the combined capex of £1.5 billion ($1.9 billion) in 2022. No doubt, the operators would argue that investing £1.1 billion in one network is better than dividing £1.2 billion or even £1.5 billion between two.

Yet Vodafone-Three's plan is to operate a much bigger network in terms of total site numbers than each UK telco has today. After decommissioning about 10,000 sites, the new company would be left with roughly 26,000 across the UK. Under the plan, annual capex per site works out at just £42,300 (rounded to the nearest hundred), only a slight increase on the £41,700 produced by dividing £1.5 billion between the 36,000 sites that Vodafone and Three currently operate.

Senior technology executives within the companies are known to see the behavioral remedy as a liberating force. It effectively unlocks the shackles they are normally made to wear by finance bosses worried about such commercial trifles as losses and debt. In normal circumstances, the bean counters can respond to a market downturn or continued lack of interest in 5G by slashing budgets. But the behavioral remedy strips them of that power by establishing a floor beneath which network spending cannot drop. Forced to maintain expenditure at a certain level to hit site upgrade targets, they could respond by hacking aggressively into other parts of the business.

Alternatively, the remedy may simply prove unworkable. It has never been tried before and BT, an opponent of the deal, thinks there is too much scope for circumvention, having argued, as the CMA puts it, "that either the remedy would be too simple to be effective or, if sufficiently designed, would be too complex to be monitored and enforced."

There is a tacit acknowledgement of the potential complexities in the CMA's recently published paper on remedies, where it discusses circumvention risks at some length. Among them is the danger Vodafone-Three invests in cheaper and lower-performance microcells to hit targets. The operators have apparently resisted a suggestion they be forced to use a certain category of macrocells, arguing those may be inappropriate in some places. Instead, they are proposing minimum power settings for radios per 5MHz deployed. It already sounds like BT may be onto something.