Vodafone-Three merger to leave Brits worse off, says new research

Picture the UK as a 5G wonderland. Masts have sprouted like crops after spring rain. Small children wear Vision Pro headsets and frolic in the shadows cast by pristine antennas. Signals reach deep into the bowels of any building and humiliate local Wi-Fi connections with their flashy performance. Hospital patients undergo 5G robot surgery without fearing the loss of limbs. And it's all available for the same price as today's lousier service.

This is an embellished version of the pitch made by Vodafone and Three (or H3G), two mobile networks that insist a merger of their companies would dramatically improve the 5G experience without leading to higher prices for consumers. The proposed deal is controversial for all sorts of reasons. It would skew ownership of spectrum in certain frequency bands. It would give Vodafone-Three a role in both the country's network-sharing joint ventures. It would put the merged entity far ahead of BT/EE and Virgin Media O2 (VMO2) on site numbers. But the main concern of the Competition and Markets Authority (CMA), which is still reviewing the deal, is whether service quality would go down just as prices go up.

Under orthodox competition theory, this would be the natural outcome of a merger that reduces the number of UK mobile networks from four to three. As in the world of sport, players that suddenly face less competition have less incentive to make improvements. But Vodafone, Three and some prominent sector analysts argue the opposite. With fewer customers and lower sales, but networks of similar scale to those operated by BT/EE and VMO2, Vodafone and Three cannot make a sufficient return on capital employed (ROCE) to justify higher expenditure. United, they say, this would change.

When two become one

The case sounds logical and probably has merit. Vodafone and Three would essentially be collapsing two nationwide networks, each with around 18,000 sites, into a single network of roughly 26,000 sites. The surplus could be scrapped or sold. Headcount and costs should plummet as two organizations become one. But this single network would serve many more customers than either of its predecessors – about 30.6 million at the latest count, adding Vodafone's 18.6 million to Three's 12 million. One convenient measure of efficiency is the number of customers per site, which would rise from an average of 850 for the standalone companies to nearly 1,200 after a merger.

All this would push up that ROCE figure, allowing Vodafone-Three to invest more in 5G than the separate networks were able to do. The telcos have promised to spend about £11 billion (US$14.4 billion) over a decade on the rollout of 5G "standalone," a souped-up version of the latest mobile technology. "Overnight, customers will get more value and pay the same price thanks to a significantly better network," they say on a website dedicated to advertising the benefits of a deal.

Some analysts sound persuaded. In a September presentation (subscription required) about the UK mobile market that was obtained by Light Reading, Enders Analysis said there was little evidence prices would increase after a merger. By contrast, a denser and more capacious Vodafone-Three network, "combined with the savings from the inefficient duplication of networks, could put enough downward pressure on pricing to outweigh any conceivable upward pressure from the removal of H3G as a disruptive player," Enders said. Across a basket of countries, it found no evidence of links between market concentration and pricing. Its considered view is that "prices are unlikely to rise in the event of consolidation from four to three players."

Where the price isn't right

Yet besides being economically counterintuitive, this assessment could be said to undermine the case for a merger. Vodafone and Three insist prices will not rise because competition authorities might otherwise obstruct the deal. But no one in the sector privately thinks telecom users pay enough in the UK or other supercompetitive European markets.

Executives jealously eye the US, where three networks serve a population of more than 330 million and 5G networks are deemed superior. Average revenue per user for a postpaid phone customer at T-Mobile US was more than $49 for the recent second quarter. At Vodafone earlier this year, it was about £18.40 ($24.10). While salaries and other costs are also greater in the US, the view is that higher prices have given US telcos a bigger pot to invest.

Enders' findings on prices and market concentration are also totally at odds with those of another report that came out this month. Rewheel, a Finnish company describing itself as an "independent telecom research firm and boutique management consultancy," drew on similar metrics to Enders and concluded that "monthly prices are several times higher in more concentrated mobile markets." It also found "network performance and average download speed are NOT higher in more concentrated mobile markets."

Different methodologies could explain the divergent results. Enders appears to have looked at prices for 100 calls plus two gigabytes of data in 14 developed countries. Levels of concentration were assessed using the Herfindahl-Hirschman Index (HHI), where a higher score denotes a less competitive market. Rewheel also used HHI data but instead measured monthly prices for 20 gigabytes of data across 50 European Union and OECD countries. The Enders chart is a random bullet spray of data points, showing no link between prices and HHI scores. In Rewheel's graphs, the data points track sloping lines that correlate higher fees with market concentration.

Higher spending but lower fees?

But if all that is somewhat inconclusive, other data in the Enders report does not show a massive improvement in ROCE after a merger. For 2022, it puts Vodafone on 2% and Three on -4%, with BT/EE on 21% and VMO2's mobile business on 18%. A merger would lift Vodafone-Three to 0%, according to Enders, which calculates ROCE of 6% after "synergies" have taken effect. Clearly, this would still be well below returns shown for the UK's two other mobile networks, and it must raise doubts about Vodafone-Three's ability to fund network improvements without increasing prices.

Three has acknowledged a merger would create a spectrum and site-numbers imbalance between Vodafone-Three and each of its rivals. While bosses have tried mollifying regulatory officials with an offer to sell frequencies to VMO2, Three has also argued that "asymmetry" holds attractions because it would force rivals to up their game. Yet, ignoring the possibility of a spectrum sale, neither BT/EE nor VMO2 would directly benefit from the merger. Higher investments would chew into profit margins unless prices rose.

Currently eager to portray themselves as challenged, ailing networks that only a merger will save, Vodafone and Three do seem to have fallen some way behind BT/EE, if not VMO2, on 5G rollout. When Ofcom, the UK telecom regulator, presented figures for "outdoor" 5G coverage at the start of the year, BT/EE led on 74%, with Three on 67%, Vodafone on 57% and VMO2 on 51%.

Unfortunately, in the absence of 5G-specific applications, there is little evidence that consumers really care. Generous offers and a reputation for good customer service are likely to be more important factors for most people choosing a telecom service. And fees are usually determined by monthly gigabyte and other usage limits, not access to the newest G. Vodafone-Three might be more financially viable than either Vodafone or Three is today. But its pitch about a network splurge unaccompanied by price rises may be hard for the CMA to accept.