Broadband services

Only BT's Dismemberment Will Sate Rivals

Hunting dogs with the smell of blood in their nostrils can be hard to restrain. BT's rivals have been savaging the UK's former state-owned incumbent ever since its possible dismemberment was first mooted last year. But with the regulator hoping for a less violent finale to the current drama, prising BT from their jaws will not be easy.

Ofcom, the national regulatory authority, certainly wants an increasingly powerful BT cut down to size, if not torn apart. It would prefer BT Group plc (NYSE: BT; London: BTA) to restructure voluntarily, taking steps to give Openreach, its infrastructure business, more legal independence from the rest of the BT Group. Earlier today, however, it expressed unhappiness with BT's efforts so far, threatening to drive through its own form of "legal separation" -- with the approval of the European Commission -- unless BT gets busy. (See Openreach Gets Chairman as Ofcom Berates BT.)

Moving In for the Kill
BT's aggressive rivals would like to see the former state-owned monopoly torn apart.  (Photo: Brian Gratwicke)
BT's aggressive rivals would like to see the former state-owned monopoly torn apart.
(Photo: Brian Gratwicke)

Openreach, and BT's ownership of it, has become a sore point in the UK telecom sector. Besides providing the networks over which BT offers services, Openreach has a wholesale role, selling connections to "asset-light" broadband operators such as Sky , TalkTalk and Vodafone Group plc (NYSE: VOD). None of these companies is happy that its biggest retail rival controls the UK's only nationwide wholesale network. (See BT, Ofcom & the Battle of Britain.)

The litany of complaints about this set-up seems to be growing. TalkTalk has previously argued that BT's unique position allows it to "squeeze" competitors through careful manipulation of wholesale and retail prices. More recently, competitors have grumbled that BT can use Openreach earnings to fund other ventures, including its costly TV business, which has spent lavish sums on rights to screen top-flight soccer.

The latest specific grievance is about the "excess profits" that BT has been able to generate thanks to Openreach. According to a new study from Frontier Economics, commissioned by Vodafone, those profits rose by more than 28%, to more than £1 billion ($1.25 billion), in the last financial year, and equate to £93.84 ($117.27) per customer annually. "It beggars belief that BT felt it could increase its excess profits at this time," said Helen Lamprell, Vodafone UK's director of external affairs, in apparent disgust that BT is boosting profits while austerity-hit consumers are struggling.

The ideal solution, as far as these companies are concerned, is the break-up of BT into separate network and retail companies. This "structural separation" would create a fully independent network that would have no incentive to favor one customer over another and could attract investment from multiple sources, they say.

Ofcom, however, believes structural separation could prove costly and disruptive and might not have the desired effects. Its wariness seems justified by experiences in other markets, such as Australia, where moves have led to escalating costs and little obvious improvement in the competitive environment. (See NBN Must Speed Up to Hit 2020 Targets, Says Senior Exec.)

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As a compromise, Ofcom has mandated what it calls "legal separation." In this scenario, BT will have separate management, an independent board and operate at even greater arm's length from other BT businesses. BT has taken steps in the right direction, today appointing Mike McTighe, an Ofcom veteran, as Openreach's chairman. Yet Ofcom needs it to go much further.

The trouble is that legal separation is just as unproven as a more stringent structural separation. Nor are the practicalities entirely clear. What happens to BT's huge pension deficit, for example? How can Openreach ever be truly independent while it remains a part of the BT Group?

BT's rivals have cautiously welcomed Ofcom's latest intervention, believing any kind of separation is better than nothing. But none will be content with a soft take on legal separation. In all likelihood, they are either hankering for an extreme interpretation of legal separation that would approximate the structural variety, or hope that efforts on legal separation will ultimately lead to a complete break-up -- perhaps because they founder. "If Ofcom's monitoring suggests that legal separation is not delivering sufficient benefits for the wider telecom industry and its customers, we will return to the question of structural separation," said Ofcom in today's update, offering encouragement to the likes of TalkTalk.

The image of BT's bisected corpus cannot easily be dispelled. Like other capital-intensive industries, the UK telecom market is grossly lopsided, from a competitive standpoint, and BT's rivals believe they have a righteous cause. Structural separation would do nothing directly to address the lack of infrastructure-based competition, but that will not discourage its advocates. In the months ahead, Ofcom's biggest challenge may be keeping the hounds at bay.

— Iain Morris, Circle me on Google+ Follow me on TwitterVisit my LinkedIn profile, News Editor, Light Reading

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