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ABSTRACT

In 2005, Ofcom, then telecommunications regulator in the United Kingdom, implemented functional separation of British Telecom plc (BT), separating its wholesale and retail services. BT established a division within the company, Openreach, to provide equal access to its local access network and backhaul products. The tenth anniversary of this regulatory and corporate experiment is an appropriate moment to ask whether functionally separating Openreach from BT benefited consumers. We find that Openreach's creation generated short-run consumer benefits in the form of lower prices but also led to negative long-run effects, which outweighed the short-term price reduction. Our econometric analysis indicates that prices for broadband and residential fixed-line telephone services are lower than one would expect based on prices in comparable countries. However, telecommunications investment, customer satisfaction, and measures of the United Kingdom's global competitiveness in telecommunications have also fallen. In particular, the United Kingdom's investment in next-generation networks is lagging compared with the rest of the world.

I. INTRODUCTION

In 2005, the United Kingdom implemented "functional separation" of British Telecom plc (BT) in response to a telecommunications sector review conducted by the United Kingdom's regulator and competition authority for the communications industries, the Office of Communications (Ofcom).1 Ofcom's market research and consultation had argued that BT held a high market share in the British telecommunications market for residential voice services, business retail services, leased lines, wholesale international services, wholesale broadband, and wholesale fixed narrowband, which purportedly prevented consumers from enjoying benefits that Ofcom otherwise expected from more robust competition.2 In response, BT proposed legally binding undertakings to create a separate division, eventually dubbed Openreach, to provide equality of access to its local access network and backhaul products.3

Ten years have passed. Has the functional separation of Openreach from BT benefited consumers? We find that Openreach's creation may have generated short-run consumer benefits in the form of lower prices but that negative long-run effects outweighed these benefits. Although prices may have fallen after the functional separation, investment, customer satisfaction, and the United Kindom's global competitiveness in telecommunications have also fallen. On balance, it would be incorrect to declare that the functional separation of Openreach from BT was a regulatory success for consumers in the United Kingdom.

In Part II, we evaluate whether Openreach's functional separation from BT increased consumer welfare since 2005. First, we analyze the short-term effects that it had on broadband and residential fixed-line telephone prices in the United Kingdom, and whether the functional separation of BT achieved Ofcom's goal of providing more affordable telecommunications services. We find that prices for these two telecommunications services are actually lower than one would expect based on prices in comparable countries. Our results suggest that Openreach's functional separation has led to increasing demand for fixed-line services, but decreasing or slower growth in the demand for broadband services. Finally, we explain that the reduction in broadband prices does not imply a transfer of wealth from BT shareholders to consumers.

In Part III, we analyze the long-run consumer-welfare effects of Openreach's functional separation. We measure the United Kingdom's investment in telecommunications and customer satisfaction with BT relative to its competitors as measures of the United Kingdom's "global competitiveness" in telecommunications. The apparently lower prices achieved in the United Kingdom themselves have come at a price. The empirical evidence shows that functional separation has presented a tradeoff between short-run and long-run economic efficiency, as investment and customer satisfaction have fallen along with prices. We examine the efficiency tradeoff between long-run reductions in investment and short-run price reductions. Although functional separation has offered short-run benefits to U.K. consumers in the form of lower prices, investment in next-generation networks is lagging in the United Kingdom compared with other comparable countries. This result is consistent with our empirical finding of lower-than-predicted broadband demand. Ofcom appears to have delivered static gains in consumer surplus at the expense of dynamic reductions of consumer surplus that may be vastly greater.

II. SHORT-RUN CONSUMER WELFARE EFFECTS OF FUNCTIONAL SEPARATION

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J. Gregory Sidak is an Expert Economist in the fields of Antitrust, Telecommunications Regulation, Commercial and Investment Arbitration, and Intellectual Property Law. Prof. Sidak is the Ronald Coase Professor of Law & Economics at Tilburg University and the Chief Economic Expert at Criterion Economics in Washington, DC. The focus of his research has been regulation of network industries, antitrust policy, the Internet and electronic commerce, intellectual property, and constitutional law issues concerning economic regulation.

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