BT in £5bn monopoly rip-off?
After analysing financial information BT must by law provide to the regulator Ofcom because it has “significant market power” i.e. an effective monopoly in certain markets, Frontier Economics (FE) found that returns on BT’s regulated services were consistently above the rate required to compensate investors, (the weighted average cost of capital as determined by Ofcom), and that wholesale prices could have been on average 10% lower over the period.
The report corroborates an earlier finding by Wik Consult in support of TalkTalk’s complaint to Ofcom that BT indulges in a “margin squeeze” by overcharging for wholesale products. Wik found that Openreach’s costs to build its FTTC network are £4.39 per line per month. BT Openreach charged resellers £7.40 or £9.95 depending on the bandwidth provided.
FE, a top 10 European economic consultancy, is chaired by former UK civil service boss Gus O’Donnell, who is widely known by his initials. On taking over as FE’s chairman in July he said he had come to respect FE “hugely”. “Not only is Frontier at the forefront of applying economics to tough public and private sector issues, it has an internal culture that is second to none.”
The FE report, The Profitability of BT’s Regulated Services, was commissioned by Vodafone. It shows that regulated wholesale prices would have been 10% lower on average, had they been set such that BT had earned a return at the benchmark level set by Ofcom. Because they weren’t, BT was able to earn on average an extra £600m/y for the period.
It found Ofcom is aware BT has been able to earn returns in excess of its cost of capital. It quotes Ofcom’s 2013 consultation on the fixed access market (now being assessed) saying, “BT’s reported profitability was significantly in excess of its cost of capital. We believed that this was prima facie evidence that wholesale charges for ISDN30 might be above the competitive level.”
FE also found that BT had to repay customers for overcharging. “For some markets where BT had cost orientation obligations, BT has been found later to have set prices above a cost oriented level and has been required to make repayments to the purchasing communication providers. The overcharges include £151m for certain Ethernet services and repayments of £42m for certain partial private circuit services.”
FE notes several potential reasons for BT being able to earn regulated returns above its weighted average cost of capital. These include
- differences between Ofcom’s and FE’s estimates of BT’s cost base
- some prices are based on costs that do not directly reflect BT’s actual costs
- BT may price services above its fully allocated costs
- Ofcom may have set RPI-X% charge controls too low, and
- some costs may have been allocated to the wrong service.
“Further analysis is required to understand which combination of these reasons may explain the results shown above,” FE said.