Following the broadband money

BT in £5bn monopoly rip-off?

with 8 comments

BT SMP markets returnsBT overcharged customers £4.9bn between April 2005 to March 2013, an independent report claims.

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.


Written by Br0kenTeleph0n3

2013/11/12 at 06:11

8 Responses

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  1. In my former employment we achieved returns greater than out cost of capital, as that was why we were there. We only invested in things with substantially higher returns than the WACC, in order to generate profit. A company that matches its cost of capital is breaking even, not growing or profitable, so I would expect to see returns above the cost of capital otherwise somebody isn’t doing a very good job.

    Investments should have a positive NPV, surely ?


    2013/11/12 at 08:00

    • Are you suggesting that it’s OK for monopolies to charge people who h

    • ave no choice but to use their services anything they like? Frontier Economics looked only at those parts of the business where BT has SMP; where it doesn’t, i.e. there is competition, BT can charge what it likes. As we have seen, especially with Global Services, it isn’t very good at competing, so it uses its monopolies in Openreach to cover its losses in other parts of the business.
      In case you still think that’s good idea, I refer you to the Public Accounts committee statement on the four big private sector suppliers to government, with whom we spend £187bn a year.
      “These reports together raise some big concerns: the quasi-monopolies that have sprung up in some parts of the public sector; the lack of transparency over profits, performance and tax paid; the inhibiting of whistleblowers; the length of contracts that taxpayers are being tied into, and the number of contracts that are not subject to proper competition.”
      Sound familiar?


2013/11/12 at 08:40

  • Phil T is quite right. A business which does not make a healthy margin above its cost of capital will not survive. Regulators should be convenred the price, quality of service and anti-comptitive behaviour – not “theoritical fictions” like cost of capital. That said, they way that the profits from BT’s monopoly operations appear to have cross-subsidised its losses in those markets where it does have to compete as well as to enter new markets (e.g. content) do appear to be indicative of regulatory failure.

    The lack of transparency regarding Central Government spend with major contractors compared to the requirements it is placing on Local Government is another, perhaps even more reprehensible, issue.

    Philip Virgo

    2013/11/12 at 10:25

  • Sorry about typoes: should have read “Regulators should be concerned with … not theoretical fictions … “

    Philip Virgo

    2013/11/12 at 10:29

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