Former state telecom monopolies are being broken up to boost broadband competition, reports John Collins

THERE IS a growing realisation in telecom circles that if effective competition and innovation in broadband are to happen, former state monopolies must be broken up.

The European Commission is planning to give national telecoms regulators the power to break up the former state operators into retail and wholesale units where "the market has failed".

The first market to go down this route, known in telecoms parlance as "functional separation", was Britain. In 2005 most of BT's network division was hived off as a separate entity called Openreach. The regulator Ofcom had the power to refer BT to the Competition Commission if it did not agree to a break-up.

"When you have a combination of a vertically integrated operator with market power there is always a tendency to favour your own business," says Ofcom's Tom Kiedrowski. "That's almost natural."

In 2005 BT and the regulator agreed how Openreach would operate so that BT's retail operation and other telcos would have access to the same products and levels of service - a concept known as equivalence.

"To the extent that BT offers wholesale products then it must supply the same product to itself that it supplies to everyone else," says BT's Peter McCarthy-Ward. Not only must Openreach offer the same products to BT but its sibling must buy them using the same processes and systems that it uses to sell to third parties. "It gives BT a very powerful incentive to ensure those products are fit for purpose," adds McCarthy-Ward.

It has proven an effective policy - certainly in terms of consumer choice. In 2005 there were eight operators using the local loop unbundling mechanism to take control of lines from BT but now there are 20, with 80 per cent of the population having a choice of at least one operator other than BT. The top broadband speeds most operators can offer is 16Mbits/sec - considerably faster than what's on offer here. The price of a basket of broadband, line rental and call charges also fell from £60 in 2002 to £40 in 2006.

The break-up of BT followed an extensive 18-month review of the sector by Ofcom ("as much to educate itself about the sector" commented one telecoms expert). Ofcom found that while there were many competitors BT still had the vast bulk of the revenues. Other operators were also just reselling BT wholesale products rather than taking control of their subscribers' phone lines. As a result they had little chance to introduce innovative products and services.

Ofcom saw a need for strong competitors who could invest in new technologies and platforms. The review concluded that there were two "competitive bottlenecks" at play where it would not be viable for alternative operators to build their own infrastructure to compete with BT - the access network, which is the copper connecting the customer premises to an exchange; and the backhaul network, which routes traffic between different telecoms providers.

BT has never explicitly stated how much the creation of Openreach cost, but it booked exceptional charges of about £100 million related to it.

Ofcom closely regulates Openreach and dictates how much it can charge other operators and what return it should be allowed make on its investments in the network. Openreach's revenues from non-BT customers doubled from £318 million in 2006 to £685 million in 2007. It made capital investments of over £1 billion each year.

"For the first two years of Openreach the service wasn't great," says Andrew Heaney, director of strategy and regulation with Carphone Warehouse. "I don't think that was malicous or intentional, it was just because it was very difficult to organise and implement equivalence."

Carphone Warehouse customers suffered more than most because the company looked to offer both voice and broadband on its own network, which pushed the new regime to its limits and left many customers without service as they switched over.

Ofcom is conducting a review of Openreach prices and BT has stated that it will look for a price rise which will squeeze margins for the other telcos. Alternative operators in the UK talk about a "land-grab phase" and that taking control of lines from BT will only pay off for those with deep pockets and a five-year business plan.

Heaney says that Openreach could do better on introducing new products and responding to requests from other operators.

"That's partly because they are a monopoly," he says. "You can control their profits, the prices the charge, equivalent access to the network but it is very difficult to regulate for product innovation and quality of the service."

McCarthy-Ward admits that the creation of Openreach has been "quite a salutary experience" but maintains BT has done its utmost to treat other operators the same way it treats its other divisions.

While the British experience is now being held up as a potential remedy that all European telecoms regulators should have, the separation of Eircom that has been proposed looks quite different. Eircom is seeking a structural separation rather than the functional split that took place at BT. The retail division would be sold off with Babcok & Brown and the ESOP retaining control of the network division. Unlike Openreach it would control all the telecoms assets now owned by Eircom rather than just the so-called "bottlenecks".

"Implementing separation when it is structural is a lot more difficult," says Heaney. "You continually have to fiddle with the boundaries of it, and if you had to deal with two separate companies that would become a nightmare."

The introduction of so-called "next generation" access networks, which brings high-speed fibre optic links to street level, would certainly require the boundaries to be re-examined. The carrot Eircom is holding out to the Government is that it would make the investment in the access network - at least in the major urban areas - which would support speeds of up to 25Mbits/sec.

Eircom is playing a high stakes game. If the company is structurally separated and different divisions sold off there will be no way back. Little wonder then that John Doherty, Comreg chairman, compared the situation to Humpty Dumpty - "if it breaks, there is no way to put it back together again".