Australian Competition Tribunal Decisions

AUSTRALIAN COMPETITION TRIBUNAL

Application by Chime Communications Pty Ltd [2008] ACompT 4

TRADE PRACTICE – Telecommunications access regime – application for review - declared services – the local call service and the wholesale line rental service – application for exemption from standard access obligations – whether decision discretionary – whether the unconditioned local loop service is a substitute - whether possible to adopt a rule of thumb – need for empirical evidence - factors to be taken into account

Trade Practices Act 1974 (Cth), Pt XIC, ss 152AB, 152AL, 152ALA, 152AQA, 152AT, 152AW, 152CLA(1)

Seven Network Limited (No 1), Re (2004) 187 FLR 351
Sydney Airports Corporation Ltd, Re (2000) 156 FLR 10
Telstra Corporation Ltd (No 3), Re (2007) 242 ALR 482

RE: APPLICATIONS UNDER SECTION 152AV OF THE TRADE PRACTICES ACT 1974 (THE ACT) FOR A REVIEW OF AN EXEMPTION ORDER DECISION (INDIVIDUAL EXEMPTION ORDER NOS. 1 – 4 OF 2008) MADE BY THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION (COMMISSION) IN RELATION TO TELSTRA CORPORATION LIMITED PURSUANT TO SECTION 152AT(3)(a) OF THE ACT

BY: CHIME COMMUNICATIONS PTY LTD

File No 2 of 2008

Justice Finkelstein (President), R Davey,

Professor D Round

22 DECEMBER 2008

MELBOURNE

IN THE AUSTRALIAN COMPETITION TRIBUNAL
	File No 2 of 2008

RE: APPLICATIONSUNDER SECTION 152AV OF THE TRADE PRACTICES ACT 1974 (THE ACT) FOR A REVIEW OF AN EXEMPTION ORDER DECISION (INDIVIDUAL EXEMPTION ORDER NOS. 1 – 4 OF 2008) MADE BY THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION (COMMISSION) IN RELATION TO TELSTRA CORPORATION LIMITED PURSUANT TO SECTION 152AT(3)(a) OF THE ACT

BY: CHIME COMMUNICATIONS PTY LTD

Applicant

JUDGE:

JUSTICE FINKELSTEIN (PRESIDENT)

R Davey

Professor D Round

DATE OF DETERMINATION:

22 DECEMBER 2008

WHERE MADE:

MELBOURNE

THE TRIBUNAL DETERMINES THAT:

The decision of the Australian Competition and Consumer Commission made on or about 22 August 2008 to grant Telstra Corporation Limited the exemption orders set out in appendixes E to H and the class exemption orders set out in appendixes I and J in its decision be set aside.

IN THE AUSTRALIAN COMPETITION TRIBUNAL
	File No 2 of 2008

BY: CHIME COMMUNICATIONS PTY LTD

Applicant

THE TRIBUNAL:

JUSTICE FINKELSTEIN (PRESIDENT)

Davey

Professor D Round

DATE:

22 December 2008

PLACE:

MELBOURNE

REASONS FOR DETERMINATION

Introduction

1 The provision of telecommunications services in Australia is heavily regulated. Part of that regulation, the establishment of a telecommunications access regime, is contained in Part XIC of the Trade Practices Act 1974 (Cth). Particular services may be declared and once declared are subject to what are referred to as standard access obligations (SAOs). Two services, the local call service (LCS) and the wholesale line rental service (WLR), were declared in July 2006 (with effect from 1 August 2006). The LCS had previously been declared by the Australian Competition and Consumer Commission (ACCC) in July 1999. These declarations require Telstra Corporation Limited (Telstra) to supply those services over its ubiquitous copper wire transmission network. By four applications (two in July 2007 and two in October 2007) Telstra sought an order from the ACCC that its provision of those services be exempt from the declarations in 387 exchanges. The applications were, in part, successful. Chime Communications Pty Ltd (Chime) has applied to the Tribunal to review the decision to grant the exemptions. APPT Limited, PowerTel Limited, Agile Pty Ltd, Macquarie Telecom Pty Limited and Primus Telecommunications Pty Limited were given leave to intervene in the review subject to control being maintained over the extent of their participation, and made submissions through Chime. The ACCC appeared to assist the Tribunal.

Background and the Legislation

2 In many key sectors of the economy the privileged position of former State-owned vertically integrated monopolies (the monopoly usually being statute-based) has resulted in market failure. The markets failed because competition was either non-existent or deficient. Firms holding a monopoly position are able to restrict output, reduce the quality of the goods and services they supply, and set prices above marginal cost. Competition laws have been developed to create a competitive environment. But competition laws by themselves do not produce efficiencies where a natural monopoly exists. By a natural monopoly we mean a situation where the entire market demand for a particular service can, due to economies of scale, be served at the least cost by a single supplier and where it is not economically efficient to replicate the facility. Typical examples are railways, ports, airports and telecommunication networks. Each is a so-called essential facility or bottleneck. Competition in natural monopoly markets is, by its very nature, unsustainable. One solution is to impose ex-ante regulation mandating access to essential facilities in order to deliver static and dynamic benefits to consumers.

3 The object of the Part XIC mandatory access regime is to promote the long-term interests of end-users: s 152AB(1). This object is to be achieved by: (a) promoting competition; (b) achieving any-to-any connectivity; and (c) encouraging the economically efficient use of, and investment in, infrastructure by which telecommunications services are, or are likely to become, capable of being supplied: s 152AB(2). Broadly speaking, the access regime operates in the following way. The ACCC may declare a listed carriage service (eg the LCS or WLR) to be a declared service: s 152AL. At the same time, the ACCC must also determine “pricing principles” relating to the price of access to the declared service: s 152AQA. The declaration must be for a period not exceeding five years, but may be extended for a further period of five years: s 152ALA. Once a service is declared the declaration requires the incumbent to supply it in accordance with the SAOs on terms and conditions agreed between it and a firm seeking access to the service. In the absence of an agreement between the incumbent and an access seeker: (a) where the ACCC has accepted an access undertaking from the incumbent, the service must be supplied on the terms and conditions in the undertaking; or (b) where no undertaking has been so accepted, on terms and conditions consistent with the relevant SAOs and pricing principles as arbitrated by the ACCC.

4 The aim of the access regime is to create conditions for improved competition by removing a barrier to entry in an upstream or downstream market that inhibits competition in that market or other markets. Access to the declared services has the capacity to promote either service-based or facility-based competition. Facility-based competition is presumed to be a necessary condition for long-term efficiency because that is when innovation is more likely to occur. Service-based competition is, over the long-term, regarded as merely a stepping stone to facility-based competition.

5 Part XIC accepts that mandated access to the telecommunications network which increases competition in the short term may harm competition in the long term and thus be harmful to end-users. Accordingly, s 152AT allows the provider of a declared service to apply for an exemption from the SAOs. In the first instance that application is made to the ACCC: s 152AT(1). The ACCC must either: (a) grant an exemption from one or more of the SAOs; or (b) refuse the application: s 152AT(3). An exemption may be unconditional or subject to conditions or limitations: s 152AT(5). However, before an exemption order is made the ACCC must be “satisfied that the making of the order will promote the long-term interests of end-users”: s 152AT(4).

6 There is a controversy concerning the nature of the power conferred by s 152AT. The issue is whether the ACCC (or the Tribunal when reviewing a decision of the ACCC) is required to make an exemption order upon being satisfied that the order will promote the long-term interests of end-users. The proponent of this view (Telstra) submits, in effect, that the condition described in s 152AT(4) defines the circumstances in which the head of power in s 152AT(3) must be exercised. The alternative position is that the state of satisfaction that is required by s 152AT(4) is simply a condition that must be satisfied before an exemption order is made and the decision-maker is still required to take all relevant considerations into account in deciding whether or not to make an order .

7 The Tribunal is of opinion that s 152AT(4) does not define the manner in which the power in s 152AT(3) is to be exercised. This is clear from the structure of the section, which to some extent is worth repeating. First, a provider of a declared service may apply for an exemption. Second, the ACCC (or the Tribunal) must consider that application. Third, after considering the application the ACCC (or the Tribunal) must: (a) make an exemption order; or (b) refuse the application. To this point no limitation is imposed on the decision-making power. Nor is there any requirement to take particular considerations into account. Then there is s 152AT(4), which in terms imposes a prohibition upon the making of an exemption order unless the criterion is satisfied. The section is silent on when the order should be made. This structure shows that there is no duty to make an exemption order if the s 152AT(4) criterion is satisfied. First, that is not what s 152AT(3) provides. It would be necessary to rewrite the section to produce that result. Second, the imposition of the supposed obligation would be inconsistent with Parliament’s intention to confer a broad power on the ACCC (and the Tribunal) such that each application must be considered on a case by case basis. The Explanatory Memorandum to the Trade Practices Amendment (Telecommunications) Bill 1996 states that “[t]he provision [s 152AT] is drafted in broad terms because ACCC judgments about the giving of an exemption and the precise nature of exemptions given need to be made on a case-by-case basis”.

8 Nor can it be accepted, as was put by the ACCC, that the range of factors that it (or the Tribunal) is able to take into account in reaching a decision is “extremely limited”. This submission was based on Re Sydney Airports Corporation Ltd (2000) 156 FLR 10. There the Tribunal considered the ambit of the Minister’s power under s 44H to declare a particular service (in that case an airport) for the purpose of enabling third parties to obtain access to that service. Section 44H(4) sets out six matters which the Minister must satisfy himself of before making a declaration. The Tribunal observed (at [223]) that s 44H(4) “cover[s] such a range of considerations that the Tribunal considers there is little room left for an exercise of discretion if it be satisfied of all the matters set out [therein]”. This is especially so when a prescribed matter includes the “public interest”. On this aspect, the contrast between s 44H and s 152AT could not be greater. Section 152AT does not specify any matters (save for the s 152AT(4) criterion) which the ACCC (or the Tribunal) must satisfy itself of before making or refusing to make an exemption order. The matter is otherwise left at large. The matters to be taken into account must be determined by implication from the subject matter, scope and purpose of Part XIC. It follows that it is for the ACCC (or the Tribunal) to determine the appropriate weight to be given to any relevant matter.

The Technology and Services

9 It is helpful to provide a brief overview of the telecommunications technology and the services with which the application is concerned. The traditional telecommunications network (and the one owned by Telstra) is a fixed network to which end-users are connected. It is usually referred to as the public switched telephone network (PSTN). The PSTN is a circuit-switched network which involves an end-to-end physical circuit between the calling party and the called party. It consists of a transmission system (copper or aluminium wires) and switching systems by means of which connections are established between the calling party and the called party. The PSTN is comprised of: (a) the customer access network (CAN) connecting end-users to local exchanges (a local loop); and (b) the inter-exchange network which enables calls to be routed between local exchanges through other exchanges.

10 There are four relevant declared services which Telstra is required to supply over its fixed network. Only two are the subject of the exemption application, the LCS and the WLR. The LCS is a service for the carriage of voice telephone calls from customer equipment (typically a handset) at an end-user’s premises to separately located customer equipment of an end-user in the same standard zone. In essence, the service involves the supply of an end-to-end voice grade local call. An access seeker who has access to the LCS is able to resell local calls without the deployment of its own telecommunications infrastructure.

11 The LCS, excluding the provision of it in the central business districts in Sydney, Melbourne, Adelaide, Brisbane and Perth, was declared in July 1999 following the ACCC’s enquiry into local telecommunications services. In July 2006 the declaration was continued until 31 July 2009.

12 The WLR is a line rental telephone service which allows an end-user to connect to the service provider’s PSTN and provides the end-user with (a) an ability to make an receive 3.1 khz bandwidth calls including local calls, national and international calls; and (b) a telephone number. The WLR is also a resale-based service. The access seeker has no need for its own infrastructure.

13 The WLR service, excluding the central business districts of Sydney, Melbourne, Adelaide, Brisbane and Perth, was declared in July 2006: ACCC, Local Services Review – Final Decision, July 2006. The service is declared until 31 July 2009.

14 With both the LCS and WLR, the access provider (the incumbent) provides its retail services on a wholesale basis to a service provider. The service provider places its brand name on the service and promotes the re-branded service to end-users. Competition takes place in the marketing, billing and customer support of the service. There is little, if any, real differentiation in the service itself. End-users will benefit to the extent that service providers compete between each other and against the incumbent to keep the overall price of supplying the service in line with the cost of supply.

15 The remaining two services are the unconditioned local loop service (ULLS) and the line sharing service (LSS). Both are used for the provision of broadband services. Access to broadband is available through a variety of technologies. The first and most commonly used are digital subscriber lines (DSL) which can convert the standard copper wire network into a high speed digital line with the installation of infrastructure at the network operator’s switches. At the switch a digital subscriber line access multiplexer (DSLAM) separates the high speed traffic. The most common form of digital subscriber line is asymmetric DSL (ADSL). Fibre optic cable technology offers speeds potentially in excess of DSL. Currently there is a proposal to roll out a fibre optic national broadband network (NBN). In April 2008 the Federal Government released a request for proposals to roll out the NBN. The request contemplates that the roll out will begin in January 2009 and be made progressively operational over five years. Nonetheless, the timeframe for the commencement and completion of the NBN roll-out is uncertain.

16 At the present time (new technology will no doubt bring about change) the widespread use of broadband is primarily available over Telstra’s copper network Subject to the roll-out of the proposed NBN there is little prospect for the replication of the network.

17 The ULLS, which was first declared in August 1999, involves the use of an unconditioned communications wire between the boundary of a telecommunications network at the end-user’s premises and a point on the telecommunications network that is a potential point for interconnection, generally an exchange. The “unconditioned communications wire” is part of the CAN. The service is described as “unconditioned” because it involves access to the raw wires that forms a local loop. The entrant is able to add its own infrastructure in order to supply high speed data carriage services to end-users or, alternatively, multiple telephony services or a combination of voice and data services.

18 The LSS, also known as the spectrum sharing service, was first declared in August 2002 and in October 2007 the declaration was extended to 31 July 2009. The LSS involves the use of the non-voiceband frequency of an unconditioned communications wire over which an underlying voiceband PSTN service is operating. The LSS gives the entrant use of the high frequency (or broadband) portion of the line to supply data services such as high speed internet access. With LSS, a local loop is used by two service providers, one making use of the high frequency portion of the loop and the other (typically Telstra) using the low frequency (or voiceband) portion of the loop.

19 The ULLS gives the entrant exclusive use of a given loop. A service provider that supplies a broadband service through LSS and wishes to “bundle” a fixed voice service (as most do) has two options. One is to bundle LSS with LCS or WLR. The other is to invest in, or acquire access to, equipment that enables the supply of fixed voice services over ULLS.

20 As already mentioned, an entrant with access to ULLS or LSS requires equipment to provide services to end-users. With Telstra’s network that equipment is usually located at, or near to an exchange, if there is space. The incumbent (Telstra) leases the space to the entrant if it physically uses the incumbent’s space. The typical piece of equipment which the entrant will install is a DSLAM. (We use the term DSLAM to embrace multi-service access nodes and other equipment capable of providing voice and/or data services by way of the ULLS or LSS.) Typically, a DSLAM connected to the ULLS would be configured so that the entrant may provide a bundled voice and broadband data service while a DSLAM connected to the LSS would be configured so that the entrant may provide a broadband data service only (the underlying voice service being provided by Telstra). DSLAMs have a relatively short commercial life expectancy because the technology is changing rapidly. Further, as the nature of the services supplied by a DSLAM change, there is a corresponding need to change all or part of a DSLAM. By way of example, a DSLAM connected to ULLS which is required to provide ADSL services must contain shelves with ADSL cards. If it is to provide voice and data services it must have shelves with ADSL cards, a splitter and voice cards.

Barriers to Entry and Expansion

21 Access to ULLS and LSS provides an opportunity for significant differentiation as the entrant can choose from a variety of DSL technologies. There is also an incentive to invest in innovative equipment. Moreover, access to ULLS and LSS fosters competition for high bandwidth services without requiring entrants to invest in a fully rolled-out network. This puts pressure on the incumbent to offer end-users a new range of competitive services. Still, use of ULLS and LSS at best creates an environment for quasi-facilities-based competition. The copper network will not be replicated until the NBN is established.

22 While entrants have been given access to ULLS and LSS to compete with the incumbent (Telstra), the roll out has been slow and Telstra’s dominant position has not been materially reduced. As at June 2008 entrants have only taken 5% of the national market for ULLS-based services in operation (SIOs). The explanation is that there are barriers that stand in the way of entry. Some barriers are capable of empirical analysis, some are not. The barriers are both absolute and strategic. The most important barriers are as follows. First, the incumbent (Telstra) has the advantage of having a ubiquitous network, a well-known brand, knowledge of the customer base, and the benefit of customer inaction. Second, the incumbent (Telstra) may easily engage in behaviour that will strategically delay entry, which will increase the entrant’s costs. For example, the entrant must install equipment in the incumbent’s (Telstra’s) exchange, and access for the installation works can easily be frustrated. Third, sometimes there is no space at a particular exchange: this is referred to as exchange capping. There are practical difficulties standing in the way of acquiring a building near a capped exchange and connecting with the exchange. If work is required at an exchange to provide space for an entrant’s equipment it will take time to complete the work. Even in exchanges where no work is required, it is not unusual for there to be delay in an entrant gaining access to a Telstra exchange to enable its equipment to be installed. If more than one entrant seeks access they are placed in a queue. The delay in carrying out the installation is commonly in the order of six months and sometimes can be up to 24 months.

23 An example of behaviour that causes delay in entry and expansion and increases an entrant’s costs is the drawn-out process by which terms of access, including pricing, are agreed. Part XIC, Div 8 establishes a regime for resolving disputes about access. Section 152CLA(1) provides that those disputes should be “resolved in a timely manner (including through the use of … mediation and conciliation)”. But experience shows that there are many disputes that take considerable time to resolve and, when legal issues arise, the parties can end up in court.

24 It is common ground that the cost of DSLAM equipment is not a prohibitive barrier to competitively significant entry. The precise cost of purchasing and installing DSLAM equipment and carrying out associated works is a matter of debate. Dependent upon the configuration of the equipment (a reflection of the type – eg voice and broadband – and number of services to be provided), the cost estimates (eg equipment, installation and other associated costs) range from $11,500 to $51,000. Nonetheless there is material which suggests that an entrant could make a return on its investment within two years and recover its outlay within five years.

25 As regards scale economies, there is a range of estimates concerning the number of SIOs an entrant would need to attract in order to make entry worthwhile: the range is from 30 to 360 SIOs with one DSLAM. The most likely explanation for the different views is that the number of end-users required to produce a reasonable return is subject to a variety of factors including the magnitude of other fixed costs, the percentage of SIOs affected by pair gains, the percentage of SIOs on fixed term contracts, the number of competitors within an exchange and other factors which are referred to below.

26 A barrier that may not be so easily overcome is the difficulty of transferring (migrating) a customer supplied with LSS-based services (bundled with a fixed voice service using LCS or WLR) to ULLS which provides both broadband and voice services. There is material suggesting that the migration is both costly and time consuming: and users may be left without a broadband service for an average of twelve days, but on occasions for upwards of three weeks.

27 Despite these barriers there are a significant number of entrants who use DSLAMs in order to access ULLS and LSS. The information concerning these entrants is derived from two sources. The first is DSLAM tracker data which is gathered from websites of telecommunications service providers and reports of independent telecommunications market analysts. This data provides information about the provision of high speed broadband in exchanges. The second source is the data provided to the ACCC by industry participants pursuant to the record-keeping rules (RKR) that were implemented under Pt XIB, Div 6. The DSLAM tracker information provides data for the periods prior to September 2007 and the RKR data for periods including and following September 2007. The DSLAM tracker includes: (a) actual and planned competitor infrastructure build in all exchanges (grouped by competitors); and (b) the number of competitors in each exchange. The RKR data identifies the number of ULLS and LSS acquirers in each exchange. It does not include data pertaining to: (a) the number of installed DSLAMs per exchange; or (b) the number of DSLAMs installed by each individual access seeker and their capacities.

28 As at June 2008 out of the 380 exchanges the subject of the application, the number of DSLAM competitors in each exchange are as follows: (a) there is at least one DSLAM competitor in every subject exchange; (b) there are two or more DSLAM competitors in 334 subject exchanges; (c) there are three or more DSLAMs competitors in 270 subject exchanges; and (d) there are more than four DSLAM competitors in 208 subject exchanges. It is to be noted that the number of DSLAM competitors in each exchange does not say anything about the number of installed DSLAMs per exchange or the number of DSLAMs per exchange installed by each individual entrant.

29 As at 14 January 2008, the DSLAM infrastructure installed in the 371 of the 380 exchanges by ULLS and/or LSS access seekers was capable of servicing 2,483,673 lines. Of those, 1,043,879 pairs were in use, leaving 1,439,794 lines available. This information does not allow the Tribunal to determine the spare capacity of the installed DSLAMs in total or in any of the exchanges. The reason is as follows. In order to provide voice functionality, voice port cards must be installed in the modular solution sub-racks in the DSLAM (in addition to DSL port cards which provide the broadband service). The number of cards that are needed is determined by the number of services being supplied using that DSLAM. Each card contains a specific number of ports. Each port in turn services one copper pair (or local loop). The number of ports serviced by a card varies. It follows that the number of spare lines alone says nothing about capacity. Capacity is also dependent on the: (a) capacity of the ports currently installed in the DSLAMs; and (b) physical space available on the DSLAMs for the installation of additional cards. There is no meaningful hard information on these matters.

30 In addition, not all DSLAMs are technologically capable of providing broadband services and standard voice services within the same device. The evidence did not identify the number of existing DSLAMs with DSL that are capable of being upgraded to deliver voice services. To ascertain the proportion of current voice service capable devices, a survey of all providers would need to be undertaken.

31 It is also impossible to reach any conclusion regarding the available space in each exchange for the installation of new DSLAMs (to accommodate service providers wishing to install additional equipment to provide voice services on ULLS).

32 The increase in the number of entrants and the aggregate size of their market share raises the question whether regulation is still required. Of course regulation has a cost. In a competitive market service providers seek to reduce costs and prices and improve services to increase profit. Regulation constrains a service provider’s flexibility. Inappropriate regulation may reduce the incentive for cost reductions, investment and innovation. For example, regulated low access prices discourage investment: an entrant will forego investment if its present returns are higher than the returns from new investment. From the incumbent’s perspective, regulated wholesale access could result in an increase in overall costs when compared with the costs of operating a principally vertically integrated operation. Hence mandatory wholesale access can be inefficient in a network industry, especially one in which the incumbent continues to provide both wholesale and retail services. Nonetheless, regulated access does prevent the incumbent from abusing its position of power and may deliver benefits to end-users, at least in the short term.

33 A decision to remove regulated access requires a balance to be struck between competing factors. On the one hand there is the risk that continued regulation will result in market distortions, high prices and fewer choices. On the other, there is the risk that premature deregulation will permit the still-dominant incumbent (and on any view Telstra still has significant market power with 89% of all fixed voice lines being supplied over Telstra’s PSTN, of which approximately 80% are lines retailed by Telstra) to engage in anti-competitive conduct, which will distort the market in the long term. The choice to be made is between ex-ante regulation of access and prices and ex-post law enforcement to deter anti-competitive conduct. If there be any appreciable risk of harm to end-users, regulation will usually trump law enforcement: cf Re Telstra Corporation Ltd (No 3) (2007) 242 ALR 482, [316] and [326]. The decision should also balance the short-term benefits resulting from continued regulation, weighed against the potential for long term benefits that may flow from deregulation.

The Application for Exemption and the ACCC’s decision

34 By its four applications Telstra seeks exemption from the obligation to observe the SAOs in its supply of LCS and WLR in a total of 387 exchanges selected on the basis that each exchange has, in addition to Telstra, at least one provider of ULLS (the so-called one plus rule). During the course of the hearing Telstra identified seven exchanges for which it no longer sought exemption because they did not meet the one plus rule. In only one of the 380 subject exchanges was the DSLAM entry based solely on LSS.

35 The ACCC and service providers in Australia have traditionally adopted a national geographic area when framing the geographic scope of telecommunications markets. Following the declaration of ULLS and LSS, the installation of DSLAMs in Telstra’s exchanges has been uneven across exchanges. This seems to be the reason that the parties have examined the competitive dynamics at a more geographically disaggregated level, namely, in areas serviced by exchanges where entrants have installed DSLAMs.

36 The Tribunal neither accepts nor rejects that approach. It does, however, accept that an exchange-by-exchange analysis may provide information about the actual level of competition in the relevant market for the provision of the relevant service. There is, of course, a danger in drawing conclusions about the universal long-term effects of conduct when that conduct takes place in only a relatively small geographic market.

37 However that may be, on 22 August 2008 the ACCC made orders exempting Telstra from compliance with the SAOs in respect of 248 exchanges, with the exemption to take effect 12 months from the publication of its decision. These were exchanges that, as at 30 June 2008, had: (a) 14,000 or more addressable SIOs connected to a Telstra exchange via an uninterrupted wire through which an end-user might be provided with an ULLS-based service; or (b) 4 or more ULLS-based competitors (including Telstra) within the exchange (referred to by the parties as the three plus rule).

38 To maximise the prospect that the exemptions were in the long-term interests of end-users, the ACCC imposed several conditions and limitations. They were that the exemptions would not apply to: (a) the supply by Telstra of the LCS or WLR to an access seeker who immediately prior to the commencement of the order used the LSS, LCS and WLR to supply an end-user with a bundled fixed voice and broadband service until such time as Telstra developed and implemented an LSS to ULLS migration process that is satisfactory to the ACCC; (b) the supply of the LCS or WLR to a queued access seeker, that is, an access seeker who had, prior to the proposed commencement of the orders, applied to Telstra to install a DSLAM in an exchange the subject of the applications (the queuing condition); (c) a capped exchange, potentially capped exchange or a constructively capped exchange (that is, an exchange the subject of the applications in which there was a physical constraint on the installation of an access seeker’s DSLAM or where Telstra might require an access seeker to pay for improvements to the exchange to enable access); (d) an exchange where Telstra ceases to supply the ULLS; and (e) the supply of the LCS or WLR provided under an agreement in force at the commencement of the orders.

39 These are the orders that are the subject of the application to review. On the review the Tribunal may either affirm, set aside or vary the orders: s 152AW(1). The review is limited in this respect – the only information to which the Tribunal may have regard is that which was before the ACCC: s 152AW(4). This limitation has the potential of imposing significant limitations upon the Tribunal’s capacity to adequately resolve a dispute in the most analytically-appropriate contemporaneous sense. There will be cases where important facts come into existence between the time of the ACCC’s decision and the Tribunal hearing which, in ordinary circumstances, an administrative tribunal would take into account. Under the present regime the Tribunal must consider the application based only on the material before the ACCC. Moreover, the Tribunal does not investigate whether the ACCC fell into error - the review is a review de novo: Re Seven Network Limited (No 1) (2004) 187 FLR 351, [1], [40] and [41]. On the other hand, the Tribunal is entitled to give the ACCC’s reasons due regard.

40 The thrust of Telstra’s case for exemption can be summarised briefly. Broadly speaking, the markets in which to determine the effect of deregulation are: (a) the downstream (retail) markets for the supply of all fixed voice and broadband data services; and (b) the upstream (wholesale) markets for the supply of inputs, including WLR, LCS, ULLS and LSS for the supply of fixed voice services as well as, potentially, broadband services. Telstra would also include mobile services and voice-over-internet protocol in the upstream markets but, according to its submission, their inclusion “[is] not decisive”. In exchanges where an entrant has installed a DSLAM ULLS is a substitute for other wholesale inputs in the upstream markets (including WLR and LCS) for the provision of services in the downstream markets. With ULLS, a service provider who has installed a DSLAM (with appropriate functionality) with switching and transmission capacity is able to provide voice and broadband services to end-users. That is to say, ULLS is equivalent to, and economically substitutable for, the voice services that can be provided by way of WLR or LCS. It is economically equivalent because there are few barriers to commence using, or expanding the use of, ULLS, assuming space is available in the relevant exchange.

The Use of a Rule of Thumb

41 Telstra’s argument for exemptions is largely founded on the opinions of Telstra’s consultant, Dr Patterson, an economist who has considerable expertise in the telecommunications industry. In his principal report Dr Patterson put forward the following propositions. There are a variety of technically and commercially viable substitutes for LCS and WLR, including ULLS and, to a lesser extent, other competing fixed access network infrastructure. In view of the provision of these substitutable services, Dr Patterson says that there is no bottleneck. Because there is no bottleneck, downstream competition will not be compromised by the grant of the exemptions. Not only would competition be undiminished but efficient competition and efficient infrastructure investment and use would be promoted by an exemption order. Here Dr Patterson’s proposition is that regulation is inefficient and that exemption best promotes efficiency. Hence, if regulation is terminated the resultant competition would stimulate efficient investment.

42 It was also through Dr Patterson’s reports that Telstra proposed its one plus decision rule, a rule of thumb it claimed should be applied to determine which exchanges should be exempt from SAOs. Dr Patterson put it this way in his report: “[T]he presence of one in-place competitor having access to ULLS at cost-based prices, and having already demonstrated a capacity to serve the market, demonstrates the inevitability of constraint on Telstra’s retail pricing behaviour at least as well as the availability of LCS/WLR.” He said he had arrived at this conclusion for two reasons: (a) “The existence of an ULLS-based competitor clearly demonstrates that there are no material barriers to competitive entry by ULLS-based operators”; and (b) Economic analysis leads to the conclusion that “there are no material barriers to ULLS-based entry or expansion”, which is “consistent with the empirical observation that entry has actually occurred”. As regards the effect of the grant of exemption on Telstra’s perceived freedom of pricing, Dr Patterson said that the existence of competitors would act as a restraint.

43 The ACCC is also of the opinion that a rule of thumb should be adopted. It opted for a three plus approach on the basis that an addressable market that can support four competitors (including Telstra) is an appropriate benchmark. It also added, as an alternative, that an exemption should be granted for an exchange that has 14,000 or more addressable SIOs on the basis that there is a relationship between the number of entrants and the average number of SIOs in an exchange.

The Ladder of Investment Hypothesis

44 Telstra also relied upon a report from Professor Cave, of the University of Warwick, which considered whether deregulation would encourage efficient investment in alternative infrastructure. In his writings Professor Cave has developed an approach to the analysis of incentives to infrastructure investment known as the “stepping stones” or “ladder of investment” hypothesis. To use Professor Cave’s description of this hypothesis: “[C]ompetitors challenge an incumbent by offering services which rely, as their market share rises, less and less on the incumbent’s assets and more and more on their own. Thus, competitors progressively build out their networks closer and closer to their customers.”

45 The ladder of investment hypothesis is based on the desirability of encouraging investment (though progressive acquisition of infrastructure assets) by entrants into a relevant regulated market. In this way, new technology will be introduced into the market and contestability will be achieved. Through such a market-driven process, socially desirable results will come about and there will be less need for the potentially distortionary effects of regulation.

46 Under this hypothesis, it is the task of regulators to signal that the terms and conditions of access will change. That is, those seeking access to the incumbent’s infrastructure will be put on notice that over time they need to increase their own infrastructure investment, and rely less on that of the incumbent. If not, then entrants run the risk that the incumbent’s services will no longer be regulated and accordingly may not be supplied, or may not be supplied under the same (regulated) prices and conditions as before. It is the regulator’s task to make this path both feasible and commercially achievable.

47 For a typical telecommunications market, the first rung is entry via reselling of an incumbent’s services, the second is the provision of some form of replicable or independent add-on capacity to the incumbent’s network and, on the third rung, the firm is expected to invest in network facilities of its own.

48 According to adherents of this hypothesis, a regulator may accelerate this process by signalling that it will withdraw protection at progressive stages of the ladder, when it becomes convinced that no bottleneck elements remain at the relevant rung, thereby forcing entrants to climb the ladder of independent provision. Essential to this process is the need for the regulator to identify accurately the disappearance of the bottlenecks which were the cause of regulation in the first place. This has, in fact, been signalled by the ACCC in its July 2006 ACCC’s Declaration Inquiry for the ULLS, PSTN OTA and CLLS – Final Determination.

49 Inherent in the ladder of investment process is the need for the regulator to be on top of what is happening in the market in terms of firm numbers, their competitive options, changes in market shares, capacity in the market, the long term-interests of end-users and in developments in technology and its deployment.

50 In deciding to withdraw regulatory protection at a lower rung of the ladder, the regulator in effect leaves entrants at the mercy of the incumbent for access to the relevant service. It must be confident that, in trying to encourage a firm to begin its technological ascent, the firm will face an equality of opportunity to compete on the next rung of the ladder with the incumbent operator (and any other recent entrants who have progressed to this rung of their own volition).

51 There are clearly costs associated with the ladder of investment hypothesis when it is applied by a regulator – the costs of false positive decision errors (when it would have been socially advantageous to withdraw protection at the lower rung, but regulation was left in place) and false negative decision errors (when the timing was not right to withdraw regulated access but this was done, resulting in damage to the newer firms and to end-users). It would normally be easier to revisit a decision at a later stage and subsequently withdraw regulation, than it would be to re-regulate after the market had been divested of some or all of its regulatory constraints.

52 When a regulator decides to withdraw regulatory oversight at a certain rung of the ladder, it needs to be confident that those previously protected by the regulation will have an equality of opportunity to compete in the market, either by: (a) retaining their old supply sources and conditions of supply; (b) by entering into contracts with alternative suppliers; (c) by investing in their own facilities; or (d) by using excess capacity of other providers operating on the next rung of the ladder.

53 When a regulator removes regulatory protection, in the hope of encouraging entrants to move up the ladder, it denies potential entrants the ability to enter the market on the same conditions as earlier entrants, for two reasons. First, the incumbent may decide not to provide the previously regulated service. This forces the entrant to enter the market at a higher rung, which in turn requires it to invest in its own capital equipment or to negotiate access to the equipment of other firms already operating on the higher rung, without having had the opportunity to learn about the market through a less complicated form of initial entry. Second, if the previously regulated service is provided, the entrant may face higher costs of entry if the incumbent chooses not to offer wholesale services at previously (regulated) prices. It follows that new entrants will face higher barriers to entry than those that came before them. This could have the effect of retarding new entrants that could have promoted competition in the market, and competition in the market will then depend on there being no barriers to the expansion of the market share of those entrants that have already entered the market.

Satisfaction of the s 152AT(4) criterion

54 The case put by Telstra, including its one plus rule, was directed to showing that the s 152AT(4) criterion (that deregulation would promote the long-term interests of end-users) had been satisfied. The ACCC’s three plus rule or its alternative of an exchange with 14,000 addressable SIOs was directed to the same end. It is to be noted that Telstra did not address the Tribunal on how its discretion should be exercised if the s 152AT(4) criterion was met. This is, no doubt, because the discretion issue was only raised late in the day by the Tribunal itself, all parties (and the ACCC) having proceeded on the false premise that there was no discretion.

55 Be that as it may, it must be said that the argument that s 152TA(4) is satisfied had little by way of empirical evidence to support it. In large measure the argument was founded simply on the view of many (if not most) industrial organisation economists that “competition is the best regulator” because regulation will inevitably produce lack of choice, inefficient investment and disincentives to innovate, whereas removing regulation will produce the opposite results.

56 The Tribunal is prepared to accept that, as a general proposition, long-term regulation may not be in the long-term interest of end-users. But whether or not regulation should end at any particular point depends, critically, upon trends in the state of actual and potential competition in the market at that time. Moreover, it is the Tribunal’s view that determining the competitive state of the market should be largely an empirical exercise. This involves examining observable market behaviour. There are many indicators of a competitive market. Principally they are: (a) the number of new entrants; (b) the growth of the entrants’ market share (either through attracting new business or taking share from the incumbent); (c) an increase in the range and quality of services provided; and (d) a reduction in the price of services. If these indicators are present they show not only rivalrous behaviour, but also socially-beneficial rivalrous behaviour.

57 It is unfortunate that each of Telstra and the ACCC avoided empirical market analysis by the adoption of a rule of thumb which they say should be applied to determine whether a particular exchange should be exempt from regulation.

58 The problem with a fixed rule of thumb in the area of deregulation is that it is just a shortcut. Simple numbers-based rules of thumb are not uncommonly used as a screening device to indicate thresholds beyond which markets might ordinarily be expected to work competitively. But a rule of thumb is a static indicator only and reveals nothing about market dynamics over time.

59 For example, Telstra’s one plus rule and the ACCC’s three plus rule identify the current number of rivals, but give no indication of: (a) how this number of firms eventuated; (b) whether their presence (market share) in the market is growing or declining; (c) whether there has been exit over time and, if so, for what reason; (d) whether end-users attracted to new entrants are increasing; (e) whether entry was for strategic or indirect purposes designed to influence behaviour elsewhere or to compete in the market (ie the particular exchange) in question. Nor can a rule of thumb reliably indicate anything about past, present, or importantly for regulatory purposes, likely future behaviour by either incumbents or potential entrants.

60 To be fair, both Telstra and the ACCC accept that ultimately the critical values used in their respective rules of thumb are a matter of judgment. While the Tribunal acknowledges that certain rules may be useful as screening devices, to be ultimately determinative of a regulatory process that seeks to minimise regulatory distortions and to promote productive, allocative and dynamic efficiencies, any rule must be carefully researched and justified (if it is capable of being justified) on grounds of sound economic knowledge.

61 The problem is that while the feasibility of entry may be demonstrated by actual entry, the fact of entry by one firm, or even by more than one firm, of itself does not establish that the incumbent is either presently restrained or is likely to be subject to the constraints of the competitive process in the future, by either the entrant or by further new entrants. Notwithstanding relatively low costs of entry and few sunk costs, the competitive impact of entry depends upon what the entrant does after it has entered, and how the incumbent responds to it.

62 A few illustrations of the kind of problems that may arise from a simplistic application of Telstra’s one plus, or the ACCC’s three plus, rules of thumb will help make the point. The facts in this matter show that the capacity of a DSLAM can vary greatly, dependent upon its configuration. But there is no hard information about the minimum or maximum capacity of the DSLAMs installed by an entrant at any exchange. In the absence of hard information about the capacity of the installed DSLAMs, it is not possible to conclude whether an entrant with one or more DSLAMs is capable of providing: (a) any competitive constraint on the incumbent (Telstra); (b) accommodation to a further entrant who is unable for whatever reason to access the exchange with its own DSLAM; and (c) short-run accommodation to existing rivals who, faced with an unregulated LCS or WLR, may be forced to consider engaging in further infrastructure-based competition in lieu of resale-based competition.

63 There is also the possibility that entry has a limited purpose, aimed at serving only a small part of the market. It may have been entry designed to accommodate the firm’s customers in other markets who seek some moderate level of service in the subject markets. It may have been a toe-hold entry designed solely to get into a queue of sorts, or to provide a signal to other potential entrants as to the firm’s intentions.

64 Toe-hold limited entry is often relatively inexpensive. Incumbent firms may make no real effort to stop it, but rather wait to see what transpires. It may be easier to block expansion than entry. If the entrant looks set to expand and threaten to take more than a few customers at the margin, the incumbent could take action to make that expansion competitively difficult by a variety of price and non-price strategies. We have the example of Telstra providing ADSL2+ only in exchanges where it is faced with an entrant providing that service. Mention has already been made of Telstra making access difficult by capping, queuing and forcing access requests to arbitration and litigation. Without characterising this conduct in pejorative terms (eg as ‘sabotage’ conduct) it has the effect of slowing down access and raising the cost of securing access.

65 There is also the possibility that the incumbent may encourage several small entrants to set up, as under these circumstances they could face great uncertainty about each other’s expansion plans. Thus, no one firm may be prepared to invest enough to seriously threaten the incumbent’s position.

66 These are just some of the factors that show that simple observation of new firms over time entering a market provides little more than an indication that those firms appear to believe that their entry will be commercially profitable within their wider set of corporate goals. It indicates either nothing, or very little, about the social usefulness of that entry in terms of constraining an incumbent to respond in ways that are likely to promote competition. In particular, in the absence of details of the type and extent of entry, and on what has happened in the market after entry, it is not possible to say anything with confidence about the impact of barriers to competitively significant new entry, barriers to expansion, or the impact of entry or competition in the subject exchanges.

67 It is also necessary to consider that the uncertainties faced by a new entrant will be greater, the greater the rate of entry, and the larger the pool of potential entrants. If minor scale entry signals a lack of commitment, end-users (especially businesses and governmental end-users) may not be prepared to leave the incumbent (for fear of later reprisals if the entrant decides to exit) and so entry, while palpable in numbers, may be of no commercial or competitive significance whatsoever.

68 Moreover, to be competitively significant an entrant must at least be likely to have both the physical capacity and the willingness to confront the incumbent and take market share away from it, by offering end-users a better price–product–service package. Whether that is happening in each exchange depends upon knowing what has happened in that exchange. In the absence of information about capacity (actual and potential), the projected growth in capacity over time and details of market activity generally, it is not possible, with any confidence, to reach conclusions about the likely impact of entry. Put another way, it is vital to have reliable hard information on these matters as well as knowledge of the asset and management capacity of the entrants, their willingness and ability to be competitive in the market and the response of their rivals, before any authoritative statement can be made on whether entry has, or is likely to, promote competition in the market.

69 In these circumstances the Tribunal is of the opinion that the fact of entry into an exchange by a firm with one, two or more DSLAMs means very little. What is important to know for competition assessment purposes is the impact of entry on Telstra: has entry had or, more importantly in terms of the Act, is entry likely to have, a competitive impact on Telstra’s behaviour?

70 Entry will have a competitive impact and is likely to achieve the objective of promoting competition if it attracts customers away from Telstra. The new entrant does this by offering a better price, better terms of sale or innovative product offerings. In addition, there will be circumstances, for example, in the case of a business or government end-user, where the entrant must convince the end-user that it has the capacity to satisfy its demands in both the short run and the long run. Also, the entrant needs the financial strength and management ability to ride out Telstra’s responses. These are the issues that require investigation. These are also the issues that the simplistic application of Telstra’s one plus, and the ACCC’s three plus, rules of thumb ignore.

71 There is simply no empirical evidence before the Tribunal from which it is possible to arrive at any, even any tentative, conclusion about market behaviour and whether entry is likely to produce a competitively significant long run impact in the relevant markets.

A Possible Framework

72 It is hard to deny that, if it were possible, it would be very useful to formulate a set of rules that provide a roadmap for deregulation. If a roadmap were to be developed based on today’s technology and knowledge, it would include at least the following eight factors: (a) the total number of addressable SIOs in the market; (b) the number of exchanges in which there is at least one entrant; (c) the number of entrants; (d) the total number of addressable SIOs broken down on an exchange by exchange basis in the subject exchanges; (e) the share of SIOs that the entrants have taken from the incumbent; (f) the physical capacity and operational willingness of the entrants to take more market share; (g) the cost and ease of installing new infrastructure; and (h) the capacity and technology status of each DSLAM in each exchange. Such an inquiry would at least provide a basis for drawing inferences on whether deregulation is likely to result in the achievement of the objective of promoting competition.

73 Interestingly, the Office of Communications in the United Kingdom uses somewhat similar criteria to determine whether an incumbent has significant market power. The Canadian regulator, the Canadian Radio-Television Telecommunications Commission, has adopted similar rules of thumb to determine whether there should be deregulation. The view the Tribunal takes is that the adoption of a definitive prescriptive roadmap is an approach that is likely to lead to error. There is little scope for the development of a general fixed rule, although it is possible to identify market features the existence of which, and following careful analysis of them, may suggest that deregulation is appropriate.

Conclusion

74 The Tribunal is not satisfied that the making of the exemption orders sought by Telstra will promote the long-term interests of end-users of carriage services or of services provided by means of carriage services. It is not, therefore, necessary to consider matters that go to discretion. Nor is it necessary to consider whether it is legitimate, for the ACCC or the Tribunal, to reach the satisfaction required by s 152AT(4) by imposing conditions or limitations.

75 The analysis and reasoning applies mutatis mutandis to the class exemption orders set out in appendixes I and J of the ACCC’s final decision. The class exemption orders were made as a consequence of the ACCC’s proposed orders in respect of Telstra and, like those orders, would have exempted service providers other than Telstra from the SAOs in respect of the LCS and WLR in any one of the subject exchanges.

Decision

76 The decision of the ACCC to grant Telstra the exemption orders set out in appendixes E to H and the class exemption orders set out in appendixes I and J, in its final decision be set aside.

I certify that the preceding seventy six (76) numbered paragraphs are a true copy of the Reasons for Determination of the Australia Competition Tribunal.

Associate:

Dated: 22 December 2008

Counsel for the Applicant:	Mr N J O’Bryan SC Mr M H O’Bryan

Solicitor for the Applicant:	Herbert Geer

Counsel for Telstra Corporation:	Dr J Griffiths SC

Solicitor for Telstra Corporation:	Mallesons Stephen Jacques

Counsel for the Australian Competition and Consumer Commission:	Mr C Caleo SC Mr S Horgan SC

Counsel for the Australian Competition and Consumer Commission	DLA Phillips Fox

Date of Hearing:	5, 6, 10, 11 & 12 November 2008

Date of Judgment:	22 December 2008