Foto: Martin Siebert
However, the realization might take time as the Czech regulator, the Czech Telecommunications Office (ČTÚ) claims that high prices guarantee investments into modern technology. Poland’s Office of Electronic Communication (UKE), meanwhile, has been pursuing a policy focused on increasing competition, which resulted in a reduction in market prices.
Annual mobile phone bills paid by Czechs are the fourth highest in the world, according to Organization for Economic Co-operation and Development (OECD) data cited in an Oct. 5 report by brokerage Wood & Company Financial Services. Czech operators charge close to $500 (Kč 12,715/€335) per account yearly, compared with an OECD average of $310.
Poland and Hungary score slightly below the mean, according to the OECD figures. This asymmetry is a substantial strain on Czech consumers, but also a source of exceptionally healthy margins achieved by market leader Telefónica O2 Czech Republic in the mobile phone segment, Wood & Company analysts state. The brokerage, however, said that this situation can change in the coming years.
The major reason should be a reduction in Mobile Termination Rates (MTR) enforced by the ruling of the European Commission. “MTR is a pre-determined price charged by operators to other carriers when calls end in their networks. The justification was to enable telecom companies to cover their network build-out costs during the development stage in order to enable mobile coverage to spread as far as possible,” Wood & Company stated. If the volume of outgoing and incoming traffic is equal in a given network, then the nominal level of MTRs is neutral to the profitability of the company. However the broker claims that the former monopolies—also called incumbent operators—have more traffic terminated in their networks than in other networks. In such a case Telefónica O2 would receive more MTRs than it pays to the competitors and benefit from the high level of the rates.
Smaller players like Vodafone Czech Republic are in the opposite situation. “Such companies pay significantly more than they receive and so are clear beneficiaries of reductions. As their costs decline with every MTR cut, they move quickly to reduce overall charges and attract customers, boosting their market share. The final effect is pricing pressure and reductions in average phone bills,” Konrad Księżopolski and Igor Muller from Wood & Company concluded, pointing out that this confirms this assertion because mobile phone bills remain the highest in countries with high MTRs.
ČTÚ spokeswoman Dana Makrlíková challenges this claim. “We argue that reducing the price for termination is not necessarily reflected in a decline in retail prices. If the regulator increases competition on the telecommunication market, companies face more risks. Consequently, they require higher rates of return on their investments. They can achieve that only by hiking the retail prices of their services. Also, the roaming regulation in the Czech Republic led to an increase in price for international text messages against an expected decrease,” she told CBW.
Piotr Dziubak, spokesman for Poland’s UKE, has a different opinion. “The theory that MTR reduction has a negative impact on the level of investments is doubtful. A lower MTR level implies a reduced margin, but at the same time fosters traffic. Moreover, judging by the official intentions to build fourth generation mobile networks, the investment appetite didn’t fall after MTR cuts were introduced in Poland in the last two years,” he told CBW.
ČTÚ and Telefónica speak the same language
Currently, the Czech Republic has the second highest MTR level in the EU at Kč 2.31 (€0.09) per minute, trailing only Bulgaria and double the level on the Polish market. According to an EU ruling cited by Wood & Company, the maximum MTR should fall from an average of €0.09 per minute in 2008 to a maximum of €0.02 by 2012. The MTR levels in the Czech Republic disappointed the European Commission so much that it sent an official letter to the ČTÚ on Oct. 14 urging an acceleration of the pace of termination rate reduction. The ČTÚ briefly rejected the criticism, pointing out that the current rates reflect the actual costs of network interconnection. Therefore, lower rates would be unfair according to the ČTÚ. Moreover, in an official press release the ČTÚ pointed out that any ad-hoc reaction would significantly damage the transparency of the regulatory body. Wood & Company’s Muller judged this development as positive for the profitability of the Czech incumbent operator. Anna Bossong, head of EME telecom research with the London Office of brokerage UniCredit CAIB, said that the ČTÚ will have to fulfill the EU requests by 2012. “I expect an accelerated rate of decline of MTRs toward around €0.02 over the next four years,” she told CBW.
ČTÚ’s Makrlíková stated that the regulator is strongly committed to MTR reductions. Indeed, although still high in a European context, the MTR rates were already reduced twice this year from the level of Kč 2.99 per minute, which means a 22 percent reduction. Another 15 percent cut is already scheduled for the beginning of 2010.
Telefónica O2 is conscious about the threat stemming from MTR reductions. “Change to these incremental costs will cause significant reduction of revenues for mobile operators,” Radka Spiesová from the media relations department of Telefónica O2 Czech Republic told CBW. Not surprisingly, the firm strongly supports the regulator’s claim that a further cut would undermine fair play in market competition. “The MTR decrease is based on a change of costing methodology, which does not reflect real mobile termination costs,” she said adding that anyway the firm assumes that the ČTÚ will fulfill the European Commission’s aims for MTR levels in 2012.
Regulations set the dynamics
The MTR dispute underlies the large impact that regulation has on the telecommunication business.
That impact is especially visible in CEE markets since every regulator has embarked on a different policy framework in the last few years. First, every regulator needs to decide whether to encourage investments or increase competition. Achieving both would be desirable but proves to be impossible. A high level of investment happens if returns are just as high. Competition reduces returns though. The second dimension is the intensity of the pressure exerted on the incumbent operator, as exemplified by the MTR reduction pace. “The regulatory environment for telco incumbents in CEE countries varies enormously by country. The Czech [regulator] seems very fair in willingness to reimburse the incumbent operator for the investment costs it incurs. The Hungarian one is focused on encouraging infrastructure investments. The Polish regulator is heavily stacked against the incumbent operator and dominant market force,” Bossong said.
The situation in Poland is expected to change after the regulator signed a contract with local incumbent Telekomunikacja Polska S.A. (TPSA). The accord requires TPSA to accelerate investments in exchange for more favorable regulations, especially stability of prices for the wholesale fixed-line services of TPSA, which are set by the UKE. Analysts consider this step as a switch into investment-oriented regulation from a competition focused one. UKE’s Dziubak, however, affirms the regulator’s continuous commitment for promoting competition on the market. “The market dominance of TPSA causes artificially high prices and low penetration rates of selected services, in the absence of regulatory intervention. The steps undertaken in the last few years by the UKE caused a visible decrease in prices; however, the level of competition is still not satisfactory for us. Therefore the UKE will strive to promote competition especially in the peripheral locations.”
Unrestricted access to incumbent network
The regulatory measures differ in the two major sectors of telecommunication, meaning fixed-line and mobile networks. The fixed-line network is a typical “natural monopoly,” meaning that the existence of only one is economically optimal, similar to the electrical, water or sewage system. Since a monopoly is a market situation that disadvantages the consumer and leads to high prices and low quality, regulators try to introduce as much competition and limits on monopolistic power as possible. The most popular solution is to force the incumbent to rent parts of its network at a price defined by the authorities. The most effective framework for line rental is called “local loop unbundling” and proved successful in Western countries like France and Germany where respectively in France 5.5 million lines were resold under an LLU framework, and 9.6 million lines were resold in Germany.
Polish authorities deregulated the incumbent network in 2006. So far it has achieved impressive results. Within a three-year period some 14 percent of voice lines and 13 percent of broadband services on the TPSA network were provided by alternative operators. Dziubak explains why the UKE decided to open the network of the former monopoly for other operators. “The incumbent controls a significant majority of the telecommunication infrastructure in the country. Consequently, TPSA holds a much stronger position on the market than its competitors. This privileged position of one player allows it to block the entrance of new companies on the market. The UKE tries to prohibit these kinds of activities, which obviously doesn’t mean that alternative operators are subsidized. They are simply offered a roughly equal competitive position with the incumbent,” Dziubak told CBW.
In the Czech Republic, LLU started in 2005. However, after two initial years of quick growth, the dynamics on new lines rented faltered. The major reason might be that the rental fee paid to the incumbent in the Czech Republic of roughly €16 is twice as high as in Poland, according to a 2007 European Commission report on the single European electronic communications market.
Telefónica O2’s Spiesová doesn’t question the policy of opening the incumbent network but warns about a possible serious drawback of a too-aggressive policy. She said she believes that too much competition can halt progress. “Unfortunately, opening the network of the incumbent operator reduces incentives to large investments, as the investor can hardly exploit the possible competitive advantages arising from the outlays realized. The risk of the eventual outcome grows, too, which further discourages investment into new technologies.”
Spiesová also said that all market participants would benefit from regulation supporting more investments. “We believe that a regulation here should be equal for all infrastructure businesses and focused on incentives to build fiber networks. Imposing an ‘LLU-like’ obligation on fiber optics networks of a single operator would lead to a reduction of investments into this business,” Spiesová told CBW. She said, though, that the regulator should offer “regulatory vacations” from the LLU regulations for the newly built networks in order to spur investments. “Certain guarantees should exist that would enable the investing party to profit from the investments, at least for a certain period of time,” she said. Moreover, according to Spiesová, alternative operators are also reluctant toward new investments if they can expect much higher returns from focusing on exploiting the network of the former monopoly.
Poland’s UKE, after achieving significant retail price reductions, also set a new focus: investment growth. The aim is to increase the number of internet users and improve the quality of the network. Dziubak explained the rationale behind the current policy. “The availability of broadband service is low, which translates into low penetration and existence of so called ‘white spots,’ areas that are excluded from modern communication technology.
UniCredit CAIB’s Bossong said that the UKE realized that it was somewhat too zealous in its previous policies. “The Polish regulator managed to increase competition but also contributed to weak investment in the broadband technology in Poland. Now they are trying to make up for that,” she said.
The investments necessary to bridge this gap need to go to billions of euro, therefore the regulator wants to facilitate their execution. On one hand, the UKE prepared a draft bill that involves regulations supporting such investments by raising the priority of telecommunication investments in the country development strategy. On the other hand, the UKE signed the an accord with the incumbent operator that obliges TPSA to build and improve a total of 1.2 million broadband lines. “We also count on the help of EU funds that for 2007–12 earmarked up to €1 billion for the development of broadband infrastructure in Poland,” Dziubak told CBW.
In the case of mobile market, the regulations are simpler since there is no monopoly. The problems regarding lack of investments is however the same—money. Telefónica O2’s Spiesová said that the willingness for large-scale investments like a fourth generation mobile network called LTE, will very strongly depend on the level of regulatory incentives. “The recent steps of the EC, for example, price control on roaming [fees] or pressure for a decrease of MTR have a discouraging effect for mobile operators in terms of new investments. This is exactly opposite to what the EC officially wants to achieve,” Spiesová said.
The UKE decided to encourage competition in the mobile market by granting advantageous conditions for the new entrants. “The UKE strives to foster competition that requires the appearance of new market players. This involves also setting asymmetrical regulatory prices for the services rendered by the operators to each other, like call termination. This kind of policy is widespread in the EU and is not considered as a subsidy or market distortion. Quite the opposite, it is deemed as beneficial for the whole market due to the increase in competition that it causes,” UKE’s Dziubak said.
In any case, the decision allowed the fourth operator, P4, to gain a significant market share and set pressure on prices of calls, especially in the pre-paid sector. As a result, the EBITDA margin of the mobile operations of TPSA fell from 39 percent in the first three quarters of 2008 to 28 percent in the same period of 2009.
The incumbents have been losing a significant market share in broadband and fixed-line phone to cable television operators for the last decade. The source of their advantage is attributed to more modern technology. Spiesová points out their supposedly more-favorable regulatory position. “Cable operators invest into new access networks because they do not have the duty to share infrastructure with competitors,” she acclaims.
Network separation doubtful
The telecommunication business can be divided into three components. First is infrastructure, including copper and fiber optic lines. Second is the technology that uses the network to provide different Internet bandwidths for the users. The last are the services like e-mail, voice over Internet protocol (VoIP) phone, Internet TV and web access. Only the first element is a natural monopoly, since it makes little sense to put two identical cables into the same flat, the others can easily be fully competitive businesses.
Most of the other natural monopolies, like electricity and heat distribution, are utilities, which are either state-owned or strictly regulated private activities, bringing unexciting but stable rates of returns on investments. A similar idea exists for the telecommunication network and is called “network neutrality,” which would separate the infrastructure owner from the provision of technology and services.
Such an idea is widely discussed in the traditionally pro-competition U.S., but it has not gained traction in Europe. Bossong is also skeptical about such an idea. “Separating investors from the final user risks a shortage of investors and mismatching of investment with user needs,” she said. “The UK is the only country where the network has been split from the retail business of the incumbent operator. Currently, it has some of the slowest broadband speeds in Europe with very poor rural coverage. Low expected profits translate into low investment and low quality,” she said.
Still some mobile potential
Investments into fixed line and mobile broadband Internet seem like the only chance for telecommunication operators to avoid a continuing decline in their sales. The growth driver of the last decade, mobile telephony, has recently run out of steam as the local markets reached saturation with over one active number per citizen. “In my opinion, in the Czech Republic the mobile penetration rate is already very high and is touching its limits. In Slovakia there is still some limited potential for growth,” said Josef Němý, analyst in economic and strategy research investment banking at Komerční banka.
“The new growth driver should be sales of value-added services, most particularly broadband,” Bossong said, pointing out that mobile voice revenue can still grow without increasing penetration rates. “The number of SIM cards is not the only driver. I see the upside potential in the amount of voice traffic as customer incomes rise and the gap between CEE and Western European revenue per user (ARPU) diminishes. Moreover, with multiple SIM card usage there is the potential for the effective population penetration to rise without seeing an increase in SIM card numbers,” she said.
The most dynamically growing business for mobile phones operators has indeed been mobile broadband, which allows subscribers to access the Internet on their laptops using mobile phone networks.
According to an April 2009 report from the UKE, mobile broadband accounted for around half of the growth in broadband access in Poland in the second half of 2008. Bossong said that this service will continue its growth. “New technologies like 3G and LTE should provide bandwith high enough to allow mobile operators to compete against WiFi technology. High levels of clients who don’t have any fixed line phone should also lead to higher levels of interest in mobile broadband,” she said.
Triple play is the name of the game
Fixed-line broadband is, however, the most promising in the long run due to the potential bandwidth available. According to data from Merrill Lynch (now part of Bank of America Merrill Lynch), today around 40 percent of households have access to broadband Internet in all the CEE countries. In the richest countries, the ratio ranges from 90 percent for Nordic countries and the Far East to around 50 percent for Italy and Spain. According to the analysts CBW interviewed, the number of lines in CEE is expected to grow by between 30 and 60 percent from today’s level of the next four to five years.
The fixed-line voice service, 15 years ago a luxury in CEE countries, has become obsolete before it became available to all citizens. The rate of fix-line voice client loss ranges from 5 percent for Telefónica O2 to as much as 11 percent for TPSA in the last 12 months. “With voice services and later broadband services likely to continue to move over to the mobile sector, it will be a challenge to slow the rate of revenue decline,” Bossong said. This is especially true in the Czech Republic, where less than half of households have fixed-line phone service, the lowest level among CEE countries. “I believe the future of fixed line is not very bright. Most Czechs prefer mobile phones, unlike in some West Europe countries, for example, Spain or Germany, where fixed line penetration is still very high,” Němý said.
Bossong is more optimistic. “If the voice service can be provided as part of a package of services, it is likely to remain in some homes and in businesses. This will be accompanied by falling prices because thanks to low maintenance costs of the network, the service can be offered profitably at a very low price, much lower than the mobile connections,” she said.
Packaged services of traditional voice, broadband and TV, where customer obtains three at a regular price of two, have become a standard on the market. “Offering combined services is the only chance for telco companies to compete with cable television operators,” Němý said. All CEE telco incumbents already offer those services together. Bossong said she believes it will lead to convergence of those two so far distinct businesses. “Fixed-line operators are likely to become increasingly similar to CATV operators, and it is likely to become harder to tell the two apart.”