The Breaking up of BT : A decentralised BT would be more effective

THE BREAKING UP OF BT 247

CONTROVERSY ANDREW DAVIES

Fellow at the Science Policy Research Unit University of Sussex

The breaking up of BT A Gecentralised BT would be more ef ,sctive

nternational telecommunications operators are lining up to provide digital net- I works to connect the branches and offices

of the world’s largest 2,500 corporations. In- dustry observers believe that only a few global operators are likely to survive the in- tensifying competition of the 1990s. The largest telecommunications operators have already formed three major strategic alli- ances - AT&T/ WorldPartners-Unisource, BT/MCI, Deutsche Telekom/France Tele- com-Sprint - in preparation for global concentration. Yet does this globalisation require the end of local, national and international operators?

The chairman of BT, Iain Vallance, thinks it does. He believes that the old hierarchy of local, long-distance and international exchanges controlled by national monopolies is obsolete. Vallance argues that with digital technologies, seamless telecommunications networks across national borders are best handled by a small number of global operators, who must act like predators abroad while satisfying their public service obliga- tions at home. According to BT’s own predic- tions, by the end of the 1990s there may be only six global operators, two in the US, two in the Pacific rim, and two in Europe.

This paper is not against large-scale organ- isations but questions the assumed link between efficiencies of scale and a single organ-

isational form where integrated local and long-distance operations are under the cen- tralised control of a global BT. When BT was privatised in 1984 its monopoly structure of integrated local and long-distance operations was wrongly left intact. Consequently, in the post-privatisation era, Oftel (the telecommunications regulator) has been preoccupied with trying to prevent BT from abusing its dominant position. BT has almost 90 per cent of the market.

Serving more with less Competition in their domestic long-distance markets first encouraged BT and AT&T to reduce costs and improve their services by investing in new network technologies which allow for almost unlimited capacity. The need to recoup the huge fixed costs in- volved provides a continuous incentive to realise economies of scale by expanding the capacity and size of networks by moving into new markets which are beyond the reach of national boundaries.

BT’s global strategy is to grow in foreign markets, by making acquisitions or taking out equity stakes in equipment and information service providers. BT is investing $lbn over ten years in project Cyclone, a global network with four high-capacity exchanges in New York, Frankfurt, London and Sydney, con- nected to a further 28 switching centres at ma-

lQ70-3535l95lO40247 + 06 612.0010 0 1995 THE DRYDEN PRESS

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jor business locations world-wide. BT has spent $4.3bn on a 20 per cent stake in MCI Communications, the second largest US long- distance operator, to establish a new company to provide services for multinational corporations.

But where does this money come from? There is a fear that an integrated local and long-distance BT will underdevelop its local networks and raise domestic monopoly prices in order to finance its international ex- ploits. Tlus problem is shown not just by BT’s

poor record in the provision of local services, but by the money wasted on unsuccessful foreign acquisitions which are ultimately paid for by British consumers. In 1990, B T sold its stake in Mitel, the loss-making Canadian telecommunications manufacturer, for a quarter of the original price. As long as BT retains its traditional integrated structure, the introduction of more domestic competition is unlikely to prevent BT from exercising monopoly power. Indeed in June 1992, Oftel wcis forced to intervene in BT’s investment decisions and instructed them to reduce prices by 7.5 per cent below the rate of inflation and install 3.53 million lulometres of optical fibres.

The policy of decentralisation Paradoxically, the increasing globalisation of telecommunications technology is not in- compatible with the decentralisation of the system into smaller organisational parts (Davies, 1994). BT should be reorganised into regional systems under independent ownership or management, and national and international long-distance operations should be placed under the control of a separately-run company, allowing each business to focus on its core markets.

The policy of decentralisation would end BT’s conficts of interest which cannot be ac- commodated within a single organkation. It is simultaneously a competitive global operator, a public service provider and potential new entrant in broadband entert,iinrnent

communications. Two radical policy changes are needed.

First, BT should place its profitable national and international long-distance operations into a separately-run services company, which is free to operate in competitive markets but not permitted to supply local exchange services, as occurred when AT&T was broken up in 1984. The decision to retain BT’s integrated stucture failed to allow Mercury - the second carrier which was licensed in 1982 - to become a signficant rival. When the duopoly of BT and Mercury was abolished in 1991, Mercury had gained only 10 per cent of the long distance market, slow progress compared to MCI, one of the two long distance competitors to AT&T, which had a market share of 19.5 per cent in 1991. Currently, BT is able to abuse its local monopoly to compete in national and international markets. On the one hand, Mercury and other new operators using BT’s local exchange networks to complete calls have had to pay excessive charges for interconnection. On the other, BT has reduced the price of national and international long-distance calls relative to local call charges (OECD, 1993).

The fact that BT bundles up local, long-distance and international services into a single package is the source of the problem. In the mid-l980s, for example, BT made sharp reductions in long-distance tariffs while raising local call charges. In 1992, an OECD study showed that BT charged higher residential prices than six other large national operators, while offering lower business tariffs than the French, German, Japanese and US operators. In January 1995, BT announced reductions in transatlantic prices to offset its announced in- creases in UK line rental charges.

A separately-run global operator could be created by a change in government policy. In the US it was Federal government which in 1984 forced the break-up of AT&T’s integrated structure. A much s h e r AT&T sup- plied long-distance services and manufac- tured equipment, while seven regional Bell


operating companies provided ‘natural monopoly’ local telephony services, since there was and is still room for only one cable-based company in each region. To emulate the suc- cess of the US model, the Japanese Ministry of Posts and Telecommunications proposes to divide NTT into a long-distance operation (which may in the future be permitted to supply international services) and one or several local monopolies as part of the government’s 1995 telecommunications review.

Alternatively, a change in corporate strategy could create an independently-managed global BT operation. While the survival of operators in global telecommunications is domi- nated by economies of scale, there are altema- tive ways of mobilising such cost-advantages without a continuing dependence on local revenues. In a radical rethinking of strategy, AT&T has concluded that big is no longer beautiful in telecommunications. Despite the continuing trend towards consolidation in the industry, in September 1995, AT&T announced one of the biggest demergers in corporate history by voluntarily splitting itself into three smaller companies: telephone services, equipment manufacturing and computing. AT&T has abandoned its century old strategy of vertical integration in favour of specialisation and flexibility, Having unbur- dened itself of its manufacturing and loss- making computing divisions, the company is concentrating on its core business of supply- ing long-distance services and preparing to enter the soon-to-be deregulated US local markets. This smaller, more highly focused company will be a powerful competitor in the war for dominance of profitable long-distance services in Europe, especially after the end of the monopolies within the EU in 1998.

South West Telecom? The second proposal is to place BT’s local exchange operations into regional companies and permit competition in the provision of services. BT’s local switching and transmission operations should be reorganised into

regional companies under independent ownership or management. The provision of a broadband information network into homes and offices could then be provided by regional companies operating in defined geographical areas.

Since 1992 BT’s local business has been eroded by competition from US-owned cable television companies. With an installed base of 400,000 lines, the cable companies have announced plans to invest E6bn over the next five years. Cable subscribers are being offered a full range of TV channels and discounts of up to 15 per cent on cable telephone services.

Yet the current government regulatory policy prevents BT from participating in the development of a new generation of broadband ’information superhighway’ networks carrying telephone, computer, television and other services into the home and office. Tele- communications operators like BT have a strong interest in pushing the development of high-capacity broadband optical fibre networks especially as the growth in conven- tional voice telephony is slow, and the market for specialised global corporate services is now thought to be more limited than pre- viously expected. The question is should BT be allowed to continue to prioritise investment in global networks, or push for the development of information highways in the local network, or both?

The 1991 Duopoly Review bans BT (and Mercury) from providing entertainment television over its local network until at least 2001, with a review in 1998. The ban was im- posed to stop BT from adding a monopoly in television transmission to its near-monopoly of telephony, and to protect the cable television companies, which are permitted to carry telephone and television services, while they invest in local networks.

BT claims that the estimated €15bn investment required to install fibre optics in the local network would be uneconomical while the company is excluded from providing entertainment and multimedia services. A 1994 re-

NEW ECONOMY 250 ~~ ~

port by PA Consulting Group found that Brit- ain was lagging fourth out of the seven most advanced countries in the deployment of fibre optics technologies in the local netu ork. The report on the development of fibre optic networks in the UK by the House of Commons Select Committee on Trade and Industry, published on 27 July 1994, has proposed lifting the ban. But even if accepted by govem- ment the lifting of the ban on a franchise-by- franchise basis would take years to have an effect nationally. The UK government is effec- tively encouraging BT’s global ambitions at the expense of broadband local comunica- tions.

The Labour Party’s policy on the mforma- tion superhighway, by contrast, would allow BT and other telecommunicahon companies to supply entertainment services in competition with cable TV companies. Access to the market would be phased from the election of a Labour government until full competition in 2002. Labour has made an informcil agreement with BT that in return for lifting the ban, BT will be free to provide free connections to the broadband network for schools and hos- pitals. The fact that Labour has not ap- proached BT’s rivals and is prepared to break the government’s agreement to protect infant cable TV companies suggests that Labour still regards BT as a national champion of the public interest. Yet the deal makes the mistake of leaving BT‘s integrated structure intact, allowing a private corporation governed by the criterion of profitability rather than the public interest, to exploit an even stronger monopoly position in its local markets to further its strategy of global expansion.

Despite the current policy emphasis on local competition (also currently being intro- duced as a bill to Congress in the US), the recent experience of the US suggests that the introduction of new transmission and switching technologies will reaffirm the natural monopoly status of cable-based local operations. Within the geographical areas of regmnal telephone operators and cable TV companies, a

single company using high-capacity fibre optics transmission and fugh-speed switching technologies, could enjoy economies of scale by handling vast flows of traffic. Without the investment required to substitute fibre optics for the ’last mile’ of copper wire, fixed-link local operators may find it difficult to compete on price with new operators using radio- based mobile technologies.

There two possible ways of dismantling BT’s local monopoly. The first was suggested by Sir Bryan Carsberg, the departing Director General of Oftel, who in June 1992 who proposed separate accounts for BT’s local and long-distance divisions, with contracts between the two that are transparent tocompeti- tors. Transparent accounting would improve the terms and conditions of interconnection with competitors. Each business would operate separately and deal with customers on the same basis as independent companies.

The other possibility, as suggested above, would be to emulate the US regional model. Whereas Oftel has the necessary legal author- ity to enforce a formal accounting separation between BT’s local and long-distance divisions, a referral to the Monopolies and Merg- ers Commission would be necessary to force the divestiture of BT’s local exchange operations. Under this proposal, regional telephone companies and cable TV companies would join together - forming joint ventures or separately-run holding companies - to provide universal broadband access within defined geographical areas. Stringent anti-trust regu- lation would prevent excessive monopoly power by disallowing mergers between regional operators.

Local exchange services have been operated by separately-run regional companies throughout this century in Canada, Denmark and Finland (which has 49 regional companies). Since it is in the interest of each regional company to furnish a high-quality service, and each can be held directly accountable for its actions on other parts of the system, the regional structure encourages cooperation


rather than opportunism in furnishing efficient through connections over separately- operated long-distance networks. W e there is no direct regional competition, a culture of managerial rivalry between operators - which is reinforced by the media to stimulate critical judgement of their performance - is a powerful incentive to be the best company in the eyes of the public.

Choice of services for residential and business consumers could be fostered by permitting competition in the supply of telephone, television and multi-media services carried over regional infrastructures. The regional networks would be open to all suppliers of broadband services, paying charges for their use of the un- derlying network to the cooperating regonal operators. Cable TV, telephone companies and entertainment providers would be allowed to create indepmdently-run service companies to compete over regional infrastructures for markets in broadband services.

The convergence of telephone and cable TV systems in local communications is driven by an economic logic which does not depend on potential buyers being prepared to pay for new and untried multimedia services, such as home shopping and video telephones. By fill- ing the redundant hours on telephone lines - in the US the average telephone line is used for only 20 minutes a day - with television, entertainment TV and multimedia services,

Illusoation: David Simonds

economies of scope could be obtained by permitting a number of service providers to offer a range of services at lower cost (than the cost of providing each service separately) over a single information highway.

Innovation and efficiency This decentralised structure offers a different route to efficiency and innovation. A balance is struck between quasi-monopolistic regional infrastructures (no complete fixed- link monopoly is possible as long as radio offers a competing system), competitive provision of broadband services into the home and office by separately-run service providers, and global carriers offering competing long-distance networks and services.

Multinational corporations have their demands met by specialised global operators, and the wider social and economic goal of a universal access to a broadband network is the responsibility of regional operators and competing service providers.

The standard argument in favour of retain- ing the integrated structure is that a modem telecoms operator has to compete for long- distance services in international markets from a strong position in its home market. The benefits of internalisation are supposed to outweigh the costs of transactions between many companies. However, what all nation-

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ally-integrated operators like BT, NIT (Japan), France Telecom and Deut- sche Telekom share - despite differences in ownership - is the ability to use their local monopoly business to cross-subsi- dise competitive markets. By contrast, separately-run global long-distance carriers

Comparison of telephone charges in different countries Average annual cpending by users fn 1991. US$ (relative position in brackets)

National lnternational carrier business residentid carrier business residential

Finland (HTC) 565.6 (2) 323.0 (2) TF 80.5 (2) 78.7 (2) Denmark (KTAS) 403.5 ( I ) 255.9 (I) TD 80.9 (3) 94.4 (4) Japan (N'TT) 988.6 (4) 323.1 (3) KDD 80.4 ( I ) 68.3 (I) UK (BT) 935.0 (3 ) 396.8 (7) BT 91.6 (4) 98.2 (5) us (AT&T/Nynex) 1386.2 (7) 389.7 (6) AT&T 93.8 (5) 83.2 (3) Germany (07) 1039.5 (5) 359.1 (4) DT 99.3 (7) 99.2 (6) France (Fl) 1054.0 (6) 359.4 (5) FT 98.5 (6) 99.3 (7)

Souce:OECDCannmidomOubdc(1?93) bte: I n c a n a i a d @ r e r a e b a r e d m r m r m y @ ~ T h e ~ taifi'schaged in the USrellectthe r$arively bge sired naiod b n g d i i rumesand bcd d k g seas.

including AT&T, MCI, Sprint, Cable and Wireless, and KDD (Japan's international operator) are unable to shift costs between divisions and hide operational inefficiencies be- cause almost all of the markets they face are competitive.

Improvements in technology and the de- clining costs of calls following the mtroduc- tion of long-distance competition iti the UK and US provides the justification for the policy of competition between separ,itely-run long-distance companies. For examF le, as late as 1987, AT&T claimed that it would take until 2010 to convert 95 per of its long-distance network to digital transmission. It was the pressure of competition from MCI and Sprint which forced AT&T to make its long-distance network almost 100 per cent digital by 1992. In the decade since divestiture AT&? reduced the price of national long-distance cafls for the average residential subscriber by over 50 per cent and international long-distance calls fell by an average of 35-40 per cent.

Independently-run regional and long-distance companies in Finland and Denmark are among the most efficient and cheapest providers of telecommunications SE rvices m the world. A study by the EC (1988) concluded that the Danish regional nehvork was around twice as efficient - in ternmi of total factor productivity - as Europe's larger national operators (BT and Deutsche Telekom). Even in the US, where regional model has

only recently been established, in 1991 all seven regional operators were more efficient than BT in terms of lines per employee, the standard industry measure.

In striking contrast to Finland and Den- mark, the cost-advantages of making BT's national long-distance operations one of the most digital networks in the OECD have not filtered through into cheaper tariffs. The Ta- ble shows how successful Finland and Den- mark have been compared to BT. In addition the long distance operators within the regional systems, together with KDD, the separately run Japanese international operator, were the cheapest provides of international calls.

BT should not be allowed to have the free- dom to use its near-monopoly position at home to become a major player abroad. The trend towards economic concentration does not invalidate the argument for decentralisation, it reinforces it. Where monopoly operators llke BT are allowed to compete freely in the world market-place their activities are dic- tated by the demands of the highly-profitable corporate customers rather than the social and economic requirements for a broadband network into the home and office. Such prob- lems can be remedied by the policy of decentralisation which encourages operators to reduce to their smallest size consistent with their core operations and the requirements of global and local customers 0

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The Breaking up of BT : A decentralised BT would be more effective