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The Moment of Truth in Australian Telecommunications
01 Dec 2005
By Paul O'Sullivan, Optus Chief Executive at Trans Tasman Business Council

Introduction

It is a pleasure to have the opportunity to speak to you at this important event. The Trans Tasman Business Circle plays an important role in encouraging business dialogue between two very close - and often friendly - neighbours in Australia and New Zealand.

The link with New Zealand is an important one for Optus. For example, the New Zealand pay television operator Sky Television is one of the largest customers of our satellite operations.

And we are a partner in the Southern Cross undersea cable between Australia, New Zealand and the United States.

Now it is often an Australian prejudice that New Zealand is ten to twenty years behind on most things. But in telecommunications it was the other way around - with privatisation and deregulation coming about a decade earlier in New Zealand.

Today I want to discuss the state of Australian telecommunications. You may be surprised, but I agree with Telstra - what happens in telecommunications is vital to Australia's national interest.

Before you fall off your chairs in shock, though, that's where the agreement will end.

I will argue that we are facing a 'moment of truth' in Australian telecommunications.

I want to show you how Telstra is trying to use this moment of truth to rebuild its monopoly for the new millennium.

At Optus, we believe there is a better option for Australia and we think it's critical that our government and policy makers take this option.

The National Interest

So let me start by considering telecommunications and Australia's national interest.

Telstra has had a lot to say about this topic in recent months. Apparently, it is their concern for the national interest which lies behind their criticisms of telecoms regulation - but they are often misleading.

For example, Telstra's new head of public policy, Phil Burgess, says that 'regulation slows the build out of the nation's telecommunications infrastructure.'

Let me make three observations.

First, the national interest is not the same thing as Telstra's interest. They are separate and distinct things.

Telstra's interest is quite naturally in preserving its market dominance, massive profitability and high market share. That is not in Australia's national interest.

Sol complains that regulation is bad because it's not enhancing the value of Telstra.

That's not their purpose. The regulations are designed to do pretty much the direct opposite - to expose Telstra to greater competition, so that all Australians benefit through lower prices, better service and more innovation.

Which brings me to my second observation. The national interest is best served, not by treating Telstra as some kind of national champion - like Phar Lap to be stuffed and preserved in a museum - but instead by encouraging vigorous competition in telecommunications.

Will that competition cut Telstra's profits? Probably - but there's plenty of fat there left to cut. Telstra earns massive monopoly profits. Its EBITDA margin is nearly 50%. It still earns nearly 90% of all the profit in the Australian telecommunications industry today.

My third observation is this. When it comes to telecommunications and Australia's national interest, who should you believe? The Australian Government, and the ACCC, who want to stimulate competition?

Or a new American management charged with selling the company - who in all likelihood will collect their bonuses and head back to the USA? These guys don't exactly have a longstanding commitment to Australia's national interest.

As one banker recently said to me, six months ago they probably thought Australia was a medium sized country in Europe with good ski-ing and lots of museums.

A Moment of Truth in Australian Telecommunications

But while there are some laughable claims being made, there are some serious issues at stake. In fact, we at Optus believe this is a moment of truth in Australian telecommunications.

When I say that, I am not talking about the privatisation of Telstra.

Of course, that is an important development. But it does not change the real issue - Telstra has substantial market power regardless of its ownership structure.

Instead, I am talking about the rise and rise of broadband.

As at June 2005, the ACCC reported that there were nearly 2.2 million broadband services in Australia, up from just under 700,000 just eighteen months before.

Why Does This Matter?

The first reason it matters is that high quality, ubiquitously available broadband is vital to Australia's national competitiveness.

Our economic future depends on the knowledge industries - education, media and communications, the finance sector, and other service industries. In turn, these industries rely on rapidly moving vast quantities of information.

Quite simply, in geographic areas where you cannot get adequate broadband access, you cannot do business. The quality of the broadband grid today is as critical to a nation's economic development as the electricity grid was 150 years ago.

The second reason it matters is that the growth in broadband demand in turn creates the conditions for a step change in the supply market.

That is, it creates the opportunity for change in the market structure of fixed line telecommunications in Australia - to break down Telstra's dominance and introduce true competition.

We have seen the same thing happen in the mobile sector over the last fifteen years.

When the new technology of GSM arrived in Australia in the early nineties, three licenses were issued: one to the incumbent Telstra and two others to Optus and Vodafone. Hence, the new entrants were able to ride the growth of the new technology and establish sustainable positions in the market.

The result is that today, the mobile sector is far and away the most competitive part of the Australian telecommunications industry. Telstra has around 46% market share, Optus has around 33%, and there are two other network operators sharing the remaining 20%.

We believe the growth of broadband offers a similar opportunity. That is why Optus is driving aggressively to capture the greatest possible share of the broadband market - both in resale DSL and through building out our own broadband network.

We have announced an investment of over $150 million, installing equipment in 340 Telstra exchanges around Australia.

We will be able to offer 2.9 million homes and businesses a suite of voice and data products that are fast, accessible, interactive and content rich. And combined with our cable, that will give us reach to over 60 per cent of Australian homes.

The competitive investment which Optus is making represents a once in a generation opportunity to attack Telstra's long standing dominance of the local loop - and establish a sustainably competitive market structure in fixed telecommunications in Australia.

Telstra's Game Plan

The real issue for Australia is whether the telecommunications industry can capture this opportunity.

Because at the same time as Optus and others are working to advance competition, the incumbent is playing a very different game.

It is trying to use the very same transformation to broadband and the government's desire to sell the company to cement a new monopoly - under the protection of a regulatory access holiday.

Ironically, at the same time as doing this, Telstra is complaining that it faces an unfair regulatory burden.

If I can use a slightly risky trans-Tasman analogy, it is like Trevor Chappell complaining about not getting a fair go from the umpire - even while he is rolling an underarm ball down the wicket.

The threat is very real. Telstra is using its imminent privatisation to try to leverage regulatory outcomes from Government - so that it can stitch up a new monopoly in broadband over the next decade.

This demands a vigorous response from Telstra's competitors - and the regulators - if we are to head off what would be a disastrous outcome for Australia.

Let me explain to you three key planks to the Telstra game plan.

The first is aggressive, anti-competitive tactics to starve their resale competitors of oxygen. In the last couple of months, Telstra has dropped retail DSL prices - it now offers an effective 25% discount on a two year contract - while preserving wholesale prices.

It has done the same thing in line rental. The wholesale price we pay Telstra will now be higher than Telstra's retail price on its most popular plans.

With both of these moves, Telstra is seeking to squeeze the margins of its resale competitors - making it harder for them to compete and have enough customers to invest in network upgrades.

The second plank in Telstra's attack on competition is to push the Government to change the price structure for something called 'unconditioned local loop service' or ULLS.

This is a formidable piece of telecoms jargon - but it is a pretty simple concept. When Optus rents the copper line between the Telstra exchange and the customer's home - we are taking the 'unconditioned local loop service'. We put our own electronics in the exchange. And we build a fibre connection from the exchange back into our network.

Optus is using this service as we build the broadband network I mentioned earlier. The only bit of the network acquired from the incumbent is the last, low tech portion - the copper wire to the customer's home. In many cases this has been in the ground for fifty years or more.

It is a bit like a new airline which comes in, flying its own planes in competition with Qantas - but using the same terminal at the very last stage to deliver the passenger safely to his or her destination.

Telstra is trying hard to blunt this competitive threat - including a last minute change to its pricing structure.

In December 2004, Telstra set the price for this service: $13 in CBD areas; $22 in the suburbs; $40 in regional areas; and $100 in rural and remote areas.

Optus thinks these price levels are too high. But we think this price structure is fair.

Telstra's network costs are much lower in the cities than in the bush. It is only fair that it should charge its wholesale customers accordingly, so we can have the same relative cost structure as the incumbent.

But Telstra has recently done a complete about face. It now says the price for ULLS should be the same across the country.

The reason is obvious: Telstra wants to jack up the price of ULLS to deter competitive entry in the cities. It wants to preserve lower per customer economics for itself - and be protected from making it available to competitors.

The third plank of Telstra's game plan is much bigger. Not content with driving back competition in today's resale voice and DSL services; and with blocking competition in tomorrow's ULLS based broadband networks; it wants to stitch up a monopoly for the next decade or two.

In its recent strategy day, Telstra announced that it planned to build a fibre to the node network delivering twelve megabits per second, to homes in the five major capital cities. Some four million 'service addresses' would get this service.

But there is a catch - something called a 'reasonable regulatory outcome'.

Let me translate that for you. It means 'massive regulatory free kick'.

Telstra wants its new network to be completely free of the legal obligation to provide 'access' to competitors.

Just in case anybody missed the point, in its recent strategic briefing, Telstra said it was targeting EBITDA margins in the new world of over 50%. In other words, it wants to use its new 'fibre to the node' network to get its monopoly back.

Let me share with you Optus' position on what Telstra is asking for. We are one hundred per cent, root and branch, die in the ditch, until the last breath in our body, opposed to it.

At Optus, we think the same principle applies for broadband as it does for any other service.

If all Australians are supplied by one monopoly operator, then you are not going to get the full benefits of the new technology you are building.

All of the experience in the Australian market and internationally says, if you want to drive mass market take up of a new technology like broadband, it is critical to have competition.

Competing providers will work harder to educate new customers to take up the service. And under competition prices are lower than under monopoly and hence more people are willing to buy the service.

So at Optus, we think that it is critical that the new Telstra - just like the old Telstra - is subject to strong, pro-competitive regulation.

That means, if Telstra owns and builds a piece of so called bottleneck infrastructure - such as a national fibre to the node network - then it must be subject to access obligations.

Telstra's new management seem to think they can bully their way into overturning the existing regulatory framework in telecommunications.

Telstra has been foolish enough to try this approach several times before - and time after time it has emerged with a bloody nose.

When Telstra tried a crude retail-wholesale price squeeze in DSL last year - we went to the ACCC and got a Competition Notice, forcing Telstra to drop its wholesale prices substantially.

When Telstra tried to charge originating and terminating access prices which were ludicrously out of step with those allowed by regulators elsewhere in the world, we successfully lobbied the ACCC to reduce those prices by around 75%.

When Telstra tried to keep broadband to itself, we persuaded the ACCC to 'declare' unconditioned local loop services. And we then got the ULLS price down to $22 in band 2 - around half the price Telstra first proposed.

So while it may be tedious to have to educate this new band of mature age backpackers, then if that's what we need to do then at Optus we are quite ready to do it.

If that means delay, if that means regulatory uncertainty, if that means litigation, if that means prices being unsettled for a considerable time, well, we're not the ones who have a prospectus to issue.

A new National broadband infrastructure and a competitive environment
In the last part of my remarks, I want to ask the question: Is there any way to get a new national high bandwidth network without it being forever locked up within a monopolist's grim embrace?

At Optus, we are optimists.

We believe it is possible to have both world class infrastructure - and vigorous competition.

We have proposed a model in which the industry as a whole shares in the investment necessary to upgrade Australia's national broadband infrastructure.

In this model, the upgrade would not be limited to four million fortunate households in the five major capital cities. With more participants and more capital, the network could be extended much more broadly.

Under our model, the new broadband network would not be accompanied by monopoly pricing - and the likely flow on consequence of relatively poor take up.

And our approach would let each party reach certainty - through contractual negotiations rather than the heavy hand of Government - about the terms on which one party could use the part of the network built by another party.

Optus has publicly, and privately, made this offer to Telstra.

I wrote to Telstra a few weeks ago indicating Optus' interest in a joint investment in a fibre to the node network.

Regrettably, Sol wrote back to me saying that Telstra was not interested. In his letter dated 17 October 2005, he said that '...we have no plans to proceed with a national fibre to the node network. There may be speculation by some that you may have read but it is not accurate.'

Since that time, clearly, things have changed. On 15 November 2005, Telstra announced that it did have plans for a fibre to the node network after all.

So I'd like to urge him to reconsider.

Optus is completely serious about this proposition.

We are ready to talk.

Who knows? We might be able to come up with a commercial model where we can jointly fund and own a national fibre network - and then we can compete vigorously to serve customers on that network.

Conclusion

In conclusion, I have argued today that we are at a moment of truth in Australian telecommunications.

We have two roads before us. There is the low road, which involves massive expense and delay - as Telstra tries to avoid its legal obligations and as we use every possible legal and regulatory avenue to drag Telstra kicking and screaming to the table.

And there is the high road, in which we work cooperatively to deliver Australia the upgraded, world class broadband infrastructure it so desperately needs.

The choice is clear - and at Optus, we know which road we'd rather be on.