Application by Vodafone Network Pty Ltd & Vodafone Australia Limited
[2007] ACompT 1
•11 JANUARY 2007
AUSTRALIAN COMPETITION TRIBUNAL
Application by Vodafone Network Pty Ltd & Vodafone Australia Limited
[2007] ACompT 1
TRADE PRACTICES – application pursuant to s 152CE(1) of the Trade Practices Act 1974 (Cth) – application for review of decision of Australian Competition and Consumer Commission to reject access undertaking – mobile terminating access service – whether terms of the undertaking are reasonable – efficiency of costs – benchmark efficient operator – fully allocated cost model – pass through safeguard
Trade Practices Act 1974 (Cth): ss 103(1)(c), 152AA, 152AB(1), 152AH, 152AL, 152AQA, 152AR, 152BS, 152BV(2) 152BU(2), 152CE(1), 152CF, Pt XIC
Telecommunications (Consumer Protection and Service Standards) Act 1999 (Cth): ss 154, 155Telstra Corporation Limited [2006] ACompT 4, applied
Application by Optus Mobile Pty Limited & Optus Networks Pty Limited [2006] ACompT 8, applied
Re Seven Network (No 4) (2004) 187 FLR 373, approved
Re Michael; Ex parte Epic Energy (WA) Nominees Pty Ltd (2002) 25 WAR 511, cited
Application by East Australian Pipeline Limited [2004] ACompT 8; [2005] ACompT 3, citedFile No 4 of 2006
RE:APPLICATION FOR REVIEW OF THE FINAL DECISION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION DATED 31 MARCH 2006 IN RELATION TO THE ORDINARY ACCESS UNDERTAKING LODGED BY VODAFONE NETWORK PTY LTD AND VODAFONE AUSTRALIA LIMITED FOR THE GSM TERMINATING ACCESS SERVICE
BY: VODAFONE NETWORK PTY LTD and VODAFONE AUSTRALIA LIMITED
Applicants
JUSTICE GOLDBERG (PRESIDENT), MR R DAVEY and MR R SHOGREN
11 JANUARY 2007
MELBOURNE
IN THE AUSTRALIAN COMPETITION TRIBUNAL
File No 4 of 2006
RE:APPLICATION FOR REVIEW OF THE FINAL DECISION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION DATED 31 MARCH 2006 IN RELATION TO THE ORDINARY ACCESS UNDERTAKING LODGED BY VODAFONE NETWORK PTY LTD AND VODAFONE AUSTRALIA LIMITED FOR THE GSM TERMINATING ACCESS SERVICE
BY:VODAFONE NETWORK PTY LTD and VODAFONE AUSTRALIA LIMITED
Applicants
THE TRIBUNAL:
JUSTICE GOLDBERG (PRESIDENT), MR R DAVEY and MR R SHOGREN
DATE OF DECISION:
11 JANUARY 2007
WHERE MADE:
MELBOURNE
THE TRIBUNAL DECIDES THAT:
1.The decision of the Australian Competition and Consumer Commission on 31 March 2006 rejecting the ordinary access undertaking given to it on 23 March 2005 by Vodafone Network Pty Ltd and Vodafone Australia Limited is affirmed.
IN THE AUSTRALIAN COMPETITION TRIBUNAL
File No 4 of 2006
RE:APPLICATION FOR REVIEW OF THE FINAL DECISION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION DATED 31 MARCH 2006 IN RELATION TO THE ORDINARY ACCESS UNDERTAKING LODGED BY VODAFONE NETWORK PTY LTD AND VODAFONE AUSTRALIA LIMITED FOR THE GSM TERMINATING ACCESS SERVICE
BY:VODAFONE NETWORK PTY LTD and VODAFONE AUSTRALIA LIMITED
Applicants
THE TRIBUNAL:
JUSTICE GOLDBERG (PRESIDENT), MR R DAVEY and MR R SHOGREN
DATE OF DECISION:
11 JANUARY 2007
WHERE MADE:
MELBOURNE
INDEX
1. INTRODUCTION ………………………………………………………………………. [1]
2. PARTIES TO THE APPLICATION …………………………………………………… [5]
3. THE LEGISLATIVE REGIME …………………………………………………………. [6]
4. ISSUES …………………………………………………………………………………. [10]
5. THE MOBILE TERMINATING ACCESS SERVICE AND THE COMMISSION’S
MTAS PRICING PRINCIPLES DETERMINATION ……………………………… [13]
6. VODAFONE’S UNDERTAKING …………………………………………………… [14]
7. BACKGROUND ………………………………………………………………………. [22]
8. THE COMMISSION’S REASONS FOR REJECTING THE UNDERTAKING …… [23]
9. MARKET DEFINITION ………………………………………………………………. [27]
10. VODAFONE’S COST MODELS …………………………………………………….. [32]
11. THE USE OF A FULLY ALLOCATED COST MODEL………………………….. [40]
12. ISSUES RELATING TO VODAFONE’S COSTS ………………………………….... [45]
13. ARE VODAFONE’S COSTS EFFICIENT COSTS? ……………………………….... [46]
14.THE BENCHMARK OF AN EFFICIENT OPERATOR …………………………… [63]
15.SPECIFIC ISSUES RELATING TO THE COSTS DETERMINED FROM THE PwC MODELS …………………………………………………………………………..…… [85]
15.1 Expert Reports ………………………………………………………………. [85]
15.2 Summary of claimed Empirical Flaws in models ……………..……………. [96]
15.3 Issue C: Asset lifetimes for radio site equipment and buildings …………..... [102]
15.4 Issue D: Error in tilted annuity calculation ………………………………. [121]
15.5 Issue E: “Incorrect” routing factor – voicemail …………………………... [128]
15.6 Issue F: Incorrect allocation of short message service (SMS) centre costs [152]15.7Issue G: “Inaccurate” splits of non‑network asset operating costs and
Issue O:Revised splits of non‑network asset costs and non‑network
indirect costs ………………………………………………………………… [159]
15.8 Issue H: Incorrect inclusion of subscriber direct assets …………........ ...... [193]
15.9 Issue I: Unaccounted for likelihood of decrease in per unit costs ……….… [195]
15.10 Issue J: Incorrect SMS and GPRS conversion factors …………………... [198]
15.11 Issue K: Price trends and changes ………………………………………... [202]
15.12 Issue L: Contingency costs …………………………………………………... [219]
15.13 Issue M: Inclusion of a return on assets in the course of construction ….. [236]15.14Issue N: Exclusion of acquisition and retention costs from non‑network indirect cost mark‑up ………………………………………………….…… [249]
15.15 Issue P: WACC – the choice of asset beta ……………………..…………... [258]
15.16 Conclusion on specific issues in relation to the PwC models ……… [262]
16. PASS THROUGH SAFEGUARD …………………………………………….…….. [263]
17. CONCLUSION …………………………………………….…………………….….. [298]
ANNEXURE A GLOSSARY AND ABBREVIATIONS
REASONS FOR DECISION
THE TRIBUNAL: JUSTICE GOLDBERG (PRESIDENT), MR R DAVEY and
MR R SHOGREN
1. INTRODUCTION
Vodafone Network Pty Ltd and Vodafone Australia Limited (together “Vodafone”) have applied to the Tribunal pursuant to s 152CE(1) of the Trade Practices Act 1974 (Cth) (“the Act”) for a review of a decision of the Australian Competition and Consumer Commission (“the Commission”) to reject an ordinary access undertaking given by Vodafone to the Commission under s 152BU(2) of the Act. The application for review was filed on 21 April 2006.
The access undertaking sets out the price and non‑price terms and conditions upon which Vodafone undertakes to provide its domestic digital mobile terminating access service on its 2G/2.5G GSM network (“VMTAS”). The VMTAS is Vodafone’s provision of a mobile terminating access service (“MTAS”), a service that was declared by the Commission under Pt XIC of the Act on 30 June 2004. The undertaking was given by Vodafone on 23 March 2005. The undertaking proposed a target price of 16.15 cents per minute (“cpm”) for access to its VMTAS from 1 January 2007. The Commission rejected the undertaking in its Final Decision made on 31 March 2006 on the basis that it was not satisfied that the price and certain non‑price terms and conditions specified in the undertaking were reasonable.
The hearing of the review was held immediately following the conclusion of the hearing of the review sought by Optus Mobile Pty Limited and Optus Networks Pty Limited (together “Optus”) in respect of the decision by the Commission to reject an ordinary access undertaking given by Optus to the Commission under s 152BU(2) of the Act. The Tribunal affirmed the decision of the Commission to reject Optus’ undertaking and its reasons are to be found in Application by Optus Mobile Pty Limited & Optus Networks Pty Limited [2006] ACompT 8. There were a number of issues that were common to the review in the Optus matter and to this review and submissions on these issues in the Optus matter were not duplicated but were taken to have been adopted in this review. These submissions related, for example, to the nature of the legislative regime, the nature of the MTAS, the function of the Tribunal and aspects of market definition.
Accordingly, these reasons do not repeat the analysis and reasoning of the Tribunal in relation to the legislative regime, the MTAS, the Commission’s MTAS Pricing Principles Determination on 30 June 2004 and aspects of market definition. We incorporate that analysis and reasoning in these reasons which should be read in conjunction with that analysis and reasoning. Annexure A contains a glossary of terms used in these reasons.
2. PARTIES TO THE APPLICATION
The following parties were granted leave to intervene in the proceeding:
·the Commission;
·Telstra Corporation Limited (“Telstra”);
·Optus Mobile Pty Limited and Optus Networks Pty Limited;
·AAPT Limited (“AAPT”);
·Hutchison 3G Australia Pty Limited and Hutchison Telecommunications (Australia) Limited (together “Hutchison”);
·Macquarie Telecom Pty Limited (“Macquarie”);
·PowerTel Limited (“PowerTel”); and
·Primus Telecommunications Pty Ltd (“Primus”).
Telstra, Optus, AAPT, Hutchison, Macquarie, PowerTel and Primus all currently acquire the VMTAS from Vodafone.
3. THE LEGISLATIVE REGIME
The telecommunications access regime under Pt XIC of the Act was considered and explained recently by the Tribunal in Telstra Corporation Limited [2006] ACompT 4 and in Application by Optus Mobile Pty Limited & Optus Networks Pty Limited (supra). We adopt that consideration and explanation in these reasons. In summary, an access provider must, if requested, supply a declared service to an access seeker in accordance with the standard access obligations set out in s 152AR of the Act.
A carrier or carriage service provider may submit an ordinary access undertaking to the Commission under which it undertakes to comply with the terms and conditions specified in the access undertaking in relation to the applicable standard access obligations: s 152BS(1). The Commission must accept or reject the undertaking: s 152BU(2), but it must not accept an undertaking unless it is satisfied that the terms and conditions specified in the undertaking are reasonable: s152BV(2)(d).
The sections critical to the review are ss 152AH and 152AB. Section 152AH(1) sets out the matters to which regard must be had by the Commission (and by the Tribunal on review) in determining whether particular terms and conditions of an access undertaking are reasonable:
“(a)whether the terms and conditions promote the long‑term interests of end‑users of carriage services or of services supplied by means of carriage services;
(b)the legitimate business interests of the carrier or carriage service provider concerned, and the carrier’s or provider’s investment in facilities used to supply the declared service concerned;
(c)the interests of persons who have rights to use the declared service concerned;
(d)the direct costs of providing access to the declared service concerned;
(e)the operational and technical requirements necessary for the safe and reliable operation of a carriage service, a telecommunications network or a facility;
(f)the economically efficient operation of a carriage service, a telecommunications network or a facility.”
Section 152AH(2) provides that subsection (1) does not, by implication, limit the matters to which regard may be had.
Section 152AB(2) provides, relevantly, that in determining whether the terms and conditions of an undertaking promote the long‑term interests of end‑users of carriage services or services supplied by means of carriage services (“listed services”), regard must be had by the Commission (and by the Tribunal on review) to the extent to which the terms and conditions are likely to result in the achievement of the following objectives:
“(c)the objective of promoting competition in markets for listed services;
(d)the objective of achieving any‑to‑any connectivity in relation to carriage services that involve communication between end‑users;
(e)the objective of encouraging the economically efficient use of, and the economically efficient investment in:
(i)the infrastructure by which listed services are supplied; and
(ii)any other infrastructure by which listed services are, or are likely to become, capable of being supplied.”
Section 152AB(3) provides that subsection (2) is intended to limit the matters to which regard may be had. Subsequent subsections of s 152AB expand upon the manner in which the Commission (and the Tribunal on review) is to have regard to those objectives.
4. ISSUES
We repeat our observation in Application by Optus Mobile Pty Limited& Optus Networks Pty Limited (supra) that where we are determining whether terms and conditions of access are reasonable and whether underlying costs are reasonable, there are no absolute answers, nor is there necessarily only one correct approach: Telstra Corporation Limited (supra) at pars [63]‑[67].
The principal issues for determination are whether Vodafone’s price term of 16.15 cpm for the period 1 January 2007 to 30 June 2007 and subsequent validity periods and the terms in “Part C – Pass Through Safeguard” of the Service Schedule to the undertaking are reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB. Those issues have led to an inquiry whether Vodafone’s costs, and its method and approach in estimating those costs, are reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB. There are also issues relating to the reasonableness of certain non‑price terms and conditions relating to credit management and security, termination and suspension, limitation of liability and confidential information. Ultimately, we must not accept the undertaking unless we are satisfied on the whole of the material before us that the terms and conditions specified in the undertaking are reasonable: s 152BV(2)(d).
From time to time in these reasons we refer to the “reasonableness of the price” and the “reasonableness of the costs” and the “reasonableness” of particular costs, methods or structures. We use these expressions as shorthand expressions to describe and explain the task that is committed to us by ss 152AH and 152AB. We are considering whether a particular price, cost or method of calculating and determining a cost, is reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB. We are not considering the reasonableness of such price, cost or method in the abstract, unrelated to the matters specified in s 152AH and the objectives set out in s 152AB.
5. THE MOBILE TERMINATING ACCESS SERVICE AND THE COMMISSION’S MTAS PRICING PRINCIPLES DETERMINATION
The basic workings of the MTAS and the Commission’s MTAS Pricing Principles Determination are explained in Application by Optus Mobile Pty Limited& Optus Networks Pty Limited (supra) at pars [21] to [29].
6. VODAFONE’S UNDERTAKING
Vodafone’s undertaking was, relevantly, in the following terms:
“2. COMMENCEMENT AND DURATION
(a)Provided that the Commission has not already accepted Vodafone’s Access Undertaking submitted to the Commission on 26 November 2004 under Division 5 of Part XIC of the TPA, this Undertaking becomes effective immediately after this Undertaking is accepted by the Commission under Division 5 of Part XIC of the TPA, and either:
(i)any applicable appeal period in relation to the acceptance by the Commission of this Undertaking has expired; or
(ii)if an appeal is lodged, there is a final resolution of that appeal and any subsequent appeals in a way which permits this Undertaking to take effect.
(Commencement Date)
(b) This Undertaking continues until the earlier of:
(i) 3 years from the Commencement Date; or
(ii)the withdrawal or termination of this Undertaking by Vodafone in accordance with the TPA; or
(iii)the Commission’s acceptance of Vodafone’s Access Undertaking submitted to the Commission on 26 November 2004 under Division 5 of Part XIC of the TPA.
3. UNDERTAKING
(a)Vodafone undertakes to the Commission that it will comply with the terms and conditions specified in Attachment A of this Undertaking in relation to the standard access obligations applicable to Vodafone in respect of the Declared Service.
(b) For the avoidance of doubt, this Undertaking:
(i) …
(ii) …
(iii)only applies to the supply of the Declared Service in respect of voice calls on Vodafone’s GSM network.”
Attachment A comprised a form of “VODAFONE AGREEMENT FOR THE PROVISION OF MOBILE TERMINATING ACCESS SERVICE” (“the Agreement”) to be entered into between Vodafone and an access seeker. The Agreement set out the terms on which Vodafone agreed to supply the VMTAS which was described as:
“… an Access service for the carriage of voice calls from a Point of Interconnection to a B‑party directly connected to the Vodafone Network (the Service).”
The charges for the VMTAS were set out in the Agreement in the following terms:
“1 RATES
1.1 The Rates payable by the Access Seeker for the Service comprise:(a) a Usage Charge as set out in this Service Schedule; and
(b)a Network Conditioning Charge for Network Conditioning in Vodafone’s Network beyond Vodafone’s Interconnect Gateway Exchanges to enable the provision of the Service to the Access Seeker, which will be based on the labour, materials and incidentals involved in undertaking the work required. Such work will not commence until the Access Seeker has accepted a quotation for such work provided to the Access Seeker by Vodafone.
1.2The Usage Charge payable by the Access Seeker for use of the Service during the applicable Validity Period is specified in Table 1 below:
TABLE 1 VALIDITY PERIOD USAGE CHARGE 1. 1 July 2004 – 31 December 2004 21 cpm 2. 1 January 2005 – 31 December 2005 19.38 cpm 3. 1 January 2006 – 31 December 2006 17.77 cpm 4. 1 January 2007 – 30 June 2007 16.15 cpm Any subsequent Validity Periods 16.15 cpm
The Agreement contained a section entitled “PART C – PASS THROUGH SAFEGUARD” in the following terms:
“1 PASS THROUGH PRINCIPLE
The aim of this Part C is to ensure that end‑users who make fixed to mobile calls realise the benefits of reductions in Usage Charges by ensuring those reductions are passed through to end‑users or customers in the form of reduced retail rates for fixed to mobile calls. This benefits end‑users or customers of fixed to mobile calls, since they will enjoy price reductions, as well as providers of fixed to mobile calls and providers of mobile termination services, since the volume of originated and terminated calls is likely to increase if the retail price falls (Pass Through Principle).
2 PASS THROUGH OBLIGATION
The Access Seeker must reduce its Average Retail Price (excluding GST) for calls which terminate on the Vodafone Network during each Validity Period so that it is equal to or less than the Target Average Retail Price specified in Table 2 below (Pass Through Obligation).
3 TABLE 2
TABLE 2 VALIDITY PERIOD TARGET AVERAGE RETAIL PRICE 1. 1 July 2004 – 31 December 2004 38.5 cpm 2. 1 January 2005 – 31 December 2005 32.72 cpm 3. 1 January 2006 – 31 December 2006 26.93 cpm 4. 1 January 2007 – 30 June 2007 21.15 cpm Any subsequent Validity Periods 21.15 cpm
4 COMPLIANCE AND PASS THROUGH DISPUTES
4.1The Access Seeker must provide written notice to Vodafone within 20 Business Days of the end of each Validity Period, signed by a Director, stating whether and how the Access Seeker has complied with the Pass Through Obligation for that Validity Period (Certification of Pass Through).
4.2Within 2 months following the end of each Validity Period, if Vodafone reasonably considers that the Access Seeker has not complied with the Pass Through Obligation, Vodafone may, by way of written notice, notify the Access Seeker of a dispute (Pass Through Dispute Notice).
4.3On receipt of a Pass Through Dispute Notice, the Parties must use their reasonable endeavours to resolve the dispute. In attempting to resolve the dispute in accordance with this clause 4.3, the Parties must act in good faith at all times.
4.4If the Parties cannot resolve the dispute within 10 Business Days following the date of the Pass Through Dispute Notice, either Party may within 20 Business Days following the date of the Pass Through Dispute Notice refer the dispute for expert determination in accordance with clause 5 provided that Party has complied with its obligations under clause 4.3.”
Clause 5 contained a dispute resolution clause which provides for expert determination of a dispute.
Clause 6 was headed “NON COMPLIANCE” and provided:
“6.1If the expert determines that the Access Seeker has not complied with the Pass Through Obligation for a Validity Period, the Access Seeker must pay to Vodafone in accordance with the terms of this Agreement, the rebate calculated in accordance with clause 6.2 (Pass Through Rebate).
6.2The Pass Through Rebate for a Validity Period will be an amount equal to the number of Conversation Minutes for that Validity Period, multiplied by the difference between:
(a) the Usage Charge set out in Table 1 for that Validity Period; and
(b)the Usage Charge for the earliest prior Validity Period in which the Access Seeker’s Average Retail Price is less than the Target Average Retail Price for that Validity Period, as specified in Table 2.
6.3If the Access Seeker does not provide sufficient information to the expert when requested, the Validity Period for the purposes of clause 6.2(b) is Validity Period 1.”
Clause 7 related to “TRANSIT TRAFFIC” and provided:
“7.1This clause 7 applies to traffic sent to Vodafone by the Access Seeker for which the retail price is set by a Carriage Service Provider other than the Access Seeker (Transit Traffic), if the total Transit Traffic being sent by the Access Seeker exceeds 750,000 minutes/month.
7.2The Access Seeker must ensure that at any time at which this clause 7 applies, each Carriage Service Provider to which it supplies transit services (Transit Carriage Service Provider) complies with the Pass Through Obligation, including this Part C.
7.3If the Access Seeker sends Transit Traffic to Vodafone for termination, then the Access Seeker must:
(a) ensure that each Transit Carriage Service Provider:
(i)is also subject to an obligation to comply with the Pass Through Obligation; and
(ii) complies with that obligation; and
(b)ensure that any disputes about the compliance of the Transit Carriage Service Provider with its Pass Through Obligation are:
(i)capable of resolution is [sic] a manner identical to that specified in clause 5; and
(ii)resolved in accordance with the procedure specified in clause 5; and
(c)provide a separate Certification of Pass Through for each Transit Carriage Service Provider that:
(i) identifies each relevant Carriage Service Provider; and
(ii)specifies the volume of Transit Traffic of each Carriage Service Provider; and
(d)co‑operate and provide all reasonable assistance to ensure that each Transit Carriage Service Provider complies with the Pass Through Obligation and that Transit Traffic is not used as a means to avoid or circumvent the Pass Through Principle.
7.4If the Access Seeker cannot or does not comply with this clause 7, the Access Seeker must not send any Transit Traffic to Vodafone for termination.”
The expression “Average Retail Price” was defined as meaning:
“… an Access Seeker’s revenues from fixed to mobile calls which terminate on the Vodafone network divided by that Access Seeker’s total Conversation Minutes for fixed to mobile calls which terminate on the Vodafone Network during the relevant Validity Period.”
Vodafone’s final price of 16.15 cpm in its undertaking was based upon the output of a fully allocated cost modelling exercise undertaken by PricewaterhouseCoopers (“PwC”) for Vodafone. The model used Vodafone’s data for Vodafone’s 2002/2003 financial year and the exercise was, according to Vodafone, verified by PwC using Vodafone’s 2003/2004 financial year data.
Vodafone contended that the prices in its undertaking were reasonable because:
·although they were based on a fully allocated cost model, this model was the subject of a number of adjustments such that it represented a close approximation to a Total Service Long Run Incremental Cost (“TSLRIC”) model;
·the PwC Cost Model allocated common costs on a basis similar to an equi‑proportionate mark‑up (“EPMU”) basis and did not involve any mark‑up for network externalities. Vodafone would have been entitled if it so chose to produce a model which allocated common costs according to Ramsey principles and which incorporated recovery of an amount for network externalities;
·when account was taken of the allocation of fixed and common costs according to Ramsey principles and the recovery of network externalities, it confirmed that the result of the PwC Cost Model represented a conservative estimate of the TSLRIC+ cost of supply of the MTAS by Vodafone.
7. BACKGROUND
Unlike its two main competitors, Telstra and Optus – which supply both fixed line and mobile services, Vodafone is a standalone mobile operator. It operates a 2G/2.5G GSM network and a 3G network. Its GSM network covers 93% of the Australian population. Vodafone was awarded the third Australian mobile telecommunications carrier licence in December 1992. By March 2004, Vodafone’s share of the Australian mobile telecommunications market was almost 17%, the rest of the market at that time being held as to 45.7% by Telstra, 35.4% by Optus and 3.1% by Hutchison.
8. THE COMMISSION’S REASONS FOR REJECTING THE UNDERTAKING
At the conceptual level, the Commission considered that the approach adopted by Vodafone, using a top‑down fully allocated cost model based on Vodafone’s 2002/2003 data, was likely to overstate the costs that would be incurred by an efficient provider of the MTAS in Australia when compared with a TSLRIC+ model. The Commission was concerned that Vodafone had used data from 2002/2003 as a basis for estimating the forward looking efficient costs of the MTAS without adjustments to reflect cost volume trends. The Commission considered that the appropriate costs to recover in determining the costs of supplying the MTAS were likely to be those of an “efficient operator”. (Vodafone objected to this standard.) The Commission did not accept that Vodafone’s costs would be likely to represent those of an efficient operator. The Commission also had concerns at the empirical level with a number of the model inputs and assumptions that underpinned the PwC model. These inputs, assumptions and certain errors suggested to the Commission that even if PwC’s conceptual modelling approach was considered appropriate, its price of 16.15 cpm was likely to overstate substantially Vodafone’s “forward‑looking efficient economic costs” of supplying the VMTAS on its GSM network.
The Commission considered that Vodafone’s proposed Pass Through Safeguard was not necessary, given the likelihood that the pass through of lower regulated MTAS rates to retail fixed‑to‑mobile prices would occur, and was likely to increase over time, as a result of a regulated reduction in the MTAS rate alone. The Commission also had significant reservations regarding the specific terms on which Vodafone proposed to implement the Pass Through Safeguard.
The Commission reached the view that the price terms and conditions contained in the undertaking were not reasonable when assessed against the relevant statutory criteria in s 152AH. The Commission considered that the undertaking price terms and conditions were above those required to meet the legitimate business interests of Vodafone and its investment in facilities used to supply the VMTAS.
The Commission also had concerns with some of the non‑price terms and conditions because of the broad nature of some of the discretions given to Vodafone. These discretions generally applied in the areas of credit management and security, suspension and termination, limitation of liability and confidential information.
9. MARKET DEFINITION
Vodafone submitted that there were two relevant markets in which its VMTAS (as well as mobile origination services) was provided. These were:
·the overall market for mobile telephony services which was a national market with both wholesale and retail components and which encompassed the provision of mobile access or subscription, mobile termination and mobile origination to customers as well as other outgoing call services. It defined this market as the “mobile services market”; and
·the market for fixed‑to‑mobile services.
The Commission submitted that there were three relevant markets:
·the wholesale market for the supply of Vodafone’s VMTAS. It was said that only Vodafone could supply MTAS in relation to calls terminating on its 2G/2.5G GSM network and that no other service was substitutable for, or otherwise competitive with the VMTAS supplied by Vodafone;
·a national market for retail mobile services, including mobile call origination and mobile subscription services. It was said that this retail mobile services market was not effectively competitive and was highly concentrated with high barriers to entry in the form of large sunk costs and the pre‑requisite of national coverage; and
·a national retail market for the pre‑selected bundle of fixed‑to‑mobile national long‑distance and international calling services.
The key difference between the submissions of Vodafone and the Commission was whether there is, as submitted by the Commission, a separate market for termination services or whether, as submitted by Vodafone, termination services are supplied and consumed as part of an overall retail market for mobile services.
In Application by Optus Mobile Pty Limited& Optus Networks Pty Limited (supra) we considered the submissions of all parties in relation to the issues relating to market definition. We do not repeat our reasoning in that decision in these reasons, but simply incorporate by reference paras [74]‑[90]. The observations and conclusions we reached in those paragraphs in relation to Optus apply equally to Vodafone in this review. It follows from those reasons that we do not consider that Vodafone’s VMTAS is provided in the retail mobile services market. Nevertheless, in determining the price Vodafone will charge its customers for making calls, Vodafone must factor into its calculations the price it will have to pay other network operators for having its customers connected into their networks so that its customers’ calls can be so connected and terminated, and the revenue it will receive from supplying its VMTAS to other network operators. It also follows from our reasoning in Application by Optus Mobile Pty Limited& Optus Networks Pty Limited (supra) that even if the retail mobile services market were effectively competitive, we do not consider that Vodafone would be strongly constrained in setting its VMTAS price by competition in the retail market. As we noted in Application by Optus Mobile Pty Limited& Optus Networks Pty Limited (supra), the mobile operators could set their termination charges on a reciprocal basis at above cost while still competing vigorously in the retail market. Again, as we noted in that decision, it was accepted that that is what they do.
For the reasons which we have set out in Application by Optus Mobile Pty Limited & Optus Networks Pty Limited (supra), we do not need to come to a definitive conclusion about market definition nor do we need to come to a definitive conclusion whether the retail mobile services market is effectively competitive.
10. VODAFONE’S COST MODELS
In 2004 Vodafone engaged PwC to develop a top‑down fully allocated cost model for the purpose of enabling Vodafone to determine the appropriate price for calls terminating on its VMTAS. On 22 March 2005, PwC provided a report entitled “The Fully Allocated Cost (FAC) of Services on Vodafone Australia’s GSM Network”. The model developed by PwC was based on a fully allocated top‑down cost model built from Vodafone’s accounting and operational data for Vodafone’s financial year 2002/2003. (We call this “the First PwC Model” and PwC’s report on it, “the First PwC Report”). The model was described as “forward looking” as Vodafone re‑valued its network assets in current cost terms. The model allocated all the relevant network and non‑network costs associated with Vodafone’s GSM network for the financial year 2002/2003 to six services:
·incoming calls (termination);
·outgoing calls (calls originating on Vodafone’s network and terminating on a different network);
·on‑net calls (calls originating and terminating on Vodafone’s network);
·SMS messages (Short Messaging Service – a facility to send text messages);
·GPRS (General Packet Radio Service) megabytes; and
·subscription.
Costs were allocated either directly to these services or indirectly across these services by way of an EPMU approach. PwC allocated Vodafone’s network asset costs directly to services using routing factors which were provided by Vodafone. A tilted annuity formula was applied to these network assets to calculate an annualised depreciation charge for these assets for 2002/2003.
The following features and components of the First PwC Model should be noted:
·the model was a top‑down fully allocated cost model which used a mixture of Vodafone’s accounting and operational data comprising input from the general ledger, the fixed asset register and call data recording systems;
·other inputs, including asset prices and routing factors were obtained directly from Vodafone;
·the model did not distinguish between costs that were incremental to the services being modelled and costs that were common across two or more services, that is costs which were fixed, common or joint;
·for network capital costs (depreciation and return on investment) the accounting based straight‑line method of depreciation was replaced with a tilted annuity calculation which reflected changes in the value of assets over time and which was underpinned by a current cost valuation of the asset base based upon the actual deployment of Vodafone’s network;
·the model allocated costs either directly to services or indirectly to services through secondary allocations. Indirect costs were broken down into network indirect costs and non‑network indirect costs;
·SMS messages and GPRS megabytes were converted to minute equivalents to enable the allocation of network costs between the different conveyance services; and
·routing factors, reflecting the extent to which the different services drove network usage for the main network elements, were provided by Vodafone.
Based on the outputs from the First PwC Model, PwC concluded that a reasonable estimate of the average cost of terminating calls on Vodafone’s GSM network was 16.15 cpm. It is on this price, derived from the First PwC Model, that Vodafone based its undertaking given to the Commission on 23 March 2005.
On 20 October 2005, PwC submitted a further report entitled “The Fully Allocated Cost (FAC) of Services on Vodafone Australia’s GSM Network – Model update incorporating data for the financial year ended 31 March 2004”. This report (which we call “the Second PwC Report”) set out further modelling work performed using data for the financial year ended 31 March 2004. PwC said that the 2003/2004 model (which we call “the Second PwC Model”) included further refinements and enhancements to allocation bases. It took into account comments received on the First PwC Model and corrected for model errors relating to the exclusion of some traffic, the uplift for working capital on network assets, the treatment of short message service (SMS) centre costs, the specification of the tilted annuity formula and the allocation of indirect network operating expenses.
PwC made the following observation in relation to the modelling approach in the Second PwC Report:
“The high‑level cost model that was originally prepared has been updated with data for the financial year ended 31 March 2004. The nature of the model and its functionality remains unchanged. However, apart from changes to the inputs, there have also been changes to some of the allocation assumptions as a result of a more detailed interrogation of the underlying financial data.”
We consider later in these reasons particular issues relating to the changes to the inputs, the changes to the allocation assumptions and the more detailed interrogation of the underlying financial data. In summary, the Second PwC Model produced a cost of termination of [X] cpm. What is significant is that the Second PwC Report stated:
“The 2003/04 model updates and replaces the 2002/03 model as the best and most recent estimate of the forward looking fully allocated cost of terminating voice calls on Vodafone’s GSM network”.
Notwithstanding this statement in the Second PwC Report, the target price in Vodafone’s undertaking remained at 16.15 cpm derived from the First PwC Model. We return to the significance of the Second PwC Model and the Second PwC Report later in these reasons.
Vodafone also relied upon a report submitted by Frontier Economics entitled “Modelling Welfare Maximising Mobile Termination Rates: A Report Prepared for Vodafone”.
The First PwC Model used Vodafone’s 2002/2003 data to estimate the forward looking efficient costs of providing the VMTAS without any adjustments to the data to reflect costs‑volume trends that might operate during the period post‑2002/2003 to 1 January 2007. The Commission considered that the per‑unit costs of supplying the VMTAS was likely to be lower, perhaps significantly lower, by 1 January 2007.
The modelling approach adopted by PwC gave rise to the following issues of principle and issues of detail:
·the use of a fully allocated cost model as distinct from a model based on a TSLRIC+ approach;
·whether Vodafone’s costs are efficient costs, setting aside issues of scale and scope;
·the benchmark by reference to which Vodafone’s costs are to be assessed. In particular whether, as the Commission contended, the benchmark is that of an “efficient operator”;
·the recovery of network capital costs and the use of forward looking asset valuations;
·the use of 2002/2003 and 2003/2004 data;
·the use of 2G/2.5G costs as opposed to 3G costs; and
·what were claimed by the Commission to be empirical flaws in the model.
11. THE USE OF A FULLY ALLOCATED COST MODEL
Vodafone submitted that the use of a fully allocated cost model was reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB. Vodafone relied upon a report dated 6 February 2006 from NERA Economic Consulting (“NERA”) which it had retained to provide an independent assessment in relation to aspects of its undertaking.
NERA addressed the differences between a fully allocated cost model and a model based on TSLRIC+. NERA concluded:
“In most respects PwC’s model of Vodafone’s network bears a close resemblance to a top‑down TSLRIC model. Where it differs significantly is that it does not use forward‑looking valuations for non‑network assets and does not distinguish between incremental and common fixed costs. For the reasons given in 8.1.2, the first of these differences may not lead to a material divergence between the cost estimates produced by the two models. The situation regarding the second difference is less clear.”
In section 8.1.2, NERA noted that the PwC model had the characteristics of a top‑down TSLRIC model in respect of its valuation of network assets but not in its valuation of non‑network assets. PwC re‑valued Vodafone’s network assets on a current replacement cost basis rather than using historical cost asset values. Non‑network capital items were not re‑valued and historical cost values were used for them. NERA observed that Vodafone’s view was that the distortion caused by not using forward looking asset values and depreciation for non‑network assets was not likely to be material, bearing in mind that they accounted for only [X]% of the total net book value of assets. Vodafone’s view in this respect, was supported by Analysys Consulting Limited (“Analysys”) who carried out a review of the PwC models on behalf of the Commission. Analysys considered whether Vodafone’s undertaking was based on a reasonable fully allocated cost top‑down model.
Analysys stated:
“Inevitably, a FAC [Fully Allocated Cost] estimate relies on a degree of judgement. Alternative allocation rules to those applied by PwC might have yielded different FAC estimates. For the purposes of setting cost‑based prices, the regulatory objectives may mean some approaches to FAC modelling are preferable to others. For example, the allocation rules for indirect costs that PwC has used bear resemblance to equi‑proportionate mark‑ups, sometimes used by regulators to adjust LRIC estimates. To the extent that the indirect costs in PwC’s model correspond to common costs (as estimated within a LRIC framework), this may make the final outputs of the model attractive if the regulator favours prices based on LRIC plus an EPMU.”
Analysys accepted Vodafone’s contention that:
“… since non‑network assets account for only about [X]% of net book value, the failure to convert the costs of these assets into a gross replacement cost is unlikely to significantly affect the final results of the model.”
Telstra and the Commission accepted that a fully allocated cost model was not unreasonable and was capable of approximating the outcomes of a TSLRIC+ approach, thereby providing a reasonable estimate of efficient costs, so long as the fully allocated cost model made appropriate adjustments.
We do not consider that the use of a fully allocated cost model, as distinct from a TSLRIC+ model is, of itself, unreasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB. We accept that in Re Seven Network (No 4) (2004) 187 FLR 373 at 410, the Tribunal expressed the view that it would generally not be in the long‑term interests of end‑users to depart from TSLRIC pricing where access is regulated. However, we would repeat the observation of the Tribunal in Telstra Corporation Limited (supra) at par [63]:
“In this area of analysis there is no one correct or appropriate figure in determining reasonable costs or a reasonable charge. Matters and issues of judgment and degree are involved at various levels of the analysis.”
Nevertheless, we still consider that in general terms the prices in access undertakings should reflect and not exceed forward looking efficient economic costs: Telstra Corporation Limited (supra) at par [46].
12. ISSUES RELATING TO VODAFONE’S COSTS
Vodafone distilled the Commission’s and other parties’ submissions against it into a number of issues. The other parties accepted that list and the hearing proceeded largely on the basis of argument under each of the headings in the list. Those issues are:
·the efficiency of Vodafone’s costs, setting aside issues of scale and scope;
·whether efficient costs should be determined by reference to an efficient benchmark operator rather than by reference to a firm of Vodafone’s actual size; that is, whether Vodafone’s actual costs should be adjusted to reflect economies of scale and scope that could be achieved by such a benchmark operator; and
·what were described by the Commission as “empirical flaws” in the PwC models.
13. ARE VODAFONE’S COSTS EFFICIENT COSTS?
As we observed in Application by Optus Mobile Pty Limited& Optus Networks Pty Limited (supra), the matters and objectives to which we must have regard in determining whether Vodafone’s price terms are reasonable, and whether they promote the long‑term interests of end‑users, as set out in ss 152AH and 152AB, lead to a consideration whether Vodafone’s costs of supplying its VMTAS are efficient costs. Section 152AH(1)(f) requires us to have regard to “the economically efficient operation of” Vodafone’s VMTAS and s 152AB(2)(e) requires us to have regard to the extent to which the price term is likely to result in the achievement of “the objective of encouraging the economically efficient use of, and the economically efficient investment in”, the infrastructure by which the VMTAS is supplied.
The Commission submitted that Vodafone had not put before it (and therefore, before us) sufficient material to establish that its historical costs, upon which the First PwC Model and the Second PwC Model were based, were efficient. It followed, submitted the Commission, that the undertaking could not be reasonable even if we were to decide that all of Vodafone’s methodologies, inputs and assumptions by which it derived its costs of supplying its VMTAS were reasonable.
Vodafone submitted that there was no material capable of casting sufficient doubt on the efficiency of its inputs into the PwC models to affect any conclusion that the prices and terms in the undertaking were reasonable. In support of this submission, Vodafone relied upon the following matters:
·neither the Commission nor any of the intervenors had nominated any specific cost, item or aspect of Vodafone’s business or network which was said to be inefficient;
·the preparation of the PwC models involved a revaluation of network assets to current day values and this would remove any suggestion that Vodafone’s network assets were overpriced;
·Vodafone’s network was developed, and its non‑network costs incurred, in a highly competitive environment. It followed that Vodafone’s costs were efficient because of the competitive market in which Vodafone operated; and
·the consultant Analysys considered that for the purposes of producing top‑down fully allocated cost results, the use of Vodafone’s actual costs was reasonable.
We do not consider that Vodafone’s submission poses the correct question. As we observed in Application by Optus Mobile Pty Limited & Optus Networks Pty Limited (supra) at par [118]:
“Although there is merit in the proposition that a firm in a competitive market has an incentive to be efficient and to incur its costs efficiently, there is still a need for the Commission (and, on review the Tribunal), to be satisfied, having regard to the matters set out in s 152AH and the objectives in s 152AB of the Act, that the firm’s costs are efficiently incurred.”
We repeat the observation in Telstra Corporation Limited (supra) at par [46]:
“…we would point out that whenever an access provider seeks approval of an access undertaking from the Commission which involves a consideration of a price term by comparing it with costs, it would be necessary, in order to satisfy the statutory framework, that the access provider establish that its costs are efficient costs.”
It is not to the point that there is no material before us capable of casting sufficient doubt on the efficiency of Vodafone’s inputs into the PwC models. Rather the point is whether we are satisfied, having regard to all the material placed before us, that Vodafone’s costs are efficiently incurred.
Further, we do not accept Vodafone’s submission that Analysys considered that for the purposes of producing top‑down fully allocated cost results, the use of Vodafone’s actual costs was reasonable. The passage in the Analysys report relied on by Vodafone for this submission related to a different issue. What Analysys in fact said was:
“Apart from the historic‑to‑current‑cost adjustment, the model is based on Vodafone’s actual costs rather than the costs of a hypothetical efficient operator. Vodafone argues that it is efficient in the costs it incurs and there is no need to make further adjustments to the costs in the model. For costing purposes, PwC has utilised 2G costs, 2G demand and assumed traffic levels that are constant (at 2002/03 levels) without any future migration to 3G services. The model does not have the functionality to consider how costs might vary if Vodafone carried a different traffic load or offered coverage over a different area. For the purposes of producing top‑down FAC results these modelling decisions are reasonable. However, this means that the model cannot indicate the implications should the ACCC decide that the undertaking should be based on the costs of a hypothetical operator, e.g. one with 25% market share carrying a proportion of its traffic using 3G technologies.”
This passage does not support the proposition that Analysys accepted that Vodafone’s costs were, in fact, reasonable or efficiently incurred.
It is significant that Analysys also observed that the fully allocated cost model does not make adjustments to eliminate inefficient costs. Vodafone’s response to this observation was that there was no basis for assuming that its relevant architecture and operating expenditure were inefficient given that it incurred these costs in a competitive environment. Putting to one side whether the retail mobile services market is competitive, we do not accept that an assumption that costs are incurred efficiently can be made simply upon the basis of the nature of the market within which the costs are incurred.
We also note that Vodafone’s independent consultant, NERA concluded that:
“Whether Vodafone is efficient or not is also an empirical question, the answer to which cannot be assumed without further analysis. In our view some kind of efficiency assessment of Vodafone is needed before any definitive conclusion can be reached.”
The Commission and the intervenors raised a number of specific arguments regarding the efficiency of Vodafone’s costs which can be summarised as follows:
·the PwC models were based on Vodafone’s existing architecture and technology which was not forward looking;
·the use of cost inputs to the PwC models from 2003, which were unadjusted, was not an appropriate basis for prices that could apply until 2010. No allowance was made for increases in traffic over the life of the undertaking;
·whether Vodafone had invested in an inappropriately large network coverage;
·whether Vodafone’s costs should have been “optimised” to take account of newer and more efficient ways of designing and operating a mobile network than those applying at the time when Vodafone incurred its costs; and
·whether an efficient operator would have chosen to share infrastructure costs with another operator or operators, contrary to Vodafone’s actual mode of investment.
Vodafone’s principal response to these criticisms was that it was entitled to base prices on its actual costs since they involved no waste and its incentives were to minimise them. It also called into question the expertise of one of the consultants upon whose reports other parties relied. We consider this issue later in our consideration of empirical flaws in the PwC models.
We consider that the main conceptual issues in relation to whether we can be satisfied that Vodafone’s costs were efficiently incurred to be:
·the weight that can be placed on the market environment and the degree of competition in which Vodafone operates;
·the degree to which the costs are sufficiently forward looking; and
·other matters relating to Vodafone’s network configuration.
We do not accept the proposition that Vodafone’s actual costs can be taken to be efficiently incurred simply because Vodafone operates in a competitive market. While that market certainly exhibits some evidence of vigorous competitive processes, for example, in the marketing of various pricing plans, it does not follow that no scope exists for inefficiency. The very nature of mobile termination, where calls to each operator’s customers can only be completed by that operator, argues for caution in concluding that inefficiency is absent. Furthermore, taken to its logical conclusion, the proposition would also lead to the view that Vodafone’s actual VMTAS prices must be reasonable and thus warrant no regulatory examination.
More specifically, with only three operators in the market during the period of Vodafone’s initial investment and roll‑out of infrastructure, economic theory does not support the contention that those firms will, ipso facto, have made efficient investments. Services provided in the market are far from homogeneous, and the operators appear to have made great efforts to differentiate their services, build strong brand names, and appeal to varying groups of consumers.
This differentiation to some extent may, as it is intended to do, constrain the effects of competition on prices. Prices may be sustained above marginal costs. The evidence was clear that operators shift costs between services as part of their strategies of expanding the market and maximising profits. This is unobjectionable. But in such a business environment, we cannot be satisfied that costs are automatically incurred efficiently.
It is relatively easy to suggest ways in which Vodafone’s network may, at the conceptual level, differ from what would be put in place by a hypothetical efficient new entrant. In the absence of evidence to support suggestions that Vodafone invested in “too much” coverage or forwent opportunities for more efficient infrastructure sharing, we place no weight on such possibilities. On the other hand, we are inclined to accept that changes in technology, such as the increasing use of optic fibre and digital processing since Vodafone was awarded its licence in 1992, mean Vodafone’s actual costs are unlikely to be forward looking in the absence of some adjustments. Merely revaluing network assets is insufficient.
We consider that Vodafone is obligated to adduce some evidence that its costs were efficiently incurred. In saying this, we have no wish to impose a requirement that the submitter of an undertaking to the Commission foresee every possible speculative criticism of its investment and other business decisions. There are limits to the second-guessing of an operator’s basic strategic decisions regarding the size of its network, the geographical area it seeks to cover, the level of market demand it seeks to satisfy and the manner of its product development. Nevertheless, it cannot be sufficient simply to assert, without any supporting material, that costs were efficiently incurred.
We consider that, for the most part, the objections to Vodafone’s costs made in the reports by Gibson Quai‑AAS Pty Ltd (“Gibson Quai”), Analysys and Marsden Jacob and Associates (“Marsden Jacob”) restate in‑principle arguments rather than produce specific evidence of inefficiency. However, Gibson Quai did give some specific examples of how a modern network would differ from Vodafone’s network. Vodafone did not respond to those specific points except in general terms. Taken together, and in the absence of material supporting Vodafone’s contentions regarding the efficiency of its costs, the points raised are sufficient to add to our lack of satisfaction that Vodafone’s costs were efficiently incurred.
We therefore conclude that we are not satisfied that Vodafone’s costs were efficiently incurred. We have reached this conclusion having regard, in particular, to the matters specified in s 152AH(1)(f) and the objectives set out in s 152AB(2)(e) (summarised in par [46] above).
14. THE BENCHMARK OF AN EFFICIENT OPERATOR
The Commission submitted that Vodafone’s prices could not be reasonable if they exceeded those that would be incurred by an efficient operator with the scale and scope achievable by all mobile network operators (“MNOs”), namely the efficient costs of an operator with a 25% market share (there being four MNOs).
The Commission argued that to base the prices of an MNO for MTAS with a market share of, say, 1%, on its actual costs, would constitute a subsidy from access seekers for its inefficient costs. On the other hand, the Commission’s position was that an operator’s actual costs provide an upper bound as a basis for prices, so that an operator with more than 25% market share should not be able to adjust its costs upwards to take account of the lesser economies of scale and scope it would enjoy were it smaller; that is, were it the size of the benchmark operator. The Commission saw no inconsistency in arguing that the larger operator’s legitimate business interests, relevant under s 152AH(1)(b), dictate that it receive no more than its actual costs.
There was little evidence before us as to the extent of any economies of scale and scope. In its assessment of Vodafone’s undertaking, the Commission came to no firm conclusions, noting only that there were “probable” scale economies and “possible” scope economies. Argument generally proceeded on the assumption that a larger operator would have lower unit costs.
Vodafone submitted that basing prices on the costs of a benchmark operator would deter or prevent new entry by operators intending to provide mobile termination services. Such new entrants could not, immediately upon entry, have access to economies of scale, and possibly of scope, achievable by all MNOs. Vodafone quoted Frontier Economics to the effect that operators of lesser scale and operators that could not take advantage of economies of scope could be eliminated, to the detriment of competition. To some extent this was portrayed as undervaluing dynamic efficiency at the expense of overvaluing productive and allocative efficiency.
Vodafone also appealed to statements by Ofcom, the United Kingdom telecommunications regulator, and to the decision of the Full Court of the Supreme Court of Western Australia in Re Michael; Ex parte Epic Energy (WA) Nominees Pty Ltd (2002) 25 WAR 511 in relation to the pricing of the services provided by a gas transmission pipeline. While both the Ofcom statements and Re Michael; Ex parte Epic Energy (WA) Nominees Pty Ltd (supra) dealt with different regulatory schemes from that applying in this proceeding, much the same issues of principle arose.
The starting point in assessing the submissions on this issue is, as throughout this proceeding, the principle that prices should be based on the forward looking costs of an efficient operator. The basic objective is to set prices that promote economic efficiency, which is the outcome that could be expected in a competitive market. It is because mobile termination has been declared as a service that inherently lacks the discipline of competitive forces that it is subject to Pt XIC of the Act.
Of course, the basis of reasonable prices in terms of s 152AH must proceed from the terms of that section, and it is those terms that direct the assessment process towards considerations of efficiency and competitive outcomes.
What outcomes would eventuate in a competitive market? In such a market, pricing above the costs that would be incurred by a new entrant having access to the latest and most cost‑effective technology would invite the entry of such an operator. Regardless of the actual costs, capital equipment and modes of operation of the incumbent operators, competition would force them to price as if they were using the latest technology. This would extend beyond the age and type of their capital equipment even to the design of their networks.
Moreover, no exemption would be given by the forces of competition to existing operators who might be smaller and consequently, or for other reasons, have higher costs than some other operators. For that matter, competitors would not allow a new entrant the luxury of charging in accordance with the higher unit costs associated with starting up a new venture.
These are the considerations that lead to the benchmark of the costs that would be incurred by an efficient, forward looking new entrant. However, it is relevant that an efficient new entrant – even, if realistic markets are envisaged, a hypothetical one – would not itself have immediate access to the economies of scale and scope that might be achievable over time.
It can be seen that, in seeking to emulate the outcomes realisable in a competitive market, some regard must be had to the actual process (the dynamics) by which operators compete and establish themselves in markets. It is not obvious that objectives of economic efficiency lead to basing prices on the costs that an efficient new entrant could achieve after some indefinite period. Similarly, the terms of s 152AH direct the assessment of reasonableness towards some aspects of market outcomes that go beyond over-simplified assumptions that could only be appropriate were perfect competition a realistic outcome.
As might be expected, this means that the task of deciding how to assess the efficient forward looking costs of a new entrant must involve some balancing of opposing considerations and must take account of the actual markets in which the relevant services are provided. This is difficult, not least because, for example – but typically for a regulated service – a competitive market in mobile termination services can only be hypothesised. That market lacks competition because it has structural, and perhaps institutional and regulatory, features that preclude effective competition. The lack of competition is not necessarily a temporary phenomenon, nor one that will be cured by any foreseeable changes in the market itself.
The Commission has dealt with this balancing requirement and the need to take actual circumstances into account by developing the idea of an efficient operator with the scale and scope achievable by all MNOs. In present circumstances that involves the efficient costs associated with a 25% market share. (We note that earlier in its assessment of Vodafone’s undertaking, when it released a draft determination, the Commission took the harder position that costs should be assessed by reference to the “most efficient operator”.)
As implied above, there is sense in benchmarking against the most efficient operator on the grounds that in a competitive market no operator would be able to charge more than the most efficient operator. However, whether this would occur in real‑life markets, even those considered effectively competitive but subject to normal features such as product differentiation, is another matter. The most efficient operator may well be able to price somewhat above its costs. In the sort of highly competitive market often hypothesised it is difficult to see how any less efficient operators could survive. The question is how close prices would actually be to this benchmark.
But even if the most efficient operator were chosen as the benchmark, the other difficulty remains that that operator would not be forced to base its prices on the costs of a hypothetical network optimised for all‑new design and technology. For that to happen the threat of new entry would have to be based on an ability, unrealisable in actuality under even the best of circumstances, to bring the new design and technology to bear immediately in a legacy‑sized network.
It might therefore be thought that the concept of basing prices on the costs of an efficient operator with the scale and scope achievable by all MNOs represents a compromise between these somewhat offsetting elements of how a competitive market – even a hypothetical one – would operate and the outcomes that it would produce.
However, the question of how to estimate that achievable scale and scope needs to be answered. What size is achievable by all MNOs?
In the present proceedings, we do not consider that a convincing case has been made that “achievable” translates into a 25% market share. Whether each of four operators in a market could achieve a 25% market share ignores questions about how the market is defined. Do all operators aspire to serve the whole market? What if some prefer certain market niches? Why should a business plan based on serving only a particular geographic area be ruled out?
Moreover, it may be that, for example, an operator that did seek to serve only a limited geographic area would enjoy the absence of some diseconomies of scale faced by a firm operating nationally. That is, it might not suffer from a lack of economies of scale at all. Alternatively, government-imposed roll‑out obligations, if there were any, could be relevant. No materials were before us on that matter.
Furthermore, no evidence was presented regarding the minimum efficient scale in this industry. It is possible that in the long run, four operators, each with a 25% market share, is not a sustainable outcome. But in any case, minimum efficient scale may be virtually impossible to determine. For example, it might itself vary for operators with differing business plans.
In proceedings where it was necessary to determine the issue of an appropriate benchmark operator in terms of scale and scope, that is, size or market share, materials supporting the proposed approach would be needed. It would be necessary to have regard to market realities.
Having regard to the conclusions we have reached in relation to other aspects of Vodafone’s cost models and in relation to the Pass Through Safeguard, it is not necessary for us to reach a concluded view on what is the benchmark of an efficient operator by reference to which an MNO’s costs are to be assessed for their efficiency.
15. SPECIFIC ISSUES RELATING TO THE COSTS DETERMINED FROM THE PwC MODELS
15.1 Expert Reports
A number of expert reports were included in the material placed before us and we wish to make some observations about how those reports came into existence, and the manner in which the parties used and relied on them.
On 14 April 2005, the Commission issued a Discussion Paper and invited interested parties to submit their views on Vodafone’s undertaking and the supporting submissions.
Submissions in response to the Commission’s invitation included two reports prepared for Hutchinson: one by Marsden Jacob dated 17 August 2005 (“the Marsden Jacob Report”), and the other by Gibson Quai dated August 2005 (“the Gibson Quai Report”).
The Commission retained Analysys to examine the two PwC reports. Analysys produced two reports for the Commission, one on 23 November 2005 (“the First Analysys Report) and the other on 23 December 2005 (“the Second Analysys Report”). The First Analysys Report which records its examination of the First PwC Model also draws on:
·a set of questions sent to Vodafone by the Commission on 3 October 2005 and Vodafone’s response, dated 17 October 2005;
·the Marsden Jacob Report; and
·the Gibson Quai Report.
The Second Analysys Report, which records its examination of the Second PwC Model, lists:
·specific concerns with revised aspects of the PwC model; and
·concerns presented in the First Analysys Report which “still apply”.
Vodafone submitted to the Commission an evaluation, dated 6 February 2006, of PwC’s modelling by NERA (“the NERA Report”). The NERA Report “... focused on the revised version of the [Second PwC] model as it corrects a number of errors in the first version and uses more up to date cost and input data.” PwC responded to the Analysys reports on 8 February 2006 in a report entitled “Response to Analysys papers on PwC Models”.
Vodafone put in issue the statement in a disclaimer appearing on page one of the Gibson Quai Report that in making the report Gibson Quai “... has used its professional skills and judgement to provide the conclusions contained in this report but makes no representation or gives any warranty in relation to the information, conclusions and statements included in this report.”
Also, on the assumption that the author of the Gibson Quai Report was Mr Dominic Quai, Vodafone queried the weight that should be given to the report. Vodafone referred to Mr Quai’s curriculum vitae and submitted that his practical experience appeared to have ended in 1987 (which was before the introduction in 1993 of GSM networks) and that the Gibson Quai Report was not one which would demand a great deal of consideration.
While a disclaimer of the kind put in issue by Vodafone may be somewhat incongruous in an expert’s report relied upon before a tribunal or a court, its existence is not such an issue as to lead us to reject, or give less weight to, the report. Indeed, if it were, it might also lead us in that direction in respect of other reports before us. For example, the First PwC Report, which Vodafone advanced as the foundation of its 16.15 cpm target price, contained the disclaimer that “PricewaterhouseCoopers LLP does not accept any responsibility and disclaims all liability (including negligence) for the consequences of any person other than Vodafone Australia acting or refraining from acting as a result of the contents of this Report”.
However, Vodafone’s submission exposes an issue which arises where a tribunal in our position is reviewing a matter on the merits on the basis of the material which was before the Commission without the opportunity to test or evaluate the experts’ evidence by hearing them or through cross‑examination. In that situation, the qualifications and experience of the persons responsible for the expert reports assume greater significance.
It is instructive to consider Vodafone’s submission with respect to the weight to be given to a report having regard to the author’s experience in the context of our function in reviewing the matter. A party seeking to have the Commission accept or reject an undertaking should have in mind that if the Tribunal were required to review the Commission’s decision, the Tribunal may have regard only to information given, documents produced or evidence given to the Commission in connection with the making of the Commission’s decision to which the review relates: s 152CF(4)(a). Thus, where a party seeks to rely on an expert’s report to advance its case, the expert’s qualifications, background and experience should, ideally, form part of the report and the relevance of the qualifications, background and experience should be linked directly to the subject matter of the report. A statement prepared to demonstrate the relevance of an expert’s qualifications, background and experience to the matter under consideration by the Commission (or, on review, by the Tribunal) is far preferable to what appear to be pro forma statements such as those submitted in connection with the First PwC Report, Second PwC Report, Gibson Quai Report, Marsden Jacob Report, NERA Report, First Analysys Report and Second Analysys Report.
Also, while it may be correct to say, as Mr Hutley QC did, that it appears from Mr Quai’s curriculum vitae that he left the employ of Telecom Australia prior to the 1987 introduction of its analogue Advanced Mobile Phone System, it does not necessarily follow that his subsequent experience is irrelevant to the matter before us or that the Gibson Quai Report should be given no weight.
15.2 Summary of claimed Empirical Flaws in models
It is material to the issue whether we are satisfied that the target price is reasonable that the two modelling exercises produced different results. The target price of 16.15 cpm in Vodafone’s undertaking is based on the First PwC Model, as outlined in the First PwC Report. The Second PwC Model, which Vodafone submitted “verified” the First PwC Model, included refinements and enhancements and corrected errors (see par [35] above) in the First PwC Model to arrive at a price [X] cpm above the target price in the undertaking.
It is also of significance that notwithstanding that the First PwC Model upon which the target price of 16.15 cpm is based contained five “errors” which were “corrected” in the Second PwC Model, Vodafone submitted we should accept the product of the First PwC Model, its target price of 16.15 cpm, as reasonable.
The Commission submitted that even if Vodafone’s conceptual approach were accepted, empirical flaws in the First PwC Model, which the Commission was able to quantify, resulted in an overstatement in the cost of supplying Vodafone’s MTAS of at least 4.76 cpm. The following table summarising the impact of correcting the First PwC Model for the empirical flaws the Commission quantified was put in support of the Commission’s submission:
Target price specified in Undertaking 16.15 cpm
Correction for too short asset lifetimes -0.65 cpm
Correction for error in tilted annuity calculation -0.97 cpm
Correction for incorrect routing factors -0.81 cpm
Correction for short message service centre costs -0.07 cpm
Correction for inaccurate splits of non‑network costs -2.42 cpmCorrection for inclusion of subscriber direct assets +0.16 cpm
Corrected target price 11.39 cpm
The Commission further submitted that while the Second PwC Model corrected the errors in:
·the tilted annuity calculation; and
·the allocation of SMS centre costs,
it introduced the following five new empirical flaws:
·unreasonable price trends;
·unsupported contingency costs;
·incorrect inclusion of a return on assets in the course of construction;
·incorrect exclusion of acquisition and retention costs from the non‑network indirect costs mark‑ups; and
·unsupported revised splits of non‑network asset costs and non‑network operating costs.
Mr Hutley QC provided an issues paper in his opening submissions on behalf of Vodafone listing the issues which had been raised in relation to Vodafone’s pricing principles, its price and its methodology. It included, by reference to the First and Second PwC Models, the items in the table provided by the Commission and the new empirical flaws the Commission submitted were introduced by the Second PwC Model. The list set out the following issues:
Methodology
A. Efficiency of costs (other than scale or scope) – inefficiency in infrastructure configuration (capital costs) and/or operating costs.
B. Economies of scale and scope – is Vodafone an “efficient” benchmark operator?
First PwC Model run 2002/2003 data
C. Asset lifetimes for radio site equipment and buildings.D. Error in tilted annuity calculation.
E. “Incorrect” routing factor – voicemail.
F. Incorrect allocation of short message service costs.
G. “Inaccurate” splits of non‑network asset and operating costs.
H. Incorrect inclusion of subscriber direct assets.
I. Unaccounted for likelihood of decrease in per unit cost.J. “Incorrect” SMS and GPRS conversion factors.
K. Price trends and changes.
Second PwC Model run 2003/2004 data
L. Contingency costs.
M. Inclusion of a return on assets in the course of construction.N. Exclusion of acquisition and retention costs from non‑network indirect cost mark‑ups.
O. Revised splits of non‑network asset costs and non‑network indirect costs.
P. Weighted Average Cost of Capital (“WACC”) – the choice of asset beta.
We have already addressed Issues A and B.
The following reasons address items in the Commission’s table at par [98] and what it described as the additional empirical flaws using the alphabetical identification attributed to them by Mr Hutley QC.
15.3 Issue C: Asset lifetimes for radio site equipment and buildings
In order to calculate Vodafone’s capital costs and a depreciation profile for an appropriate return of capital (as distinct from a return on assets which is the function of the WACC), both PwC models relied on an estimate of the useful economic life of each relevant Vodafone asset.
While the First PwC Report was silent on the basis for the estimate of the useful economic life of each relevant Vodafone asset, the Second PwC Report provided the following explanation:
“The expected economic life was also estimated by Vodafone’s engineers. The process followed was to use the accounting lives as a starting point, and consider whether there were or were not any specific reasons why the accounting life would not be suitable for use in the model, given the requirement for the financial statements to fairly present the Net Book Value of Vodafone’s assets. It was concluded that the accounting lives were suitable for all asset categories.”
Hutchison, Telstra and the Commission put in issue the estimate of [X] years for the useful economic life of radio site equipment and buildings submitting that the estimate was too short. Hutchison submitted that an appropriate estimate of the useful life of such assets was 25 years, consistent with the approach adopted in other jurisdictions such as Sweden. Telstra submitted that such asset life should be at least 15 years. The Commission submitted that asset life should be at least 15 years, if not 25 years. A number of the expert reports supported the proposition that the useful economic life of these assets used in the PwC models was too short. Gibson Quai believed that:
“The economic lives of buildings such as switch buildings should be at least 25 years, not [X] years as suggested by PwC.”
Marsden Jacob said:
“We have compared the asset lives in the PwC model with those in publicly available models. Our review indicates the asset lives in the PwC model are too short and hence will tend to overstate annualized costs.”
Analysys in its First Report believed that a [X] year lifetime was short, and that 15‑20 years was more appropriate. In its Second Report Analysys said under the heading “Concerns presented in our previous report which still apply” that the asset lifetime of [X] years for site acquisition was short.
Vodafone’s consultant, NERA, did not expressly support the reasonableness of the estimate. NERA said:
“Based on NERA’s experience of building mobile TSLRIC models, [X] years would appear to be rather a short asset life for sites and 15 years would be much more typical. However, Vodafone have argued that the [X] year lifetime is effectively an average of [X] years for the average site lease term and less than [X] years for ancillary costs such as power, cabinets and air conditioning. If that is the case, the use of a composite asset life of [X] years, which is broadly consistent with an average site lifetime of 15 years, may not be unreasonable.”
The effect of adopting an unreasonably short life is to increase the cost of the VMTAS, all other things being equal. Analysys estimated adjusting this asset life would reduce the VMTAS cost estimate by 4%. The Commission submitted that the adjustment would reduce the VMTAS cost estimate by 0.65 cpm.
During the hearing, an issue arose whether the [X] year asset lifetime assumption for radio site equipment and buildings as calculated by Analysys related just to the lease or to all of the costs of establishing a site, that is, the lease and the equipment such as macrocells, microcells, and picocells. Having regard to all the material before us we do not consider that the assets in issue include base station receivers. Further, we do not consider that the lifetimes of similar assets adopted by Optus are relevant to our consideration.
In the course of its consideration of the undertaking the Commission on 3 October 2005 asked Vodafone to respond to a number of questions. One question was “Is the economic life really [X] years for radio and switch sites? What data is available to support a [X]% annual replacement of radio sites today?” Vodafone replied on 17 October 2005:
“The lives used in the model are Vodafone’s accounting lives – they represent a view of economic value given uncertainty and risk. Vodafone considers that an economic life of [X] years for radio and switch sites is reasonable and appropriate for a number of reasons.
Vodafone believes it is appropriate to consider the nature of leases for radio sites when determining whether an economic life assumption is appropriate. Vodafone estimates that the average term of site leases is [X] years. The average lease term could be said to give an upper limit for the life of the site acquisition and preparation as some of the up‑front capital spend would not necessarily last for the whole life of the lease, e.g. the cabinet, power equipment, air conditioning. Therefore, the weighted life of the site acquisition and preparation is below the average lease term.
Further, there is considerable risk to Vodafone that it will be required to relocate or remove its equipment from a site for a variety of reasons including:
(1)when the lease of a site has expired, there is considerable risk that the landlord will not enter into a new lease;
(2)in relation to rooftop installations, a landlord is typically able to terminate a lease within its term if the landlord wishes to renovate or demolish the building where the site is located;
(3)the suitability of the site may alter during the term of the lease (e.g. interference) requiring Vodafone to terminate the lease and relocate to another site;
(4)Vodafone’s anticipates, given its investment in a 3G network, that it will be seeking to decommission some 2G sites over the next three or so years;
(5)Discussions are taking place with other carriers about network sharing for 2G assets. While these discussions are preliminary and would be subject to the necessary regulatory approvals, this also adds to the uncertainty regarding the life of Vodafone’s 2G sites;
(6)the community concerns regarding electromagnetic emissions (EME) also increase the risks to Vodafone that it will be required to relocate its equipment from existing sites (e.g. sites close to schools).
Based on all the above considerations, Vodafone has concluded that there is no reason to diverge from the accounting life which has been assessed by Vodafone’s independent auditors who concluded that a life of [X] years is appropriate.”
We note that Vodafone did not supply to the Commission any data to support its contentions, nor did it give any examples of the occurrences or circumstances to which it referred.
NERA’s response to Analysys’ view was to the effect that:
·allocation of non‑network indirect costs proportionately across all services, including subscriber acquisition and retention, would have the result of reducing the product of the Second PwC Model by [X]%, not the 5% claimed by Analysys;
·noting PwC’s views that the cost of subscriber acquisition and retention included items such as dealer commissions where the related overheads would not be significant, it would more appropriate to count only half the cost of subscriber acquisition and retention in the cost base to which non‑network indirect costs were allocated; and
·if its conclusion were adopted, it would result in a [X]% (or [X] cpm) reduction in the [X] cpm product of the Second PwC Model.
Having regard to the view expressed by Analysys and, in particular, the view expressed by Vodafone’s own expert NERA, that it would be appropriate to count half the cost, (which we prefer to Analysys’ view to the effect that all the cost should be counted), we do not accept Vodafone’s submission that it is reasonable, having regard to the matters specified in s 152AH and the objectives set out in s 152AB, to exclude subscriber acquisition and retention costs from non‑network indirect costs.
Accordingly, we are of the opinion that the [X] cpm product of the Second PwC Model is not reasonable, having regard to the matters specified in s 152AH and the objectives set out in s 152AB, because it is overstates Vodafone’s costs of providing its VMTAS by [X]% (or [X] cpm). A fortiori, when this overstatement is aggregated with other overstatements resulting from flaws in the Second PwC Model identified by the Commission as outlined above.
15.15 Issue P: WACC – the choice of asset beta
Hutchison submitted that Vodafone’s estimated post‑tax nominal WACC of [X]% was inappropriate and resulted in an overstated estimate of the VMTAS costs. It submitted that Vodafone’s WACC estimate did not take into account the lower level of risk posed by providing mobile termination services as opposed to mobile services at large. Hutchison relied upon the analysis of its consultant Marsden Jacob which Hutchison contended yielded a vanilla WACC of 9.24% and a post‑tax nominal WACC of 7.91%.
Vodafone used an asset beta of [X] as an input into its WACC calculation. Marsden Jacob’s conclusion on the appropriate asset beta for a mobile operator to use in Australia was as follows:
“Based on the available evidence we estimate that a reasonable range for the asset beta for a mobile operator in Australia is 0.7‑1.1. We note that the asset beta for the MTAS will be lower than the mobile business as a whole. In the absence of sufficient data to make an explicit adjustment to the asset beta, we propose to use a beta value for the MTAS of 0.7 [i.e. the minimum].”
Marsden Jacob may have used a different asset beta from that used by Vodafone, but the asset beta used by Vodafone was within the “reasonable range” referred to by Marsden Jacob.
In such circumstances, we reject Hutchison’s submission in relation to Vodafone’s WACC as on the evidence before us we can only conclude that it is a reasonable figure.
15.16 Conclusion on specific issues in relation to the PwC models
The end result of our analysis of what have been described as the empirical flaws in the two PwC models is that we are not satisfied that the costs produced by either model generate a total cost of providing the VMTAS of 16.15 cpm. Indeed, for the reasons we have outlined we are not satisfied, having regard to the matters specified in s 152AH and the objectives set out in s 152AB, that the target price of 16.15 cpm is reasonable. Our analysis shows that the total cost of providing the VMTAS is at least 4 cpm less than 16.15 cpm. If Vodafone were to be allowed to charge its target price of 16.15 cpm to access seekers it would recover significantly more than its costs of providing the VMTAS, which is not reasonable in the sense to which we have referred.
16. PASS THROUGH SAFEGUARD
As may be seen by reference to par [17] above, the Pass Through Safeguard would impose, on a fixed‑to‑mobile operator seeking access to the VMTAS, an obligation to reduce its retail price for a fixed‑to‑mobile call which terminates on Vodafone’s mobile network so that the price is equal to or less than an average retail price specified in Table 2 of Part C of the undertaking’s Service Schedule extracted at par [17]. Table 2 takes a fixed‑to‑mobile price for 2004 of 38.5 cpm as the starting point of a price path along which a fixed‑to‑mobile operator seeking access to the VMTAS must reduce its retail price to arrive at a 21.15 cpm price for 2007 and any subsequent validity period of the undertaking (that is, a 5 cpm mark‑up on the undertaking’s 16.5 cpm target price). The 5 cpm mark‑up is based on an estimate of the cost of originating, transmitting and retailing a fixed‑to‑mobile call made by the Commission in its June 2004 report Mobile Services Review: Mobile Terminating Access Service.
The provisions relating to the Pass Through Safeguard were challenged on a number of grounds. The challenges may be summarised as follows:
·the provisions were invalid as they were not provisions “in relation to” the standard access obligations applicable to a declared service. Rather they were provisions in relation to another service (a retail service) which had its own pricing regime and pricing controls. There was in existence a Ministerial Price Control Determination in relation to that service, with which the Pass Through Safeguard conflicted;
·price regulation in respect of retail telecommunications services was not properly the function of Pt XIC of the Act – rather it was properly the function of the responsible Minister;
·the Safeguard was predicated on the existence of the fixed‑to‑mobile market not being competitive and there was no evidence that that was the fact. Vodafone accepted that if the fixed‑to‑mobile service market was competitive then the Safeguard was not reasonable;
·it was not necessary to have such a mandatory and inflexible Pass Through Safeguard, as pass through could be expected to occur in any event. Economic theory suggested that at least 50% of a price reduction would flow through to retail prices;
·the target average retail price would need to have regard to the costs of providing fixed‑to‑mobile calls. Vodafone had fixed on 5 cpm as the cost of fixed origination and transmission but that figure had not been verified and was challenged, in particular by Telstra and Optus;
·it was not reasonable because pass through could occur in a number of ways, such as in the quality of the service provided, but the Safeguard only operated in one way, by reducing the amount of the retail price;
·pass through of the MTAS price reduction would be more appropriately achieved by instituting price controls at the downstream level applied to a broad‑based basket of services such as all the services supplied in the retail fixed line services market.
·the Safeguard operated so as to give the rebate to Vodafone and not to access seekers or end‑users. It did not appear that the rebate would be passed on to end‑users which would not be in the long‑term interests of end‑users. This consequence did not fit in with any of the matters specified in s 152AH and the objectives set out in s 152AB. Vodafone contended that it provided an incentive to access seekers to pass through a price reduction to end users;
·the reductions in fixed‑to‑mobile retail prices required by the Safeguard were disproportionate to the reductions in the VMTAS price that Vodafone undertook to make. The Pass Through Safeguard required year‑on‑year reductions in fixed‑to‑mobile retail prices of 15%, 18% and 21% as compared to the year‑on‑year reductions Vodafone undertakes to apply to the MTAS price of 7.7%, 8.3% and 9.1%;
·the transit traffic provisions were unreasonable because:
o they extended the Pass Through Obligation not only to the access seeker but also to any other carriage service provider who used the access seeker’s carriage services and had fixed line calls terminated on Vodafone’s network;
o they required the access seeker to ensure and certify each transit provider’s compliance with the Pass Through Obligation and required the disputes regarding a transit provider’s compliance with the Pass Through Obligation to be resolved in the manner specified in the undertaking;
o the access seeker would, in effect, be forced to renegotiate existing supply arrangements with transit providers (which may or may not be possible) or else to cease to terminate transit traffic on Vodafone’s network;
o if only one transit provider did not comply with the Pass Through Obligation or the access seeker could not ensure the compliance of transit providers, the access seeker must not send any transit traffic to Vodafone for termination;
·there were difficulties in implementing the Safeguard having regard to the definitions and scope of the expressions “average retail price”, “validity period” and “earlier usage period”;
·the implementation of the obligation was practically unworkable and unreasonable for a number of reasons;
·prima facie it contravened ss 45A and 46 of the Act; and
·price regulation in respect of retail telecommunications services is not properly the function of an undertaking which relates to the terms on which an access seeker supplies a wholesale service.
Vodafone submitted that the Pass Through Safeguard was reasonable as the market in which fixed‑to‑mobile services are provided is not effectively competitive. Vodafone’s argument was that if suppliers of fixed‑to‑mobile services were charged prices for the VMTAS that were less than the prices set out in the undertaking, then it was unlikely that the savings from these reduced charges would be passed on in full, or at all, to customers acquiring fixed‑to‑mobile services as a result of the absence of competition in the market in which fixed‑to‑mobile services were provided.
Vodafone contended that suppliers had both the ability and the incentive not to pass through to end‑users any reduction in the VMTAS. Vodafone said that if providers of fixed‑to‑mobile services were unlikely to pass through price reductions then a reduction in the price of the VMTAS would not increase investment in infrastructure or increase quality of services. Vodafone submitted that without the Pass Through Safeguard the evidence suggested that end‑users in the fixed‑to‑mobile market would hardly benefit at all from regulated reductions in the VMTAS price.
Vodafone maintained that in the absence of the Pass Through Safeguard the reduction in the VMTAS price would simply result in a wealth transfer from Vodafone to fixed‑to‑mobile service providers, which was likely to have negative impacts on competition in the market for telephony services. Vodafone contended that in the absence of a pass through mechanism, a reduction in the price of the MTAS would inhibit Vodafone’s ability to compete in the provision of retail services to which the MTAS was an input.
The Commission submitted that if the undertaking were accepted, the Pass Through Safeguard would deprive access seekers of the flexibility to determine competitively the form in which the reductions in the VMTAS would be passed through to the retail fixed services market. It submitted that this would retard allocative and dynamic efficiency, would not be in the long‑term interests of end‑users and was therefore not reasonable. The Commission submitted that Vodafone’s contention that in the absence of the Pass Through Safeguard a reduction in the VMTAS would result in a wealth transfer from Vodafone to fixed‑to‑mobile service providers, failed to take into account the fact that a reduction in the price of the VMTAS would promote competition in the retail fixed services market and reduce prices paid by end‑users of fixed‑to‑mobile services and other fixed line services, thereby increasing demand for fixed‑to‑mobile services and consequently for the VMTAS. This was likely to increase the total number of termination minutes on mobile networks which might increase the total revenue Vodafone received from the supplier of the VMTAS.
AAPT challenged the manner in which the Pass Through Safeguard was implemented. It drew attention to the following issues:
·Vodafone’s formula does not permit a supplier of fixed‑to‑mobile calls to make any revenue from fixed‑to‑mobile calls above the actual costs of supply, at least with respect to calls to Vodafone customers. If this formula was replicated in all agreements between access seekers and the four MTAS providers, this would have a significant effect on the ability of access seekers to recover common costs incurred in supplying fixed line services and achieve a return from the supply of fixed‑to‑mobile calls. This would not be in the long‑term interests of end‑users; and
·the pass through requirement allowed Vodafone to make profits above its own estimate of its costs of supplying the MTAS and penalised access seekers who chose to use reductions in the wholesale price of the MTAS to compete in other ways such as an increase in the quality of services provided or reductions in the price of other services provided in the bundle of preselected fixed line services.
Hutchison agreed in principle that a pass through mechanism was necessary given that the fixed‑to‑mobile market was not effectively competitive but submitted that the particular Pass Through Safeguard proposed by Vodafone was unreasonable. It was unclear to Hutchison what the proposed fixed‑to‑mobile retail rates were benchmarked against.
Telstra contended that the Pass Through Safeguard was unreasonable because it provided for Vodafone to receive a revenue windfall unrelated to the direct costs of supplying the VMTAS which might result in access seekers being charged an amount for the supply of the VMTAS as high as 21 cpm for all conversations terminated on Vodafone’s network during the given validity period.
As to the first challenge to the Pass Through Safeguard summarised in par [264] above, we do not accept that the inclusion of the Pass Through Safeguard raises any issue of the invalidity of the undertaking or deprives the undertaking of the character of an “ordinary access undertaking” as defined in s 152BS(1) of the Act. Vodafone is entitled, and indeed required, by s 152BS(1) to set out in the undertaking that it will comply with the terms and conditions “specified in the undertaking” in relation to the applicable standard access obligations. Those obligations are found in s 152AR(3) and include the obligation “to supply an active declared service …”: s 152AR(3)(a). It follows that it is entitled to set out in the undertaking the manner in which it will supply that service, including any terms and conditions of supply. That will include, for example, the price at which it will supply the service although one does not find any reference in s 152BS(1) or s 152AR(3) to the carrier or access provider being obliged or entitled to specify in the undertaking the price at which it will supply the service. Nevertheless, the price is a term and condition “specified in the undertaking” in relation to the standard access obligation in s 152AR(3)(a). It is one of the terms in the undertaking which relates to its obligation to supply the service.
So are the Pass Through Safeguard provisions. Vodafone is stating in the undertaking that it will supply the service for the price specified and also on the basis that the access seeker will comply with and carry out the Pass Through Obligation. It is not a term on which Vodafone or any other carrier will supply a downstream retail service but rather a term on which it will supply the service specified in the undertaking in respect of which there will be consequences if the access seeker supplies a downstream retail service in a particular way.
The words “in relation to” in s 152BS(1) extend to, and cover, the terms and conditions in the undertaking, with which Vodafone states in the undertaking it will comply, which form the basis on which it will supply the specified active declared service. It is undertaking to supply that service on condition that, inter alia, access seekers pay the specified price and observe the provisions relating to the Pass Through Safeguard.
As part of its attack on the validity of the Pass Through Safeguard, Telstra submitted that it was inconsistent with a Ministerial price control determination which applied to a number of Telstra’s services. Pursuant to s 154 of the Telecommunications (Consumer Protection and Service Standards) Act 1999 (Cth) (“the TCPSS Act”) the Minister may determine that specified “carrier charges” are subject to price control arrangements. Section 155(1) of the TCPSS Act provides that where a carrier charge is subject to price control arrangements, the Minister may determine:
(a)price‑cap arrangements and other price control arrangements that are to be applied in relation to the charge; or
(b) principles in accordance with which Telstra is to make alterations to the charge;
or both.
Telstra is obliged to comply with such a determination.The relevant applicable price control determination for the purposes of this review is the Telstra Carrier Charges – Price Control Arrangements, Notification and Disallowance Determination No. 1 of 2005 as amended. Clause 11 of that Determination provides that for the purposes of s 154(1) of the TCPSS Act carrier charges for connections, line rentals, local calls, trunk calls and international calls are subject to price control arrangements. Trunk calls include fixed‑to‑mobile calls. This basket of services is subject to a price cap. The effect of the Determination is that the charge for services in this basket as a group must not increase in nominal terms.
We do not consider that the Pass Through Safeguard is inconsistent with, or contrary to, the provisions of this Determination. The provisions of the Determination may be relevant to the reasonableness of the Pass Through Safeguard but they do not result in such an inconsistency with the Determination that it has the consequence that the undertaking is invalid. The Determination puts a price cap on the increase in the price of a basket of services which includes fixed‑to‑mobile calls whereas the Pass Through Safeguard provides that if an MNO’s fixed‑to‑mobile charges exceed a specified charge then Vodafone is to receive a rebate from the MNO in respect of the fixed‑to‑mobile calls so made. The Pass Through Safeguard does not contain any provision which conflicts with the price cap imposed by the Determination. In such circumstances, it is not inconsistent with it.
The Pass Through Safeguard provisions raise no issue as to the validity of the undertaking or its proper characterisation as an “ordinary access undertaking” but they do raise issues as to their reasonableness having regard to the matters specified in s 152AH and the objectives set out in s 152AB.
Vodafone calculated the end fixed‑to‑mobile target average retail price of 21.15 cpm by adding an estimate of 5 cpm for fixed‑to‑mobile origination, transmission and retailing costs to its VMTAS end price of 16.15 cpm. Although Vodafone adopted the 5 cpm estimate from a figure provided in the Commission’s MTAS final decision, there was no material before us, it was submitted, by which we could independently be satisfied of the reasonableness of the 5 cpm estimate. It was submitted that we would need to have some evidence as to the costs of fixed‑to‑mobile origination, transmission and retailing, as well as termination, before we could accept an undertaking dealing with the price of fixed‑to‑mobile calls.
In its submissions to the Commission (23 March 2005) which accompanied the undertaking, Vodafone adopted 5 cpm as it was “the Commission’s conservative estimate of the cost of fixed origination and transmission”. Telstra’s submissions to the Commission in August 2005 on the Pass Through Safeguard did not challenge directly the figure of 5 cpm, but it did raise the issue whether common costs of fixed‑to‑mobile services (which were supplied jointly with other PSTN services) would be efficiently recovered in the manner implied by the 5 cpm figure. Telstra also contended that the figure of 5 cpm appeared to be based on an equi‑proportionate approach to the allocation of common costs which did not allow cost recovery from consumers in a way that minimised the welfare distortions of marginal cost pricing. In its submission in January 2006 in response to the Commission’s draft decision, Telstra made no specific submission in relation to the figure of 5 cpm although it referred back to its August submission and maintained its submission that the Pass Through Safeguard was not reasonable.
Vodafone submitted before us that having regard to “Telstra’s silence before the Commission on this issue” we should give little weight to the submission that there was no material before us by reference to which we could be satisfied that the estimate of 5 cpm was reasonable.
There are a number of difficulties with this submission. Whatever stance Telstra may have taken earlier on the issue, Optus challenged the 5 cpm estimate before us. Optus submitted that Vodafone needed to put material before the Commission, which would be available before us, to satisfy us that the proposed target price was a reasonable price having regard to the price of the VMTAS and the costs of any relevant fixed service operators. Optus submitted that we could not be so satisfied.
The only material relating to the figure of 5 cpm was the observation of the Commission in its June 2004 Mobile Services Review of the MTAS. The Commission considered that evidence collected by it showed that the average price of fixed‑to‑mobile calls appeared to be at least double their underlying cost of production. The Commission considered that while the average price of fixed‑to‑mobile calls was around 38.5 cpm, the average underlying cost was likely to be in the order of 10 cpm to 17 cpm, depending on assumptions regarding the cost of the MTAS. That figure was based on a range of estimates of TSLRIC+ of providing the MTAS in the range of roughly 5 cpm to 12 cpm. The Commission then noted:
“… this range is consistent with estimates of the TSLRIC+ of providing the MTAS based on data collected by the Commission as part of its Regulatory Accounting framework (RAF). In addition to this, the Commission has conservatively estimated that the TSLRIC+ of providing the other elements of a FTM call are likely to be in the order of 5 cents per minute.”
The Commission did not explain how the figure of 5 cpm was derived or broken down and there is no material before us from which we can determine whether that figure of 5 cpm (for fixed origination and transmission) is reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB.
Notwithstanding Vodafone’s submissions, we are still required to be satisfied that the Pass Through Safeguard provisions are reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB. That, in turn, requires us to be satisfied that the target average retail prices specified in Table 2 of cl 3 in the Pass Through Safeguard provisions (extracted at par [17] above), particularly 21.15 cpm for the validity periods after 1 January 2007, are reasonable in the same sense. A critical component in the structure of that price is the 5 cpm figure. We have no material before us which might satisfy us that 5 cpm is a reasonable figure in the sense to which we have referred for the fixed origination and transmission costs of a fixed services operator. We have been told that it is the Commission’s “conservative estimate” but we have no basis on which to assess or determine whether it represents efficient costs. Further, that estimate was given in the Commission’s Mobile Services Review in June 2004 and we have no material before us as to the relevance or applicability of that estimate for the validity period 1 January 2007 to 30 June 2007 or any subsequent validity periods.
We are unable, therefore, to be satisfied that Vodafone’s target average retail price of 21.5 cpm for the validity periods after 1 January 2007 is reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB.
It may well be, as the Commission submitted, that the Pass Through Safeguard is not necessary as pass through might occur in a number of other ways. However, we do not consider that the Pass Through Safeguard is unreasonable because it has a potential consequence or effect on the level of prices in the fixed‑to‑mobile market. Although the Safeguard operates so as to give the rebate to Vodafone and not to its access seekers or end‑users, it operates as an incentive for access seekers who supply fixed‑to‑mobile services not to keep or raise their level of fixed‑to‑mobile service charges above the level specified in the undertaking.
We have more concerns about the operation of the transit traffic provisions of the Pass Through Safeguard. The provision with which we have the most concern is the provision found in cl 7.4 (extracted at par [19] above) which provides that if the access seeker cannot or does not comply with cl 7 then it must not send any transit traffic – that is not just the traffic of the defaulting transit carriage service provider but the traffic from all transit carriage service providers – to Vodafone for termination. This may not have been Vodafone’s intention but it is the manner in which the provision operates. It is not for us to re‑write the provision. We cannot see how such a provision is in the long‑term interests of end‑users of carriage services or of services supplied by means of carriage services, some of whom would be denied access to their mobile service due to no default on the part of themselves or their access provider. It has a consequence of penalising them in circumstances where neither they, nor their access provider, is in default. We consider that this provision is not reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB. We do not consider that it is in the legitimate business interests of Vodafone and it is most certainly not in the interests of access seekers to the VMTAS. Further, it certainly is not likely to result in the achievement of the objective of promoting competition in markets for listed services, as referred to in s 152AB(2)(c) and, indeed, in its terms, would defeat that objective.
We are also concerned that the Pass Through Safeguard is inflexible in relation to the opportunity for competition to be promoted as a result of any reduction in the price of the VMTAS. It limits the opportunity of access seekers to determine the form in which any reductions they may receive in the supply of the VMTAS may be passed through to the retail fixed services market.
We consider that the pass through provisions in the undertaking deprive access seekers of the flexibility to determine competitively the individual price elements for services within the basket of services that are supplied within the fixed‑to‑mobile market, and the form in which pass through will take place. This approach retards allocative and dynamic efficiency, inhibits competition, is not in the long‑term interests of end‑users and, in our view, is not reasonable.
We are also concerned about the difficulties identified in implementing the Safeguard having regard to the definitions and scope of “validity periods” and “earliest prior validity period” (cl 6.2(b)). If we were to accept the undertaking now, then it would only operate prospectively from the validity period commencing 1 January 2007. That gives rise to issues as to what is the relevant “earliest prior validity period”. Overall, we are not satisfied that the Pass Through Obligation can be implemented in a manner which is clearly and precisely laid out for access seekers. In such circumstances, we do not consider that the implementation of the Pass Through Obligation is reasonable having regard to the interests of access seekers.
Telstra submitted that the implementation of the Pass Through Obligation was practically unworkable and unreasonable for the following reasons:
·it was not commercially acceptable from a corporate governance standpoint for a director to be required to certify all the matters required by the undertaking, including in respect of third parties;
·access seekers would be forced to spend considerable time and resources on compliance and monitoring tasks, thereby reducing their ability to focus on operational efficiencies and improving the quality of service to end‑users;
·the incorporation of a subjective standard to trigger the dispute process was inappropriate; and
·the expert determination process was likely to involve the divulging of the confidential and commercially sensitive information of the access seeker to Vodafone.
We have insufficient material before us to enable us to determine whether Telstra’s submission in this respect is well‑founded. Having regard to our conclusions on other provisions of the Pass Through Safeguard, it is not necessary for us to reach a concluded view on this submission.
Telstra submitted that the inclusion of the Pass Through Obligation resulted in the undertaking being inconsistent with the applicable standard access obligations because:
·the Pass Through Obligation, which makes Vodafone’s compliance with the standard access obligations contingent on the price which access seekers charge for retail services, is inconsistent with Vodafone’s obligation to supply the MTAS on request under s 152AR(3)(a); and
·the prohibition on transit traffic in cl 7.4 of Pt C of the Service Schedule to the Access Agreement is inconsistent with Vodafone’s obligation to supply the MTAS on request pursuant to s 152AR(3)(a).
These issues do not give rise to inconsistencies with Vodafone’s obligations to comply with the standard access obligations; rather they are relevant to the issue of the reasonableness of the Pass Through Safeguard in respect of which we have made other findings and reached other conclusions.
We have not dealt with all the issues and submissions raised and made in relation to the Pass Through Safeguard as we are not satisfied, having regard to the matters specified in s 152AH and the objectives set out in s 152AB, that the provisions of the Pass Through Safeguard to which we have referred, are reasonable for the particular reasons to which we have referred.
Our conclusion that we are unable to be satisfied, having regard to the matters specified in s 152AH and the objectives set out in s 152AB, that the provisions of the Pass Through Safeguard are reasonable has the consequence that we are unable to be so satisfied as to the undertaking as a whole. The Pass Through Safeguard provisions are an integral and material part of the undertaking. It is not open to us to excise the Pass Through Safeguard provisions from the undertaking and otherwise accept it. It is only open to us either to affirm the Commission’s decision or to set that decision aside and accept the undertaking.
Clause 19.8 of the Agreement in Attachment A of the undertaking contains a severance provision in the following terms:
“(a)Subject to paragraph (b), if the whole or any part of a provision of this Agreement is unenforceable, partly unenforceable, void or illegal in a jurisdiction, then it is severed to the extent necessary to make this Agreement enforceable in that jurisdiction.
(b)This clause 19.8 does not apply if the severance materially changes the intended effect of this Agreement, alters its basic nature, is contrary to public policy or the Telecommunications Laws.”
That provision provides no basis for us to exclude or excise the Pass Through Safeguard from the Agreement, and thereby from the undertaking. Severing the Pass Through Obligation from the Agreement would materially change the intended effect of the Agreement and alter its basic nature.
In the light of our findings and conclusions in relation to the efficiency of Vodafone’s costs, what have been described as the empirical flaws in the PwC models and certain provisions in the Pass Through Safeguard, it is not necessary to reach any conclusions in relation to the reasonableness of a number of other non‑price terms and conditions in the undertaking which were the subject of submissions.
17. CONCLUSION
For the reasons set out earlier, we are not satisfied that:
·Vodafone’s costs were efficiently incurred;
·the costs produced by either of the PwC models generate a total cost of providing the VMTAS of 16.15 cpm;
·Vodafone’s price term of 16.15 cpm for the period 1 January 2007 to 30 June 2007 and for any subsequent validity periods does no more than cover Vodafone’s long‑run incremental costs of supplying its VMTAS.
Those consequences lead us to the conclusion that we are not satisfied that Vodafone’s price term of 16.15 cpm for the period 1 January 2007 to 30 June 2007, and for any subsequent validity period, is reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB. Nor are we satisfied that the particular provisions of the Pass Through Safeguard to which we have referred are reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB. The end result is that we are not satisfied that the undertaking is reasonable having regard to the matters specified in s 152AH and the objectives set out in s 152AB.
The result is that the decision of the Commission rejecting Vodafone’s access undertaking will be affirmed.
I certify that the preceding three hundred (300) numbered paragraphs are a true copy of the Reasons for Decision herein of the Honourable Justice Goldberg, Mr R Davey and Mr R Shogren. Associate:
Dated: 11 January 2007
Counsel for Vodafone Network Pty Limited & Vodafone Australia Limited: N Hutley QC with R Beech‑Jones Solicitor for Vodafone Network Pty Limited & Vodafone Australia Limited: Gilbert + Tobin Counsel for the Australian Competition and Consumer Commission: J Beach QC with M Borsky Solicitor for the Australian Competition and Consumer Commission: Corrs Chambers Westgarth Counsel for Telstra Corporation Limited: Dr J Griffith S.C. Solicitor for Telstra Corporation Limited: Mallesons Stephen Jaques Counsel for the Optus Mobile Pty Limited and Optus Networks Pty Limited: T Bannon S.C. with S Balafoutis Solicitor for the Optus Mobile Pty Limited and Optus Networks Pty Limited: Gilbert + Tobin Counsel for Hutchison 3G Australia Pty Limited and Hutchison Telecommunications (Australia) Ltd:
N Murray Solicitor for Hutchison 3G Australia Pty Limited and Hutchison Telecommunications (Australia) Ltd: Allens Arthur Robinson Counsel for AAPT Limited: J Arnott Solicitors for AAPT Limited: Allens Arthur Robinson Date of Hearing: 31 August, 1, 4, 5 and 11 September 2006 Date of Judgment: 11 January 2007 GLOSSARY AND ABBREVIATIONS
AICC assets in the course of construction
capex capital expenditure
cpm cents per minute
EPMU equi‑proportionate mark‑up
F&F furniture and fittings
GPRS General Packet Radio Service
GRC gross replacement cost
GSM Global system for mobiles
MNO mobile network operator
MTAS
mobile terminating access service Ofcom Office of Communications, the United Kingdom telecommunications regulator
opex operating expenditure
PSTN public switched telecommunications network
SMS Short Messaging Service
TSLRIC
Total service long‑run incremental cost TSLRIC +
Total service long‑run incremental cost plus a mark‑up to enable a recovery of organisation‑level common costs, estimated according to the EPMU rule
VMTAS Vodafone’s domestic digital mobile terminating access service on its 2G/2.5G GSM network
WACC Weighted Average Cost of Capital
3
0