A tale of two airports: part two

In part one I conjectured that Amy Adams’ analogy of the UFB being an airport terminal was either a poor analogy or signalled a significant change of policy direction.

The hope is that it’s just a poor analogy but here I expand on the thought that if it is a significant change of policy then the implications are massive.

First – what is the policy change that might or might not be taking place?

Most, if not all of us, believe that the fundamental policy choice made by the Government back in 2008 was that the UFB fibre network would compete with the existing copper network (in the airport analogy this is building a new airport to compete with the old airport).

This policy was in stark contrast to the alternative where the new fibre network would replace the copper network (in the analogy this is upgrading the old airport with a new terminal, etc.).

There is a lot of evidence to confirm this was the policy, not least:

• Statements by Ministers and documents referring to the price of copper broadband services acting as a competitive constraint on the price of fibre services;
• The choice of TSLRIC - a pricing principle that is applicable to on-going copper services but is not applicable where fibre is replacing copper.
• The relatively minor addition to the purpose statement of the Telco Act asking the Commission to consider the innovation and investment incentives of new technologies but not changing the underlying purpose of the Act which is to promote competition.
• The UFB contracts between CFH and Chorus/LFCs which set the price of future fibre services without any reference to the future regulatory price of copper services;
• Chorus - which has most to gain from a replacement policy – is required to leave the copper service in place when it installs fibre.

In contrast, if the underlying policy was that fibre would replace copper we would have seen an entirely different implementation process similar to Australia’s with Government ownership of the resulting fibre network, compensation paid to the operator of the copper network and compulsory switching of customers onto the new network – and a bill to the taxpayer in proportion to the $40 billion+ Australian bill.

Taking as read the original policy intent the next question would be what reasons the Government might have for changing this policy? The most obvious reason would be that they were concerned that it was no longer going to meet its objectives. The Government essentially had two objectives: one was deployment of the fibre to 75% of New Zealand, the other, much vaguer, was a broader economic growth objective which was reliant upon customers actually taking up the fibre service and using it.

By all accounts the deployment objective is, if anything, ahead of expectations. The Government has cast iron contracts in place with penalty clauses relating to the deployment schedules and costs, so there is little doubt that this objective will be met.

The take-up objective clearly could not be mitigated by contracts or penalty clauses; the risks are the political risks that the Government’s initiative won’t pay off. Nevertheless, all the indications from Telecom and others is that take up of fibre, albeit low, is around expectations and those indications have been echoed by Amy Adams. While potential lack of take-up may be a concern it is hardly a major concern at this early stage, at least not for the Government - and it’s certainly not of a magnitude that would suggest a need to change the underlying policy.

The Government should have little reason to think that its objectives are not going to be met.

The other party that does have a concern is Chorus. It has signed up to a demanding contract with a demanding customer – the Government. There are strong indications that its estimates of the cost of deployment were too low i.e. it is costing Chorus more to deploy the fibre infrastructure than it initially estimated – perhaps a lot more.

Put into the Airport analogy the Government and Chorus went into a PPP to build a new airport. They negotiated a contract and as far as everyone is concerned the Government has kept its side of the contract. To-date Chorus has also kept its side of the contract; the new airport is coming along as planned. The only fly in the ointment may be that its costing Chorus more than envisaged.

Many of us would say that is a commercial risk that Chorus took with its eyes wide open - that’s business.

So why all this talk of a new terminal at the old airport – what has that got to do with the new airport? Most of us would say absolutely nothing – because after all, the matter to hand is the building of the new airport, not the state of the old one.

If the new airport is costing Chorus more than it estimated it has got a number of options.

• It could borrow more to cover the additional costs;
• It could cut its costs;
• It could renegotiate its contract with the Government (but why would the Government do that?);
• It can cross subsidise the build of the new airport with profits from the old airport (but the independent regulator effectively controls those profits and is proposing to reduce them); or
• It can combine these last two options and claim that what everyone else believes to be two separate projects (maintain copper, build fibre) is actually one big single project (replace copper with fibre).

To achieve the last option would require the Government to change its policy direction of having a competing fibre network to one of having a replacement fibre network. That in turn would mean the Government would have to change the legislated regulatory settings to stop the Commerce Commission from cutting Chorus’ copper revenue (the consequence of basing copper prices on cost, as required by the law today) but it would mean a lot, lot more as well.

• Chorus would get additional revenue from the customers of the old network (= Chorus happy, customers unhappy).
• The negotiated fixed price for the new fibre services would have to change as there would be no fibre service per se - there would be an interim hybrid copper/fibre service for at least 8 years.
• As the hybrid copper/fibre service would be a monopoly, the Commerce Commission would have to regulate it based upon a yet to be determined pricing principle – or, worse, prevented by legislation from regulating it.
• The interim hybrid copper/fibre service planned to cover 75% of the country would be paid for by 100% of the country (= very unhappy 25% rural customers, who would be paying for something they would not get).
• There would be a large number of customers who are happy with their existing copper broadband service and the expectation that its price will fall. They would have to pay the same higher price as fibre users but not get the better service (= unhappy customers).
• Contracts with LFCs other than Chorus would have to be renegotiated - if that is possible (= happy LFCs if they end up with a monopoly, or unhappy LFCs if they don’t - but in either case = unhappy consumers).

All of this would represent a fundamental shakeup and a great deal of work for the industry and the government – when the case for the need for it is not clear. All of these implications and others beside come back to whether or not the Government is changing its policy from one of having fibre competing with copper to having fibre replacing copper.

I hope that I’m interpreting Amy Adams’ analogy incorrectly. I hope that the Government intends no fundamental change of policy.

With that thought in mind the clearest signal that the Government can give to concerned consumers and investors is that the proposed review of the regulatory environment will not move away from the policy of copper and fibre broadband services being entirely separate and competing with each other.

The discussion document being published later this month should unequivocally start from a position of confirming the Government’s current objectives and policy position and explaining whether those objectives and policies have been successful and what evidence there is to suggest they might not continue to be successful.

That needs to be followed with a clear description of any new objectives and proposed policies to deliver those objectives.

Finally there needs to be an evaluation of the possible options (including the status quo option) and how those options will deliver on any new objectives.

Reg Hammond is a policy consultant for InternetNZ and a former manager of the ICT Regulatory Group for the Ministry of Economic Development (now part of MBIE).