Submission by the Commissioner of Competition Before the Canadian Radio-television and Telecommunications Commission — Telecom Notice of Consultation CRTC 2014-76 — Review of wholesale mobile wireless services

May 15, 2014

I. Introduction

  1. The Competition Bureau (the "Bureau") is an independent law enforcement agency which ensures that Canadian businesses and consumers prosper in a competitive and innovative marketplace. Headed by the Commissioner of Competition (the "Commissioner"), the Bureau is responsible for administering and enforcing the Competition Act,Footnote 1 which applies to virtually all sectors of the Canadian economy, including the telecommunications sector.Footnote 2 The purpose of the Competition Act is to maintain and encourage competition in Canada to, among other things, promote the efficiency and adaptability of the Canadian economy and provide consumers with competitive prices and product choices.Footnote 3
  2. On February 20, 2014, the Canadian Radio‑television and Telecommunications Commission (the "CRTC") initiated a proceeding to determine whether wholesale mobile wireless services markets are sufficiently competitive now and will be sufficiently competitive in the future.
  3. Pursuant to section 125 of the Competition Act,Footnote 4 the Commissioner wishes to intervene in this proceeding and is pleased to provide this submission by the Bureau in response to Telecom Notice of Consultation 2014‑76.

II. The Appropriate Methodology

  1. This proceeding affords the CRTC an opportunity to increase the economic efficiency of the Canadian economy. Specifically, by taking steps to increase competition in wholesale mobile wireless services markets, the CRTC can improve consumer welfare by enhancing the affordability and variety of retail mobile wireless services. The Bureau submits that the CRTC should seize this opportunity because doing so is consistent with the Canadian telecommunications policy objectives in section 7 of the Telecommunications ActFootnote 5 and in the Order Issuing a Direction to the CRTC on Implementing the Canadian Telecommunications Policy Objectives.Footnote 6
  2. An examination of economic efficiency and consumer welfare should begin with an assessment of whether market forces are sufficient to incent competitive prices in wholesale mobile wireless services markets and thereby enhance the affordability and variety of retail mobile wireless services in Canada.
  3. When spectrum access is limited and network costs are high, there may be low incentives for incumbent mobile wireless carriers ("incumbents") to offer competitive terms for wholesale mobile wireless arrangements (such as roaming agreements, tower sharing arrangements and network sharing arrangements) to rival retail carriers. This artificially and unnecessarily limits the ability of new mobile wireless carriers ("new entrants") to offer competitive choices to retail consumers and apply competitive pressure to incumbents.
  4. The internationally recognized concept for assessing whether market forces are sufficient to ensure competitive prices and overall efficiency is market power. Market power is the ability of a single firm or a group of firms to profitablyFootnote 7 maintain prices above the competitive level, or other elements of competition such as quality, choice, service or innovation below the competitive level, for a significant amount of time.Footnote 8 The CRTC has endorsed this approach and in Telecom Decision CRTC 94‑19 highlighted "a general consensus that the concept of ‘market power’, commonly used in competition law, should be the standard by which to determine whether a market is competitive"Footnote 9 in telecommunications proceedings.
  5. As discussed in more detail below, the incumbents may have the ability and incentive to profitably raise the rates they charge new entrants for wholesale roaming services, and potentially other wholesale arrangements, above competitive levels because:
    1. they are competing for the same retail customers and benefit when their rivals face higher costs due to higher roaming charges;
    2. some retail customers that are served by an incumbent’s wholesale customers may be switching to that incumbent as it increases its roaming charges to its wholesale customers, and
    3. the incumbents earn a margin on these recaptured customers that reflects their retail market power.
  6. This is not in the public interest for two reasons. First, not all retail customers who depart from carriers that depend on wholesale arrangements continue to participate in retail mobile wireless services markets. Some drop service altogether due to affordability. This is a "deadweight loss" for the Canadian economy — a loss of economic efficiency due to available resources not being allocated to their most valuable use. Second, in the medium‑term, as retail customers depart the carrier that depends on wholesale arrangements, this competitor may retrench or disappear, thereby depriving retail consumers of both a competitive alternative and, potentially, increased product choice and quality.

Application of the Market Power Concept to Mobile Wireless Services Markets

  1. In assessing the competitiveness of wholesale mobile wireless services markets, it is important to consider the competitiveness of retail mobile wireless services markets in Canada. This is because the sellers of wholesale mobile wireless services also compete with their wholesale customers to sell retail mobile wireless services to consumers. That is, the suppliers of wholesale mobile wireless services are typically vertically integrated into the provision of retail mobile wireless services. In this context, the prospect for anti‑competitive behavior in wholesale mobile wireless services markets is affected by the competitiveness of retail mobile wireless services markets, including any supra‑competitive margins earned by the incumbents at the retail level through the exercise of their market power at the wholesale level.
  2. A seller of wholesale services that is considering raising its wholesale prices or making other changes to its wholesale business will consider the impact of those changes on its entire business — both wholesale and retail. Raising its wholesale price may have several effects on a wholesaler. For example, a wholesaler may:
    • lose wholesale revenue because some of its wholesale customers switch to a competing wholesaler;
    • lose wholesale revenue because its wholesale customers raise their retail prices to pass on some or all of the wholesale price increase to consumers and, consequently, some of those consumers either switch to the retail services of other retailers or leave the market altogether;
    • gain wholesale revenue because its remaining wholesale customers pay more to the wholesaler; or
    • gain retail revenue because its wholesale customers raise their retail prices to pass on some or all of the wholesale price increase to consumers and, consequently, some of those consumers switch to the wholesaler’s retail services.
  1. To assess the incumbents’ ability and incentive to profitably raise the rates they charge new entrants for wholesale roaming services, and potentially other wholesale arrangements, above competitive levels, the CRTC should consider:
    • whether the incumbents’ wholesale customers are likely to switch to a competing wholesaler;
    • whether the incumbents’ wholesale customers are likely to pass on a wholesale price increase to consumers;
    • whether consumers are likely to leave the market altogether or switch to other suppliers, including the incumbents’ retail offerings; and
    • the margins the incumbents earn from their retail offerings.
  1. In order to assess the relative importance of each of these effects, and therefore assess whether a wholesale price increase (or other wholesale service change) is profitable, it is important to understand the characteristics and dynamics of wholesale mobile wireless services markets and retail mobile wireless services markets.
  2. The CRTC should consider both direct and indirect indicators when assessing market power. This will allow the CRTC to take into account all available evidence on the competitive dynamics in the relevant markets. The Bureau adopts this analytical framework in the Abuse of Dominance Guidelines and the MEGs. As noted above, the CRTC has endorsed this analytical framework in several of its decisions, including CRTC 94‑19.

III. Market Power in Retail Mobile Wireless Services Markets

  1. In his submissions in Telecom Notice of Consultation CRTC 2013‑685 (the "Roaming Proceeding"), the Commissioner stated that a recent study by Jeffrey Church and Andrew Wilkins (the "C‑W Report") did not provide adequate support for the incumbents’ claims that retail mobile wireless services markets in Canada are competitive.Footnote 10
  2. The Commissioner identified various deficiencies in the C‑W ReportFootnote 11. As noted in the Commissioner’s intervention, the profitability analysis that forms the centerpiece of the C‑W Report examines only one service provider, does not measure that service provider’s cost of capital and, properly interpreted, does not support the C‑W Report’s conclusions.
  3. The Commissioner also identified additional deficiencies in the authors’ submissions. The deficiencies identified by the Commissioner focused on the inadequacy of the C‑W Report’s international comparisons and the authors’ examination of the efficiency of an additional entrant.
  4. Having regard to the deficiencies in the C‑W Report, the Commissioner has chosen to commission and file in this proceeding an expert report that examines the competitiveness of Canadian mobile wireless services markets. That report, prepared by Doctors James D. Reitzes, Kevin Hearle, Giulia McHenry, Jeremy Verlinda and Coleman Bazelon of the Brattle Group (the "Brattle Report"), is filed together with the Commissioner’s intervention.
  5. In summary, the Brattle Report found:
    • Canadian mobile wireless industry metrics suggest that additional competition would benefit consumers. Canadian mobile wireless carriers are highly concentrated, especially at the province‑level. At a national level, cross‑country comparisons, particularly with the United States, suggest the Canadian mobile wireless services sector is underperforming in several respects.
    • TELUS’ and Rogers Communications’ ("Rogers") wireless businesses are generally earning above‑normal returns on their investments, consistent with the exercise of market power. Pre‑tax returns for TELUS’ wireless business range from 11.6% to 16.8% through 2018 (versus pre‑tax cost of capital of 12.2%) and from 13.8% to 17.9% through 2030 (versus pre‑tax cost of capital of 11.5%). After‑tax returns for Rogers range from 11.2% through 2018 (versus post‑tax cost of capital of 8.5%) to 12.7% through 2030 (versus post‑tax cost of capital of 8.1%).
    • Analysis of stock price reactions suggests that entry by Verizon would have resulted in approximately an average 8% drop in variable profits for Bell, Rogers and TELUS, assuming there was a 50% likelihood of Verizon entry. The Brattle Report estimates that the cumulative effect of the two Verizon announcements between August and September 2013, which together clarified that Verizon would not enter the mobile wireless business in Canada, increased stock prices by 10% for Rogers, 5% for Bell Canada ("Bell") and 11% for TELUS.
    • Using these stock price effects, the Brattle Report predicts that the entry of an additional nationwide carrier would increase consumer surplus in Canada by approximately $1 billion annually, which represents 5% of industry revenues in 2012. The Brattle Report estimates that an additional nationwide carrier would expand mobile wireless penetration in Canada from 78% to 81%, and drive down the incumbents’ average retail prices by about 2%. Much of this increase in consumer surplus is driven by a modest increase in market size due to increased penetration and additional brand value associated with a new entrant.
    • Incorporating the potential loss in industry "variable profits", the Brattle Report still finds total annual surplus gains of approximately $1 billion per year. The annual loss in total industry variable profits, including incumbent losses and entrant gains, would equal approximately 0.1% of annual wireless service revenues in Canada in 2012. This analysis, however, does not consider the entrant’s investment cost to build a network, or any additional cost imposed on the incumbents if they have less access to spectrum as a result of entry by the additional nationwide carrier.
    • To understand these other costs, the Brattle Report separately estimates that the incumbents could avoid constructing a modest number of cell sites through 2017 if they were able to deploy an additional 10 MHz of spectrum, as opposed to having an additional nationwide carrier emerge. The Brattle Report estimates that Rogers could avoid constructing roughly 750 cell sites, Bell could avoid constructing approximately 350 cell sites, and TELUS could avoid constructing approximately 290 cell sites. The savings through 2017 would amount to between $80 million and $200 million for each carrier in present value terms.
  6. The findings in the Brattle Report support the Bureau’s conclusion that the incumbents have market power in retail mobile wireless services markets in Canada.

Assessing market power in retail mobile wireless services markets

  1. The appropriate framework for assessing market power is set out in the Abuse of Dominance Guidelines and the MEGs.Footnote 12 As discussed in these guidelines, market power can be measured both directly and indirectly.
  2. Direct indicators of market power include profitability and evidence of supra‑competitive pricing.
  3. Indirect indicators of market power include a variety of qualitative and quantitative factors, such as:
    • market share, including share stability and distribution;
    • barriers to entry, including the conduct of allegedly dominant firms; and
    • other market characteristics, including the pace of technological change in the market.
  1. Given the complex and dynamic nature of mobile wireless services markets, the CRTC should consider as many direct and indirect indicators of market power as possible when assessing whether to incumbents possess market power.
  2. The Bureau submits that the incumbents possess market power in retail mobile wireless services markets in Canada. The evidence put forward in the Brattle Report demonstrates that Canadian retail mobile wireless services markets are characterized by above‑normal profits and comparatively low service penetration levels, both direct indicators of market power.
  3. In addition, as the Commissioner submitted in his intervention in the Roaming Proceeding, Canadian retail mobile wireless services markets are characterized by high concentration and very high barriers to entry and expansion.
  4. High barriers to entry in Canadian retail mobile wireless services markets are due not only to the considerable costs of building out networks and acquiring necessary spectrum, but also to the incumbents’ use of product bundles and long‑term contractsFootnote 13 to raise additional barriers for new entrants looking to attract new customers.
  5. Furthermore, Canadian retail mobile wireless services markets are characterized by other factors that, when combined with high concentration and high barriers to entry and expansion, create a risk of coordinated conduct in these markets.Footnote 14
  6. The mere exercise of market power, whether unilateral or coordinated, does not by itself raise concerns under the Competition Act. However, due to the vertically‑integrated nature of Canadian mobile wireless services markets, the CRTC should take the incumbents’ retail market power into account when considering both incentives and opportunities for anti‑competitive conduct in upstream wholesale mobile wireless services markets.

IV. Incumbents Appear to be Raising Wholesale Rates for their Retail Competitors

  1. As discussed in more detail below, incumbents appear to have the ability and incentive to profitably raise the rates they charge their retail competitors for wholesale roaming services, and potentially other wholesale arrangements, above competitive levels. The incumbents’ wholesale customers may be passing these price increases on to retail customers. These retail price increases may be harming competition in retail mobile wireless services markets in Canada. In particular, more competitive markets could deliver approximately $1 billion in benefits to the Canadian economy.Footnote 15
  2. As mentioned previously, to assess the incumbents’ ability and incentive to profitably raise the rates they charge for wholesale roaming services, and potentially other wholesale arrangements, above competitive levels, the CRTC should consider:
    • whether the incumbents’ wholesale customers are likely to switch to a competing wholesaler;
    • whether the incumbents’ wholesale customers are likely to pass on a wholesale price increase to consumers;
    • whether consumers are likely to leave the market altogether or switch to other suppliers, including the incumbents’ retail offerings; and
    • the margins the incumbents earn from their retail offerings.
  1. The following paragraphs address the presence of these incentives in markets for wholesale roaming services.

Switching may be difficult for wholesale customers

  1. When determining whether wholesale customers could switch to alternative services, it is important that the CRTC consider the extent to which it is feasible for a wholesale customer or third party to duplicate an incumbent’s facilities or services. The high costs of building mobile wireless networks and acquiring sufficient spectrum on a national basis means that, in many cases, new entrants will need to reach a roaming arrangement with incumbents in order to provide national coverage for their retail customers.
  2. Across Canada, there are generally no more than two mobile wireless carriers with extensive geographic coverage in any given region. Rogers operates its proprietary nationwide network, while Bell and TELUS achieve a national network only by way of joint roaming agreements. Any carrier that did not build out its own nationwide network would need to either secure a roaming agreement with Rogers or build a piecemeal network by signing roaming agreements with multiple carriers.
  3. There may exist technical impediments that prevent carriers from using the wholesale services of certain incumbents. In its evidence filed in the Roaming Proceeding, Globalive Wireless Management Corp. ("WIND") claims that it must still rely on Rogers’ network due to the fact that many of its customers still operate legacy handsets that cannot operate on the Bell/TELUS network.

Wholesale customers may pass wholesale price increases on to retail customers

  1. When prices for wholesale services increase, wholesale customers may pass the extra costs along to their retail customers by raising their own prices. This may significantly weaken these carriers’ positions in downstream retail markets, reducing competitive pressure on the incumbents’ own retail offerings.
  2. Evidence put forward by WIND and Bragg Communications Inc. ("Eastlink") indicates that pass on may be occurring.
  3. In their evidence filed in the Roaming Proceeding, WIND and Eastlink both described the difficulties experienced by wholesale customers as a result of such price increases.
  4. WIND submitted that its domestic roaming arrangements had forced it to establish "pricing zones" where its customers pay lower rates for service in geographic areas where WIND operates its own network and higher rates in geographic areas where service is only obtainable through a roaming arrangement.
  5. Eastlink’s evidence is that when it first launched service, it also priced its services using zones, which resulted in poor customer attraction. Eastlink also indicated that it does not use the incumbents’ LTE roaming services because the price to Eastlink for data usage by customers using this technology would be greater than Eastlink could absorb, which would force it to pass the prices on to its retail customers. Although Eastlink is not currently passing its wholesale prices through to its consumers, it may do so in the future.

Consumers may be switching to other suppliers, leaving the market, or not entering the market

  1. In their submissions in the Roaming Proceeding, WIND and Eastlink indicated that using "pricing zones" has caused them to lose a substantial number of customers. WIND indicated that because it had to pass its high roaming prices on to its customers, its services were less attractive to a large segment of potential customers. As a result, its initial rate of customer acquisition slowed and WIND did not achieve reasonable scale. Eastlink had to abandon the zone approach to retain its customers, at the cost of absorbing a financial loss every time its customers travel outside of Eastlink’s home network.
  2. In addition, some potential customers may choose not to enter the retail markets at all due to unattractive prices and product offerings caused by high wholesale rates. The Brattle Report finds that Canadian mobile wireless penetration levels are lower than those enjoyed in other developed countries. By the end of 2012, Canada’s penetration rate was only 79%, which is 24% lower than the United States and even lower than those found in other developed countries, such as members of the European Union, New Zealand and Australia.
  3. The Brattle Report concludes that, relative to the United States, lower usage levels and higher per‑minute pricing in Canada suggest that increased competition could expand the subscriber base, decrease prices, and still keep mobile wireless carriers profitable. These findings provide evidence that more customers are either leaving Canadian retail mobile wireless services markets or not entering these markets at all, than would have in a fully competitive marketplace.

Incumbents may be earning supra‑competitive profits

  1. As discussed in the Brattle Report, Rogers and TELUS are generally earning above‑normal returns on their mobile wireless investments. TELUS’ internal rate of returnFootnote 16 ("IRR") through 2030 is in the range of 13.8% to 17.9%, as compared to a pre‑tax weighted‑average cost of capital of 11.5%. Similarly, Rogers enjoys an after‑tax wireless IRR through 2030 of 12.7%, as compared to an 8.1% competitive return.
  2. These above‑normal profits are consistent with these carriers exercising market power in retail markets through the use of supra‑competitive retail pricing.

Other wholesale arrangements

  1. In the Bureau’s view, the same general principles regarding incumbents’ incentives also apply to other wholesale mobile wireless services, including tower sharing services and network sharing arrangements.
  2. Although the Bureau does not have the evidence at this time to provide a detailed analysis of tower sharing services and network sharing arrangements, it may comment further on these matters depending on the evidence it obtains from other parties to this proceeding.

V. The Impact of this Conduct Appears to be Substantial

  1. According to the Brattle Report’s findings, more competitive retail mobile wireless services markets would increase consumer surplus in Canada by approximately CDN $1 billion annually, representing 5% of industry revenues in 2012. More consumers would use mobile wireless services and the incumbents’ average prices would drop by about 2%.
  2. Although the Bureau does not currently have access to the quantitative evidence to make a definitive link between these economic losses and the incumbents’ conduct in relation to wholesale mobile wireless services, the incumbents’ conduct may be causing or contributing to these important negative impacts on consumers and the overall efficiency of the Canadian economy.Footnote 17
  3. Jeffrey Church, Andrew Wilkins and others (such as Navigant EconomicsFootnote 18) assert that there is limited opportunity to further enhance competition in the Canadian wireless sector, particularly through entry of additional carriers. They also assert that certain policies proposed to enhance competition in this sector may actually harm consumers or be infeasible.
  4. The Bureau disagrees with these assertions. The Brattle Report indicates that:
    1. the Canadian wireless sector may support efficient entry by an additional carrier and
    2. such entry would entail significant gains in consumer surplus.
  5. Through an event study and a market simulation model, as well as a network build‑out model that takes into account the technological trade‑off between spectrum and cell sites, the Brattle Report provides a detailed analysis that tests these assertions. The Brattle Report concludes that:
    • Canadian financial markets predicted that entry by Verizon would have a substantial effect (a decrease of approximately 8%) on the variable profits of each of the three incumbents.
    • Prices charged by the incumbents would fall by almost 2% after entry by an additional nationwide carrier and mobile wireless penetration would increase to 81%.
    • Entry by an additional nationwide carrier could increase consumer surplus by approximately $1 billion annually.
  1. Given these findings, the CRTC has an opportunity to significantly increase the economic efficiency of the Canadian economy. Specifically, by taking steps to increase competition in wholesale mobile wireless services markets, the CRTC can improve consumer welfare by enhancing the affordability and variety of retail mobile wireless services in Canada.
  2. To achieve these significant gains, the CRTC should adopt measures to address the incentives for the incumbents to raise their retail competitors’ wholesale prices. Appropriate measures may include the introduction of competitive safeguards or mandated wholesale access, or targeted spectrum allocations towards non‑incumbent carriers in upcoming auctions, which the Bureau may address further as additional evidence develops in this proceeding.

VI. Conclusion

  1. The Bureau is pleased to respond to the CRTC’s Call for Comments. Regulation of telecommunications services, including mandated access to wholesale services, should be used only where it is the most effective means to control market power in relevant downstream retail markets. Where market forces are insufficient to prevent the abuse of market power by market participants, however, the CRTC may need to impose regulatory measures to ensure that Canadians enjoy the benefits of greater competition in wireless markets, including lower prices, higher quality service and greater innovation.

VII. Procedural Matters

  1. In accordance with section 125 of the Competition Act, the Commissioner requests that the CRTC permit the Commissioner or his designated representative to appear at the public hearing. Given the nature of the issues raised, the Commissioner’s written submissions are unlikely to address all issues that parties will address at the public hearing. The Commissioner’s presence at the public hearing will accordingly assist the CRTC in understanding the Commissioner’s submissions and the methodologies supporting them so that the CRTC can receive full benefit of the Commissioner’s specialized knowledge and expertise respecting competition.
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