CRTC review of the approach to rate setting for wholesale telecommunications services: Competition Bureau reply to interventions
November 27, 2020
On this page:
- Executive summary
- Proposals involving commercial negotiations
- Proposals involving elements of retail-minus
- Next steps: Perfecting a methodology that supports competition
- The Commissioner of Competition (Commissioner) files these comments of the Competition Bureau (Bureau) in accordance with the procedure set out in Telecom Notice of Consultation 2020-131-2, published by the Canadian Radio-television and Telecommunications Commission (CRTC) on 19 October 2020.Footnote 1 The Bureau makes these comments further to the Commissioner's mandate to act as an advocate for the benefits of a competitive marketplace.Footnote 2
II. Executive summary
- The Bureau has reviewed the interventions of other parties in this proceeding, with a view to assessing the effect that proposed rate-setting methodologies could have on competition in the Canadian telecommunications industry.
- In this submission, the Bureau discusses two of the most detailed rate-setting proposals. The first proposal, from Bell Canada (Bell), suggests that rates be set through commercial negotiations with a final offer arbitration (FOA) backstop. The other, from Shaw Communications Inc. (Shaw), suggests the use of a modified retail-minus approach for lower speed products, and commercial negotiations for higher speed products.
- These proposals, as currently specified, include some elementsFootnote 3 that could negatively affect competition. Accordingly, the Bureau cautions against establishing a new wholesale rate-setting methodology based only on the options set out in this proceeding. There is still necessary work to be done to properly ensure that any resulting methodology does not materially reduce the level of competition in Canada's telecommunications industry.
- The Bureau recommends that the CRTC proceed in a two-stage approach. First, the CRTC should decide the type of methodology that it prefers based on the information in this proceeding. Then, the CRTC should commence a follow-on proceeding with the goal of specifying, analyzing, and finalizing the details of an ultimate rate-setting methodology.
III. Proposals involving commercial negotiations
- Several interveners in this proceeding have specified methodologies for commercial negotiations that they believe could be effective for wholesale rate setting. Bell, in particular, has proposed a commercial negotiations-based methodology in a high degree of detail.Footnote 4 In this section of its submission, the Bureau discusses certain aspects of Bell's proposal, in order to outline some of the effects that it, or a similar methodology, could have on competition.
Constraints on the FOA process can affect competition by shifting bargaining power
- Bell proposes to set wholesale rates using commercial negotiations with an FOA backstop. Consistent with the CRTC's existing FOA regime for broadcasting sector disputes,Footnote 5 Bell proposes that rates determined in the negotiation and FOA process remain confidential.Footnote 6 Bell also suggests methodological elements designed to prevent what it views as undesirable buyer "gaming": specifically what it refers to as "shopping" and "coordinated shopping".Footnote 7
- The Bureau is concerned that these methodological elements could shift the relative bargaining power of network owners and wholesale-based competitors in a manner that prevents the FOA process from realizing its desired outcome—i.e., a wholesale rate that enables vigorous competition and maximizes economic efficiency.Footnote 8
- For example, in its anti-gaming measures, Bell recommends that parties commit to minimum volume commitments as a condition for triggering FOA. Bell states that this will prevent wholesale-based competitors entering the FOA process with multiple network owners, but only purchasing access under the most favourable contract.Footnote 9 Bell argues that these restrictions are necessary to avoid concentrating bargaining power in the hands of wholesale-based competitors by allowing them to gain one-sided knowledge of the confidential rate information of multiple network owners.Footnote 10 In order to prevent what is essentially the same issue, but coordinated through multiple wholesale-based competitors, Bell also proposes maximum volume limits or a prohibition on resale by one wholesale-based competitor to another.Footnote 11
- Transitioning to commercially negotiated rates creates significant informational asymmetries that generally favour vertically integrated network owners.Footnote 12 Furthermore, keeping arbitrated rates confidential serves to exacerbate these asymmetries. Since each network owner will likely engage in multiple FOA proceedings, once the first FOA rate is set for a network, the owner of that network will have the informational advantage of knowing that rate, while the other party in any subsequent FOAs (a wholesale-based competitor) will not. This advantage improves the network owner's position when making final offers during FOA, and could limit the competitive impact of wholesale-based competitors.
- The overall willingness of network owners and wholesale-based competitors to trigger FOA is based on their expectation of the outcome of arbitration. In this case, Bell's anti-gaming remedies could have the effect of improving network owners' bargaining power at the expense of wholesale-based competitors'.Footnote 13 This shift in bargaining power could lead to negotiation outcomes that yield sub-optimal wholesale rates, which could have the effect of limiting the competitive efficacy of wholesale-based competitors.
- This is just one example of a methodological element having an effect on relative bargaining power in the commercial negotiation/FOA process. Should the CRTC employ any methodology involving commercial negotiation, it is imperative that the details of such a system be carefully examined and consciously chosen so as to balance bargaining power in a way that brings about desirable outcomes.
- The Bureau recommends that this evaluation of bargaining power occur in a follow-on proceeding where all interveners can share their specific proposals and concerns. The CRTC's task, in this proceeding, would be to decide on a set of mechanisms that effectively balance bargaining power so that wholesale rates are set in a manner that ensures effective competition and maximizes economic efficiency.Footnote 14
IV. Proposals involving elements of retail-minus
- Both Cogeco Communications Inc. (Cogeco) and Shaw propose rate-setting methodologies that rely on a form of retail-minus rate setting for lower speed wholesale access, and commercial negotiation for higher speeds. These proposals seek to set wholesale rates in a regimented and calculable fashion for lower speed services, while providing greater flexibility in setting higher speed rates.
- Of these two proposals, Shaw provides a more detailed plan of how its method would be implemented. Accordingly, the Bureau focuses on analyzing Shaw's proposal.
Retail-minus approaches are not economic replicability tests
- The Bureau generally classifies Shaw's proposed approach as a retail-minus methodology. This is because, like retail-minus, Shaw's methodology observes retail prices charged for a set of products, and subtracts from those prices in order to determine an acceptable level for wholesale rates (i.e., a price ceiling for those rates).
- In its submission, Shaw invokes the concept of economic replicability testing (ERT) in labelling its methodology as an "ERT approach".Footnote 15 Shaw appears to do this because, unlike traditional retail-minus, Shaw's methodology subtracts actual costs from observed retail prices, rather than a "predetermined percentage [of retail prices]".Footnote 16
- As a matter of terminology, the Bureau wishes to clarify that, while retail-minus is a wholesale rate-setting methodology, ERT is not. Internationally, ERT is not used to determine wholesale rates; rather, ERT is used to decide whether a wholesale rate (determined by some other methodology) could allow network owners to engage in exclusionary conduct to the detriment of competition (e.g., margin squeezing).Footnote 17 The European Commission (EC) recommends the use of ERT as part of a greater package of safeguards designed to ensure that wholesale-based competitors can act as an effective competitive constraint on network owners.Footnote 18
- Accordingly, the Bureau cautions the CRTC from concluding that retail-minus-like rate-setting methodologies could alone act as a sufficient deterrent for exclusionary marketplace conduct. The Bureau recognizes that Shaw does not explicitly make such a claim in their intervention; however, the Bureau believes that it is important to clarify the role of ERT and its relationship to rate-setting methodologies.
Portfolio approach to retail-minus may harm competition
- The retail-minus methodology contemplated by the CRTC in this proceeding would set wholesale rates "… based on the current retail rates for similar services, less a predetermined percentage."Footnote 19 However, providers sell a number of services at varying levels of speed and capacity, and this fact somewhat complicates any retail-minus approach. One way to apply the retail-minus methodology is to set rates on a product-by-product basis, subtracting the predetermined percentage from the retail price for each product that a network owner markets.
- Shaw's proposal does not favour this product-by-product approach. Rather, Shaw claims that setting prices on a product-by-product basis would be inadvisable, since its methodology involves the subtraction of a network owner's costs from retail prices, rather than simply a predetermined percentage of those prices. Accordingly, applying Shaw's methodology on a product-by-product basis would incur the administrative burden of "… allocat[ing] and averaging of shared costs between individual services …"Footnote 20
- Therefore, Shaw proposes to set rates based on a "portfolio approach". Under this approach, wholesale rates are acceptable as long as, on average, the revenues earned by the network owner exceed the costs incurred by the network owner on their own sales of those products bundled together, plus a "reasonable rate of return".Footnote 21
- This portfolio approach allows relatively profitable products to cross-subsidize those that are not. In other words, a network owner's wholesale rates may satisfy Shaw's portfolio-level test while, at the same time, rendering one or more products unprofitable for a wholesale-based competitor to sell. This, in effect, could allow network owners to steer wholesale-based competitors to specific (presumably lower-margin) customers, rather than allowing market forces to determine commercial opportunities. Such a mechanism would have the potential to limit competition for certain types of consumers.
- Furthermore, a portfolio-based approach is at odds with the recommended application of ERT in Europe. The EC has explicitly recognized the negative cross-subsidization effect that portfolio-based approaches can bring about, stating that:
"In order to exclude cross-subsidisation between different products in a bundle or portfolio, NRAs should conduct only a single-level test, i.e. between the retail services and the most relevant NGA access input for the access seekers …"Footnote 22
- The CRTC should exercise caution in allowing a portfolio-level approach as part of any rate-setting methodology. While such an approach may yield administrative benefits, it could also provide network owners with a mechanism to influence the marketplace actions of wholesale-based competitors, thus limiting the ability of these providers to enact competitive discipline.
Price regulation of anchor products is not sufficient on its own
- Cogeco and Shaw both propose control over rate setting for a set of lower speed "anchor" products, with commercial negotiations being relied on to set rates for higher speed "non-anchor" products. The Bureau recognizes that some international jurisdictions follow a similar practice; however, these jurisdictions also rely on additional safeguards to ensure that wholesale-based competitors can act as an effective competitive constraint.
- In 2013, the EC elaborated three competitive safeguards to be satisfied as part of a regulatory regime similar to that proposed by Cogeco and Shaw:
- a demonstrable retail pricing constraint must exist for the non-anchored products;
- an ERT must be passed in respect of [each of the] rates for non-anchored products; and
- access to the service must be provided in a technically replicable manner and on an equivalence of inputs basis.Footnote 23
- When these safeguards are not met, regulators should not be satisfied that competition in respect of higher speed, non-anchor products would be sufficiently vigorous. Should the CRTC wish to implement a methodology such as those proposed by Cogeco and Shaw, the CRTC should first be satisfied that each of these three competitive safeguards is met in respect of each higher speed, non-anchor product.
Commercial negotiation requires a backstop
- In its rate-setting proposal, Shaw does not specify a backstop for commercial negotiation of wholesale rates for higher speed, non-anchor products. This is problematic, as there are serious doubts as to whether network owners would enter into wholesale access agreements absent a regulatory requirement to do so.Footnote 24, Footnote 25
- In a circumstance where wholesale-based competitors are denied access to a certain class of products, consumers of those products would equally be denied the benefits of competition brought about by wholesale-based competitors—i.e., lower prices, greater consumer choice, and increased levels of innovation.Footnote 26
- The CRTC can avoid such a situation by requiring a regulatory backstop that would apply in the event that commercial negotiations fail. Nearly all interveners who favoured commercial negotiation acknowledged this need.Footnote 27
V. Next steps: Perfecting a methodology that supports competition
- The Bureau has analyzed elements of two of the most detailed rate-setting proposals: those from Bell and Shaw. Both of these proposals feature elements that may negatively affect competition and, therefore, require further safeguards prior to implementation.
- Because there remain serious issues like these to resolve, the Bureau recommends that the CRTC proceed in a two-stage approach. First, the CRTC should use the record of this proceeding to choose only the general type of methodology that it finds most favourable. From there, the CRTC should hold a follow-on proceeding to perfect the specific rules surrounding its chosen methodology. This approach will allow interveners to better contextualize and focus their evidence and areas of inquiry, resulting in a more robust, more fully tested, final rate-setting methodology.
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