Chink in the mobile-phone duopoly
- 20 March, 2010 22:00
Two men and a photocopier is how Vodafone executives cheekily described mobile start-up Econet, now rebranded as 2degrees. It took the new telephone company (telco) a decade and an investment of $250 million to build a national 2G Network and put Vodafone back in its box. Last August, 2degrees launched New Zealand's third mobile network, and it was quickly evident that New Zealanders were ready for an alternative to Telecom and Vodafone.
In its first six months, the firm has attracted 206,000 subscribers, exceeding its own expectations and the financial market.
This puts 2degrees' market share by subscribers at 5 per cent in the pre-pay market, compared with Vodafone (52.6 per cent) and Telecom, (41.8 per cent), according to telco analyst IDC.
This is not bad for a company that began life so inauspiciously, if Vodafone is to be believed.
So all is good then. 2degrees has broken Vodafone and Telecom's duopoly and we can look forward to the company expanding aggressively, with much cheaper mobile prices and more innovation, right?
Well, not necessarily. There is one significant regulatory hurdle that must be overcome before a truly competitive mobile market can develop, according to the Telecommunications User Association of New Zealand (TUANZ) which represents big corporate users such as banks, universities and supermarkets.
And that has to do with high termination fees. The very phrase is enough to make anyone's eyes glaze over, and even the most enthusiastic telco executives are tired of this issue, but it is significant.
Termination fees are the rates network operators charge each other to terminate calls on their networks.
TUANZ, along with 2degrees, argues that high termination rates are a big reason why mobile prices are so high in New Zealand. TUANZ has been lobbying for six years to bring them down.
On the other side of the camp sit Telecom and Vodafone, but particularly the biggest mobile player Vodafone, who collect hundreds of millions of dollars in revenue in these fees a year. Unsurprisingly, Vodafone says mobile termination fees don't have a bearing on a new entrant's ability to compete.
In the last two years, the Commerce Commission has investigated whether to regulate these fees or not, sifting through endless submissions and complex economic matrixes from telcos on the matter.
At the heart of this is the fact that Vodafone and Telecom have built up closed networks of users.
For instance, Vodafone offers Best Mate, where it is much cheaper to phone or text your friend on Vodafone than it is to make a call to someone on Telecom's network.
So it is hard, some argue, for a new entrant such as 2degrees to compete, because they have to pay high termination fees every time a customer on their network wants to call a friend on Vodafone or Telecom.
Mobile termination rates have become a hotly contested issue.
TUANZ isn't the only consumer lobby group in the fray. There is also the Drop the Rate campaign, which on its website boasts 12,000 supporters, including Airnet NZ, Consumer New Zealand, Federated Farmers, 2degrees and TUANZ.
In a surprising decision last month, the Commerce Commission decided to recommend against regulation.
Instead, it believes Minister for Communications and Information Technology Steven Joyce should accept undertakings from Vodafone and Telecom.
Vodafone and Telecom have offered to cut termination charges by a further 80 per cent over five years to 0.1 cents a second by 2014.
While this sounds significant, the fees are still up to 110 per cent above the commission's estimates of internationally benchmarked forward-looking mobile termination costs, and will remain 20 to 50 per cent higher than these costs at the end of 2014.
This was pointed out by associate commissioner Anita Mazzoleni, who disagreed with telco commissioner Ross Patterson and associate commissioner Gowan Pickering's view that Vodafone and Telecom's undertakings should be accepted.
The undertakings bind the telcos to cutting termination fees on October 1 this year.
But Mazzoleni says the fees will still remain high compared with benchmarks, even if the undertakings are accepted, and 2degrees still won't be able to compete effectively.
Patterson and Pickering say that although the undertakings are above benchmarked costs, they lie within the range of estimated on-net mobile termination rates.
Analysts says these are the rates telcos could theoretically place on calls between customers of the same network.
So a small entrant such as 2degrees should be able to offer mobile services across to Vodafone and Telecom's network at prices that are comparable to the average on-net retail prices of the telcos, assuming that on-net rates will fall by about 5 per cent annually for the next five years.
Patterson says an industry solution which addresses the commission's competition concerns is preferable to regulation.
He says the undertakings of Telecom and Vodafone do address competition issues.
Former communications minister David Cunliffe told The Independent he had high regard for Patterson's work, but on this occasion, he agreed with Mazzoleni's view.
"The public's interest is served by having the lower rates that regulation demands, and a demonstrable and transparent process backed by the force of regulation."
Drop the Rate spokesman Matthew Hooton describes Patterson and Gowering's decision as an "about- face".
About 78 per cent of New Zealanders want the Government to regulate the fees, according to a Curia Market Research poll this month.
The same poll suggests the public is dissatisfied with the status quo, with 79 per cent believing Telecom and Vodafone are overcharging them, and 59 per cent don't trust companies to lower their prices voluntarily.
Joyce has the final word, and observers says it is anyone's guess which way the poker-faced Minister for Communications, who has managed to avoid showing his colours, will go. But show his colours, he must.
The minister isn't saying when he will make a decision, but he promises it will be in a "timely manner". He doesn't want to engage in protracted back-and-forth negotiations, and he won't accept "last minute" proposals from the mobile companies.
It's no wonder Joyce is carefully picking his words.
This fraught issue has had a contentious political history as well.
At the end of 2006, the commission recommended that mobile termination rates should be regulated.
Cunliffe had to hand that decision over to his colleague, Minister of Education Trevor Mallard, to avoid a perceived conflict of interest.
Mallard, for unknown reasons, went against the advice of the commission and the Ministry of Economic Development, and instead accepted offers from Vodafone and Telecom to reduce the fees.
But what about 2degrees? Do they think they will be able to compete aggressively in the marketplace without regulation?
Chief executive Eric Hertz says it will still survive, but it will slow progress and hamper its ability to be aggressive in the marketplace.
"It's important that we get the rules clear."
He declined to comment on Patterson's opinion that 2degrees would be able to offer the same retail prices as Vodafone and Telecom's prices of its closed network plans.
Hertz is coy about how much market share it is aiming for, and says as a private company, they won't be discussing that for a while.
United States private-equity firm Trilogy took a 25 per cent stake in 2degrees in October 2008, buying out Econet's shareholding.
Industry maverick Tex Edwards and his sidekick, Andrew Davis, created Econet (backed by Zimbabwe- based parent Econet Wireless) in New Zealand in 2000, with the intention of launching the country's third mobile network in a couple of years.
The former investment banker has said on many occasions that he didn't realise it would take so long - 10 long years of battles with the regulator and the Government.
The catalyst for change was the Labour government's telco reforms of 2006, which gave the Commerce Commission wider powers to investigate the mobile market without ministerial approval.
The commission identified that mobile prices were significantly above the average of other Organisation for Economic Co- operation and Development (OECD) countries, and began a series of investigations into entry barriers.
This directly led to private-equity partners Communications Venture Partners' investment vehicle Tesbrit BV and General Enterprise Management (GEMS) of Hong Kong buying a 66 per cent stake in Econet in 2007, pumping in $100m of capital.
Star-studded international telco executives were flown in to take over the reins at the firm, which was renamed NZ Communications.
The colourful Edwards, who is fond of calling himself a "freedom fighter", stayed on at the firm working on regulation, but has backed off from making any comments to the media, including for this article.
Speculation is rife that the private- equity shareholders' end game is to sell off the company, possibly to Australia's mega telco, Telstra.
Hertz disagrees, and says majority shareholder Trilogy International Partners is a long-term operator, "who knows how to build value in the business".
But industry observers say Trilogy is relatively young, and hasn't proved whether it's a long-term investor or not.
In July 2009, Trilogy upped its stake to 52 per cent, which sparked the departure of chief executive Mike Reynolds.
Hertz, formerly the the head of Seattle-based mobile media firm Zumobi, moved into the role.
Trilogy's chief technical officer, Stewart Sheriff, took over the chairman's role last month.
Sheriff has 30 years of operational experience in mobile, including a spell as chief executive of Ireland's third mobile entrant, Meteor, which launched its network in 1991, achieved 5 per cent market share in 2.5 years and is now at 20 per cent.
He told The Independent that the world was moving to zero-priced termination rates.
"I hope New Zealand grasps the opportunity to be part of that movement.
"For too long customers in New Zealand have been paying too much for too little, and I see an opportunity to really shake things up, " said Sheriff.
In January, Trilogy was cleared by the Overseas Investment Office to buy 100 per cent of the mobile company.
The value of 2degrees was estimated at just over $170m as at the end of March 2009.
Interestingly, Sheriff told The Independent that it didn't plan to buy the company outright.
"We are particularly pleased to be working with our local partner, the Hautaki Trust, and recognise the mutual benefits of having a Maori investor in the mix."
Vodafone corporate manager Tom Chignell argues that 2degrees doesn't need any more help from the regulators, and is doing quite well, actually.
But then again, that would be the company line to avoid further regulation.
While 2degrees has picked up good share in pre-pay, it is still just a minnow in the market.
Chignell doesn't understand why TUANZ is so worked up about the mobile termination rate issue.
Vodafone has bought down voice termination rates by 83 per cent since 2004, and cut text termination rates by 100 per cent, he says.
One of the reasons that Patterson accepted the undertakings, believes Chignell, is that the commission has achieved a real advance on text pricing.
That's important because New Zealand has one of the highest levels of text usage of OECD countries.
Chignell thinks if Joyce rejects the undertakings, the matter will go back to the commission and take up to 18 months for regulation to be put through.
But this is contrary to Mazzoleni's view that a standard terms determination will take only three months to finalise.
Under the undertakings, Vodafone will lose $450m in revenue and $140m in earnings before interest and tax over the next five years, Chignall says.
The firm plans to offset the loss through growing its fixed-line share, and tightening operational costs.
Offsetting the fall in mobile termination revenue is "a real challenge", says Chignell.
The company's parent, Vodafone UK, is used to the New Zealand firm status as a growing business.
"When I first joined 10 years ago, it was growing at 25 per cent revenue a year. Now it's less than 5 per cent.
"We're kind of going backwards."
Vodafone UK is less inclined to provide the company with discretionary investment income.
It will therefore be harder to develop its fixed-line business, particularly the rollout of equipment in Telecom's exchanges to provide high-speed broadband, known as unbundling, he says.
IDC analyst Rosalie Nelson says there is a view that isn't right, that if Joyce doesn't accept regulation, then there will be no change.
The commission had a clear idea of where mobile termination rates needed to go based on European fees, she says.
Everyone is focusing on mobile termination rates, but there are many other variables to retail costs, such as retail channels, handset cost, and subscriber acquisition costs, she says.
Newman says TUANZ is "utterly determined" to get the issue resolved. "If Joyce makes the wrong decision, we will come back at him in some other way, until we remove the market distortion that is so detrimental to our members' interests."
Putting mobile termination rates to one side, how is the general state of our mobile market?
The market is in a much better position, says Newman.
In the last year, the sector has developed from two operators using incompatible technology to three network companies with interchangeable subscriber identity module (SIM) cards. "But we want to preserve that. Mobile termination rates are crucial to that.
"We want to maximise the vibrancy of that market, make it easy for people to choose their own networks, and swap networks when better deals come along.
"We don't want people to be trapped with their existing provider."
Sidebar: Handset war warms up
The launch of Telecom's 3G network, called XT, has not delivered cut-throat pricing, observers says, but it has finally opened the mobile broadband floodgates.
Mobile broadband revenue growth will become increasingly important for telcos, with the erosion of traditional voice and messaging revenues.
Telco analyst IDC predicts take- up of new types of mobile handsets, such as USB connectors, 3G embedded laptops and notebooks will take penetration from 110 per cent to 127 per cent over the next four years.
Vodafone is clearly winning the handset battle as the only provider of the popular Apple iPhone in New Zealand.
The company has 46 handsets in its range. Other sought- after handsets include the Nokia E63 and Vodafone 541.
Vodafone says its Nokia 6121 has proved popular for people moving from Telecom's XT network (which has had three significant outages, causing thousands of customers to shift providers).
Mobiles embedded with Google's Android operating system are also in demand.
In October 2009, information technology analyst Gartner forecast that Android would become the world's second-most popular smartphone platform, behind the Symbian system which powers Nokia phones.
The Android system allows users to upload videos to YouTube, and has an integrated camcorder, camera and gallery interface.
Vodafone has sold the Android HTC Magic, and will launch the Sony Ericsson X1oi in April.
Telecom retail head Alan Gourdie says it plans to launch Android devices, but declined to say when.
The company has seven smart- phones in its range, including the recently launched Blackberry 9700.
It's understood that Telecom has been trying to negotiate with Apple to secure the iPhone for its range, without avail.
But Gourdie declined to comment on that, only saying that it was happy with its handset range, which was attracting customers.
2degrees is introducing 3G technology, over the top of its 2G network, later this year.
Until now, the company has offered much more expensive mobile data rates for casual use, than either Vodafone or Telecom.
But chief executive Eric Hertz says it will launch cheaper mobile plans than its rivals, when it launches the 3G network.
To support their growing range of handsets, Vodafone and Telecom plan to roll-out HSPA+ with peak download speeds of 21megabits per second.
Vodafone says the next step is long-term evolution (LTE), which offers speeds of up to 155 megabits per second, and puts it on par with the fixed line world.
LTE commercial rollout is expected in 2012 or 2013, depending on spectrum availability.
IDC analyst Rosalie Nelson says Vodafone's and Telecom's network specifications and coverage to 97 per cent of the population, places them among the top 20 per cent of networks globally. Independent