Internode Blog

Price Squeeze Explained

Thursday, September 30th, 2010 by

(This is a clearer explanation of the price squeeze, abstracted in part from a longer blog posting from the author here: http://blog.internode.on.net/2010/09/24/price-squeeze-update/)

Those who follow developments in the Australian Internet industry will be aware that many Internet Service providers and their customers are currently suffering the effects of another ‘Telstra Price Squeeze’ in geographic areas of Australia where Telstra holds a monopoly on ADSL broadband services supply.

However, those outside of the Internet service provider industry may be understandably unclear on what this is, what it means, and why it matters.

Where this is mentioned, it can be frequently misunderstood by consumers to mean that providers are just ‘crying poor’ or ‘not trying hard enough’ – that its nothing but an exercise in sour grapes.

It is none of those things.

I’ll try to shed some light, here, on what it does mean.

So: What is a “Price Squeeze” and why does it matter?

The genesis of these ‘squeezes’ is typically (as in this case) a decision by a vertically integrated monopoly telecommunications provider (Telstra) to lower its retail ADSL2+ pricing substantially.

Earlier in 2010, Telstra BigPond decided to reduce pricing nationally on ADSL2+ services to a substantial extent.

These reductions sacrificed both Telstra’s income (and its EBITDA) for ADSL2+ services by amounts of around $30 per month in typical cases, and ranged up to even greater reductions on ‘high end’ plans.

These changes in BigPond retail pricing were made in response to an extended period during which BigPond was suffering a substantial net outflow of ADSL2+ customers to better offerings from its competitors.

So far, so good! Price reductions are good for consumers, at face value.

However, the real problem here has occurred as a downstream consequence; Telstra Wholesale has failed to appropriately adjust the relevant wholesale access costs for access to ‘ADSL2+ ports and aggregation’, that it charges telecommunications companies (such as Internode) for wholesale ADSL2+ service access in monopoly geographic areas.

The resulting pressure (“squeeze”) on provider margins places them at an unfair disadvantage in the geographic market areas where the only ADSL2+ infrastructure that exists is that owned by Telstra.

This, in turn, results in a worsening of choice for consumers in those non-competitive areas (which we believe constitutes as much as half of the entire Australian population).

By just doing nothing substantial (at wholesale), Telstra have reduced competition. This is a subtle but highly effective (and very common) tactic for a market monopoly to use. Inaction creates no overt outcry because ‘nothing happened’.

However, in reality, something major has happened – but its been done in a subtle manner, through an effective piece of misdirection. They created the price squeeze by the simple mechanism of doing practically nothing in a specific part of their business (wholesale) in concert with their retail price shifts.

The most financially effective tactic for a monopoly to exercise in general (because it is hardest to act against efficiently) is the combination of delay, inaction, and denial, in wholesale access pricing.

This delay begins with a tendency to profess surprise and a lack of understanding that there is any real problem, in public, peppered with the odd pieces of misdirection related to quoting pricing for other, unrelated, wholesale services as if they are the solution – when they are not.

The longer this unfair situation can be maintained, before justice is done, the greater the financial and market gain advantages for the monopoly.

A Price Squeeze creates an invidious choice for competitors, who are (naturally) motivated to want to offer services on a consistent basis to all of their market – but who are no longer able to do so.

On the one hand, they can decide to lose money hand over fist to retain their customers in monopoly areas (and risk becoming a memorial to Compass Airlines by repeating their history).

On the other hand, they can charge a retail price in these monopoly areas that is based on their (unfairly high relative, to BigPond) wholesale input costs.

In doing so, they naturally risk the loss of substantial parts of their customer base by having it ‘siphoned’ into 24 month contracts with Telstra (the very same entity maintaining the unfairly high wholesale pricing!).

It is not much of a choice, and the losers here are ultimately consumers, whose choice of broadband ADSL2+ services at an equitable retail price in monopoly areas is unfairly impacted by the squeeze in wholesale pricing that creates a reduction in competitive retail choices.

Examination of market pricing at this time makes it clear that competitors are generally choosing the second option, and are now offering differential pricing to the market.

This means, specifically, that they are offering higher pricing – above that of BigPond – outside of competitive areas, contrasted with far more competitive pricing and offers than BigPond in competitive geographic areas.

(I will note, also, that in examining the market, it is very important not to confuse the ‘competitive terrain’ offers of retailers with the offers available in monopoly areas. The understandable tendency is for retailers to advertise only their best pricing, not withstanding that it is not available in monopoly areas).

It is important to appreciate that Telstra has ‘form’ in this realm.

This has happened before, most recently in 2004, when an extremely similar situation developed and was worked through by the ACCC and industry with Telstra.

The ACCC took action in 2004 under the Trade Practices Act, including the issuing of a “Part A Competition Notice”. This notice, and the related ACCC investigations ultimately lead to Telstra acknowledging the price squeeze and modifying its wholesale access pricing to restore fair and equitable industry competition to be restored to the market.

A very approachable summary of the 2004 Price Squeeze can be downloaded here as a PowerPoint presentation:

http://bit.ly/aMaaeR

(or it can be found using Google to search for “2004 price squeeze Mark Rakers”)

To understand why this conduct by Telstra is bad for consumers, and why it is illegal (and not merely undesirable), I would ask you to take the time to read that PowerPoint presentation, including the speakers notes under each slide.

Meantime, in 2010, Internode (and other retail providers including iiNet) have raised fresh complaints with the ACCC (and, of course, directly with Telstra) about this repeat of the same conduct that was undertaken in 2004:

http://www.zdnet.com.au/telstra-price-squeeze-claims-go-to-accc-339304519.htm

(or Google for “internode iinet price squeeze 2010 complaint”)

This is an ideal time for Telstra to use the Price Squeeze to regain market share and to siphon customers into its retail ranks, ahead of the building of the NBN.

Where an entity is a monopoly holding substantial market (monopoly) power, appropriate provisions of the Trade Practices Act require it to offer fair and equitable wholesale access pricing to services for which it holds a geographic monopoly on the underlying infrastructure.

The issue here isn’t a moral one, or a question of providers such as Internode ‘not trying hard enough’ or ‘not negotiating well enough’.

It is also important not to confuse this situation with a slanging match over which competitive providers have built more of their own ADSL2+ DSLAM deployments; The unfair conduct by Telstra is the conduct that is occurring in the market areas where it is not economically feasible for any competitor to construct ADSL2+ deployments at all (and where none exist as a result).

These areas of competitive ‘market failure’ are those where consumers (not service providers) are suffering the consequences in terms of reduced consumer choice and higher pricing.

These are the consequences of the ADSL2+ services realm now being split into two distinct marketplaces:

  1. In geographic locations where consumers have access to competitive ADSL2+ provider infrastructure, there are a variety of service choices available (including from Internode) that are far better value than the revised BigPond plans. Competition is present, and consumers win.
  2. Where consumers only have access to ADSL2+ services via Telstra owned port infrastructure, this Price Squeeze is a severe and constraining factor that denies them access to competitive alternative services at competitive pricing.

The ‘have nots’ are in the numerical majority of Telstra exchange service areas, and also include all customers stuck behind Telstra sub-exchange aggregation devices such as the infamous (and often overloaded and congested) green ‘RIM cabinets’.

In the ‘have not’ regions, there is no effective retail price competition – so pricing will not continue to reduce. In these areas, consumers will be at an increasing financial and choice disadvantage relative to competitive ADSL2+ geographic areas, until the price squeeze is resolved.

In effect, until it is resolved, consumers in those ‘have not’ regions have had the last price reduction they’ll ever have. Meanwhile, competitive regions will see continued progressive value improvements into the future, as a natural function of a normally competitive marketplace.

Right now, we’re in an interim period where various things are happening at once:

  • The ACCC are working through our complaint (and the complaints of other industry providers). This is a detailed and complex evidence gathering process, due to the ACCC being required to give Telstra every avenue of reasonable doubt. However, the precedent from 2004 is very clear and we reasonably expect (and we urge) the ACCC to take comparable action this time.
  • As a part of our formal complaint, we (and others) are also arguing to the ACCC that access to these services should be “Declared”. Declaration is a competition enhancement process under the Trade Practices Act that (if adopted) would allow the ACCC to make binding determinations on price and non-price aspects of these wholesale services more directly than can otherwise be done.
  • Telstra is remaining essentially silent on the topic in public other than issuing the occasional denial that a problem exists (this is normal practice for Telstra during these situations, as delay is to its advantage)
  • Competitors are providing the best pricing they can reasonably provide in the meantime in these ‘monopoly’ geographic areas, while offering excellent value services (far better than BigPond) in the ‘competitive’ ADSL2+ service areas.
  • The market is continuing to ‘negotiate’ diligently and in good faith with Telstra Wholesale (despite the relatively artificial nature of such ‘negotiation’ in a monopoly market).

What next?

Like all previous price squeezes, justice will ultimately be done. It is merely a question of how long Telstra can delay the onset of that justice.

The fact that Telstra is apparently not prepared to resolve this situation without being compelled to do so underscores precisely the reason why the laws concerned here matter so much.

It also amplifies our deep disappointment that further important consumer centric legal reforms in this area, that were promised prior to the last federal election, have not yet been implemented. Those reforms were based on government acknowledgement of the seriousness of situations of this sort.

Instead consumers have been let down (and are being disadvantaged), right now, because of that lack of action.

That there is a market price squeeze occurring at the same time that Telstra is agitating to sort out its cosy financial deal to be paid off over the NBN by the government simply rubs further salt into the wound.

This situation also underscores that a key and critical requirement for the future National Broadband Network, in whatever form it takes, which is that there is an ironclad legal requirement that the NBN Company must only be a wholesale provider – that it must not directly offer retail services to consumers.

This price squeeze (and the fact that it isn’t the first time), serves to demonstrate that any vertically integrated entity will ultimately decide to disadvantage its own wholesale customers to advantage itself – any time it can get away with it – and often despite the provisions of the Trade Practices Act that should function to protect against that outcome.

As a result, it is clear that the only permanent solution to prevent this form of issue occurring again and again is the structural separation of Telstra.

It remains very disappointing that one major side of politics has failed in its promise to force this outcome, and the other side of politics claims (despite this obvious evidence to the contrary) that this separation is not even necessary because the current system ‘works’.

No, it doesn’t. The current system is badly broken. And consumers are the losers.

Simon Hackett
Managing Director
Internode