Friday, September 24th, 2010 by Simon Hackett
Those who follow developments in the Australian Internet industry will be aware that providers and consumers are currently suffering the effects of another ‘Telstra Price Squeeze’ in ‘monopoly’ ADSL geographic areas
This is an update on the current status of that price squeeze, and an indication of interim plan changes that are coming up for Internode customers while the process continues toward full resolution.
What is the Price Squeeze?
This is a reference to a situation whose initial trigger is a time when a vertically integrated monopoly telecommunications provider (Telstra) has decided to lower its retail ADSL2+ pricing substantially (which is good for consumers).
This becomes a ‘price squeeze’ when Telstra Wholesale (TW) has fails to appropriately adjust the wholesale access costs charged to other telecommunications companies (such as Internode) at the same time as the Telstra Retail price is reduced.
The resulting pressure (“squeeze”) on provider margins places them at an unfair disadvantage in the monopoly geographic market areas where the only ADSL2+ infrastructure that exists is that owned by Telstra.
This in turn generates bad outcomes for consumers, as it reduces their choice of competitive providers in the monopoly geographic areas concerned.
If Internode, matched the current Telstra Retail pricing using Telstra Wholesale inputs, they would lose a substantial amount of money on every customer for which that service was provided. This is clearly not a tenable situation.
This has happened before, most recently in 2004, and the pattern is the same in this case (though the severity of the situation is higher this time around).
Why should Telstra Wholesale have to be price competitive with Telstra Retail at all?
Because its a monopoly. That status gives it something that is legally referred to as ‘substantial market power’.
Entities holding that power are required (by the Trade Practices Act), in this situation, to provide a financially tenable wholesale access pricing path in monopoly areas where they offer retail services.
This, in turn, allows other providers to offer equivalent retail pricing to that provided by Telstra Retail, so they can fairly compete, without doing so at a loss (including all reasonable operating costs required to field such a service).
The issue here isn’t a moral one, or a question of providers such as Internode ‘not trying hard enough’. Its a legal issue under the Trade Practices Act.
The margins concerned, for pricing parity, are not merely small, they are actually negative.
More background detail are available on the first page of this whirlpool thread. In particular, if you click through to the noted ZDNet media article, you’ll be able to download a pdf letter that sets out the details of our formal complaint on this matter to the ACCC.
Those interested in the details are asked to take the time to read that pdf’d letter. This sets out in detail the nature of the complaint that this Price Squeeze has lead to, why we believe it is in breach of the Trade Practices Act, and hence why we believe Telstra Wholesale should adjust their pricing to a level that restores appropriate competition, of benefit to consumers, in the areas concerned.
Does this problem exist everywhere?
No, it doesn’t. In areas where providers such as Internode have built or otherwise have access to more competitive ADSL2+ infrastructure, then a variety of better value offers than those fielded by Telstra Retail are available to consumers, and while other problems remain in those areas, they are of a smaller order of magnitude than the price squeeze.
The marketplace in Australia, more than ever, is now a divided one:
Whats the current status?
Right now, we’re in an interim period where various things are happening at once:
What movement is there on pricing in the meantime?
In the last week, Internode received an interim wholesale pricing revision on ADSL2+ access pricing from TW, which applies until around the end of January (unless superseded).
The wholesale pricing will rise again in the absence of any better offer that may be provided between now and then.
Importantly, however, all customers Internode signs up in this interim period will be able to retain access this interim pricing model for the life of their service.
This revised wholesale pricing falls far short of being good enough to properly address the price squeeze – it remains impossible to field competitive pricing offers at all quota points offered by Telstra Retail (currently 2 GB, 50 GB and 200 GB plans) based on this interim pricing.
After careful modelling, based on this interim wholesale pricing change, Internode intends to release a revised version of its current ‘FAST’ plan table, called ‘FAST2’.
The ‘FAST2’ table represents the best, economically tenable, value points that Internode can offer its customers in monopoly areas at this point in time.
Note: Of course, customers in ‘competitive’ market spaces have access to the new Easy T-Shirt plans, which offer far better value than any offer from Telstra Retail; The price squeeze issue applies only in ”Telstra monopoly” geographic areas.
What is the interim offer from Internode in monopoly ADSL2+ areas?
Here is the currently intended new ‘Telstra Port” plan table from Internode.
Its possible that this may be modified before official release, but this represents our current intentions.
This table shows the existing (unchanged) 512 and STANDARD plans in context with the new FAST2 plans.
What are “Zones” in the context of this pricing table?
These zones are as defined by Telstra Wholesale.
They are an artificial construct through which Telstra Wholesale charges Internode an even higher monopoly port price outside of Zone 1
Broadly, ‘Zone 1’ tends to be the designation where there are competitive DSLAM’s present in exchanges. This is, however, not entirely consistent. In short, the zone classification of an exchange service area is determined by Telstra Wholesale at their sole discretion.
Customers can confirm the zone they are in by using the Internode Online Signup tools, the Internode Coverage checker or the Internode plan changer, once the FAST2 plans have been released. These tools will automatically determine your zone and present the appropriate pricing choices from the FAST2 table.
Where are the 2 GB and 200 GB price points in the new table? BigPond has those quota points, why don’t you?
It is not economically tenable to offer 2 GB plans at pricing in the same realm as existing BigPond 2 GB plans.
This is because the underlying TW port pricing remains so high that each plan concerned would lose money on practically every customer for whom it was sold. As a result, Internode is not currently offering a 2 GB ADSL2+ plan on the FAST2 table.
It is not economically tenable to offer 200 GB plans at pricing in the same pricing realm as existing BigPond 200 GB plans.
This is because the underlying TW AGVC (network capacity access) pricing remains so high that pricing anywhere near current BigPond price points would lead to massive losses for Internode on practically every customer signed up at that quota point. This is due to the massive cost component from those AGVC charges that would be required to support the delivery of 200 GB plans into the TW infrastructure.
The TW “AGVC” charge has, in comparative terms, not gone down in a decade. It is a signature example of monopoly pricing in that regard.
Because BigPond don’t pay this charge at all (it is a cost added on only for Telstra Wholesale access customers), they simply didn’t consider this cost in their revised 200 GB pricing.
In doing so, they have (by side effect) exposed the reality that this AGVC charge is dramatically above the real world delivery cost of data transported in the Telstra ADSL network.
Nobody believes (and Telstra certainly do not claim) that BigPond is operating their 200 GB plans at a loss. And yet, this wholesale-only AGVC charge would force a substantial monthly loss upon Internode, if we matched the BigPond 200 GB price point.
As a result, what you see on the FAST2 table provided here is the best pricing that we can sustainably offer during this interim period, in the presence of the interim underlying wholesale pricing concerned.
I can find some apparently better offers from other providers using Telstra Wholesale ADSL2+ ports. Why is that?
Lets start with the reality that pricing and value assessment in this realm isn’t always easy. Have a read of this blog post about the challenges of plan comparison in the Australian market, if you haven’t done so already!
Next, please appreciate that this is not because Internode isn’t a good negotiator on pricing!
This situation isn’t one where negotiating skill is really at issue – when negotiating with monopoly providers, the usual processes and the usual commercial leverages that exist when negotiating supply price just don’t apply. Its an artificial situation, for which specific aspects of the Trade Practices Act apply.
Its also not a scale issue – we’re one of the largest ISPs in Australia.
Its important to appreciate that Internode doesn’t have access to the pricing that other industry members are charged by Telstra Wholesale. Its all supplied in confidential contracts.
However, it seems logical to believe that some other industry players, who have not competed as vigorously as Internode by building their own competitive infrastructure, may be being offered better pricing than that offered to Internode, in exchange for agreeing not to engage in investment in their own ADSL2+ infrastructure.
In other words, we must speculate that ‘favourites are being picked’ here in a way that is not respecting the concept of a ‘level playing field’ in the manner that it previously was respected by Telstra Wholesale.
(Solving this ‘non-level playing field’ issue is one of the core future benefits that the National Broadband Network promises to service providers, and by extension, to consumers).
Its also possible that some other players are deciding to operate ‘loss leaders’ in order to retain market share in geographic monopoly areas.
The bottom line is that Internode can’t construct pricing based on what other people pay. It can only construct its pricing offers to the market based on what Internode pays.
Internode has made the business decision, in the name of its own commercial sustainability, not to operate ‘loss leader’ plans in monopoly areas.
We’ve tried doing that in the past and it hasn’t worked out well – we have previously ‘forward priced’ against expected drops in TW source cost that simply never transpired, and we have suffered significant financial impacts as a result.
Instead, we are concentrating on two paths in parallel:
What we have found during this price squeeze, and it has encouraged us greatly, is that many of our customers understand and are sympathetic to this situation, and they have appreciated the money they’ve saved over the last decade compared to previous BigPond pricing.
So they know they’re way ahead, however they progress from this point forward.
Its also important to appreciate that in general, Internode customers are far more satisfied with our services than customers are with BigPond services (and take a look at this survey result for an example of this from an independent assessment source).
In other words, there are many non price reasons to prefer Internode over BigPond in practice – regardless of the presence of a price squeeze in the meantime.
We will keep operating at our usual high standards and trust that our customers will see value in our doing so. Its a simple formula, but its worked exceptionally well for us since our inception.
Despite all of that, we do accept (though we hate it) that we may suffer a significant siphoning of some of our valued customers over to Telstra Retail until this current price squeeze ends. We hold the view that this is better than going broke – which ultimately assists nobody.
When will FAST2 plans be released?
We are slated to release the FAST2 interim plans during the week commencing 25th October 2010.
(slightly delayed – we originally intended to release them in the week commencing 18th October 2010).
Summary and likely next steps
What happens next – and exactly when – is still up in the air at the moment.
Telstra could get up one day and offer us financially reasonable wholesale port and AGVC access pricing compared to Telstra Retail prices. The ACCC may issue a Competition Notice, as they did in 2004, to compel TW to change their pricing. Or the ACCC may use one of the other legal mechanisms in the Trade Practices Act to drive a change in Telstra Wholesale pricing.
Timing is unclear on all of this – its essentially up to the ACCC and TW to decide when, and how, underlying wholesale access pricing changes further at this point.
Internode remains committed to offering pricing that delivers its high quality services with a reasonable operating margin.
We are not prepared to operate over TW infrastructure on a ‘loss leader’ basis, as past exercises in doing that have simply lead to losses – and the current Price Squeeze provides little comfort regarding the specific timing or magnitude of ‘permanent’ and sustainable TW pricing changes.
In the meantime, more than ever before, Australians live in a divided ADSL market. There are those who have access to highly competitive, excellent value plans from Internode over non-TW infrastructure (exemplified by the new Easy T-Shirt plans).
And there are those whose only access to ADSL2+ services is via monopoly TW infrastructure, for whom Internode is offering sustainable pricing based on its real costs, and where Internode is not in a position to operate at a loss to match BigPond pricing ‘across the board’, until the price squeeze is properly resolved.
(When this price squeeze is properly resolved, we have good reason to expect a return to the historical status quo over most of the last decade, where Internode pricing in TW only areas has offered equivalent or better value than BigPond pricing, as well as being delivered with higher customer satisfaction).
We remain optimistic that, like all previous price squeezes, justice will ultimately be done.
It also amplifies our deep disappointment that the consumer centric legal reforms in this area, that were promised prior to the last federal election, were never pursued in practice. Consumers are suffering reduced choice in the market, today, as a direct result of that broken promise.