Research Notes

EU Vice President’s Neelie Kroes new proposal for the “Digital Single Market in the Connected Continent” is a ticking bomb in the European telecommunications market and will likely have a negative impact on telecom investment in coming years

Tomorrow, Thursday 12 September 2013, Vice President for the European Commission Neelie Kroes will present her ​​suggestions on improving the telecom market and incentives for investment in infrastructure. Strand Consult has reviewed her proposal for “laying down measures to complete the European single market for electronic communications and to achieve a Connected Continent, and amending Directives 2002/20/EC, 2002/21/EC, and 2002/22/EC and Regulations (EC) No 1211/2009and (EU) No 531/2012” and her “Connected Continent” document, the guide to “what will change in telecom and associated markets and why it must”. Strand Consult’s assessment of Ms. Kroes proposal includes an overview of the 8 False Assumptions and Assertions of Kroes’ Proposal followed by Commentary on some of the specific suggestions in the document.

To understand the document, consider that Ms. Kroes is at the end of her political life and wants to present a grand plan so she will be immortalized for saving Europe’s telecom sector and revitalizing its internet industry. It’s a noble but ultimately hubristic ambition. On the other hand, Kroes is one of the few EU politicians taking leadership for telecom, what she calls the “cornerstone of the digital ecosystem”. Apparently Kroes’ report reflects 3 years of work. She gets credit for at least for making an attempt. Earlier European leaders just kicked the can down the road. So here we are today.

Though the report has a few good elements, the proposal does not offer much improvement over the status quo today. It is likely that if the whole proposal is implemented, it will have a negative effect on Europe and the telecommunications industry’s willingness and ability to invest in the infrastructure the next 12-24 months, the very infrastructure that Ms. Kroes believes to be so vital for the digital single market.

The main problem with this proposal is that its authors seem to have a limited understanding of the telecommunications market. It relies too much on armchair economics and too little on rigor. Outside of a few provisions, the proposal is designed to sound good to consumers. But the “bait and switch” strategy of promising consumers something now that will cost them later is still a form of shortchanging. The proposal states that the goals are to make it easier to establish telecommunications companies across countries, increase competition, and lower roaming prices, but the authors have not investigated sufficiently the negative consequences the proposal brings for the industry’s ability and willingness to invest in infrastructure.

The proposal if implemented will not create more value. Instead it will create price wars between operators, which will deliver lower prices for consumers in the short term, but remove incentives for operators to invest long term. The inevitable result is consolidation, which means that the number of telecom operators in Europe will be reduced significantly over the next few years. As companies compete each other out of the market, a wide range of investments will be put on hold. The next question is whether the competition authorities will accept the consolidation. The even bigger question is whether and when telecom companies will find a stable point to start investing again in infrastructure. As Kroes observes, the past few years have not been conducive to investment.

The 8 False Assumptions of Kroes’ Proposal
Any remedy for economic malaise holds assumptions about how the market works. Kroes’ proposal comes with a number of assumptions which are important to question. Unfortunately the proposal has at least 8 false assumptions.

1. Kroes asserts that the conditions for infrastructure investment in the USA are better, so Europe should just do what America does. She gives the example of the USA being ahead of Europe in LTE. Yet the telecommunications histories of the US and EU are very different. Kroes does not explain why American operators have invested heavily in infrastructure in recent years, but these reasons, a combination of history and luck, are not things that the EU can create. Read Strand Consult’s research note where the reasons why America is ahead in infrastructure investment are described.

2. In another rhetorical flourish, Kroes asserts that Asia and Africa are ahead of the EU in rollout LTE. Again, to assume that Europe should just do what other regions do is not tenable. She does not explain that Asian and African operators have simply repurposed old spectrum to new technology. The EU made a conscious choice to refarm the spectrum, a process which takes years. This means that the spectrum is allocated in an orderly fashion (and divided in such a way as to maximize money for national governments). There is a big difference whether an operator can use repurposed spectrum or whether it must purchase spectrum which must first be refarmed from other uses. In fact EU countries UK, Denmark, Sweden and Norway have LTE. They got it the same way as certain Asian countries, by reallocated existing 1,800 MHz spectrum.

3. Kroes makes some oversimplified assertions about operators’ high debt levels, among other challenges. Debt levels are consequences of conscious decisions by the EU government, national regulators, and telecom companies and their shareholders. There are many reasons why operators have economic challenges ranging from fierce national competition to exorbitant prices for licenses to the focus on raising dividends to fund investments in new markets outside Europe rather than existing national business.

4. Kroes makes a common mistake of many politicians to misunderstand the data about broadband speeds. This is based on a mistaken assumption that just increasing broadband speed in a mature European economy will increase economic development. The reality is that broadband is one of many important inputs. Furthermore there’s a big difference between what is available to consumers and what they choose to buy. For example 65% of homes in Denmark are passed by a broadband technology that can deliver 100 Mbps, but only 0.7% subscribe to the fastest tier. In countries such as Denmark, Sweden, Belgium, and Netherlands residents have access to high speed broadband but they choose the level that fits their needs and budget, which is generally a lower tier.

5. Kroes makes a claim that there is a 774% differential in call per minute price and refers to this source. The methodology of the study was simply to collect figures from European national regulators who were not supplied a standardized format to enter or calculate the prices. In practical terms, operators provided the information to the regulator, and then the EU itself had to guess at how to determine by the prices by looking at a series of differentiated bundles of voice, SMS, MMS and data. The study is directly misleading, and some of the countries that appear to have the most expensive prices, are in fact some of the cheapest for mobile telephony, according to the OECD.

6. Kroes makes another complaint that wholesale copper prices vary from €4-€14 euros per month, a 333% difference. This assertion fails to recognize that it does not cost the same to build, operate and maintain a copper network in all 28 EU countries. Kroes also forgets to mention that if an operator earns €14 euros per month, then it is still possible for the national regulator to lower the price.

7. Kroes lambasts the fact that telecom prices vary across the 28 member states. Putting aside for the moment the reality that the EU allows each national regulator to create regulation necessary for the circumstances of that country, Kroes’ assertions fails to point out the elephant in the living room: taxes. Each European country has its own tax regime. If a telecommunications company sells TV from Luxembourg, there is only a 3% VAT on the services, but other countries are as high as 20-25%. If fact, taxation on telecom products can vary from 15% in Luxembourg to 27% in Hungary. Don’t forget that Hungary levied special telecommunications taxes to offset the impact of the financial crisis, a problem caused by a different industry all together. For more information see this document.

8. Another false assumption from Kroes is that competition will drive operators’ incentives to invest in infrastructure. The scenario that Kroes proposes may increases competition, but it also increases operators’ sales and marketing costs. So while prices may fall, costs will go up. Operators’ earnings will be less. When earnings are under pressure, less is incentive to invest.

These are just a few of the false assumptions from the “Digital Single Market Connected Continent” documents. These mistakes reflect that fundamentally Kroes and her co-authors don’t under the telecommunications market. Given that they hold these assumptions, they have misdiagnosed the situation in the EU and have made the wrong suggestions for improvement.

Comments to the EU Commissioner’s proposal
Looking at the many suggestions in the proposal, they raise more questions than provide answers. In practice, the reliance on “feel good” suggestions to help the legislation gain popular support, can have negative consequences for operators’ willingness to invest in infrastructure, the very goal that Kroes is trying to achieve.

Roaming proposal – Sounds good to consumers, but creates a perverse incentive for arbitrage.
“Roam like home” sounds good. What consumer wouldn’t want it to pay the same to call from Paris to London as a call from Paris to Nice? A point of fact is that the current roaming regulation was completed in 2012 and provides a transition plan through 2022. It requires companies to offer a roaming wholesale product from 1 January 2013. Furthermore from 1 July 2014, operators are required to offer a decoupled roaming product to end users. Structural steps to promote competition in both the wholesale and retail market are in place. It is only September 2013, so the regime is just starting to work.

Additional reductions come in 2014 at the wholesale level (which would apply until 2022) as well as price reductions at the retail level (which are valid until 2017). This regime creates transparency and predictability and allows operators to adjust to revenue declines which mean hundreds of millions of euros to their income statements. Many stakeholders were involved to build the regime. It just needs a chance to get traction in the marketplace.

But Kroes’ proposal upends all of that. It creates a parallel “new” set of rules, requiring operators from 21 of 28 countries to offer some type roaming products on top of the previously agreed rules. This adds additional complexity for customers and operators.

The worst thing about the new roaming proposal is that it opens up border arbitrage. It creates an incentive for small operators in countries with small networks to sell traffic very cheaply to countries where operators have higher fixed costs of large and expensive networks. Strand Consult predicts that many side economies built on arbitrage will evolve from these regulatory distortions. The same model that allows Netflix to sell its services cheaply from low tax Luxemburg VAT to high tax countries (at a lower price than competitors) is the same model that is being introduced with Kroes’ roaming regime. Cheap SIM cards from small, low-cost traffic countries could now be used in big, high-cost traffic countries. It will be a ticking bomb in the telecommunications economy, and certainly not an incentive to invest in networks.

The old landline network is technologically locked and is not attractive for upgrade and investment in new technology
Kroes presents a politically desirable proposal: harmonize landline infrastructure across Europe so that it is easy to launch services across countries. The problem is that the quality of the landlines in Europe vary greatly from country to country. Operators need to invest a lot to upgrade their networks. Their incentive to do this dimmed because they see a future of falling prices.

One of the primary drivers for fixed broadband is digital television, and it is often difficult to make a credible business plan for new players to enter the market on old networks. New technologies and equipment are required, and these upgrades are expensive. In practice, there is only a business case in urban areas. The EU rules are a disincentive to incumbents because they have to lease their networks to competitors.

The problem is that the EU says the system is not working, but in reality there is no incentive to compete in markets with actors that already have a large volume. Harmonizing services and prices across the 28 countries and 28 different copper networks of different quality requires considerable investment. There is no money for it today or tomorrow.

The focus on Wi-Fi is fine, but Kroes forgets to look at how the Wi-Fi market will affect mobile investment.
The EU says that Wi-Fi is a good technology solution for the last mile of fixed operators. Strand Consult does not agree. Today there are mobile operators with large fixed networks that also maintain a national Wi-Fi network. With the new proposal, the operators that have both fixed and mobile networks and can easily build Wi-Fi to gain a competitive advantage over those that only have mobile network.

The suggestions around 4G, Wi-Fi, and small cells have a number of problems. It’s easy to talk about Wi-Fi and small cells, but the process to establish them in the public domain can be difficult and expensive. In Strand Consult’s report “10 Steps to reduce the cost of mobile masts and improve regulation” describes the challenges that Kroes has not taken into account in her proposal. It would be an enlightening exercise for the EU to examine the process and costs of erecting mobile infrastructure in the public domain. Read our research note about how infrastructure providers are losing revenue because of operators’ challenges.

There is a need for consolidation but Kroes is afraid to address the issue.
The Digital Single Market report notes,

Creating a single market is our policy objective. Consolidation, on its own, cannot be a policy objective. Why? First, mergers are never an end in themselves. Second, we cannot put the cart before the horse… Creating a Single Telecoms Market would allow operators to expand more easily to other European markets and change the way in which consolidation is looked at under applicable EU competition control rules. But creating a single market is the pre-condition for changes in the competition law analysis.”

In other words, Kroes would like a market with some major operators covering all of Europe, but she does not want to take the political risk to say the unpopular but inevitable word: consolidation. This means that there are winners and losers. This means that the strong eat the weak. This also means that the national telecom regulatory authorities’ sacred cow, “artificial competition”, which has many players, low prices, but no investment, is a failure. A single market can only be created by industry consolidation–or by raising prices so much that operators decide to re-enter the markets that they left.
It is sad that Neelie Kroes will not take a position on this issue that is more relevant each passing day and is the crux of the problem. Consolidation will increase incentives for investment.

Net neutrality—Allowing operators the freedom to make contracts is good. Regulating OTTs is interesting. The net neutrality lobby will feel betrayed.
Kroes has risked a quid pro quo with the net neutrality lobby, and she may have lost. For many years, Kroes suggested that consumers could simply change providers if they did not like their practices. To get support for her proposal, she presented herself as the Angel of the Open Internet, promising to enshrine a series of constraints on operators.

The proposal suggests a no blocking rule but allows companies to differentiate by speed and quality of service on a non-discriminatory basis. This means that operators can make contracts with content providers to deliver content and services that consumers want.

But paying for priority and quality of service are anathema to net neutrality lobby. They call it the “not neutrality” approach. Strand Consult can understand why the lobby is upset because this proposal is clearly what they don’t want. It would be better for Kroes to admit that there’s can’t be an investment environment where there is a zero price rule. At least that would be honest, and then there could be a discussion based on facts. Consider the mobile operators in the Netherlands since net neutrality was presented in 2011. ARPU and services revenue for the leading firms have declined. This downward trend has been noted by Informa, IDG and Telecom Paper in their study commissioned by the Dutch Consumer and Market Authority (ACM).

For the net neutrality lobby, operators’ traffic management is a question of human rights which can’t be rationalized by economics. To be sure, there will be more debate about whether existing human rights and competition laws are adequate.

In any case, the judges of the Washington D.C. Court of Appeals which is hearing the case between Verizon and FCC in the US, observed earlier this week in oral arguments that operators make contracts with actors across the internet: backbones, exchange points, peering points, content delivery networks, and most certainly, end users. That operators should not be allowed to contract with content and application providers is not logical. There is nothing inherently discriminatory about mutually-agreed contracts, nor should there be a prohibition as such.

That the EU would hold OTTs providing telecom services to account for discrimination and may be the subject of telecom regulation are interesting concepts. Strand Consult believes that if there are net neutrality rules, that they should apply to all actors in the internet value chain, not just operators. The proposal might mean greater scrutiny of OTT players, which are exploiting Europe’s tax regime at present, however legally.

No to an EU super regulator – but the EU should have veto power over national regulators
One of the ghosts that have been in the EU for many years is that of a super regulator, one that would trump all the national regulators and impose an overall structure and goal. Having met resistance at the national level, Kroes clearly says no to the super regulation idea. That being said, there is still the risk of regulatory fragmentation, so Kroes has suggested an EU veto power.

Historically, regulators took an ex post approach, waiting for evidence of actual harm before intervening. The shift toward ex ante regulation means that bureaucrats proactively analyze the market to look for problems. Kroes’ proposal may be an employment project for civil servants and the possibility of increasing the number of officials in the EU so as to slowly create the framework for a super regulator.

In practice the veto power has many similarities to an EU super regulator, however it disclaims the responsibilities of a regulator. So in effect, the EU would get additional power without having to face the regulators’ challenges and decisions at the national level.

Trying to be all things to all people is a guarantee to disappoint everyone. The Digital Single Market Connected Continent proposal will likely make no one happy and leave everyone worse off. Kroes sets up a false dichotomy that the future of Europe is a battle between industry and consumers, as if satisfying the one nullifies the other. The reality is that the two groups—as well as government—need each other. There will be no tax revenue for government if there is not strong industry based in Europe. If there is no tax revenue, consumers can receive no services from the state. Furthermore consumers are not just on the receiving end of things. They participate in the economy in many important ways. Consumers also comprise much of the labor force, and this proposal it not informed by sufficient investigation on how exactly ICT will facilitate employment. Just relying on the “app economy” is not enough.

The documents presented by Kroes have been created to dress up the EU and in hope that she can live up to her promises. While some of the proposals may increase the EU’s popularity in the short term, it is likely that the telecom industry will slow their investments until they know the financial implications of the proposal.

The Kroes proposal is based on many erroneous assumptions which misdiagnose the problem and provide the wrong solutions. It is very difficult to see how this proposal can play a constructive role to address the challenges in the telecommunications market in the EU.

The roaming proposal is especially distressing as it creates a market for opaque products that exploit the cost differences between countries and undermine the investment modern mobile networks. The message of the proposal for operators is: go for low capex but ensure high profitability. Operators that invest will get into financial trouble and become a takeover target for operators that are holding back.

To learn more about this topic, request a copy of our research note Generating Growth in Europe, How ICT Is the Solution. Strand Consult CEO John Strand can be reached at and +45 2085 0444.

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