Research Notes

The European Commission just cancelled Christmas. Fair share update for telecom shareholders

On October 10, the European Commission published a summary report on the consultation on the future of the electronic communications sector and its infrastructure with reference to critical issues like consolidation, spectrum, and a fair contribution mechanism. The EC State of the Digital Decade report just reported a €200 billion gap in connectivity investment. This sets the stage for policy action. Telecom shareholders had hoped that the EC report would be coupled with a plan to transform the sector from EU Commissioner for the Internal Market Thierry Breton. The best that Santa and his elves at the Commission could pull together was a LinkedIn post (not even a proper mention on the Commission website) tossing the ball back to the industry with a new acronym, DNA, the Digital Networks Act.  Investors wanted presents under the Christmas tree; instead, they got a Christmas card.

One year remains in von der Leyen’s Commission of 5 years; key commissioners have left or are in process (Vestager). It’s unclear how Breton will push further. From a shareholder perspective, the European Commission cancelled this year’s Christmas party but hopes that the next Commission will plan a party in 2025.

From the point of view of shareholders, the European Commission says that shareholders should not expect good news for the European telecommunications companies until the next Commission. This means sell telecom shares now, place the money somewhere else, and start buying them again in 2025 should good news come from the European Commission.

Strand Consult chronicles these developments as part of its Global Project for Broadband Cost Recovery.

However, the EC report summary is a gift for telecom operators outside the EU which wish to further their already advanced efforts on broadband cost recovery, some nations with multiple bills already proposed. The report summary offers a valuable and statistically significant overview of the key stakeholders, the challenges, and solutions. Moreover, it reiterates the key components of a fair contribution mechanism:

  • Good faith negotiation, dispute resolution, and arbitration
  • A requirement that only large traffic generators (LTGs) negotiate with broadband providers (small and medium content providers are excluded from the need to negotiate)
  • Minimum thresholds to define LTGs for negotiation, e.g. min 100 million users on respective platform; annual European revenues exceeding EUR 10 billion; only entities responsible for 5% or more of total network capacity, 5% of peak hour bandwidth, or 10% of peak time traffic.
  • Transparency provisions to show how funds are collected, distributed, and invested

The future for fair share is brighter outside the EU. Europeans continue to suffer a lack of leadership not just on fair share, but on network investment, spectrum reform, and consolidation. The EC and Breton repeat the same message which prior administrations have done for the last 15 years. Almost a decade ago Strand Consult published “The EU’s Broadband and Telecom policy is not working. Europe is falling further behind the US.” This report described Europe falling behind on 4G. It’s the same story today on 5G. Today China has entered the picture, and the gap between Europe and 5G leaders has widened.

A statement from GSMA and ETNO’s called for urgent and accelerated action for Breton’s proposed Digital Networks Act. These trade associations seem satisfied with the result. This is disappointing for shareholders, and they should expect more from telecom operators’ membership fees. Strand Consult has yet to see a list of bankable results for the industry from these organizations. With increasing interest rates, the situation is growing worse for Europe. The EC’s very call for more and better networks will likely be met with less investment. If shareholder value is in fact their goal, shareholders should review whether trade associations are focused on the right initiatives and associated deliverables.

Strand Consult’s Assessments of the Commission’s Key Takeaways

The consultation conducted a survey, gathered data, and collected stakeholder views on four topics: technological and market developments, fairness for consumers, barriers to the Single Market and a fair contribution. The report reflects the submissions from the perspectives of telecom providers, broadcasters, cloud service providers and platforms, business associations, consumer organisations, citizens, non-governmental organisations, public authorities, trade unions and academics.The Commission noted three takeaways: (1) We need innovation and efficient investment. (2) We need to leverage the Single Market to boost investment and innovation. (3) We need to secure our networks.

These key points are obvious, and one cannot but agree. The disappointment is that the Commission seems hopelessly behind, always putting off to “tomorrow” what should have been done yesterday. Europe cannot, as the EC writes, just now throw “its hat into the ring with the regulatory framework and investments needed to foster innovation and technological leadership in areas such as online platforms, AI, data, cloud, quantum and virtual worlds” and expect to compete. Von der Leyen’s Commission has had 4 years to deliver. The best they can issue is a summary and restatement of what everyone knows. To be fair, the Commission has issued no shortage on policy to regulate every new technology once it is created somewhere else, but they offer limited strategy to incentivize enterprise in the European Union.

So, as we enter the fourth quarter of 2023, we can see that Europe accounts for less than 2 percent of the world’s internet market value. There is no new European internet enterprise of significance. Europe will soon be eclipsed by Africa in the total value of internet market. The performance of EU member states on the Digital Economy and Society Index (DESI) has not meaningfully advanced as member states “still struggle to close the gaps in digital skills, the digital transformation of SMEs, and the roll-out of advanced 5G networks.”

The Commission somehow expects that investment will magically appear in an overregulated environment. They write, “Yet, to succeed in a fast-evolving landscape we need to ensure coherence and maximise the multiplier effect of EU actions on private investments, as we did for semiconductors under the Chips Act.” 

The Commission can be effective when it wants. Strand Consult applauds the Commission’s continued work to secure networks. This success proves that Breton and the Commission can work together with the member states to achieve the objectives for the people of the European Union.

The silver lining of the process is that now there is a document outlining stakeholder views and noting areas of statistical consensus, for example: “EU-wide regulatory streamlining and simplification can slash administrative costs and speed up infrastructure deployment”, “a more harmonised approach to spectrum management would unlock larger market potential,” and “ exploiting economies of scale in the EU Single Market, and leveraging full access to 450 million European customers, would be key to overcome investment difficulties…the removal of obstacles, notably burdensome sectoral regulation, can facilitate cross-border consolidation and emergence of true Single Market.” While some of these items require nation state action, the Commission should do more.

Spectrum and Consolidation

The promotion of “cross-border” consolidation is not a real policy goal. Strand Consult has long detailed that there are limited synergies of cross border consolidation. Rather the action is in “in-country” consolidation. This is where competition authorities must loosen their death grip. Requiring 3 or 4 operators for the sake of the numbers in tiny little European countries is ridiculous. The report observes that EU has 38 operators with more than 500,000 customers but the US only 7, Japan 4, and China 3. Indeed Strand Consult described South Korea’s pioneering 5 to 3 mobile market consolidation in 2002; the is one important element of that country’s leadership in 5G leader—the ability to make and recoup investments. Strand Consult’s report on 4 to 3 mobile mergers provides an insightful look on the topic and examines 150 analyses of 4 to 3 mobile mergers around the world. See Strand Consult’s library of notes and reports on mergers and consolidation.

Spectrum and market consolidation are linked. Operators would invest more if they could get better returns on their spectrum holdings. There will never be a single market for mobile communications in Europe without spectrum reform. Europe today is divided into dozens of nation state markets each with different rules This is one policy area which the Commission could advance, but has achieved little.

Many leading authorities have described the benefits of a pan-European spectrum market including but not limited to improving the rollout of 5G, economic growth and productivity, and improved mobile coverage and public safety.  Moreover, the EC itself has raised this issue noting its benefits, at least twice in 2023 (See here and here). Indeed, many authorities have recognized the value of such a market, and further, the presence of conflicting national rules for spectrum creates barriers for a single market.

Consultation process and respondents

Conducting such a consultation requires administrative resources to create the questionnaire and survey instrument, collect the responses, and synthesize the responses. The EC should publicize the response of the “public consultation” and redact where appropriate, but alas it does not. In any event, it reports receiving  437 responses with 164 position papers. 108 corporate contributions, 87 business associations, 124  citizens (114 by EU citizens and 10 by non-EU citizens), 47 NGOs, 16 academic institutions, 17 public authorities, 14 consumer organisations, and 5 trade unions. This is a statistically significant response which offers valuable base on which to study and build policy.  The consultation included a survey as well as the ability for stakeholders to submit standalone documents.

Growing traffic does not mean increased revenue.

Strand Consult participated in the survey and submitted its Fact Check on Analysys Mason’s Claims on Big Tech Investments and Arguments Against Broadband Cost Recovery. This report debunks key claims from Big Tech that increasing traffic is a revenue opportunity and that content delivery networks reduce traffic and costs.

Importantly many in the report described Netflix is the primary contributor to traffic on fixed networks. Heavy loads were attributed to Facebook (on mobile networks), Google, TikTok, DAZN, “popular porn websites”, and Hulu.

Respondents noted that compounding growth of network traffic, 20-30 percent year over year, exceed the benefits of content delivery networks and compression technologies. They report that such codecs do not reduce cost or traffic; they simply make traffic delivery more efficient. Hence there is increased traffic on networks, the cost of which is not recovered today, either from end users, content providers, or taxpayers.

“Poor Returns” on Investment

More than two dozen telecom respondents reported making investment of EUR 258 billion over 2017-2021, about €64 billion annually. Despite some initial interest, these numbers have declined in recent years. Revenues are of course, flat, if not declining. By comparison, the US the annual broadband network investment level approaches $90 billion annually.

Under the status quo, the EU will not reach its Digital Decade for goals of full 5G and fiber for all Europeans by 2030, requiring €174 billion to as much as €300 billion. The increasing cost of money makes realizing this challenge even more difficult.

To no surprise, universal service obligations (USOs) were not considered meaningful solutions to close the investment gap. Notably the EU does not have the power to tax, and there is concern that the funds collected by government entities would not be fairly or rationally distributed. This contrasts to the USA which has an established, dedicated regulatory function for this purpose and can legally and rationally assess Big Tech for contributions. The United Nations Broadband Commission observes a global shortfall in network investment of $2 trillion while half of the world’s population remains offline for issues of affordability. It calls for broadening the base of financial contributions to broadband networks from its leading financial beneficiaries. 

Fair Contribution Mechanism

The consultation noted the broadband provider suffered “imbalanced bargaining power” with “large traffic generators (LTGs)” and that “LTGs can reroute their traffic through any route independently of its capacity and influence the consumers’ choice of Internet service provider via indexes assessing the quality of service of the Internet service providers.”  It was for this reason that broadband providers have sought the support of the Commission to help create such a framework to enable cost recovery.

A majority of all survey respondents said they supported the view that “digital players benefitting from the digital transformation should contribute in a fair and a proportionate manner to the costs of public goods, services and infrastructures, and about the introduction of a mandatory mechanism of direct payments from content application providers (CAPs)/LTGs to contribute to finance network deployment.” Such a mechanism “could reduce the investment gap, incentivise traffic generation, and benefit consumers. Implementing the mechanism would require introducing the obligation to negotiate, a dispute resolution mechanism, and price monitoring.” Respondents felt that LTGs should be the main contributors. Thresholds for contribution were suggested at 100 million users; annual European revenues exceeding EUR 10 billion; those responsible for 5% or more of total network capacity, 5% of peak hour bandwidth, or 10% of peak time traffic.

Telecom providers noted benefits such “reduced investment gaps, increased economic attractiveness, faster rollout of advanced networks, better internet quality for European citizens, sustainability, innovation, job creation, consistent and competitive prices for EU consumers, improved business case for access networks and investors, enhanced network coverage and reliability for Big Tech companies, improvement of the digital single market, improved coverage in remote regions, limited regulatory costs and administrative burdens, and a direct contribution mechanism with fair price signals.”

A proposed structure for the mechanism includes (1) good faith negotiation between LTGs and broadband providers on the fee to be paid based on data traffic and reflecting investments; (2) introduction of dispute resolution mechanism if no agreement is reached, and (3) arbitration. Broadband providers and semiconductors companies expressed a preference for a market-led framework based on bilateral negotiations on fair and reasonable terms.

Importantly, measures such as excluding small and medium traffic generators from direct payments and transparency about the funds each network operator receives and how these funds are used to improve network infrastructure could be enabled.

Operators should not wait to recover broadband costs

There is no EU law which prevents negotiations for broadband cost recovery. European operators should put on their big boy pants like the operators in USA and Korea and use the existing EU laws (including the new rules against Big Tech gatekeepers) to action cost recovery.

As has been the experience in South Korea and other nations, LTGs consistently claim that they have no obligation to negotiate or pay for the use of others’ networks. However, this should not stop broadband providers from documenting the shortfalls, making the outreach to Big Tech, and submitting that documentation to authorities. Indeed, broadband providers should consider publicizing these efforts to demonstrate the anticompetitive behavior.

It is unfortunate that GSMA and ETNO have not delivered better results to their members’ shareholders. It’s hard to see how they can rejoice when the European Commission has cancelled Christmas for the next two years. Strand Consult will be listening to hear whether telecom CEOs share this enthusiasm on their next investor call and at Mobile World Congress in 2024.

To learn more about this topic, check out Strand Consult’s Global Project for Broadband Cost Recovery.