Companies & Industries

Two-year phone contracts won't fix telecom's bigger problems: Peter Nowak

Don't expect prices to drop.

Bell Canada (Brent Lewin/Bloomberg via Getty Images)

Bell Canada (Brent Lewin/Bloomberg via Getty Images)

So Canadians finally have a set of rules that will shield them from the worst practices of cellphone carriers—three-year contracts and exorbitant roaming rates among them—thanks to the Canadian Radio-television and Telecommunications Commission and its new Wireless Code of Conduct. But will the regulator’s manifesto result in lower monthly bills? In some cases, perhaps, but in others, no.

The code effectively makes three-year contracts moot by requiring carriers to divide up the cost of customers’ phone subsidies over a maximum of 24 months. If a customer wants to cancel early within that time frame, carriers are only allowed to recoup whatever subsidy is left on the device and nothing more. They’re still free to offer three-year contracts, but with customers able to walk away after 24 months with zero charges, there’s no point.

The rules also cap roaming fees at $100 and data overage charges at $50, unless the customer expressly agrees to more in either case. Both measures should prevent those horror stories where subscribers have been saddled with bills in the thousands of dollars. Carriers will also be required to unlock subsidized phones within 90 days and those fully paid for up front immediately. It’s all good stuff.

Carrier reaction will likely take the form of higher upfront costs on phones. Today’s $179 iPhone 5 on a three-year contract might quickly turn into a $400 device on a two-year deal. Instinctively that’s not good, but in the long run it’s okay because it will finally make prices—both on devices and services—comparable to other countries, meaning it’ll be easier to see if Canadians are indeed overpaying.

Overall, the code won’t make much difference, which is why analysts are expecting wireless bills—and profits—to climb higher. Canada is actually one of the few countries where that’s the expectation; in most other jurisdictions, the momentum on both measures is downward.

The onus is now on the federal government to fix the bigger issue, which is a lack of competition between big players. There’s little doubt that Ottawa’s effort to inject more competition into the market five years ago is teetering on failure. New entrant Mobilicity is being acquired by Telus, a big chunk of wireless spectrum reserved for new players is about to be transferred from Shaw and Quebecor to Rogers, and the other small independent players—Wind and Public Mobile—are reportedly running out of cash. Analysts are probably correct in saying that the past few years of somewhat lower bills were just a hiccup—Canadian wireless companies are on the verge of resuming business as usual. In that case, let’s get the pool started: how long till the system access fee makes a return?

The debate now turns to the larger issue. Can the government salvage its effort to drive more competition into the market and therefore lower bills, or does it cut its losses and effectively tell consumers, “Sorry folks, you’re out of luck?”

Plenty of suggestions are being thrown around. University of Ottawa professor Michael Geist, writing in the Toronto Star, correctly asserts that when meaningful competition between market players is absent, regulation is necessary. He suggests stronger rules governing things like the sharing of cellphone towers, a full set-aside of spectrum for new companies in the upcoming spectrum auction, and the complete removal of foreign investment restrictions.

Those are all good ideas, but Geist also suggests one terrible one: regulations forcing third-party access to the wireless networks of Bell, Rogers and Telus. Such a scenario would lead to the creation of a swath of companies known as Mobile Virtual Network Operators (MVNOs), who effectively buy discounted minutes and data from network owners, then resell them under their own banner.

Canada already has a number of these, with the likes of President’s Choice and 7-11 currently in voluntarily negotiated agreements with the big carriers. MVNOs are also enjoying something of a renaissance in the United States.

The thing is, MVNOs fail far more often than they succeed—Amp’d, which piggy-backed on Telus’s network, folded after only four months while Virgin was eventually swallowed by Bell—simply because their existence is predicated on the whims of their partner. Absent regulations, network owners get to call all the shots, from the rates MVNOs can effectively charge to the types of phones they’re allowed to sell. That makes it hard for the virtual operators to come up with any sort of viable, long-term business plan.

Instituting regulations to govern all that might be just as bad, if the wired Internet side of things is any indication. As is painfully apparent to anyone who pays attention to this wholesale realm, it’s just one long tennis match in front of the CRTC, with independent operators complaining about mistreatment from big network owners in one form or another. Throttling and usage-based billing are two of the more recent examples.

It might all be worth it if those wholesale players were making some kind of a difference, but they’re not. Despite all the years of back and forth between the likes of Bell and smaller companies such as Teksavvy, smaller Internet providers account for only about 6% of the market. They generally provide better-priced plans, but ultimately such ISPs aren’t doing much to discipline bigger players or change things for the better. Given that, a similar scheme in wireless hardly seems worth the trouble.

It’s therefore time for government and regulators to revisit a more serious measure: the forced splitting of companies and the networks they own. Known as operational or structural separation, such a setup usually involves big telecom companies carving off into a separate organization the parts of their respective companies that are devoted to running networks. That unit then sells access to the network to all comers, including the parent company, on a completely equal basis.

The network business is thus the ultimate wholesaler, with strong, institutionalized business incentives to maintain its neutrality (i.e. executives can get pay bonuses based on the total number of customers they sign up).

The concept has been effective in numerous infrastructure-based sectors that are inclined to natural monopolies, including railroads, gas and electricity. The logic has been pretty simple: in the cases of these industries, it’s simply too expensive, impractical or undesirable for multiple parties to build infrastructure. It simply makes much more sense for them to all share the same base on equitable terms.

Whether or not such separation is a good idea for telecom networks is still an open question, but there is mounting evidence that it is. The pioneering example is BT in the United Kingdom. The company initially fought separation tooth and nail, but eventually decided to do so voluntarily before the regulator forced the matter. In 2006, the company set up Openreach—a network-governing unit that would sell broadband access to anyone who wanted it.

Openreach’s success can be measured in a number of ways. Despite its initial reluctance, the move has been a boon for BT, which has seen its stock double since the launch.

Critics also routinely say that mandated wholesale arrangements discourage network owners from investing in upgrades, which is indeed what we’ve heard in just about every dispute between big companies and small ISPs in Canada. However, the Organization for Economic Co-operation and Development studied structural separation (links to PDF) across various industries several years ago and didn’t find that to be the case:

Where an infrastructure owner is subject to mandatory access requirements, it may choose to refrain from developing additional capacity on its network, even in the face of considerable demand, in order to prevent its downstream competitors from gaining access to the infrastructure necessary to supply the downstream market. Alternatively, as has also been an issue in the context of the switch to smart electricity grids, where the transmission system owner remains part of a vertically integrated firm, it has an incentive to implement network upgrades in a manner that excludes third parties from the competitive segments. In such circumstances, structural separation is likely to improve the infrastructure owner/operator‘s incentives to investment in the facility, or to do so in a manner that facilitates competition in non-monopoly sectors.

That’s exactly what has happened with Openreach. The BT unit is currently spending $4 billion on fibre upgrades in response to strong demand from wholesale customers, and is planning on being done 18 months ahead of time.

Most importantly among all this, broadband choice in the U.K. has exploded. Consumers have a huge field of providers to choose from, some of whom are offering insane prices. Supermarket chain Tesco, for one, is selling broadband access with unlimited usage for $3 a month. That’s as alien a reality in Canada as a winter without bone-chilling temperatures.

There is at least one clear downside to the separated wholesale system in that it creates a gap between the network owner and the end user. That means if something goes wrong with the service, there can be delays in getting things fixed, which leads to customer frustration. It’s happening with Openreach and it’s also happening with wholesale ISPs in Canada. It’s definitely one aspect of the scheme that needs to be further developed.

That hiccup notwithstanding, Openreach seems to be accomplishing the objectives of all U.K. stakeholders, from government and regulators to corporations to consumers: better returns for BT, more investment for the country, cheaper prices and better service for consumers.

The CRTC studied the idea of structural separation way back in the early nineties before ultimately rejecting it in 1994, opting to go with a less-stringent wholesale regime instead. Given the string of failures to prevent continually rising bills in both wired and wireless services, it’s time to dust the idea off and give it another serious look.