Speech to the CommsDay Congress 2010

I hope today to set out a framework for what will become a rational and responsible debate about the provision of broadband in Australia.

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I hope today to set out a framework for what will become a rational and responsible debate about the provision of broadband in Australia.

So let me begin by setting out two principles and one policy objective.

The first principle is that Governments should not go into business in areas where the private sector is capable of providing the necessary services.

Governments should financially intervene in the market, by way of subsidies for example, only where the market fails to deliver services at a quality and a price we regard as appropriate.

Second, a free market and competition between firms is the best way of delivering us the things we want at the best price. Governments should seek to promote competition and where a Government is in the business of providing services to the public it should not place any barriers in the way of private competition.

The policy objective is that all Australians should have affordable access to fast broadband services.

We are one of the most highly urbanised societies in the world and as a consequence most Australians live in cities where there is more than enough commercial incentive to provide broadband services.

However, a small percentage of Australians live in regional and remote areas where the cost of providing such services is so high that, were the costs of provision to be recovered, the service would be unaffordable. In those areas there is a clear case of market failure in the sense that the market fails to deliver the policy objective of universal access to broadband at an affordable price. In those areas there is a need for Government to subsidise the provision of those services and both sides of politics have been committed to doing that.

I would have thought those principles and that policy objective would find wide support.

And what we have needed is a rigorous debate of the most cost effective means of achieving that objective consistent with those free market principles.

Unfortunately, Labor prefers to frame the public debate over its plan and any alternative proposals as a series of caricatures and false dichotomies. It’s the NBN or perpetual mediocrity. Fast fibre or overcrowded wireless. Visionary nation building versus mean-spirited penny pinching. The future versus the past.

In reality, as everyone in this room appreciates, the policy choices to be made in broadband are a great deal more complex and nuanced than this. Reducing them to cartoons is helpful only if you are trying to avoid scrutiny.

Of course avoiding scrutiny has so far been central to the Government’s strategy.
I’ve elsewhere made the point that even though the NBN represents the largest single public investment in infrastructure in Australia’s history, it was devised and commenced without any meaningful evaluation of direct or indirect economic costs and benefits, and without a public business case.

Indeed only a few days ago we were advised by the management of NBN that they had not yet finalised their business case or submitted it to the Board, let alone their shareholder the Government.

So for more money than it would cost to buy all of Telstra, the Government is building a new telecommunications company without having received a business case from the management it has tasked to do so.

Infrastructure Australia, an expert body the current Government set up and tasked with exactly this mission, has not been allowed to review the project, notwithstanding its whole mission is to identify, prioritise and rigorously assess infrastructure projects of national importance.

And as Ken Henry said in 2009, “Government spending that does not pass an appropriately designed cost-benefit analysis necessarily detracts from Australia’s well being.”

Even more astonishing than the lack of cost-benefit analysis is that Labor has never explicitly defined the precise shortcomings that the NBN is intended to resolve. What exactly are we trying to achieve? And what options are available to achieve it?

This lack of precision goes all the way back to March 2007 when Labor unveiled its original $4.7 billion fibre to the node proposal with a purposeful nod to “nation building” and a dire warning that Australia risked being “left behind” in broadband.

More than three years later, the cost and complexity of Labor’s proposed solution has increased tenfold. Yet the Government still hasn’t articulated exactly what it is trying to achieve. Put another way, if fibre to the premises is the solution, what is the problem?

Well, on the face of it, it appears that the NBN is a response to four separate objectives:

• First, the Government wishes, as a matter of policy, to provide a guaranteed level of basic access to broadband to all Australians. The peak speeds provided by fixed wireless and satellite networks proposed for around 750,000 regional and remote households reveal to us what the Government considers to be a minimum acceptable community standard: 12 megabits per second.
• Second, the uniform wholesale pricing structure proposed for the NBN reveals that the Government has decided, again as a matter of policy, to provide a cross-subsidy from urban broadband users to those in the regions. Rather than make this cross-subsidy explicit, it prefers to conceal it by requiring NBN Co to charge access seekers in all locations an average price.
• Third, the Government has decided that most Australians should have access to substantially higher broadband speeds than currently available in the market, with Telstra’s fast broadband offering over its upgraded HFC network in Melbourne the main exception.
• Finally, the Government also wishes to achieve a major change in market structure. This is clear from its proposed legislation requiring Telstra to separate or be excluded from bidding for next-generation wireless spectrum; and from the decommissioning of Telstra’s copper network contemplated in the proposed NBN Co/Telstra deal. The rationale for this restructuring is to increase retail competition, even if this is at the cost of re-establishing an entrenched wholesale fixed-line monopoly.

Let’s examine each of these policy objectives in turn, and consider whether the NBN is the most cost-effective way to achieve the desired outcome.

Universal access

Given the growing importance of broadband to our economy and society, both sides of politics agree that there is a case for universal access.

The majority of Australians already have access to fast broadband.

But around 1.2 million premises in urban Australia do not, because of historic network design constraints – pair gains and the like – which mean ADSL is not available. And many other suburban households and businesses receive lower speeds than are available to the majority because they are a long way from exchanges.

Underserved areas in the cities can most swiftly be answered with network upgrades to remove the barriers to the extension of ADSL2 to all metropolitan homes. Telstra has estimated the cost of this at roughly $2 billion. Alternatively, some of these areas can be remediated with fixed-wireless service. The Coalition’s broadband policy at the recent election provided $1 billion of funding to address these areas.

In thinking about how to address black spots, Labor is quick to dismiss wireless as a broadband contender. We have just heard from Bevan Slattery one of the authors of the Alliance for Affordable Broadband paper which include some of our most experienced telco CEOs and their contention is “We believe that next generation 4G technologies are the best fit for purpose for the vast majority of consumers and SOHO clients currently without other broadband delivery options.”

Likewise, the largest new national broadband initiative in the United States at present is the $7 billion LightSquared project to build a nationwide 4G wireless broadband network to provide up to 100mbps peak speed connectivity.

The Coalition does not believe that wireless is the only answer to access shortcomings – but we do argue it is a real option for many people, that its next evolution will involve much higher speeds, and that to dismiss it as a non-contender is hardly credible.

In regional and remote areas too, there are also many places where broadband access is very poor and certainly not comparable to that available in the cities. And a lack of competition in the backhaul backbone of the network has prevented access seekers from competing with Telstra in some areas.

If the Coalition Government’s OPEL plan proposed in 2007 had gone ahead, service would already be much better in many of these areas. Instead, little other than rhetoric was delivered to these Australians between 2007 and 2010.

At the August 21 election the Coalition and Government offered essentially identical upgrades to service for households and businesses in the ‘last 7 per cent’ of the nation. Both promised to hold a tender to provide a fixed-wireless network for more than 400,000 premises outside cities and towns, and to use next-generation Ka-band satellites to deliver service to about 350,000 remote premises.

While both sides are broadly agreed on how to address the ‘last 7 per cent’, it is important that this be done in the most efficient and cost-effective way. In this vein I note with concern recent press reports that the NBN Co has decided to reject the recommendation of the McKinsey/KPMG Implementation Report that a tender be held for the fixed wireless network, and instead build it itself.

Cross-subsidies for regional users

Just as both sides of politics broadly agree on the importance of universal access to a reasonable level of service, I think we are also in accord on the importance of broadband being affordable in regional and remote areas.

Now, since telecommunications tends to involve high upfront fixed capital costs and relatively low variable operational costs, much of the cross-subsidy involved in equalizing prices between the cities and the regions is captured up front in the network roll-out. Therefore the explicit funding both Labor and the Coalition have proposed for broadband service in the most remote areas goes a long way toward delivering fairly equal access pricing.

Beyond this, the NBN also proposes an implicit cross-subsidy of operational costs, which is built into the uniform wholesale access price that will be charged across the nation.

To the extent that an ongoing cross-subsidy is needed in addition to funding for the capital cost of the network, the Coalition’s normal preference would be to deliver this through a direct subsidy to carriers from the Budget or a user-level mechanism such as vouchers. Both of these delivery mechanisms have the benefit of being far more transparent than the hidden cross-subsidy inherent in the currently proposed NBN wholesale pricing arrangements.

This would be more consistent with the reality that since the late 1980s, Australian public policy has attempted to render cross-subsidies more transparent, so their true costs can be assessed and the most efficient way of addressing regional needs can be found.

Faster speeds

The third apparent objective of the NBN is to greatly increase the speed of the broadband services available to most Australians. Today, roughly 80 per cent or so of Australians are served by exchanges which are ADSL2 enabled and therefore receive access speeds as high as 24 megabits per second, although in a great many cases speeds are considerably lower due to distance from the exchange. Of course many of those who could receive this level of service prefer to pay less for slower access, or not to subscribe to broadband at all.

A smaller proportion of Australian households and businesses, around 30 per cent, are also passed either by Telstra or Optus HFC cable. These premises can receive broadband access speeds of up to 30 megabits per second; higher speeds across the Optus network following a recent upgrade; and in the case of Telstra’s upgraded cable in Melbourne 100 megabits per second – if consumers are willing to pay for it. So far, a few thousand have decided to do so.

All universities, most larger businesses, hospitals, and a majority of schools, are already connected directly to fibre and already have even higher speeds if they want them.

Now, the Government has advanced the proposition that these existing speeds are grossly inadequate, and that over the next eight years it is critical to deliver broadband access at 100 megabits per second to 93 per cent of homes.

That was the brief given to Mike Quigley and there has never been any explanation for why the Government’s goal of universal 12 mbps broadband suddenly morphed in April last year into 100 mbps FTTH.

And neither the Government nor the NBN Co have been able to describe the compelling productivity enhancing applications which will become available on 100 mbps that are not available at 20 or 12 mbps nor have they been able to explain why consumers would be willing to pay substantially higher prices for such increased bandwidth.

At this point let me quote from a recent account by Swinburne University’s Jock Given of the ‘Fibre to the Home Conference and Expo’ last month in Las Vegas, where Ericsson North America’s director of deep fibre access, Fred Terhaar, laid out a user case for household broadband of 120 megabits per second by 2020.

Mr Terhaar reportedly suggested that household connected over fibre could be simultaneously been using cloud-based 3D gaming (20 to 40 megabits per second), a high-definition video conference (18 megabits per second), three high-definition TV channels including one video course lecture (45 megabits per second ), remote home security (10 megabits per second ) and “other equipment” (24 megabits per second).

Now, that sounds like a terrific set of services for the household, and for the retail service providers who are selling consumers these applications over a fast network. But is this necessarily a vision that the Government and taxpayers should be heavily subsidising? As opposed to subsidising better hospitals, better roads, public transport, fast rail to name but a few worthy public infrastructure objectives.

And even Mr Terhaar reportedly conceded that, and I quote, “I don’t think the business case for FTTH is a slam dunk”.

If there is a legitimate case for policies that increase the average broadband speeds available to Australians, there are considerably cheaper ways to achieve this than a $43 billion overbuild of almost the entire existing copper network.

The first and most obvious step would be to provide Telstra and Optus with the investment certainty required to encourage them to upgrade their HFC cable to DOCSIS 3.0 – a step which would cost less than a tenth of the fibre overbuild, and would almost immediately permit nearly one third of Australian homes to access 100 megabits per second Internet if they so wished. Now, not eight years from now.

Beyond this, it is clearly the case that a gradual upgrade of the existing network over time, coupled with subsidies and new network rollouts in underserved areas as outlined above, would achieve much faster access speeds for most Australians far sooner than the NBN, and at a far lower cost.

Critics of the existing copper network point out that the costs to Telstra of maintaining and operating it are gradually rising, and over time much of it will gradually be decommissioned and replaced by fibre.

But that should be a process driven by economic evaluation rather than Government fiat. Government policy should be technologically agnostic. Australia should be striving for fibre to the deepest economically viable point in the network – as determined by market demand, technology alternatives available at the time, and the need to gradually replace copper over time.

Competition

The Government claims it will promote competition by eliminating the vertical integration of Telstra. It does this by overbuilding the entire Telstra CAN, at public expense, and by contracting with Telstra to decommission its own network.
There is not an end however to monopoly. There is simply an end to vertical integration. The Government would say that the NBN will be a common carrier, open to all, selling bandwidth capacity indifferent to the nature of the data and undistracted by the conflict of interest of also owning a retail business competing with its wholesale customers.

But in response we must recognise that if vertical integration is indeed the problem, then a structural or functional separation is the answer.

There have been numerous studies done within and without Telstra on the mechanics of separating out the network business. Many people have argued such a spin-off would be value accretive to Telstra shareholders and that the sum of Telstra’s parts would be more valuable than the whole.

On this scenario, such a separated network entity would become a utility providing wholesale access to all. It would operate under a regulatory regime which sets an access price to reconcile two competing objectives: to prevent the utility exercising monopoly pricing power, while providing it with clear incentives to upgrade, but not gold plate, its infrastructure. Where such upgrades are not commercial, because of geography, explicit government subsidies can be provided either to the network company or to would be customers.

In short – if vertical integration is the problem, the NBN is not the answer unless you believe in taking a sledgehammer to crack a nut.

The public benefit of competition is that firms strive to provide better and more innovative products at lower prices.

But why do we imagine the NBN will lead to lower prices? The NBN’s massive
capital investment will require a return and as we have seen recently with electricity prices, when utilities invest a lot of money in new infrastructure they will, all other things being equal, be obliged to raise their prices.

A highly capitalised utility with a market limited by geography is caught, like Odysseus, between Scylla and Charybdis. It must either raise its rates to get a return on its investment, or if it cannot do that it must accept a less than adequate return and a consequent diminution in its asset value. Put another way, either the consumer pays up in higher prices and/or the taxpayer pays up in higher taxes to fund the excessive investment.

There is no shortage of infrastructure projects which have found themselves unable to generate a return appropriate to the level of investment and plenty of them are in the telecommunications space. Think of the writedowns on the Nextgen and Powertel cable networks. Think of the tens of billions lost on sub-sea cable systems in the late 90s and then consider the billions lost when toll roads and tunnels too were financed on the “build it and they will come” philosophy.

But NBN will be a fixed line monopoly and with competition only from wireless broadband it will be able to charge every year higher and higher rates for access as the McKinsey Implentation Study proposes.

And insofar as those higher rates are a consequence of the need to service unnecessary capital investment they will be in effect a tax paid by broadband consumers to finance the folly of the Labor Government.

If the Government were serious about competition then it would not compel Telstra to shut down its copper network and migrate its customers to the NBN. And it certainly would not contract to prevent Telstra and Optus from offering competitive broadband services on their HFC networks which are capable of offering 100 mbps broadband to around 2.7 million homes and can do so right now – not in eight years time and at a cost which is a tiny fraction of FTTH.

Another important part of achieving a competitive, dynamic marketplace is fair and predictable rules around access.

My predecessor Tony Smith indicated before the election that the Coalition was supportive of the Government’s legislation reforming Parts XI B and XI C of the Trade Practices Act, which are contained in legislation currently before the Parliament. This remains the Coalition’s position.

These reforms will create needed certainty for the industry and avoid the delays and disputation that have characterised the operation of Parts XI B and XI C to date. By facilitating up-front price setting and allowing the specified access pricing regime to apply for a longer duration, these reforms will help create an investment climate in which Telstra and other market participants will be more willing to undertake investment.

The next step

It is no wonder that one leading business figure after another, including recently and most cogently our host Grahame Lynch [Communications Dav 11 October 2010] is telling the Government it must undertake a rigorous cost-benefit analysis of this project.

There is every reason to believe that the private sector can deliver the broadband objectives I have discussed with some Government support in rural and remote areas.
And for those who cry out “nation building” and “vision” when matters of finance are raised consider this: why is subsidising the provision of a near infinite range video and entertainment services to every Australian home more worthy than building a decent public transport system in our cities, better hospitals and roads, let alone fast trains and water infrastructure.

Governments deal with scarce resources – your taxes – and they owe it to us to rigorously prioritise and analyse the projects on which those taxes are spent.
The Government must immediately undertake a thorough cost benefit analysis of this project. It is not too late, the die is far from cast. There is still time to get the broadband services we need at a price we can afford.