adl deregulation final full version

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Deregulation of the Telecom Sectorand its Impact on the Overall Economy

November, 2005

www.adlittle.com


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Executive Summary

In many countries deregulation of the telecoms sector is being discussed as a meansto stimulate investment into new infrastructure

The continuation of a regulatory policy that was designed to support the liberalizationof telecoms markets favors competition on existing technology platforms and makes

investment into new infrastructure less attractive By analyzing regulatory policy changes in the US over the last years it becomes

evident that deregulation has led to significant investment announcements of theleading fixed operators in the country

Several studies suggest a positive impact of deregulation on the amount of in-vestments in the telecoms sector and on the overall economy; a positive relationship

between investments into the ICT sector and economic growth is common sense

To realize welfare gains, regulatory policy must pay attention to market andtechnology changes and consider deregulation to stimulate investments into newinfrastructure platforms

0Executive Summary

Deregulation stimulates infrastructure investment and has a positive impacton the overall economic growth and consumer welfare


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Introduction1

(De-)Regulation Perspectives2

Market Perspectives3

Agenda

Conclusions4

AnnexA


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In many telecom markets, deregulation is currently discussed; this discus-sion paper examines the impact of deregulation on the overall economy

Key Questions In which countries is deregulation currently disscussed and what are the most

relevant issues? What would be the impact of deregulation on investment, innovation and overall

welfare? Is there evidence of successful deregulation and what are the lessons learned?

Having achieved significant welfare gains after liberalization of thetelecom industry, many markets are considering deregulation

Explain the life cycle from liberalization and regulation towards deregulation and give an overview of countries

where deregulation is currently discussed Describe the relationship between (de-)regulation, market dynamics and telecom operator's investment decisions

Provide evidence of the positive relationship between deregulation and investment decisions based on a countrycase study

Draw conclusions on how deregulation can create incentives for more innovation and investment

In this paper we will:

Introduction Key Questions 1


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Market liberalization encourages the entry of new players

Liberalized markets are often regulated to prevent abuses by de facto orlegal monopolies and to protect consumers' and new entrants' rights

While achieving a lasting competitive market environment, deregulation isa logical step to sustain the further development of the industry

The rationale for deregulation is that less regulation will lead to highercompetitive intensity, an increase in related investments, more innovationand higher customer benefits

Regulation

Liberalization

Deregulation

Liberalized telecom markets have been regulated to achieve public-interest objectives (such as widespread service availability) and to avoidabuse of market power by incumbents through price discrimination, cross

subsidization and remonopolization Network owners viewed as having considerable market power are obliged

to provide access to other market players (non-discriminating and basedon regulated prices)

1

Regulation supports the liberalization process from a monopoly to acompetitive market

Introduction Definitions


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Introduction Milestones

Deregulation is the process of lowering the level of imposed regulation andshould be introduced as competition develops

1

Regulatory Milestones in Establishing Efficient Markets

Main targets

Preconditions

Consequencesof failure

Liberalization Regulation Deregulation

Achieve public interestobjectives

Avoid sub-optimal marketstructures

Stimulate investment in newinfrastructure

Establish technologycompetition

Existing public interests- information society- broadband diffusion- avoidance of digital divide

Efficient market andcompeting technologies

Players that are willing toinvest in (additional) networks

Technology alternatives

available Public interests not achieved

Discrimination(service & price)

Low investment level

Lack of innovation

Limited investments andtherefore limited techno-logical innovation

Stagnating price / perfor-mance levels due to limitedtechnology competition

Encourage competition toincrease efficiency andlower prices

Established basicinfrastructure

Additional players that areinterested in entering themarket

No sustainable competitionwill develop

High prices due toinefficiencies

Lack of innovation due tolow level of competition

not exhaustive


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Introduction1



Agenda

Conclusions4

AnnexA


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Policy makers face a choice between protecting competition in staticmarkets by regulation or accelerating dynamic market effects byderegulation

2(De-)Regulation Perspectives Regulatory policy crossroad

RegulatoryPolicy

Provide equal terms of access Universal service obligation Price regulation Local Loop Unbundling (LLU)

Wholesale obligation Regulatory certainty constricted in favor ofconsumer interests

Prioritization of regulatory certainty

Regulation limited to bottlenecks

Focus on provisioning of high investmentincentives (i.e. regulatory holidays)

No regulation of new infrastructure and markets(regulatory forbearance)

RegulatoryImpact

Competition is mainly based on existingtechnology platforms (infrastructure)

Limited possibilities to differentiate due toenforced infrastructure sharing obligations atregulated prices

Limited investment incentives for incumbents

due to expected low / negative ROI

Market is driven by technology innovation

Investment into new infrastructure could be usedas a means to differentiate

Increase of infrastructure based competition

Acceptance of short term market inefficiencies

Continued regulation supportsdevelopment of static markets

Deregulation supportsdevelopment of dynamic markets

Deregulate if the expected overall welfare gains outweigh short term market inefficiencies

Ongoing Regulation Deregulation

Regulatory Policy

Crossroad


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To stimulate additional investments in the telecom sector, deregulation isbeing discussed in many countries

(De-)Regulation Perspectives Deregulation Discussions 2

Country Intention of Deregulation StatusBackground / Reasoning

US

Hong Kong

Australia

Canada

Germany

Fade out of unbundling, line sharing andcollocation obligations for broadbandconnections

No unbundling obligations for futureFTTx infrastructure

Implemented

Fade out of unbundling obligations for

FTTx Ending of compulsory provision of LLU

Implemented;LLU phase-out 2008

Enable potential investors to set outaccess terms and conditions beforeinvestment

Subject to approval

Framework for forbearance of highspeed intra-exchange digital services

Partial deregulation of local telecommarket

Ongoing hearing,decision Jan. 2006

"Regulatory holiday" i.e. forbearance ofunbundling obligation for FTTx/VDSLinfrastructure investment

Deregulation of international calls

Need for EU approval;Affiliation in Germantelecom act

Enable investments in network infra-

structure to earn returns adequate to theassociated risk

Investment certainty for additionalnetworks

Bell Canada's application to react onpricing and fierce competition

Investment incentives Regulatory certainty Incumbent lost significant market power

in the international voice business

Decline in investment Imparity between cable and telco

regulation

Source: Country regulators 2005

Current Deregulation Discussions not exhaustive


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Introduction1



Agenda

Conclusions4

AnnexA


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3Market Perspectives - Chapter Summary

Deregulation encourages operators to innovate by investing in new accesstechnologies

Summary

Increased infrastructure competition raises consumer welfare and operators would bewilling to invest in case of an adequate ROI

Market convergence may result in the entrance of neighbouring players in eachothers core business, increasing the pressure for innovation and related investment

Market convergence and related infrastructure competition is more likely to takeplace in dynamic markets

Deregulation is expected to positively influence the infrastructure investmentdecisions of incumbents and to unlock dynamic market effects

Based on market studies in the US, we expect deregulation of the telecom sector tostimulate investment in new infrastructure

There is a common understanding in the US that regulation resulted in a decline ofinfrastructure investment

Recent studies suggest that deregulation of the telecom sector has a considerablepositive impact on employment, tax receipts, consumption and GDP


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Introduction1



Agenda

Conclusions4

Market Drivers3.1

Case Study3.2

AnnexA


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Market convergence may result in the entrance of neighboring players ineach others core business, increasing the pressure for innovation andrelated investment

Market Perspectives Market convergence 3.1

Fixed Operators Mobile Operators

Cable / TV Other Platforms & Players

DVB-T andsatellite attack

cable TV

Mobile entersfixed voice &broadband

market

Fixed entersTV market(TVoDSL)

Fixed entersmobile voice

market

Convergence increases thechoice for consumers

Players are increasingly underpressure to differentiate throughinvestments into new

infrastructure and technology Incumbents find it hard to

defend themselves becausethey are the only marketparticipants restrained byregulation policy. Differentiationthrough capital expenditure is

not possible if regulatory policywill grant access to newinfrastructure to competitors

Cable entersfixed voice &broadband

market

observed convergence trends

Comments

Platformsenter fixed &mobile voicemarket (VoIP)

Mobileenters TV

market

(DVB-H)


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Deregulation

Regulation

Market convergence and related infrastructure competition is more likely totake place in dynamic markets

Market Perspectives Market dynamics 3.1

Dynamic Market Static Market

Revenuedecline

Lowerconsumer

prices

Investment tostabilize returns

only

Short termwelfare gains

Investment toinnovate

Investmentmultipliereffects

Long termwelfare gains

Generation ofnew revenue

sources

Company related results Welfare related resultsMarket development & company (re-)actions

Competitionon existing

infrastructure

1

Capitalexpenditure

4Differentiation(service,

brand, etc)

3

Competitionbetween multiple

technologies

6

Servicecommoditisation

2

Serviceinnovation based

on newinfrastructure

5


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Deregulation is expected to positively influence the infrastructure investmentdecisions of incumbents and to unlock dynamic market effects

Market Perspectives Operators Options 3.1

Options

Description

Implications

Incumbents Investment Options illustrative

Attractiveness

Impact on Economy

Invest(after deregulation)

Invest(based on current regulation)

"Business as usual"

No investment in new infrastructure Differentiation is focused on

marketing, brand, service applicationand packaging issues

Investment in new infrastructure butregulation behaviour potentiallydestroys business case, creatingfinancial uncertainty

Investment in new infrastructure Market development and competitors

behaviour during investment phasestill unclear

1 2a 2b

Competition is carried out onexisting technology platformswhich leads to commoditisationand limited differentiation potential

High risk results in lower expectedROI

No competitive edge and limiteddifferentiation possibilities due toaccess and wholesalerequirements

Possible first mover advantages Investment payoff is unproven

Risk of aging infrastructure Innovation might be limited to

existing technology platforms

Ongoing arbitrage businessmodels

Positive impact on welfaredue to additional investmentsand service innovation


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Introduction1



Agenda

Conclusions4

Market Drivers3.1

Case Study3.2

AnnexA


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3.2

There is a common understanding in the US that regulation resulted in adecline of infrastructure investment

Market Perspectives Case Study

Telecom Act of 1996

Federal CommunicationsCommission (FCC)Principles & Policy Goals:

Overview of US Regulation Approach

0

10

20

30

40

50

1996 1997 1998 1999 2000 2001 2002 2003

Annual ILEC & CLEC CapitalExpenditures (bn USD)

Market development

Sources: FCC and court documents, T. Rowe Price, Arthur D. Little analysis

Encourage the ubiquitousavailability of broadbandaccess to the Internet forall Americans

Ensure that broadbandservices exist in a minimalregulatory environment thatpromotes investment andinnovation

Develop an analyticalframework that is asconsistent as possible,across multiple platforms

Mandatory items:

Interconnection

Resale

Unbundled access tonetwork elements

Number Portability

Universal service contributions

911 rules Definition of details in the following years

Extensive unbundling and resaleobligations on RBOCs to encouragecompetitive entry of competitors intolocal markets

No significant development ofinfrastructure based competitionfor local telecom services

Market exit of numerous resellers

Asymmetric regulation betweencable and telecom operators

Significant decline in long distance

market revenues Significant decline of investment in

the public telecom market sinceY2000


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3.2Market Perspectives Case Study

In the US unbundling obligations for new infrastructure investments byRBOCs have been abolished

CommentsObligation TelecomAct 1996 New RuleExplanation

UNE-L RemainsIn force, "cost-

based" pricing

CLECs will not be able to service customers unlessthey combine UNE-L and installation of their owninfrastructure

Unbundled networkelements-loop. Local

copper loop (does notinclude switching)

Note: Please refer to glossary in appendix Sources: FCC and court documents, Arthur D. Little analysis

Obligations to Regional Bell Operating Companies in US

Effective dates of UNE-P elimination are not uniformlydefinedUNE-P

In force, "cost-based" pricing

Eliminated

Unbundled networkelements-platform. Allowsend to end service withoutowning infrastructure

Line Sharing EliminatedIn force, "cost-based" pricing

Line sharing is no longer available as an unbundledelement. A 3 year transition period is established, withnew orders only being accepted during the first year

Access to the higherfrequency portions of thelocal copper loop to provideDSL services

WholesaleDSL Services Eliminated

In force, "cost-based" pricing

No future obligation to provide access to wholesalewireline broadband Internet services. One yeartransition period. ISPs may still negotiate commercialwholesale agreements with an RBOC

Allowed ISPs to buy DSLservices at wholesale pricesand resell them to endcustomers

Fibre andHybrid LoopUnbundling

Not requiredNo rule

No unbundling requirement in greenfield situations.Where fibre replaces copper or is installed alongside,limited unbundling requirements (either provideaccess to narrowband fibre or to a spare copper loop)

Refers to both FTTH andFTTC with a final copperconnection


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Source: FCC Policy highlights of Michael K. Powell's FCC Tenure (2005); FCC Press Releases and Web Site; Arthur D. Little analysis

FCC deregulation decisions have been directly followed by investmentannouncements of telco operators


2003 2004 2005

FCCDecisions

Timeline of Deregulation and Market Reactions

Reactions

Investment

June: BellSouthInvestment

Announcement

2002

August:Verizon

Statement

June:BellSouthStatement

October: VerizonInvestment

Announcement

October: SBCInvestment

Announcement

October:SBC

Statement1 2 3

45 6

August: FCCderegulates wirelinebroadband Internet

access services(copperline DSL)

December: FCCintroduces

amended regulationconcerningunbundlingobligations

October: FCCconfirms the

deregulation ofFTTC

connections

August: FCCderegulates fiber

to apartmentbuidings

February: FCCderegulates new FTTx

connections, linesharing and collocation

obligations

March: Cable modemdeclared as

"information service"by FCC*

*In June 2005 the Supreme Court asserted the FCC's cable ruling (Brand X Case)


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The FCC's deregulation decisions have been highly welcomed by the largestlocal incumbents


Statements to Deregulation by RBOCs

Source: Press clippings, Arthur D. Little analysis

This is an important step This decision will help accelerate deployment of broadbandnetworks, enabling greater choice and increased access for consumers.

Susanne A. Guyer, Verizon senior vice president for federal regulatory affairs, August 5,2004

"with this positive policy movementThe path forward is much clearer. This is the

latest in a series of broadband rulings that demonstrate this Administration and the FCCunderstand that keeping outdated regulation off of tomorrow's technology will boost jobs,investment and innovation.."

SBC Chairman and CEO Edward E. Whitacre Jr., 14 October 2004

"By rejecting the CLEC petitions and moving quickly to bring regulatory parity for high-speed broadband providers, the FCC can spark even more investment and fasterdelivery of innovative services to customers..."

Herschel Abbott, BellSouth vice president governmental affairs, June 30, 2005

1

2

3


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The deregulation decision was followed by large scale investment announce-ments by the RBOCs


Capex in new infrastructure is about 1

bn$ in 2004 and 1.3 bn$ in 2005 Installations of fiber-to-the-curb in 2004

were 126,000 and 200,000 areestimated in 2005

BellSouth Boosts Fiber Deployment Following FCCOrderBellSouth told the FCC today that it plans to deploy fiber to almost60 percent more locations in 2005 than it did in 2004AlthoughBellSouth had installed fiber in many branches of its network, therate of deployment rapidly increased once the commission's actionremoved the disincentive Press, June 30, 2005

Project Lightspeed: Target is to reach18 million homes by 2007 / 2008 (17mio FTTN + 1 mio FTTH)

Cumulative capex over 3 years isexpected to be about $4 billion + $1billion for investment in customeractivations

SBC Communications Will Deploy Advanced BroadbandServices To Reach 18 Million Homes In 2-3 YearsSBC Communications Inc. said today it will dramatically accelerateits plan to build a new fiber-optics network into neighborhoodsintwo to three years rather than five years as previouslyannounced Press Release, Oct. 14, 2004

Target is for about half of the homesin the covered areas to have FTTH orFTTN by end-2008, i.e. 15 million

Total investment of $15-20 billion Intention to hire between 3,000 and

5,000 new employees by the end of2005

Fast as light, Verizon is moving to roll out advancedfiber-based broadband technology to customers in sixmore states.At a news conference here today, the company announced newfiber-to-the-premises (FTTP) deployment to homes andbusinesses News Release, Oct. 25, 2004

Investment Announcements by RBOCs*

Company Announcement Details

4

5

6

Source: Press clippings, Arthur D. Little analysis *) Qwest has not made an investment announcement related to the FCC rulings


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There will be significant increase of new infrastructure investment andadditional FTTx homes passed until 2007


RBOCs Communicated FTTx Investment

Company Annual Capex in New Infrastructure ($ bn) RBOC Coverage

0,9

2,02,9

3,8

0

1

2

3

4

2003 2004 2005e 2006e 2007e

1,6

3,4

0

1

2

3

4

2003 2004 2005e 2006e 2007e

1,0 1,3

0

1

2

3

4

2003 2004 2005e 2006e 2007e

BellsouthVerizonVerizon+SBCSBC Qwest

Verizon+ Qwest

Verizon+ BS

Annual add. FTTx homes passed (m)

0

5

10

15

2003 2004 2005e 2006e 2007e

n.a. n.a. n.a.

n.a.

n.a. n.a. n.a.

Source: Press clippings, Arthur D. Little analysis


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In addition to RBOCs, cable operators and competitors have announced toinvest into broadband technology


Installation of additional broadbandequipment in approximately 200 centraloffices across the nation, increasingCovad's nationwide broadband networkto more than 2,000 central offices

broadening the access network enablesCovad to more efficiently utilize its coreATM network

Covad Announces 2004 Network Expansion InitiativeCovad today announced plans to expand its nationwidecoverage area and customer reach for digital subscriber line(DSL), frame access, and T1 broadband services.Company press release, January 7, 2004

Agreement with Level 3Communications to expand fiberfootprint

Network expansion including fibercapacity, routing and opticalequipment

Comcast Extends National Fiber Infrastructureto provide inter-city and metro dark fiber as part of Comcast'sextension of its fiber footprint. This backbone ensures thatComcast has a technically advanced and fully upgradeablenationwide broadband networkCompany press release, December 7, 2004

OEN plans to offer integrated IPTVservice, 10 to 100 Mbps Internet, Voice,Video-on-Demand (VOD) and otherbroadband applications

OEN said it has acquired programmingagreements for IPTV distribution of over400 television channels

OEN Plans Large-Scale FTTH Deployment in Houston announced plans to deploy FTTH to 1,600,000 households inHouston, the 10th largest television market in the U.S. Thecompany plans to launch its United States service offering inDecember 2005Press release, October 2005

Investment Announcments by Other Market Players

Company Announcement Details

OEN

examples

Source: Press clipings, Arthur D. Little analysis


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Comment

Consumer surplus isdefined as the valueconsumers place on agood or service abovewhat they actually pay

A report to the USchamber of commercepredicts that consumersurplus from broadbandalone will increasebetween 46% and 76%per year due toderegulation compared tothe baseline case

Cumulative additionalconsumer surplus in theyears from 2005 to 2009could be up to 42.7 billionUS Dollars

Household broadbandpenetration (%)

Consumer surplus($ bn)

5,9

12,1

17,722

26,4

4,5

6,6

8,1

10,6

12,9

34%

41%

57%

47%

52%

0

5

10

15

20

25

30

35

40

45

2005 2006 2007 2008 20090%

10%

20%

30%

40%

50%

60%

Baseline growthin surplus

Incremental surplusdue to deregulation

Broadband penetration

Source: Hazlett et al.: Sending the right signals (2004)

Expected Broadband Penetration & Consumer Surplus


Deregulation is expected to trigger substantial growth of consumer surplusdue to increased broadband penetration


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Comment

A study prepared by Allen Sinaiet al. for the ACCF (AmericanCouncil for Capital Formation)expects that deregulation willcontribute up to 0.2% ofadditional GDP growth over thenext years

On average, 91,000 new jobswill be generated annuallythrough 2008

Cumulative additional federal taxreceipts will be up to $14.4billion

Personal consumptionexpenditure will increase froman additional $8.6 billion in 2005

to an additional $20.3 billion in2007

Recent studies suggest that deregulation of the telecom sector has a consi-derable positive impact on employment, tax receipts, consumption and GDP

GDPFederal TaxReceipts

Source: Sinai et al.: Macroeconomic Effects of Telecommunication Deregulation (2004)

1,12,3

3,4 3,9 3,7

2

8,6

16,4

20,318,8

6,6

12,9

18,319,7

16,6

30

69

130

114110

0

10

20

30

2004 2005 2006 2007 20080

20

40

60

80

100

120

140

Difference in Level($ bn)

Additional jobs per annum('000)

PersonalConsumptionExpenditures

Employment

Expected Economic Impact of Deregulation in the US



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There are several studies supporting the conclusions that deregulation ofthe telecom sector triggers investments and overall growth of the economy

Unbundling decreases ILECs cashflowscash flows are used to financeILEC investments unbundlinggenerally lowers ILEC investment in a

proportionate manner "Capex increase resulting from the

elimination of UNE-P regulationswould have had a multiplicative effecton the economy"

Regulation caused decrease ofCapex leads to lower ROI and inconsequence to the elimination of

jobs "to address the profit squeeze"

Mandatory unbundling and irreversibleinvestment in telecom networks

(Pindyck 2004):

"[The Telecom Act of 1996] leads to an

asymmetric allocation of r isk and return whichcreates a significant investmentdisincentive[and] reduce incentives to buildnew networks or upgrade existing ones"

"Regulations that impede telecommunicationsinvestment harm the economy

ICT investments fuel growth of productivity andare worth approximately $56bn in output for

GDP (CA) Intense regulations harm investments and

reduce the economic output meaning fewerjobs and lower wages

Deregulation significantly fuelsfurther Capex "Cascading effecton overall economic growth" mightlead to $13bn additional Capex in

3 years Major impact on GDP: Reform of

UNE rules (-> deregulation) couldincrease GDP up to $102bn in 3years

Reform of UNE rules(deregulation) and resultinginvestments in the ICT market

could create up to 669k jobs in 3years

An accurate scorecard of theTelecommunications Act 1996:Rejoinder to the Phoenix CentreStudy No.7 (Crandall et al. 2003):

Extracts from Studies about Deregulation

How telecom regulationsharm California consumers

(Pociask 2003):

1 2 3

4

Telecom deregulation and theeconomy The impact of UNE-Pon jobs, investment and growth

(Eisenach et al. 2003):

All studies came to the conclusion that deregulation would triggeradditional investments and boost the overall welfare of the economy


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Introduction1

(De-)Regulation perspectives2


Agenda

Conclusions4

AnnexA


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Deregulation stimulates additional investments in new infrastructureenabling overall welfare gains

Conclusions Economic Impact of Deregulation 4

Status Quo Deregulation

Expected

Effect

Conclusions: Effects of Deregulation

InfrastructureInvestments

Investments primarily in existing infrastructure(stable to decreasing)

Limited incentive to invest into newinfrastructure

Additional potential investments by incumbentsdue to positive business cases

Potential competitor related bandwagoninvestment effect

Price Decline Competition ensures decreasing prices

due to commoditization More competition on access networks and

services leads to decreasing prices

ServiceInnovation

Service innovation limited to existingtechnologies and hence focused on e.g.service applications, product bundlesand pricing only

Service innovation based on new infrastructureand technology competition

Additional service innovation

BroadbandPenetration

Stable growth until maturity stage Increased infrastructure competition acceleratesbroadband penetration

GDP Positive impact through additional investments

and multiplier effects Contribution to GDP by fixed telecom

sector will slowly decline

OverallEmploymentLevel

Declining due to high cost pressure The employment level in the telco industry will bestabilized due to the roll out of new infrastructureand services

Potential positive impact on employment in otherindustries due to spillover effects

Competition Competition is carried out on existing platform

(static market view)

Focus on arbitrage business models

Competition is carried out between platforms(dynamic market view)

Business model focus on innovation


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Studies point out the positive relationship of ICT investments and GDPgrowth

4

ICT investments contribute to an overall increase incapital and an increase in labor productivity

ICT capital investment contributed on average 0.5%

to GDP growth in OECD countries from 1995 to 2001 The contribution of ICT capital to GDP growth has

strongly increased since the first half of the 1990s

Conclusions Economic Impact of Deregulation

Effects of increased investment in current generationbroadband technologies- 61,000 new jobs could be created on average per year

until 2021- Wide adoption of broadband (DSL, cable) could lead to

an increase in GDP of $179.9bn until 2021

Investments into more advanced technologies (FTTH)could be up to $82.8bn until 2021

The combined investments into existing and advancedbroadband technologies- will be up to $146.4bn until 2021

- will lead to a cumulative additional GDP of $414bn until2021

- Generate on average 140,000 new jobs per year

The economic impact of ICT Measurement,Evidence and Implications

(OECD 2004):

The effects of ubiquitous broadband adoption oninvestment, jobs and the US economy

(Criterion Economics 2003):

Studies suggest that there is a considerable relation between ICT investments andGDP growth

Extracts from Studies on ICT Investment and GDP Growth


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If the regulatory approach does not match current market conditions, regulation

leads to market distortions, i.e. the risk of absent or delayed investments

The regulatory approach must be reviewed on a regular basis to identifyderegulation possibilities in order to keep up with market and technologicaldevelopments; subsequently remaining regulation has to transfer to generalcompetition law

If market participants believe that the regulator changes the rules during thegame, investments and innovation may be held back due to the uncertainregulatory environment

Once the regulator has committed to a certain regulatory approach, it must alsodefine a planning horizon during which regulation conditions are not changed

No Regulation of

NewInfrastructure

Timing of RegulatoryEasing

Avoid Uncertainty

If regulation of new infrastructure investments reduces the expected ROI farbelow market returns of the same investment in an unregulated environment,potential investors are likely to refrain from taking the risk associated withinvestments

To overcome this problem, regulatory policy must provide investmentincentives, i.e. allow investors to benefit from first mover advantages by notregulating (or deregulating) new investments or granting regulatory holidays

To realize welfare gains, regulators must pay attention to possible pitfallsand behave accordingly

Conclusions Key Success Factors of Regulators 4


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Putting it All Together

Increased infrastructurecompetition raises consumerwelfare and operators would bewilling to invest if ROI isadequate

Deregulation is expected topositively influence theinfrastructure investmentdecisions of incumbents and tounlock dynamic market effects

As indicated by several studies, deregulation stimulates additional investments innetwork infrastructure and results in a positive economic impact

To stimulate economic growth, regulatory policy must consider market andtechnology changes

Conclusion: Deregulation Results in Higher Welfare Gains!

Policy makers face a choicebetween protecting competitionin static markets by regulation oraccelerating dynamic marketeffects by deregulation

Deregulation is a logical step onthe way from a monopoly to anefficient market

(De-)RegulationPerspectives:

Challenge betweenOperators and Customers

Interests

Market Perspectives:Market Demand and

OperatorsWillingness to Invest

While establishing sustainablecompetition in the telecom industry,many markets are considering areduction in regulation

The debate is whether and to whatdegree deregulation will stimulateinvestment and growth

Key Questionsabout Deregulation

Conclusions Summary

Deregulation clearly stimulates investments and recent studies in the USsuggest a significant positive impact on the overall economy resulting inhigher welfare gains

4


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Introduction1



Agenda

Conclusions4

AnnexA


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Glossary of Abbreviations

Informations and Communications TechnologyICT

Incumbent Local Exchange CarrierILEC

Global System for Mobile CommunicationsGSM

IP TelevisionIPTV

Digital Subscriber LineDSL

DefinitionTerm

Gross Domestic ProductGDP

Superordinate term for the different levels ofFiber deployment

FTTx

Fiber To The PremisesFTTP

Fiber To The NodeFTTN

Fiber To The HomeFTTH

Fiber To The CurbFTTC

Federal Communications Commission. USnational regulation authority fortelecommunications and broadcast

FCC

Competitive Local Exchange CarrierCLEC

Capital ExpendituresCapexInternet ProtocolIPInternet Service ProviderISP

Local Loop UnbundlingLLU

Multiple Input Multiple OutputMIMO

Next Generation NetworkNGN

Regional Bell Operating Company (US)RBOC

Return on InvestmentROI

Unbundled Network ElementsUNE

Universal Mobile Telecommunications SystemUMTS

Unbundled Network Elements-Loop. Refers tothe local copper loop itself, but does not

include switching facilities (US)

UNE-L

Unbundled Network Elements-Platform. End-to-end service on third party infrastructure (US)

UNE-P

Voice over Internet ProtocolVoIP

DefinitionTerm

A


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Testimony (extracts) of Thomas Tauke, Senior Vice President Public Policy, Verizon before U.S.House Energy and Commerce Committee

Existing federal regulations handicap Verizons provision of DSL. The FCC has applied the section 251 unbundlingand resale requirements to Verizon and other incumbent local telephone companies. They require Verizon to allowcompetitors to put their DSL equipment not only in our central office equipment buildings but also in small "remoteterminal" boxes in local neighborhoods.

They require us to provide not only unbundled lines from our locations to customers, but also "subloop" pieces of thoselines. The FCC first required us to provide DSL-capable loops, then it required "line sharing" -- allowing a competitor touse only a portion of the capacity of the loop almost for free to provide DSL service while Verizon provided theunderlying basic telephone service. Now we are also required to "line split" -- to arrange for two different competitors toshare our lines, while we provide no service at all to the customer.The FCC is now considering requests from other carriers that we be required to provide our new DSL services to themat very low TELRIC prices -- that is prices that are below our costs. If we have to do this, what incentive will wehave to make the investments that make these services possible? And yet that investment is exactly what you

and the public expect from us.The other characteristic of the regulatory landscape is uncertainty -- participants and investors dont know for sure whatthe rules are. Whether Verizon must provide wholesale DSL services at discounts to their competitors and whether itmust unbundle its retail DSL service are now before the courts. Our investment decisions, and the investmentdecisions of our competitors, will be affected by the actions of these courts and by the Commissions actionsin response to them

A

RBOCs attributed the decline in infrastructure investment to the existingregulation framework not providing investment incentives

Deregulation Case Study United States

Comment on FCC Regulation by Verizon April 25, 2001


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Verizon

Verizon announced a significant increase in infrastructure investment afterthe deregulation decision of the FCC

Deregulation Case Study United States A

Verizon comment to FCC decision regarding theremoval of common carrier obligations and to createparity in the regulatory treatment between cable andphone company-provided broadband services.

Susanne A. Guyer, Verizon senior vice president

for federal regulatory affairs, August 5, 2004:

This is an important step This decision will helpaccelerate deployment of broadband networks,enabling greater choice and increased access forconsumers We commend Chairman Martin and thecommission for acting quickly to move us closer tothe presidents goal of broadband deployment to allAmericans by 2007.

Ivan Seidenberg, CEO Verizon 09/05

"Verizon wants to pass an incremental 50% of homesin his territory in the next three years"

Verizons plans are the most ambitious of the RBOCs

Roll out target is for about half of the homes in the areas in which it hastraditional telephone franchises to have FTTH or FTTN by end-2008, i.e.15 million

Total investment of $15-20 billion

Intention to hire between 3,000 and 5,000 new employees by the end of2005 to help build the network

Video will initially be provided in traditional multichannel cable TVdistribution mode, with IPTV (only requested channels are sent to ahome) later

Source: Company documents, CIBC, Arthur D. Little analysis

Annual add. FTTxhomes passed (m)

0,9

2,0

2,9

3,8

1

4

23

0

1

2

3

4

2003 2004 2005e 2006e 2007e

0

5

10

15

Annual capex in newinfrastructure ($ bn)


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SBC (Rebranding to at&t)

The FCC deregulation decision paved the way for accelerated SBCinvestment and FTTN roll out


SBC comment on the FCC decision to removecommon carrier obligations and to create parity in theregulatory treatment between cable and phonecompany-provided broadband services.

SBC Chairman and CEO Edward E. Whitacre Jr.,

14 October 2004

"with this positive policy movement, the delivery ofnext-generation broadband and video services is nolonger at some distant point in the future. The pathforward is much clearer. This is the latest in a seriesof broadband rulings that demonstrate thisAdministration and the FCC understand that keeping

outdated regulation off of tomorrow's technology willboost jobs, investment and innovation. It will beequally important at the state and local level that thepath remain clear of unnecessary regulatory orlegislative hurdles."

SBC Communications announced in Oct. 2004 that it will dramatically

accelerate its plan to build a new fiber-optics network into neighborhoods Project Lightspeed: Roll out target is to reach 18 million homes by 2007 /

2008 (17 mio FTTN + 1 mio FTTH)

Cumulative capital investment over 3 years is expected to be about $4billion + $1 billion for investment in customer activations

Provisioning of 25Mbps, four streams of HQ video per line, Internetaccess and VoIP service (U.S. expectation is to offer 4 different videochannels at any one time to different viewers in a household)

Source: Company documents, Press releases, Arthur D. Little analysis

0,0 0,0 0,0

1,6

3,4

10

0

6

0

1

2

3

4

2003 2004 2005e 2006e 2007e

0

5

10

15




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BellSouth

Although BellSouth had installed fiber in many branches of its network, therate of deployment rapidly increased once the FCC's ruling removed thedisincentive to invest


Bellsouth comment on the FCC decision to removecommon carrier obligations and to create parity in theregulatory treatment between cable and phonecompany-provided broadband services.

Herschel Abbott, BellSouth vice presidentgovernmental affairs.

"By rejecting the CLEC petitions and moving quicklyto bring regulatory parity for high-speed broadbandproviders, the FCC can spark even more investmentand faster delivery of innovative services tocustomers The radical rewriting of the fiber-to-the-curb order proposed by [CLECs] runs the risk ofparalyzing the ability of incumbents to evolve theirnetworks and implement new, advanced

technologies."

Source: Company documents, Wachovia, Arthur D. Little analysis

Capex in new infrastructure is about 1 bn$ in 2004 and 1.3 bn$ in2005

Installations of fiber-to-the-curb were 126,000 in 2004 and200,000 are estimated for 2005

The increase is being attributed to the decision to have nounbundling obl igations on FTTC installations

1,01,3

0,10 0,13

0,20

0

1

2

3

4

2003 2004 2005e

0,0

0,5

1,0




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Optical Entertainment Network

OEN is an example for an alternative operator investing in new infrastructure


OEN Plans Large-Scale FTTH Deployment in Houston (Oct. 2005)

Optical Entertainment Network (OEN), a private investor-backed company based in Texas,announced plans to deploy FTTH to 1,600,000 households in Houston, the 10th largesttelevision market in the U.S. The company, which has partnered with leading Europeanand North American vendors plans to launch its United States service offering in December2005 and begin European operations in Q2 of 2006.

The company plans to offer integrated IPTV service, 10 to 100 Mbps Internet, Voice,Video-on-Demand (VOD) and other broadband applications such as, Home Security,videoconferencing and telemedicine. OEN said it has acquired programming agreementsfor IPTV distribution from top programming television networks and will deliver over 400television channels, including 50 plus channels of HDTV.

OEN's first deployment partner is Phonoscope of Houston, Texas, owner of the largestprivately held metro fiber networks. Already the existing network reaches 200,000household easements and is within 100 to 500 yards of approximately 1.6 millionhouseholds in the 6 county areas around Houston.

Announced Services

10 to 100 Mbps InternetOEN's FISION willprovide Internet service atspeeds of 10 to 100 Mbpsand each FISIONsubscriber will receive aminimum of 10 Mbps of

symmetrical connectivity. Online gaming Digital video recorder

with time shiftingcapabilities

Tailored advertisingImagine seeingcommercials that aretailored to customer'slifestyle and interests

Personalized TV Unlimited local, national

and global televisionchannels

Source: Company website


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Alcatel

Infrastructure suppliers endorse the deregulation in the US in order tosustain the growth of the US broadband market


November 9, 2005

The following statement should be attributed to Tim Krause, Chief Marketing Officer and Senior Vice President forGovernment Relations for Alcatel in North America, who testified today before the Telecommunications and InternetSubcommittee on the forthcoming BITS (Broadband Internet Transmission Services) Act:

"Alcatel endorses the BITS Act, and requests the Committee move it forward in the legislative process without delay.

The BITS Act will ensure the continued growth of the U.S. broadband market by creating legal and regulatory certaintyfor the services that flow over powerful new broadband networks, such as the IPTV networks being built by Alcatel forU.S. telecommunications carriers, in several ways:

"First, it generally protects nascent broadband services from regulation at the Federal, State, and local level,and does so in a socially conscious manner by preserving important public policies, such as E911. (emphasisadded)"The bill creates a streamlined Federal video franchise process for broadband video services that will ensure they canbe a key driver of continued broadband deployment immediately. The BITS Act achieves this goal while protecting theability of municipalities to manage their local rights of way, as well as the video franchise fee revenue streams theyhave come to rely on.

"Alcatel also supports the inclusion into the BITS Act of Internet Neutrality principles, which promotes consumerbroadband demand, as well as protections for municipal entry into the broadband market when necessary."

Source: Verizon; Alcatel (system integrator for SBCs Project Lightspeed)

Example


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Since 1995, new entrants followed differentstrategies in the Hong Kong market

Hong Kong Broadband Network had no choicebut to build its own network infrastructure

Hutchison also started to invest into its owninfrastructure

New World Communications and Wharf T&Trelied mainly on Type II interconnection

In 2004, about 53% of households were connectedby at least two independent networks, including thatof the incumbent

The broadband market share of new entrants(including broadband offers from the Hong Kongcable operator) amounted to 45%

Narrowband market share for new competitors wasabout 28% of the total market

Regulation Background Results

ADeregulation Case Study Hong Kong (1/2)

The market liberalization has led to substantial competition and the regulatorstarted to review its policy in 2003

Type II interconnection policy was introduced in 1995

Type II interconnection is interconnection to afixed carrier's network at the customer accessnetwork level

The policy made unbundling for the incumbent(PCCW-HKT Telephone Ltd.) mandatory butrequired regulatory intervention only if commercialnegotiations failed

The policy mainly applied to three new entrants:

Wharf T&T Ltd.

New World Communications Ltd.

Hutchison Global Communications Ltd.

New competitors entering the market from 2003 were

not eligible for Type II interconnection as of right (i.e.Hong Kong Broadband Network)

Source: Hong Kong Legislative Council Brief (2004)

The Telecommunication Authority found that the continuation of mandatory access was justified only ifbenefits from facilitating competition and consumer choice would outweigh detriments arising fromdampening of incentives for investment in network infrastructure and began to review its policy in 2003


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The outcome of the policy review induced the Telecommunications Authorityto decide in favor of a regulation fade-out

A

Implications

Source: Hong Kong Legislative Council Brief (2004)

End regulation immediatelyContinue regulation

Discourage furtherinvestments into advancedtelecommunications networks

High level of servicescompetition and enhancedcustomer choice

Total withdrawal would meanthat around 400 000 customerswould be forced to switch toanother telecommunicationsprovider

Competitors relying oninterconnection would be forcedto invest immediately

Regulation fade-out

A regulation fade-out wouldmean that customers could facea reduction of choices in theshort to mid-term

In the medium to long term, theaccelerated rollout of networksshould more than compensate75%-80% of consumers

Analysis

Options

Decision

The interconnection rules were only partially responsible for the development of the market The infrastructure on which interconnection is based has limitations concerning future services Additional investments into new infrastructure should be stimulated to keep Hong Kong's leading

edge

The Hong Kong Telecommunication Authority has chosen to fade-out interconnection until 2008 This fade out is limited to buildings which are connected by two alternative networks The Telecommunications Authority hopes that this policy will give both incumbents and competitors

incentives for further investments into advanced networks

Deregulation Case Study Hong Kong (2/2)


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In Canada deregulation is discussed with respect to local exchange anddigital broadband services

ADeregulation Case Study Canada

The regulatory body CRTC* opened a proceeding in April 2005 to determine the framework and the criteria for aframework for forbearance from the regulation of residential and business local exchange services.The proceeding covers the following issues:

1) the local exchange services that should be within the scope2) the relevant market(s) with respect to services and geographic areas3) the criteria to be applied to determine whether the relevant market(s) is/are sufficiently competitive for

forbearance4) the appropriate scope of the Commission's forbearance from its powers and duties5) post-forbearance criteria and conditions6) the process for future applications for forbearance from the regulation of local exchange services

In addition the CRTC intends to determine whether there should be a transitional regime that provides ILECs withmore regulatory flexibility prior to forbearance through:

1) lessening or removing competitive safeguards on promotions and the no-contact restriction under thewinback rules

2) permitting the ex parte filing of tariff applications for promotions3) the waiving of service charges for residential local winbacks

Forbearance ofregulation of localexchange services

Telecom Public NoticeCRTC 2005-2

Canada

Details

Source: CRTC, Arthur D. Little analysis

Intention of

Deregulation

Framework forforbearance of highspeed intra-exchangedigital services

Telecom Public NoticeCRTC 2005-8

The CRTC opened a proceeding in June 2005 to establish the framework and the criteria for forbearance from

regulation of intra-exchange high-speed digital services (HSDS). The proceeding covers the following issues:the definition of intra-exchange HSDS;

1. the relevant market(s) with respect to services and geographic areas2. the qualitative and quantitative criteria for determining market power3. the scope of the Commission's forbearance from its powers and duties4. the process to consider future applications for forbearance of intra-exchange HSDS5. post-forbearance criteria, conditions or safeguards

*Canadian Radio-television and Telecommunications Commission

adl deregulation final full version

Documents