Dispute between TalkTalk and Openreach relating to single jumpered MPF: Provisional Conclusions

TalkTalk response

Non-confidential version

October 2013

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Table of Contents

1 Introduction and summary .............................................................................. 2

2 Ofcom’s cost assessment ................................................................................. 3 2.1 Ofcom’s model assumptions ................................................................................ 3

2.1.1 Volume assumptions ............................................................................................ 3 2.1.2 Which exchanges should SJ-MPF be deployed in................................................. 4 2.1.3 ‘Top up’ strategy................................................................................................... 5 2.1.4 Usable spare capacity on DJ-MPF TAM / tie cables ............................................. 5 2.1.5 Survey costs .......................................................................................................... 6 2.1.6 Test head .............................................................................................................. 6 2.1.7 Master controller ................................................................................................. 7 2.1.8 Jumper installation / removal .............................................................................. 7 2.1.9 Frame cost ............................................................................................................ 9 2.1.10 Valuation assumptions ..................................................................................... 10 2.1.11 Conclusion ........................................................................................................ 10

2.2 Other considerations ......................................................................................... 10

3 Openreach’s conduct ...................................................................................... 12 3.1 Appropriate start date ....................................................................................... 12 3.2 Openreach’s assessment of whether was request was reasonable ...................... 13 3.3 Other points ...................................................................................................... 16

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1 Introduction and summary

1.1 This is TalkTalk Group’s (TTG) response to Ofcom’s Provisional Conclusions in respect of the Dispute between TalkTalk and Openreach relating to single jumpered MPF. Our key points are as follows

1.2 Though we agree with the overall approach we disagree with a number of assumptions that Ofcom has made. The key errors that Ofcom has made are (and suggested corrections) are:

Start date for development of SJ-MPF should be based on when the SOR was rejected not when the dispute determination is published since the key question is whether the request was reasonable and thus whether Openreach should have developed SJ-MPF when requested. The impact is this is to increase the NPV by £14m

Deploying SJ-MPF in exchange type 3 is value destroying (i.e. reduces NPV from introducing SJ-MPF). Deploying only in exchange type 1 and 2 increases the NPV by £6m

Assuming, in line with practical barriers, that it will not be possible to fill 100% of unused capacity on existing TAMs since some capacity is genuinely unusable. Increase in NPV of £5m

No need for additional test head in each exchange where SJ-MPF is deployed. Increase in NPV of £3m

No need for additional master controller in each exchange where SJ-MPF is deployed. Increase in NPV of £2m

Cost of jumper installation/removal increased from about £2 to £3.20 in line with evidence from previous dispute. Increase in NPV of £1m

Saving on incremental frame costs increased from £1 to £2.90 to be consistent with the incremental frame cost resulting from additional jumper used in 2013 LLU/WLR Charge Control. Increase in NPV of £7m

Inclusion of value from cash flows after year 7. Increase in NPV of £8m

1.3 If all these errors are corrected the financial case for SJ-MPF is very strong with an positive NPV of £81m1.

1.4 In addition we consider that Openreach’s did not properly assess whether SJ-MPF was a reasonable requests and is thus in breach of its regulatory obligations. Despite its clear obligation to properly assess whether TalkTalk’s request was reasonable and having access to information and evidence regarding the appropriate approach to

1 In this case it is worth deploying SJ-MPF in exchange type 3 exchanges since it is lower cost this will

increase the NPV. The impact of all the changes together is not simply the sum of all the differences due to the way the calculations work

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assess the request, Openreach’s model to assess the cost saving from SJ-MPF was error-strewn and not fit-for-purpose.

2 Ofcom’s cost assessment

2.1 In this dispute Ofcom has developed a model that properly (with a few important exceptions) assesses the case for Openreach to introduce a SJ-MPF product based on a detailed analysis of the different costs2. This is plainly the appropriate approach to adopt in assessing whether TalkTalk’s request was reasonable and whether Openreach should have developed SJ-MPF.

2.2 We broadly agree with Ofcom’s overall approach and particularly:

Based on the overall cost impact on Openreach and CPs using MPF

Compares the incremental costs of deploying MPF lines using a SJ-MPF configuration rather than DJ-MPF configuration

Exclude revenues (since they are merely cost transfers) and reallocations of costs (since they do not affect incremental costs)

The costs that differ include TAMs, master controllers, racks, test heads, tie cables, frame and jumper install/removal

2.3 With a few differences this is principally the same approach that TalkTalk adopted (though is very different to the approach that Openreach adopted – see §3.7 below).

2.4 Though we agree with the overall approach we disagree with a number of assumptions that Ofcom has made which we explain in section 2.1. In section 2.2 we discuss other factors that might be taken into account in assessing whether the request was reasonable – we consider that these factors provide additional reasons for developing SJ-MPF.

2.1 Ofcom’s model assumptions

2.5 We consider that Ofcom should make a number of amendments to the key assumptions that it uses in its modelling (regarding volumes, equipment counts, unit cost and valuation approach/parameters). We describe these below.

2.1.1 Volume assumptions

2.6 Ofcom has assumed that since the dispute will likely conclude in December 2013 and there will be a 18 month lead time that SJ-MPF will be first deployed from July 20153. We see two errors in Ofcom’s assumption.

2 This approach is in contrast to Ofcom’s review of SJ-MPF in the 2012 LLU/WLR Charge Control which

even after many months of work was inconclusive 3 Ofcom say it is Q2 2015/16 which equates to Jul-Sept 2015 (§A2.31)

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2.7 We consider that the appropriate start time should be based on when Openreach would have launched SJ-MPF if it had not rejected the SOR (see §3.2 below). We think that the appropriate start date is therefore August 2013:

Given the SOR was submitted in May 2012 and Openreach have 60 days to respond they could have started development in August 2012 (particularly since they were well aware of the product requirement).

12 months is ample time to complete the development and start deploying MPF lines onto SJ-MPF TAMs

Openreach were well aware of the product before May 2012 given that it had been subject to a previous SOR and analysis in the context of the 2012 LLU/WLR Charge Control

EMP development could be completed in 9 months. From the go-ahead decision Openreach developed PCP-only GEA in 9 months which is arguably more complex

The deployment of TAM / tie cables for SJ-MPF could be planned and installed in parallel to EMP development

As we have previously described the development required by CPs is minimal

2.8 Accordingly, Ofcom’s model should assume that SJ-MPF will be first deployed from August 2013. Using this assumption will approximately increase the NPV by £14m4 (all else equal i.e. using Ofcom base case assumptions) since the volumes over the valuation period will be higher.

2.1.2 Which exchanges should SJ-MPF be deployed in

2.9 Ofcom has rightly made a sensible improvement to TalkTalk’s model in that it allows SJ-MPF to be not deployed in certain (smaller) exchanges – see §2.19.2.5 This will allow a more reliable estimate of the costs savings since otherwise the model would include exchanges where deploying SJ-MPF resulted in a net cost increase i.e. value destroying.

2.10 However, we note that based on Ofcom’s base case assumptions it is ‘value destroying’ to deploy SJ-MPF in type 3 exchanges since the NPV is higher if SJ-MPF is not deployed in these exchanges6. The increase in NPV from not deploying in exchange area 3 (all else equal) is about £6m.

2.11 We note that Ofcom has assumed that SJ-MPF will not be deployed in new exchanges (since they are smaller). In fact the case to deploy SJ-MPF in new

4 Using the model that Ofcom published (which included some numbers redacted) we have

‘reconstructed the model so that it gives an NPV equal to that for Ofcom’s working model. We have then flexed our model to derive changes in NPV under different assumptions 5 although a change to TalkTalk’s model to allow this functionality could have been done in a few

minutes 6 Done by setting cell C44 to zero

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exchanges is strongest since there is no existing estate (TAM, tie cables, master controller, test head, racks etc) that can be leveraged and so net cost savings from SJ0MPF are higher. The cost saving (in NPV terms) per line in new exchanges where there will be 200 or more MPF lines per operator using SJ-MPF (only) rather than DJ-MPF (only) is about £15-20 per line (in NPV terms). Including these exchanges would increase the NPV from introducing SJ-MPF.

2.1.3 ‘Top up’ strategy

2.12 Ofcom has made the assumption that from the assumed start date for SJ-MPF (July 2015), though net adds could be deployed on SJ-MPF these new lines will be deployed on existing TAMs / tie cables (used for DJ-MPF) since there will be spare capacity on these existing TAMs / tie cables.

The model makes an assumption about how much spare capacity there exists on DJ-MPF TAMs, which from an industry wide efficiency perspective should be fully utilised before considering alternative methods of provision. (A2.38)

2.13 This is not necessarily correct. Even if there is existing unused TAM capacity (which can effectively be used for ‘free’) it may still be lower cost overall to deploy the lines on SJ-MPF given the cost savings on the frame (and lower connection / disconnection costs). Therefore, Ofcom should adapt its models to reflect that the additional lines can be deployed in two different ways (and obviously select the option that is lowest cost).

2.14 We have not modelled the impact of this – the impact is either no change or an increase to the NPV of SJ-MPF.

2.1.4 Usable spare capacity on DJ-MPF TAM / tie cables

2.15 As described above even if SJ-MPF is deployed in a particular exchange it may be lower cost to deploy the lines on spare capacity on existing TAMs / tie cables (used for DJ-MPF). As we explain above this might not be the lowest cost strategy. However, in the case that it is assumed that the existing capacity is used a critical assumption is how much capacity is spare and usable.

2.16 Ofcom has assumed that when SJ-MPF starts utilisation of DJ-MPF TAMs / tie cables will be 90%. Ofcom then go on to assume that the unused 10% can be fully and immediately used for the additional lines. This assumption is not correct.

2.17 There are two main reasons why utilisation is normally less than 100%:

The equipment (particularly TAM) is bought in modules of 200 lines each so it is impossible in most cases to have 100% utilisation (see §A2.55) – we refer to this as modularity

Certain lines on a TAM are unusable since, for instance, there are left in jumpers (due to stopped lines) or certain ports are faulty

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2.18 It appears that the second reason is the prevalent reason for low utilisation:

Given the TAM size is 200 lines one would expect on average that there to be 100 unused lines in each exchange (i.e. 50% of the total capacity) due to the modularity issue

Yet according to Ofcom’s model the number of spare lines in exchange type 1 is 1,154 lines and in exchange type 2 lines is 514

This implies that the majority of the unused capacity is due to lines being unusable rather than due to modularity

2.19 Under a top-up strategy the under utilisation due to modularity can be fully overcome (since the TAMs can be topped up to their full usable capacity). However, it would not be possible to achieve the 100% utilisation on the existing DJ-MPF estate unless the unusable ports were brought back into service. This will though involve costs (e.g. left in jumper clear up programme or faulty port repair) and the cost of this is not included. Therefore, it is not realistic to assume 100% utilisation unless the costs of making the currently unusable ports usable is also included.

2.20 We have changed the model to assume that amount of usable spare capacity is 100 lines per exchange (i.e. 50% of the 200 line module) i.e. that the under-utilisation due to modularity is overcome but that unusable ports remain unusable. The impact of this is to increase the NPV from deploying SJ-MPF by £5m.

2.21 More generally we note that Ofcom assumes that up to 99% of TAM capacity can be used. We think a more realistic utilisation assumption would be to assume that the maximum utilisation on TAM / tie cables is say 90% (aside of low utilisation due to modularity) on all TAMs / tie cables e.g. existing and new. This will mean there will be higher utilisation on the existing TAMs / tie cables (since won’t suffer from modularity) but the utilisation will not be unrealistically high. Further, it cannot be assumed that the DJ-MPF TAM / tie cable estate immediately reaches this utilisation level since it will take some time.

2.1.5 Survey costs

2.22 It appears that the cost of survey for new TAM, tie cables, racks etc is reflected through a higher cost for ‘new build’ TAMs (as against growth TAMs). It would be useful to break out the cost for this separately and to ensure that survey costs are not included elsewhere (i.e. double counting). We note that Openreach suggests (§A2.88) that survey costs would be higher for SJ-MPF TAMs since DJ-MPF TAMs are located near the MDF whereas SJ-MPF TAMs can be located anywhere. We don’t think this will result in higher survey costs for SJ-MPF TAMs since SJ-MPF TAMs could be located near the MDF (they could also, if lower cost, be located elsewhere).

2.1.6 Test head

2.23 Ofcom assumes that a new test head is required in every exchange where SJ-MPF is deployed (whereas these lines if put on DJ-MPF can use the existing test head

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provided it does not reach its 5,000 line capacity) (§A2.78). The cost of these additional test heads is close to £3.0m7 (NPV). We do not understand why a new test head is required. A test head is agnostic to the cabling arrangements and the same test head is able to test lines using SJ-MPF TAMs as well as lines using DJ-MPF TAMs. Ofcom have not presented any evidence or explanation to support its claim (and nor has Openreach who never mentioned this during the discussions).

2.24 If this is changed the NPV would increase by about £3m.

2.1.7 Master controller

2.25 Ofcom assumes that a master controller is required in every exchange where SJ-MPF is deployed (whereas these lines if put on DJ-MPF can use the existing master controller, provided it does not reach its capacity) (§A1.50). The cost of this is close to £1.9m8 (NPV). We do not understand why a new master controller is required.

2.26 Ofcom have not presented any evidence or explanation to support its position (and though Openreach made the same claim before they never provided any explanation9).

2.27 If this is changed the NPV would increase by about £2m.

2.1.8 Jumper installation / removal

2.28 A major saving resulting from SJ-MPF is the fact that only a single jumper needs to be installed (or removed). There are three important assumptions in deriving the saving:

The level of churn which affects the number of connections and disconnections

The number of jumper activities (i.e. installations or removals) per connection / disconnection

The saving per jumper activity

2.29 We agree with Ofcom’s 15% churn assumption.

2.30 With regard to the number of jumper activities, Ofcom has assumed:

0.80 jumper activities per connection (§A2.4). This reflects that though most connections onto SJ-MPF (90%) involve one less jumper than onto DJ-MPF

7 £3.0m is the difference in test head costs which reflects the additional test heads for SJ-MPF less the

small number of additional test heads that would be required under DJ-MPF. Thus the cost of the additional test heads for SJ-MPF is close to £3.0m 8 £1.9m is the difference in master controller costs which reflects the additional master controllers for

SJ-MPF less the small number of additional master controllers that would be required under DJ-MPF. Thus the cost of the additional master controllers for SJ-MPF is close to £1.9m 9 TalkTalk’s model included an extra master controller when SJ-MPF was deployed. However, we did

not agree with Openreach’s claim (see TalkTalk dispute submission §6.49)

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some connections onto SJ-MPF require one more jumper10. The cases where one more jumper is required are where the connection is from DJ-MPF of a different CP (stopped line, WLTO, migration). However, these connections from other MPF CPs will in time increasingly not be from DJ-MPF but rather from SJ-MPF (as the prevalence of SJ-MPF increases)11. If the connection is from SJ-MPF then there will be one less jumper activity required (rather than one more). Thus the ratio will increase towards 1.0 over time particularly since SJ-MPF lines will tend to be recycled to SJ-MPF (and DJ-MPF recycled to DJ-MPF).

0.35 jumper removals per disconnection (§A2.171). This reflects that Ofcom assumes that in the case of a stopped line no jumpering work is carried out and that in the case of lines that migrate to MPF the reduction in jumpering activity has already been captured in the connections. However, Ofcom’s approach underestimates the jumper activities per disconnection:

as Ofcom itself recognises (§A2.170, §A1.13), there will be ‘clean-ups’ that will involve jumper removal

the reduction in jumpering activity will only be captured in the connections if it is assumed that not all migrations from MPF to SJ-MPF are from DJ-MPF. However, Ofcom has assumed (see above) that all migration from MPF are from DJ-MPF in its assumption for jumper activities per connection (see above and footnote)

2.31 With regard to the cost per jumper installation / removal activity it appears from our approximate model that Ofcom has used a incremental cost figure of about £2.00 to £2.50. We think that this is too low. In the WLR/SMPF SIMprovide dispute12 Ofcom provided a range for the CCA FAC cost per jumper of £3.16-£3.8013. Given that the LRIC cost is the vast majority of the FAC cost for migration (93% was used in 2013 LLU/WLR charge control at §6.163) then, using a mid-point the LRIC cost per jumper is about £3.20.

2.32 The impact of using the £3.20 figure is to increase the NPV by about £1m.

10

Ofcom is correct (§A2.82) to ignore the scenario where there are three more jumpers which is restart of a stopped DJ-MPF line since these lines would always be restarted on DJ-MPF and not SJ-MPF since the DJ-MPF estate is retained 11

That the connection will increasingly be from SJ-MPF is the corollary of assuming no jumper activity on disconnection where the line moves from SJ-MPF 12

Dispute between BT and TalkTalk relating to MPF to WLR + SMPF simultaneous migration offer. http://stakeholders.ofcom.org.uk/binaries/enforcement/competition-bulletins/closed-cases/all-closed-cases/cw_01097/Final_Determination_Non_Con1.pdf 13

The cost per jumper is certainly not excessive since the LRIC cost of connections is about [[£25]] and they involve on average 3 to 4 jumper installs/removals suggesting that the jumper install/removal cost is only 50% of the total LRIC cost.

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2.1.9 Frame cost

2.33 A major saving resulting from SJ-MPF is the fact that only a single jumper is used on the frame rather than two. Therefore, the assumption for incremental cost saving due to SJ-MPF is important.

2.34 There are a number of costs/activities to the frame:

Capex: MDF ironwork, blocks, ladders, lighting

Opex: accommodation, power, repair/maintenance (of MDF and of jumpers)

2.35 Ofcom (and Openreach) considers that the only capex costs that are incremental are the blocks (see §A2.186 and §A2.192) – this appears to be about equivalent to an annual cost of £0.10 per line14. Ofcom are rather vague as to what opex items might be incremental though they ultimately conclude that £1 is incremental and should be included in the analysis (see §A2.197). Thus Ofcom assumes in effect the incremental frame saving is £1.10 per year.

2.36 We think this assumption is incorrect for two reasons: first it is inconsistent with the assumption used for incremental frame cost in the LLU/WLR charge control and second it is inconsistent with other evidence.

2.37 Both this provisional conclusion regarding the SJ-MPF dispute and the provisional LLU/WLR charge control purport to make an estimate for the long run incremental frame cost of one more/one less jumper. In the case of the LLU/WLR charge control the incremental cost figure is used to determine the difference in incremental cost of MPF due to it being double jumpered (as against WLR which is single jumpered) and here we are determining the difference in the incremental costs if MPF moved from double jumpering to single jumpering. However, in the LLU/WLR Charge Control the incremental cost is about £2.9015 yet here it is £1.10. There is no justification for this difference.

2.38 Ofcom’s conclusion here is also contrary to the CVE evidence. Ofcom says that the CVE is a reasonable proxy for the LRIC/FAC ratio (see footnote 7216). The CVE for Local exchanges general frames capital is 0.93 and Local exchanges general frames current is 0.94. Thus on Ofcom’s own analysis the frame saving should be £2.94 ( = £1.80 x 93% + £1.35 x 94% )

2.39 If the same assumption that is used in the LLU/WLR charge control (~£2.94) is used in the case of assessing SJ-MPF then the NPV saving increases by about £7m.

2.40 []

14

Given that the frame cost is £1 per line and results in an NPV saving of £3.6m whereas the NPV of the block cost saving is £0.4m 15

Though Ofcom is not explicit about the LRIC for frame in the LLU/WLR charge control it can be implied that the LRIC is 90% to 95% of the FAC and the FAC in 2013/14 is £3.13 (Table A2.10) 16

Same comment made in LLU/WLR Charge Control §3.197: “… it should be noted that the CVEs and AVEs used in the cost model are derived from LRIC to FAC ratios”

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2.1.10 Valuation assumptions

2.41 We agree that the right approach to assess the savings is using an NPV approach.

2.42 Ofcom has used a base case valuation period of 7 years and run sensitivities for various periods less than this. We have two comments on this.

2.43 First, the valuation should reflect that there will be value beyond year 7 (rather than truncating it). Though the TAM/tie cable equipment may need replacing after 7 or more years the cost of replacement equipment under DJ-MPF and SJ-MPF is similar. Yet SJ-MPF will deliver continuing cost saving from lower frame costs and lower connection / disconnection costs (compared to DJ-MPF). We do not consider there is any sound reason to ignore this cost saving17. If cash flows were considered to remain constant after year 7 then the terminal value could be estimated at 11 times the last year cash flow ( = 1 / 8.8%). Using a conservative assumption of a terminal value multiplier of 6 times would increase the NPV by £8m

2.44 Given that, as Ofcom highlights (§A2.144), TAMs last for more than 7 years and other equipment also last for more than 7 years, a period of more than 7 years should be the base case and sensitivities run above and below this.

2.45 We agree with using the 8.8% discount rate since the majority of the costs incurred are part of Openreach.

2.1.11 Conclusion

2.46 Though we broadly agree with Ofcom’s overall modelling approach we consider there are a number of significant errors that should be corrected.

2.2 Other considerations

2.47 Though the conclusion as to whether SJ-MPF should be developed rests principally on whether there is a net cost saving (i.e. positive NPV) there are a number of other considerations that are relevant that might (in the case the cost analysis is inconclusive) swing the decision one way or another. Our view on these is given below – we consider that taken together these reasons provide greater reason to develop SJ-MPF rather than to not develop SJ-MPF.

2.48 Deploying SJ-MPF will (based on TalkTalk’s analysis that there is a material cost saving) result in a number of dynamic efficiency benefits (some of which Ofcom has recognised):

17

In TalkTalk’s original model the model was truncated at 7 years. This was, in part, because the exclusion of future years did not make a large difference to the outcome since the value was so clearly positive. However, the correct approach is to not truncate the valuation. In any case, Ofcom is not in any way bound to follow what TalkTalk or Openreach have done and instead should adopt what it considers is the most appropriate assumption

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Less distorted competition and a more level playing field as between MPF and WLR providers leading to stronger merits based competition (§3.18)

As a result of increased competition there will be increased pressure on other (non-MPF) operators to lower their costs and prices to consumers

Reduced costs will make more exchange unbundling viable and so increase investment and competition – this is particularly the case since in new exchanges SJ-MPF provides an even greater costs saving since there is no existing ‘sunk’ TAM, tie cable equipment that can be used for free for DJ-MPF. We estimate that the saving per MPF lines is about £15 to £20 (NPV equivalent) in new exchanges

Possible increase in service innovation

2.49 Deploying SJ-MPF will also have a number of other benefits:

Small increase in demand for MPF/WLR lines (in aggregate) and for broadband

There will be fewer faults which will (in addition to the cost saving for Openreach which is reflected in the model) reduce costs for CPs and consumers – we describe below why this reduction in faults will not be offset by an increase in faults due to complexity

Requiring Openreach to develop SJ-MPF will create better incentives for Openreach’s future compliance and make clear that it cannot discriminate in its product development against the interests of consumers (see section 3.2)

2.50 Ofcom suggests that there may be some downsides that are not reflected in the costing analysis. We think these are mostly irrelevant, trivial and/or exaggerated:

Ofcom suggests that there is an asymmetric risk to Openreach (§A3.40). Though there is some risk it is trivial since:

The risk will not be asymmetric provided that he projections are the ‘mid-case’ and, we believe, they are

Apart from the development spend (which is about £1.3m) most of the exchange equipment expenditure (e.g. TAMs and test heads) is made in response to firm demand from CPs so most of the expenditure is not ‘at risk’

In the case of SJ-MPF, any risk in respect of most of the exchanges equipment (e.g. TAMs) will be born by CPs and not Openreach. Under DJ-MPF Openreach purchase the TAMs and CPs ‘purchase’ on a per line basis meaning that Openreach bear the risk. Under SJ-MPF CPs effectively purchase the TAMs and Openreach does not bear the risk. Thus the risk for Openreach is actually lower under for SJ-MPF than today under DJ-MPF

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Openreach is compensated for the risk it takes since its prices include a return on capital at 8.8% (which is double the risk free rate18)

The impact on other EMP developments is overplayed. A competent operator would be able to reschedule the content of releases with little trouble and we doubt whether there are other EMP releases that are more valuable that this development. Openreach have not provided any evidence to suggest that there will be any difficulty quickly implementing SJ-MPF in EMP. It is notable that in the past they have implemented regulatory ‘asks’ quickly.

Ofcom suggests (§3.23.1) that an additional product/process will lead to more engineering training. This is highly unlikely since a ‘job’ the engineer receives involves a number of instructions for jumper installs/removes. The work they do is agnostic to the actual product they are moving from/to (they do not know which product they the jumpers installs/removes are for). Thus the ‘complexity’ of the additional product is born by the system and the engineer is in practice unaffected. Further, it is notable that Openreach manages a range of provisioning products today e.g. for MPF only and ignoring bulk variations: MPF New Provide, MPF Connection (from MPF), MPF Connection (from WLR), MPF Connection (from WLR+SMPF), MPF Cease, MPF Working Line Takeover, MPF Stopped Line Restart. There has never been a suggestion from Openreach that this adds complexity or difficulty for engineers (because it doesn’t)

Ofcom suggests (§3.23.2, §A2.187.4) that an additional product/process will increase complexity and lead to higher faults (during provision). There is no explanation or evidence to support this assertion. In any case, as explained above the complexity is managed by the systems and there is a large degree of complexity today that has never been suggested leads to faults.

3 Openreach’s conduct

3.1 In this section we comment on Openreach’s conduct and behaviour during the assessment of the SOR and in the process leading up to the dispute and the implications that it has on the start date to be used in the cost analysis and Openreach’s (or legally BT’s) compliance with FAA1 and FAA2.

3.1 Appropriate start date

3.2 We have serious concerns about Ofcom’s proposal to use a start date of July 2015 in its costs model. This date is based on Openreach starting to develop the product following the determination of this dispute. The start date is critical since there are declining numbers of MPF net adds (as a result of the market maturing) that could be deployed on a SJ-MPF configuration and therefore a later start results in fewer lines on SJ-MPF and a lower cost saving. As we explain above (at §2.8) solely changing this assumption in Ofcom’s model changes the NPV from –£4.7m to + £9.5m. In other

18

current WACC is 8.8% from 2012 LLU/WLR Charge Control which was based on a real risk free rate of 1.4% and inflation of 3% i.e. nominal risk free rate is 4.4%

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words in this case, if a start date at request refusal is assumed there is a positive NPV (implying that the request was reasonable) whereas if a start date after dispute determination is assumed the NPV is negative (implying that he request was not reasonable). Thus the start date is very critical.

3.3 As set out in our original dispute submission, TalkTalk submitted its statement of requirements at the beginning of May 2012. Openreach rejected the statement of requirements in July 2012. The subject of this dispute is whether that rejection in July 2012 was consistent with BT’s regulatory obligations which include:

FAA1.1 Where a Third Party reasonably requests in writing Network Access, the Dominant Provider shall provide that Network Access. The Dominant Provider shall also provide such Network Access as Ofcom may from time to time direct.

FAA1.2 The provision of Network Access in accordance with paragraph FAA1.1 above shall occur as soon as it is reasonably practicable and shall be provided on fair and reasonable terms, conditions and charges and on such terms, conditions and charges as Ofcom may from time to time direct.

3.4 The key question in this dispute is whether TalkTalk’s SOR was a ‘reasonable request’. If it was a reasonable request (when it was requested) then to be in compliance with its obligations Openreach should have provided SJ-MPF as soon as reasonably practicable. The logic of the obligation is straightforward – if the request is reasonable Openreach shall develop the product. The obligation is not that Openreach need only develop the product following an Ofcom direction.

3.5 Therefore, the cost analysis must be based on whether the request was reasonable at the point that the request was made/rejected. Accordingly, the cost analysis must be based on the presumption that Openreach started development in July 2012 when it rejected the request19. A further reason for using the request rejection date is that if the dispute determination date it used as the start point it creates perverse and harmful incentives on BT to delay and prevaricate (see §3.12 below).

3.2 Openreach’s assessment of whether was request was reasonable

3.6 In considering whether TalkTalk’s request was a reasonable one it is relevant to consider Openreach’s behaviour through the various discussions and specifically what concrete steps Openreach itself took to establish whether it was a reasonable request.

3.7 It is relevant context that Openreach’s / BT’s incentives are to not develop SJ-MPF. The costs savings from SJ-MPF would be mostly passed through to CPs (who use SJ-MPF) and consumers meaning that Openreach would not see a material increase in its margins. Further, since only BT’s downstream rivals would enjoy the cost saving this would competitively disadvantage BT.

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The subject of the dispute is not about whether Openreach should in future develop SJ-MPF (though that may be relevant to the question of remedy).

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3.8 As Ofcom is aware there were many discussions through 2012 regarding SJ-MPF (and indeed there had been SORs and discussions previously in 2010 and 2011). Throughout the discussion in 2012 (as per the documentation supplied with the dispute submission) TalkTalk continuously sought to gain a better understanding of why Openreach did not consider TalkTalk’s request reasonable and had rejected TalkTalk’s request for a single jumpering product to be developed. Despite these repeated requests from TalkTalk (see emails from August 2012 to December 2012), Openreach refused to disclose significant and important details about its own model and continued to assert that their model showed a negative NPV value.

3.9 However, when Ofcom analysed Openreach’s model as part of its dispute investigation it became apparent that the model20 was error-strewn and not fit-for-purpose. In particular, Ofcom concludes that Openreach models were inappropriate for assessing whether the request was reasonable for a number of reasons:

Openreach’s model incorrectly included common costs which were not incremental. TalkTalk had made clear to Openreach early on that it was only appropriate to include incremental costs21. As Ofcom noted:

“[Openreach’s] model was of limited use for our purposes. In particular, it did not assess the incremental cash costs of providing SJ-MPF services. All estimated charges were based on FAC including a cost of capital” (see §A2.11).

Openreach’s model incorrectly included revenue impacts. TalkTalk had made clear to Openreach early on that it was only appropriate to include incremental costs and that revenue impacts were irrelevant (since a society wide impact was appropriate) 22. As Ofcom noted:

“We consider that [Openreach’s] model is also of limited use for our purposes. As noted in paragraph 3.14 in Section 3 in the Provisional Conclusions document we do not consider it appropriate to consider prospective revenue impacts …” (see §2.15).

Openreach’s model significantly overstated the costs of TAMs for SJ-MPF – the modelling error that led to this was so basic it either demonstrates significant incompetence, wilful negligence or intentional error. As Ofcom noted:

“… Openreach model overstated the impact of demand growth on the costs of SJ-MPF significantly” (see §A2.15).

“Under DJ-MPF, future TAM equipment volumes were calculated by taking total demand and dividing it by the average size of unit to be installed, assumed to be a 400 port TAM (i.e. a standard TAM with two 200 port TASMs). This effectively assumed utilisation will be close to 100% for most sites. In contrast, equipment volumes under SJ-MPF were calculated assuming that a 400 port standard TAM (or 392 port evoTAM) would be installed at each site every year. This was on the basis that additional demand per site per annum was over 200 ports (but less than 400).

This latter assumption leads to significant assumed overcapacity in the long run …” (see §A2.16, §A2.17)

20

There were two different models that did different things – see §§2.4.2, 2.4.3 21

See email Andrew Heaney to Bob Lee 12/9/12 page 2 22

See email Andrew Heaney to Bob Lee 12/9/12 page 1

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Openreach’s model incorrectly ignored the opportunity to top-up i.e. use existing DJ-MPF TAM assets:

“The Openreach models did not include any explicit or implicit assumption about the topping-up of DJ-MPF assets” (see §A2.138).

Throughout our discussions Openreach insisted that evoTAMs rather than standard TAMs should be used for SJ-MPF even though it now transpires that they are significantly more expensive and would introduce delay (and Openreach knew this at the time): “… In Openreach’s models evoTASMs are considerably more expensive” (see § A2.179). Accordingly, Ofcom concluded that in fact:

“therefore, whilst the model is set-up to test the cost impact of utilising an evoTASM based SJ-MPF solution, we do not consider it appropriate for any of our scenarios. We have instead favoured a standard TASM in all the Ofcom scenarios” see §A2.181.

Openreach’s model did not include different geo-types. Further, it assumes that SJ-MPF would only be deployed in a limited number of exchanges though it is not clear how these exchanges were chosen (§A2.12, §A2.19.2)

In one of Openreach’s models they excluded any frame cost savings (§A2.185)

Openreach wrongly assumed connections equalled net adds (§A2.14.2)

Openreach had not carried out any feasibility study even though it had ample opportunity and reason to do so (§A2.121)

3.10 Thus Openreach’s model was not remotely adequate for assessing whether TalkTalk’s request was reasonable. Importantly, there was no good reason for Openreach to have adopted such a flawed method and assumptions – it had available all the information it needed to correctly assess TalkTalk’s request. TalkTalk had provided a model which for the most part used appropriate assumptions insofar as they were available to TalkTalk23.

3.11 Further, in the case of most of the errors described above, TalkTalk had either pointed out Openreach’s error to them (if they had told us what they had done) or Openreach had full access TalkTalk’s model and therefore had ample opportunity to decide whether its own approach was reasonable. Openreach exacerbated its problem by refusing to disclose its method or assumptions through for instance, describing its model in meaningful terms or providing a dummy excel model with commercially sensitive inputs redacted (as Ofcom has done). If it had done this TalkTalk could have highlighted to Openreach the simple mistakes Openreach had made.

3.12 A number of conclusions can be drawn regarding Openreach’s behaviour:

Openreach’s assessment of whether TalkTalk’s request was reasonable displayed a fundamental lack of basic cost modelling competence. The errors

23

The unit costs figures were not accurate since Openreach refused to disclose these. In any case, Openreach has these figures so the lack of accurate figures in TalkTalk’s model does not mean that Openreach were hampered in any way

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found by Ofcom were by no means minor or the result of judgment calls between different equally valid assumptions. Rather they were fundamentally and objectively wrong.

The only possible alternative explanations to one of incompetence is either negligence or that the mistakes were intentional

It therefore seems to us that the individuals in Openreach involved in the assessment and negotiations with TalkTalk did so without their facts and calculations being overseen or checked by senior management or colleagues with appropriate knowledge and expertise. TalkTalk cannot speculate how Openreach management came to allow a flawed model to be used in this matter given Openreach’s clear regulatory obligations. However, it clearly shows that Openreach did not have in place robust governance procedures in place to ensure that it properly assessed whether TalkTalk’s request for single jumpering was a reasonable request under SMP Conditions FAA1.

Not only was Openreach’s assessment inadequate but it did not take easily available and reasonable steps to improve its assessment. In particular, Openreach could have used the correct assumptions that were in TalkTalk’s model and/or engaged in discussions and ‘negotiations’ with TalkTalk which could have helped to identify and overcome it failings. However, it refused to do and did not even disclose its modelling approach.

3.13 In our view these demonstrate clearly that Openreach did not discharge its obligation under FAA1 to properly assess whether TalkTalk’s request was reasonable and if so provide the product.

3.14 The points above also reinforce our position that the appropriate start date for assessing SJ-MPF should be based on what Openreach starting SJ-MPF development at the time it rejected the SOR (in July 2012) rather than assuming SJ-MPF development starts after the final dispute determination. A later start could mean that SJ-MPF has a negative NPV and is not a reasonable request and is not developed advantaging BT (see §3.7 above). Therefore assuming a later start date would have the perverse consequence of actually rewarding Openreach for not properly assessing whether TalkTalk’s requests was reasonable. Indeed, Openreach’s failure to conduct a proper analysis meant that TalkTalk had to pursue months of fruitless negotiations and then submit a dispute to Ofcom with a view to seeking redress.

3.3 Other points

3.15 We note that Openreach rather bizarrely argued at the beginning of the dispute procedure that the only relevant SMP condition was FAA2, which concerns requests for network access. We are pleased that Ofcom has confirmed our understanding of the regulatory framework that SMP Condition FAA2 is a separate and complementary obligation to the access obligations set out in SMP Conditions FAA1 and FAA9. However, in our view, the fact that Openreach insisted that the relevant SMP Condition was FAA2 is yet another indication of the fact that there is a fundamental misunderstanding within Openreach’s senior management (to which

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we count the individuals from Openreach who attended the enquiry-phase meeting) as to the correct interpretation of the SMP Conditions that Ofcom has imposed.

3.16 At Step 4 in its analysis Ofcom assesses whether there was a breach in the way Openreach handled the request.

In Step 4 below we have considered whether there was any breach of FAA2 regarding Openreach’s process in handling the original request and, in light of our provisional conclusion on this question, whether Ofcom should make any declaration setting out the rights and obligations of the Parties in relation to FAA2 under s190 (2)(a) of the Act.

3.17 Ofcom’s assessment of whether there was a breach in Openreach’s handling of the request focuses solely on the question of whether there was a breach of FAA2. However, this is too narrow an interpretation which focuses simply on procedural matters rather than whether Openreach took concrete steps to conduct and then actually conducted the assessment properly. Openreach will have breached FAA1 if it did not properly assess whether the TalkTalk’s request was reasonable. As we have explained above they failed to do that.