dispute between level 3 communications uk limited and bt … · 2016. 8. 25. · dispute between...

Dispute between Level 3 Communications UK Limited and

BT relating to historic partial private circuit charges

This version is non-confidential

Confidential redactions are indicated by []

Final Determination

Issue date: 16 May 2014

[As corrected on 16 July 2014]

Dispute between Level 3 and BT relating to historic PPC charges: final determination

Contents

Section Page 1 Summary 4

2 Introduction and background 7

3 The analytical framework 16

4 Analysis and Provisional Conclusions 25

5 Analysis and conclusions 47

6 Repayments 71

Annex Page 1 Determination to resolve the dispute between BT and Level 3 82

2 Relevant cost measures and terminology 86


Glossary 2008 BCMR Statement: Ofcom’s Review of the retail leased lines, wholesale symmetric broadband origination and wholesale trunk segments markets published 8 December 2008. See: http://stakeholders.ofcom.org.uk/binaries/consultations/bcmr08/summary/bcmr08.pdf 2008 LLCC Consultation: Ofcom’s Leased Lines Charge Control: A new charge control framework for wholesale traditional interface and alternative interface products and services Consultation published 8 December 200. See: http://stakeholders.ofcom.org.uk/binaries/consultations/llcc/summary/leasedlines.pdf 2009 LLCC Statement: Ofcom’s Leased Lines Charge Control: A new charge control framework for wholesale traditional interface and alternative interface products and services Statement published on 2 July 2009. See: http://stakeholders.ofcom.org.uk/binaries/consultations/llcc/statement/llccstatement.pdf 2009 PPC Determinations: Ofcom’s Determinations to resolve disputes between each of Cable Wireless, THUS, Global Crossing, Verizon, Virgin Media and COLT and BT regarding BT’s charges for partial private circuits, Determinations and Explanatory Statement, published 14 October 2009. See: http://stakeholders.ofcom.org.uk/binaries/consultations/draft_deter_ppc/PPC_final_determination.pdf 2013 PPC Determinations: Ofcom’s Determinations to resolve disputes between each of Cable Wireless, THUS, Global Crossing, Verizon, Virgin Media and COLT and BT regarding BT’s charges for partial private circuits, Determinations and Explanatory Statement, published 8 February 2013. See: http://stakeholders.ofcom.org.uk/binaries/consultations/ethernet_services/statement/determination.pdf Alternative interface symmetric broadband origination (AISBO): A form of symmetric broadband origination service providing symmetric capacity between two sites, generally using an Ethernet IEEE 802.3 interface. Additional Financial Information (AFI): Financial information which BT produces in addition to the RFS, provided to Ofcom on a confidential basis. Bandwidth: The physical characteristic of a telecommunications system that indicates the speed at which information can be transferred. In analogue systems, it is measured in cycles per second (Hertz) and in digital systems in bits per second (Bit/s). CAT: Competition Appeal Tribunal CC’s Determination: Competition Commission Reference under section 193 of the Communications Act 2003, Cable & Wireless UK v Office of Communications Case 1112/3/3/09, Determination 30 June 2010. CLZ: Central London Zone Common Costs: See Annex 2.

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http://stakeholders.ofcom.org.uk/binaries/consultations/bcmr08/summary/bcmr08.pdf

http://stakeholders.ofcom.org.uk/binaries/consultations/llcc/summary/leasedlines.pdf

http://stakeholders.ofcom.org.uk/binaries/consultations/llcc/statement/llccstatement.pdf

http://stakeholders.ofcom.org.uk/binaries/consultations/draft_deter_ppc/PPC_final_determination.pdf

http://stakeholders.ofcom.org.uk/binaries/consultations/draft_deter_ppc/PPC_final_determination.pdf

http://stakeholders.ofcom.org.uk/binaries/consultations/ethernet_services/statement/determination.pdf

http://stakeholders.ofcom.org.uk/binaries/consultations/ethernet_services/statement/determination.pdf


Communications Provider (CP): A person who provides an Electronic Communications Network or provides an Electronic Communications Service (as defined by section 32 of the Communications Act 2003). CPL: BT’s Wholesale Carrier Price List. CRF: Common Regulatory Framework. Current Cost Accounting (CCA): See Annex 2. Customer sited handover (CSH): Interconnection occurs at a communications provider’s premises. Dispute periods: The time periods covered by this Dispute: in relation to rental charges for 2 Mbit/s local end charges it is the period between 1 October 2009 and 30 September 2010; and in relation to Type 1 POH additional services charges it is the period between 1 April 2010 and 30 September 2011. Distributed LRIC (DLRIC): See Annex 2. Distributed SAC (DSAC): See Annex 2. Fixed common costs (FCC): See Common costs. Fully allocated cost (FAC): See Annex 2. In-span handover (ISH) Leased line: A permanently connected communications link between two customer premises, or between a customer’s premises and the CP’s network, dedicated to the customers’ exclusive use. Long Run Incremental Cost (LRIC): See Annex 2. Mbit/s: Megabits per second. A measure of speed of transfer of digital information. NCC Guidelines: Network Charge Control Guidelines. Partial Private Circuit (PPC): A generic term used to describe a category of private circuits that terminate at a point of connection between two communications providers’ networks. It is therefore the provision of transmission capacity between a customer’s premises and a point of connection between the two communications providers’ networks. It may also be termed a part leased line. Parties: BT and Level 3. POH Pricing Review Statement: Ofcom’s LLCC PPC Points of Handover pricing review Final Statement on modification of SMP conditions, published 21 September 2011. See: http://stakeholders.ofcom.org.uk/binaries/consultations/revision-points-handover-pricing/statement/final-statement.pdf Point of Handover (POH): A point where one communications provider interconnects with another communications provider for the purposes of connecting their networks to 3rd party customers in order to provide services to those end customers.

2

http://stakeholders.ofcom.org.uk/binaries/consultations/revision-points-handover-pricing/statement/final-statement.pdf



PPC appeal: BT’s appeal of the 2009 Final Determinations. PPC Judgment: The CAT’s judgment disposing of the PPC appeal: British Telecommunications plc v Office of Communication [2011] CAT 5. PPC Court of Appeal Judgment: The Court of Appeal’s judgment in BT’s appeal of the PPC Judgment and the PPC Preliminary Issues Judgment: British Telecommunications plc v Office of Communications [2012] EWCA Civ 1051. Regulatory Financial Statements (RFS): The annual financial statements that BT is required to prepare and publish in order to demonstrate compliance with its regulatory obligations. ROCE: Return on Capital Employed. SDH: Synchronous Digital Hierarchy – a transmission technology that supports the transmission of various bandwidths of data over fibre optic networks and is used extensively in the provision of leased lines services. SG&A costs: Sales, General and Administration costs SMP: Significant Market Power. Stand Alone Cost (SAC): See Annex 2. The Act: Communications Act 2003. Traditional interface symmetric broadband origination (TISBO): A form of symmetric broadband origination service providing symmetric capacity from a customer’s premises to an appropriate point of aggregation in the network hierarchy. PPCs are based on TISBO, whereas Ethernet services are based on AISBO (not TISBO). Type 1 POH charges: include the services listed in Section B8, Part 8.10, Sub-Section 1.6 of BT’s Carrier Price List: https://www.btwholesale.com/shared/document/CPL/SectionB8_Partial_Private_Circuits/b8_01.xls Type 2 POH charges: include the services listed in the column entitled “3rd party POH rental fixed charge p.a.” in Section B8, Part 8.03, Sub-Section 1.1 of BT’s Carrier Price List: https://www.btwholesale.com/shared/document/CPL/SectionB8_Partial_Private_Circuits/b8_03.xls

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https://www.btwholesale.com/shared/document/CPL/SectionB8_Partial_Private_Circuits/b8_01.xls





Section 1

1 Summary 1.1 This Statement and Determination sets out our resolution of a dispute brought by

Level 3 Communications UK Limited (“Level 3”) against British Telecommunications plc (“BT”) (collectively the “Parties”) about BT’s charges for certain Partial Private Circuit (“PPC”) services (the “Dispute”).

Background

PPCs

1.2 PPCs are interconnection products that are purchased by communications providers (“CPs”) and combined with their own networks to provide leased lines to business customers. All PPCs require:

1.2.1 a local end, which is a dedicated link between BT’s local serving exchange and the end-user’s premises; and

1.2.2 a Point of Handover (“POH”), which is a high capacity link connecting a CP’s network to that of BT.

1.3 Charges which BT levies for POH services are characterised as being Type 1 or Type 2.1 Type 1 POH services include services known as SMA-1, SMA-4, SMA-162 and bearer.

The Dispute

1.4 Level 3 alleges that BT overcharged it between 1 October 2009 and 30 September 2011 (the “Dispute Period”) by failing to ensure that the charges for 2Mbit/s local ends and Type 1 POH services set by BT were cost orientated. BT disagrees that its charges were not cost orientated.

1.5 During the Dispute Period, BT was under an obligation to ensure that its charges for PPCs were cost orientated pursuant to SMP Condition G3.1. PPC charges were also subject to a charge control set in the Leased Line Charge Control Statement published on 2 July 2009 (the “2009 LLCC Statement”). This charge control was effective from 1 October 2009 but certain charges, including the disputed charges, were adjusted and re-set following an appeal of the 2009 LLCC Statement to the Competition Appeal Tribunal (“CAT”).

1 As we explain in Section 2, Type 1 POH charges are for POH services purchased by CPs on wholesale terms from the outset and charged by BT on the basis of the capacity of the POH. BT introduced Type 1 POH charges from July 2010. Type 2 POH charges are for POH services initially purchased on retail terms and subsequently re-designated as wholesale and are charged on the basis of the capacity of the circuit using the POH. 2 These services are described according to the capacity of the POH equipment used to hand over the circuits (SMA-16 has the highest capacity of the three). The bearer charge is imposed where the circuits are handed over at the CP’s premises or at a CP’s nominated footway box (as opposed to at a BT nominated footway box within 100 metres of a Serving Exchange).

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Ofcom’s conclusions on the matters in dispute

1.6 In assessing the cost orientation of the charges levied by BT, we have applied the following framework:

• Step 1: We first consider whether the evidence provided by BT demonstrates to our satisfaction that the charges in dispute were cost orientated in accordance with SMP Condition G3.1.

• Step 2: If we are not satisfied that BT has demonstrated that its charges were cost orientated, in Step 1, we will assess the extent to which the charges in dispute were nonetheless compliant with SMP condition G3.1. In assessing this issue, we first consider what data we should use in undertaking our analysis. We then go on to compare the charges in dispute with an appropriately calculated distributed stand-alone cost (“DSAC”) 3 and identify any charges that exceed DSAC.

• Step 3: Before reaching any conclusions on overcharging, we consider whether there are other factors which should be taken into account when assessing whether overcharging has taken place. In particular, we consider:

o the magnitude and duration of the amounts by which charges exceeded DSAC; and

o whether, and the extent to which, charges exceeded a fully allocated cost (“FAC”).

• Step 4: If BT has not complied with its obligations under SMP Condition G3.1, should we require BT to make repayments and if so what level should the repayments be?

Provisional conclusions

1.7 On 25 March 2014 we published our Provisional Conclusions in the Dispute.

1.8 Our provisional conclusions were that:

• For 2Mbit/s PPC local ends, BT’s charges were cost orientated and it did not therefore overcharge Level 3 for the period 1 October 2009 to 30 June 2010.

• For Type 1 POH additional charges:

o BT’s charges for each of its SMA-1, SMA-4 and SMA-16 services were not cost orientated in either 2010/11 or 2011/12 and that it therefore overcharged Level 3 for these services in the period 1 July 2010 to 30 September 2011.

o BT’s charges for its bearer services were cost orientated in both 2010/11 and 2011/12 and therefore it did not overcharge Level 3 for these services.

3 As explained in Section 3, we consider that DSAC is the appropriate cost benchmark to assess whether the disputed charges were cost orientated.

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• BT overcharged Level 3 a total of [] for Type 1 POH services during the Dispute Period;

• BT should refund Level 3 the amounts overpaid:

o For SMA-1: []

o For SMA-4: []

o For SMA-16: []; and

• That an interest rate of Bank of England base rate plus 1% should apply to payments directed in this Dispute.

Final Determination

1.9 Ofcom set the parties a deadline of 8 April 2014 to comment on the Provisional Conclusions. Comments were received from BT, Level 3, Vodafone and a joint submission from Vodafone, Virgin and Verizon. These submissions are discussed in the relevant sections of this document and we have taken them into consideration in reaching our final conclusions.

1.10 Having taken account of the issues raised, we have decided that our overall conclusions should remain broadly unchanged from our Provisional Conclusions. As we discuss in more detail in Sections 5 and 6, we have identified some errors in our calculations of the revenue generated by BT from Type 1 POH services, which led us to underestimate the amount by which BT overcharged Level 3. After correcting for these errors, we conclude that BT has overcharged Level 3 a total of [] for Type 1 POH services during the Dispute Period and that BT should refund Level 3 this amount with interest calculated at the Bank of England rate plus 1%. We do not consider it appropriate to require any repayments in relation to other services in dispute.

Structure of the remainder of this document

1.11 The introduction and background to this Dispute are set out in Section 2, our analytical framework is set out in Section 3, and our analysis and provisional conclusions are set out in Section 4. In Section 5, we refer to the stakeholder responses we received to our Provisional Conclusions, and set out our final conclusions. In Section 6 we set out our conclusions about repayments. Annex 1 is our Determination. Annex 2 explains relevant cost measures and terminology.

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Section 2

2 Introduction and background Issues in dispute

2.1 This Dispute was referred to Ofcom by Level 3 against BT. It concerns the level of certain PPC charges imposed by BT between 1 October 2009 and 30 September 2011. Level 3 alleges that BT overcharged it by failing to ensure that the following charges for PPCs were cost orientated (as required by SMP Condition G3.1) in the periods specified:

• Rental charges for 2Mbit/s local ends between 1 October 2009 and 30 September 2010; and

• Type 1 POH additional charges between 1 April 2010 and 30 September 2011.

Factual background

The services in dispute

2.2 PPCs are interconnection products that are purchased by communications providers and combined with their own networks to provide leased lines to business customers.

2.3 The Dispute relates to BT’s charges for two PPC services that it provided to Level 3: (i) 2Mbit/s local end services and (ii) POH services charged as Type 1 POH.

2.4 PPCs are typically made up of the constituent parts set out in the diagram below. All PPCs require a local end and a POH.

(i) Local ends

2.5 The local end is often referred to as the “last mile” and is the dedicated link between BT’s local serving exchange and the end-user’s premises. BT imposes a connection and fixed rental charge by bandwidth for providing the local end of the circuit. However, the Parties are only in dispute about the level of the rental charge.

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2.6 There are two different rental charges, one for the ‘central London zone’ (CLZ) and one for the non-central London zone’ (non-CLZ). However, the FAC and DSAC information associated with these charges are not reported on a disaggregated basis in BT’s RFS.

(ii) Points of Handover

2.7 The POH is a high capacity link, which connects a CP’s network with that of BT and comprises the physical infrastructure (duct and fibre) as well as electronics at either both or one end of the link (depending on the type of POH purchased).

2.8 POH charges are characterised as being Type 1 or Type 2. Type 1 POH charges are for POH services purchased by CPs on wholesale terms from the outset. Type 2 POH charges are for POH services initially purchased on retail terms and subsequently re-designated as wholesale.4

2.9 BT recovers some of the PPC POH costs from CPs through a combination of connection and rental charges. BT also levies additional POH charges, aimed at recovering that element of costs not recovered via the previous two charges. It is the Type 1 POH additional charges which are the subject of this Dispute.

2.10 Type 1 POH additional charges are set on a per POH basis,5 whereas Type 2 POH additional charges are imposed on a per-circuit basis, according to the bandwidth of the circuit.6

Legal framework for resolution of the Dispute

Ofcom’s duty to handle disputes

2.11 Ofcom has the power to resolve the following types of disputes referred to it by one or more of the parties:

a) a dispute relating to the provision of network access (section 185(1) of the Act);

b) a dispute relating to entitlements to network access that a CP is required to provide by or under a condition imposed on him under section 45 of the Act between that CP and a person who is identified, or is a member of a class identified, in the relevant condition (section 185(1A) of the Act); and

c) a dispute between CPs, which is not an ‘excluded dispute’, relating to rights or obligations conferred or imposed by or under a condition set under section 45 of the Act or any of the enactments relating to the management of the radio spectrum (section 185(2) of the Act).

4 The history of the recovery of additional POH costs is complicated. Prior to the 2009 LLCC, BT recovered these costs through an uplift on local ends and this was included in the PPC local end rental charge. In the 2009 LLCC we required BT to set a separate charge to recover these costs – this led to the introduction of the POH additional charge. To encourage efficiency, we also asked BT to introduce separate per POH charges that were based on the capacity of the POH rather than the capacity of the circuits using the POH. BT introduced these charges from July 2010. 5 SMA-1, SMA-4, SMA-16, plus a bearer charge for CSH and ISH extension (Customer Sited Handover, or “CSH” circuits are handed over at the CP’s premises, In-Span Handover extension or “ISH extension” circuits are handed over at a CP’s nominated footway box). 6 Sub 2Mbit/s, 2Mbit/s, 34Mbit/s and 155Mbit/s.

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2.12 Sections 186(1) and (2) of the Act provide that where a dispute is referred to Ofcom in accordance with section 185, Ofcom must decide whether or not it is appropriate to handle the dispute. Section 186(3) provides that Ofcom must decide that it is appropriate for it to handle a dispute falling within section 185(1A) or section 185(2) unless there are alternative means available for resolving the dispute which would be consistent with the requirements of section 4 of the Act and would be likely to result in prompt and satisfactory resolution.

Ofcom’s powers when determining a dispute

2.13 Ofcom’s powers in relation to making a dispute determination are limited to those set out in section 190 of the Act. Except in relation to disputes relating to the management of the radio spectrum, Ofcom’s main power is to do one or more of the following:

a) make a declaration setting out the rights and obligations of the parties to the dispute (section 190(2)(a));

b) give a direction fixing the terms or conditions of transactions between the parties to the dispute (section 190(2)(b));

c) give a direction imposing an obligation on the parties to enter into a transaction between themselves on the terms and conditions fixed by Ofcom (section 190(2)(c)); and

d) give a direction requiring the payment of sums by way of adjustment of an underpayment or overpayment, in respect of charges for which amounts have been paid by one party to the dispute, to the other (section 190(2)(d)).

2.14 A determination made by Ofcom to resolve a dispute binds all the parties to that dispute (section 190(8)). Whilst Ofcom’s dispute resolution powers can therefore only bind the parties to a dispute on a bilateral basis, we would expect dispute determinations to be read across and followed as appropriate, and if other BT customers approach BT seeking similar repayment of any overcharge for the services which are the subject of this Dispute, we would expect BT to take account of our conclusions in this Final Determination.

Ofcom’s duties when determining a dispute

2.15 When resolving a dispute under the provisions set out in sections 185 to 191 of the Act, Ofcom is exercising one of its regulatory functions. As a result, when Ofcom resolves disputes it must do so in a manner which is consistent with both Ofcom’s general duties in section 3 of the Act, and (pursuant to section 4(1)(c) of the Act) the six Community requirements set out in section 4 of the Act, which give effect, amongst other things, to the requirements of Article 8 of the Framework Directive.7

2.16 In addition, where a dispute falls within section 185(1) of the Act, section 190(2A) of the Act provides that Ofcom must exercise its powers in the way that seems most appropriate for the purpose of securing: efficiency, sustainable competition, efficient investment and innovation and the greatest possible benefit for the end users of public electronic communications services.

7 Directive 2002/21/EC of 7 March 2002 (as amended).

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Accepting the Dispute for resolution

2.17 Having considered Level 3’s submission and subsequent comments made by BT, we were satisfied that the Dispute is a dispute between CPs within the meaning of section 185(1A) of the Act. This is because the Dispute concerns the terms on which BT provides network access to Level 3, and that network access is required to be provided by or under a condition imposed under section 45 of the Act (Condition G3.1 set out below).

2.18 On 17 January 2014 we informed the Parties of our decision that it was appropriate for us to handle the Dispute for resolution in accordance with section 186(3) of the Act.

The scope of the Dispute

2.19 On 20 January 2014 we published details of the Dispute, including the scope, on the Competition and Consumer Enforcement Bulletin part of our website:8

“The scope of the dispute is to determine:

1. Whether BT overcharged Level 3 by failing to ensure that the following charges paid to BT by Level 3 were compliant with SMP Condition G3.1 in the periods identified:

a Charges for 2Mbit/s Local End services between 1 October 2009 and 30 September 2010; and

b Point of Handover additional charges between 1 April 2010 and 30 September 2011.

SMP Condition G3.1 requires that BT secure and be able to demonstrate to the satisfaction of Ofcom, that each and every charge offered, payable or proposed for Network Access covered by Condition G1 is reasonably derived from the costs of provision based on a forward looking long run incremental cost approach and allowing an appropriate mark up for the recovery of common costs including an appropriate return on capital employed.

2. If BT overcharged Level 3 for either of the charges described in 1a) and 1b), whether and how much BT should pay Level 3 by way of adjustment.”

2.20 The scope of the Dispute was formulated on the basis of Level 3’s dispute submission and BT’s response. It relates only to Type 1 POH additional charges, as these were the charges referred to in Level 3’s dispute submission. Level 3 submitted after publication of the scope of the Dispute that it was also overcharged for certain Type 2 POH charges. As these Type 2 POH charges fall outside the published scope of the Dispute, they are not considered in this Statement and Determination.

Interested parties

2.21 Vodafone and Virgin Media have expressed an interest in the outcome of this Dispute.

8 http://stakeholders.ofcom.org.uk/enforcement/competition-bulletins/open-cases/all-open-cases/cw_01118/.

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http://stakeholders.ofcom.org.uk/enforcement/competition-bulletins/open-cases/all-open-cases/cw_01118/

http://stakeholders.ofcom.org.uk/enforcement/competition-bulletins/open-cases/all-open-cases/cw_01118/


The regulatory background

The 2008 Business Connectivity Market Review

2.22 On 8 December 2008, Ofcom published its second review of the markets for retail leased lines, symmetric broadband origination and wholesale trunk segments, publishing its conclusions in a statement (the “2008 BCMR Statement”).9

2.23 Ofcom defined a separate market for wholesale low bandwidth traditional interface symmetric broadband origination (“TISBO”) (with a bandwidth capacity up to and including 8Mbit/s) (the “low bandwidth TISBO market”). Ofcom concluded that BT continued to have significant market power (“SMP”) in the low bandwidth TISBO market10 and imposed a number of SMP obligations on BT in that market requiring it, among other things, to provide network access on reasonable request (Condition G1).

2.24 The SMP obligations also included an obligation on BT to ensure and to be able to demonstrate that its low bandwidth TISBO service charges were cost orientated (Condition G3.1):

“Unless Ofcom directs otherwise from time to time, the Dominant Provider shall secure, and shall be able to demonstrate to the satisfaction of Ofcom, that each and every charge offered, payable or proposed for Network Access covered by Condition G1 is reasonably derived from the costs of provision based on a forward looking long run incremental cost approach and allowing an appropriate mark up for the recovery of common costs including an appropriate return on capital employed.”11

2.25 The provision of 2Mbit/s local ends are services falling within the low bandwidth TISBO market and, accordingly, rental charges for those services were subject to the cost orientation obligation.

2.26 Additional charges for POH services were also subject to the cost orientation obligation. In the 2008 BCMR Statement, Ofcom did not define a separate market for interconnection services but decided that BT must continue to make available existing TISBO handover products in relation to those TISBO wholesale markets where it has been found to have SMP. Ofcom further concluded that the remedies imposed in those TISBO wholesale markets would equally apply to interconnection services.12

2.27 Type 1 POH services were used for delivery of services in the low bandwidth TISBO market by BT to Level 3 and, consequently, the provision of those services was subject to the same regulatory obligations, including a requirement to ensure that POH charges were cost orientated under Condition G3.1.

9 http://stakeholders.ofcom.org.uk/consultations/bcmr08/summary 10 Ofcom first found that BT had SMP in the low bandwidth TISBO market in in Ofcom’s Review of the retail leased lines symmetric broadband origination and wholesale trunk segments markets, 25 June 2004. 11 This obligation can be found in Schedule 1 of Annex 8 of the 2008 BCMR Statement. 12 The relevant TISBO handover products were: Customer-Sited Handover (“CSH”); and In-Span Handover (“ISH”) including ISH extension circuits which were in paragraph 8.470 of the 2008 BCMR Statement.

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http://stakeholders.ofcom.org.uk/consultations/bcmr08/summary


The 2009 Leased Lines Charge Control

2.28 The 2008 BCMR Statement concluded that, in principle, BT should be subject to charge controls in the markets where BT had SMP. The Leased Lines Charge Control consultation (the “2008 LLCC Consultation”) was published at the same time as the 2008 BCMR Statement and set out proposals as to the scope and form of the new charge controls that should apply to leased line services in light of the conclusions in that statement. The 2008 LLCC Consultation included details of the charge controls proposed on TISBO services.

2.29 The charge controls were set in the 2009 LLCC Statement and were effective from 1 October 2009. The 2009 LLCC Statement defined six charge control baskets, of which the traditional interface (“TI”) including low bandwidth TISBO covering the services which are the subject of the charges in dispute.

2.30 In addition, Ofcom introduced changes to the way in which certain POH costs were recovered. Certain POH costs had previously been recovered through an adjustment to the price of third party local end rental charges levied to CPs (the “local end adjustment”). In the 2009 LLCC Statement, we used BT’s estimates of the costs recovered by the local end adjustment of £11.7m to calculate four new 3rd party POH rental charges to be applied on a per circuit basis (i.e. as Type 2 charges) at 64Kbit/s, 2Mbit/s, 34/45 Mbit/s and 140/155Mbit/s. Ofcom decided that the four new POH charges should be included in the TI basket and each charge should be subject to a sub-cap of RPI-0%. BT was required to introduce these new charges from 1 October 2009.

2.31 In addition to the four new 3rd party POH rental charges, we required BT to introduce within three months of the publication of the LLCC 2009 Statement, a cost recovery mechanism that would incentivise migration to new, aggregated POHs. Therefore, there was an expectation, following the publication of the charge control that BT would develop and launch Type 1 POH charges. BT introduced these Type 1 POH charges on 1 July 2010.

2.32 Condition G3.2, imposed in the 2008 BCMR Statement, provided:

“For the avoidance of any doubt, where the charge offered, payable or proposed for Network Access covered by Condition G1 is for a service which is subject to a charge control, the Dominant Provider shall secure, and shall be able to demonstrate to the satisfaction of Ofcom, that such a charge satisfies the requirements of Condition G3.1.”

The 2009 LLCC appeal

2.33 On 2 September 2009 Cable & Wireless lodged an appeal with CAT, challenging certain aspects of the setting of the charge control in the 2009 LLCC Statement. In particular, Cable & Wireless claimed that Ofcom had erred:

• in allowing BT to increase charges at the start of the price control for 2Mbit/s local end services; and

• in its specification of new, separate charges for POH.

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2.34 It was agreed that all the issues raised in the appeal were specified price controls matters and, accordingly, on 16 December 2009 the CAT referred questions to the CC for its determination.

2.35 On 30 June 2010 the CC notified the CAT of its determination (the “CC’s Determination”). In relation to 2Mbit/s local end rentals and POH the CC’s Determination was that:

• Ofcom had erred in permitting an increase to 2Mbit/s local end prices as part of the one-off adjustments to starting charges.13 In arriving at this determination, the CC found that the pre-adjustment prices fell within the Distributed Long Run Incremental Cost (“DLRIC”) and DSAC14 boundaries.

• Ofcom had erred in its use of BT’s estimate of the costs to be recovered by the POH charges.15

• Ofcom had erred in concluding that its decision regarding the recovery of POH charges was appropriate for promoting sustainable competition.16

• Ofcom had erred in giving BT the discretion it did as to future charges for POH.17

2.36 On 20 September 2010 the CAT allowed the appeal and remitted the decision under appeal to Ofcom on a forward looking basis with specific directions in relation 2Mbit/s local end rentals and POH. The CAT’s directions included:

• to implement a reduction of £116.76 in the price per 2Mbit/s local end rental;

• to assess the reasonableness of BT’s revised estimate of POH costs18 and determine the appropriate level of the new POH charges;

• to assess the various regulatory options for implementing new POH charges in light of the CC’s assessment; and

• to decide how POH costs should be recovered.

2.37 On 30 September 2010 Ofcom adopted, among other changes, the revision to the price for 2Mbit/s local end services, which took effect on 1 October 2010.19

2.38 With regard to the CAT’s direction relating to POH, on 30 September 2011 Ofcom published the LLCC PPC Points of Handover pricing review: Final Statement on modification of SMP Conditions (“the POH Pricing Review Statement”). For this statement, Ofcom developed its own bottom-up model to set the additional POH charges. Based on this model, Ofcom estimated that the costs of providing additional POH were £2.9m on a LRIC basis. On the basis of revised cost estimates, Ofcom

13 Paragraphs 3.65 and 3.203 of the CC’s Determination. 14 The definitions of these cost concepts can be found in Annex 2. 15 Paragraph 5.55 of the CC’s Determination. More detail on this point is included in Sections 4 and 5. 16 Paragraphs 5.95 and 5.242 of the CC’s Determination. 17 Paragraphs 5.288 and 5.317 of the CC’s Determination. 18 BT revised its FAC estimates downwards during the appeal of the 2009 LLCC Statement, see paragraph 4.24 below for more information. 19 The initial price for external 2Mbit/s local ends was revised from £663.76 to £570.23 as stated in paragraph 1.12 of Ofcom’s statement: Leased Lines Charge Control, Adoption of Revised SMP Conditions following the CAT’s Directions of 20 September 2010.

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decided to implement a new additional POH charge control from 1 October 2011. Ofcom also concluded that the cost recovery approach should be based on LRIC.20

Basis of Level 3’s claims

2.39 Level 3’s arguments centre on the revisions that Ofcom made to the disputed charges following the 2009 LLCC appeal.

2.40 Level 3 believes that it was overcharged for the rental element of 2Mbit/s PPC local ends provided by BT on the basis that the CAT and CC concluded in the appeal of the 2009 LLCC Statement that “BT had over-charged for 2Mbit/s PPC Local End services, as a consequence of Ofcom’s error in the Leased Line Charge Control Statement of 2nd July 2009”.21

2.41 Level 3 believes that it was overcharged for Type 1 POH additional charges on the basis that in its review of POH charges, “Ofcom calculated the costs of providing additional POHs and found them to be much lower than the calculations used by BT to set its prices from 1 April 2010”.22

2.42 In summary, Level 3 alleges that the decision of the CAT (which was based on the CC’s Determination) in the 2009 LLCC appeal, and subsequent decisions of Ofcom amending the disputed charges, establish that the disputed charges were “significantly above a cost oriented level”.23 It submits that the “necessary implication” of these findings is that is that BT, from the effective date of the 2009 LLCC Statement until Ofcom had re-set the level of the charge control, had overcharged Level 3.

2.43 Level 3 submits that Ofcom should evaluate the extent of BT’s overcharge. If the overcharge is confirmed, it submits that Ofcom should:

• determine a revised charge for the relevant services that meet BT’s cost orientation obligation;

• order BT to repay in full the overcharge; and

• order BT to pay compound interest on the overcharge and Level 3’s costs.

Submissions from BT

Comments on Level 3’s submission

2.44 We provided a copy of Level 3’s submission to BT on 19 December 2013. In response, BT expressed the view that Ofcom should not open the Dispute for three reasons:24

• Level 3 is seeking to misuse the dispute resolution provisions in the Act to have Ofcom make changes to an ex ante charge control with retrospective effect, which is not something Ofcom can do;

20 The definitions of this cost concept can be found in Annex 2. 21 Level 3 dispute submission, paragraph 1.16. 22 Level 3 dispute submission, paragraph 1.21. 23 Level 3 dispute submission, paragraph 1.12. 24 BT letter to Ofcom dated 7 January 2014.

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• Ofcom’s established position is that “a charge controlled price is not the only charge that would satisfy the cost –orientation obligation;[and] that the cost orientation and charge control conditions are separate and distinct and that one cannot rely on a charge control price to prove that the charge is not cost-orientated”.25 For this reason, no action is needed in this case. Accepting the Dispute would therefore be contrary to Ofcom’s duties under the Act in that it should use its dispute resolution powers in those cases where action is needed; and

• In any event, BT’s charges were cost orientated at all relevant times, and there is no case to answer. BT submits that its 2Mbit/s local end rental charges were at all relevant times below its published DSAC for this service, which demonstrates that they complied with its cost orientation obligation. BT submits that it set its POH additional charges below contemporaneous estimates of FAC, which likewise demonstrates their compliance with the cost orientation obligation.

Submission concerning compliance with SMP Condition G3

2.45 On 17 January 2014 we wrote to BT asking it to explain how it ensured that the disputed charges were compliant with its cost orientation obligation under SMP condition G3.1. BT responded, submitting that it had complied with its cost orientation obligations:26

• for 2Mbit/s local end rentals, by setting its prices below its published DSAC ceiling.27

• for Type 1 POH additional charges, by consistently seeking to price POH services at FAC, using contemporaneous estimates of FAC.

Information relied upon in resolving the Dispute

2.46 This Statement and Determination draws on the key information provided by the Parties and other stakeholders. This includes responses to information requests issued under section 191 of the Act, submissions and related correspondence and responses to our Provisional Conclusions.

2.47 In addition to the information provided by the Parties, our analysis refers to previous Ofcom dispute determinations and relevant case law as cited in this Statement and Determination. It also refers to data previously provided to Ofcom by BT in connection with the 2012 Leased Line Charge Control Statement.

25 BT letter to Ofcom dated 7 January 2014, page 2. 26 BT letter to Ofcom dated 24 January 2014. 27 DSAC for weighted average price for CLZ/non CLZ // Nationally averaged cost. BT’s 2009/10 Regulatory Financial Statement, page 42: http://www.btplc.com/Thegroup/RegulatoryandPublicaffairs/Financialstatements/2010/CurrentCostFinancialStatements2010.pdf.

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Section 3

3 The analytical framework 3.1 We first set out below the views expressed by the Parties regarding how Ofcom

should go about assessing BT’s compliance with its cost orientation obligation. We then set out our conclusions on the appropriate analytical framework to use to assess the matters in dispute.

Parties’ views

3.2 Level 3 submits that during the Dispute Period, the disputed charges were subject to SMP Condition G3.1. It submits that, in line with Ofcom’s previous determinations and the decision of the CAT in the PPC and Ethernet cases, “BT’s cost-orientation obligations for each of the services relating to this dispute carry separate and distinct compliance requirements”.28

3.3 Level 3 set out in its dispute submission the basis for its belief that 2Mbit/s local ends and Type 1 POH additional charges were not cost orientated, with reference to particular charge control decisions.

3.4 With respect to 2Mbit/s PPC local ends, Level 3 argues that:

“In the Cable & Wireless Appeal, the CAT, in accordance with the Determination of the Competition Commission, decided that BT had over-charged for 2Mbit/s PPC Local End services, as a consequence of Ofcom’s error in the Leased Line Charge Control Statement of 2nd July 2009. The nature of Ofcom’s error was such as to allow a price increase which took the price of these services outside the range of prices that could be cost-oriented. Accordingly, the CC determined that the price increase was unlawful and that the charge control condition required amendment in order to address the problem.

The CAT duly directed Ofcom to amend the Charge Control Condition with effect from 1 October 2010 and Ofcom did so on 30 September 2010.

The necessary implication of these findings is that during the Relevant Period (prior to the amendment of the charge control condition) BT’s prices did not comply with the Cost Orientation Condition.

We believe that BT has therefore overcharged Level 3 for the period 1 October 2009 to 30 June 2010 for 2Mbit/s PPC Local End services.”29

3.5 In relation to Type 1 POH additional charges, Level 3 argues that:

“On 21 September 2011 Ofcom published the LLCC PPC Points of Handover pricing review - Final Statement on modification of SMP

28 Level 3 dispute submission, pages 2-3 29 Level 3 dispute submission, paragraphs 1.16, 1.18 and 1.19.

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Conditions30 setting the ceiling prices for BT's recovery of additional POH costs on a per MUX basis.

In that Statement, Ofcom implemented a cost recovery approach based on LRIC. Ofcom calculated the costs of providing additional POHs and found them to be much lower than the calculations used by BT to set its prices from 1 April 2010. Ofcom set a new charge control for additional POHs, to reflect that assessment of costs.

That charge control condition took effect from 1 October 2011.

The necessary implication of these findings is that during the Relevant Period (prior to the setting of the charge control condition) BT’s prices did not comply with the Cost Orientation Condition.

We believe that BT has therefore overcharged Level 3 for the period 1 April 2010 to 30 September 2011. Level 3 has calculated that overcharge using the original starting prices from 1 April 2010.”31

3.6 BT submits that “Ofcom’s previous decisions clearly establish that one cannot rely on a charge control to allege that the charge is not cost oriented” and that “the first order test to assess cost orientation has been established as a DSAC price ceiling, not the LRIC standard used to set the POH charge in the amended charge control”.32 BT states:

“Level 3’s claim that BT’s prices were not cost oriented is primarily based on the findings of the Competition Commission (CC) and the Competition Appeals Tribunal (CAT) in resolving an appeal by Cable and Wireless and Verizon against Ofcom’s 2009 Leased Lines Charge Control Statement, and Ofcom’s 2011 LLCC PPC Point of Handover Pricing Review Statement. The CC and CAT’s decisions are based on a forward looking assessment for the remaining period of the charge control i.e. from 1 October 2009 and 30 September 2010 for 2Mbit/s PPC Local End and between 1 April 2010 and 30 September 2011 for PoH services respectively. In reaching those decisions the CC and CAT did not (and legally could not) alter the regulatory status of the pricing of those services before the relevant dates”.33

3.7 In response to our Provisional Conclusions, the Parties have maintained their respective positions.

An additional ‘fair and reasonable’ test: guidance from the TRD case

3.8 Vodafone submits that Ofcom is required to determine in this Dispute what the reasonable terms and conditions as between the parties were. In support of this submission, Vodafone relies on the judgment of the CAT in the TRD case34 to suggest that there is an additional general obligation on Ofcom to ensure that the

30 http://stakeholders.ofcom.org.uk/consultations/revision-points-handover-pricing/final-statement/ 31 Level 3 dispute submission, paragraphs 1.20 to 1.24. 32 BT’s letter dated 24 January 2014, page 5. 33 BT’s response to Level 3’s dispute submission, pages 1-2. 34 T-Mobile v Office of Communications [2008] CAT 12.

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http://stakeholders.ofcom.org.uk/consultations/revision-points-handover-pricing/final-statement/

http://stakeholders.ofcom.org.uk/consultations/revision-points-handover-pricing/final-statement/


charges set are fair and reasonable. Vodafone argues that Ofcom is required to have regard to the following guidance given by the CAT in the TRD case:

“The word ‘reasonable’ in this context means two things. First it requires a fair balance to be struck between the interests of the parties to the Regulated Contract. It therefore requires the same kind of adjudication that any arbitrator appointed by the parties to determine a dispute about the reasonable rate would carry out [“the first s185 requirement”]. But secondly, because OFCOM is a regulator bound by its statutory duties and Community requirements it also means reasonable for the purposes of ensuring that those objectives and requirements are achieved [“the second s185 requirement”].”

3.9 Vodafone also argues that Ofcom committed a legal error in conflating the legal requirement that the SMP conditions setting price controls may not have retrospective effect (on the one hand) with (on the other) its powers to resolve disputes.35 Vodafone states as follows:

“The conclusion that to use the CC/CAT’s analysis to determine a dispute would be retrospective application of a charge control is wrong in law (to illustrate the point, if that were right, the TRD decision would be wrong). Using dispute resolution is the exercise of a different power and whilst we agree that a charge control cannot be applied on a retrospective basis, the issue at hand is the resolution of a dispute, not the retrospective application of a charge control.”

Ofcom’s view

3.10 We will deal with each of the comments in turn, starting with Level 3’s comments that the charges set in the revised charge controls form an appropriate benchmark against which to assess BT’s charges before addressing the comments that Vodafone makes about a ‘fair and reasonable’ test.

3.11 We disagree with Level 3’s suggestion that the level of the charges set in the revised charge controls is the appropriate benchmark by which to assess BT’s compliance with its cost orientation obligations in respect of either 2Mbit/s local end rental charges or Type 1 POH additional charges.

3.12 Charge controls and cost orientation constitute separate obligations, have differing objectives and compliance with those obligations is therefore assessed in accordance with different tests. Accordingly, amendments to prices in a charge control cannot automatically be read across to the cost orientation assessment. Further, we agree with BT that the revisions to the charge controls resulting from the appeal of the 2009 LLCC Statement can only apply on a prospective basis and it is therefore not appropriate (indeed not lawful) to seek to apply the revised charge controls on a retrospective basis.

3.13 Moreover, by seeking to apply the reductions that we made to the charges for POH additional services following the appeal of the 2009 LLCC Statement to the period prior to the appeal, Level 3 is effectively seeking to use LRIC as the cost standard for assessing cost orientation in that period. However, the LRIC standard has not

35 T-Mobile v Office of Communications [2008] CAT 12, paragraphs 10-20.

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previously been used by Ofcom in assessing compliance with a cost orientation obligation and we do not consider it appropriate to do so in this case. Ofcom has in the past applied a DSAC cost standard in assessing cost orientation and, as set out by the CAT in the PPC Judgment, “the use of DSAC as a test for cost orientation was not only entirely appropriate, but actually the only satisfactory available course open both to BT (in seeking to comply and show compliance with [the cost orientation obligation], and to Ofcom (in seeking to monitor that compliance)”.36 As set out above, cost orientation and charge controls constitute separate obligations pursuing differing objectives and we see no reason why, in this case, we should depart from Ofcom’s previous practice and the PPC Judgment by the application of a LRIC cost standard to assess compliance with SMP Condition G3.1.

An additional ‘fair and reasonable’ test: guidance from the TRD case

3.14 Vodafone relies on the judgment of the CAT in the TRD case to suggest that there is an additional general obligation on Ofcom to ensure that the charges in dispute are fair and reasonable.

3.15 In this case, the scope of the dispute that has arisen is to determine BT’s compliance, or otherwise, with a specific regulatory condition, namely SMP Condition G3.1. In the TRD case, the facts were fundamentally different in that there was no regulatory condition in place.

3.16 Further, we note that SMP condition G1.2 further specifically excluded an additional assessment of “fair and reasonable”.37 We do not therefore consider that it would be appropriate to seek to resolve this dispute by reference to a test which Ofcom had excluded in the regulatory conditions themselves.

3.17 In this respect that the CAT has endorsed Ofcom’s approach in Telefonica UK Limited v Office of Communications38, where it found that Ofcom was entitled to place weight upon the existence of the SMP regulation applicable to the charges in dispute taking into account Ofcom’s regulatory duties and responsibilities39. We are satisfied that the outcome of the present dispute is consistent with the range of duties and responsibilities placed upon Ofcom and do not therefore consider it necessary to consider BT’s charges by reference to an additional “fair and reasonable” test which was explicitly excluded by the SMP Conditions themselves.

Our approach to determining whether BT’s charges were cost orientated

Which charges should be cost orientated?

3.18 The charges in dispute are subject to SMP Condition G3.1, which requires “each and every charge” to be cost orientated. The wording of Condition G3.1 is identical to that of the SMP condition which was considered in the PPC Judgment (Condition H3.1).

36 PPC Judgment, paragraph 287. 37 Condition G1.2 which applied to the low bandwidth TISBO market provided as follows: “The provision of Network Access in accordance with paragraph G1.1 shall occur as soon as reasonably practicable and shall be provided on fair and reasonable terms and conditions (excluding charges) and on such terms and conditions (excluding charges) as Ofcom may from time to time direct.” 38 [2012] CAT 28 39 Paragraph 53

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3.19 In the PPC Judgment the CAT considered the appropriate level of aggregation for assessing BT’s compliance with Condition H3.1 given the requirement (identical to that in G3.1) that BT secure that “each and every charge offered, payable or proposed for Network Access” is cost orientated.

3.20 The CAT found that Ofcom was correct to consider, discretely, the charges for each separate trunk service offered by BT. It considered that “the starting point for any question about BT’s cost orientation obligations … is the true construction of Condition H3.1”40 and held that:

“According to Condition H3.1, “each and every charge offered” must be cost orientated. We consider that the effect of these words is to render the test for cost orientation applicable separately to each discrete trunk service - i.e. the charge for each bandwidth must be cost orientated.”41

3.21 In the CAT’s view such a construction “makes sense” because a purchaser of any particular service “will want to know that the particular service he is buying is cost orientated. He will doubtless be rather less concerned with the cost orientation of services he is not purchasing”.42

3.22 In addition, if cost orientation was assessed on an aggregated basis, this would permit cross-subsidisation between different groups of purchasers of PPC circuits. The CAT considered this to be “a powerful pointer in favour” of its construction of Condition H3.1.43

3.23 Furthermore, the CAT found that:

“…we fail to see how either OFCOM or this Tribunal could sanction an approach to cost orientation that disregarded the clear meaning of Condition H3.1.”44

3.24 We have therefore considered BT‘s charges on a disaggregated basis i.e. considered whether BT has secured that each and every disputed charge is cost orientated.

Has BT overcharged Level 3 for the services in dispute?

What do BT’s obligations in relation to cost orientation require?

3.25 BT’s compliance with its cost orientation obligation under SMP condition G3.1 is at the heart of this Dispute. Therefore in order to determine whether or not BT has overcharged Level 3, we need to assess BT’s compliance with its cost orientation obligation in respect of each of the distinct charges in dispute.

3.26 Condition G3.1 (like Condition H3.1) requires that:

“Unless Ofcom directs otherwise from time to time, the Dominant Provider shall secure, and shall be able to demonstrate to the satisfaction of Ofcom, that each and every charge offered, payable or proposed for Network Access covered by Condition G1 is

40 PPC Judgment, paragraph 214. 41 PPC Judgment, paragraph 228. 42 PPC Judgment, paragraph 228. 43 PPC Judgment, paragraph 228. 44 PPC Judgment, paragraph 229.

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reasonably derived from the costs of provision based on a forward looking long run incremental cost approach and allowing an appropriate mark up for the recovery of common costs including an appropriate return on capital employed.”

3.27 Condition G3.1 involves a two stage assessment, as recognised by the CAT in the PPC Judgment:45

• Step 1: Has BT demonstrated to our satisfaction that its charges in dispute were cost orientated (i.e. were they based on an appropriate allocation of common costs)? If it has done so, then there is no overcharging.

• Step 2: If it has not done so, we must ask whether BT’s charges were nevertheless appropriate (i.e. based on an appropriate allocation of common costs). This raises an important question: what is the most appropriate cost benchmark or test for Ofcom to use in assessing compliance? We consider this issue next.

DSAC as an appropriate cost benchmark

3.28 In order to assess whether charges are cost orientated, it is necessary to allocate costs across services. There are a number of methodologies which could potentially be used to allocate costs.

3.29 In the 2009 PPC Determinations we explained why we considered DSAC to be the most appropriate cost benchmark for our assessment of BT’s compliance with the relevant condition. Our decision was based on a number of reasons including:

• the DSAC approach reflects the practical application of underlying economic theory, recognising the major conceptual and practical challenges of implementing the full-blown approach of Stand Alone Cost (“SAC”)46 and combinatorial tests;47

• in our view DSAC strikes an appropriate balance between the desire to provide BT with the incentives and flexibility to both reduce costs and efficiently recover common costs, and the desire to protect consumers and competition from either harmful or anti-competitive charges that could arise from boundless pricing flexibility;48 and

• the use of DSAC was recognised by BT (including in its own yearly Primary Accounting Documents throughout the Dispute Periods) as the approach that Ofcom would adopt for analysing complaints that charges were unreasonable “in order to avoid complex combinatorial tests” and that the DSAC represents the “maximum price that can be charged”.49

3.30 The CAT found in the PPC Judgment that50 DSAC represented “the best single measure for assessing whether the condition had been satisfied and so marked the

45 PPC Judgment, paragraph 249. 46 This cost concept is explained in Annex 2. 47 2009 PPC Determinations, paragraph 5.56. 48 2009 PPC Determinations, paragraph 5.112. 49 2009 PPC Determinations, paragraph 5.56. 50 On 22 March 2011 the CAT issued its judgment (“the PPC Judgment”) disposing of BT’s appeal (“the PPC appeal”) of Ofcom’s determinations (“the 2009 PPC Determinations”) of disputes about the pricing of Partial Private Circuits. The CAT dismissed BT’s appeal in its entirety and upheld the 2009

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upper limit or ceiling on the permissible mark up of prices”. The CAT considered that the two other approaches available to Ofcom (i.e. SAC/combinatorial testing and FAC) were not appropriate on the basis of “FAC being too rigid and combinatorial tests being unworkable”. As a consequence, the CAT found that “in the context of orienting to cost prices like 2Mbit/s trunk, DSAC was the only practicable test to use”.51

3.31 The CAT rejected BT’s arguments that the operation of the cost orientation condition was not clear and BT could not have anticipated that Ofcom would use DSAC to assess cost orientation, finding that “we do not consider that BT can have been in any way surprised or taken aback by Ofcom’s resort to the DSAC test”. The CAT went on to reject BT’s complaint that Ofcom had treated prices above DSAC as intrinsically excessive and in breach of the cost orientation condition. The CAT concluded that “this is exactly what Condition H3.1 requires”.52

3.32 Given the clear similarities and overlaps between the issues in this Dispute and those considered in the 2009 PPC Determinations and the PPC Judgment, we consider that the use of DSAC as the primary cost benchmark for considering cost orientation for the charges in dispute in this case is appropriate.

Ensuring that the DSAC test is not implemented in a mechanistic way

3.33 In the 2009 PPC Determinations we explained that we did not consider it appropriate to apply the DSAC test in a purely mechanistic manner. Rather we considered that “other factors need to be taken into consideration before it can be concluded that charges are unreasonable or otherwise anti-competitive”.53 The specific factors to be taken into account are dependent on the details of the case under consideration. In the 2009 PPC Determinations we considered a range of factors beyond the DSAC test. For a number of services this led us to conclude that, despite failing the DSAC test for at least one year, the charges for those services nevertheless did not constitute overcharging.

3.34 In the PPC Judgment the CAT concluded that, although Condition H3.1 (and therefore by implication Condition G3.1) requires Ofcom to treat prices above DSAC as intrinsically excessive and in breach of the condition,54 “Ofcom must guard against the possible injustices of a mechanistic application of a test for the allocation of common costs”.55 The CAT considered that “Ofcom acted appropriately in looking to other factors in addition to the mere fact that DSAC had been breached by BT’s prices”.56

3.35 The CAT’s reasoning for adopting this position reflects the fact that the regulated firm (in this case, BT) is prospectively seeking to ensure that it complies with the cost

PPC Determinations, concluding that BT’s charges for certain PPCs, namely 2Mbit/s PPC trunk services, were in breach of its relevant cost orientation obligation. BT had therefore overcharged for those PPCs and was required to repay to the other parties in dispute the sums they had overpaid. The PPC Disputes were resolved in the 2009 PPC Determinations in respect of 2 Mbit/s PPC trunk services only. The PPC Disputes also included certain other PPC services, which were resolved on 8 February 2013 (“the 2013 PPC Determinations”). 51 PPC Judgment, paragraph 307: http://www.catribunal.org.uk/238-5136/1146-3-3-09-British-Telecommunications-Plc-.html. 52 PPC Judgment, paragraph 307. 53 PPC Final Determinations, paragraph 5.37. 54 PPC Judgment, paragraph 307(3). 55 PPC Judgment, paragraph 305. 56 PPC Judgment, paragraph 305.

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orientation obligation (i.e. at the time it sets its charges) while we are retrospectively assessing whether it has been compliant (i.e. at the time the disputes were brought to us). The CAT accepted that:

“...even a firm doing its level best to comply with Condition H3.1 (by, for example, seeking to apply DSAC) might find that, even so, the DSAC ceiling was on occasion breached. We consider that, in such circumstances, such a firm might well be in compliance with Condition H3.1, in that its mark up for the recovery of common costs would have been “appropriate”.

Accordingly, when retrospectively seeking to determine compliance with Condition H3.1, it would not be right for Ofcom to apply DSAC (or, no doubt, any test for the allocation of common costs) in a mechanistic way. That would overlook the fact that that it is hard in practice for the regulated firm to comply absolutely with whatever test is being used to determine the appropriate allocation of common costs.”57

3.36 The CAT concluded that Ofcom acted correctly in considering:

a) the magnitude and duration of the amounts by which charges exceeded DSAC;

b) whether, and the extent to which charges exceeded FAC; and

c) the rate of return on capital employed.58

3.37 In accordance with the PPC Judgment, our view is that the following additional factors are relevant to our determination,59 and which we consider at Step 3:

a) The magnitude and duration by which charges exceeded DSAC: DSACs of an individual service can vary from year to year, meaning that an unchanged charge that was below DSAC in one year might be above DSAC the following year. If BT were able to demonstrate that, despite its best endeavours, it could have reasonably expected its charges to be cost orientated, or that its charges exceeded DSAC as a consequence of genuine difficulties arising from the nascent nature of the market (for example, difficulties in accurately forecasting costs), we might consider that such charges above DSAC were nonetheless cost orientated.

b) Whether, and the extent to which, charges exceeded FAC: As discussed above, we consider that the DSAC test should play a central role in determining whether BT overcharged its external customers. However, where charges are above DSAC, we also consider the relationship of charges to FAC to determine whether a charge is nonetheless cost orientated, despite being above DSAC. The use of FAC in this manner can act as a useful cross-check to ensure that unjust outcomes are avoided. A charge being above FAC is not in itself sufficient to demonstrate that a charge is not cost orientated. However if a charge was above DSAC, and revenues were significantly above FAC, this evidence would corroborate a conclusion of overcharging.

57 PPC Judgment, paragraphs 303 and 304. 58 PPC Judgment, paragraph 305. 59 PPC Judgment, paragraph 305.

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Further steps

3.38 On the basis of our assessment in Steps 1 to 3, in Step 4 we consider whether we think it is appropriate for us to exercise our discretion to order repayments.

3.39 Finally, we set out views about why the way in which we have resolved the Dispute is consistent with our statutory duties and Community obligations.

Summary of our analytical framework

3.40 Our analytical framework comprises the following four steps:

Step 1: Has BT satisfactorily demonstrated that the charges in dispute are compliant with SMP condition G3?

If we conclude BT has satisfactorily demonstrated compliance, no further action is required. If we conclude BT has not satisfactorily demonstrated compliance, we continue to Step 2.

Step 2: Are the charges in dispute nonetheless compliant with SMP condition G3?

We will compare BT’s charges with an appropriately calculated cost ceiling and identify any charges that exceed this cost ceiling.

Step 3: We consider whether there are other factors which should be taken into account when assessing compliance with the cost orientation obligation.

If we find that BT has overcharged, we continue to Step 4.

Step 4: Should we require BT to make repayments and if so what level should the repayments be?

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Section 4

4 Analysis and Provisional Conclusions 4.0 In this Section we apply the first three steps of our analytical framework as described

in Section 3 to the facts of the case and set out the Provisional Conclusions we reached as to whether BT had overcharged Level 3 for the services in dispute.

Step 1: Has BT demonstrated to Ofcom’s satisfaction that each and every charge was cost orientated?

Introduction

4.1 As discussed in Section 3, SMP Condition G3.1 requires that BT secure and be able to demonstrate to Ofcom’s satisfaction the cost orientation of each and every charge for network access covered by SMP Condition G1, including those also subject to a charge control.

BT’s position

2Mbit/s local ends

4.2 We asked BT to show how it complied with its cost orientation obligation in relation to 2Mbit/s local end services. In its letter to Ofcom dated 24 January 2014, BT responded that “during the period under dispute BT has maintained the prices for Local End services significantly below the published DSAC ceiling as shown in BT’s published Regulatory Financial Statement (RFS)”.60

4.3 In support of its argument, BT provided the information in Table 4.1 below, which sets out BT’s published DSAC figures from the RFS and BT’s prices from the Carrier Price List61 within the Dispute Period.

60 Page 3, BT’s 24 January 2014 letter. 61 BT Carrier Price list: ACCN 957 gives prices for PPC rentals at 1 September 2009, ACCN 995 gives prices implemented at 10 March 2010, ACCN 1053 gives prices at 1 October 2010 (within the current prices schedule) https://www.btwholesale.com/pages/static/Library/Pricing_and_Contractual_Information/carrier_price_list/index.htm.

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https://www.btwholesale.com/pages/static/Library/Pricing_and_Contractual_Information/carrier_price_list/index.htm

https://www.btwholesale.com/pages/static/Library/Pricing_and_Contractual_Information/carrier_price_list/index.htm


Table 4.1: 2Mbit/s local end prices and DSAC provided by BT

Price DSAC

2009/10 RFS62 £1,023.00

From 1 September 2009 £833.76

From 1 October 2009 £663.76

From 10 March 2010 £686.99

2010/11 RFS63 £1,391.08

From 1 October 2010 £570.23

4.4 BT noted that the CC had recognised that prices for 2Mbit/s local ends were between DLRIC and DSAC in the CC’s Determination. The CC stated (BT emphasis):

“Justification in the context of the objective of cost orientation

3.123. We note that there is no dispute between Ofcom and C&W that the price of 2 Mbit/s trunk was above DSAC, that the price of DPCN services was below DLRIC and that the price of 2 Mbit/s local ends was within the DLRIC-DSAC range.

3.124. The adjustments to the price of 2 Mbit/s trunk and the price of DPCN services were therefore justified as being necessary in order to meet the objective of cost orientation, ie ensuring that those services were not priced at levels which posed a risk of distortion of competition. However, the one-off adjustments together could not be justified if considered solely by reference to the cost-orientation objective, since 2 Mbit/s local ends were already priced within the DLRIC and DSAC boundaries and therefore the adjustment to the price of that service goes beyond what is necessary for cost-orientation reasons.”64

4.5 The CC’s Determination considered the one-off starting charge adjustments made by Ofcom to a number of PPC services, including 2Mbit/s local end services, in the 2009 LLCC Statement. The CC concluded that Ofcom had erred in increasing the starting charge for 2Mbit/s local end services.

Type 1 POH additional charges

4.6 BT explained that it was unable to demonstrate that its charges were compliant by reference to published DSAC figures because these services were not required by Ofcom to be separately reported in the RFS during the Dispute Period. Instead, BT has sought to demonstrate compliance by reference to its estimates of FAC.

62 2009/10 RFS, page 42: http://www.btplc.com/Thegroup/RegulatoryandPublicaffairs/Financialstatements/2010/CurrentCostFinancialStatements2010.pdf. 63 2010/11 RFS, page 43: http://www.btplc.com/Thegroup/RegulatoryandPublicaffairs/Financialstatements/2011/CurrentCostFinancialStatements2011.pdf. 64 Competition Commission Determination of 30 June 2010 in Case 1112/3/3/09, C&W v Ofcom, http://www.catribunal.org.uk/files/1112_Cable_Wireless_Determination_300610.pdf.

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http://www.catribunal.org.uk/files/1112_Cable_Wireless_Determination_300610.pdf


4.7 In its letter to Ofcom dated 24 January 2014, BT states that “in order to comply it has consistently sought to price PoH at FAC (a threshold substantially below DSAC), using contemporaneous estimates of FAC. Moreover, at the time the prices were set, Ofcom confirmed that it was satisfied that the approach used to set these charges was reasonable”.

4.8 For the period 1 April 2010 to 1 July 2010 (when it re-set prices), BT claims that “Ofcom checked BT’s estimated costs and concluded that the methodology and assumptions applied by BT were reasonable. In other words, Ofcom validated BT’s FAC estimates and determined the starting prices on this basis”.65

4.9 BT submits that it introduced Type 1 POH charges on 1 July 2010, and “updated its cost estimates of the total FAC of PoH services in 2010 at the time the new PoH services were introduced taking into account all of the most recent information available to it. The updated FAC costs figures were used as the basis for the new PoH prices implemented as of 1 July 2010.”66

Ofcom’s provisional view

2Mbit/s local ends

4.10 BT relies on the fact that charges for 2Mbit/s local end services were below the DSACs reported in the RFS for 2009/10 and 2010/11 to demonstrate that its charges were cost orientated.

4.11 We agree that DSAC would be an appropriate cost standard to use for the purposes of assessing BT’s compliance with its cost orientation obligations (see paragraphs 3.28 to 3.32 in Section 3). However, there are several reasons why we do not consider it would be appropriate to rely on the charges and DSACs provided by BT in its 24 January 2014 letter as a means of demonstrating compliance with Condition G3.1.

4.12 First, we note that the charges BT refers to in its 24 January 2014 letter apply to non-CLZ local ends. Separate, lower, charges apply to 2Mbit/s local ends in the CLZ area. Table 4.2 sets out the average prices for 2Mbit/s local end CLZ and non-CLZ as reported in the RFS for 2009/10 and 2010/11.

Table 4.2: 2Mbit/s local end average unit prices as reported in the RFS

2009/1067 2010/1168

External CLZ £417 £350

External Non-CLZ £775 £728

4.13 Furthermore, the RFS reports a single unit DSAC figure that is aggregated across CLZ and non-CLZ 2Mbit/s local ends. As noted above, BT levies separate charges

65 Page 6, BT letter dated 24 January 2014. 66 Page 7, BT letter dated 24 January 2014. 67 Page 42, 2009/10 RFS, charges presented include enhanced maintenance http://www.btplc.com/Thegroup/RegulatoryandPublicaffairs/Financialstatements/2010/CurrentCostFinancialStatements2010.pdf. 68 Page 43, 2010/11 RFS, charges presented include enhanced maintenance http://www.btplc.com/Thegroup/RegulatoryandPublicaffairs/Financialstatements/2011/CurrentCostFinancialStatements2011.pdf.

27






for CLZ and non-CLZ services. As BT is required to demonstrate that “each and every charge” is cost orientated, this aggregated figure does not allow Ofcom to assess whether CLZ and non-CLZ charges are separately cost orientated.

4.14 In addition, Ofcom considered whether BT’s charges for 2Mbit/s local end services were compliant with its cost orientation condition in the 2009 PPC Determination. As part of that dispute, Ofcom made a number of adjustments to BT’s cost data. These adjustments may be relevant for this Dispute and BT has not taken these into account in seeking to demonstrate compliance.

4.15 In light of the above factors, we do not consider that BT’s assessment of its compliance with the cost orientation obligation based on the data reported in the RFS has demonstrated to our satisfaction that its charges for 2Mbit/s local end services were cost orientated.

Type 1 POH additional charges

4.16 As identified by BT, revenue and cost data associated with Type 1 POH services is not separately reported in the RFS. Instead, this data is included within the data of other services reported in the RFS.

4.17 BT told us that in 2010/11 revenue and cost data associated with Type 1 POH additional charges were included within the revenue and cost data for Customer Sited Handover (“CSH”) and In Span Handover (“ISH”) POH rental services reported in the RFS.69 In 2011/12, revenue and cost data associated with Type 1 POH additional charges was included within the reported revenue and cost data for External 3rd party POH rental products by bandwidth.

4.18 We recognise that it would not be appropriate to rely on data presented in the RFS in 2010/11 or 2011/12 to demonstrate that Type 1 POH additional charges were cost orientated. This is because the reported unit FAC and DSAC figures represent the average unit cost over a number of different services combined and are not likely to represent the costs associated with Type 1 POH additional charges alone.

4.19 BT explained that in the absence of available DSAC data, it has complied with its cost orientation obligation on the basis that it set its Type 1 POH additional charges using contemporaneous estimates of FAC.

4.20 BT first introduced Type 1 POH additional charges on 1 July 2010. It then increased them by 5% on 1 January 2011 before Ofcom set new Type 1 POH additional charges on a LRIC basis from 1 October 2011. Table 4.3 shows these Type 1 POH additional charges in this period.

Table 4.3: BT’s Type 1 POH additional charges during 2010/11 and 2011/12, unit

1 July 2010 1 January 2011 1 October 2011

SMA-1 £3,272 £3,435 £402

SMA-4 £4,866 £5,109 £477

SMA-16 £7,764 £8,151 £1,349

Bearer £322 £338 £227

69 BT response dated 7 February 2014 to Q1 of the s191 request dated 28 January 2014.

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4.21 We asked BT to explain what FAC estimates it had used to set its Type 1 POH additional charges.70

4.22 BT replied that it provided an estimate of total POH costs to Ofcom in connection with the 2009 LLCC Statement. This estimated BT’s overall FAC costs for POH at £11.7m (although we note that this FAC cost does not all relate to Type 1 POH, it also includes costs associated with Type 2 POH, which as explained in Section 2, are not within the scope of the Dispute).

4.23 Ofcom used this cost data provided by BT to set the starting prices for the new POH additional charges introduced in the 2009 LLCC Statement. The charges set by Ofcom in the 2009 LLCC Statement were Type 2 POH charges only. In the 2009 LLCC Statement we noted that BT had proposed to introduce new ‘efficient’ POH charges following the charge control – these were the Type 1 POH charges introduced by BT in July 2010.

4.24 BT explained that:

“C&W’s September 2009 appeal of the LLCC included a complaint about how POH charges were calculated. BT took these criticisms on board and amended its top down model. The revised model (with a lower overall cost of £6.7m) was used as the basis for setting the new POH charges effective from July 2010.”71

4.25 Approximately [] of its £6.7m total additional POH FAC estimate related to Type 1 charges.72 Therefore the Type 1 POH additional charges it introduced in July 2010 were designed to recover around [] of FAC.

4.26 BT also commented that:

“In September 2010, following CC Judgement, the CAT remitted the issue of POH charges back to Ofcom who conducted a year-long pricing review into the charges. In its 21 September [2011] POH pricing review statement Ofcom eventually decided that from 1 October 2011 BT should price POH services on a LRIC basis with prices set using Ofcom’s bottom up model.”73

4.27 The bottom up model to which BT refers74 was used by Ofcom to set both Type 1 and Type 2 POH additional charges from 1 October 2011. These forward looking charges were based on estimates of the LRIC to BT of providing additional POH. In order to obtain LRIC estimates, the bottom up model first estimated the FAC costs of providing additional POH and then multiplied some of the FAC estimates by 70% in order to derive LRIC estimates. At the time Ofcom said: “We consider the estimates derived using our bottom-up model to be more robust than the top-down estimates

70 BT response dated 7 February 2014 to Q9 of the section 191 request dated 28 January 2014. 71 BT response dated 7 February 2014 to Q9 of the section 191 request dated 28 January 2014. 72 BT response dated 7 February 2014 to Q9 of the section 191 request dated 28 January 2014. Figures taken from the spreadsheet called “point of handover cost summary”, sheet “calculation summary”, cell Y39. 73 BT response dated 7 February 2014 to Q9 of the section 191 request dated 28 January 2014. 74 http://stakeholders.ofcom.org.uk/binaries/consultations/revision-points-handover-pricing/annexes/model.xls. Note that the POH Pricing Review Statement made some changes to this model that are not incorporated in the published model. In particular, paragraph 4.141 of the Statement sets out that the final version of the model used a cost of capital of 6.5%; a figure of 189 fibres per duct and RPI inflation of 5%. We have incorporated these changes into the model.

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http://stakeholders.ofcom.org.uk/binaries/consultations/revision-points-handover-pricing/annexes/model.xls

http://stakeholders.ofcom.org.uk/binaries/consultations/revision-points-handover-pricing/annexes/model.xls


provided by BT, particularly because the latter have been obtained using very broadly defined increments, and tend to be volatile over time”.75 The model also applied an inflation assumption to estimate costs as at 1 October 2011 – without this inflation assumption the costs in the model were appropriate for the 2010/11 financial year.

4.28 It is therefore possible to use the bottom up model to obtain FAC estimates for Type 1 POH additional charges. Ofcom has previously used the bottom up model to derive FAC estimates of POH in the 2013 PPC Determination. In resolving that dispute we needed to estimate additional POH costs in order to make an adjustment to BT’s local end costs (prior to the introduction of additional POH charges, POH costs were recovered via an uplift on local end charges). We estimated additional POH FAC costs of around £3m in 2010/11 using the bottom up model.76 BT did not disagree with our use of the bottom up model to estimate additional POH costs (although it disagreed with the £3m figure we derived from the model).77

4.29 The bottom up model can be used to derive FAC associated with Type 1 POH. The resulting FAC estimate for 2010/11 is approximately £0.7m (see Table 4.4).

4.30 The total FAC is derived using unit FAC estimates from the bottom up model and applying them to volumes of Type 1 POH services provided by BT in response to our section 191 request dated 28 January 2014.78

Table 4.4: Type 1 POH FAC derived from bottom up model (2010/11)

Unit FAC Industry Volumes Total FAC

SMA-1 £426 151 £0.1m

SMA-4 £509 461 £0.2m

SMA-16 £1,454 198 £0.3m

Bearer £278 402 £0.1m

Total £0.7m Source: Ofcom bottom up model, BT responses dated 7 & 14 February to Question 3 of the 28 January 2014 section 191 request

4.31 To derive our unit FAC estimates from the bottom up model we did the following:

• Where a LRIC adjustment reducing values to 70% had been made on the “inputs” sheet we replaced this with 100%. This meant that the figures were now on a FAC basis.

• We set the RPI assumption to 0% on the “inputs” sheet. This is because the inflation assumption in the model was used to derive cost estimates as at 1 October 2011. Removing the inflation assumption gives cost estimates as at 31

75 LLCC PPC Points of Handover pricing review, 26 January 2011, paragraph 1.16. 76 2013 PPC Determination, paragraph 12.165. 77 2013 PPC Determination, paragraph 12.168. 78 BT responses dated 7 & 14 February 2014 to Q3 of the section 191 request dated 28 January 2014.

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March 2011, which falls within 2010/11 (the first financial year covered by this Dispute).

4.32 BT seeks to demonstrate that its Type 1 POH additional charges were cost orientated because they were set with reference to its FAC estimate of £6.7m (of which Type 1 FAC was around []).

4.33 However, for the reasons set out in the POH Pricing Review Statement, we consider that the FAC data on which BT relies is likely to overstate its costs. The FAC estimates that BT used to set Type 1 POH additional charges are much greater than those derived from Ofcom’s bottom up model. Ofcom’s bottom up model has been reviewed in detail by Ofcom as part of the POH pricing review and was consulted upon with industry. It has also previously been used by Ofcom to estimate POH costs in the 2013 PPC Determination.

4.34 The data produced by Ofcom’s bottom up model suggests that BT’s contemporaneous FAC estimates were too high. We consider that the FAC estimates derived from the bottom up model represent the most reliable data available to us in order to assess whether BT’s Type 1 POH additional charges were cost orientated. Given the basis of BT’s FAC estimates and the significant difference between those and the estimates derived from Ofcom’s bottom up model, we do not consider that BT can rely on its contemporaneous FAC estimates when demonstrating compliance with its cost orientation obligation. For this reason we do not consider that BT has demonstrated to our satisfaction that Type 1 POH additional charges were cost orientated.

Step 2: If BT has not satisfied us that its charges were compliant with the cost orientation obligation, were the charges nevertheless cost orientated?

Parties’ views

2Mbit/s local ends

4.35 Level 3 claims that the CAT in the 2009 LLCC appeal decided that Ofcom had made an error in the 2009 LLCC Statement which had allowed price increases for 2Mbit/s local ends to go “outside the range of prices that could be cost-oriented”. Level 3 claims that the CAT also found that as a result of Ofcom’s error, BT had overcharged for these services.79

4.36 Level 3 submits that these findings imply that from the effective date of the 2009 LLCC Statement until the effective date (30 September 2010) of Ofcom’s amendment of the charge control condition, BT’s rental charges for 2Mbit/s local ends did not comply with its cost orientation obligation.

4.37 BT argues that its prices for 2Mbit/s local ends during the Dispute Period were at a level below its published DSAC for these services, which was acknowledged by the CC in its Determination (see paragraphs 4.2 to 4.5 above).

79 Level 3 dispute submission, paragraph 1.16.

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POH additional charges

4.38 Level 3 submits with respect to POH additional charges, that following the 2009 LLCC appeal and Ofcom’s POH pricing review, Ofcom incorporated “new prospective cost-oriented prices...into the charge control condition”. Level 3 claims that while BT had complied with the amended charge control condition, it has not “addressed the question of non-compliance with the cost-orientation condition during the [Dispute Period]”.80

4.39 Level 3 believes that in the POH pricing review Ofcom had found that the costs of providing “additional POHs” were significantly less than those that BT had used to set POH additional charges from 1 April 2010, and set a new charge control to reflect these lower costs. It argues that the “necessary implication” of these findings is that between 1 April 2010 and 1 October 2011, being the effective date of the re-set charge control following the POH pricing review, BT had not complied with the cost orientation condition, and therefore overcharged Level 3 for these services.81

4.40 In its response to Level 3’s dispute submission, BT confirms that DSAC information is not available at the level of the individual POH charges in dispute. BT however claims that revenues earned from POH services during the Dispute Period were significantly below cost, as demonstrated by the return on Mean Capital Employed published in the RFS.82

4.41 BT also submits that “no evidence has been offered as to why the charges were not cost oriented. The price changes in October 2011 were primarily driven be the need to change the basis of how BT recovered common costs previously allocated to PoH services. This is simply a policy change in the approach taken to recover common costs and cannot reasonably be interpreted as evidence that cost orientation obligations had not been met.”83

Ofcom’s provisional views

2Mbit/s local ends

4.42 Table 4.5 shows the data reported in the RFS for 2Mbit/s local ends in 2009/10 and 2010/11. We focus on external prices and cost data since this is most relevant to this case.

80 Level 3 dispute submission, paragraphs 1.9 and 1.10. 81 Level 3 dispute submission, paragraphs 1.21 to 1.23. 82 See “Technical areas (Point of Handover) (Annex 11)”, http://www.btplc.com/thegroup/regulatoryandpublicaffairs/financialstatements/2011/currentcostfinancialstatements2011.pdf. 83 BT response to Level 3 dispute, page 5.

32

http://www.btplc.com/thegroup/regulatoryandpublicaffairs/financialstatements/2011/currentcostfinancialstatements2011.pdf

http://www.btplc.com/thegroup/regulatoryandpublicaffairs/financialstatements/2011/currentcostfinancialstatements2011.pdf


Table 4.5: 2Mbit/s local end data per RFS

Unit basis £ million basis

2009/10 2010/11 2009/10 2010/11

External CLZ

Price £417 £350 £1.6m £1.4m

FAC £759 £758 £2.8m £3.0m

DSAC £1,023 £1,391 £3.8m £5.6m

DSAC test (£606) (£1,041) (£2.3m) (£4.2m)

External Non-CLZ

Price £775 £728 £40.1m £37.4m

FAC £759 £758 £39.2m £38.9m

DSAC £1,023 £1,391 £52.9m £71.4m

DSAC Test (£248) (£663) (£12.8m) (£34.0m)

4.43 In the previous section we noted that BT had not considered the following factors when demonstrating that its charges for 2Mbit/s local end services were cost orientated:

• Separate charges for CLZ and non-CLZ 2Mbit/s local end services;

• Aggregation of cost data reported in the RFS; and

• Reported cost data may need to be adjusted in line with adjustments made in the 2009 PPC Determination.

4.44 Before assessing whether or not BT’s charges were cost orientated, we have considered each of these factors.

2Mbit/s local end charges

4.45 In Table 4.5 we set out the 2Mbit/s local end charges that applied during 2009/10 and 2010/11. There were separate charges during this period for CLZ and non-CLZ 2Mbit/s local end rentals. Since, as discussed in Section 3, the cost orientation obligation refers to ‘each and every charge’ we do not consider it would be appropriate to aggregate the CLZ and non-CLZ charges together when assessing compliance with the cost orientation obligation.

Aggregation of cost data in the RFS

4.46 Although BT reports separate charges for CLZ and non-CLZ 2Mbit/s local end services in the RFS, it reports a single aggregated unit cost figure84. The unit FACs and unit DSACs reported in the RFS therefore represent BT’s estimate of costs for CLZ and non-CLZ 2Mbit/s local end services combined.

84 Whilst it sets out Unit FAC and Unit DSAC for CLZ and non-CLZ services separately, these figures are identical and have been calculated on an aggregate basis.

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4.47 We asked BT to provide FAC and DSAC data relevant to each 2Mbit/s local end charge.85 BT was unable to provide this data and instead provided the unit FAC and unit DSAC data reported in the RFS, which it described as the national average unit cost.86

4.48 CLZ charges are significantly less than non-CLZ charges, and this is likely to be driven by differences in the cost of providing these local ends inside and outside of Central London. Therefore, we have considered what information is available to us to attempt to disaggregate the FAC and DSAC data reported in the RFS between CLZ and non-CLZ 2Mbit/s local ends.

4.49 In connection with the 2012 LLCC Statement, BT provided estimates of geographic costing for local end services, including 2Mbit/s local ends.87 For 2Mbit/s local end services, BT estimated that the unit cost for the “London metro” area was [] of the national unit cost. We have assumed that the “London metro” area is similar to the CLZ area that BT uses for charging purposes.

4.50 Table 4.6 shows the results of applying this [] ratio to the unit costs of 2Mbit/s local end services. We have applied the ratio to both FAC and DSAC. Average prices for CLZ and non-CLZ local ends continue to be below DSAC after taking into account the potential difference in costs between CLZ and non-CLZ 2Mbit/s local ends.

Table 4.1: 2Mbit/s local end data after adjusting for differences in CLZ costs [redacted values fall within stated range]

Unit basis £ million basis 2009/10 2010/11 2009/10 2010/11

External CLZ

Price £417 £350 [ £1m-£2m] [ £1m-£2m]

FAC [ £400-£500] [£400-£500] [ £1m-£2m] [ £1m-£2m]

DSAC [ £500-£600]

[ £700-£800] [ £2m-£3m] [ £3m-£4m]

DSAC test [ (£100-£200)]

[ (£400-£500)] [ (£0-£1m)] [ (£1m-

£2m)]

External Non-CLZ

Price £775 £728 [ £36m-£44m]

[ £34m-£41m]

FAC [ £700-£800]

[ £700-£800]

[ £36m-£45m]

[ £36m-£44m]

DSAC [ £1,000-£1,100]

[ £1,400-£1,500]

[ £49m-£60m]

[ £67m-£81m]

DSAC Test [ (£200-£300)]

[ (£700-£800)]

[ (£13m-£16m)]

[ (£33m-£40m)]

85 BT’s response dated 14 February 2014 to question 14 of the 28 January section 191 request. 86 BT’s response dated 7 February 2014 (Q13 template_FINAL”.xls, Note 6). 87 BT’s response to Ofcom’s section 135 information request dated 21 May 2012.

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Adjustments made in the 2009 PPC Determination

4.51 In the 2009 PPC Determination, a number of FAC adjustments were made to 2Mbit/s local end services.88 Table 4.7 summarises the adjustments made and the average annual impact on FAC.

Table 4.7: Impact of adjustments to 2Mbit/s local end FAC in the 2009 PPC Determination

2009 PPC Determination FAC adjustments

Average annual FAC impact

Removal of costs associated with equipment and POH costs89 -[]%

Other adjustments90 -[]%

4.52 Table 4.7 illustrates that the most significant adjustment was removal of costs associated with equipment and POH costs. We asked BT whether the cost for 2Mbit/s local end rentals reported in the RFS included costs associated with equipment and POH (i.e. whether this adjustment was required). BT responded that “in 2009/10 and 2010/11 the 2Mbit/s local end rentals did not include costs associated with third party customer local end equipment and infrastructure”.91 As a result, we do not consider that this adjustment is required.

4.53 The remaining adjustments applied to 2Mbit/s local ends were relatively small and amounted to an annual reduction in FAC of approximately []. We have not considered whether or not these other adjustments would be required in 2009/10 and 2010/11 but we have considered whether making them would be likely to affect DSAC to such an extent that BT’s charges for 2Mbit/s local ends would exceed them.

4.54 Table 4.8 shows the impact on the cost base of 2Mbit/s CLZ and non-CLZ local ends that making these adjustments would have, if we were to apply them. We have assumed that if we made these adjustments the reduction in FAC and DSAC for 2Mbit/s local ends would be [] in each year. We have applied this reduction to the disaggregated costs shown in Table 4.6. We note that BT’s charges remain close to FAC and considerably below DSAC after taking into account the potential impact of these adjustments.

88 2009 PPC Determination, paragraphs 6.58 to 6.130. 89 The percentage reported here includes the impact of the equipment selling costs. Although this was included as a separate adjustment in the 2009 PPC Determination, it also involves removing costs associated with local end equipment from the costs base of local end rentals. 90 Other adjustments relate to a) removal of costs associated with 21CN, b) Payment Terms and c) removal of costs associated with excess construction charges. 91 BT response dated 7 February 2014 to Q15 of the section 191 request dated 28 January 2014.

35


Table 4.2: 2Mbit/s local end data after adjusting for impact of CLZ costs and potential cost adjustments per 2009 PPC Determination (redacted value falls within stated range)

Unit basis £ million basis 2009/10 2010/11 2009/10 2010/11

External CLZ Price £417 £350 [ £1m-£2m] [ £1m-£2m]

FAC [ £300-£400]

[ £300-£400] [ £1m-£2m] [ £1m-£2m]

DSAC [ £500-£600]

[ £700-£800] [ £1m-£2m] [ £2m-£3m]

DSAC test [ (£100-£200)]

[ (£300-£400)] [ (£0 - £1m)] [ (£1m-

£2m)] External Non-CLZ

Price £775 £728 [ £36m-£44m]

[ £34m-£41m]

FAC [ £700-£800]

[ £700-£800]

[ £33m-£41m]

[ £33m-£41m]

DSAC [ £900-£1,000]

[ £1,300-£1,400]

[ £46m-£55m]

[ £61m-£74m]

DSAC Test [ (£100-£200)]

[ (£500-£600)]

[ (£9m-£10m)]

[ (£27m-£33m)]

Provisional conclusion in relation to 2Mbit/s local ends

4.55 On the basis of the analysis that we have carried out and the results shown in Table 4.8 above, we provisionally conclude that BT’s charges for 2Mbit/s local end services did not exceed DSAC during the period and were thus cost orientated.

Points of Handover

4.56 In the previous section we indicated that BT had not demonstrated to our satisfaction that its charges for additional POH services were cost orientated because it relied on its own contemporaneous FAC estimates which were significantly above the FAC estimates derived using Ofcom’s bottom up model of POH costs.

4.57 In light of this, we set out below our provisional analysis and conclusion as to whether these charges were nevertheless cost orientated within the Dispute Period. We first set out the revenue and cost data we have used to assess whether BT’s Type 1 POH additional charges were cost orientated.

Type 1 POH revenue

4.58 Type 1 POH additional charges92 were introduced on 1 July 2010.

4.59 BT levied a number of different charges for Type 1 POH services during the Dispute Period. Table 4.9 summarises the charges that applied during the Dispute Period and calculates an average charge across each of BT’s financial years 2010/11 and 2011/12, calculated by weighting the charges by the number of days they were in effect.

92 SMA-1, SMA-4, SMA-16, plus a bearer charge for CSH and ISH extension (Customer Sited Handover, or “CSH” circuits are handed over at the CP’s premises, In-Span Handover extension or “ISH extension” circuits are handed over at a CP’s nominated footway box).

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Table 4.9: BT Type 1 POH additional charges and weighted average price, unit

SMA-1 SMA-4 SMA-16 Bearer charge

Charge introduced:

01/07/2010 £3,272 £4,866 £7,764 £322

01/01/2011 £3,435 £5,109 £8,151 £338

01/10/2011 £402 £477 £1,349 £227

Weighted average charge in full financial year

2010/11 £2,496 £3,713 £5,924 £246

2011/12 £1,923 £2,799 £4,760 £283

Source: BT response dated 7 February 2014 to Q1 of the section 191 request dated 28 January 2014

4.60 BT provided volumes for Type 1 POH in response to a section 191 request.93 These are set out in Table 4.10 along with the revenues. Revenues are calculated by multiplying volumes by the weighted charges from Table 4.9.

Table 4.10: Type 1 POH industry volumes and revenues 2010/11 2011/12

SMA-1

Volumes 151 138

Weighted unit average charge £2,496 £1,923

Revenue £0.4m £0.3m

SMA-4

Volumes 461 529



SMA-16

Volumes 198 206



Bearer

Volumes 402 465

Weighted unit average charge £246 £283


Type 1 POH FAC

4.61 As noted above, BT’s estimates of the costs associated with Type 1 POH additional charges were included within other services in the reported RFS. As such, the cost data reported in the RFS is not likely to be representative of the costs associated with Type 1 POH additional charges. BT recognises this as it has not sought to rely on the

93 BT response dated 7 & 14 February 2014 to Q3 of the section 191 request dated 28 January 2014.

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data reported in the RFS to demonstrate that its Type 1 POH additional charges were cost orientated.

4.62 Table 4.11 sets out the Type 1 POH FAC estimates derived from the bottom up model for 2010/11, which we consider to be the most reliable data available to us.94 In order to derive a FAC estimate appropriate for 2011/12 we have uplifted the unit FAC figure for 2010/11 by 3.5% (the CPI for the year to March 2012).95

Table 4.11: Type 1 POH industry volumes and FAC 2010/11 2011/12

SMA-1

Volumes 151 138

Unit FAC £426 £441

Total FAC £0.1m £0.1m SMA-4

Volumes 461 529

Unit FAC £509 £527

Total FAC £0.2m £0.3m SMA-16

Volumes 198 206

Unit FAC £1,454 £1,505

Total FAC £0.3m £0.3m Bearer

Volumes 402 465

Unit FAC £278 £287

Total FAC £0.1m £0.1m

Type 1 POH DSAC

4.63 As set out in Section 3, we intend to assess whether BT’s charges were cost orientated by comparing revenues against DSAC.

4.64 DSAC data, however, is not available for Type 1 POH services. Given this, we have considered the following options for deriving estimates of DSAC for Type 1 POH services:

• Require BT to derive estimated DSAC based on its LRIC model; or

• Estimate DSAC by applying DSAC/FAC ratio estimates to our FAC estimates.96

94 We explain how we obtained FAC estimates for 2010/11 using the bottom up model in paragraphs 4.28 to 4.34. 95 We note that RPI in the year to March 2012 was 3.6%. 96 We also considered the possibility of using the absolute difference between FAC and DSAC for POH services and using this to uplift FAC. However, due to the level of aggregation of the DSAC data in the RFS, this was not an option in these circumstances.

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Running the LRIC model

4.65 In theory, BT could produce DSAC estimates by running its LRIC model, identifying separate cost components specific to Type 1 POH additional charges. Such an exercise would involve a significant amount of work and time to complete, which we do not believe would be practicable or proportionate in the context of resolving this Dispute in four months. This is consistent with the approach we took in the Ethernet Determinations,97 where we identified a number of issues with asking BT to run its LRIC model98 and decided it was neither practicable nor proportionate.

4.66 Issues with running the LRIC model include the following:

• Costs associated with Type 1 POH additional charges are not separately identified in BT’s cost allocation system. BT would need to separately identify these services, decide which cost components they require and amend its systems accordingly.

• Assuming that Type 1 POH additional charges were separately identified in BT’s cost allocation system, the LRIC model would need to be re-run for the whole of BT and not just the services in dispute. This reflects the fact that the LRIC model uses cost components rather than services as the basis for modelling and uses the concept of increments to calculate DSAC data.

• The model would need to be re-run separately for 2010/11 and 2011/12 (reflecting the time period for the Dispute).

• In order to ask BT to re-run the LRIC model, we would need to set out the changes we require. It may not have been possible to ask BT to re-run the LRIC model before we had decided what the appropriate FAC data was.

• While the disputed time period April 2010 to September 2011 is relatively recent, BT’s model is continually refined and updated and BT may no longer have the data or the parameter information needed to estimate the DSACs for the Dispute Period. It would therefore be necessary for Ofcom and BT to agree how the modelling should be configured to estimate values for each of the years.

Applying DSAC/FAC ratios

4.67 DSAC estimates for costs associated with Type 1 POH additional charges could be derived by applying appropriate DSAC/FAC ratios to our FAC estimates set out in Table 4.4.

4.68 DSAC/FAC ratios can be calculated by reference to the unit DSAC and unit FAC data reported in the RFS in 2010/11 and 2011/12. We have therefore considered which services we should use to calculate DSAC/FAC ratios as not all services reported in the RFS are relevant to POH services.

4.69 As set out in paragraphs 4.16 to 4.18, the costs associated with Type 1 POH additional charges were included within the cost base of other reported services in

97 Disputes between each of Sky, Talk Talk, Virgin Media, Cable & Wireless and Verizon and BT regarding BT’s charges for Ethernet services, Determinations and Explanatory Statement published on 20 December 2012 (“the Ethernet Determinations”). These Determinations are subject to appeals to the CAT. Judgment is pending. 98 Ethernet Final Determination, paragraph 13.389.

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the RFS in these years. In particular, these costs were included within CSH and ISH rentals in 2010/11 and in the cost base of 3rd party POH rentals in 2011/12.

4.70 We consider that a reasonable starting point is to consider the DSAC/FAC ratios for these services reported in the RFS since they implicitly include BT’s estimates of the costs associated with Type 1 POH charges. Table 4.12 sets out these DSAC/FAC ratios.

Table 4.12: DSAC/FAC ratios for RFS services which included BT’s estimates of the costs of Type 1 POH additional charges 2010/11 2011/12

CSH rental 1.24 1.47

ISH rental 1.29 1.64

3rd Party POH Rental 64Kbit/s 1.65 2.69

3rd Party POH Rental 2Mbit/s non CLZ 1.82 2.05

3rd Party POH Rental 2Mbit/s CLZ 1.84 1.94

3rd Party POH Rental 34/45Mbit/s 1.85 1.92

3rd Party POH Rental 140/155Mbit/s 1.67 2.08

Minimum 1.24 1.47

Average 1.62 1.97

Maximum 1.85 2.69

4.71 There may be reasons why the DSAC/FAC ratio for Type 1 POH would be expected to differ from the ranges presented in Table 4.12 due to the characteristics of the service. For example, Type 1 POH costs largely relate to operational costs,99 which may typically be associated with different levels of common costs than capital costs. However, for the purposes of this provisional determination we consider that it is reasonable to consider some DSAC/FAC ratios reported in the RFS for services associated with Type 1 POH in order to derive a range.

4.72 Table 4.13 applies these ratios to the unit FAC data presented in Table 4.4.

99 This can be seen in Ofcom’s bottom up model. The charges are derived from costs estimates for “operational costs”, “support costs” and “network overheads”. See the “summary” sheet in the model.

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Table 4.13: Type 1 POH additional charges unit DSACs based on minimum, average and maximum DSAC/FAC ratios, unit

2010/11 2011/12

SMA-1

Minimum £529 £648

Average £691 £868

Maximum £787 £1,183

SMA-4 Minimum £632 £775

Average £826 £1,038

Maximum £941 £1,415

SMA-16

Minimum £1,805 £2,213

Average £2,361 £2,965

Maximum £2,687 £4,042

Bearer

Minimum £345 £423

Average £451 £5766

Maximum £513 £772

Did BT’s Type 1 POH additional charges exceed relevant DSAC?

4.73 In order to assess whether BT’s Type 1 POH additional charges were cost orientated, we must determine whether they exceeded DSAC.

4.74 Table 4.14 sets out the revenue, FAC and DSAC data for Type 1 POH additional charges on both a unit basis and absolute basis (i.e. unit basis multiplied by industry volumes). The three unit DSACs presented in the table correspond to the minimum, average and maximum DSAC/FAC ratios shown in Table 4.12.

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Table 4.14: Type 1 POH additional charges, FACs and DSACs based on minimum, average and maximum DSAC/FAC ratios


2010/11 2011/12 2010/11 2011/12

SMA-1

Revenue £2,496 £1,923 £0.4m £0.3m

FAC £426 £441 £0.1m £0.1m

DSAC

Minimum £529 £648 £0.1m £0.1m

Average £691 £868 £0.1m £0.1m

Maximum £787 £1,183 £0.1m £0.2m

SMA-4

Revenue £3,713 £2,799 £1.7m £1.5m

FAC £509 £527 £0.2m £0.3m

DSAC

Minimum £632 £775 £0.3m £0.4m

Average £826 £1,038 £0.4m £0.5m

Maximum £941 £1,415 £0.4m £0.7m

SMA-16

Revenue £5,924 £4,760 £1.2m £1.0m

FAC £1,454 £1,505 £0.3m £0.3m

DSAC

Minimum £1,805 £2,213 £0.4m £0.5m

Average £2,361 £2,965 £0.5m £0.6m

Maximum £2,687 £4,042 £0.5m £0.8m

Bearer

Revenue £246 £283 £0.1m £0.1m

FAC £278 £287 £0.1m £0.1m

DSAC

Minimum £345 £423 £0.1m £0.2m

Average £451 £566 £0.2m £0.3m

Maximum £513 £772 £0.2m £0.4m

4.75 Table 4.15 shows the results of the DSAC test for Type 1 POH additional charges using the minimum, average and maximum DSAC/FAC ratios shown in Table 4.10. Figures are presented on both a unit and absolute basis.

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Table 4.15: DSAC test results for Type 1 POH additional charges using minimum, average and maximum DSAC/FAC ratios


2010/11 2011/12 2010/11 2011/12

SMA-1

Minimum £1,968 £1,275 £0.3m £0.2m

Average £1,805 £1,055 £0.3m £0.1m

Maximum £1,710 £740 £0.3m £0.1m

SMA-4

Minimum £3,081 £2,0125 £1.4m £1.1m

Average £2,886 £1,761 £1.3m £0.9m

Maximum £2,772 £1,384 £1.3m £0.7m

SMA-16

Minimum £4,118 £2,546 £0.8m £0.5m

Average £3,563 £1,795 £0.7m £0.4m

Maximum £3,236 £718 £0.6m £0.1m

Bearer

Minimum (£99) (£140) (£0.0m) (£0.1m)

Average (£205) (£284) (£0.1m) (£0.1m)

Maximum (£268) (£489) (£0.1m) (£0.2m)

4.76 The results of the DSAC test show that unit revenues for SMA-1, SMA-4 and SMA-16 exceeded DSAC in both 2010/11 and 2011/12. Revenues for the bearer were below DSAC in both years.

4.77 We note that in order for the unit revenues of SMA-1, SMA-4 and SMA-16 to be below DSAC in 2010/11 and 2011/12, the DSAC/FAC ratios would need to be significantly higher. Table 4.16 shows the DSAC/FAC ratios that would be required in order for charges for these services to be below DSAC.

Table 4.16: DSAC/FAC ratios required for charges to be below DSAC

DSAC:FAC ratio SMA-1 SMA-4 SMA-16

2010/11 5.9 7.3 4.1

2011/12 4.4 5.3 3.2

4.78 None of the DSAC/FAC ratios we have considered in Table 4.12 would support a DSAC/FAC ratio as high as these.

Provisional conclusion in relation to Type 1 POH additional charges

4.79 On the basis of the analysis that we have carried out above and the results shown in Table 4.15 above, we provisionally conclude that certain of BT’s Type 1 POH additional charges exceeded DSAC during the Dispute Period.

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Step 3: Are there any other factors which should be considered?

Further factors in our assessment

4.80 As we set out in Section 3, we consider that it is not appropriate to apply the DSAC test in a mechanistic manner. For the services and years in which we have found BT’s charges have exceeded DSAC, we consider under Step 3 other factors that might indicate these charges were nonetheless cost orientated. We then conclude whether overcharging has occurred.

4.81 The additional factors which we consider are relevant in this case are:

• The magnitude and duration by which charges exceeded DSAC.

• Whether, and the extent to which, charges exceeded FAC.

4.82 We consider these factors for each of the services we have found to be in excess of DSAC under Step 2, namely Type 1 POH additional rental charges for SMA-1; SMA-4; and SMA-16 services.

4.83 We could not assess the return on capital employed (“ROCE”) as we often do in such assessments because, for the services in question, reliable ROCE estimates are not available.

4.84 In relation to bearer charges, we have not found BT’s charges were in excess of relevant DSAC estimates over the Dispute Period. Additionally, we note that in 2010/11 and 2011/12, BT’s average additional rental charges for POH Bearer were slightly below our estimates of FAC in each year.

POH additional rental charges for SMA-1, SMA-4 and SMA-16

The magnitude and duration by which charges exceeded DSAC

4.85 In relation to SMA-1, SMA-4 and SMA-16, we present below the magnitude and duration by which charges exceeded DSAC.

Table 4.17: Comparison of BT’s charges relative to DSAC estimates

2010/11

(Relevant period assessed 1 July 2010 to 30 March 2011)*

2011/12

Relevant period assessed 1 April 2011 to 30 September 2011)**

BT unit revenues as % of upper and lower estimates of DSAC SMA-1 317% to 472% 163% to 297%

SMA-4 395% to 587% 198% to 361%

SMA-16 220% to 328% 118% to 215% Source: Ofcom 2014 (based on Table 4.14) Notes: *Prior to 1 July 2010, BT did not charge separately for its POH additional charges. **On 1 October 2011, BT set its charges in line with the POH pricing review.

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4.86 The above table shows that BT’s charges exceeded our estimates of DSAC in the relevant periods assessed for each financial year by a significant amount, even when taking account of different DSAC estimates as shown in Table 4.14.

4.87 We note that the Dispute Period itself is a relatively short timeframe, however BT had an opportunity to review its POH additional charges when it introduced the new Type 1 charges on 1 July 2010 to ensure that they were cost orientated. Furthermore, it had another opportunity to check on cost orientation when it revised its additional POH charges on 1 January 2011.100 At this time, BT chose to increase its charges by 4.99%.

4.88 BT has provided no evidence to us that it sought to satisfy itself that the new additional charges were likely to meet its cost orientation obligations. Instead, it has referred to aggregated unit revenues and FAC estimates for POH services reported in the RFS:

“BT is unable to draw upon published DSAC figures to demonstrate compliance with cost orientation for the disputed PoH charges…

However, BT can demonstrate that in order to comply it has consistently sought to price PoH at FAC (a threshold substantially below DSAC), using contemporaneous estimates of FAC. Moreover, at the time the prices were set, Ofcom confirmed that it was satisfied that the approach used to set these charges was reasonable.”101

4.89 However, as discussed at paragraphs 4.16 to 4.34, we do not consider that this is sufficient to demonstrate cost orientation, which relates to each and every charge.

4.90 BT claims that we confirmed that we were satisfied that the approach used to set these charges was reasonable. While BT may have considered that the broad approach that it had used to set charges (i.e. in line with FAC) was acceptable to us, this cannot be relied upon to demonstrate compliance with cost orientation if its charges were based on incorrectly calculated FAC estimates. BT’s inability to correctly calculate its costs cannot be a justification for BT failing to set charges on a cost orientated basis and would send the wrong incentive signals for future compliance.

4.91 The fact that BT’s Type 1 POH additional charges exceeded DSAC for two consecutive years by a considerable margin, despite BT having opportunities to review whether the charges were cost orientated, is suggestive that BT has not complied with its cost orientation obligations.

The extent to which charges exceeded FAC

4.92 As a cross check on our results above, in Table 4.18 below we present the extent to which BT’s POH additional charges exceeded FAC.

100 BT price notification ACCN 1051. 101 Page 5, BT’s letter to Ofcom 24 January 2014.

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Table 4.18: Comparison of BT’s charges relative to FAC estimates

2010/11

(Relevant period assessed 1 July 2010 to 30 March 2011)*

2011/12

(Relevant period assessed 1 April 2011 to 30 September 2011)**

BT unit revenues as % of FAC SMA-1 587% 436%

SMA-4 729% 531%

SMA-16 407% 316% Source: Ofcom 2014 (based on Table 4.14) Notes: *Prior to 1 July 2010, BT did not charge separately for its POH additional charges. **On 1 October 2011, BT set its charges in line with the POH pricing review.

4.93 The above table shows that BT’s charges were very substantially above FAC in the relevant periods assessed for each financial year. The analysis of FAC therefore provides no evidence that the Type 1 POH additional charges were cost orientated.

Our provisional determination

4.94 Based on the evidence available to us and the lack of satisfactory explanation from BT, our provisional conclusions were that:



o BT’s charges for each of its SMA-1, SMA-4 and SMA-16 services were not cost orientated in either 2010/11 or 2011/12 and that it therefore overcharged Level 3 for these services in the period 1 July 2010 to 30 September 2011.

o BT’s charges for its bearer services were cost orientated in both 2010/11 and 2011/12 and therefore it did not overcharge Level 3 for these services.

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Section 5

5 Analysis and conclusions Introduction

5.1 Ofcom received four non-confidential responses to the Provisional Conclusions, from BT, Level 3, Vodafone and a joint submission from Vodafone, Virgin Media and Verizon.

5.2 In this section, we summarise the key issues raised in the responses to the Provisional Conclusions and set out our analysis and final conclusions.

5.3 We have carefully considered these responses. For the reasons set out below, the matters raised in the four responses have not caused us to change our overall conclusions from those set out in the Provisional Conclusions. We have, though, made certain adjustments to our approach to calculating the charges and costs that applied during the Dispute Period and have corrected calculation errors that impact on both the DSAC test and the level of repayments set out in Section 6. In both cases it is the correction of our calculation errors (as opposed to adjustments to our approach) that have resulted in the most significant changes to our revenue and cost estimates in the Provisional Conclusions.

5.4 In setting out the responses and analysis we use broadly the same headings and ordering as that used in the analytical framework that we used to reach our provisional conclusions.

Step 1: Has BT demonstrated to Ofcom’s satisfaction that each and every charge was cost orientated?

Stakeholders’ views

5.5 BT argues that an appropriate threshold must be met before Ofcom considers a dispute or goes into a detailed consideration of costs and charges like that carried out in Step 2. BT asserts that it provided Ofcom with sufficient evidence to demonstrate that both the 2Mbit/s local end charges and the Type 1 POH additional charges were cost orientated.

5.6 BT is of the view that where prices are below published DSAC, “Ofcom should presume BT’s prices are cost oriented unless the referring CP can show that there is a specific and sound reason for Ofcom to investigate further. Any other approach is disproportionate.”102 BT argues that Level 3 failed to provide any evidence to justify Ofcom needing to investigate local end charges further.

5.7 BT notes that although it must ensure that its charges are cost orientated, it does not have to produce a DSAC for each and every price to demonstrate this. BT argues that such an approach would be disproportionate.

102 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 7.

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2Mbit/s local ends

5.8 BT disagrees with our provisional conclusion that it failed to demonstrate that its 2Mbit/s local end charges were cost orientated because it had relied on aggregated DSAC data. BT asserts that such a conclusion would be inconsistent with the approach adopted by Ofcom in the 2009 PPC Determinations.103

5.9 BT notes that although it has set a discounted price for 2Mbit/s local ends purchased in the CLZ, it could in theory set a different discounted rate for each of the 5,500 local exchange areas. BT argues that it would be disproportionate for it to have to demonstrate that each and every discounted local end charge was cost orientated.

5.10 With respect to 2Mbit/s local ends, BT submits that the charges are for a single service, under which it was permitted to offer geographic discounts on the national price, but was not permitted to offset the discount by increases to the undiscounted national price. BT notes that there was no disaggregation of costs to allow BT to rebalance cost recovery to match the price differential. BT therefore allocated common costs equally to all local ends. BT believes that this approach was appropriate and that the DSAC test should therefore be applied to the undiscounted national price.104

5.11 Level 3 agreed with our assessment that BT had failed to demonstrate that its 2Mbit/s local end charges were cost orientated, noting that “the DSAC figures published in the RFS for 2009/10 and 2010/11 are not in themselves sufficient to demonstrate compliance with the cost-orientation obligation”.105

Points of Handover

5.12 BT argues that where DSAC information is not available, but FAC data is, it is reasonable to conclude that a charge is cost orientated where that charge is not significantly above FAC.

5.13 BT claims that it complied with its cost orientation obligation on the basis of the best information available to it at the time, and that in doing so it had used the same top-down cost model used by Ofcom to set the POH prices in the 2009 LLCC Statement.

5.14 In our Provisional Conclusions we used Ofcom’s bottom-up model to estimate costs, on the basis the FAC estimates derived from this model represent the most reliable data available to assess the cost orientation of BT’s Type 1 POH charges.

5.15 BT argues that such an approach cannot be correct or lawful. BT could not have assessed prices using Ofcom’s bottom-up model because it was not available at the time that it set prices. BT adds that it “had no reason in July 2010 to believe that the methodology [it had used] was unreasonable and there was no way BT could have evaluated the prices by reference to all the information Ofcom is now attempting to use to assess compliance with the cost orientation obligation at the time in question.”106

5.16 BT argues in its response to the Provisional Conclusions that it would be contrary to the rules of legal certainty for Ofcom to find that charges, which were set on the basis

103 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraphs 8, 12 and 13. BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 13. 105 Level 3’s response dated 8 April 2014 to the Provisional Conclusions, page 2. 106 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 19.

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of a methodology that Ofcom had previously agreed, were inappropriate and not cost orientated.

5.17 BT further argues that unless there was some clear, contemporaneous indication that the FAC methodology that both BT and Ofcom had used was not sufficient to demonstrate cost orientation, BT must be allowed to rely on that methodology to demonstrate compliance in any retrospective investigation by Ofcom. BT notes that Ofcom has essentially taken this position itself in relation to the application of the DSAC test when assessing cost orientation compliance.

Ofcom’s views

5.18 Ofcom recognises that it should consider whether an appropriate threshold has been met before deciding that it is necessary to carry out a detailed assessment of BT’s costs and charges. In Step 1 of the analytical framework we have asked BT to explain why its charges are cost orientated and only proceed to a detailed assessment in Step 2 if BT has not demonstrated to our satisfaction that its charges complied with the cost orientation obligation.

5.19 As we explain further below, we disagree with BT that it has provided sufficient evidence to meet this threshold.

5.20 Ofcom will only be able to rely on published DSAC information (or FAC information if BT seeks to demonstrate compliance on this basis) where it is satisfied that the published DSACs (or FACs) are sufficiently accurate and that they match the charges that are the subject of the Dispute. In the case of 2Mbit/s local ends and Type 1 POH, BT failed to satisfy us that this was the case.

2Mbit/s local ends

5.21 BT argues that it would be disproportionate for it to have to demonstrate that each and every discounted local end charge was cost orientated because in theory it could set a different charge for each of the 5500 exchange areas. As we explain in Sections 3 and 4 above, the cost orientation obligation requires that each charge that BT sets for network access be cost orientated. 2Mbit/s local ends are a form of network access and BT currently sets separate charges for these services depending on whether they are provided within the CLZ or outside of it.107 BT is therefore required to ensure and be able to demonstrate that each of these charges is cost orientated. If BT did offer separate charges for each exchange area then it would need to demonstrate that each of those charges was cost orientated. We note that, in practice, BT has only two charges for 2 Mbit/s local end rental services.

5.22 As we explain in Section 4, we did not consider that BT had been able to demonstrate that each of the CLZ and non-CLZ 2Mbit/s local end rental charges were cost orientated on the basis of the information that it provided at the time.108 BT had only considered the non-CLZ charges and compared these to DSACs that

107 We note BT’s suggestion that it could in theory set separate charges for local ends provided in each of its 5,500 local exchange areas. SMP Condition G3 would require that each and every one of these charges be cost orientated as each would represent a charge for network access. 108 BT submitted that its charges are for a single service under which it is permitted to offer geographic discounts on a national price, but it was not permitted to offset the discount by increases to the undiscounted national price. However, Ofcom notes that the obligations that BT is referring to relate to which price reductions would count towards compliance with its charge control as set out in the 2009 LLCC Statement (see for example paragraphs 3.283 to 3.298). This is separate to BT’s obligations in respect of cost orientation which apply to each and every charge.

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represented the aggregate DSAC across both CLZ and non-CLZ 2Mbit/s local end services. In the 2009 PPC Determination we did compare charges for 2Mbit/s local ends against aggregated DSAC data, although we took into account potential adjustments to this data. We noted that these potential adjustments were unlikely to change our conclusions since revenues for 2Mbit/s local end services were substantially below DSAC and therefore it was not necessary in the circumstances to undertake a more granular assessment since this would have given the same result.109

5.23 We recognise that cost data reported in the RFS sometimes reflects costs for a number of different services combined. However, given that the cost orientation condition applies to each and every charge and BT is therefore required to demonstrate to Ofcom that each and every charge is cost orientated, aggregated figures do not allow Ofcom to assess compliance with the cost orientation obligation. It is therefore necessary in Step 2 of our analysis to disaggregate costs if such data is available to do this. As we explain in paragraphs 4.48 to 4.50, we did have such data available from BT. Given the significant difference between the charges for CLZ and non-CLZ services, it was possible that disaggregation of the cost data could have led to a different conclusion. We consider that it is appropriate for us to consider whether disaggregation of cost data is possible on a case by case basis.

5.24 BT submitted that its charges are for a single service under which it is permitted to offer geographic discounts on a national price, but it was not permitted to offset the discount by increases to the undiscounted national price. However, Ofcom notes that the obligations that BT is referring to are those contained in the charge control. As we have set out, this is separate to BT’s obligations in respect of cost orientation which apply to each and every charge.

Points of Handover

5.25 Step 1 of the analytical framework considers whether BT has demonstrated to the satisfaction of Ofcom that its charges were cost orientated. In order for Ofcom to conclude its investigation at this stage of the process, it must be satisfied that it is clear that BT’s charges were cost orientated and that there is no need to consider further BT’s costs or the circumstances in which the charges were set.

5.26 As discussed in Section 4, we do not consider that BT’s top-down FAC model can be relied upon to produce accurate cost information for the services which are the subject of this dispute. Ofcom’s 2010/11 PPC POH pricing review identified that there were significant variances in the outputs of BT’s model over time, despite volumes being kept constant, and that cost apportionments did not look reasonable.110 Ofcom concluded that it remained “concerned about the reliability of the method used by BT to produce POH top down estimates and consequently the outputs of BT’s model”.111 In the 2010/11 PPC POH pricing review Ofcom also built a bottom-up cost model which estimated significantly lower costs than those estimated by BT’s top-down model. We cannot, therefore, be satisfied that BT’s Type 1 POH additional charges were cost orientated, because BT is seeking to demonstrate this by reference to cost estimates that we concluded were not reliable in the POH Pricing Review Statement.

109 2009 PPC Determinations, paragraph 6.126. 110 See paragraphs 4.11 to 4.21 of the POH Pricing Review Statement: http://stakeholders.ofcom.org.uk/binaries/consultations/revision-points-handover-pricing/statement/final-statement.pdf. 111 POH Pricing Review Statement, paragraph 4.21.

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Legal certainty

5.27 BT is seeking to rely on statements made by Ofcom in the 2009 LLCC Statement to argue that its Type 1 POH additional rental charges over the Dispute Period should be found to be cost orientated. BT suggests that Ofcom gave BT an expectation that, in adopting a top down approach to the modelling of POH costs, its approach to compliance with the cost orientation obligation was reasonable such that it would now be unfair to find that charges based on that approach were not compliant.

5.28 We do not accept BT’s argument. The cost model used by BT to estimate costs of £11.7m which Ofcom considered in the 2009 LLCC was subsequently revised by BT making adjustments to its estimates in the course of the appeal of the 2009 LLCC to the CAT112 and prior to the start of the Dispute Period. Further, in the course of the appeal, the CC, in its determination of 30 June 2010, raised doubts as to the reliability or otherwise of the revised estimates.113 We therefore do not consider that BT’s arguments on legal certainty have any merit and have not therefore changed the approach set out in the Provisional Conclusions.

Conclusion on Step 1

5.29 We remain of the view that BT has failed to demonstrate that its 2Mbit/s local end charges and Type 1 POH additional charges were cost orientated during the Dispute Period. We therefore proceed to carry out our own assessment of whether or not these charges were cost orientated.

Step 2: If BT has not satisfied us that its charges were compliant with the cost orientation obligation, were the charges nevertheless cost orientated?


2Mbit/s local ends

5.30 BT submits that the local end cost adjustments made in the Provisional Conclusions were already reflected in the 2009/10 RFS. 114 BT notes that the 2009/10 RFS describes these changes: “BT has removed the estimated costs of 'other single payments', resilience and third party equipment and infrastructure charges ('support costs') from the costs of unrelated services in the TISBO, AISBO and Wholesale Trunk Segments Markets”. BT also notes that 21CN components were not allocated to 2Mbit/s local end services in these years.

5.31 Level 3 said that it “found no reason to challenge the figures in Table 4.8 [of the Provisional Conclusions, which showed that revenues for 2Mbit/s services were below DSAC in 2009/10 and 2010/11]. On this basis, we accept Ofcom’s provisional finding in [paragraph] 4.55 that BT’s charges for 2Mbit/s local end services did not

112 Paragraphs 5.19 to 5.21 of the CC’s Determination set these out in greater detail. 113 See paragraph 6.70 of the Competition Commission’s Determination in case 1112/3/3/09, Cable & Wireless UK v Office of Communications, 30 June 2010: http://www.competition-commission.org.uk/assets/competitioncommission/docs/pdf/non-inquiry/appeals/communications_act/final_determination_excised_version_for_publication. 114 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 14.

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http://www.competition-commission.org.uk/assets/competitioncommission/docs/pdf/non-inquiry/appeals/communications_act/final_determination_excised_version_for_publication




exceed DSAC during the period of the dispute and that it is reasonable to conclude that they were cost-orientated.”115

5.32 Vodafone submits that it is unclear from the Provisional Conclusions whether our treatment of costs associated with equipment charges is consistent with our approach in the Ethernet Determination. It also claims that there is insufficient data to determine whether the 2Mbit/s cost adjustments are consistent with those made in the Ethernet Determination in relation to the translation of FAC adjustments to DSAC adjustments.116

Points of Handover

5.33 BT believes that Ofcom should have applied the test at paragraph 11.39 of the Ethernet Determination in deciding whether to use a methodology that was different to that used by BT for assessing whether its Type 1 POH additional charges were cost orientated. Such a test would include an assessment of whether BT had relied on a methodology that was obviously inappropriate.

5.34 BT argues that were Ofcom to apply this test, it should find that BT’s methodology was reasonable (having been previously assessed as such by Ofcom), and notes that Ofcom identified no errors itself despite conducting extensive reviews in 2009 and 2011.

5.35 BT submits that the bottom-up model used by Ofcom to estimate POH costs is “intrinsically inadequate” as it is an incremental model not intended to provide FAC or DSAC estimates, which omits certain indirect costs. BT considers that a clear distinction should be made between estimating costs on a FAC basis, as used to derive DSAC estimates to assess cost orientation, and a model used to estimate the incremental costs associated with the provision of POH, which Ofcom ultimately decided should apply to the POH charge control from October 2011. BT claims that “there are key elements where the bottom up model, as adjusted by Ofcom, systematically omits costs”.117 These omissions related to:118

• Common accommodation costs;

• Network planning and management costs;

• General management and corporate costs; and

• SG&A (selling, general and administration costs).

5.36 BT argues that the ratio we used in our Provisional Conclusions to translate FAC to DSAC is not reasonable. It states that PPC Main Link uses exactly the same equipment as Type 1 POH, so the FAC:DSAC ratio for this service should be the proxy used.

5.37 With regard to BT’s volume data, Level 3 comments that there was a substantial re-designation exercise during the Dispute Period and asks Ofcom to assure itself that

115 Level 3’s response dated 8 April 2014 to the Provisional Conclusions, page 2. 116 Vodafone’s response dated 8 April 2014 to the Provisional Conclusions, paragraphs 21 and 22. 117 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 29. 118 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraphs 26 and 28 to 32.

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this re-designation is reflected in the data used in our analysis, and that it is consistent with RFS data.119

5.38 Level 3 also submits that:

“In view of the large pricing variations adopted during the period, we submit that the use of weighted averages is likely to lead to an unacceptably high margin of error and we propose that the model should be split out on a per-month basis. We believe that a per-month approach would be consistent with that which has previously been taken, notably in previous PPC determinations.”120

5.39 Level 3 is of the view that there is “considerable room for doubt as to the accuracy” of Ofcom’s DSAC estimates in the absence of readily available DSAC figures, and claims that the DSAC estimates used in the Provisional Conclusions appear to be at variance with the POH Pricing Review Statement. Level 3 states that it is unclear why there should have been such changes to the assumptions between two calculations and asks Ofcom to give a reasoned explanation. Level 3 submits that there is scope for Ofcom to determine charges which lie in the range between DLRIC and the estimated DSAC and is disappointed that Ofcom has taken the approach it has, which Level 3 believes, would tend to grant BT the benefit of any error. Level 3 suggests that, “Given the number and significance of the margins for error, we believe it would be safer for Ofcom to determine charges that are appreciably below the estimated DSAC in order to have an appropriate degree of certainly [sic] that no over-recovery had taken place.”121

Ofcom’s views

2Mbit/s local ends

Adjustments to the RFS

5.40 BT argues that the cost adjustments discussed by Ofcom in Step 2 of its Provisional Conclusions had already been reflected in BT’s RFS. We discuss the cost adjustments in paragraphs 5.41 to 5.43, though we note that our analysis demonstrates that in this case the adjustments make no difference to our overall conclusion that BT’s charges for 2Mbit/s local ends were below DSAC.

Consistency with approach in the Ethernet Determinations

5.41 Vodafone has asked for clarity around the treatment of costs associated with equipment charges. Vodafone notes that “Ofcom’s provisional view in paragraph 4.52 is that no adjustment is required for such costs in 2009/10 and 2010/11. However we note that in these years, the Regulatory Financial Statements describe the costs associated with these charges as “matched costs”. This is the same description given in those years to costs associated with Excess Construction charges in the AISBO market, which we note were adjusted for in the December 2012 Ethernet Determination. It is unclear from the provisional decision if Ofcom’s approach is consistent with that determination.”122

119 Level 3 response dated 8 April 2014 to the Provisional Conclusions, page 2. 120 Level 3 response dated 8 April 2014 to the Provisional Conclusions, page 3. 121 Level 3 response dated 8 April 2014 to the Provisional Conclusions, page 3. 122 Vodafone response dated 8 April 2014 to the Provisional Conclusions, paragraph 22

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5.42 We note Vodafone’s comments regarding the same description of “matched costs” being applied by BT to PPC equipment charges as to Excess Construction charges for Ethernet services is based on notes from BT’s RFS. However, our decision on whether or not to make an adjustment for local end equipment and POH costs was informed by BT’s response to a section 191 information request that specifically asked whether costs associated with local end equipment and POH costs had been included within the cost base of 2Mbit/s local end rentals reported in the RFS in 2009/10 and 2010/11. If these costs had been included within the cost base of 2Mbit/s local end rentals then it would have been appropriate for us to make an adjustment to remove these costs in line with the adjustment made in the 2009 and 2013 PPC Determinations and with similar adjustments made in the Ethernet Determination.

5.43 In its response to our section 191 notice BT stated that the “2Mbit/s Local End rentals did not include any costs associated with third party customer equipment and infrastructure”. Given that we have specifically asked BT using our formal powers whether costs associated with local end equipment and POH equipment have been included in the cost base of 2Mbit/s local end rentals and BT has responded that they are not, we are satisfied that this adjustment is not required for the purposes of resolving this Dispute.

FAC to DSAC

5.44 Vodafone comments that “there is insufficient detail in the provisional decision to enable us to fully understand how the adjusted local end DSAC numbers in Table 4.8 have been calculated. In particular we are unclear if the adjustments made to DSAC are consistent with Ofcom’s December 2012 Ethernet Determination in relation to the translation of FAC adjustments into DSAC adjustments. We note that Ofcom’s approach to this matter evolved between the October 2009 PPC Determination, which concluded that all DSAC adjustments should be made in line with the absolute £ adjustments made to FAC, and the December 2012 Ethernet Determination, which concluded that many DSAC adjustments should be made in line with the proportional percentage adjustments made to FAC (or equivalently, that DSAC:FAC ratios be applied).”

5.45 We can confirm that where we made adjustments to FAC and DSAC in the Provisional Conclusions we did so by applying the same percentage reductions to both FAC and DSAC. This is akin to the ‘proportionate’ adjustment in the Ethernet Determination to which Vodafone refers.123 We made a proportionate adjustment to DSAC because we were assessing whether reducing the FAC of 2Mbit/s local end services was likely to lead to revenues in excess of DSAC. Translating reductions in FAC to reductions in DSAC using a proportionate approach leads to a lower DSAC than using an absolute approach and is therefore appropriate when the purpose is to assess whether making these adjustments to FAC is likely to lead to revenues below DSAC. If these FAC adjustments were significant to our assessment (i.e. led to revenues being above DSAC) then we would have considered the most appropriate way to translate these adjustments into changes in DSAC. However, in this instance, we do not consider that this approach was necessary.

123 Paragraphs 4.50 and 4.54 of the Provisional Conclusions.

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Conclusion in relation to 2Mbit/s local ends

5.46 On the basis of the analysis that we have carried out and the results shown in Table 4.8 above, we conclude that BT’s charges for 2Mbit/s local end services did not exceed DSAC during the Dispute Period and were thus cost orientated.

Points of Handover

5.47 In this sub-section we first consider each of the points raised by stakeholders and then present the revised revenue and cost data we have used to assess whether BT’s charges for Type 1 POH services were cost orientated.

Application of the test in Ethernet

5.48 In paragraph 11.39 of the Ethernet Determination, we set out a list of factors that we would take into consideration when deciding whether it was appropriate to depart from data published in BT’s RFS.124 These factors included whether an adjustment was necessary to correct either an error in BT’s RFS or a methodology used in the RFS that is obviously inappropriate for the purpose of resolving the dispute.125

5.49 BT says that we should consider these factors when deciding whether to use a cost estimate different from BT’s cost estimate. We disagree with BT that we have not considered these factors when considering if it is appropriate to assess whether BT’s POH charges were compliant on the basis of the data presented in the RFS or, in the absence of such appropriate data, on BT’s contemporaneous FAC estimates generated by its top-down model.

5.50 As the CAT set out in the PPC Judgment, Ofcom and industry stakeholders ought to be able to rely upon the RFS “without great investigation, re-checking or adjustment by Ofcom”126 on the basis that the RFS are produced as a result of a regulatory obligation. As we set out in paragraphs 4.16 to 4.18 of the Provisional Conclusions, we recognised that it would not be appropriate to rely on data presented in the RFS to demonstrate that Type 1 POH additional charges were cost orientated as the reported unit FAC and DSAC figures represent the average unit cost over a number services combined and are not likely to represent the costs associated with Type 1 POH additional charges alone. We therefore considered what would be the most appropriate data to use for the purposes of assessing BT’s compliance with its cost orientation obligations.

5.51 Unlike the RFS, the cost data put forward by BT in this case is not data produced pursuant to a regulatory obligation. We therefore considered BT’s contemporaneous FAC estimates to determine whether or not those estimates provided an appropriate basis on which to assess compliance with SMP Condition G3.1. We explained in paragraph 4.33 of the Provisional Conclusions that Ofcom looked in detail at BT’s top-down cost model and assessed whether it was reliable as part of the 2010/2011 PPC POH pricing review. As discussed in paragraphs 4.33 and 4.34 of the Provisional Conclusions and in paragraph 5.26 above, we identified that there were “significant variations in the outputs of BT’s model over time, despite volumes being kept constant”, and that BT was unable to objectively account for the significance of

124 Disputes between each of Sky, TalkTalk, Virgin Media, Cable & Wireless and Verizon and BT regarding BT’s charges for Ethernet services - Determinations and Explanatory Statement: http://stakeholders.ofcom.org.uk/binaries/consultations/ethernet-services/annexes/Ethernet_FD.pdf. 125 These considerations are set out in paragraph 11.39 of the Ethernet Determination. 126 PPC Judgment, paragraph 161

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http://stakeholders.ofcom.org.uk/binaries/consultations/ethernet-services/annexes/Ethernet_FD.pdf


the variances.127 We also identified that the apportionment of costs between Type 1 and Type 2 POHs and the asset lives in revised models produced by BT did not “look reasonable”.128 We therefore concluded that our concerns about the reliability of both the method used to produce BT’s model and the outputs from that model meant that it was not appropriate to use BT’s top down model. We considered that it was more appropriate to use Ofcom’s bottom-up model, particularly given the difference in the level of cost estimates generated by the two models.

5.52 Given our conclusions in the POH Pricing Review Statement, we remain of the view that it would not be appropriate to rely on data presented in the RFS and that the FAC data on which BT relies is likely to overstate its costs. We conclude that the FAC estimates derived from the bottom-up model represent the most reliable data available to us in order to assess BT’s compliance with its cost orientation obligation.

Indirect costs to add to Ofcom’s model

5.53 BT argues that the bottom up cost model used by Ofcom does not accurately calculate FAC because it omits certain contributions to overheads.129 In its response to the Provisional Conclusions, BT identifies particular indirect costs that it considers have been excluded from the bottom up model but which would be typically included in a FAC estimate for Type 1 POH services.

5.54 Whilst we remain of the view that the FAC estimates derived from the bottom-up model represent the most reliable data available to us, we recognise that the objective of the bottom up model was to estimate incremental costs associated with additional POH services and acknowledge that as such it may not have explicitly included contributions to overheads. We agree that a FAC estimate would typically include contributions to overheads. Therefore, where no allowance has been made for the particular overheads identified by BT in its response and where the inclusion of those overheads is likely to have a material impact on our estimate of FAC, we agree that an adjustment to our FAC estimate should be made. We consider below each of the overheads identified by BT in its response.

Accommodation costs

5.55 BT claims that “Ofcom has only included the direct floor space occupied by the [POH] equipment based on a multiple of the equipment footprint used for planning operational areas of BT’s exchanges. However, this makes no allowance for common areas, corridors or entrance areas, nor for any of the costs associated with housing power and chilling plant other accommodation costs.”130 BT did not provide an estimate of the accommodation costs it considered had been omitted from the bottom up model.

5.56 BT made a similar point about accommodation costs during the 2010/2011 PPC POH pricing review. In the June 2011 POH consultation we noted that BT had commented that “the rack footprint factor of 3.85 (which was used to derive the total operational space required by the POH equipment) did not include any allowance for fixed common costs, such as space for cable-runs, space between the racks to allow for

127 POH Pricing Review Statement, paragraph 4.12. In BT’s original model, costs fluctuated from £6.7m in 2006/07 to £13.7m in 2008 to £8.6m in 2008/09. 128 POH Pricing Review Statement, paragraph 4.21. 129 BT response dated 8 April 2014 to the Provisional Conclusions, paragraph 28. 130 BT response dated 8 April 2014 to the Provisional Conclusions, paragraph 29, bullet 1.

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access, common space areas such as entrances corridors between rooms, welfare facilities and security and services”.131

5.57 In responding to BT’s comments we explained in the POH Pricing Review Statement that the footprint factor of 3.85132 allowed in the model “includes an allowance for space between racks and for cabling within the rack. As cable runs would be under-floor or suspended from ceilings we would not expect any further allowance would be needed for these. We are also of the opinion that this factor includes sufficient space to account for any incremental security and common services and areas.”133

5.58 Given that BT has raised no new arguments about accommodation costs and has provided no evidence or estimates to support a view that different costs should apply, we remain of the view that the footprint factor included in the bottom up model includes sufficient space to account for common areas and associated accommodation costs. We have therefore made no adjustment to the bottom up model for additional accommodation costs.

Network planning and management

5.59 BT claims that indirect costs such as networking planning and management were overlooked in the bottom up model.134

5.60 We disagree with BT that the model fails to include an allowance for network management costs. Based on data provided by BT, the model assumed that network management costs represented 17% of total network operating costs. In the June 2011 POH consultation we explained that “the costs [BT] had included were those associated with the exchange (the accommodation, power, cooling plant and maintenance costs) together with network management costs to calculate a percentage of those total network operating costs that were attributable to network management. [BT] noted that SDH equipment depreciation costs and general management costs had not been included.”135

5.61 BT has not provided an estimate of the indirect network management costs it considers had been omitted. Given that network management costs are explicitly included in the model, we have not made any adjustment to the model for additional network management costs.

5.62 BT is, however, correct that network planning costs were not explicitly included in the bottom up model, though it is not clear that this omission has had a significant impact on the overall cost estimates generated by the model.136

5.63 Network planning costs would be more significant where BT was connecting many new POHs or CPs were reorganising or rationalising the way they connected with BT. However, the number of new POH connections has fallen over time and in

131 June 2011 POH pricing review consultation, paragraph 2.31. 132 We also noted that “the 3.85 factor is the minimum footprint allowed, since we allow either the 3.85 factor, or the minimum area required to allow for sufficient heat dissipation, whichever is greater”. 133 June 2011 POH pricing review consultation, paragraph 2.39. 134 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 29, bullet 2. 135 June 2011 POH pricing review consultation, paragraph 2.69: http://stakeholders.ofcom.org.uk/binaries/consultations/revision-points-handover-pricing/summary/condoc.pdf. 136 It is possible that the allowance for network management costs may capture some network planning costs if BT captures some planning costs as part of network management.

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http://stakeholders.ofcom.org.uk/binaries/consultations/revision-points-handover-pricing/summary/condoc.pdf

http://stakeholders.ofcom.org.uk/binaries/consultations/revision-points-handover-pricing/summary/condoc.pdf


2012/13 there were no new POH connections reported in the RFS (see Figure 5.1 below).

5.64 New connections were however being made in 2010/11 and 2011/12, the Dispute Period. This is likely to have driven some network planning cost associated with the provision of POH, although given the low number of connections we would not expect this to be a significant cost.

Figure 5.1: Number of POH connections over time

Source: RFS 5.65 Using data from AFIs provided to Ofcom by BT with its RFS each year, we estimate

that the amount of planning cost that BT allocated to POH services in 2010/11 and 2011/12 was very low (approximately [] in 2010/11 and [] in 2011/12).137 On this basis we do not consider that the addition of network planning costs to the bottom up model would have a material impact on our FAC estimate for Type 1 POH services (which only represent a proportion of the all POH services). We have therefore not made an adjustment to our FAC estimate derived from the bottom-up model for network planning costs.

General management and corporate costs

5.66 BT argues that a FAC model should include a contribution to overheads such as general management and corporate costs.138 We recognise that the bottom up model does not include overheads associated with general management costs and that a FAC figure would typically include a contribution to such overheads. We have therefore amended our FAC estimate to include an allowance for general management costs.

5.67 BT did not provide an estimate of the general management and corporate costs it considered should be included in our FAC estimate. We have therefore considered what data is available to us to help assess the impact on our FAC estimate for Type 1 POH services of including an allowance for general management overheads.

137 This analysis was based on the cost sector “planning and development” which we assume includes costs related to network planning. BT’s Detailed Attribution Methodology document indicates that the planning and development cost sector “covers the planning of the network” (DAM 2012, page 25). 138 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 29, bullet 3.

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5.68 One way to take account of general management overheads would be to calculate the proportion of total FAC represented by general management costs and then uplift our Type 1 POH FAC estimate by this amount. Table 5.2 below uses data from the RFS and from AFIs provided confidentially to Ofcom to estimate the uplift that would apply to total FAC to take account of general management costs.

Table 5.2: General management cost data 2010/11 2011/12

Total CCA (£m) £8,187 £6,697

Total MCE (£m) £16,069 £15,294

Total FAC (£m) £9,843 £8,073

General Management (£m) [] []

Total FAC before General Management (£m) [] []

General Management uplift (%) [ 5-15%] [ 5-15%]

Source: Total CCA and total MCE come from pages 22,24,25 &27 of the 2011/12 RFS. FAC has been estimated by applying the Openreach WACC to access markets MCE and the rest of BT WACC to the remaining MCE. General management costs come from BT’s AFI 4 (using the cost sector entitled “general management”). 5.69 We have applied these uplift ratios to our Type 1 POH FAC estimates in order to

derive a FAC estimate including general management.

SG&A costs

5.70 BT notes that the incremental SG&A costs included in the bottom up model are based on an assumption that a single person provides all activity relating to POH services. BT argues that this is inconsistent with the level of SG&A incurred across its business, which it estimates to be around 10% of sales revenue.139

5.71 BT is correct in its understanding that SG&A costs have been included in the bottom up model assuming an annual cost of £105k. After taking account of the general management overheads above, the SG&A cost represents between 2.1% and 7.3% of the FAC of each Type 1 POH service.140

5.72 We have considered how this compares to the proportion of SG&A cost within total FAC for other PPC services. Table 5.3 shows that the proportion of FAC represented by SG&A costs varies in each market, but broadly speaking it might be expected to represent between 2% and 10% of FAC depending on the service and market. The proportion of FAC represented by SG&A costs for Type 1 POH does not therefore appear inconsistent with the proportions seen elsewhere within BT’s RFS. On this basis, and absent any further evidence from BT, we have not made any adjustment to the SG&A cost included in the POH bottom up model.

139 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 29, bullet 4. 140 SMA-1: 7.3%; SMA-4: 6.1% and SMA-16: 2.1%.

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Table 5.3: Proportion of total FAC represented by SG&A costs for PPC services 2010/11 2011/12

Range Average Range Average

TISBO<8Mbit/s 0.2%-12.9% 5.3% 0.8%-8.4% 4.2%

TISBO<45Mbit/s 2.4%-8.6% 6.6% 2.1%-9.8% 5.0%

TISBO>45Mbit/s 3.9%-8.5% 5.5% 2.4%-6.5% 4.4%

Technical areas (POH) 1.5%-8.3% 3.9% 1.7%-9.2% 4.5% Type 1 POH (as per bottom up model) 2.1%-7.3%

DSAC/FAC ratios

5.73 BT said that the DSAC/FAC ratio we used was not reasonable.141 In order to derive DSAC estimates associated with Type 1 POH additional charges, we applied DSAC/FAC ratios to our FAC estimates from the bottom-up model, as set out in Table 4.11. The DSAC/FAC ratios we used were calculated with reference to the unit DSAC and unit FAC of services reported in the RFS that are associated with Type 1 POH charges in 2010/11 and 2011/12. In particular, the costs associated with Type 1 POH charges were included within CSH and ISH rentals in 2010/11 and in the cost base of third party POH rentals in 2011/12. Table 4.12 set out these DSAC/FAC ratios. In Table 4.15 we set out the results of the DSAC test using the minimum, average and maximum DSAC/FAC ratios from Table 4.12. For the purposes of ordering repayments we proposed to use the DSAC test results derived using the average DSAC/FAC ratio.

5.74 BT said that a better proxy for the DSAC of Type 1 POH services could be derived by using the DSAC/FAC ratio for the PPC Main Link service since this uses the same equipment as the Type 1 POH services.142

5.75 Table 5.4 sets out the DSAC/FAC ratios calculated using the FAC and DSAC figures reported in the RFS for PPC Main Link services. BT did not say which PPC Main Link service it was referring to in its response so the table includes the DSAC/FAC ratio for each main link service reported by bandwidth. We assume BT was recommending that we use the average DSAC/FAC ratio for PPC Main Link services (though the individual ratios do not vary much).

141 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 33. 142 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraph 33.

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Table 5.4: DSAC/FAC ratios for PPC Main Link services per RFS

2010/11 2011/12

64Kbit/s 1.56 2.29

2Mbit/s 1.59 2.28

34/45Mbit/s 1.52 2.16

140/155Mbit/s 1.49 2.12

Average PPC Main Link 1.54 2.21

Average DSAC/FAC ratio used in Provisional Conclusions 1.62 1.97

5.76 Adopting BT’s proposal would result in a lower DSAC/FAC ratio being used in 2010/11 compared to the average DSAC/FAC ratio used in the Provisional Conclusions and a higher DSAC/FAC ratio being used in 2011/12. The effect on the total overcharge calculated in these final conclusions across the two years of using the average PPC Main Link DSAC/FAC ratio rather than the average DSAC/FAC ratio from the Provisional Conclusions would be a decrease of around 1%.

5.77 While the PPC Main Link services may use the same equipment as Type 1 POH services, the charges in dispute do not recover equipment costs. POH equipment costs are recovered from POH connection and rental charges. The Type 1 POH additional charges in dispute largely recover costs related to duct, fibre, accommodation and general management.143 It is therefore not necessarily the case that the DSAC/FAC ratios associated with the charges for Type 1 POH services would be similar to PPC Main Link since the types of cost included in their respective cost stacks are different. As a result we disagree with BT that the DSAC/FAC ratios of PPC Main Link services necessarily offer a better proxy for Type 1 POH services than the DSAC/FAC ratios we calculated in the Provisional Conclusions.

5.78 We recognise that the DSAC/FAC ratios we calculated in the Provisional Conclusions were based on POH rental services reported in the RFS. While the POH rental services reported in the RFS will include costs associated with equipment,144 they will also reflect the types of costs associated with additional POH charges such as accommodation. While the resulting DSAC/FAC ratios are not an exact proxy for the DSAC/FAC ratio for Type 1 POH services, they do reflect in part the costs associated with these services and the likely relationship between FAC and DSAC. We therefore consider that the DSAC/FAC ratios we calculated in the Provisional Conclusions are a more appropriate proxy that the PPC Main Link ratios suggested by BT since our ratios better reflect the types of costs that are recovered from Type 1 POH charges and the likely relationship for these services between FAC and DSAC. In the absence of more direct benchmarks we have calculated the DSAC test using the minimum, average and maximum DSAC/FAC ratios from Table 4.12 of the Provisional Conclusions. As set out in in paragraph 6.30, we have decided to order repayments based on the average DSAC/FAC ratio.

143 See for example Figure 3 on page 73 of the January 2011 POH pricing review consultation. 144 Since they include for example costs associated with CSH and ISH rental, which recover costs associated with equipment.

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Using weighted average charges

5.79 Level 3 said that “Ofcom has proposed a model based on weighted average charges. In view of the large pricing variations adopted during the period, we submit that the use of weighted averages is likely to lead to an unacceptably high margin of error and we propose that the model should be split out on a per-month basis.”145

5.80 We used weighted average charges in order to compare the average charge for the year with the average unit FAC and unit DSAC for the year. We usually only have cost data on a financial year basis (for example from BT’s RFS) so it makes sense as a starting point to consider both charges and costs on an annual basis.

5.81 However, we agree with Level 3 that the use of average charges could underestimate the degree to which revenue exceeded DSAC over the course of the year. This is particularly the case in 2011/12 where Type 1 POH charges were reduced significantly on 1 October 2011 in line with the POH Pricing Review Statement.146 The period disputed by Level 3 ends on 30 September 2011, the day before these lower charges came into effect. We therefore do not consider that it is appropriate to take into account revenue associated with the lower POH charges that was generated outside the Dispute Period in our assessment of whether BT’s higher POH charges were cost orientated during the Dispute Period.

5.82 By averaging charges over the whole of 2011/12 (as we did in our Provisional Conclusions), we took into account the significantly lower charges which applied outside of the Dispute Period and therefore under-estimated the revenue that BT earned from Type 1 POH services in the Dispute Period. This error in our approach caused us to underestimate the amount of overcharge that occurred during the Dispute Period because the average charge used to compare against DSAC was depressed by the lower charges in place from 1 October 2011.

5.83 For 2011/12 we have therefore separately assessed the charges in place prior to 1 October 2011 (i.e. the charges in place up to the end of the Dispute Period). We have compared these charges against our estimate of unit FAC and DSAC for the whole financial year. As explained in paragraph 4.62, unit FAC for 2011/12 is estimated by applying CPI of 3.5% to our unit FAC estimates for 2010/11. We then derive a unit DSAC estimate by applying a DSAC/FAC ratio as explained in paragraphs 4.67-4.72. In order to calculate the total FAC and DSAC for the period of 2011/12 we are interested in (i.e. the period from 1 April 2011 to 30 September 2011) we have multiplied our unit cost estimates by annual volumes and then weighted the result by the proportion of the year the charges were in effect.147

5.84 The use of weighted charges in 2010/11 does not have the same effect because the charges in place for Type 1 POH services in dispute are either all above the DSAC for the year148 or all below149. In situations where charges are all above or below DSAC for the year, comparing weighted average charges for the year against DSAC gives the same answer as comparing each individual charge to DSAC separately.150

145 Level 3’s response dated 8 April 2014 to the Provisional Conclusions, page 2. 146 For example charges for SMA-1 went from £3,435 to £402. 147 In 2011/12 Type 1 POH charges were in effect from 1 April 2011 to 30 September 2011, 183 days of the year. 148 This is the case for SMA-1, SMA-4 and SMA-16 charges. 149 This is the case for the bearer charge. 150 This assumes that each charge can be separately compared to the unit DSAC for the year. In the absence of any data indicating how DSAC may have developed over the year this seems to be a reasonable assumption.

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However, for consistency with 2011/12, we have separately assessed each of the charges in place in 2010/11 against the unit DSAC for the year.

5.85 In making this change to consider each charge separately we also identified an error in our modelling in the Provisional Conclusions. This error related to the way we presented total FAC and DSAC for Type 1 POH services in 2010/11.

5.86 In the Provisional Conclusions our total revenue figures for Type 1 POH in 2010/11 related to the nine months of the financial year that the Type 1 POH charges were in effect (1 July 2010 to 31 March 2011). Our FAC and DSAC estimates however related to the whole 12 months since they were calculated by multiplying the annual unit FAC and DSAC estimates by the annual volumes, with no adjustment for the fact that Type 1 POH were not introduced until 1 July 2010; three months into the financial year. This meant that in 2010/11 we were comparing nine months of revenue with 12 months of FAC and DSAC.

5.87 Consequently our total FAC and DSAC estimates were too high in 2010/11. As a result the DSAC test results for 2010/11 presented in Table 4.15 of the Provisional Conclusions were too low. The impact of correcting this error in the Provisional Conclusions would have been to increase the total positive DSAC test results by around 6%. This error has been addressed in the data reported in Table 5.8 below.

BT’s re-designation of POH charges

5.88 Level 3 said “we have no evidence to query the volume and unit revenue data that BT reportedly supplied in response to Ofcom’s demand for information under s.191. However, we are aware that a substantial re-designation exercise was undertaken during the period in question and ask Ofcom to assure itself that data relating to these re-designations has been fully captured and are consistent with the relevant RFS data”.151

5.89 On 1 July 2010, BT introduced the new Type 1 POH charges.152 When these Type 1 POH charges were introduced, a number of Type 2 POH charges (which are charged on a per circuit basis) were re-designated as Type 1 (which are charged on a per mux basis). The section 191 response received from BT indicates that approximately [] of Type 2 POH volumes were re-designated to Type 1 ‘efficient’ POHs in July 2010. BT’s section 191 response therefore appears to capture the re-designation to which Level 3 refers. BT’s section 191 response also shows how the volumes and revenues associated with Type 1 and Type 2 POH services reconcile to the figures reported in the RFS in the Technical Areas (Point of Handover) market in 2010/11 and 2011/12. BT’s section 191 response is therefore consistent with the relevant RFS data.

DSAC estimate variances with those used in 2011 LLCC Points of Handover pricing review

5.90 Level 3 claims that “there is considerable room for doubt as to the accuracy” of Ofcom’s DSAC estimates. Level 3 notes that “the DSAC estimates proposed by Ofcom appear to be at variance with those used in the 2011 LLCC Points of Handover pricing review which, to our knowledge have been accepted by BT. It is

151 Level 3’s response dated 8 April 2014 to Provisional Conclusions, page 2. 152 SMA-1, SMA-4, SMA-16, plus a bearer charge for CSH and ISH extension (Customer Sited Handover, or “CSH” circuits are handed over at the CP’s premises, In-Span Handover extension or “ISH extension” circuits are handed over at a CP’s nominated footway box).

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unclear to us why there should have been such changes to the assumptions between the two calculations and we invite Ofcom to give a reasoned explanation”.153

5.91 It is not clear which DSAC estimates Level 3 is referring to because the POH Pricing Review Statement, including Ofcom’s bottom up model, does not calculate a DSAC associated with POH services. The bottom up model derives a LRIC estimate based on FAC estimates for the relevant cost items. For the purposes of resolving this Dispute, we have derived DSAC estimates for Type 1 POH services by applying DSAC/FAC ratios from BT’s RFS to the FAC data from the bottom up model. We recognise that the use of DSAC/FAC ratios can only approximate what the DSAC for Type 1 POH services might be if it was practicable to re-run BT’s LRIC model using the appropriate FAC data. However, for the reasons given in paragraphs 4.67 - 4.71 and 5.78, we consider that the DSAC/FAC ratios we have used are likely to give a reasonable estimate of the relationship between FAC and DSAC for Type 1 POH services.

Determining a charge appreciably below DSAC

5.92 Level 3 states that “given the number and significance of the margins for error, we believe it would be safer for Ofcom to determine charges that are appreciably below the estimated DSAC in order to have an appropriate degree of certainly [sic] that no over-recovery had taken place”.154

5.93 We recognise that there is no DSAC data for Type 1 POH services that we can readily observe. We therefore need to estimate a DSAC for these services. We explained in the Provisional Conclusions how we estimated a range for the DSAC and that for the purposes of ordering repayments we selected a DSAC estimate from this range that appeared reasonable given the data available to us.

5.94 However, once we have selected an appropriate DSAC estimate from this range, we do not agree with Level 3 that it would be appropriate to determine charges at a level below this DSAC estimate or in the range between DLRIC and this DSAC estimate. We maintain that using DSAC as the primary cost benchmark for considering cost orientation for the charges in dispute in this case is appropriate. We explain our rationale in using DSAC at paragraphs 3.29 to 3.32 above.

5.95 We do not agree with Level 3 that our approach tends to grant BT the benefit of any error. We have estimated DSAC using the average of a reasonable range based on observable DSAC/FAC ratios from the RFS. In the absence of further evidence as to the precise relationship between the FAC and DSAC for Type 1 POH services, taking the average strikes a balance between a high DSAC value (which would result in a lower overcharge, benefitting BT) and a low DSAC value (which would lead to a higher overcharge).

Summary of adjustments to figures in provisional conclusions

Revenues

5.96 We concluded in paragraph 5.84 that we would assess each Type 1 POH additional charge separately during the Dispute Period. BT set two additional charges for each of the Type 1 POH services during the Dispute Period. These are summarised in Table 5.5, which shows how the charges relate to each of the two financial years

153 Level 3’s response dated 8 April 2014 to Provisional Conclusions, page 3. 154 Level 3’s response dated 8 April 2014 to Provisional Conclusions, page 3.

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2010/11 and 2011/12. The table also shows the revenues by applying annual industry volumes from Table 4.10 and then weighting these revenues by the number of days the charges were in effect.

Table 5.5: Type 1 POH charges Unit basis, £ £ million basis

2010/11 2011/12 2010/11 2011/12

Charge period

1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 - 30 Sept

2011 1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept 2011

SMA-1 3,272 3,435 3,435 £0.25m £0.13m £0.24m SMA-4 4,866 5,109 5,109 £1.13m £0.58m £1.35m SMA-16 7,764 8,151 8,151 £0.77m £0.40m £0.84m Bearer 322 338 338 £0.07m £0.03m £0.08m

FAC

5.97 We concluded in paragraph 5.84 that we would assess each Type 1 POH charge separately during the Dispute Period. Our full-year unit FAC estimates start from those derived from Ofcom’s bottom up model as explained in paragraph 4.31. In 2010/11 we have uplifted these unit FAC estimates for general management overheads as described in paragraphs 5.68 – 5.69. In 2011/12 we have uplifted the unit FAC estimates for general management overheads and also included an uplift for CPI inflation as described in paragraphs 4.62 and 5.83. Table 5.6 summarises our full-year unit FAC estimates and also the total FAC estimates for the period each charge was in effect. As with our total revenue calculation, total FAC has been calculated by multiplying our annual unit FAC estimates by annual industry volumes from Table 4.10 and then weighting by the number of days the charges were in effect.

Table 5.6: FAC estimates for Type 1 POH services Unit basis, £ £ million basis

2010/11 2011/12 2010/11 2011/12

Charge period

1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept

2011 1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept 2011

SMA-1 463 463 483 £0.04m £0.02m £0.03m

SMA-4 554 554 578 £0.13m £0.06m £0.15m

SMA-16 1,582 1,582 1,650 £0.16m £0.08m £0.17m

Bearer 302 302 315 £0.06m £0.03m £0.07m

DSAC

5.98 Unit DSAC has been calculated by applying to our full-year unit FAC estimates the minimum, average and maximum DSAC/FAC ratios from Table 4.12. Total DSAC has been calculated by multiplying our annual unit DSAC estimates by annual industry volumes from Table 4.10 and then weighting by the number of days the charges were in effect.

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Table 5.7: DSAC estimates for Type 1 POH services Unit basis, £ £ million basis

2010/11 2011/12 2010/11 2011/12

Charge period

1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept

2011 1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept 2011

SMA-1

Minimum 575 575 711 £0.04m £0.02m £0.05m Average 752 752 952 £0.06m £0.03m £0.07m Maximum 856 856 1,297 £0.07m £0.03m £0.09m SMA-4 Minimum 688 688 850 £0.16m £0.08m £0.23m Average 899 899 1,138 £0.21m £0.10m £0.30m Maximum 1,024 1,024 1,551 £0.24m £0.12m £0.41m SMA-16 Minimum 1,965 1,965 2,427 £0.20m £0.10m £0.25m Average 2,570 2,570 3,251 £0.26m £0.13m £0.34m Maximum 2,925 2,925 4,432 £0.29m £0.14m £0.46m Bearer Minimum 375 375 464 £0.08m £0.04m £0.11m Average 491 491 621 £0.10m £0.05m £0.14m Maximum 559 559 847 £0.11m £0.06m £0.20m

5.99 Table 5.8 sets out the results of the DSAC test for Type 1 POH additional charges using the minimum, average and maximum DSAC/FAC ratios. The figures presented on a unit basis represent the difference between the charge for the period and the full-year unit DSAC. The figures presented on a £ million basis represent the difference between the revenues for the period less DSAC for the period.

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Table 5.8: DSAC test results for Type 1 POH services Unit basis, £ £ million basis

2010/11 2011/12 2010/11 2011/12

Charge period

1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept

2011 1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept 2011

SMA-1

Minimum 2,697 2,860 2,725 £0.21m £0.11m £0.19m Average 2,520 2,683 2,484 £0.19m £0.10m £0.17m Maximum 2,416 2,579 2,138 £0.18m £0.10m £0.15m SMA-4 Minimum 4,178 4,421 4,259 £0.97m £0.50m £1.13m Average 3,967 4,209 3,971 £0.92m £0.48m £1.05m Maximum 3,842 4,085 3,557 £0.89m £0.46m £0.94m SMA-16 Minimum 5,799 6,186 5,725 £0.58m £0.30m £0.59m Average 5,194 5,582 4,900 £0.52m £0.27m £0.51m Maximum 4,839 5,227 3,720 £0.48m £0.26m £0.38m Bearer Minimum (53) (37) (126) (£0.01m) (£0.00m) (£0.03m) Average (169) (153) (283) (£0.03m) (£0.02m) (£0.07m) Maximum (237) (221) (509) (£0.05m) (£0.02m) (£0.12m)

5.100 The results of the DSAC test show that revenues for SMA-1, SMA-4 and SMA-16 exceeded DSAC throughout the Dispute Period. Revenues for the bearer were below DSAC across the Dispute Period.

5.101 We note that in order for the unit revenues of SMA-1, SMA-4 and SMA-16 to be below DSAC, the DSAC/FAC ratios would need to be significantly higher than the DSAC/FAC ratios we have considered. Table 5.9 shows the DSAC/FAC ratios that would be required during the Dispute Period in order for charges for these services to be below DSAC. None of the DSAC/FAC ratios we considered in Table 4.12 would support a DSAC/FAC ratio as high as these.

Table 5.9: DSAC/FAC ratios required for charges to be below DSAC 2010/11 2011/12

Charge period

1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept

2011 SMA-1 7.1 7.4 7.1 SMA-4 8.8 9.2 8.8 SMA-16 4.9 5.2 4.9

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Conclusion in relation to Type 1 POH additional charges

5.102 On the basis of the analysis that we have carried out above and the results shown in Table 5.8, we conclude that BT’s Type 1 POH additional rental charges for each of its SMA-1, SMA-4 and SMA-16 services exceeded DSAC during the Dispute Period. We conclude that BT’s bearer charges for these services did not exceed DSAC during the Dispute Period.

Step 3: Are there any other factors which should be considered?


5.103 BT asserts that some of the factors looked at in Step 3 of our analysis are irrelevant. Specifically, BT argues that the assessment of prices against FAC and the assessment of the ROCE earned by BT on the services in dispute provide no additional insight as to whether or not overcharging is taking place.

5.104 BT notes that as DSAC is higher than FAC, any charge that is above DSAC will also be above FAC. Moreover, given that FAC values always include a ROCE calculated at BT’s WACC, it is inevitable that a service whose price is above FAC will have a ROCE that is greater than BT’s WACC.

5.105 Referring specifically to paragraph 4.87 of the Provisional Conclusions, BT submits that it did not miss the opportunity to ensure the cost orientation of the January 2011 charges notified to Ofcom in October 2010, as Ofcom’s bottom-up model had not been built at that time.

5.106 Vodafone submits that Ofcom’s finding that 2Mbit/s local end charges were cost orientated is hard to justify as consistent given that the outcome of the appeal of the 2009 LLCC Statement was that Ofcom (as corrected by the CC/CAT) should not have allowed a price increase. Vodafone asserts that this finding is in breach of Ofcom’s duties under section 3(3) of the Act.155

Ofcom’s views

Relevance of FAC and ROCE assessments

5.107 We note the concerns raised by BT in its response to the Provisional Conclusions regarding the value of assessing prices against FAC and of assessing the level of ROCE earned by BT. However, given that we don’t place any weight on these assessments in this case, it is unnecessary for us to give further consideration here to the issues that BT raises.

Availability of the bottom-up model

5.108 Although we recognise that the bottom-up cost model that we have used to assess cost orientation was not available to BT at the time that it set its charges, the information within it was. In creating the bottom-up cost model, Ofcom used publicly available information and cost information provided by BT. BT could have adopted an approach which took account of this information to provide a more appropriate basis for the estimate of its costs, but failed to do so.

155 T-Mobile v Office of Communications [2008] CAT 12, paragraph 16.

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Consistency with the 2009 LLCC Statement

5.109 Vodafone asserts that Ofcom’s finding that BT’s 2Mbit/s local end charges were cost orientated is hard to justify as consistent given that the outcome of the appeal against the 2009 LLCC Statement was that Ofcom should not have allowed a price increase. As we explained in paragraph 3.12 above, the revisions to the charge controls resulting from the appeal of the 2009 LLCC Statement can only apply on a prospective basis and it is therefore not appropriate (indeed not lawful), which Vodafone acknowledges, to seek to apply the revised charge controls on a retrospective basis.

5.110 In our view, Vodafone relies on an incorrect interpretation of the CC’s Determination with respect to 2Mbit/s local end charges. As set out in the CC’s Determination, Ofcom had not assessed BT’s compliance with cost orientation in the development of the 2009 LLCC Statement.156 Ofcom’s objective was rather to achieve an appropriate set of adjustments to bring prices into line with costs (through a combination of starting charge and a glide-path). This included a minimum requirement that in deciding the structure of starting charges, prices should be within the range of DLRIC and DSAC, while taking into account wider efficiency incentive properties of the charge control.157

5.111 In the CC’s Determination, it did not suggest that the starting charge increase in 2Mbit/s local end charges resulted in charges that were no longer ‘cost orientated’. Rather the CC stated that:

“…the one-off adjustments together [including those made to 2Mbit/s local ends] could not be justified if considered solely by reference to the cost-orientation objective, since 2 Mbit/s local ends were already priced within the DLRIC and DSAC boundaries and therefore the adjustment to the price of that service goes beyond what is necessary for cost-orientation reasons.”158

5.112 The CC’s view was therefore that, because 2Mbit/s local end charges were already within the DLRIC and DSAC boundaries (prior to the starting charge increase), this did not provide a motivation for an increase in the 2Mbit/s local end price. The CC also determined that wider efficiency arguments that Ofcom put forward were not a valid reason to allow increases to 2Mbit/s local end charges.159

5.113 We note that BT’s arguments on legal certainty (addressed at paragraph 5.28 above) could, in principle, also be relevant to Step 3 of our analysis. However, on the basis set out in paragraph 5.28, we do not consider that BT’s arguments on legal certainty are warranted in this case. We therefore do not consider that they are a relevant factor for consideration at Step 3 in this case.

Conclusion on Step 3

5.114 The additional points raised by stakeholders give no further indication that BT’s Type 1 POH additional charges were cost orientated in the Dispute Period.

156 CC’s Determination, paragraphs 3.93 to 3.107. 157 CC’s Determination, paragraphs 3.94 and 3.96. 158 CC’s Determination, paragraph 3.124. 159 CC’s Determination, paragraph 3.140.

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Conclusions on Steps 1-3

Our determination

5.115 Based on the evidence available to us and the lack of satisfactory explanation from BT, our conclusions are that:



o BT’s charges for each of its SMA-1, SMA-4 and SMA-16 services were not cost orientated in the period 1 July 2010 to 30 September 2011 and that it therefore overcharged Level 3 for these services during this period.

o BT’s charges for its bearer services were cost orientated in the period 1 July 2010 to 30 September 2011 and therefore it did not overcharge Level 3 for these services.

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Section 6

6 Repayments Amount of repayment

Introduction

6.1 In Section 5, we have concluded that BT has overcharged for the rental of its SMA-1, SMA-4 and SMA-16 POH services.

6.2 Where Ofcom has made a determination of the proper amount of a charge in respect of which amounts have been paid by one of the Parties to the other, section 190(2)(d) of the Act gives us the power to give a direction, enforceable by the party to whom the sums are to be paid, requiring the payment of sums by way of an adjustment of an underpayment or an overpayment.

6.3 In this section we consider whether we should exercise our discretion to require BT to make a repayment to Level 3, by way of an adjustment of an overpayment, and if so, what the level of any such repayment should be.

6.4 In reaching our decision, we have been guided by our duties and Community obligations under sections 3, 4 and 4A of the Act (as amended). We have also taken account of submissions from the Parties and the findings of the CAT and the Court of Appeal in relation to Ofcom’s power under section 190(2)(d) to require repayments in previous judgments.

Parties’ views

6.5 Level 3 is seeking repayments of alleged overcharge as follows:

• [] for PPC 2Mbit/s local end services purchased between 1 October 2009 and 30 September 2010; and

• [] for POH purchases between 1 April 2010 and 30 September 2011.

6.6 Level 3 calculated these amounts using the difference between the charges set out in BT’s CPL for the relevant period and the charge control price as amended by the appeals. Level 3 then multiplied this difference by the volumes it purchased during the relevant time period.

6.7 BT argues that “Ofcom does not have the power to impose a specific obligation on BT requiring repayment of charges in respect of a cost orientation condition that was not in force at the time the dispute was raised with Ofcom”. In support of this view BT cites its arguments in Part A of its amendments to its Notice of Appeal and application to amend its Notice of Appeal to include a new ground challenging Ofcom’s jurisdiction.160

6.8 BT “believes that even if Ofcom has the power to order repayments it would be inappropriate for it to exercise its discretion to do so. This is in particular because there was no suggestion before the prices were set and paid that the relevant cost ceiling for cost orientation was LRIC (and in any case the cost ceiling in fact remains

160 BT’s application dated 29 November 2013 in the Ethernet appeal.

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at DSAC). To change the ceiling retrospectively would be impermissible. Further there is no contemporaneous reason for BT to have believed that it was not complying with the cost orientation obligations in force when it set those prices.”161

6.9 BT also believes that Level 3 has made errors in quantifying the amount it claims to be repayable, stating that: “Whilst BT does not accept the basis of Level 3’s claim, in any event it appears that their calculations in relation to POH are inconsistent with the claim.”162 BT explained that it undertook the calculation using the same methodology as Level 3 and that this “shows the claim should be quantified at the lower figure [] rather than the [] figure calculated by Level 3”.163

6.10 BT maintains its position that Ofcom does not have the power to adjust retrospectively and order repayments “in relation to prices set before the dispute was referred to Ofcom and/or the matter raised by Level 3 with BT and/or in relation to cost orientation obligations which were no longer in force”.164 Level 3 and Virgin Media Ltd, Vodafone Ltd and Verizon UK Ltd (“the joint respondents”) agree with Ofcom’s provisional conclusion that Ofcom has jurisdiction to order repayments in disputes, such as the current dispute, where the SMP condition has expired.

6.11 In addition, BT submits that:165

“… any repayment calculated on the basis of the difference between BT’s prices and Ofcom’s DSAC cannot be seen simply as a retrospective adjustment to restore the parties to the position that they would have been in if the prices for PoH had been set as Ofcom now contends that they should have been set. The repayment is depriving BT of revenues which could have recovered from the other products of the TI basket had it known it had to price PoH at a lower level.

Ofcom itself had argued in the January 2011 consultation that “Our (Ofcom’s) approach is also proportionate as BT would be able to recover the common costs that we have excluded from other services in the TI basket.” Therefore, in applying the results of a model finalised in September 2011 retrospectively to prices between April 2010 and September 2011 Ofcom has denied BT the opportunity to recover the common costs that are now being excluded from its retrospective prices by virtue of the repayment.”166

Ofcom’s views on whether BT should make repayments to Level 3

6.12 Ofcom has the power pursuant to section 190(2)(d) of the Act to direct that one party to a dispute should pay a sum to another party by way of an adjustment of an overpayment. In assessing whether it is appropriate for us to order BT to make repayments to Level 3 in this case we have given consideration to the impact of BT’s overcharging for POH services on competition and the impact that allowing BT to retain profits realised from overcharging might have on incentives for future compliance with cost orientation obligations.

161 BT’s letter dated 24 January 2014, page 9. 162 BT’s first tranche section 191 response, 7 February 2014, page 6. 163 BT’s first tranche section 191 response, 7 February 2014, page 6. 164 BT response dated 8 April 2014 to the Provisional Conclusions, paragraph 40. 165 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraphs 37 and 38. 166 BT’s response dated 8 April 2014 to the Provisional Conclusions, paragraphs 37 and 38.

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6.13 We do not agree with BT’s argument that Ofcom does not have the power to order repayments in this case. In fact, Ofcom’s powers to order repayment in circumstances where overcharging in breach of an SMP condition has occurred has been explicitly addressed in previous cases. For example, on 27 July 2012 the Court of Appeal handed down its judgment in the appeal of the PPC Judgment which considers, among other matters, Ofcom’s power under section 190(2) to require repayments. In its Judgment, the Court of Appeal stated that:

“The starting point must be, in a case of overcharging in breach of an SMP condition, to order repayment of the amount of the excess charge. If, however, the payee can show some good reason why a lesser repayment or no repayment at all would better achieve the objectives of the Act and the CRF then that would provide a principled basis for Ofcom to give a direction for only a partial repayment or to make no direction for repayment at all.”167

6.14 The PPC Court of Appeal Judgment considered the issue of repayments under section 190 of the Act. It concluded that Ofcom’s discretion under section 190 was:

“a discretion to make such order for repayment as will best achieve the objectives of the Act and the CRF on the particular facts of the case.”168

6.15 The Court held that the discretion under section 190 “must be exercised in a principled way with a view to achieving those objectives”.169

6.16 In relation to BT’s arguments in Part A of its amendments to its Notice of Appeal and application to amend its Notice of Appeal, we note that BT’s application to amend its Notice of Appeal was refused by the CAT on 11 March 2014.170 We remain of the view that BT’s assertion in relation to jurisdiction is incorrect.

6.17 Overcharging for PPC products, including POH services, distorts competition between BT and its competitors, which is ultimately detrimental to consumers. We therefore believe it would be appropriate, in light of our duties to further the interests of consumers, where appropriate by promoting competition, in this case to require repayments to be made.

6.18 Further, if we were not to require repayments, BT would be able to unfairly retain the gains from overcharging, and this could provide a disincentive for it to comply with its regulatory obligations going forward. The incentives and regulatory signals that determinations in disputes send to CPs as to how we interpret regulatory obligations and are likely to assess future conduct are important.

6.19 We consider that to require BT to make payments to Level 3 by way of adjustment of overcharges promotes the interests of consumers and competition, by ensuring that the SMP obligations set on BT are enforced. The enforcement of BT’s SMP obligations protects consumers, enables other providers to compete with BT and

167 PPC Court of Appeal Judgment, paragraph 85: http://www.catribunal.org.uk/237-5136/1146-3-3-09-British-Telecommunications-PLC.html. 168 PPC Court of Appeal Judgment, paragraph 83. 169 PPC Court of Appeal Judgment, paragraph 84. 170 British Telecommunications plc v Office of Communications (Ethernet Determinations) [2014] CAT 4, Ruling (Application for Permission to Amend Notice of Appeal); http://www.catribunal.org.uk/167-8410/Ruling-Application-for-Permission-to-Amend-Notice-of-Appeal.html.

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http://www.catribunal.org.uk/237-5136/1146-3-3-09-British-Telecommunications-PLC.html

http://www.catribunal.org.uk/237-5136/1146-3-3-09-British-Telecommunications-PLC.html


helps to level the playing field for BT’s competitors, leading to downward pressure on prices, availability of a wider range of services and improved quality of service.

6.20 In this respect, we note that POH services are only purchased by BT’s competitors and not by its own downstream divisions. As such, any overcharging for these services is likely to have a greater impact on competition in downstream markets, which further supports our position of requiring that repayments be made.

6.21 As set out in Section 5, we have concluded that BT could not place any reliance upon Ofcom’s statement in the 2009 LLCC Statement in respect of the charges in dispute from 1 April 2010. We do not, therefore, consider it appropriate to reduce the level of any repayment to take this into account.

6.22 BT has raised concern that requiring repayments in this Dispute would deprive it of the ability to fully recover common costs by denying it the ability to historically raise the prices of other PPC services. In this regard, we would note that BT has provided no evidence to demonstrate that it would not have recovered its common costs if required to make repayments of the amounts it has overcharged Level 3 (and other CPs) for Type 1 POH services. The repayments we have determined are based on Type 1 POH additional rental charges being set at DSAC. Prices set at DSAC allow BT considerable scope to recover its common costs and there is no indication that BT would have failed to fully recover its common costs of providing PPC services if required to make the determined repayments.

6.23 Ofcom therefore remains of the view that it is appropriate to require BT to make a repayment to Level 3.

Ofcom’s views on amount of repayment

6.24 Although we agree with Level 3 that repayment of BT’s overcharge for additional POH services during the Dispute Period would be appropriate in this case, we do not believe that its proposed methodology for calculating repayments is appropriate. As discussed in Section 3, the level of charges set in the charge control is not the only set of charges that would satisfy BT’s cost orientation obligation. We consider that any charges between LRIC and DSAC would be compliant with the cost orientation obligation. Therefore, calculation of the appropriate repayment should be based on the difference between BT’s charges and DSAC.

Error in the Provisional Conclusions

6.25 We have identified an error in the Provisional Conclusions that affects the repayment amount for 2010/11 presented in that document.

6.26 In the Provisional Conclusions, our total revenue figures for Type 1 POH in 2010/11 related to the nine months of the financial year that the Type 1 POH charges were in effect (1 July 2010 to 31 March 2011). Our FAC and DSAC estimates however related to the whole 12 months. Without adjustment, this would mean that in 2010/11 we were comparing nine months of revenue with 12 months of FAC and DSAC costs.

6.27 Our repayment calculation for 2010/11 correctly pro-rated DSAC for the period of 2010/11 that was in dispute. However, our repayment calculation incorrectly pro-rated revenue again. This was incorrect as the revenue amount already related to the nine months of the year that were in dispute (since the dispute period in 2010/11 coincided with when Type 1 POH charges were introduced).

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6.28 As a result the revenue figures we used when calculating the amount of overcharge were too low, meaning that the resulting repayment to Level 3 we proposed was also too low. Had this error not occurred then the total repayment proposed in the Provisional Conclusions would have been around 35% higher.

Assessment of the amount of repayment

6.29 As discussed in Section 4, BT does not provide disaggregated DSACs for the charges in question in its RFS. Therefore, in Section 5, we estimated a DSAC range for each of the charges based on the DSAC/FAC ratio of related products for which DSACs were published in the RFS. The estimated ranges, as well as the average DSAC for each charge, are presented in Table 6.1 below.

Table 6.1: DSAC estimates based on LLCC PPC Points of Handover pricing review bottom-up model, unit

Unit basis, £

2010/11 2011/12

Charge period

1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept

2011 SMA-1

Minimum 575 575 711 Average 752 752 952 Maximum 856 856 1,297 SMA-4 Minimum 688 688 850 Average 899 899 1,138 Maximum 1,024 1,024 1,551 SMA-16 Minimum 1,965 1,965 2,427 Average 2,570 2,570 3,251 Maximum 2,925 2,925 4,432

6.30 To order repayments, we need to decide on specific DSAC levels on which to base the calculations. We have considered whether there is a particular ratio we might use based on the estimates in Table 6.1. However, none of the individual ratios seem more appropriate to use than the others. This is particularly the case as BT has allocated costs and revenues associated with Type 1 POH additional charges to different POH services over time. We therefore consider it reasonable to use the average DSAC/FAC ratios for each year to estimate the DSACs on which to base repayments. The average of all the ratios we considered is 1.62 for periods of the Dispute falling within 2010/11 and 1.97 for periods of the Dispute falling within 2011/12.

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Calculation of the overcharge

6.31 Table 6.2 sets out the overcharge per unit for each Type 1 additional POH charge in dispute. The figures in the table are equivalent to the average unit DSAC test results in Table 4.15.

Table 6.2: Type 1 additional POH unit overcharge based on average DSAC/FAC ratios, £unit

2010/11 2011/12

Charge period

1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Apr 2011 – 30 Sept

2011 SMA-1 2,520 2,683 2,484 SMA-4 3,967 4,209 3,971 SMA-16 5,194 5,582 4,900

6.32 In order to calculate the repayment due to Level 3 we have first multiplied the unit overcharge by the number of circuits Level 3 bought in 2010/11 and 2011/12. Level 3 provided us with details of the monthly payments it had made per circuit.171 From this data we have estimated the volumes of Type 1 POH services purchased by Level 3 during the dispute period. These estimates are shown in Table 6.3.

Table 6.3: Level 3 volumes of Type 1 additional POH services purchased during the dispute period, unit

2010/11 2011/12 Total

SMA-1 [] [] []

SMA-4 [] [] []

SMA-16 [] [] [] Note: due to roundings totals for services may not match.

6.33 We then multiply the result by the number of days each charge was in effect. The final repayment we are directing is shown in Table 6.4. These figures have been rounded to the nearest thousand pounds.

Table 6.4: Level 3 repayment for disputed period in financial years 2010/11 and 2011/12, £’000

2010/11 2011/12 Total

Charge period

1 Jul 2010 - 31 Dec 2010

1 Jan 2011 - 31 Mar 2011

1 Jul 2010 - 31 Dec 2010

SMA-1 [] [] [] []

SMA-4 [] [] [] []

SMA-16 [] [] [] []

Total [] [] [] []

6.34 We therefore direct BT to repay the amounts set out in Table 6.4.

171 Level 3 section 191 response, 12 February 2014.

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6.35 We note that the total repayment to Level 3 has increased by around 150% from a total of []172 in the Provisional Conclusions to [] now.

6.36 There are four reasons for this. First, as explained in paragraphs 6.25-6.28 the repayment calculation in the Provisional Conclusions incorrectly calculated revenues in 2010/11. As set out in paragraph 6.28, the impact of correcting this error increases the total repayment by 35%.

6.37 Second, as explained in paragraphs 5.81 – 5.87 we have now calculated the revenue for the period of the Dispute falling within 2011/12 by reference to the charges in effect during this period, rather than by taking a weighted average of the charges across the whole of 2011/12. This increases the repayment for 2011/12 as we are only considering the charges in effect up to the end of the Dispute Period (30 September 2011) and not the lower charges that Ofcom required BT to introduce on 1 October 2011. The impact of correcting for this error is to increase the total repayment by a further 22%.

6.38 Third, as explained in paragraph 5.69, we have amended our estimate of the FAC of Type 1 POH services to include an uplift for general management overheads. Since this increases FAC (and subsequently DSAC), the overcharge reduces. The impact of this is to reduce the total repayment by [ 0-5%]. Finally, the volumes of Type 1 POH services purchased by Level 3 have been corrected in Table 6.3.

6.39 Table 6.5 provides a breakdown showing the impact of these corrections and changes from the Provisional Conclusions on the repayment to Level 3.

Table 6.5: Reconciliation of total repayments between Provisional Conclusions and Final Conclusions, £,000s

Provisional Conclusions

Correct 2010/11 revenue

calculation

Correct 2011/12 revenue

calculation

FAC uplift

Level 3 volume

correction

Final Conclusions

SMA-1 [] [] [] [] [] [] SMA-4 [] [] [] [] [] [] SMA-16 [] [] [] [] [] [] Total [] [] [] [] [] []

Note: due to roundings totals for services may not match Table 6.4.

Interest


6.40 Level 3 requests, “in the event that Ofcom concludes that an overpayment has, in fact, occurred and Ofcom elects to require a restatement of historic charges, then we request that Ofcom should consider whether interest is payable and, if so, then on what terms this should be calculated.” Level 3 believes that Ofcom should apply the same principles in its consideration of interest as it did in the recent determination of

172 Service level repayments in the Provisional Conclusions were [], [], and [] which sum to []. The [] proposed in the Provisional Conclusions was a rounded total, rather than a sum of the rounded individual services totals.

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a dispute dated 25 October 2013 between Gamma and BT regarding the “Oftel Interest Rate” contained within BT’s Standard Interconnect Agreement.173

6.41 In response to our Provisional Conclusions, Level 3 confirmed it agreed that the Bank of England rate plus 1% would be more appropriate than the contractual rate, but asks Ofcom to “clarify, for the avoidance of doubt, that in all respects other than the rate of interest, the provisions of the contract would continue to apply”.

6.42 BT believes that any interest directed to be paid should be based on the contractual rate, which is the Oftel Interest Rate.174 It did not make any submission about the award of interest in its response to our provisional conclusion that the Bank of England base rate plus 1% should apply.

6.43 In response to our Provisional Conclusions, we received a joint response from the joint respondents regarding our approach to the award of interest in this Dispute. The joint respondents refer to their submissions in the Oftel Interest Rate dispute, and submit that:

• It is not appropriate to apply a single rate across disputes, and to set a default rate in Guidance is too inflexible, as evidenced by our Provisional Conclusions;

• the application of the Bank of England base rate plus 1% rate as the appropriate rate to reflect the benefit derived by the overcharging firm substantially favours BT over the “losing CP”; and

• there has in this Dispute been a mechanistic application of the default rate.

Ofcom’s views

6.44 The PPC services in dispute were provided under BT’s Standard PPC Handover Agreement (“PPC Agreement”). Clause 9.7 of that agreement provides that:

“If any charge (or the means of calculating that charge) for a BT service or facility has retrospective effect (for whatever reason) then BT shall, as soon as reasonably practicable following publication in the Carrier Price List, adjust and recalculate the charges in respect of such service or facility using the new charge and calculate the interest for any sum overpaid or underpaid at the Oftel Interest Rate.”

6.45 The Oftel Interest Rate is defined in Annex D to the PPC Agreement as:

“...three eighths of one per cent (3/8%) above the London Inter Bank Offered Rate being the rate per annum of the offered quotation for sterling deposits for delivery on the due date for payment for a period of three months as displayed on page 3750 on the Telerate Service (or any other page that may replace page 3750 on that service) at or about 11 am London time on the due date of payment provided that if such a rate is not so displayed London Inter Bank Offered Rate shall mean the rate quoted by National Westminster

173 See: http://stakeholders.ofcom.org.uk/enforcement/competition-bulletins/closed-cases/all-closed-cases/cw_01108/. 174 BT’s letter dated 24 January 2014, page 9.

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http://stakeholders.ofcom.org.uk/enforcement/competition-bulletins/closed-cases/all-closed-cases/cw_01108/

http://stakeholders.ofcom.org.uk/enforcement/competition-bulletins/closed-cases/all-closed-cases/cw_01108/


Bank PLC to leading banks in the London interbank market at or about 11 am London time on the due date of payment for the offering of sterling deposits of a comparable amount for a period of three months. Such interest shall be calculated on a daily basis.”

6.46 Ofcom has recently determined a dispute between Gamma and BT regarding a similar provision which was contained in BT’s Standard Interconnection Agreement (“SIA”)175 (“the Oftel Interest Rate Determination”). Annex 2 to the Oftel Interest Rate Determination contained guidance about our approach to interest in the context of resolving a dispute involving charges payable under BT’s SIA (“the Interest Guidance”).

6.47 Although we noted that the scope of the dispute in the Oftel Interest Rate Determination related specifically to repayments directed by Ofcom in relation to charges payable under BT’s SIA, we considered that, in principle, the Interest Guidance may also be relevant more generally to repayments directed by Ofcom relating to other products and services.176

6.48 In the Oftel Interest Rate Determination, we considered the Oftel Interest Rate was “generally unlikely to be an appropriate interest rate to apply when making a direction for repayment in a dispute”.177 We consider that the basis for this conclusion, as set out at paragraphs 3.97 to 3.104 of the Oftel Interest Rate Determination, would also apply to the Oftel Interest Rate in the context of the PPC Agreement, and therefore to this Dispute. We have not identified any factors which would distinguish the present case from the Oftel Interest Rate Determination and therefore consider that the application of the Oftel Interest Rate in this case would not be appropriate to meet our statutory duties.

6.49 In the Interest Guidance, we stated that the Bank of England base rate plus 1% “is likely to be an appropriate rate to reflect the benefit derived by the overcharging firm from the overcharge in most cases. In the absence of evidence to the contrary, we consider that it is likely to provide a reasonable approximation of the cost of debt for a firm in the position of an overcharging CP.”178

6.50 We note that Level 3 agrees that Bank of England base rate plus 1% is more appropriate than the Oftel Interest Rate, and that while BT believes the contractual rate should apply, it has not made any submission about the use instead in the Dispute of the Bank of England base rate plus 1%.

6.51 The joint respondents refer to their previous submissions in the Oftel Interest Rate dispute and their Notice of Appeal in the appeal of the Ethernet Determination to support their assertion that applying the Bank of England base rate plus 1% as a default rate may not be appropriate and that a rate higher than that (based on WACC) would be more appropriate.

6.52 The joint respondents acknowledge that the facts underlying the appeal of the Ethernet Determination might be considerably different to the facts in this Dispute. They do not, however, explain or provide any evidence or analysis why a higher rate

175 Dated 25 October 2013 which can be found here: http://stakeholders.ofcom.org.uk/binaries/enforcement/competition-bulletins/closed-cases/all-closed-cases/cw_01108/CW_011080613.pdf. 176 Paragraph 4.14 of the Oftel Interest Rate Determination. 177 Paragraph 4.82 of the Oftel Interest Rate Determination. 178 Paragraph A2.12 of the Interest Guidance.

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http://stakeholders.ofcom.org.uk/binaries/enforcement/competition-bulletins/closed-cases/all-closed-cases/cw_01108/CW_011080613.pdf

http://stakeholders.ofcom.org.uk/binaries/enforcement/competition-bulletins/closed-cases/all-closed-cases/cw_01108/CW_011080613.pdf


than that proposed in our Provisional Conclusions would be appropriate in the circumstances of this Dispute.

6.53 We are not determining, in our resolution of this Dispute, or commenting on, whether the Bank of England base rate plus 1% would be an appropriate default rate to apply in disputes in general. Instead, we have taken into account the relatively recent analysis that we undertook for the Oftel Interest Rate dispute and the Guidance, and on this basis considered whether the Bank of England base rate plus 1% would be appropriate in this specific dispute.

6.54 We do not consider our use of the Bank of England base rate plus 1% in this Dispute to be a mechanistic application of a default rate, and note that the Parties have not made any submission suggesting this. Moreover, the joint respondents have not provided any evidence to support their assertion.

6.55 Having concluded that the Oftel Interest Rate is not a suitable interest rate, and noting that there do not appear to be any distinguishing features of this Dispute which might justify a departure from the Interest Guidance, our view is that the Bank of England base rate plus 1% should apply in this Dispute.

6.56 Level 3 has asked that Ofcom “clarify, for the avoidance of doubt, that in all respects other than the rate of interest, the provisions of the contract would continue to apply”. In resolving this dispute, it has not been necessary for Ofcom to consider any of the contractual provisions other than the clause relating to the payment of interest. The scope of the dispute is clearly defined from the outset and did not include a consideration as to whether the remaining terms of the contract should apply since, on the basis of the submissions of Level 3 and BT, those terms were not in dispute. As Ofcom has not had cause to consider such terms in resolving the dispute, it would not be appropriate for Ofcom to make any comment as to the validity or otherwise of the remaining terms of the contract.

Summary of Ofcom’s assessment

6.57 Based on the analysis set out in Section 4 and Section 5, Ofcom determines that:

• BT has overcharged for certain Type 1 POH services (SMA-1, SMA-4 and SMA-16) for time period that is the subject of these Disputes;

• BT has overcharged Level 3 a total of [] for Type 1 POH services during the Relevant Period; and

• BT should refund Level 3 the amounts overpaid:

o For SMA-1: []

o For SMA-4: []

o For SMA-16: []

Assessment of consistency of Ofcom’s conclusions with our statutory duties and Community obligations

6.58 As discussed in Section 2, Ofcom is obliged to handle disputes that fall within section 185(1A) of the Act unless there are alternative means available for resolving the

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dispute. We concluded that it is appropriate for us to handle the Dispute and therefore accepted the Dispute for resolution on 17 January 2014.

6.59 As part of our analysis, we have also considered our general duties in section 3 of the Act and also the six “Community requirements” set out in section 4 of the Act, which give effect, among other things, to the requirements of Article 8 of the Framework Directive.179 We consider that our assessment and conclusions are consistent with these duties.

6.60 In setting out our conclusions, we have also kept in mind our duty under subsection 3(3)(a) of the Act to ensure that our regulatory activities are, among other things, transparent, accountable, proportionate and targeted only at cases where action is needed and to other principles of best regulatory practice. In particular, this document sets out the Parties’ arguments and the reasoning that underpins our conclusions, and the Parties have had an opportunity to comment on this in advance of our final determination of the Dispute.

6.61 We also consider that the direction is consistent with our principal duty under section 3 of the Act, and the Community requirements set out in section 4 of the Act. Ensuring that charges are capped at a cost orientated level and that BT’s SMP obligations are enforced serves to promote effective competition, and through this furthers the interests of consumers.

6.62 Level 3 has requested that we address its request regarding an award of costs. In line with our guidance on Ofcom’s approach to payment of costs and expenses in regulatory disputes180, we will consider submissions as to costs following the issuing of this Final Determination.

179 Directive 2002/21/EC. 180 http://stakeholders.ofcom.org.uk/binaries/consultations/payment-costs/statement/guidance.pdf

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Annex 1

1 Determination to resolve the dispute between BT and Level 3 Determination under sections 188 and 190 of the Communications Act 2003 (“the Act”) for resolving a dispute between Level 3 Communications UK Limited (“Level 3”) and British Telecommunications plc (“BT”) concerning BT’s charges for partial private circuits (“PPCs”).

WHEREAS—

(A) Section 188(2) of the Act provides that, where Ofcom has decided pursuant to section 186(2) of the Act that it is appropriate for it to handle the dispute, Ofcom must consider the dispute and make a determination for resolving it. The determination that Ofcom makes for resolving the dispute must be notified to the parties in accordance with section 188(7) of the Act, together with a full statement of the reasons on which the determination is based. Ofcom must publish so much of its determination as (having regard, in particular, to the need to preserve commercial confidentiality) it considers appropriate to publish for bringing it to the attention of the members of the public, including to the extent that Ofcom considers pursuant to section 393(2)(a) of the Act that any such disclosure is made for the purpose of facilitating the carrying out by Ofcom of any of its functions;

(B) Section 190 of the Act sets out the scope of Ofcom’s powers in resolving a dispute which may, in accordance with section 190(2) of the Act, include—

• making a declaration setting out the rights and obligations of the parties to the dispute;

• giving a direction fixing the terms or conditions of transactions between the parties to the dispute;

• giving a direction imposing an obligation, enforceable by the parties to the dispute, to enter into a transaction between themselves on the terms and conditions fixed by Ofcom; and

• for the purpose of giving effect to a determination by Ofcom of the proper amount of a charge in respect of which amounts have been paid by one of the parties to the dispute to the other, giving a direction, enforceable by the party to whom sums are to be paid, requiring the payment of sums by way of adjustment of an underpayment or overpayment;

(C) On 8 December 2008, Ofcom published a statement called Review of the retail leased lines, wholesale symmetric broadband origination and wholesale trunk segments markets (“the 2008 BCMR Statement”)181 which found that BT held significant market power (“SMP”) in a number of markets including that for wholesale low bandwidth traditional interface symmetric broadband origination (with a bandwidth capacity up to and including 8Mbit/s) (“the low bandwidth TISBO market”);

181 See http://stakeholders.ofcom.org.uk/binaries/consultations/bcmr08/summary/bcmr08.pdf.

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http://stakeholders.ofcom.org.uk/binaries/consultations/bcmr08/summary/bcmr08.pdf


(D) In the 2008 BCMR Statement, Ofcom imposed a series of SMP conditions on BT in relation to the low bandwidth TISBO market under section 45 of the Act including a basis of charges obligation which requires:

“G3.1 Unless Ofcom directs otherwise from time to time, the Dominant Provider shall secure, and shall be able to demonstrate to the satisfaction of Ofcom, that each and every charge offered, payable or proposed for Network Access covered by Condition G1 is reasonably derived from the costs of provision based on a forward looking long run incremental cost approach and allowing an appropriate mark up for the recovery of common costs including an appropriate return on capital employed. G3.2 For the avoidance of any doubt, where the charge is offered, payable or proposed for Network Access covered by Condition G1 is for a service which is subject to a charge control, the Dominant Provider shall secure, and shall be able to demonstrate to the satisfaction of Ofcom, that such a charge satisfies the requirement of Condition G3.1. G3.3 The Dominant Provider shall comply with any direction Ofcom may from time to time direct under this Condition.”;

(E) On 16 December 2013, Level 3 referred a dispute with BT to Ofcom for dispute resolution requesting a determination that:

a) BT has overcharged them for certain PPC services provided to Level 3 (which depends on whether or not BT’s charges for 2Mbit/s local end services were cost orientated between 1 October 2009 and 30 September 2010, and on whether or not BT’s Point of Handover additional charges were cost orientated between 1 April 2010 and 30 September 2011);

b) if so, by how much they have been overcharged; and

c) they should therefore be reimbursed; (F) Having considered the submissions of the parties, Ofcom set the scope of the issues in dispute to be resolved as follows -

“The scope of the dispute is to determine:

1. Whether BT overcharged Level 3 by failing to ensure that the following charges paid to BT by Level 3 were compliant with SMP Condition G3.1 in the periods identified:

a. Charges for 2Mbit/s Local End services between 1 October 2009 and 30 September 2010; and

b. Point of Handover additional charges between 1 April 2010 and 30 September 2011.

SMP Condition G3.1 requires that BT secure and be able to demonstrate to the satisfaction of Ofcom, that each and every charge offered, payable or proposed for Network Access covered by Condition G1 is reasonably derived from the costs of provision based on a forward looking long run incremental cost approach and allowing an appropriate mark up for the recovery of common costs including an appropriate return on capital employed. 2. If BT overcharged Level 3 for either of the charges described in 1a) and 1b), whether and how much BT should pay Level 3 by way of adjustment.”

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(G) In order to resolve this dispute, Ofcom has considered (among other things) the information provided by the parties and Ofcom has further acted in accordance with its general duties set out in section 3 of, and the Community requirements set out in sections 4 and 4A of the Act;

(H) A fuller explanation of the background to the dispute and Ofcom’s reasons for making this Determination is set out in the explanatory statement accompanying this Determination; and

NOW, therefore, Ofcom makes, for the reasons set out in the accompanying explanatory statement, this Determination for resolving this dispute—

Declaration of rights and obligations, etc.

1. BT has overcharged Level 3 in respect of additional charges for the provision of certain Point of Handover services, known as SMA-1, SMA-4 and SMA-16 between 1 July 2010 and 30 September 2011.

2. The level of that overcharge is determined at [].

3. Ofcom directs BT to pay Level 3, by way of adjustment of an overpayment in respect of the overcharge identified in paragraph 2 the sum of [], plus interest calculated at the Bank of England base rate plus 1%.

Binding nature and effective date

4. This Determination is binding on Level 3 and BT in accordance with section 190(8) of the Act.

5. This Determination shall take effect on the day it is published. Interpretation

6. For the purpose of interpreting this Determination— (a) except as otherwise defined in this Determination, words or expressions used in

this Determination (and in the recitals hereto) shall have the same meaning as they have been ascribed in the Act;

(b) headings and titles shall be disregarded; and (c) the Interpretation Act 1978 shall apply as if this Determination were an Act of

Parliament.

7. In this Determination— (a) “Act” means the Communications Act 2003 (c.21);

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(b) “BT” means British Telecommunications plc whose registered company number is 1800000, and any of its subsidiaries or holding companies, or any subsidiary of such holding companies, all as defined by section 1159 of the Companies Act 2006;

(c) “Level 3” means Level 3 Communications UK Limited, whose registered company

number is 02495998, and any of its subsidiaries or holding companies, or any subsidiary of such holding companies, all as defined by section 1159 of the Companies Act 2006;

(d) “Ofcom” means the Office of Communications; and (e) “PPC” means Partial Private Circuit.

Neil Buckley

Director, Competition Investigations

A person duly authorised in accordance with paragraph 18 of the Schedule to the Office of Communications Act 2002

16 May 2014

[As corrected on 16 July 2014]

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Annex 2

2 Relevant cost measures and terminology The key cost measures relevant to this Disputes and the common terminology used are summarised in the table below. Incremental cost is the cost of producing a specified additional product, service or increment of output over a specified time period. In many cases, the relevant increment may be the entire output of a particular service or group of services. The incremental costs of a service are then those costs which are directly caused by the provision of that service in addition to the other services which the firm also produces. Another way of expressing this is that the incremental costs of a service are the difference between the total costs in a situation where the service is provided and the costs in another situation where the service is not provided. Long Run Incremental Cost (“LRIC”) is the incremental cost over the long run, i.e. the period over which all costs can, if necessary, be varied. Common costs are those costs which arise from the provision of a group of services but which are not incremental to the provision of any individual service. Common costs may be identified in the following way: if the incremental costs of each service are removed from the total cost of providing all services, what are left are the common costs (i.e. those costs which are shared). Where there are no common costs, incremental cost and SAC are the same. Where there are common costs, the firm’s SAC of a service is the sum of the incremental cost of the service plus all of the costs which are common between that service and other services. Stand Alone Cost (“SAC”) is the cost of providing that particular service on its own, i.e. on a stand-alone basis. Distributed Long Run Incremental Cost (“DLRIC”) is a cost measure related to the LRIC of a component. Within BT’s network, groups of components are combined together to form what is known as a “broad increment”. Two of these “broad increments” are the core network (the “Core”) and the access network (“Access”). The DLRIC of a component is equal to the LRIC of a component plus a share of the costs that are common between the components within the “broad increment” (which are known as “intra-group” common costs). The common costs are shared between the components by distributing them on an equi-proportionate mark up (EPMU) basis. The sum of the DLRICs of all the components in the Core is equal to the LRIC of the Core itself. This is represented in the diagram below:

Distributed Stand Alone Cost (“DSAC”) is a cost measure related to the SAC of a component. As described above, there are components within the “broad increment” of the

Group of Services X Group of Services Y

Intra-Group Common Costs Intra-Group Common Costs

Common Costs Across All Services

LRICs for individual services

Intra-group common costs

DLRIC for an individual service in group X

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Core. As an example the DSAC of a core component is calculated by distributing the SAC of the Core between all the components that lie within the Core. Each core component therefore takes a share of the intra-group common costs, and the costs that are common to the provision of all services. The sum of the core components DSACs is equal to the SAC of the Core. This is demonstrated in the diagram below:

Fully allocated cost (“FAC”) is an accounting approach under which all the costs of the company are distributed between its various products and services. Fixed and variable costs: when considering which costs are fixed and which are variable the time period is key. In the short-run some costs (particularly capital costs) are fixed. The shorter the time period considered, the more costs are likely to be fixed. In the long-run, all costs are (by definition) considered variable. Current Cost Accounting (“CCA”) is an accounting convention, where assets are valued and depreciated according to their current replacement cost whilst maintaining the operating or financial capital of the business entity. Weighted average cost of capital (“WACC”): a company's WACC measures the minimum rate of return that a firm needs to earn in order to reward its investors. It is an average representing the expected return on all of its securities, including both equity and debt.

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