Chorus: a year on from the demerger

On December 1, 2011 Chorus became a standalone company, CEO Mark Ratcliffe and industry representatives reflect on the company's progress

Telecom demerged Chorus in order to take part in the government’s fibre network, but 99 per cent of Chorus's fixed line income is from the copper network.

Chorus maintains it needs the income from the copper network to invest in fibre.

“We’re investing $480 million in our fibre network in the next year; the government is making a $100 million contribution. We think our capital expenditure next year will be in the region of the high $500 million,” says CEO Mark Ratcliffe.

The price of access to the copper network for access seekers such as Vodafone and CallPlus is under review. The pricing had been de-averaged with a non-urban price of $36.63 and an urban price of $19.82. Under the legislation, that price is to be averaged and the Commerce Commission has undertaken a benchmarking process in which it looks at comparable overseas markets to determine the correct price. The outcome is due to be announced on Monday December 3, 2012.

Buy After Structural Separation from the Amazon Kindle store for more indepth information from this article and transcripts from the leading industry players.

Chorus says it should be $24.46, the amount you would get if you averaged the current urban and non-urban prices. But the access seekers – whose business models are centred on urban exchanges – say it should be closer to the current urban price.

While fibre is the future, copper is the here and now, and that’s how RSPs can acquire and maintain market share. As TUANZ CEO Paul Brislen explains:

“I have heard the figure of one-third of New Zealand households being connected [to UFB] by 2017. To my mind that means that by the end of the decade two-thirds of us will still be on copper.”

Brislen says we are being sold “the dream of fibre” when the reality is it could be copper for another seven years while the network is built.

Ratcliffe says only five percent of copper lines have been unbundled, but a change in the access price is likely to flow through to its much larger source of revenue – Unbundled Bitstream Access (UBA). That’s the wholesale price that ISPs pay Chorus to resell a copper line with services included.

“At the end of last year we were required to average the UBA and average the Unbundled Copper Local Loop prices as an input into the UBA services,” telecommunications commissioner Stephen Gale explains.

Currently the UBA price is a retail-minus calculation and is based on what Telecom was charging when it owned Chorus. But now the legislation requires that the UBA service become cost-based in two years.

Chorus says if the price of access to the copper loop is reduced it will simply mean that profits will shift to players further along the food chain.

“It will reduce our revenue and it will reduce our ability to pay dividends at the level we currently do, unless we can make some other adjustments,” says Ratcliffe. “It basically just shifts profits away from us to other parts of the industry.”

InternetNZ CEO Vikram Kumar says the commissioner should go with the lowest prices for the copper, as this is the best outcome for end users.

He says the lowest urban price is still more than the price that would be arrived at under a benchmarking exercise. “There is already an element of cross-subsidy happening. The fibre world is several years away, so why would we, in the interim period, you and I, pay Chorus shareholders?”

Most customers with copper broadband, called a Digital Subscriber Line, are getting theoretical download speeds up to 24 Mbps (although it’s likely to be less than half that in practice due to contention rates and other factors). This technology is referred to as ADSL2+. A technology called VDSL promises maximum speeds of around 50 Mbps, but the catch is that the customer has to live less than one kilometre from an exchange.

The VDSL service is being offered by some ISPs now. CallPlus is trialling it for residential users and may launch services next year.

“Over in Europe you’ve got VDSL technology and vectoring technology delivering 100 Mbps over copper,” says CallPlus CEO Mark Callander. “I don’t say it’s a replacement for fibre, but there is a path you can go down with copper before you get people on to fibre. You’ve got to get them on ADSL before fibre, got to get them on VDSL before you can get them to take the fibre leap. It’s how the various technologies are positioned over time that is important.”

Callander says he is concerned that from a regulatory perspective copper is being seen as a competitive threat to fibre.

Chorus chair Sue Sheldon highlighted the lack of a properly thought-out migration path from copper to fibre, during her opening remarks at the Commission’s conference on copper pricing in September.

“Investors cannot understand the rationale for reducing copper pricing, at the same time as taxpayers are supporting a government-backed programme of investment in fibre. This has raised concern about whether the UFB fibre policy and the regulatory policy on copper are misaligned,” Sheldon told the conference.

“This tension raises important questions about New Zealand’s policy environment and whether there is, or is not, a clear compass pointing the industry to transition to fibre when the investment choice has already been made.”

Labour ICT spokesperson Clare Curran also questions what the migration path from copper to fibre is and claims the National Government doesn’t have a strategy for this. Prior to the general election last year, Labour said if it got into power it would review the contracts signed by Crown Fibre Holdings. But Curran says that is unlikely now as “the genie is out of the bottle”.

“The issue will be ‘how important is it for us to migrate to fibre, why are we doing this in the first place?’ How important is it to migrate to fibre; if it’s really important, should we be hastening that process?” says Curran.

So how would Labour do that?

“I think the Commerce Commission is grappling with that issue at the moment,” Curran says, ducking the question.

Gale says there are no regulatory levers the Commission can pull to push Retail Service Providers to invest in copper or in fibre.

“It’s really just these two or three bald numbers – the contract prices for UFB (which start at $37.50 wholesale for a 30 Mbps fibre connection) and these prices for Unbundled Copper Local Loop and Unbundled Bitstream Access,” he says.

Curran points out that in Australia the government solved the migration issue by buying the copper loop off the incumbent provider Telstra.

But the Australian taxpayer investment is about A$43 billion, while the government here expects that by the end of the deal, when Chorus and the LFCs have paid the money back, the actual cost to the New Zealand taxpayer will be $600 million.

Zac Summers – who prior to becoming chief strategy officer for Vodafone NZ held a similar role in Vodafone Australia – says he prefers the New Zealand government’s approach. He says a cashed-up Telstra may be having a detrimental effect on the Australian telco market.

“It puts the Australian competitive market in a very difficult position, if you’re Vodafone Australia sitting there and your biggest competitor, who already has 50 percent of most of the markets and 80 percent of the industry profits, has just been given a A$13 billion free cheque. The question of how sustainable is competition in the Australian market becomes a big issue. I genuinely believe that the solution the government here came up with is better, because the separation of Chorus removes that tension,” Summers says.

“Chorus has got a job to do to build this network, and Telecom will be fighting on an equal competitive footing with all of us. The government is putting in enough seed funding to get it started – the dynamics of the market will make the migration happen.

“I don’t think the 30 Mbps and the 100 Mbps are the end of it [the two wholesale UFB products being offered to retail service providers]. I think in a year or two’s time that will change. Technology goes only one way – it gets faster and overall cheaper. That’s the way this thing will evolve.”

Meanwhile, it isn’t just deploying the fibre network, or the Rural Broadband Initiative, that is putting Chorus under pressure. Ratcliffe says that a rapid increase in ‘business as usual’– that is, installing or changing ordinary broadband connections – has seen the company ramp up its staff numbers and those of its service delivery partners Downers, Visionstream and Transfield.

In the first seven months of its operation Chorus added an additional five per cent broadband lines, and Ratcliffe says that prior to demerger it underestimated its workload.

Chorus now employs 670 staff; prior to demerger the division had 270 employees.

Ratcliffe says its service partners need fibre jointers, testers, project managers and labourers but he doesn’t think there is a skills shortage.

“It’s just growing volume, and it’s not just robbing Peter to pay Paul [such as poaching workers from the other LFCs]; you’ve got to try and bring all levels of our business up to the new volumes. You’ve got to be responsible about trying not to drive industry wages up to unsustainable levels. There were 2000 to 2500 people working for Downers, Visionstream and Transfield a year ago; now they are closer to 5000.”

If the company is rapidly growing to meet existing demand and spending over $500 million next year on new networks, why build in areas where fibre networks already exist? For example, in the Hawke’s Bay where Unison, the local lines company, is rolling out a network, and in Nelson/Marlborough where Network Tasman has already built a fibre network?

Ratcliffe says Chorus is building in those areas because it is obligated to. “They’ve got their own reasons for continuing to invest, and we’ve got a contractual obligation to do it. If they wanted us to utilise their network then they’ve got the option to come and talk to us about a contractual arrangement.”

Meanwhile Chorus is still mulling over whether to buy a stake in Local Fibre Companies Enable Networks (Christchurch area) and WEL Networks (central North Island area). It has until May next year to make a decision, so why invest?

“It’s better to put our assets into the company that’s going to roll out fibre and be part of that, than sit there and try and compete against it,” says Ratcliffe.

“Philosophically we’re against overbuilding, so we’ll look at an opportunity where we might be able to enter into commercial arrangements. They can utilise their existing network and we get a shareholding in the company.”

What Chorus can’t do is invest in a mobile player – because it is prohibited from becoming a retail service provider on any network, whether fixed line or mobile.

* This article, together with Telecom in the new era, marks the first anniversary of the structural separation of Telecom on December 1, 2011.

An extended version of this article is available as a Kindle eBook, After structural separation, for $2.99 at amazon.com. It includes interview transcripts with the following leading industry players Telecom CEO Simon Moutter, Chorus CEO Mark Ratcliffe, Telecommunications Commissioner Stephen Gale, Vodafone chief strategy officer Zac Summers, Labour ICT spokesperson Clare Curran, CallPlus CEO Mark Callander, Telecommunications Users Association CEO Paul Brislen, and and InternetNZ CEO Vikram Kumar.