UK faces an uphill struggle to make a success of 4G

UK faces an uphill struggle to make a success of 4G

The tail has wagged the dog. A terminal device (the smart-phone) is in process of up-ending the economics of UK mobile networks. A mobile telephone network is being turned into a high-speed mobile Internet but the up-grading is running late and running up-hill. With the government’s current mobile policy it is likely to run out of steam around the next corner…and 4G will disappoint not only millions of consumers but a raft of new digital industries creating the jobs of the future.

Piecing together the big picture of economic change

Mobile is an industry in its own right and contributes in the region of 2% of GDP. However the mobile Internet, together with the fixed Internet, have become critical underpinning infrastructures for an economy far bigger than their own. These two pillars support an Internet economy that is estimated to be 5.7% of GDP and growing. Added to this are the efficiency gains they contribute to the rest of the economy. Mobile, in particular, contributes mobility, personalisation and location to a digital economy. So both networks are important. The Government has a good grip on policy for the fixed broadband network. But they have taken their eye off the ball for mobile networks and missing a picture of huge transformational changes: 

1.Internet economics subvert mobile network economics

The world has moved from “mobile phones connected to a telephone network” paid for “by the second” of telephone usage to “computers connected to the Internet” and paid for by a “monthly subscription”. Data caps provide only a weak link to usage.

The absence of a data usage charge is essential to the Internet economy. It provides powerful and plentiful “over the top” Internet players with free distribution to millions of consumers who feel free (from usage charges) to explore and use at whim. A perfect high growth model. These “over the top” players generate huge wealth (GDP) from the Internet services (and jobs), stimulate a rising demand for data in the process but leave the phone companies to find the cost of the extra capacity to meet this demand. The mobile network operators have less scope to sustain this model than the fixed broadband providers but smart-phones are pulling the market towards mobile networks:

 

2. Highly skewed delivery from the new 4G (and 3G) technologies

The new mobile technologies (3G HSPA and 4G) have improved mobile connections speeds significantly but the capacity to deliver these high speeds drops very steeply away with distance from a radio mast. Left unaddressed large dark valleys of chronic under-speed will envelope the country. Redressing this requires “denser” mobile networks (ie more base stations). Nobody is yet planning for this new layer of investment. (Note: “National roaming” would jump start more dense wide area networks but this does not fit with the current network competition model).

3. The impact WiFi on mobile network economics

The introduction over the past 3-4 years of WiFi on almost all new smart-phones is opening up consumer choice to totally by-pass national mobile networks whenever they are near a WiFi point. Other players such as BT and Virgin are pursuing WiFi strategies whereby “club members” can access not just their own home WiFi but a substantial number of other WiFi access points. Thus the country is essentially on two parallel mobile network tracks. In the short term the two are complementary. In the longer term they are competitive.

In this competitive mode one technology is getting free spectrum from Ofcom and free back-haul from BT (and Virgin). For the other technology billions of pounds is being charged for spectrum and BT (and others) are charging commercial rates for the back-haul. So mobile operators will inevitably lose their grip in very dense urban areas where they compete. In parallel Skype and IT messaging will be haemorrhaging their telephone and SMS revenues.

4. Convergence of Fixed and Mobile Internet’s

Hitherto fixed broadband and mobile broadband have been treated as separate stand-alone networks. As mobile networks get ever denser the fixed broadband Internet will essentially gate not just the technical performance of mobile networks but their costs. Denser mobile networks will drive up these costs significantly. Over some of the country these mobile back haul links are provided by a monopoly provider (BT).

5. Spectrum Auctions and spectrum pricing

If Ofcom is asked whether the purpose of a spectrum auction is to raise money for the Government they reply, with legal justification, that it is not. Few outside of Ofcom understand why an auction is held “not to raise any money”. The explanation is that Ofcom follows an economic theory (of the mobile “telephone” age) that a company who pays the most for spectrum must have a business plan to generate the biggest profit and this equates to the country generating the most wealth from the spectrum. The theory works because the wealth generated by the country from mobile spectrum is captured almost entirely by the mobile operators since they alone have got all the telephone and SMS service revenues (either retail or wholesale).

But the auction theory breaks down with 4G as the main function of a 4G network is to provide mobile access to the Internet. Revenues from the myriad of services over the Internet do not go directly or even indirectly (via carriage fees) to the mobile operators. It follows that since the mobile operators do not enjoy the Internet service revenues this huge national economic benefit will not be reflected in an auction bid price for the spectrum. So the theory that Ofcom use to justify a spectrum auction has become invalid for the mobile broadband Internet age. We cannot rely anymore on auctions to allocate spectrum efficiently.

Even when the spectrum auction theory was valid there were unintended consequence. The 3G auction showed that intense competition blocked off the ability to recover auction payments from customers, so instead the mobile operators slashed their capital budgets for building the networks. Put in simple terms: a pound extracted at a spectrum auction was a pound not spent on network investment.

This leaves the spectrum auctions of the type run by Ofcom falling between stools. They do not do an effective job in raising money for the Treasury and they do not do an effective job of allocating the spectrum. The 4G auction has done little more than extract money out of an already deflating mobile industry economy and the arbitrary decision to auction some spectrum and allow re-farming of other spectrum by incumbants has left the UK 4G market in an incoherent state.

6. An investment crunch sits around the next corner

Ofcom have spent the past decade focussing on competition to drive down phone bills and they have been very successful in this. But the same measures have also driven down the “return on capital”. It has nearly halved in the past 10 years. The large multi-national companies that own the UK mobile networks are now having to ration their capital between the various countries in which they operate – all hungry for investment. In global markets capital flows to where it gets the best return. The UK is no longer offering the best return. So we have an inevitable investment crunch around the next corner. On the one hand there is a substantial demands for additional layers of investment to fill out the large dark valleys of chronic under-speed (the feature of the new technologies) and sustain ever expanding capacity over the entire network(driven by a successful digital economy). On the other hand traditional revenues are coming under growing pressures over and above those of normal market competition.These new dynamics sit within a UK mobile market offering less and less attractive returns for inward investment. 

When the numbers no longer add-up the mobile network operators will take the best decisions in their own interest. They will adapt and survive. The question for Ofcom and the Government are whether those company centric decisions will deliver a national mobile broadband infrastructure that maximises the wealth and job creating potential of an expanding UK digital economy. The government’s and Ofcom’s current mobile policies (created in a mobile telephone age) is simply not up to meeting this new challenge.  

 

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