Review of the 3G Spectrum Cap

This short paper has been prepared to assist interested parties in making submissions to the Ministry of Economic Development’s review of the 3G spectrum cap. Third Generation (3G) technologies support the development of high speed mobile data and innovative new service applications. Over the next few years, these are likely to be complemented by 4G (principally Long Term Evolution, or LTE) technologies.

The 3G Spectrum Cap

A cap of 15 MHz (plus the relevant natural pair) and 5 MHz of TDD spectrum per 3G Management Right holder is currently in place to facilitate the development of competition in the provision of mobile services in New Zealand.

Imposing the spectrum cap for the 2GHz auction in 2000 addressed concerns that one or two of the 3G spectrum bidders might purchase enough spectrum rights to significantly reduce future competition in downstream telecommunications markets, due to lack of appropriate spectrum available to potential new entrants.

Current Management Right holdings in the affected spectrum are shown in table one:
 

Table One: 3G Management Right Holdings in the 2 GHz Band

The caps were set for an initial period of three years, as set out in Management Right deeds between the Crown and each purchaser of 3G spectrum. However, the Crown reserved the right to extend the caps for a further period, should that prove to be necessary to continue to facilitate workable and effective competition.

Why Facilitate Competition?

Firms not subject to competitive pressures have less incentive to be productively efficient in the use of resources (to produce at least cost), and less incentive to be dynamically efficient (to invest in new technologies and processes). It is the improvement of processes, with the adoption of new technology, which contributes to economic growth. Such firms may also have the ability to act anti-competitively.

In this context, reliance on purely market forces risks impediments to competition. This is because dominant firms may have an unrestricted ability to grow and/or acquire resources, thereby preventing smaller firms entering the market. The resultant delays to investment and innovation can have a significant impact, given the rapid rate of technological advance in cellular telephony.

Where a spectrum cap (or other prescriptive intervention) is imposed as a precaution against market dominance, there is potential for a loss of allocative efficiency, as spectrum may not go to where it is most valued. A key judgement is whether this initial loss of efficiency is outweighed by increased competition and by dynamic efficiency over time.

Active Competition Enhancement

The form of regulation that best facilitates competition depends upon the demand for spectrum in a band, the services offered, and the type of technology used. The Radiocommunications Act 1989 is silent on competition policy, with the exception of section 138 which specifically deems Management Rights and Spectrum Licences granted within the Management Rights Regime to be assets of a business for the purposes of the Commerce Act.

The Commerce Act prohibits the purchase of business shares or assets if that purchase leads to a substantial lessening of competition in the relevant market (section 47). Section 66 of the Act allows firms to make clearance applications to the Commerce Commission for an acquisition of business assets or shares. The Commission, in granting the clearance, must be satisfied that the acquisition does not have the effect of substantially lessening competition in the market.

The test of ‘substantially lessening competition’ does not prevent ‘creeping acquisitions’, where a firm makes small and incremental acquisitions of spectrum which result in the firm acquiring substantial market power. It was considered that the Commerce Act provisions were not sufficient to promote competition in the 3G cellular market because the market was still emerging, and the acquisition of spectrum is fundamental to how competition in a sector develops.

Sole reliance on the Commerce Act for competition promotion can be problematic where services are not clearly defined or are non-existent, as the Commerce Commission guidelines rely on well defined markets and market shares, and are difficult to apply where the future market is unknown. It can also take considerable time to progress a case under section 47 of the Act.

In the absence of spectrum caps, if an acquisition proceeds but subsequently has the effect of maintaining or enhancing the market power of the right-holder, then the restrictive trade practices prohibition in Part 2 of the Act are not well placed to enable access to the spectrum by existing or potential competitors.

This is because the Commerce Act provisions constitute a largely principles-based approach and serve to restrict or punish anti-competitive behaviour after or as it is happening (ex post), whereas measures that actively promote competition (such as a spectrum cap) tend to be rules-based and prescriptive (ex ante, or forward-looking).

Therefore, Commerce Act mechanisms cannot easily facilitate ongoing market supervision. Orders may or may not be effective, may prove to be unenforceable, or may prove to be counterproductive or inappropriate as market circumstances change over time. Dominant firms often have several alternative methods of behaving anti-competitively, meaning that obtaining orders to restrict one form of anti-competitive conduct can leave open other potential anti-competitive opportunities.

Specific competition safeguards for the 2 GHz spectrum, incorporated in the deeds in the form of ownership caps, were created due to a perceived lack of certainty with the applicability of the Commerce Act mechanisms. This ensured a minimum number of participants in the 3G cellular market at a time when there were no 3G services planned for deployment. The 3G cap was established by the Crown as a condition of the original sale of spectrum in 2001. While it can be continued if appropriate, once the cap lapses it cannot readily be re-established without recourse to other regulatory mechanisms.

2007 Review of the 3G Spectrum Cap

The spectrum caps contained in the 3G Management Right deeds were reviewed in 2004 and again in February 2007, after consultation with industry.

In deciding to extend the caps in 2007, the government took into account the special features of the 3G services market (including the limited amount of spectrum available for 3G cellular services at that time). The government also looked at the price performance of New Zealand cellular services compared to other OECD countries, the slower than anticipated development of the 3G market, and the views of existing 3G spectrum rights holders.

Continued uncertainty regarding the application of the Commerce Act to 3G spectrum acquisitions was also observed in the review. Given the potential importance of 3G technologies for the economic development of New Zealand, the government wanted to ensure that all conditions that promote competitive entry into this market are maintained. The government therefore considered that it remained in the interests of consumers to ensure that potential future entrants have access to appropriate spectrum.

The spectrum management rights subject to the cap have tenure of 20 years, with expiry in 2021. The rights are therefore at approximately their halfway point. Any limited deployment of 3G technologies in these management rights is likely to have been influenced by the higher costs of providing effective coverage at 2 GHz.  Telecommunications firms have generally favoured alternative spectrum (such as that at 850/900 MHz) for deployment of 3G networks.

3G Equipment Deployment in Cellular Spectrum

To establish a 3G mobile network in New Zealand potential 3G service operators require access to appropriate radio spectrum. 3G technologies bring together high-speed radio access and IP-based communication services, providing capability for improved cellular telecommunications services. 3G Management Rights are currently held by five telecommunications companies, with three currently offering 3G services (one of which is currently offering such services only to inbound roamers).

When the cap was first established, the envisaged 3G services could only be implemented in the 2 GHz range. Since the last review in 2007, technology has developed to the extent that 3G services can now be implemented in a number of frequency bands. In particular, technology has been specified in bands that previously were exclusively 2G. These include the 850 MHz and 900 MHz bands owned by Telecom, Vodafone, and 2Degrees. Therefore, in addition to recent deployments of 3G services at 2 GHz, there is now extensive use of 3G technology in the 850 and 900 MHz bands throughout New Zealand.

Other spectrum not utilised internationally for 3G cannot be relied upon at this stage to preserve a competitive entry option. This is due to New Zealand’s position as a technology taker and its reliance on overseas scale economies in equipment and handset manufacture. There are also global roaming advantages with restricting spectrum allocation to internationally standard frequencies.

In the case of a joint venture, parties could sell down their spectrum holdings to work within the spectrum cap. If parties demonstrate substantial benefits to consumers of such an arrangement and it becomes apparent that the cap is preventing or delaying beneficial developments to occur, the Ministry could recommend that the cap be allowed to lapse or modified for particular circumstances, subject to appropriate safeguards.

For example, in remote areas it may not be efficient to build more than one 3G network. The government could therefore consider allowing the 3G cap to be exceeded for servicing particular lower density areas with marginal commercial potential. 2 GHz spectrum may not be the most appropriate band for this application, however.

3G Cellular Market Maturity

Over the next few years, 3G services will be complemented by 4G technologies as new equipment and other spectrum bands (such as the Digital Dividend) become available. It is likely that operators will utilise their 3G network assets in current spectrum bands for some years to come before gradual replacement with 4G.

3G networks use circuit-switching for voice and SMS services, creating a valuable revenue stream that a 4G (solely IP) network would not. Operators may also choose to retain a 3G network as a safety net underlay to their 4G network.

The 3G market may or may not therefore see the continuance of present market structures, despite spectrum allocations in the 2 GHz band being capped to ensure that there is sufficient spectrum for at least four cellular service operators.

Should the Spectrum Cap be Renewed or Left to Expire?

A useful starting point is to ask whether the Commerce Act provisions would now be sufficient (in the absence of spectrum caps) to regulate competition in the market for 3G services. Since downstream markets may be better known and therefore the 2G/3G market better defined than in 2007, the Ministry is interested in how stakeholders view the current value of the spectrum caps in promoting competition.

A few key questions may assist to answer the general question:

• How much is current competition a result of the spectrum caps in place?

• How much is competition dependent on the spectrum caps in place?

• How does the existence of any ‘idle’ spectrum affect the cost of service provision in New Zealand?

• Is this spectrum conversely serving as a competitive restraint through the threat of a fourth operator entering the market?

• What roles do other entry barriers or pro-competition measures play in the effectiveness of spectrum caps in promoting competition in 3G services?

  • National roaming;
  • Mobile Termination Access Services (MTAS);
  • Co-location and co-siting of base stations; and

  • ‘Use or Lose’ provisions and other licensing conditions.

• Is there a potential for hoarding 3G spectrum?

  • With the spectrum cap?

  • Without the spectrum cap?

• On balance, should the spectrum caps should be renewed or left to expire?