Ofcom's decision to cut MTRs has met with mixed reactions from mobile operators, but may set a precedent for other EU states, says consultant David Black

UK regulator Ofcom recently announced significant cuts to future mobile termination rates (MTRs) - the fees operators charge each other for connecting calls. Ofcom has proposed to change how it calculates the charges to be consistent with a recent EC recommendation aimed at harmonising these charges across Europe, and this may indicate likely outcomes for decisions to come in other member states.

The result of Ofcom's decision is that MTRs will fall by 88% on average, from their current average of 4.3 pence per minute (ppm), to just 0.5ppm by 2015. This news has been welcomed by fixed-line operators and 3UK, but heavily criticised by the larger mobile operators. Ofcom plan to issue a final statement on MTRs later in 2010.

The European Commission is concerned both about the high level of MTRs and the variance across member states: in 2008 MTRs ranged from 2 eurocents to 16 eurocents per minute. At that point, UK MTRs were in line with the EU average. In May 2009, the Commission revised the methodology for determining the cost of termination to Long Run Incremental Cost (LRIC). In the past, European regulators such as Ofcom have used a LRIC+ approach, where common costs with other mobile services such as spectrum were also recovered.

In its decision, Ofcom indicates that it believes the merits of LRIC versus LRIC plus are finely balanced, but due to the Commission recommendation it has adopted a LRIC approach. If Ofcom had instead adopted a LRIC+ approach, the MTR would have fallen to 1.5ppm by 2015 (compared to 0.5ppm under the LRIC approach). Other reasons for the steep fall in MTRs are falling equipment prices and rising mobile data volumes (which reduce the proportion of costs attributed to voice).

The direct implications of the proposed decision are lower payments by fixed operators to mobile operators and reduced transfer between mobile operators. However, the more interesting implications are likely to be the indirect consequences: how will the lower MTRs change the way the way that operators compete with each other? Entrant mobile operators are likely to benefit, as high MTRs disproportionately impact on them relative to the larger operators, as smaller operators are likely to have a higher proportion of "off-net" calls (terminated on another network). Lower MTRs are expected to allow entrant operators to compete more vigorously, particularly for high-use customers. This places further downward pressure on mobile prices.

Lower MTRs should also enable greater competition between fixed and mobile networks. While MTRs will still be higher than fixed call termination rates, much lower MTRs will lower the floor price for fixed to mobile calls. This is likely to enable fixed operators to bundle large volumes of calls to mobiles into their packages. This will remove existing barriers to consumers calling from fixed to mobile networks and enhance the competitiveness of fixed relative to mobile calls.

The actual competitive impact in member states will depend on aspects such as the structure of the existing market and whether there is an entrant operator able to compete with other operators. In the UK, T-Mobile and Orange have recently merged to reduce the number of mobile operators from five to four. 3 UK has a much smaller market share (around 7%) than the other operators and the reduction in MTR might be expected to stimulate additional competition. The incumbent fixed-line operator, BT, does not own a mobile operator and therefore gains the full benefit from the decision.

Reduced MTRs could result in either lower returns for mobile operators or a rebalancing of charges, whereby a greater proportion of costs are recovered from subscriptions or calls (the "waterbed effect"). In practice, a mixture of both outcomes may occur. The impact will partly depend on the competitive dynamics discussed above: if lower MTRs result in more competition then the change will have a greater impact on returns. There is a question as to the continued profitability of pre-pay services; some operators have suggested that a move to charging customers for receiving calls (receiver party pays) may be required. Ofcom has dismissed the likelihood on the grounds that consumers see this approach as less favourable than alternative means of raising revenue.

Ofcom's proposed new MTRs are likely to indicate future direction of charges in other European states as the EC's Directive is reflected in national regulators' decisions, along with decreasing equipment prices and increasing data rates. This is likely to result in steep reductions in MTRs in member states. Lower MTRs may make life more difficult for established mobile operators with less revenue from fixed-line callers and increased competition.

David Black is a senior managing consultant at LECG

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