Submission to Senate on NBN Implementation Study

As noted in my earlier post, the Australian Government officially released the much heralded KPMG/MCKinsey NBN Implementation Study to both the Department of Broadband, Communications and the Digital Economy (DBCDE) and the Senate Select Committee on the National Broadband Network. Pretty much immediately the DBCDE established a public wiki for discussion (no longer available) and the Senate Committee set a deadline of the 27th May 2010, for public feedback regarding the Implementation Study recommendations (found here).

This post is a more approachable highlight of key points and observations from my review of the KPMG/McKinsey Implementation Study submission to the Senate Select Committee on the National Broadband Network.

Why we want an NBN:
Providing all Australian’s with available, accessible and affordable broadband, regardless of their geographical location or their socio-economic status will not only help to improve the quality of life for all citizens, it will also reduce costs and improve efficiency throughout the whole economy. In order to achieve this outcome though, it is crucial that the NBN successfully eliminate the existing digital divide in Australia such that all citizens have access to high performance broadband services regardless of location and it is crucial that the NBN also successfully eliminate the socio-economic divide such that all citizens, regardless of income, can afford at least a basic broadband service and its associated benefits of access to improved health, informational, entertainment, business and government services.

In economics, that combination of affordability, coverage and performance is achieved through a combination of addressing social welfare (making basic services affordable to all), ensuring increased output efficiency (making premium services available to those who demand and are willing to pay for them) and supporting a free, open and competitive marketplace where providers can actively innovate services for consumers (making services available to everyone at every price-point). Throughout my submission, the focus was on ensuring the NBN actively support innovation, support the evolution of a free, open and competitive marketplace and support affordability through social welfare without compromising the long term viability of the market or itself.

How is innovation affected?
Innovation by definition occurs only when people use products or services in entirely unanticipated and often unexpected ways! Innovation is fostered by increasing choice and flexibility around how product and service components can be acquired and then utilised; if products and services are constrained to say a single bundle or forced tie-in combinations–then innovation around those products and services will also be constrained and even at times completely prevented. The Implementation Study and NBN Co independently have often confronted various challenges by analysing the options and then making a specific decision or choice. In some cases, these choices are made in an exclusive manner–I contend that in many of these cases the more correct approach would be to offer multiple choices into the market and then let natural market dynamics converge upon and determine the optimal balance. This was one of the areas of focus in my submission.

The Implementation Study:
Overall the KPMG/McKinsey NBN Implementation Study reflected a very high quality of analysis and detail in the challenging area of advising the Government on how best to determine and implement various policies required to support the NBN and NBN Co, as well as analysing in depth the potential business case for funding the NBN and achieving an acceptable return on investment. For the most part, the report was pretty good.

However, in several areas, the Implementation Study was clearly unsure of concrete recommendations that it could or should make–mostly due to conflicting information coming from the industry experts the study members interviewed and/or from the lack of formal industry standards to provide guidance. This situation was especially apparent in the areas of QoS (Quality of Service), PoI (Points of Interconnect) and backhaul; all intended to promote a strong, healthy and vibrant competitive marketplace. In these areas, the Implementation Study correctly listed all the desirable outcomes and options available that may impact such outcomes. Yet, it sadly fell short of the mark by failing to then determine the most appropriate mechanism by which to ensure the desired outcomes.

In the case of PoI and backhaul, the Implementation Study exhibited a serious error of judgement, by adopting an equal-outcome based interpretation of their “levelling the playing field” principal instead of a rules based equal-opportunity approach. This was unfortunately, the bad of the report (see section below).

In the areas of the report responsible for recommending an appropriate QoS strategy and wholesale product design, the Implementation Study was sadly very unclear and ended up delegating responsibility to NBN Co to determine the most appropriate course of action. Thus failing to make any real guiding recommendations. Recent events and engagements with NBN Co would seem to indicate that they are not coming to grips with this area either. This was the ugly of the report (see section below).

The Good:
Most of the Implementation Study should actually be considered quite good. Not only did it cover an extremely broad range of topics from fixed fibre through fixed wireless and satellite. Its analysis also covered the technology, procedural, policy and economic aspects of each those, including a fairly detailed geospatial analysis which resulted in a recommendation to increase the 90% FTTH target of coverage to 93% (a target which subsequently has been adopted by NBN Co and supported by their Government shareholder).

Fundamentally the report format was typically along the following lines:

1. Introduce a topic area for analysis and define relevant considerations and terms,
2. Summarise the input data and results of detailed analysis and highlight option impacts,
3. Draw conclusions about the best option and make both formal recommendations and provide informal advice.

Some of these recommendations included ones recommending that NBN Co actively engage with end-user interest groups, industry players and the wider community to ensure the best-aligned delivery model for its wholesale services (pages 122, 129, 423-424, 453 and others) and that such engagements should be conducted in “an open, transparent and consultative approach (which) will reduce the risk of misalignment and assist more rapid adjustment”. Others include recommendations to support innovation by maximising the modularity of the services and products and to support consumer welfare and output efficiency through differentiation of services and prices (pages 104, 122, 142, 143, 146, 199, 253, 256-258, 261, 329, 334, 440, 443, 457, 459, 462).

Finally, the study provided probably the most important piece of advice overall to the Government, that being that the Government must ensure it firmly grab the reins of NBN Co to ensure the NBN horse doesn’t bolt off in any direction and potentially maim itself and the economy in the process.

Pg 500-501: The complexity of the project and its implications across multiple departmental portfolios means that substantial interdepartmental coordination will be required. It will be important to implement a governance model that keeps stakeholder agencies updated on the project’s progress, so that decisions with policy implications can be syndicated and resolved. Each agency will have its own legal and administrative responsibilities and processes, which must be respected, but coordinated in a way that is practical and efficient for NBN Co management.

Similarly, the cross-portfolio implications of the project will mean that multiple Government stakeholders will be inclined to make requests of, or present views to, NBN Co. In the absence of a governance model that manages this process, uncoordinated communications from different Government stakeholders are likely to act as an unnecessary distraction to NBN Co management and leave NBN Co in the awkward position of having to resolve potentially conflicting messages from different parts of Government.

While policy objectives will be communicated to the company by a Statement of Expectations from the Minister, and through other formal exchanges between the company and the Government, these standard mechanisms for interaction are likely to be too formal and unwieldy to provide in themselves the frequent and raid policy guidance that NBN Co will require.

While it is beyond the scope of this report to address issues internal to Government regarding how it might provide ongoing oversight and guidance to NBN Co, the Implementation Study highlights that these challenges need to be considered by Government in designing its internal governance model for the NBN initiative.

The Bad:
From the outset, the Australian Government established the NBN initiative by specifying a number of primary objectives. These objectives, “Coverage, Competition, Customer Care, Cost Effectiveness and Collaboration”, were adopted by both the Implementation Study as well as NBN Co. Now obviously, these objectives are very general, so they have interpreted and broken down into a set of specific guiding principals. Unfortunately, something went amiss during this process and the final results don’t always align with the original intent.

A pertinent example is the “coverage” objective, which has been captured within a “level playing field” principal by both NBN Co and the Implementation Study. Unfortunately the term “level playing field” is more colloquial than technical. And even worse, it has been used in numerous contexts since its inception, each with their own different interpretations ranging from handicaps, subsidies and taxes all the way through to equal opportunities, fair rules and open access policies. It is unfortunate that the term is so heavily and semantically loaded and that it lacks a useful and formal definition, because it admittedly sounds noble and good. And I suspect that because of this, it has been used widely within the Implementation Study, albeit at times with a very inappropriate interpretation.

So how does a simple interpretation possibly affect the health and performance of a competitive market? Well, there have been several recent studies aimed at examining exactly the impact on competitive markets that the application of policies and incentives based on differing interpretations of “levelling the playing field” can have. Many of these studies concluded that if the resulting policies are aimed at ensuring “equal opportunity”, “fair access” and the removal of any “discriminatory practices” then often a “open, fair, healthy and competitive marketplace” evolves. Thus delivering the benefits of increased consumer welfare and increased output efficiency. However, if the resulting policies are aimed at “leveling the outcomes”, by “flattening prices”, either removing or masking the ability for market players to differentiate from one another and/or to leverage strategic advantage, then the end result is actually a loss of healthy competition (see references below). Thus failing to deliver increased output efficiency and improved social welfare. This is the interpretation currently adopted by NBN Co and the Implementation Study.

This highlights just how dangerous it can be to apply the loose concept of “levelling a playing field” without fully understanding the implications such actions or decisions based on particular interpretations may have on the evolution of a truly competitive market.

References:

“Equal rules or equal opportunities? Demystifying level playing field”, Marja Appelman, Joeri Gorter, Mark Lijesen, Sandar Onderstal and Richard Venniker, CPB Document, No 34, October 2003.

“The myth of the level playing field: Knowledge, affect & repetition in public debate”, Jeremy N. Sheff, St. Johns University, 2009.

“The myth of the level playing field”, Sam Bostaph, The Future of Freedom Foundation, 2005.

“Economic effects of ‘leveling the playing field’ in international trade”, Alan V. Deardorff, The Journal of International Trade & Economic Development, Vol 19, Issue 1, March 2010 pp9–32.

To fix this, the focus of any policy actions must really be towards ensuring an “open, fair, healthy and competitive marketplace” rather than on the colloquial “ensuring a level playing field” interpretation of removing opportunities for players to compete and differentiate. There are occasions within the document where this term has been misapplied and caused incorrect conclusions to be drawn and hence certain recommendations (Recommendations 50, 51 and 52.3 specifically) are flawed and should be rejected in preference of mechanisms which re-establish a fair and competitive market environment.

Finally, one other area that I consider to constitute bad advice is the material on pages 254-255, which seems to justify the concept of raising prices for telecommunications services to increase revenue and margins as opposed to the historical constant of prices reducing and services improving/increasing over time. It would be very concerning to see NBN Co and/or the Government pursuing this course of action.

The Ugly:
Sadly, there were quite a few areas where the Implementation Study either provided conflicting recommendations or was not confident enough to draw any conclusions and thus deferred the choice for a path of action to NBN Co. Nowhere was this more apparent than in the areas of QoS, Price Differentiation and the aforementioned forced backhaul bundling. It’s difficult to tell exactly how or why KPMG/McKinsey became confused regarding mechanisms for implementing and addressing QoS to support price differentiation in a Layer-2 Ethernet FTTH based network, however clearly they formed conclusions (for instance page 201) that mechanisms similar to IntServ (Integrated Services, typically based on RSVP or similar and which form the basis of QoS support within HFC DOCSIS networks and the LTE Mobile networks) were not available to support FTTH networks (this is true) and that mechanisms such as MPLS and/or 802.1p are not capable of supporting the requirements (this is false).

This confusion over the capability of technology to support business pricing flexibility led to significant indecisiveness within the report. For instance, the report often provides a fantastic overview and justification for why price differentiation and QoS differentiation is highly desirable (pages 149, 199, 201, 202, 258, 329, 431, 440, 459, 462) but then completely fails to form any concrete recommendations that actually deliver the desirable outcomes–and in some cases they even leave the decision for NBN Co to figure out (recommendations 39, 40, 42, 47). This aspect of the report was really ugly because the reality is that there is already published literature that addresses exactly these concerns for exactly these type of natural monopoly, next generation and converged type networks (reference) and provides guidance on how to do it. And the real ugly of this situation, is that it would appear the NBN Co, who as mentioned have been assigned the responsibility by KPMG/McKinsey to determine a solution, are in no better a position of understanding how to do this themselves. I did offer to consult to NBN Co, however as noted in this post, one of NBN Co’s architects kindly informed me that they “have it all under control” and “do not wish to engage my assistance at this time”. C’est la vie.

Everything Else:
In closing, there were a few other miscellaneous areas of discussion and recommendation within my review. A quick summary of those includes:

• A proposal to extend recommendation 1, “That NBN Co only enter markets where there is insufficient infrastructure …” to establish a set of standards such that private enterprise can privately fund and construct their own (NBN Co compatible and equivalent) fibre access networks without compromising the National Broadband Network initiative.
• A proposal to extend recommendation 4, to allow NBN Co to prioritise construction on a commercial basis for premise as well as non-premise connections (i.e. allow councils to semi-fund their own FTTH in order to accelerate the availability).
• A proposal to extend recommendation 6, to have NBN Co prioritise its rollout in the areas which are currently not served or under-served for broadband (services availability unable to deliver a target 12Mbps minimum capacity).
• Commentary and proposals regarding the future support of a Universal Service Obligation (USO) for recommendations 13 and 30.
• Commentary and proposals regarding the potential support of a future Layer-3 VPRN access service, recommendations 32 and 63.

And that was pretty much it. Till next time…