Optus calls for Telstra split by 2010

The Singtel-owned carrier has made four key suggestions to the Government on how to deal with Telstra's market dominance prior to rolling out the National Broadband Network.

First, that Telstra should be structurally separated into an access providing wholesale company and a retail company.

Second, that Telstra's access company should be obligated to provide the same prices and terms to competitors as its retail business.

Third, that access pricing should be aligned to Telstra's costs; and fourth that the ACCC should be given more power to regulate the sector.

The main problem to address, said Andrew Sheridan, general manager of regulatory affairs at Optus, is that Telstra's current ownership structure gives it the "incentive and opportunity" to discriminate against other players in the industry.

Optus' central recommendation is for Telstra to be "structurally separated" into an access business and a retail business, each with its own independent board and management, with strict rules in place which enforce the separation of brand, employee incentives and financial reporting.

The access business would not necessarily need to be spun out under such a proposal, the submission said. Telstra shareholders could merely receive a share in both the retail business and access business for every existing Telstra share owned.

Sheridan told iTnews it is important the competition debate moves beyond functional separation - the means by other incumbent carriers (such as BT and Telecom New Zealand) have been regulated.

"Functional separation would certainly be a vast improvement on the arrangements we have today," he said. "But I feel they still don't quite address the problem of the incumbent's incentives to cheat."

In the UK, Sheridan said, "there is still that temptation of [BT's wholesale division] Open Reach management to act in the interest of the wider [BT] group rather than just Open Reach."

Without structural separation, Sheridan said Governments are forced to enforce "detailed and complex ring fencing rules" to control the relationship between the different business units of the carrier.

"Those rules can work, but to work effectively the incumbent has to buy-in not only to the details of the rules but also the spirit of the rules," he said.

"I am sceptical of Telstra's capacity to buy into the spirit of functional separation. They have always had this tendency to try and get around the rules, to have some clever lawyer work out ways to bend them to the disadvantage of competitors."

The submission says Telstra's access business should own and operate all Telstra's network assets and should be obligated to provide the same prices and terms to competitors as its retail business.

The submission also says that access pricing should be aligned to Telstra's costs.

Sheridan told iTnews that doesn't necessarily mean Telstra's access company isn't entitled to earn profits - just not the ridiculous margins it earns today. He said Telstra in some cases earns 80 per cent profit margin on long distance calls.

A better regulated Telstra should be entitled to earn "a normal rate of return on its investment," he said.

With the right ownership and incentive structure within Telstra, Sheridan hopes the ACCC would actually have far less work to do settling disputes and insuring competition. But he nonetheless feels the ACCC's powers and competition law needs to be addressed.

"You could drive a bus through most of the regulations we have today," he said.

With submissions to the regulatory review due by June 3, Sheridan said a "best case outcome for consumers" would be for the Government to introduce new legislation in the winter session (September) to come into effect by 2010.

"We are pleased the Government recognises that we have a dysfunctional market and an ineffective regulatory regime, which leads to poor consumer outcomes," he said. "We are particularly heartened that the Government has said they will fix this up.

"We should introduce these reforms now. Let's embrace the right model today, and the competition will help the industry get ready for the NBN. The prospects of the NBN will be better served by a large number of well-funded viable players competing than the current scenario."

Read on to page two for Sheridan's predictions for how structural separation would affect Telstra shareholders and Optus.

Outcomes for Telstra shareholders

Sheridan admitted he "can't speak with great authority on market variations", but believed that the regulatory reform Optus has suggested will be good for Telstra shareholders.

"In principle, this should not have a significant or material impact on share evaluations one way or another," he told iTnews.

"Analyst reports in fact say that the parts of Telstra might be worth greater than the whole due to the increased transparency of the business."

Regardless, he said, structural separation would surely produce better outcomes for Telstra shareholders than the agressive strategies of former CEO Sol Trujillo and former chairman Don McGauchie - Trujillo famously being quoted that should he ever submit Telstra to structural separation he "should be shot."

"The regulatory strategy of Telstra for the last 18 months has certainly not delivered great value for Telstra shareholders," Sheridan said. "Some $10 billion has been wiped off their share price.

"At the end of the day, the Government is looking into regulatory reform, with Telstra as its focus, and that will have to have an impact on the Telstra business. 

"In putting together our submission, our greatest concern wasn't for Telstra shareholders but for the broader base of consumers."

Sheridan said he is unsure of how the new management team at Telstra will deal with the need for regulation.

"They shouldn't take a glass of whiskey and a revolver and go into a closed room," he said. "They should recognise that an important line has been created with the Government's announcement. Clearly the writing on the wall is for structural separation."

Good for the gander?

Sheridan said Optus does not feel it should be governed by the same rules it has devised for controlling Telstra.

"I don't think the same issues apply to Optus," he said. "Optus is in a totally different circumstance. Optus is not a vertically-integrated incumbent, which 12 years after the introduction of competition still maintains 70 per cent of fixed line revenues with margins between 55 and 88 per cent. Our position in fixed line communications is a long, long way behind."

The same need for regulation doesn't apply in the mobile market, he said, where Telstra owns a 42 per cent share as opposed to 70 per cent in fixed line.

"Regulatory reform should be focused on those parties with significant market power," he said. "In the case of fixed line communications, it's Telstra."