The telecoms sector will have to grapple with two important challenges during 2023 and beyond.
The first one is to keep investing in next-generation infrastructure to meet increasing demand from end users and help support growth in other sectors of the economy. Making a business case for such large scale investments can be challenging in some geographic areas, as companies face uncertainty over future demand from new use cases and their ability to monetise that demand, including as a result of ongoing changes in the value chain. In addition, they face new cyclical headwinds. Some input costs, especially for energy, have risen; the investment climate has become tougher; and consumers may have less disposable income. The second significant challenge is to ensure that telecom services remain affordable, given the cost-of-living crisis and poor general state of the global economy.
Policymakers and operators will need to strike the right balance between these two challenges. In particular, they will be keen to ensure that any measures focused on affordability do not undermine incentives to invest. This article discusses these challenges and related trade-offs, and concludes that any interventions in retail markets should be light-touch in nature and designed carefully to avoid deterring investment in next-generation infrastructure.
Investing in costly next-generation infrastructure despite rising input prices and a worsening investment climate
The investment challenge
In 2023 and beyond, operators will be expected to continue rolling out next-generation telecoms networks, including both gigabit-capable fixed broadband networks (i.e. full fibre or DOCSIS 3.1) and 5G mobile networks. By 2030 the European Commission (EC) wants gigabit-capable fixed broadband networks to cover 100% of households and 5G to reach 100% of the population. The scale of investment needed will far exceed what companies have spent in the past. It has been estimated that an extra €150bn of investment will be required to upgrade existing fixed infrastructure and to roll-out full fibre to gigabit speeds in Europe. For full 5G roll-out, a further €150bn will have to be found.
Gigabit-capable fixed broadband networks and 5G will provide a step change in performance and therefore open up new cases. However, there is considerable uncertainty about future demand for such use cases and whether telecom operators will be able to monetise the demand given changes in the value chain e.g. the potential for Big Tech firms to play a larger role in the value chain.
Ensuring operators have sufficient incentives to roll out next-generation infrastructure is a challenge that has been amplified over the past year or so due to increases in input prices and a worsening investment climate.
Increases in input prices
Input prices are on the rise due to soaring energy costs, which are a noteworthy cost for telecom networks both to directly power the network and ancillary costs such as transport costs for engineering work and maintenance. In addition, telecom operators are facing higher wage demands than in previous years. And disruptions to global supply chains have led to shortages of chips, which are critical for telecom networks. Unsurprisingly, several telecom operators have announced cost-cutting measures in recent months to help contain increases in input prices.
Harsher investment climate
The investment climate has recently become tougher given rising interest rates. This means that future cashflows from network investments may be discounted more heavily, thereby increasing the future returns required from any investments. Moreover, the level of uncertainty regarding the future economic outlook, and therefore the demand for premium and/or new telecoms services, has also increased.
Two other important considerations affect the roll-out of telecoms infrastructure:
- Network resilience. As a result of recent geopolitical events, including the war in Ukraine and tensions between the US and China, there is likely to be an even greater focus on network resilience and security. A number of countries have now imposed rules restricting the equipment vendors that operators are allowed to use. However, the emergence of Open Ran may lead to new vendors entering the market, which could help to spur competition and contain increases in input prices.
- Carbon emissions. Minimising the carbon emissions associated with the use of telecoms infrastructure is moving up the agenda, as is the role that telecom networks can play in helping other sectors to reduce emissions. Next-generation networks tend to be more efficient than legacy networks, at least per unit of traffic. Therefore, rising energy prices and the increased focus on carbon emissions may give policymakers and operators more of an incentive to accelerate the transition to next-generation networks. Linked with this, there may be greater reluctance to run legacy and next-generation networks in parallel. This might stir a debate as to whether an earlier switch-off of legacy networks may be warranted.
Heightened focus on affordability
As a result of the cost-of-living crisis and the state of the global economy, the affordability of telecom services is likely to come into sharper focus in 2023 and beyond. Soaring energy bills have attracted most attention to date. This is understandable. The percentage increase has been significant and energy bills take up a sizeable chunk of disposable incomes. But policymakers will also be keen to ensure that telecom services remain affordable for all customers. Data from Ofcom shows that the percentage of households struggling to pay for telecom services has jumped sharply over the past year. Given the importance of communications services, customers will only give up their service at the extreme, but may seek to move to cheaper packages or not upgrade services.
Figure 1 - Percentage of households reporting problems affording their communication services
Source: Ofcom - Affordability of Communications Services (01 December 2022)
There are signs that telecoms regulators are starting to focus more heavily on affordability concerns. Some are encouraging operators to offer social tariffs for the most vulnerable customers and to make sure that they are well publicised. For example, Ofcom “urges” all UK telecom providers to offer social tariffs and expects them to raise awareness of the deals, as take-up is currently low.
Many wholesale contracts have built-in price increases linked to inflation, so significant price increases for at least some retail services seem inevitable as these wholesale prices are passed through, in part, to end users. Whether or not authorities would try to intervene to contain high increases is an open question. Ofcom has just launched an investigation into whether telecom operators provided consumers with sufficient information about mid-contract retail price rises.
Regulation of retail telecom prices has generally been limited over the past decade, with the focus being on addressing sources of market power at the wholesale level. Authorities may initially try to resort to regulatory dialogue rather than direct intervention. Or they may focus more on indirect measures, such as those that aim to increase pricing transparency and/or make switching easier. In the UK, operators have reached an agreement with the government to ensure they support all users (and not just those on benefits) who are struggling to pay their telecom bills. Measures include allowing users to switch to cheaper deals without facing termination charges and agreeing manageable payment plans.
Striking the right balance
By triggering a rapid shift to teleworking and the online provision of public services, including education, the Covid-19 pandemic underlined the importance of high-quality broadband infrastructure. This has further strengthened policymakers’ resolve to avoid a digital divide. Indeed, telecom services are increasingly seen in some quarters as a basic human right.
Policymakers and operators need to strike the right balance between incentivising the roll-out of next-generation infrastructure and making sure that telecom services remain affordable. In doing so, they may have to consider some trade-offs. Prior to the cost-of-living crisis, there were signs that policy was starting to place greater weight on ensuring that operators have sufficient incentives to invest in high-quality infrastructure, even if this meant putting less emphasis on driving prices as low as possible. But it is possible that the squeeze on household budgets due to high inflation may be prompting regulators to reconsider their priorities somewhat.
On balance, widespread intervention that could significantly restrain operators’ flexibility in setting retail prices for a broad range of services appears risky. This course of action may appear attractive to policymakers in the short term, but it could ultimately be bad for consumers if it dampened investment incentives in upgrading networks or were to distort competition in retail markets e.g. access seekers may face pressure on their margins if wholesale prices were to increase by more than retail prices.
Over the long term consumer welfare will be driven by the availability and uptake of new technologies which provide both lower unit cost and higher quality. As such the best way of keeping prices affordable in the medium to long term is to ensure that there continues to be effective competition at a retail level combined with sufficient incentives to continue upgrading networks. Retail interventions that are intrusive, untargeted and not evidence-based risk damaging investment by reducing returns for operators; they also have the potential to undermine investors’ confidence in the medium- to long-term regulatory framework if they represent unexpected and disproportionate changes in the regulatory approach.